UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(Commission File Number 333-51037)
ICG SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 84-1448147
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
161 Inverness Drive West
Englewood, Colorado 80112
(888) 424-1144 or (303) 414-5000
(Address of principal executive offices and registrant's telephone numbers,
including area codes)
ICG Services, Inc. has no securities registered pursuant to Sections 12 (b) or
12 (g) of the Act.
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 X No
_____ _____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
On March 27, 2000 ICG Services, Inc. had 10 shares of common stock
outstanding. ICG Communications, Inc. owns all of the issued and outstanding
shares of common stock of ICG Services, Inc.
TABLE OF CONTENTS
PART I.......................................................................1
ITEM 1. BUSINESS..........................................................1
Overview....................................................................1
Industry...............................................................2
Market Opportunity and Strategy........................................3
Products Descriptions and Major Contracts..............................4
Leasing Services.......................................................6
Network and Facilities.................................................7
Customers and Marketing................................................7
Competition............................................................8
Regulatory Activity....................................................8
Financing Activities...................................................9
Investments............................................................10
Sale of Assets.........................................................11
Employees..............................................................12
Trademarks and Trade Names.............................................12
ITEM 2. PROPERTIES........................................................12
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ITEM 3. LEGAL PROCEEDINGS.................................................13
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............13
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PART II......................................................................14
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
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STOCKHOLDER MATTERS............................................14
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ITEM 6. SELECTED FINANCIAL DATA...........................................14
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
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CONDITION AND RESULTS OF OPERATIONS...............................17
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
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MARKET RISK.......................................................27
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................29
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
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ACCOUNTING AND FINANCIAL DISCLOSURES..............................29
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PART III.....................................................................30
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT....................30
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ITEM 11. EXECUTIVE COMPENSATION............................................31
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
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MANAGEMENT........................................................36
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................37
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PART IV......................................................................40
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K...40
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Financial Statements...................................................40
Finacial Statement Schedules...........................................40
Exhibits...............................................................40
FINANCIAL STATEMENTS.........................................................F-1
PART I
Unless the context otherwise requires, the term "Company" or "ICG Services"
means the combined business operations of ICG Services, Inc. and its
subsidiaries, including ICG NetAhead, Inc. (NetAhead) and ICG Equipment, Inc.
(ICG Equipment). All dollar amounts are in U.S. Dollars. The Business section
and other parts of this Report contain "forward-looking statements" intended to
qualify as safe harbors from liability as provided for under the Private
Securities Litigation Reform Act of 1985. These forward-looking statements can
generally be identified as such because the context of the statement includes
words such as "intends," "anticipates," "expects," "estimates," "plans,"
"believes" and other similar words. Similarly, statements that describe the
Company's future plans, objectives or goals also are forward-looking statements.
All forward-looking statements are subject to certain risks and uncertainties
that could cause actual results or outcomes to differ materially from those
currently anticipated. Factors that could affect actual results include, but
are not limited to, the Company's ability to obtain financing necessary to fund
its planned expansion, its dependence on increased traffic on the Company's
facilities, the successful implementation of the Company's strategy of offering
an integrated telecommunications package of wholesale and retail data services,
the successful implementation of the Company's strategy to offer access to the
Internet over emerging technologies, continued development of the Company's
network infrastructure and actions of competitors and regulatory authorities.
ITEM 1. BUSINESS
--------
Overview
The Company was formed on January 23, 1998 and is a wholly owned subsidiary
of ICG Communications, Inc. (ICG). On January 21, 1998 ICG acquired NETCOM On-
Line Communication Services, Inc. (NETCOM), and NETCOM was subsequently
contributed by ICG to the Company. In February 1999, the Company sold certain of
the operating assets and liabilities of NETCOM, but retained NETCOM's domestic
Internet backbone assets. See "Sale of Assets." In January 1998, the Company
formed ICG Equipment for the principal purpose of providing lease financing of
telecommunications equipment and services to ICG Telecom Group, Inc. (ICG
Telecom), a wholly owned subsidiary of ICG. In 1999, the vast majority of the
Company's revenue was derived from ICG Equipment's leasing activities.
Enhanced Internet Access Services
By retaining the NETCOM Internet backbone, the Company positioned itself to
provide enhanced network data access services and data management to Internet
service providers (ISPs), application service providers (ASPs) and other
customers. The Company's network assets provide nationwide data services to
approximately 700 cities with 227 data points of presence (POPs). During 1999,
the Company began to implement its "Gateway Strategy," which includes meeting
demand for multiple access methods to the Internet (such as dial-up, wireless
and digital subscriber lines) and to provide advanced network management and
applications. The Company's current product offerings to the ISP and ASP
markets include dial-up products such as primary rate interface (PRI), which is
a product provisioned by ICG Telecom, remote access service (RAS) and Internet
remote access service (IRAS), as well as broadband access services,
1
including T1 and T3 connections.
A focus of the Company's long-term strategy is to expand its national
network and facilities, based upon anticipated demand under existing contracts.
Network expansion will be undertaken through a combination of constructing owned
facilities and entering into long-term fiber and capacity agreements with other
telecom carriers. Network build-out is designed to support increased future
capacity demands. At year end 1999, the Company's network and related facilities
included:
. 18,000 miles of long-haul broadband capacity under long-term leases;
. 24 ATM switches (that deliver advanced voice, data and video services)
. 16 frame relay switches;
. 145 ISP customer collocation sites; and
. Voice over Internet Protocol (VoIP) network capability from most POP
sites.
During 1999, the Company took steps to streamline its business and focus on
core operations. The Company sold non-core assets for net cash proceeds of
approximately $282.9 million, including the Company's retail ISP customer
business. See "Sale of Assets" The Company also centralized its provisioning
process to maximize economies of scale and opened a new provisioning center in
San Jose, California.
Equipment Leasing
The Company's subsidiary, ICG Equipment, was established for the principal
purpose of providing equipment financing of telecommunications equipment and
services to ICG Telecom. This financing is provided through ICG Equipment's
purchase of telecommunications equipment, software, network capacity and
related services from original equipment manufacturers, providers of inter-city
network facilities and ICG Telecom, and subsequent lease of such assets to ICG
Telecom.
Industry
The Internet access business in which the Company competes is growing at a
substantial rate, driven in large part by new technologies. This market is
expected to increase from approximately $18.0 billion in 1999 to over $48.0
billion in 2002, reflecting expanded market size as well as enhanced service
offerings. Internet subscribers have grown dramatically in the past two years
and are expected to continue rapid growth for the coming three years. Growth in
Internet is expected to come in the form of dial-up modem access in the near-
term to and transition to higher growth from emerging broadband access methods.
Dial-up Internet access was estimated to increase from approximately 37 million
users at year-end 1998 to approximately 43 million by year-end 1999. At the same
time, broadband subscribers were expected to grow from 1.5 million to 3.1
million. Over the next three years, at year-end 2002, dial-up Internet accounts
are forecast to increase another 15 percent to nearly 50 million while broadband
subscribers are forecast to grow over 500 percent to 20 million. In addition,
the number of users per household and the time connected to the Internet is
expected to
2
increase. (See Forrester Research, Inc. Reports from February and April
1999) More users and more time on the Internet are expected to create
continued, rapid increase in the demand for ISP access ports nationwide.
Market Opportunity and Strategy
Geographical Expansion
In order to meet its customers' needs and maximize traffic across its
network, the Company intends to expand its footprint nationwide to deliver basic
and enhanced data services on Company-owned facilities. The Company's objective
is to supply communications infrastructure for its ISP customers while adding
new systems to serve ASPs, a quickly emerging group of companies that deliver
advanced communication services over the Internet.
As the Company enters new markets, it is following a "smart build" network
strategy. Consistent with this strategy, the Company plans to build-out its
network to meet existing demand, while infrastructure and facilities are
designed to support future demand. The Company's expansion into new markets is
supported by existing three- to five- year term contracts for over 700,000 new
Internet access ports.
Gateway Strategy
The Company's growth in the near term will be related to the ISP segment.
The Company is expanding its network to deliver a broad range of Internet access
methods and to support enhanced data services to its customers both directly and
by partnering with other companies. The Company jointly offers Internet access
and data management services through a partnership with its affiliate, ICG
Telecom. The Company intends to continue this partnership with ICG Telecom to
offer a broad range of voice and data services to its customers. Geographical
expansion is intended to be complemented with expanded product and service
offerings as the Company seeks to provide a portfolio capable of supplying the
telecommunications needs of its customers.
The Company's Gateway Strategy includes offering multiple Internet access
methods and more advanced network management features to ISP and ASP markets.
As these customers seek to grow their businesses, they frequently require broad
geographical coverage and more sophisticated facilities and network management
capabilities, as well as the capability to connect their end-use customers to
the Internet via dial-up or broadband methods.
In order to capture market share in the fast-growing Internet market, the
Company seeks to reach the end-user customer by partnering with third party
providers as well as through direct marketing channels. The Company plans to
introduce additional Internet access technologies as demand for new methods
dictates. The Company also provides direct broadband connections to its
customers through T1 lines delivering 1.5 megabits of data per second (Mbps) and
T3 lines at 44.7 Mbps. By adding new broadband customers or migrating existing
dial-up customers to broadband services, the Company can deliver additional
value-added services and applications that increase customer satisfaction,
increase the value of each customer and increase customer
3
reliance on the Company.
Advanced Services
New products and technologies under the Gateway Strategy include advanced
network services such as managing content, providing applications and managing
Internet traffic. Advanced applications are intended to be offered both
directly through the Company and through partnerships with ICG Telecom and other
application providers. The Company is adding computing power within its network
to support these new services. For example, the Company is increasing the number
of traffic servers on its network which will enable the Company to provide
caching services for its customers. It is anticipated that these services will
increase the download speed of data by as much as 30 percent and improve network
efficiency. The Company has already established a relationship with a provider
to deliver Unified Messaging on its network. Other services that the Company
plans to introduce in 2000 include virus protection within ICG's network,
reducing individual protection requirements for customers, and Virtual Private
Networks (VPNs) and Virtual Private Dial-up Networks (VPDNs). These services
combine the functionality of private networks and employ the far reach and cost
effectiveness of the Internet.
With deployment of application and content servers on its network, the
Company anticipates offering its customers network infrastructure to support
services such as web and e-mail hosting, video and voice streaming applications
and other media applications. The Company plans to introduce these and other
advanced services in 2001 and beyond. With its extensive network, the Company
expects that it will be able to deliver these products nationwide, as they are
developed, providing revenue opportunities for the Company and its ISP and ASP
partners.
During 2000, the Company intends to build a new on-line, web-based customer
management center. This center will allow ISPs to retain control over service
levels to their retail customers while at the same time outsourcing their
network requirements to ICG. Service level alerts and on-line reporting and
provisioning are expected to be a part of this initiative.
Although several new applications are being added to the Company's network
in 2000 and 2001, significant new revenue from these applications is not
expected to contribute meaningfully until 2002 and beyond.
Product Descriptions and Major Contracts
Products and Services to ISP Customers
During 1999, the Company provided wholesale network capacity and enhanced
data services to ICG Telecom and other telecommunications providers. In late
1999, the Company began complementing ICG Telecom's PRI product with additional
network services to ISPs, including RAS and IRAS. PRI, which is provisioned by
ICG Telecom, has been the traditional product that allows an ISP to connect to
its customer by utilizing the Company's local access network. The dial-up
customer calls the ISP and the call is routed to the Company through the public
telephone service network. Using ICG Telecom's switch network, the
4
Internet call is routed via a signal to the ISP remote access service modem
bank, which is generally located at a collocation site provided by the Company.
The ISP can either route the call to the Internet or to its network to terminate
the call.
To further support the ISP in its network needs, the Company, in
conjunction with ICG, provisions the RAS product. RAS utilizes the Company's and
ICG Telecom's switches and owned modem banks. This service provides modem access
at either ICG Telecom's or the Company's switch location, eliminating the need
for ISPs to deploy modems physically at each of its POPs. RAS is a "connect and
send" approach, which enables the Company to act as an aggregator for ISP
traffic while limiting the ISP's capital deployment. RAS service reduces the
ISP's capital expenditures by eliminating the need for ISPs to purchase separate
modems, and transfers a portion of its network management responsibilities to
the Company. As of January 2000, ICG Telecom and the Company had contracted for
the provision of approximately 200,000 RAS lines.
The Company, again in conjunction with its partnership with ICG, also
provides Internet RAS, or IRAS, which combines access, transport and routing
services to deliver IP data packets either directly to the ISP or directly to
the Internet bypassing the ISP. The Company estimates that more than 65 percent
of all of its ISP traffic is routed directly to the Internet. IRAS enables
regional or local ISPs to expand their geographical footprint outside their
current physical locations without significant capital expenditures by carrying
the ISP's out-of-region traffic on ICG's nationwide data network. As of January
2000, ICG Telecom and the Company were obligated under long-term contracts to
deliver approximately 500,000 IRAS lines. Of a total of approximately 700,000
RAS and IRAS lines contracted for in 1999, 500,000 remained to be provisioned
during 2000.
The Company markets integrated packages of network services and enhanced
services to ISPs through its subsidiary, NetAhead. NetAhead's services generally
are not subject to utility regulation by federal and other governmental
authorities. See "Regulatory Activity."
Significant Contracts
In conjunction with the sale to of its subsidiary NETCOM to MindSpring
Enterprises, Inc. (MindSpring) (see "Sale of Assets), NETCOM retained the
domestic Internet backbone assets which, as of December 31, 1999 included 227
POPs serving approximately 700 cities nationwide. (The legal name of the
Company's NETCOM subsidiary was subsequently changed to ICG NetAhead, Inc.)
Commencing in the first quarter of 1999, NetAhead began to utilize these
retained network operating assets to provide wholesale Internet access and
enhanced network services to MindSpring. On February 17, 1999, NetAhead entered
into an agreement to provide IRAS, dedicated Internet access and toll free
service to MindSpring for a one-year period. Under the Agreement, NetAhead
provides MindSpring with IRAS ports at a fixed fee in exchange for a minimum of
$27 million. MindSpring utilizes the capacity under the RAS ports to provide
Internet access to MindSpring's dial-up services customers. In addition, under
this agreement NetAhead received for a one-year period 50 percent of the gross
revenue earned by MindSpring from the dedicated access customers formerly owned
by NETCOM. The MindSpring contract is currently operating under a 90-day
extension that ends in May 2000, and
5
discussions are ongoing between the Company and MindSpring to extend the
business relationship beyond that time.
Leasing Services
ICG Equipment was formed for the principal purpose of providing financing
of telecommunications equipment and services to ICG Telecom. Such financing is
provided through ICG Equipment's purchase of telecommunications equipment,
software, network capacity and related services from original equipment
manufactures, providers of intercity network facilities and ICG Telecom and the
subsequent lease of such assets to ICG Telecom. The equipment and services
provided to ICG Telecom are utilized to upgrade and expand ICG's network
infrastructure.
All leasing and other arrangements between ICG Equipment and ICG Telecom
contain fair and reasonable terms and are intended to be conducted on the basis
of fair market value and on comparable terms that the Company would be able to
obtain from a comparable third party. ICG Equipment has engaged a third party
to conduct independent appraisals of the assets ICG Equipment purchases from ICG
Telecom. Such appraisals provide ICG Equipment with an independent evaluation
of the fair value of the assets at the time of purchase, the estimated economic
life of the various classes of assets and the estimated fair value of the assets
at points in time during their economic life. ICG Equipment purchases assets
at the request of ICG Telecom and, accordingly, maintains only a limited
inventory of unleased assets on any date.
All of ICG Equipment's leases with ICG Telecom are structured as operating
leases, with non-cancelable initial terms ranging from two to 10 years. Although
lease revenue is recognized from the date the assets are placed in service,
lease payments are due and payable one year in arrears. Under master lease
agreements between ICG Equipment and ICG Telecom, ICG Telecom is also required
to pay ICG Equipment a monthly lease service fee based on the average monthly
balance of assets purchased by ICG Equipment and intended for future lease to
ICG Telecom, but not yet placed into service. The master lease agreements
require ICG Telecom to insure the leased assets against casualty loss, to pay
all related property, sales and other taxes and to maintain the assets in good
operating condition.
Residual values of leased assets are established at lease inception. In
estimating the residual value, ICG Equipment considers relevant facts regarding
the assets, including their potential obsolescence within the telecommunications
industry and the probability that the assets will continue to be installed and
in use by ICG Telecom at the end of the lease term. ICG Equipment has engaged a
third party to conduct substantially all of ICG Equipment's lease documentation
and administration activities.
6
At December 31, 1999, ICG Equipment had $560.6 million of
telecommunications equipment, software, network capacity and related services
under lease to ICG Telecom and approximately $165.8 million of such assets
intended for future lease to ICG Telecom, but not yet placed into service.
Revenue from the Company's Leasing Services was approximately $93.7 million for
the year ended December 31, 1999.
Network and Facilities
National Data Network
The Company acquired an extensive data network as part of its acquisition
of NETCOM in 1998. During 1999, the Company began providing Internet access
services to Mindspring, ICG Telecom and other customers over its data network.
To service its customers, the Company owns and operates a Tier I nationwide data
network which at December 31, 1999 included public and private peering
locations, 227 POPs, 16 frame relay switches and high-performance routers
connecting a backbone of 24 leased ATM switches and 18,000 miles of leased long-
haul fiber optic lines in the United States. The data network connects to major
public Internet peering connections at MFS MAE East NAP (Washington, D.C.), MFS
MAE West NAP (Santa Clara, California), PacBell NAP (San Jose, California),
Sprint NAP (Newark, New Jersey) and Ameritech NAP (Chicago, Illinois). In
addition, the Company has several private peering relationships with major ISPs.
The network carries and will carry all IP data traffic associated with the
Company's ISP business. The design and architecture of the physical network
permits the Company to offer flexible, high-speed services to its customers.
Customer service and monitoring of the Company's network facilities and
infrastructure are provided 24 hours per day, seven days per week. ICG has two
network monitoring centers. The center in Englewood, Colorado monitors and
manages ICG's regional fiber networks and provides high-level monitoring of its
local exchange switches and is also a back-up monitoring site for the Company's
data network. The Company's center located in San Jose, California monitors
and manages the data network facilities.
Planned Capacity Upgrades
In order to meet the requirements of its growing customer base, the Company
intends to increase the capacity of its national data network. During 2000, the
Company plans to increase its data network capacity to OC-48, capable of
carrying 2,488 megabits of data per second, 16 times the OC-3 capacity the
Company had at year-end 1999. If required, the Company has an option to further
increase capacity on its network by a factor of four, to OC-192, prior to year-
end 2000. The Company also plans to install up to 36 new gigabit routers during
2000 to further increase the capacity and efficiency of its network.
Customers and Marketing
The Company's major customers include ISPs, ASPs and other
telecommunications customers. The Company's primary marketing strategies to
these customers are to offer a broad range of data and infrastructure provider
services at cost-effective rates. The Company markets its service offerings
through direct sales to customers through sales agents. The Company has
developed a dedicated internal sales channel that sells and markets ISP
services. The Company is focused on improving its customer service and
provisioning process, which is essential for attracting and retaining customers.
Further, efforts are being made to increase customer satisfaction by
improving the provisioning, billing and back office processes. With respect to
provisioning, over the last year,
7
the Company has increased its provisioning capacity and centralized the process
in a new national provisioning center. During 1999, ICG also began implementing
a new billing technology from Saville, PLC which the Company anticipates using
in its business. The Company anticipates that this new system will enhance its
collection capabilities and improve customer service by providing customers with
reliable, easy to understand invoices.
Competition
The Company operates in a highly competitive arena and expects that
competition will continue to intensify as customers seek additional capacity to
satisfy the continued growth of the Internet. In addition, numerous
competitors, including major telecommunications carriers, are rapidly expanding
their network capabilities in order to service the ISP industry. The Company
believes that the primary competitive factors for the provision of network
services are quality of service, network coverage, reliability, price, and
product innovation.
The Company's competitors in the Internet access market possess (or will
possess) significant network infrastructure enabling them to provide ISPs with
capacity and access to the Internet. The Company's primary competitors in this
segment include Level 3, UUNet, Verio, Concentric, PSINet and Splitrock. While
the Company believes that its network and products will enable it to compete in
this industry sector, some of the Company's competitors have significantly
greater market presence, brand recognition and financial, technical and
personnel resources than the Company. In addition, the Company believes that
new competitors with significant resources will enter this market and construct
networks similar to the Company's networks. There can be no assurance that the
Company will be able to compete effectively with these companies.
While strong competition currently exists in all sectors of the industry,
the Company believes that the demand for enhanced services will provide expanded
opportunity for new providers such as the Company. There can be no assurance,
however, that sufficient demand will exist for the Company's network services in
its selected markets, that market prices will not dramatically decline or the
Company will be successful in executing its strategy in time to meet new
competitors, or at all.
Regulatory Activity
Although, the Company is not currently subject to direct regulation by the
Federal Communications Commission (FCC), it operates in a highly regulated
industry. Therefore, changes in the regulatory environment relating to the
Internet and other telecommunications services, including regulatory changes
which directly or indirectly affect telecommunications
8
costs or increase the likelihood or scope of competition from the Regional Bell
Operating Companies (RBOCs) or other telecommunication companies, could have a
material adverse effect on the Company's financial position or results of
operations.
Various existing federal and state regulations are currently the subject of
judicial proceedings, legislative hearings and administrative proposals which
could change, in varying degrees, the manner in which the Company must operate.
Neither the outcome of these proceedings, nor their impact upon the
telecommunications industry generally, or on the Company particularly, can be
predicted at this time. In addition, over the past several years both the
federal and state governments have adopted new legislation and rules profoundly
affecting the telecommunications industry. There is no assurance that changes
in legislation or new legislation, and the regulations adopted by the FCC or
state regulators pursuant to such legislation, will not have a material adverse
impact on the Company.
Financing Activities
1999 Activities
On August 12, 1999, two of the Company's subsidiaries, ICG Equipment and
NetAhead, entered into a $200.0 million senior secured financing facility
(Senior Facility) consisting of a $75.0 million term loan, a $100.0 million term
loan and a $25.0 million revolving line of credit. At year end 1999, these
subsidiaries had borrowed $80.0 million under the loans at interest rates
ranging from LIBOR plus 3.125% to 3.5% or 9.35% to 9.67%. Quarterly repayments
on the debt commence at various dates beginning September 30, 1999, with
remaining outstanding balances maturing on June 30, 2005 for the $100.0 million
term loan and the $25.0 million line of credit, and March 31, 2006 for the $75.0
million term loan. The terms of the Senior Facility provide customary
limitations on the use of proceeds, additional indebtedness, investments, asset
sales, dividends, prepayment of the Senior Facility and other indebtedness and
certain other transactions. Additionally, the Company, ICG Equipment and
NetAhead are subject to certain financial covenants based on their results of
operations. During 1999 and January 2000, certain defined terms in the credit
agreement for the Senior Facility were amended to ensure that the Company and
its subsidiaries would remain in compliance with the financial covenants of the
Senior Facility.
Subsequent Activities
During the first quarter of 2000, the Company signed letters of intent with
its two biggest vendors, Lucent Technologies, Inc. (Lucent) and Cisco Systems,
Inc. (Cisco) to obtain financing on future equipment purchases. The Company
believes that these financing agreements, if consummated, will better enable the
Company to fund its scheduled network expansion through the purchase of Lucent
and Cisco equipment. The Lucent credit agreement will provide the Company with
up to $250.0 million of capital which can be drawn down during the year
following the closing to purchase network equipment. Under the terms of the
agreement, the Company will commit to purchase a minimum of $175.0 million of
equipment, and an additional $75.0 million will be available to purchase
equipment if and when ICG obtains equity financing. The Lucent financing will
provide for a five-year repayment schedule and will require quarterly principal
9
repayments beginning in June 2001. The Cisco credit facility will provide the
Company with up to $180 million of capital lease financing with a three-year
repayment term.
In February 2000, the Company's parent, ICG announced that it had
arranged to sell approximately $750.0 million (before estimated expenses and
fees of $45.0 million) of convertible preferred stock in ICG to three investors:
affiliates of Liberty Media Corporation (Liberty), Hicks, Muse, Tate & Furst
Incorporated (Hicks Muse) and Gleacher Capital Partners (Gleacher). Under the
terms of the transaction, Liberty will invest $500.0 million, Hicks Muse will
invest $230.0 million and Gleacher will invest $20.0 million in exchange for a
total of 750,000 shares of Series A convertible preferred stock at $1,000 per
share. The preferred stock will be convertible into ICG common stock at a
conversion rate of $28.00 per common share. ICG will also issue 10 million
common stock warrants that will be exercisable at $34.00 per share. The proceeds
from this new equity investment will be used principally by ICG to fund network
expansion, including expansion of the Company's data network. It is expected
that this equity financing will close during the second quarter of 2000.
Also in February 2000, ICG and Teligent, Inc. (Teligent) agreed to a common
stock share exchange whereby ICG will purchase one million shares of Teligent
and Teligent will acquire 2,996,076 of ICG shares. ICG anticipates that this
share exchange may create business opportunities for both companies. The
pricing for each company's shares was based on the average closing price for
stock during the ten days prior to the announcement of the transaction.
While the Company anticipates that the Lucent and Cisco debt financing
transactions, the preferred stock investment and the Teligent share exchange
will be consummated during the second quarter of 2000, there is no assurance
that the Company or ICG will be able to close these transactions on acceptable
terms and conditions. In the event ICG or the Company is not able to finalize
one or more of these transactions, the Company's ability to undertake its
network expansion and execute its business plan could be materially adversely
affected. See Part II, "Liquidity and Capital Resources," below.
Investments
On August 27, 1998, the Company purchased, for $9.1 million in cash, the
remaining 20% equity interest in ICG Ohio LINX, Inc. (ICG Ohio LINX) which ICG
Telecom did not already own, including incremental costs of obtaining that
investment of $0.1 million. ICG Ohio LINX is a facilities-based competitive
local exchange carrier which operates a fiber optic telecommunications network
in Cleveland and Dayton, Ohio. The Company has accounted for its investment in
ICG Ohio LINX under the equity method of accounting. For the years ended
December 31, 1998 and 1999, the Company included approximately $1.1 million and
$1.8 million, respectively, in its consolidated statements of operations for its
proportionate share of earnings of ICG Ohio LINX.
On March 1, 1999, the Company purchased from ICG Telecom, for $35.1 million
in cash, a 49% equity interest in ICG ChoiceCom, L.P. (ChoiceCom). Based in
Austin, Texas, ChoiceCom currently provides facilities based telecommunications
service in Austin, Corpus Christi, Dallas, Houston and San Antonio, Texas. The
remaining 51% equity interest in ChoiceCom is owned by ICG Telecom.
10
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock (NorthPoint
Preferred Stock) of NorthPoint Communications, Inc. (NorthPoint). The Series D-1
Preferred Stock was automatically converted into approximately 555,555 Class B
Common Shares upon Northpoint's initial public offering. The Company is
restricted from selling the NorthPoint Class B Stock for one year from the date
of the purchase of the Series D-1 Preferred.
On August 11, 1999, the Company purchased 1,250,000 shares of Series C
Preferred Stock (ThinkLink Preferred Stock) of International ThinkLink
Corporation (ThinkLink), or approximately 8% of the outstanding shares, for $1
million in cash. The ThinkLink Preferred Stock will automatically convert to
common stock upon the completion of the initial public offering of the common
stock or upon election to convert by the holders of a majority of the ThinkLink
Preferred Stock.
On November 15, 1999, the Company entered into an agreement to purchase a
limited partnership interest in Centennial Strategic Partners VI, LP
(Centennial). The primary purpose of the partnership is to invest in venture
capital investments, principally by investing in equity or equity-orientated
securities of privately held companies in the electronic communications
industry. The Company has a capital contribution commitment to Centennial of
$1.0 million to be funded in installments through January 15, 2002. Through
December 31, 1999, the Company had contributed approximately $0.3 million to the
partnership.
On February 22, 2000, the Company purchased 61,845 shares of restricted
Series D Preferred Stock (Cyras Preferred Stock) of Cyras Systems, Inc., a
California corporation and manufacturer of telecommunications equipment (Cyras)
for approximately $1.0 million. Cyras Preferred Stock is automatically
convertible into shares of common stock of Cyras, upon the initial public
offering of common stock of Cyras or upon the election to convert by more than
66% of all the preferred stock holders of Cyras.
Sale of Assets
To better focus its efforts on core operations, the Company disposed of
certain assets which management believes did not complement its overall business
strategy.
On January 21, 1998, the Company acquired NETCOM, a provider of Internet
connectivity, Web site hosting services and other value-added services. On
February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring, an ISP located in Atlanta, Georgia. Total
proceeds from the sale were $245.0 million, consisting of $215.0 million in cash
and 376,116 shares of unregistered common stock of MindSpring, valued at
approximately $79.76 per share at the time of the transaction. Assets and
liabilities sold to MindSpring included those directly related to the domestic
operations of NETCOM's Internet dial-up, dedicated access and Web site hosting
services. On March 16, 1999, the Company sold all of the capital stock of
NETCOM's international operations for total proceeds of approximately $41.1
million. Specifically, MetroNET Communications Corp. (MetroNET), a Canadian
entity, and Providence Equity Partners (Providence), located in
11
Providence, Rhode Island, together purchased the 80% interest in NETCOM Canada
Inc. owned by NETCOM for approximately $28.9 million in cash. Additionally,
Providence purchased all of the capital stock of NETCOM Internet Limited,
NETCOM's subsidiary in the United Kingdom, for approximately $12.2 million in
cash. The Company realized a combined gain on the NETCOM transactions of
approximately $178.9 million, net of income taxes of approximately $18.3
million. The Company's consolidated financial statements reflect the operations
of NETCOM as discontinued for all periods presented.
The Company will from time to time evaluate all of its assets as to its
core needs and, based on such analysis, may sell or otherwise dispose of assets
which management does not believe complement its overall business strategy.
Employees
As of December 31, 1999, the Company employed approximately 236 individuals
on a full-time basis. None of the Company's employees is represented by a union.
The Company has not experienced any strikes or work stoppages and believes that
relations with its employees are satisfactory.
The Company believes that its ability to successfully implement its
business strategy will depend on its continued ability to attract and retain
qualified employees, which in the current competitive environment is becoming
increasingly difficult. In order to attract and retain highly qualified
employees, the Company believes that it is imperative to maintain a competitive
compensation program. Included in the Company's compensation program are non-
cash benefit programs offered by its parent ICG, including a 401(k) program,
stock option grants and a bonus package which is based on both individual and
ICG performance. The Company believes that it generally offers compensation
packages that are comparable with those of its competitors who are similar in
size and capital structure. Due to the existing labor market, qualified
personnel are difficult to recruit and retain and the Company cannot guarantee
that it will be able to attract and retain the personnel necessary to implement
its business strategy.
Trademarks and Trade Names
The Company filed United States federal trademark applications for the
marks "ICG", "NetAhead", "ICG NetAhead" and "ICG NetAhead, Inc.". The Company
also filed a separate United States federal trademark application for the
diamond logo used in conjunction with ICG on March 20, 1997. These applications
are pending and the Company has no assurance that they will be granted.
ITEM 2. PROPERTIES
----------
The Company's physical properties include owned and leased space for
offices, storage,
12
equipment rooms, collocation sites and POPs. Additional space may be purchased
or leased by the Company as networks are expanded.
As of December 31, 1999, the Company leased approximately 66,792 square
feet of office and operations space, and NetAhead leased an additional 227,472
square feet for its POP sites at over 270 locations across the country.
Effective January 1, 1999, the Company purchased ICG's corporate
headquarters building, land and improvements (collectively, the Corporate
Headquarters) for approximately $43.4 million, which amount represented
historical costs and approximated fair value. The Corporate Headquarters is
approximately 239,749 square feet. The Company financed the purchase primarily
through a mortgage granted in favor of an affiliate of the seller, which
encumbers the Corporate Headquarters. Effective May 1, 1999, the Corporate
Headquarters was transferred to ICG 161, L.P., a special purpose limited
partnership owned 99% by a subsidiary of the Company and 1% by an affiliate of
the mortgage and seller, and ICG 161, L.P. assumed the loan secured by the
mortgage. The partnership agreement for ICG 161, L.P. grants to the one-percent
partner an option to acquire all of such subsidiary's interest in the
partnership for a purchase price of $43.1 million which option is exercisable
from January 1, 2004 through January 31, 2012.
Effective December 10, 1999, a subsidiary of the Company acquired an 8.36
acre parcel of vacant ground located adjacent to the Corporate Headquarters for
approximately $3.3 million. The Company plans to use this parcel in connection
with the expansion of its Corporate Headquarters.
ITEM 3. LEGAL PROCEEDINGS
-----------------
The Company is a party to certain litigation that has arisen in the
ordinary course of business. In the opinion of management, the ultimate
resolution of these matters will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows. The Company
is not involved in any administrative or judicial proceedings relative to an
environmental matter.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
None.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
----------------------------------------------------------------------
All of the Company's common stock issued and outstanding is owned by ICG.
There exists no established public trading market for the Company's common
stock. Since the formation of the Company and ICG's initial acquisition of the
Company's common stock, there have been no sales or transfers of the Company's
common stock. No cash dividends have been declared and the Company does not
intend to pay any cash dividends.
In April 1998, the Company sold $405.3 million principal amount at maturity
($250.0 million original issue price) of 9 7/8% Senior Discount Notes due 2008
(the 9 7/8% Notes). Morgan Stanley & Co. Incorporated acted as placement agent
for the offering and received placement fees of approximately $7.5 million. In
February 1998, the Company sold $490.0 million principal amount at maturity
($300.6 million original issue price) of 10% Senior Discount Notes due 2008 (the
10% Notes). Morgan Stanley & Co. Incorporated acted as placement agent for the
offering and received placement fees of approximately $9.0 million.
Both of the foregoing offerings were exempt from registration pursuant to
Rule 144A under the Securities Act of 1933, as amended (the Securities Act).
Sales were made only to "qualified institutional buyers," as defined in Rule
144A under the Securities Act, and other institutional accredited investors.
The securities sold in both of the foregoing offerings were subsequently
registered under the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The selected financial data for the years ended December 31, 1995 through
1999 have been derived from the audited consolidated financial statements of the
Company. The information set forth below should be read in conjunction with the
Company's audited consolidated financial statements and the notes thereto
included elsewhere in this Report. Upon the formation of the Company, ICG
contributed its investment in NETCOM to the Comany and NETCOM became a wholly
owned subsidiary of, and predecessor entity to, the Company. Accordingly, the
historical consolidated financial statements of the Company prior to January 23,
1998 consist solely of the accounts of NETCOM. On February 17, 1999, the Company
sold certain of the operating assets and liabilities of NETCOM to MindSpring
Enterprises, Inc. and, accordingly, the Company's consolidated financial
statements reflect the operations of NETCOM as discontinued for all periods
presented. ICG owns all of the Company's issued and outstanding common stock.
The Company does not present loss per share from continuing operations or net
loss per share as such disclosure is not considered to be meaningful. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
14
Years Ended December 31,
----------------------------------------------------------------------------------------
1995 1996 1997 1998 1999
---------------- ---------------- ---------------- ---------------- --------
(in thousands)
Statement of Operations Data:
Revenue $ - - - 9,911 100,115
Cost of services - - - - 3,613
Selling, general and administrative - - - 3,761 1,948
Depreciation - - - 4,064 55,334
---------------- ---------------- ---------------- ---------------- --------
Operating income - - - 2,086 39,220
Interest expense - - - (45,522) (74,351)
Interest income - - - 23,436 26,133
Other income, net - - - - 440
---------------- ---------------- ---------------- ---------------- --------
Loss from continuing operations before
share of net earnings
(losses) - - - (20,000) (8,558)
Share of net earnings (losses) of
equity investees - - - 1,075 (8,019)
---------------- ---------------- ---------------- ---------------- --------
Loss from continuing operations
before extraordinary gain - - - (18,925) (16,577)
Loss from discontinued operations (14,064) (44,265) (33,092) (60,965) -
Extraordinary gain on sales of
operations of NETCOM, net of
income taxes of $18.3 million
(note 3) - - - - 178,917
---------------- ---------------- ---------------- ---------------- --------
Net (loss) income $(14,064) (44,265) (33,092) (79,890) 162,340
================ ================ ================ ================ ========
Other Data:
Net cash (used) provided by
operating activities $ - - - (85,764) 115,603
Net cash used by investing activities - - - (352,073) (251,687)
Net cash provided by financing
activities - - - 532,802 70,034
EBITDA (1) - - - 6,150 94,554
Capital expenditures of continuing
operations (2) - - - 301,969 645,437
Capital expenditures of discontinued
operations (2) 43,601 53,992 17,258 25,971 -
15
At December 31,
-----------------------------------------------------------------------------------------
1995 1996 1997 1998 1999
----------------- ---------------- ---------------- ---------------- --------
(in thousands)
Balance Sheet Data:
Cash, cash equivalents and short- term
investments available for sale $ - - - 155,380 53,664
Net current assets (liabilities) of
discontinued operations (3) 131,917 53,646 38,698 (22,328) -
Working capital (deficit) 131,917 53,646 38,698 248,438 (35,525)
Property and equipment, net - - - 297,905 852,680
Net non-current assets of discontinued
operations (3) 53,549 91,145 73,637 54,023 -
Total assets 185,466 144,791 112,335 679,749 1,187,757
Current portion of long-term debt and
capital lease obligations - - - - 2,701
Long-term debt and capital lease
obligations less current portion - - - 594,617 772,951
Common stock and additional paid- in
capital 203,271 205,622 207,325 207,798 129,402
Accumulated deficit (17,777) (62,042) (95,134) (175,024) (12,684)
Stockholder's equity 185,466 144,791 112,335 32,655 116,718
(1) EBITDA consists of loss from continuing operations before interest, income
taxes, depreciation, other expense, net and share of net earnings (losses)
of equity investees, or operating income plus depreciation. EBITDA is
provided because it is a measure commonly used in the telecommunications
industry. EBITDA is presented to enhance the understanding of the
Company's operating results and is not intended to represent cash flows or
results of operations in accordance with generally accepted accounting
principles (GAAP) for the periods indicated. EBITDA is not a measurement
under GAAP and is not necessarily comparable with similarly titled measures
of other companies. Net cash flows from operating, investing and financing
activities as determined using GAAP are also presented in Other Data.
(2) Capital expenditures includes assets acquired under capital leases and
excludes payments for construction of the Company's corporate headquarters
and corporate headquarters assets acquired through the issuance of long-
term debt. Capital expenditures of discontinued operations includes the
capital expenditures of NETCOM for all periods presented.
(3) Net current assets (liabilities) of discontinued operations and net non-
current assets of discontinued operations represents the assets and
liabilities of NETCOM for all periods presented.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
The following discussion includes certain forward-looking statements which
are affected by important factors including, but not limited to, the Company's
ability to obtain financing necessary to fund its planned expansion, the
Company's lack of operating history, the Company's successful implementation of
its strategy of offering wholesale network services to ISPs, ICG Telecom and
other telecommunications providers and its lack of credit support from ICG that
could cause actual results to differ materially from the forward-looking
statements. The results of operations for the years ended December 31, 1997,
1998 and 1999 have been derived from the Company's audited financial statements
included elsewhere herein. The Company's consolidated financial statements
reflect the operations of NETCOM as discontinued for all periods presented.
Company Overview
ICG Services, Inc. (ICG Services or the Company) was formed on January 23,
1998 and is a wholly owned subsidiary of ICG Communications, Inc. (ICG). The
Company's Leasing Services operations are primarily conducted through ICG
Equipment, Inc. (ICG Equipment) and its network services operations are
conducted through ICG NetAhead, Inc. (NetAhead) (formerly NETCOM On-Line
Communication Services, Inc. (NETCOM)).
On January 21, 1998, ICG acquired NETCOM, a Delaware corporation and
provider of Internet connectivity and Web site hosting services located in San
Jose, California, in a transaction accounted for as a pooling of interests. As
consideration for the acquisition, ICG issued approximately 10.2 million shares
of common stock of ICG (ICG Common Stock), valued at approximately $284.9
million on the date of the merger. Upon the formation of ICG Services, ICG
contributed its investment in NETCOM to ICG Services and NETCOM became a wholly
owned subsidiary of, and predecessor entity to, ICG Services. Accordingly, the
historical consolidated financial statements of the Company prior to January 23,
1998 consist solely of the accounts of NETCOM.
In January 1998, the Company formed ICG Equipment, a Colorado corporation,
for the principal purpose of providing financing of telecommunications equipment
and services to ICG Telecom Group, Inc., an indirectly wholly owned subsidiary
of ICG and provider of competitive local exchange services, and its subsidiaries
(ICG Telecom). Such financing is provided through ICG Equipment's purchase of
telecommunications equipment, software, network capacity and related services
from original equipment manufacturers, providers of intercity network facilities
and ICG Telecom, and subsequent lease of such assets to ICG Telecom. The
equipment and services provided to ICG Telecom are utilized to upgrade and
expand ICG's network infrastructure. Management believes that all leasing and
other arrangements between ICG Equipment and ICG Telecom contain fair and
reasonable terms and are intended to be conducted on the basis of fair market
value and on comparable terms that the Company would be able to obtain from a
comparable third party. ICG Equipment completed its first significant
transaction on June 30, 1998 and, accordingly, ICG Equipment's operations
17
prior to that date are not significant. During the second half of 1998 and the
year ended December 31, 1999, ICG Equipment entered into a series of agreements
whereby ICG Equipment purchased telecommunications equipment and fiber optic
capacity from and for ICG Telecom and leased the same telecommunications
equipment and fiber optic capacity to ICG Telecom under operating leases.
Additionally, under master lease agreements between ICG Equipment and ICG
Telecom, ICG Telecom is required to pay ICG Equipment a monthly lease service
fee based on the average monthly balance of assets purchased by ICG Equipment
and intended for future lease to ICG Telecom, but not yet placed into service.
At December 31, 1999, ICG Equipment had approximately $560.6 million of
telecommunications equipment, software, network capacity and related services
under lease to ICG Telecom and approximately $165.8 million of such assets
intended for future lease to ICG Telecom, but not yet placed into service.
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., an Internet service
provider (ISP) located in Atlanta, Georgia and predecessor to EarthLink, Inc.
(MindSpring), for total proceeds of $245.0 million, and on March 16, 1999, the
Company sold all of the capital stock of NETCOM's international operations in
Canada and the United Kingdom to other unrelated third parties for total
proceeds of approximately $41.1 million. For the year ended December 31, 1999,
the Company recorded a combined gain on the sales of the operations of NETCOM of
approximately $178.9 million, net of income taxes of approximately $2.0 million
and payments required to be made under the tax sharing agreement of $16.3
million. Offsetting the gain on the sales is approximately $16.6 million of net
losses from operations of NETCOM from November 3, 1998 (the date on which the
Company's board of directors adopted the formal plan to dispose of the
operations of NETCOM) through the dates of the sales. Since the operations sold
were acquired by ICG in a transaction accounted for as a pooling of interests,
the gain on the sales of the operations of NETCOM is classified as an
extraordinary item in the Company's consolidated statement of operations. The
Company's consolidated financial statements reflect the operations of NETCOM as
discontinued for all periods presented.
In conjunction with the sale to MindSpring, the legal name of the NETCOM
subsidiary was changed to ICG NetAhead, Inc. NetAhead has retained the domestic
Internet backbone assets formerly owned by NETCOM which include 227 points of
presence (POPs) serving approximately 700 cities nationwide. NetAhead is
utilizing the retained network operating assets to provide wholesale Internet
access and enhanced network services to MindSpring and other ISPs, ICG Telecom
and other telecommunications providers. On February 17, 1999, NetAhead entered
into an agreement to lease to MindSpring for a one-year period the capacity of
certain network operating assets formerly owned by NETCOM and retained by the
Company. MindSpring is utilizing the Company's network capacity under this
agreement to provide Internet access to the dial-up services customers formerly
owned by NETCOM. In addition, the Company received for a one-year period 50% of
the gross revenue earned by MindSpring from the dedicated access customers
formerly owned by NETCOM. All cash operating losses under this agreement were
offset by the periodic recognition of approximately $34.7 million of the
proceeds from the sale of certain of NETCOM's domestic assets and liabilities to
MindSpring, which the Company deferred on February 17, 1999. Accordingly, the
Company did not
18
recognize any revenue, operating costs or selling, general and administrative
expenses from services provided to MindSpring for the term of the agreement.
Incremental revenue and costs generated by other customers have been recognized
in the Company's consolidated statement of operations as incurred. During the
year ended December 31, 1999, the Company applied $29.3 million of deferred
proceeds to the network capacity agreement with MindSpring.
NetAhead also provides network capacity and enhanced data services to ISPs,
ICG Telecom and other telecommunications providers. In December 1998, ICG
announced several new network services offerings available to its business and
ISP customers which utilize ICG's and, consequently, NetAhead's nationwide data
network and service capabilities to carry out-of-region traffic and enhance data
services provided. Modemless remote access service (RAS), also known as managed
modem service, allows NetAhead to provide modem access at ICG's and the
Company's switch locations, thereby eliminating the need for ISPs to deploy
modems physically at each of their POPs. RAS benefits the ISPs by reducing
capital expenditures and shifting network management responsibility from the
ISPs to NetAhead. During the year ended December 31, 1999, ICG and the Company
together entered into contracts to supply over 700,000 RAS and Internet RAS
lines. NetAhead also provides transport services to deliver all Internet
protocol (IP) data packets either directly to the ISP, if the ISP is not
collocated at the telecommunications provider's local switch, or directly to the
Internet, bypassing the ISP. Additionally, through its network operations
center, NetAhead monitors the usage of each line and is responsible for the
administration of all network repair and maintenance.
In August 1998, ICG Telecom began offering enhanced telephony services via
IP technology. ICG Telecom currently offers this service in 230 major cities in
the United States, which cities account for more than 90% of the commercial long
distance market. ICG Telecom carries the IP traffic over NetAhead's nationwide
data network and terminates a large portion of the traffic via NetAhead's POPs.
NetAhead charges ICG Telecom for calls carried and terminated on NetAhead's
network.
The Company has and will continue to enter into partnership arrangements
with ICG Telecom to provide network services at negotiated rates. Management
believes that all such arrangements have and will contain fair and reasonable
terms and are intended to be conducted on the basis of fair market value and on
comparable terms that the Company would be able to obtain from a comparable
third party. The Company is not presently able to determine the impact that the
offerings of its newly developed network services will have on revenue or EBITDA
in 2000 or future years. The nature, volume and consideration received for
network services from ISPs and other telecommunications providers, as well as
that received under its agreements with ICG Telecom are ultimately dependent
upon demand from ISPs and other telecommunications providers. Thus, while ICG
Telecom and NetAhead believe the Internet services market sector will benefit
from these services, there is no assurance that ICG Telecom and NetAhead will be
able to successfully deploy and market their services efficiently, or obtain and
retain new customers in a competitive marketplace.
19
The Company may acquire telecommunications and related businesses that
complement ICG's business strategy to offer a wide array of telecommunications
and related services primarily to communications-intensive business customers.
Additionally, the Company may acquire businesses from ICG which ICG currently
owns and operates. Any further acquisitions would be primarily through the use
of cash on hand and the proceeds from securities offerings, including offerings
of ICG Common Stock. However, there is no assurance that acquisitions at
favorable prices to the Company will occur or that the Company will have
sufficient sources of funding to make such acquisitions. The Company's results
of operations and financial condition will change as the operations of ICG
Equipment and NetAhead become more significant and as it consummates
acquisitions, if any.
Results of Operations
The following table provides certain statement of operations data and
certain other financial data for the Company for the periods indicated. The
table also presents revenue, cost of services and expenses, operating income and
EBITDA as a percentage of the Company's revenue.
Years Ended December 31,
---------------------------------------------------------------------------------------
1997 1998 1999
--------------------------- ---------------------------- ------------------------
$ % $ % $ %
--------------- --------- --------------- --------- ------------ ----------
(Dollars in thousands)
Statement of Operations Data:
Revenue - - 9,911 100 100,115 100
Cost of services - - - - 3,613 4
Selling, general and administrative - - 3,761 38 1,948 2
Depreciation - - 4,064 41 55,334 55
--------------- --------- --------------- --------- ------------ ----------
Operating income - - 2,086 21 39,220 39
Other Data:
Net cash (used) provided by (85,764) 115,603
operating activities -
Net cash used by investing activities - (352,073) (251,687)
Net cash provided by financing
activities - 532,802 70,034
EBITDA (1) - - 6,150 62 94,554 94
Capital expenditures of continuing
operations (2) - 301,969 645,437
Capital expenditures of discontinued
operations (2) 17,258 25,971 -
(1) (2) See notes 1 and 2 under "Selected Financial Data" for the
definitions of EBITDA and capital expenditures, respectively.
20
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenue. The Company recorded revenue of approximately $9.9 million and
$100.1 million for the years ended December 31, 1998 and 1999, respectively. The
increase in revenue relates primarily to the continued expansion of ICG
Equipment's operations since June 30, 1998. Revenue recorded on operating
leases of property and equipment to ICG Telecom was $4.9 million and $79.1
million for the years ended December 31, 1998 and 1999, respectively.
Additionally, the Company charges lease service fees to ICG Telecom for the cost
of carrying assets not yet placed into service. For the years ended December 31,
1998 and 1999, revenue earned on lease service fees was $5.0 million and $14.6
million, respectively. The Company also received rental income from ICG under
the operating lease for ICG's corporate headquarters, which the Company
purchased and simultaneously leased to ICG, effective January 1, 1999. For the
year ended December 31, 1999, the Company recorded revenue on the operating
lease for the corporate headquarters of $4.8 million. For the year ended
December 31, 1999, NetAhead generated revenue of approximately $1.6 million for
RAS custom programming and IP network services provided to ICG and other
customers. Revenue earned of $38.6 million for the year ended December 31, 1999
under the Company's network capacity agreement with MindSpring was offset by
cost of services and selling, general and administrative expenses of $67.9
million incurred under the same agreement. This $29.3 million operating deficit
has been equally offset by the recognition of $29.3 million of the deferred
proceeds from the sale of certain of the domestic operating assets and
liabilities of NETCOM.
Cost of services. Cost of services of $3.6 million for the year ended
December 31, 1999 consists of line costs and other direct costs of NetAhead
associated with NetAhead's and ICG Telecom's joint service offering of IP
telephony services.
Selling, general and administrative expenses. Selling, general and
administrative (SG&A) expenses were approximately $3.8 million and $1.9 million
for the years ended December 31, 1998 and 1999, respectively. SG&A expenses
include allocations of a portion of ICG's general and administrative expenses
for certain direct and indirect costs incurred by ICG on behalf of the Company.
Such allocations were $2.4 million and $0.9 million, representing approximately
63% and 47% of total SG&A expenses for the years ended December 31, 1998 and
1999, respectively. Remaining SG&A expenses include general corporate
administrative expenses, including professional and cash management fees. SG&A
expenses for the year ended December 31, 1998 include increased professional
fees due to the start-up and organization of the Company in 1998. SG&A expenses
are expected to increase in absolute dollars as the volume of ICG Equipment's
operations increases and as NetAhead obtains new customers.
Depreciation. Depreciation increased $51.2 million, from $4.1 million for
the year ended December 31, 1998 to $55.3 million for the year ended December
31, 1999. Depreciation consists primarily of depreciation of ICG Equipment's
property and equipment purchased from and for ICG Telecom and leased to ICG
Telecom under long-term operating leases, in addition to depreciation of
property and equipment of NetAhead. The increase in depreciation is primarily
due to the continued expansion of ICG Equipment's operations since June 30,
1998. The
21
Company's depreciation expense will continue to increase as NetAhead purchases
additional property and equipment, ICG Equipment places in service equipment
that has already been purchased and purchases additional property and equipment
for lease to ICG's other operating subsidiaries.
Interest expense. Interest expense increased $28.9 million, from $45.5
million for the year ended December 31, 1998 to $74.4 million for the year ended
December 31, 1999, which includes $63.6 million of noncash interest. Interest
expense is primarily attributable to the 10% Senior Discount Notes due 2008 (the
"10% Notes") issued in February 1998, the 9 7/8% Senior Discount Notes due 2008
(the "9 7/8% Notes") issued in April 1998 and the senior secured financing
facility (the "Senior Facility") completed in August 1999. The Company's
interest expense has and will continue to increase as the principal amounts of
the 10% Notes and the 9 7/8% Notes increase until the 10% Notes and the 9 7/8%
Notes begin to pay interest in cash in 2003.
Interest income. Interest income increased $2.7 million, from $23.4
million for the year ended December 31, 1998 to $26.1 million for the year ended
December 31, 1999 and primarily represents net interest income from ICG of
approximately $4.6 million and $18.6 million during the years ended December 31,
1998 and 1999, respectively, for invoices paid by the Company on behalf of ICG
and its other operating subsidiaries and repaid on a quarterly basis. The
Company also earned interest on invested cash balances during both the year
ended December 31, 1998 and the year ended December 31, 1999. The increase in
interest income is attributable to the increase in cash, cash equivalents and
short-term investments available for sale during the year ended December 31,
1999, arising from the proceeds from the sales of the operations of NETCOM in
February and March 1999 and the completion of the Senior Facility in August
1999, offset by a decrease in cash, cash equivalents and short-term investments
available for sale as the Company invests available cash balances in
telecommunications equipment and other assets.
Other income, net, including realized gain on marketable trading
securities. Other income, for the year ended December 31, 1999 primarily
includes the net gain on the common stock of MindSpring which the Company
received as partial consideration for the sale of the domestic operations of
NETCOM. The Company sold its investment in MindSpring in April 1999.
Share of net earnings (losses) of equity investees. The Company's share of
net earnings (losses) of equity investees decreased $9.1 million, from net
earnings of $1.1 million for the year ended December 31, 1998 to net losses of
$8.0 million for the year ended December 31, 1999. The Company's share of net
losses of equity investees for the year ended December 31, 1999 consists of the
Company's share of net earnings of ICG Ohio LINX, Inc. (ICG Ohio LINX) of $1.8
million and the Company's share of net losses of ICG ChoiceCom, L.P. (ChoiceCom)
of $9.8 million. For the year ended December 31, 1998, share of net earnings of
equity investees consists of the Company's share of net income of ICG Ohio LINX.
The Company purchased a 20% equity interest in ICG Ohio LINX in August 1998 and
a 49% equity interest in ChoiceCom in March 1999.
22
Loss from continuing operations. Loss from continuing operations improved
$2.3 million, or 12%, from $18.9 million for the year ended December 31, 1998 to
$16.6 million for the year ended December 31, 1999 primarily due to the
increase in revenue, offset by increases in depreciation and interest expense,
as noted above.
Extraordinary gain on sales of operations of NETCOM. The Company reported
an extraordinary gain on the sales of operations of NETCOM during the year ended
December 31, 1999 of $178.9 million, net of income taxes of $18.3 million.
Offsetting the gain on the sales is approximately $16.6 million of net losses of
operations of NETCOM from November 3, 1998 through the dates of the sales and
$34.7 million of deferred sales proceeds from the sale of certain of the
domestic operating assets and liabilities of NETCOM to MindSpring. The deferred
proceeds were recognized on a periodic basis over the term of the Company's
network capacity agreement with MindSpring.
Loss from discontinued operations. For the years ended December 31, 1997
and 1998, loss from discontinued operations was $33.1 million and $61.0 million,
respectively. Loss from discontinued operations consists of the net loss of
NETCOM in both periods. The Company sold the operations of NETCOM in February
and March 1999.
Quarterly Results
The following table presents selected unaudited operating results for
three-month quarterly periods during the years ended December 31, 1998 and 1999.
The Company believes that all necessary adjustments, consisting of normal
recurring entries, have been included in the amounts stated below to present
fairly the quarterly results when read in conjunction with the Company's
consolidated financial statements and related notes included elsewhere in this
Annual Report. Results of operations for any particular quarter are not
necessarily indicative of results of operations for a full year or predictive of
future periods. The Company's development and expansion activities during the
periods shown below materially affect the comparability of this data from one
period to another. ICG owns all of the Company's issued and outstanding common
stock. The Company does not present loss per share from continuing operations
or net loss per share as such disclosure is not considered to be meaningful.
23
Three Months Ended Three Months Ended
-------------------------------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
----------- ----------- ------------ ------------ ----------- ----------- ------------ ---------
(in thousands)
Statement of Operations
Data:
Revenue $ - 452 3,104 6,355 14,603 20,041 32,844 32,627
Operating (loss) income (489) (711) 1,312 1,974 6,498 4,933 16,215 11,574
Loss from continuing
operations (2,324) (6,703) (5,065) (4,833) (1,648) (5,602) (502) (8,825)
Loss from discontinued
operations (16,579) (11,794) (14,062) (18,530) - - - -
Net (loss) income (18,903) (18,497) (19,127) (23,363) 191,381 (5,602) (502) (22,937)
=========== =========== ============ ============ ========== =========== ============ =========
Other Data:
Net cash provided
(used) by operating
activities $ 1,762 31,636 (75,347) (43,815) 3,620 2,715 (24,584) 133,852
Net cash (used)
provided by
investing
activities (14,123) (54,113) (105,521) (178,316) 130,621 (147,136) (104,793) (130,379)
Net cash provided
(used) by financing
activities 291,469 242,373 (384) (656) (2,572) 153 73,602 (1,149)
EBITDA (1) (489) (563) 1,848 5,354 13,628 18,746 31,140 31,040
Capital expenditures of
continuing operations (2) 2,123 50,113 71,521 178,212 67,814 229,175 156,728 191,720
Capital expenditures of
discontinued
operations (2) 6,509 8,439 5,270 5,753 - - - -
(1)(2) See notes 1 and 2 under "Selected Financial Data" for the definitions of
EBITDA and capital expenditures, respectively.
Net Operating Loss Carryforwards
As of December 31, 1999, the Company had federal net operating loss
carryforwards (NOLs) of approximately $169.4 million, which expire in varying
amounts through December 31, 2018. However, due to the provisions of Section
382 and certain other provisions of the Internal Revenue Code and Treasury
Regulations (the "Code"), the utilization of the Company's NOLs may be limited.
In addition, the Company is also subject to certain state income tax laws which
may also limit the utilization of NOLs for state income tax purposes.
Liquidity and Capital Resources
The Company's growth to date has been funded through a combination of
equity, debt and lease financing and non-core asset sales. The Company has also
incurred losses from continuing operations since inception and, as of December
31, 1999, had a working capital deficit of $35 million. As of December 31, 1999,
the Company had approximately $53 million of cash and short term investments,
$203 million receivable from ICG and approximately $120 million of credit
available under the Senior Facility. At year end 1999, the Company's capital
requirements under its year 2000 business plan well exceeded its liquidity and
capital resources indicating that additional financing will be required to meet
its financial objectives.
The Company and/or its parent, ICG, has entered into several financing
agreements during the first quarter of 2000 to provide additional capital to
support the Company's earnings deficit and planned capital expansion, including:
24
i) The Company's parent, ICG, signed an agreement with affiliates of
Liberty Media Corporation, Hicks, Muse, Tate & Furst Incorporated and
Gleacher Capital Partners to sell 750,000 shares of Convertible
Preferred Stock and warrants (See Part IV - Subsequent Events) for
estimated proceeds to the Company of approximately $750.0 million,
(before estimated expenses and fees of $45.0 million). This transaction
is subject to customary closing conditions including certain regulatory
approvals and is expected to close during the second quarter of 2000.
ii) The Company signed letters of intent with two major vendors, Lucent
Technologies, Inc. and Cisco Systems, Inc., to provide financing for
the acquisition of equipment. Together this financing will provide for
$355.0 million of financing, with an additional $75.0 million to be
provided if and when the Company raises additional equity. The Company
anticipates that these transactions will close during the second
quarter of 2000.
Management believes that the preferred stock purchase and warrant agreement
discussed in (i) above as well letters of intent for the $355.0 million in debt
and capital lease financing discussed in (ii) above will close prior to June 30,
2000 and that these transactions will provide the financing necessary for the
Company's 2000 business plan and into the year 2001.
Importantly, should the Company or ICG be unable to complete the above
financing arrangements, management would be required to obtain alternative
sources of financing or curtail or otherwise significantly modify its business
plan for the year 2000. Such modifications would likely result in a significant
reduction in planned capital expenditures, which could be material and affect
its ability to expand its network facilities within the time frame originally
planned. Network expansion is a key component of achieving the Company's
targeted future growth. While the Company believes that it could obtain
requisite additional financing, there can be no assurance that such financing
would be available on a timely basis or on acceptable terms.
Net Cash (Used) Provided by Operating Activities
The Company's operating activities used $85.8 million and provided $115.6
million for the years ended December 31, 1998 and 1999, respectively. Net cash
used by operating activities for the year ended December 31, 1998 is primarily
due to losses from continuing operations, in addition to changes in working
capital items and non-cash expenses, such as recognition of deferred gain,
deferred interest expense and depreciation. Net cash provided by operating
activities for the year ended December 31, 1999 is primarily due to changes in
working capital items and non-cash expenses such as deferred interest expense
and depreciation as well as changes in operating assets and liabilities such as
accounts payable and accrued liabilities.
Net Cash Used By Investing Activities
The Company's investing activities used $352.1 million and $251.7 million
for the years ended December 31, 1998 and 1999, respectively. Net cash used by
investing activities for the year ended December 31, 1998 includes the
acquisition of property, equipment and other assets,
25
the purchase of short-term investments available for sale and the purchase of
the Company's investment in ICG Ohio LINX. Net cash used by investing activities
for the year ended December 31, 1999 includes the acquisition of property,
equipment and other assets of $503.9 million, the purchase of corporate
headquarters and payments for construction of corporate headquarters of $13.8
million, the purchase of the 49% equity interest in ChoiceCom of $35.1 million,
the purchase of long-term investments of $11.3 million and the increase in
restricted cash of $1.0 million, offset by the proceeds from the sales of the
operations of NETCOM of $252.9 million and the proceeds from the sale of short-
term investments available for sale and marketable securities of $60.6 million.
The Company will continue to use cash in 2000 and subsequent periods for the
purchase of telecommunications equipment by ICG Equipment for lease to ICG
Telecom, the expansion of NetAhead's operations and, potentially, for
acquisitions. The Company acquired assets under capital leases of $141.5 million
during the year ended December 31, 1999.
Net Cash Provided By Financing Activities
The Company's financing activities provided $532.8 million and $70.0
million for the years ended December 31, 1998 and 1999, respectively. Net cash
provided by financing activities for the year ended December 31, 1998 includes
net proceeds from the private placement of the 10% Notes and the 9 7/8% Notes
issued in February 1998 and April 1998, respectively. For the year ended
December 31, 1999, the Company's financing activities consist of the proceeds
from the Senior Facility, principal payments on capital leases and the Senior
Facility and deferred financing and lease administration costs.
On August 12, 1999, ICG Equipment and NetAhead entered into a $200.0
million senior secured financing facility (the "Senior Facility") consisting of
a $75.0 million term loan, a $100.0 million term loan and a $25.0 million
revolving line of credit. During the year ended December 31, 1999, the Company
borrowed $80.0 million under the loans at interest rates ranging from LIBOR plus
3.125% to 3.5% or 9.35% to 9.67% at December 31, 1999. Quarterly repayments on
the debt commence at various dates beginning September 30, 1999 with remaining
outstanding balances maturing on June 30, 2005 for the $100.0 million term loan
and the $25.0 million line of credit and March 31, 2006 for the $75.0 million
term loan.
As of December 31, 1999, the Company had an aggregate accreted value of
approximately $734.8 million outstanding under the 10% Notes, the 9 7/8% Notes
and the Senior Facility. The 10% Notes require payments of interest to be made
in cash commencing August 15, 2003 and mature February 15, 2008. The 9 7/8%
Notes require payments of interest to be made in cash commencing November 1,
2003 and mature May 1, 2008. As of December 31, 1999, the Company had $7.7
million of capital lease obligations and $33.1 million of other indebtedness
outstanding. With respect to fixed rate senior indebtedness outstanding on
December 31, 1999, the Company has cash interest payment obligations of
approximately $44.5 million in 2003 and $89.0 million in 2004, 2005 and each
year thereafter through 2007.
During the first quarter of 2000, the Company signed letters of intent with
its two biggest vendors, Lucent Technologies, Inc. and Cisco Systems, Inc. for
financing of future capital expenditures. The Company believes that these
financing agreements will better enable the
26
Company to fund its scheduled network expansion through the purchase of Lucent
and Cisco equipment. The Lucent credit agreement provides the Company with up to
$250.0 million of long-term debt financing which can be drawn down during the
year following the closing to purchase network equipment. Under the terms of the
Lucent letter of intent, the Company will commit to purchase a minimum of $175.0
million of equipment with principal amounts outstanding required to be repaid in
quarterly installments over a five-year period beginning 2001. The Cisco credit
facility will provide the Company with up to $180 million of capital lease
financing with a three-year repayment term. During the first quarter of 2000,
$50.0 million of the capital lease financing with Cisco was finalized, however,
no amounts have been drawn down under this facility. The Company anticipates
that these transactions will close during the second quarter of 2000. There is
no assurance, however, that these transactions will close during the second
quarter, or at all.
Other Cash Commitments and Capital Requirements
The Company's capital expenditures of continuing operations, including
assets acquired under capital leases, were $645.4 million for the year ended
December 31, 1999. The Company anticipates that the expansion of the Company's
businesses as currently planned will require capital expenditures of
approximately $1.0 billion for the year ended December 31, 2000. In the event
that ICG's and the Company's efforts to acquire new customers and deploy new
services are more successful than planned, the Company may be required to expend
capital resources earlier than expected to accommodate customer demands. To
facilitate the expansion of its services and networks, the Company has entered
into equipment purchase agreements with various vendors under which the Company
will purchase equipment and other assets, including a full range of switching
systems, fiber optic cable, network electronics, software and services. If the
Company fails to meet the minimum purchase level in any given year, the vendor
may discontinue certain discounts, allowances and incentives otherwise provided
to the Company. Actual capital expenditures will depend on numerous factors,
including certain factors beyond the Company's control. These factors include
economic conditions, competition, regulatory developments and the availability
of equity, debt and lease financing.
Changes in the Company's business plan may require additional sources of
cash which may be obtained through public and private debt or equity financings,
capital leases and other financing arrangements. To date, the Company has been
able to secure sufficient amounts of financing to meet its capital and operating
needs. There can be no assurance that additional financing will be available to
the Company or, if available, that it can be obtained on terms acceptable to the
Company. The failure to obtain sufficient amounts of financing could result in
the delay or abandonment of some or all of the Company's development and
expansion plans, which could have a material adverse effect on the Company's
business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
The Company's financial position and cash flows are subject to a variety of
risks in the normal course of business, which include market risks associated
with movements in interest rates and equity prices. The Company routinely
assesses these risks and has established policies and business practices to
protect against the adverse effects of these and other potential
27
exposures. The Company does not, in the normal course of business, use
derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
The Company's exposure to market risk associated with changes in interest
rates relates primarily to the Company's investments in marketable securities
and its senior indebtedness.
The Company invests primarily in high grade short-term investments which
consist of money market instruments, commercial paper, certificates of deposit,
government obligations and corporate bonds, all of which are considered to be
available for sale and generally have maturities of one year or less. The
Company's short term investment objectives are safety, liquidity and yield, in
that order. As of December 31, 1999, the Company had approximately $53.7
million in cash, cash equivalents and short-term investments available for sale,
at a weighted average fixed interest rate of 5.20% for the year ended December
31, 1999. A hypothetical 10% fluctuation in market rates of interest would not
cause a material change in the fair value of the Company's investment in
marketable securities at December 31, 1999, and accordingly, would not cause a
material impact on the Company's financial position, results of operations or
cash flows.
At December 31, 1999, the Company's indebtedness included $655.2 million
under the 10% Notes and 9 7/8% Notes. Future increases in interest rates could
increase the cost of any new borrowings by the Company. The Company does not
hedge against future changes in market rates of interest.
On August 12, 1999, the Company entered into the Senior Facility,
consisting of two term loans and a revolving line of credit. All components of
the Senior Facility bear variable annual rates of interest, based on changes in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate.
Consequently, additional borrowings under the Senior Facility and increases in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate will
increase the Company's indebtedness and may increase the Company's interest
expense in future periods. Additionally, under the terms of the Senior
Facility, the Company is required to hedge the interest rate risk on $100.0
million of the Senior Facility if LIBOR exceeds 9.0% for 15 consecutive days.
As of December 31, 1999, the Company had $79.6 million outstanding under the
Senior Facility. A hypothetical change in annual interest rate of 1% per annum
would result in a change in interest expense of approximately $0.8 million.
Equity Price Risk
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock of NorthPoint
Communications Holdings, Inc. (NorthPoint) which was converted into 555,555
shares of Class B common stock of NorthPoint (the NorthPoint Class B Shares) on
May 5, 1999. The NorthPoint Class B Shares are convertible on or after March
31, 2000 on a one-for-one basis into a voting class of common
28
stock of NorthPoint. The Company will be subject to the effects of fluctuations
in the fair value of the common stock of NorthPoint until such time as the
Company liquidates its investment in NorthPoint.
On August 11, 1999, the Company purchased 1,250,000 shares of Series C
Preferred Stock (the "ThinkLink Preferred Stock") of International ThinkLink
Corporation (ThinkLink), or approximately 8% of the outstanding shares, for $1.0
million in cash. The ThinkLink Preferred Stock is exchangeable into common stock
of ThinkLink at any time. The ThinkLink Preferred Stock will automatically
convert to common stock upon the completion of the initial public offering of
the common stock of ThinkLink or upon election to convert by the holders of a
majority of the ThinkLink Preferred Stock. The conversion rate from the
ThinkLink Preferred Stock to common stock of ThinkLink is initially one-for-one;
however, such conversion rate is subject to adjustment. The Company will be
subject to the effects of fluctuations in the fair value of the common stock of
ThinkLink until such time as the Company liquidates its investment in ThinkLink.
Although changes in the fair market value of the common stock of NorthPoint
and ThinkLink may affect the fair market value of the Company's investments in
NorthPoint and ThinkLink and cause unrealized gains or losses, such gains or
losses will not be realized until the securities are sold.
Market Price Risk
The fair value of the Company's Senior Discount Notes outstanding was
$462.7 million as of December 31, 1999 compared to the carrying value of $655.2
million. A hypothetical 10% fluctuation in market rates of interest would not
cause a material change in the fair value of the Company's Senior Discount Notes
at December 31, 1999.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The consolidated financial statements of the Company appear on page F-1
of this Annual Report.
Selected quarterly financial data required under this Item is included
under Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None.
29
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
----------------------------------------------
The Directors and executive officers of the Company are set forth below.
The Directors of ICG Services hold office until their successors are appointed
and qualified or until their death, resignation or removal.
Set forth below are the names, ages and positions of the Directors and
executive officers of the Company.
Name Age Position
- ---------------------------------------------------------------------------------------------------------
J. Shelby Bryan 54 Chief Executive Officer and Chairman of the Board of Directors
William S. Beans, Jr. 34 President and Director
Harry R. Herbst 48 Executive Vice President, Chief Financial Officer and Director
H. Don Teague 57 Executive Vice President, General Counsel, Secretary and Director
Michael D. Kallet 46 Executive Vice President
James R. Washington 47 Executive Vice President
John V. Colgan 55 Vice President, Controller and Director
J. Shelby Bryan has been Chairman of the Board of Directors and Chief
---------------
Executive Officer since January 1998. Prior thereto, he served as President,
Chief Executive Officer and Director of ICG from May 1995. Mr. Bryan has over
20 years of experience in the telecommunications industry, primarily in the
cellular business. He co-founded Millicom International Cellular S.A., a
publicly owned corporation providing cellular service internationally, served as
its President and Chief Executive Officer from 1985 to 1994 and served as a
Director through May 1998.
William S. Beans, Jr. has been President and Director of the Company since
---------------------
January 2000. Prior thereto, he was Executive Vice President of the Company and
Executive Vice President Network Services of ICG from June 1999. Prior to
joining ICG, Mr. Beans held several positions in the Teleport Communications
Group, a division of AT&T Local Services. He was National Vice President -
Operations from November 1997 until June 1999, Vice President Customer
Care/Customer Service from October 1995 to November 1997 and Vice President of
Network Development from September 1993 to October 1995.
Harry R. Herbst has been Executive Vice President of ICG and the Company
---------------
since July 1998 and, in August 1998, he also became Chief Financial Officer of
ICG and the Company. He has served as a Director of the Company since August
1998. Mr. Herbst has been a member of the Board of Directors of ICG since
October 1995. From November 1995 to July 1998, he was Vice President of Finance
and Strategic Planning of Gulf Canada Resources Ltd (Gulf Canada). He was Vice
President and Treasurer of Gulf Canada from January to November 1995.
Previously, Mr. Herbst was Vice President of Taxation for Torch Energy Advisors
Inc. from 1991 to 1994, and tax manager for Apache Corp. from 1987 to 1990. Mr.
Herbst is a certified
30
public accountant, formerly with Coopers & Lybrand, now known as
PricewaterhouseCoopers LLP.
H. Don Teague has been Executive Vice President, General Counsel and
-------------
Secretary of ICG since May 1997. In January 1998, Mr. Teague became Executive
Vice President, General Counsel and Secretary and a Director of the
Company. Prior to these positions, Mr. Teague was Senior Vice President,
Administration and Legal with Falcon Seaboard Holdings, L.P. and its
predecessors from April 1994 through April 1997. From 1974 to April 1994, Mr.
Teague was a partner in the law firm of Vinson & Elkins LLP.
Michael D. Kallet has been Executive Vice President of the Company since
-----------------
January 2000. Prior thereto, he was Vice President of the Company since August
1999 and Senior Vice President of Products and Services of ICG from 1998. He has
been General Manager and Chief Operations Officer of ICG NetAhead, Inc., a
subsidiary of the Company, since February 1999. Prior to joining ICG, he held
several positions in the technology industry, including positions at IBM,
Computer Support Corporation, Walker Interactive and Software Publishing
Corporation (Harvard Graphics).
James R. Washington joined the Company in January 2000 as Executive Vice
-------------------
President. Prior to joining the Company, Mr. Washington was Vice President of
Local Planning at AT&T from June 1998 to December 1999. From January 1993 to
June 1998, Mr. Washington held several positions at Teleport Communications
Group, including Regional Vice President and Vice President of Carrier Relations
and Settlements. Mr. Washington also held executive positions at American
Mobile Systems, PacTel Paging and MobileComm.
John V. Colgan has been a Director of the Company since August 1998. Mr.
--------------
Colgan is currently Senior Vice President of Finance and Controller of ICG and
has held a number of positions at ICG since 1994, including Vice President of
Financial Planning and Analysis of ICG and Senior Vice President of Finance for
ICG Telecom Group, Inc. Prior to joining ICG, Mr. Colgan held several executive
positions in the transportation and logistics industry, including Vice President
and General Manager of TLN, Inc., a logistic information systems integrator,
Executive Vice President of Administration and Treasurer for MNX, Inc. a
publicly held transportation services provider and Vice President of Finance of
Burlington Northern Motor Carriers. Mr. Colgan, a certified public accountant,
was employed for 10 years by Arthur Andersen & Co.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
Director Compensation
All of the Company's Directors are employees of ICG and therefore receive
no additional compensation for serving as Directors.
Compensation Committee and Insider Participation
The Company has no compensation committee. However, the Compensation
Committee of the Board of Directors of ICG (the "Compensation Committee")
evaluates compensation levels of senior management and evaluates the various
factors affecting compensation of the
31
Company's highest paid officers. The Compensation Committee consists of four
non-employee Directors: William J. Laggett, Vice Chairman of the ICG Board of
Directors, John U. Moorhead II, Walter Threadgill and Leontis Teryazos.
Board Compensation Committee Report on Executive Compensation
The compensation of senior management is paid by ICG, with the exception
of Michael D. Kallet, currently an Executive Vice President of the Company, who
was paid by ICG NetAhead, Inc., a subsidiary of the Company. The Compensation
Committee believes that compensation to the Company's executive officers should
be designed to encourage and reward management's efforts to further strengthen
the Company's business and to create added value for the stockholders. Such a
compensation program helps to achieve the Company's business and financial
objectives and also provides incentives needed to attract and retain well-
qualified executives. The Company operates in a competitive marketplace and
needs to attract and retain highly qualified senior management and executive
personnel in order for the Company to achieve its goal of continued growth. The
Compensation Committee attributes a substantial portion of the Company's overall
performance, as well as the individual contributions of the executive officers,
to the executive officers' compensation.
All senior management, except for J. Shelby Bryan, President, Chief
Executive Officer and Chairman of the Board of Directors, are compensated with a
base salary and incentive bonus. The base salaries are intended to compensate
executives for their ongoing leadership skills and management responsibility.
The incentive bonuses are dependent upon ICG's and the Company's performance.
For purposes of determining incentive bonuses, the Compensation Committee
evaluates the accomplishment of goals set at the beginning of each fiscal year
and compares ICG's and the Company's performance in each year to those goals. As
a result of ICG's and the Company's performance during fiscal 1999, the
Compensation Committee approved bonuses for the Named Executive Officers of the
Company. See "Executive Compensation" for the definition of Named Officers and
the bonuses paid to executive officers.
In addition, on June 1, 1999 the Stock Option Committee of ICG awarded
stock options to certain employees of the Company, including executive officers.
These grants were based on individual performance and responsibility and were
related to the executive officers' past performance during the year ended
December 31, 1999, as well as an incentive for continued efforts and success.
The Compensation Committee believes that stock options serve as important long-
term incentives for executive officers by encouraging their continued employment
and commitment to ICG's and the Company's performance. The Compensation and
Stock Option Committees do not consider the number of options currently held by
all executive officers in determining individual grants because such
consideration could create an incentive to exercise options and sell the
underlying stock. See "Summary Compensation Table" for the stock options
granted to the executive officers.
The compensation of the Company's Chief Executive Officer and Chairman of
the Board of Directors, J. Shelby Bryan, is paid by ICG and is set forth in his
employment contract. Mr.
32
Bryan's base salary is computed as: the sum of (i) one percent (1%) of the
increase in revenues of ICG for such fiscal quarter over revenues of ICG for the
immediately prior fiscal quarter and (ii) three percent (3%) of the increase in
EBITDA before nonrecurring and noncash charges of ICG for such fiscal quarter
over EBITDA of ICG for the immediately prior fiscal quarter (such payments were
previously calculated on a monthly basis prior to July 1, 1999). In addition, as
further incentive to Mr. Bryan, ICG has entered into a Deferred Compensation
Agreement with Mr. Bryan pursuant to which Mr. Bryan will receive ten annual
installments of $500,000 each, commencing on the later of January 1, 2001 or the
date of Mr. Bryan's retirement or termination (whether by resignation by Mr.
Bryan or by discharge by ICG) from his position of Chief Executive Officer of
the Company. Mr. Bryan was also granted, on March 10, 1999, an option to
purchase 200,000 shares of ICG Common Stock at $18.8125 per share. Mr. Bryan
receives other benefits, as well. See "Summary Compensation Table" for the type
and amount of these payments.
Further, in the event any payments paid or payable by ICG or benefits
received or receivable by Mr. Bryan from ICG (collectively, the "Executive
Payments") are of the type encompassed within Section 280G of the Code, are
subject to tax imposed by Section 4999 of the Code, and/or any comparable tax
imposed by any state or local taxing authority, including any interest or
penalties (collectively, the "Excise Tax"), ICG will pay an additional amount in
cash (the "Gross-Up Payment") so that the net amount retained by Mr. Bryan after
deduction of the Excise Tax on the Gross-Up Payment, as well as any other taxes
due solely as a result of the Gross-Up Payment, shall be equal to the full
amount of the Executive Payments. The Compensation Committee believes that the
compensation paid to Mr. Bryan is appropriate based on Mr. Bryan's experience in
the communications industry and because his compensation is directly tied to the
performance of ICG and the Company.
The Compensation Committee has reviewed the compensation of ICG's and the
Company's executive officers and has concluded that their compensation is
reasonable and appropriate in view of ICG's and the Company's performance. The
Compensation Committee continually evaluates the compensation of ICG's and the
Company's executive officers, including an assessment of compensation reports
for comparable companies and for the telecommunications industry in general.
The Compensation Committee believes that maintaining suitable executive
compensation programs is necessary to support the future development of ICG and
the Company and growth in stockholder value.
William J. Laggett
John U. Moorhead II
Leontis Teryazos
Walter Threadgill
(Members of the ICG Compensation Committee)
33
Executive Compensation
The following table provides certain summary information concerning
compensation paid or accrued by ICG and the Company for the years ended December
31, 1998 and 1999 to or on behalf of J. Shelby Bryan, the Company's President,
Chief Executive Officer and Chairman of the Board of Directors, and the
Company's only executive officer paid directly by the Company at December 31,
1999 (the "Named Officers").
Summary Compensation Table
Long-term
Annual Compensation Compensation
------------------------------------------------ ------------------
Other Annual Securities All Other
Name and Principal Fiscal Compensation Underlying Compensation
Position Year Salary ($) Bonus ($)/(1)/ ($) Options ($)
-----------------------------------------------------------------------------------------------------------------------------------
J. Shelby Bryan 1999 1,500,000 /(2)/ - 98,658 /(3)/ 200,000 -
President, Chief 1998 1,435,191 /(2)/ - 159,554 /(4)/ - -
Executive
Officer and Chairman of
the Board of Directors
Michael D. Kallet 1999 240,154 125,147 19,523 /(5)/ 55,000 -
Senior Vice President, 1998 198,846 83,919 9,577 /(6)/ 35,000 /(7)/ 37,500 /(8)/
General Manager and
Chief Operating Officer
of NetAhead and
Executive Vice President
of Services
(1) Consists of amounts earned and paid in the current year and earned in the
current year but paid in the subsequent year.
(2) Consists of amounts earned pursuant to the compensation formula in Mr.
Bryan's employment agreement with ICG, as adjusted for amounts earned in
1999. All amounts earned have been paid by ICG.
(3) Consists of $13,997 for car allowance, $49,583 for housing expenses and
Company contributions to ICG's 401(k) Defined Contribution Plan in the
amount of $35,078. All amounts earned have been paid by ICG.
(4) Consists of $24,430 for car allowance, $46,964 for housing expenses and
Company contributions to ICG's 401(k) Defined Contribution Plan in the
amount of $88,160. All amounts earned have been paid by ICG.
(5) Consists of $3,000 for car allowance, Company contributions to ICG's 401(k)
Defined Contribution Plan in the amount of $16,067 and $456 for group term
life insurance premiums.
(6) Consists of Company contributions to ICG's 401(k) Defined Contribution
Plan.
(7) Includes options regranted as a result of the repricing of ICG's options on
September 18, 1998. See "Ten-Year Option/SAR Repricings."
(8) Consists of an incentive bonus awarded for continued employment through the
date of the merger between ICG and NETCOM.
34
Option/SAR Grants in Last Fiscal Year
The Company granted no stock options or stock appreciation rights during
the year ended December 31, 1999 to the Named Officers or to other employees.
The Company's employees are eligible to participate in the stock option plans of
ICG. The following table provides information on option grants to purchase ICG
Common Stock to the Named Officers during the year ended December 31, 1999:
Potential realizable value
Individual grants at assumed
---------------------------------------
Number of Percent of total Exercise annual rates of stock
securities options granted or base price appreciation for
underlying to employees in price Expiration option term
----------------------------------
Name options granted (#) fiscal year ($/Sh) date 5% ($) 10% ($)
- ---------------------------------------------------------------------------------------------------------------------------
J. Shelby Bryan 200,000 7.2 18.8125 3/9/09 2,365,397 5,993,908
Michael D. Kallet 25,000 0.9 18.8125 3/10/09 295,777 749,557
30,000 1.1 17.8750 5/31/09 337,128 854,281
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year
End Option Values
The following table provides information on options to purchase ICG Common
Stock exercised during the year ended December 31, 1999 by the Named Officers
and the value of such officers' unexercised options at December 31, 1999:
Number of securities Value of unexercised in-the-
Shares underlying unexercised money options at
acquired on Value options at fiscal year end (#) fiscal year end ($) /(1)/
----------------------------------- -----------------------------
Name exercise (#) realized ($) Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------------------------
J. Shelby Bryan - - 1,750,000 100,000 17,634,375 -
Michael D. Kallet 10,000 115,251 94,845 81,251 208,582 75,469
(1) Based on the closing price of a share of ICG Common Stock on the Nasdaq
National Market of $18.75 on December 31, 1999.
Executive Employment Agreements
ICG has an employment agreement with Michael Kallet. ICG's employment
agreement with Mr. Kallet provides for an initial term of two years which
commenced July 1, 1999. Upon completion of one year of the initial term, the
agreement automatically renews from month to month such that there is always one
year remaining in the term until either ICG or Mr. Kallet provides notice of its
or his desire to terminate. In such case, the term ends upon the date indicated
in the notice of termination. The agreement provides for an annual base salary
and an incentive bonus determined by the Board of Directors of ICG. Mr. Kallet
is also entitled to such other benefits as are generally provided to executive
officers of ICG, including options under ICG's stock option plans, a car
allowance and reimbursement of reasonable out-of-pocket expenses incurred on
behalf of ICG. The agreement may be terminated by ICG upon 30 days written
notice if Mr. Kallet is prevented from performing his duties by reason of
illness or
35
incapacity for 140 days in any 180-day period. The agreement may also be
terminated by ICG or Mr. Kallet upon 30 days written notice in certain other
circumstances. If the agreement is terminated due to the death of Mr. Kallet,
his estate will receive an amount equal to three months salary. Upon a change in
control of ICG, Mr. Kallet will receive an amount equal to his annual base
salary, his targeted incentive bonus and the value of his other benefits, and
his unvested options shall fully vest. If Mr. Kallet is terminated pursuant to a
change in control transaction or if he resigns for good reason, he shall receive
an amount equal to two times his annual base salary, his targeted incentive
bonus and the value of his other benefits, and certain of his unvested options
shall fully vest. If Mr. Kallet is terminated by ICG without cause and not
involving a change in control transaction, he will receive an amount equal to
his salary for the remaining term of the agreement, and certain of his unvested
options shall fully vest. If Mr. Kallet resigns without good reason after
February 17, 2000, he will receive six months' salary, bonus and health
insurance benefits. Mr. Kallet is also subject to a ten-year confidentiality
covenant, a one-year non-competition commitment and a two-year non-solicitation
agreement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
ICG owns all of the outstanding shares of common stock of the Company.
The following table sets forth, as of March 27, 2000, the number of
shares of ICG Common Stock owned by all executive officers and Directors of the
Company, individually and as a group. The persons named in the table below have
sole voting and investment power with respect to all of the shares of ICG Common
Stock owned by them, unless otherwise noted.
Amount/Nature of Beneficial
Name and Address of Beneficial Owner Ownership Percent /(1)/
- ----------------------------------------------------------------------- --------------------------- ----------------------
J. Shelby Bryan........................................................ 2,235,941 (2) 4.42%
Chief Executive Officer and Chairman of the Board of Directors
William S. Beans, Jr................................................... 1,613 (3) *
President and Director
Harry R. Herbst........................................................ 110,702 (4) *
Executive Vice President, Chief Financial Officer and Director
H. Don Teague.......................................................... 60,910 (5) *
Executive Vice President, General Counsel, Secretary and Director
Michael D. Kallet...................................................... 111,501 (6) *
Executive Vice President
James R. Washington.................................................... 0 *
Executive Vice President
John V. Colgan......................................................... 33,274 (7) *
Vice President, Controller and Director
All executive officers and Directors of the Company as a group (7 persons) 2,553,941 (8) 5.05%
_______
* Less than one percent of the outstanding shares of ICG Common Stock.
(1) Based on 48,582,035 issued and outstanding shares of ICG Common Stock on
March 27, 2000, plus shares of ICG Common Stock which may be acquired by
the person or group indicated pursuant to any options and warrants
exercisable, or pursuant to any shares vesting under ICG's 401(k) Plan
within 60 days.
(2) Includes 165,000 shares of ICG Common Stock held by Mr. Bryan, 20,941
shares of IGC Common Stock held by a 401(k) Plan in Mr. Bryan's name and
2,050,000 shares of ICG Common Stock that may be acquired pursuant to the
exercise of outstanding stock options. Figure does not include 2,000 shares
held in the name of Mr. Bryan's spouse for which Mr. Bryan specifically
disclaims benificial ownership.
36
(3) Includes 1,000 unrestricted shares owned by Mr. Beans and 613 shares held
in ICG's Stock Purchase Plan.
(4) Includes 3,518 unrestricted shares of ICG Common Stock held by ICG's
Employee Stock Purchase Plan and 107,184 shares of ICG Common Stock that
may be acquired by Mr. Herbst pursuant to the exercise of outstanding stock
options.
(5) Includes 910 shares of ICG Common Stock held by a 410K Plan in Mr. Teague's
name and 60,000 shares of ICG Common Stock that may be acquired by Mr.
Teague pursuant to the exercise of outstanding options.
(6) Includes 937 shares of ICG Common Stock held by a 401K plan in the name of
Mr. Kallet, 719 shares of ICG Common Stock held by ICG's Employee Stock
Purchase Plan and 109,845 shares of ICG Common Stock that may be acquired
by Mr. Kallet pursuant to the exercise of outstanding stock options.
(7) Includes 4,100 shares of ICG Common Stock held by Mr. Colgan, 1,400 shares
of ICG Common Stock held in the name of Mr. Colgan's spouse, 3,268 shares
of ICG Common Stock held by a 401k Plan in Mr. Colgan's name, 2,318 shares
of ICG Common Stock held by ICG's Employee Stock Purchase Plan and 22,188
shares of ICG Common Stock held that may be acquired by Mr. Colgan pursuant
to the exercise of outstanding options.
(8) Includes 171,500 shares of ICG Common Stock held directly by the officers
and directors as a group, 26,056 shares of ICG Common Stock held by ICG's
401(K) Plan in the names of the individual officers and directors of ICG
Services, 7,168 shares of ICG Common Stock held by ICG's Employee Stock
Purchase Plan and 2,349,217 shares of ICG Common Stock that may be acquired
pursuant to the exercise of outstanding stock options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
Upon its formation, the Company, including its subsidiaries, entered into
certain intercompany and shared services agreements with ICG, whereby ICG
allocates to the Company direct and certain indirect costs incurred by ICG or
its other subsidiaries (the "Restricted Subsidiaries") on behalf of the Company.
Allocated expenses generally include a portion of salaries and related benefits
of legal, accounting and finance, information systems support and other ICG
employees, certain overhead costs and reimbursement for invoices of the Company
paid by ICG. Conversely, any cash collected by ICG on behalf of the Company or
invoices paid by the Company on behalf of ICG are in turn reimbursed to the
Company by ICG. As the Company and its subsidiaries and ICG and its Restricted
Subsidiaries jointly enter into service offerings and other transactions, joint
costs incurred are generally allocated to each of the Company and ICG according
to the relative capital invested and efforts expended by each party. All
transactions between the Company, including its subsidiaries, and ICG, including
its Restricted Subsidiaries, contain fair and reasonable conditions and/or are
approved by the Board of Directors of the Company and of ICG. All such
transactions are settled in cash on a quarterly basis.
For the year ended December 31, 1999, ICG charged approximately $46.8
million to the Company for intercompany transfers and direct and indirect costs
incurred by ICG and its Restricted Subsidiaries on behalf of the Company. Of
this amount, approximately $0.9 million is included in the Company's selling,
general and administrative expenses for the year ended December 31, 1999. In
addition, for the year ended December 31, 1999, the Company charged
approximately $607.9 million to ICG and its Restricted Subsidiaries for
intercompany transfers and direct and indirect costs incurred by the Company on
behalf of ICG and its Restricted Subsidiaries. The net receivable from ICG for
all intercompany charges combined is included in due from ICG in the Company's
consolidated balance sheet at December 31, 1999. Net interest income accrued by
the Company on outstanding balances from ICG and its Restricted Subsidiaries is
included in interest income in the Company's consolidated statement of
operations and was approximately $18.6 million for the year ended December 31,
1999.
37
Effective January 1, 1999, interest accrued on outstanding balances of
intercompany transfers and direct and indirect costs between the respective
entities at 12 1/2% per annum.
During the year ended December 31, 1999, ICG Equipment purchased certain
telecommunications equipment and fiber optic capacity both from and for ICG
Telecom for an aggregate purchase price of approximately $466.7 million.
Simultaneously with each of the purchases, ICG Equipment entered into separate
agreements to lease the same telecommunications equipment back to ICG Telecom
under operating leases, with annual lease payments commencing one year from the
date of the lease. During the year ended December 31, 1999, ICG Equipment
entered into separate agreements to lease $374.1 million of telecommunications
equipment to ICG Telecom. ICG Equipment recognizes revenue from the lease
payments ratably over the lease terms. The Company recognized approximately
$79.1 million in revenue under these operating leases for the year ended
December 31, 1999, all of which is included in lease receivables at December 31,
1999. The purchase prices and lease payments for all leases are subject to
adjustment, based on the results of an independent appraisal which may be
requested at the option of ICG Telecom and ICG Equipment on or before 90 days
from the purchase date. ICG Equipment submitted a request to ICG Telecom for
independent appraisals of certain of the telecommunications equipment and fiber
optic capacity purchased through June 30, 1999. The Company received the
appraisals for certain transactions completed during the years ended December
31, 1998 and 1999 which determined the fair value of the purchased
telecommunications equipment and fiber optic capacity exceeded the book value,
and accordingly, the original purchase price, by $82.3 million. The Company has
reflected the payment of the excess of fair value over the original purchase
price as a reduction of equity in the accompanying consolidated financial
statements.
Additionally, under a master lease agreement between ICG Equipment and ICG
Telecom, ICG Telecom is required to pay ICG Equipment a monthly lease service
fee, at an annual rate of prime plus 4% (12 1/2% at December 31, 1999), based on
the average monthly balance of assets purchased by ICG Equipment and intended
for future lease to ICG Telecom, but not yet placed into service. For the year
ended December 31, 1999, ICG Equipment recognized approximately $14.6 million of
monthly service fee revenue under this agreement and approximately $4.9 million
was included in lease receivables at December 31, 1999. The amount of assets
purchased by ICG Equipment and intended for future lease to ICG Telecom, but not
yet placed into service, was approximately $165.8 million at December 31, 1999.
In the normal course of business during the year ended December 31, 1999,
ICG Telecom provided the use of certain of its local access lines to NETCOM and
NetAhead and, accordingly, charged NETCOM and NetAhead for costs of any
installation and recurring access to its network. For the year ended December
31, 1999, NETCOM and NetAhead incurred approximately $4.3 million for
installation and recurring local access charges from ICG Telecom, which have
been included in the extraordinary gain on the sales of the operations of NETCOM
for those charges relating to NETCOM and in operating costs for those charges
relating to NetAhead, a portion of which were applied against the deferred gain
on the sale of certain of NETCOM's domestic operating assets and liabilities in
the Company's consolidated financial statements for the year ended December 31,
1999.
38
On March 1, 1999, the Company purchased from ICG Telecom, for $35.1 million
in cash, a 49% equity interest in ChoiceCom. Based in Austin, Texas, ChoiceCom
currently provides local exchange and long distance services in Austin, Corpus
Christi, Dallas, Houston and San Antonio, Texas. The Company accounted for its
investment in ChoiceCom under the equity method of accounting. The remaining
51% equity interest in ChoiceCom is owned by ICG Telecom.
On August 27, 1998, the Company purchased, for $9.1 million in cash, the
remaining 20% equity interest in ICG Ohio LINX, Inc. (ICG Ohio LINX) which ICG
Telecom did not already own, including incremental costs of obtaining that
investment of $0.1 million. ICG Ohio LINX is a facilities-based competitive
local exchange carrier which operates a fiber optic telecommunications network
in Cleveland and Dayton, Ohio. The Company has accounted for its investment in
ICG Ohio LINX under the equity method of accounting.
Effective January 1, 1999, the Company purchased ICG's Corporate
Headquarters building. The Company assumed the lease of the building from the
prior owner upon acquisition and is leasing the building to a subsidiary of ICG
under an operating lease. For the year ended December 31, 1999, the Company
earned leasing revenue from the Restricted Subsidiary of ICG of approximately
$4.8 million under the operating lease, which is included in revenue and due
from ICG in the Company's consolidated financial statements. The Company
received $2.5 million from the subsidiary as a security deposit on the operating
lease, which is included in other long-term liabilities in the Company's
consolidated financial statements.
Effective January 1, 1999, the Company entered into a tax sharing agreement
with ICG and its other subsidiaries. According to the tax sharing arrangement,
the parties have mutually agreed to reimburse other members of the affiliated
group should one member's income tax attributes be used to offset income or
gains of another member through the filing of consolidated federal and combined
state income tax returns. During the year ended December 31, 1999, the Company
recorded a liability of $16.3 million to reimburse ICG for income tax losses
generated by ICG's other subsidiaries which were used to offset current income
tax liabilities of the Company in accordance with the tax sharing agreement.
39
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
----------------------------------------------------------------
(A) (1) Financial Statements. The following financial statements are
---------------------
included in Item 8 of Part II:
Page
----
Independent Auditors' Report Report of KPMG LLP................................. F-2
Independent Auditors' Report Report of Ernst & Young LLP........................ F-3
Consolidated Balance Sheets, December 31, 1998 and 1999.......................... F-4
Consolidated Statements of Operations, Years Ended December 31,
1997, 1998 and 1999 ......................................................... F-6
Consolidated Statements of Stockholder's Equity, Years Ended
December 31, 1997, 1998 and 1999............................................. F-8
Consolidated Statements of Cash Flows, Years Ended December 31,
1997, 1998 and 1999.......................................................... F-9
Notes to Consolidated Financial Statements....................................... F-11
(2) Financial Statement Schedules.
------------------------------
None.
(3) List of Exhibits.
-----------------
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or
Succession.
None.
(3) Corporate Organization.
3.1: Certificate of Incorporation of ICG Services, Inc.
[Incorporated by reference to Exhibit 3.1 to Registration
Statement on Form S-4 of ICG Services, Inc., File No. 333-
51037, as amended].
3.2: By-laws of ICG Services, Inc. [Incorporated by reference to
Exhibit 3.2 to Registration Statement on Form S-4 of ICG
Services, Inc., File No. 333-51037, as amended].
(4) Instruments Defining the Rights of Security Holders, Including
Indentures.
4.1: Indenture, dated February 12, 1998, between ICG Services,
Inc. and Norwest Bank Colorado, National Association
[Incorporated by reference to Exhibit 4.4 to Registration
Statement on Form S-4 of ICG Services, Inc., File No. 333-
51037].
40
4.2: Indenture, dated April 27, 1998, between ICG Services, Inc.
and Norwest Bank Colorado, National Association
[Incorporated by reference to Exhibit 4.4 to Registration
Statement on Form S-4 of ICG Services, Inc., File No. 333-
60653].
4.3: Loan Agreement, dated as of January 1, 1999, by and among
TriNet Realty Capital, Inc. and ICG Services, Inc.
[Incorporated by reference to Exhibit 10.1 to ICG Services,
Inc.'s Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1999].
4.4: Promissory Note, dated as of January 1, 1999, by and among
TriNet Realty Capital, Inc. and ICG Services, Inc.
[Incorporated by reference to Exhibit 10.2 to ICG Services,
Inc.'s Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1999].
4.5: Deed of Trust, Assignment of Rents and Security Agreement,
made as of January 1, 1999, granted by ICG Services, Inc.
for the benefit of TriNet Realty Capital, Inc.
[Incorporated by reference to Exhibit 10.3 to ICG Services,
Inc.'s Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1999].
4.6: Amended and Restated Loan Agreement, dated as of May 1,
1999, by and among TriNet Realty Capital, Inc. and ICG 161,
L.P. [Incorporated by reference to Exhibit 10.1 to ICG
Services, Inc.'s Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 1999].
4.7: Credit Agreement, dated as of August 12, 1999, among ICG
Equipment, Inc. and ICG NetAhead, Inc., as Borrowers, ICG
Services, Inc., as Parent, the Initial Lenders and the
Initial Issuing Bank, as Initial Lenders and Initial
Issuing Bank, Royal Bank of Canada, as Administrative Agent
and Collateral Agent, Morgan Stanley Senior Funding, Inc.,
as Sole Book-Runner and Lead Arranger and Bank of America,
N.A. and Barclays Bank Plc, as Co-Documentation Agents
[Incorporated by reference to Exhibit 10.3 to ICG Services,
Inc.'s Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 1999].
4.8: Security Agreement, dated August 12, 1999, from ICG
Equipment, Inc. and ICG NetAhead, Inc., as Grantors to
Royal Bank of Canada, as Collateral Agent [Incorporated by
reference to Exhibit 10.4 to ICG Services, Inc.'s Quarterly
Report on Form 10-Q for the quarterly period ended June 30,
1999].
4.9: Amendment No. 1 to Credit Agreement, dated as of September
30, 1999, among ICG Equipment, Inc. and ICG NetAhead, Inc.,
as Borrowers, ICG Services, Inc., as Parent, certain
Initial Lender Parties thereto, Morgan Stanley Senior
Funding, Inc., as Sole Book-Runner and Lead Arranger, Royal
Bank of Canada, as Collateral Agent and as Administrative
Agent for such Lender Parties, and Bank of America, N.A.
and Barclays Bank Plc, as Co-Documentation Agents
[Incorporated by reference to Exhibit 10.1
41
to ICG Services, Inc.'s Quarterly Report on Form 10-Q for
the quarterly period ended September 30, 1999].
4.10: Amendment and Waiver No. 2 to the Loan Documents, dated
as of December 29, 1999, among ICG Equipment, Inc., ICG
NetAhead, Inc., ICG Services, Inc., certain Initial
Lender Parties party thereto, Morgan Stanley Senior
Funding, Inc., as Sole Book-Runner and Lead Arranger,
Royal Bank of Canada, as Collateral Agent and as
Administrative Agent for such Lender Parties, Bank of
America, N.A., as Documentation Agent and Barclays Bank
Plc, as Co-Documentation Agent.
4.11: Amendment No. 3 to the Loan Documents, dated as of
February 11, 2000, among ICG Equipment, Inc., ICG
NetAhead, Inc., ICG Services, Inc., as Parent, certain
Initial Lender Parties party thereto, Morgan Stanley
Senior Funding, Inc., as Sole Book-Runner and Lead
Arranger, Royal Bank of Canada, as Collateral Agent and
as Administrative Agent for such Lender Parties, Bank of
America, N.A., as Documentation Agent and Barclays Bank
Plc, as Co-Documentation Agent.
(9) Voting Trust Agreement.
None.
(10) Material Contracts.
10.1: Shared Administrative and Operational Services Agreement,
dated as of January 23, 1998, between ICG Communications,
Inc. and ICG Services, Inc.
10.2: Form of Master Lease Agreement between ICG Equipment,
Inc. and each of ICG Telecom Group, Inc., ICG Ohio LINX,
Inc., ICG Access Services, Inc., ICG Telecom of San
Diego, L.P. and Bay Area Teleport, Inc.
10.3: Purchase Agreement, dated as of January 1, 1999, by and
among TriNet Essential Facilities X, Inc. and ICG
Services, Inc. [Incorporated by reference to Exhibit 10.4
to ICG Services, Inc.'s Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 1999].
10.4: Assumption and Modification Agreement, dated as of May 1,
1999, by and among ICG Services, Inc., ICG 161, L.P. and
TriNet Realty Capital, Inc. [Incorporated by reference to
Exhibit 10.2 to ICG Services, Inc.'s Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 1999].
10.5: Employment Agreement, dated as of July 1, 1999, between
ICG Communications, Inc. and Michael D. Kallet.
(11) Statement re Computation of per Share Earnings.
Not Applicable.
42
(12) Statement re Computation of Ratios.
Not Applicable.
(13) Annual Report to Security Holders.
Not Applicable.
(21) Subsidiaries of the Registrant.
21.1: Subsidiaries of the Registrant.
(22) Published Report re Matters Submitted to Vote of Security
Holders.
Not Applicable.
(24) Power of Attorney.
Not Applicable.
(27) Financial Data Schedule.
27.1: Financial Data Schedule of ICG Services, Inc. for the
Year Ended December 31, 1999.
(B) Reports on Form 8-K.
--------------------
None.
(C) Exhibits. The exhibits required by this Item are listed under Item
---------
14(A)(2).
(D) Financial Statement Schedules.
------------------------------
None.
43
FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report - Report of KPMG LLP........................ F-2
Report of Ernst & Young LLP, Independent Auditors........................ F-3
Consolidated Balance Sheets, December 31, 1998 and 1999.................. F-4
Consolidated Statements of Operations, Years Ended December 31, 1997, 1998
and 1999................................................................ F-6
Consolidated Statements of Stockholder's Equity, Years Ended
December 31, 1997, 1998 and 1999........................................ F-8
Consolidated Statements of Cash Flows, Years Ended December 31, 1997, 1998
and 1999................................................................ F-9
Notes to Consolidated Financial Statements............................... F-11
F-1
Independent Auditors' Report - Report of KPMG LLP
-------------------------------------------------
The Board of Directors and Stockholder
ICG Services, Inc.:
We have audited the accompanying consolidated balance sheets of ICG Services,
Inc. and subsidiaries (the "Company") (a wholly owned subsidiary of ICG
Communications, Inc.) as of December 31, 1998 and 1999 and the related
consolidated statements of operations, stockholder's equity, and cash flows for
each of the years in the three-year period ended December 31, 1999. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits. We did not audit the consolidated
financial statements of NETCOM On-Line Communication Services, Inc. (NETCOM), a
discontinued wholly owned subsidiary of the Company, for the year ended December
31, 1997, whose loss from operations constitutes 100 percent of the consolidated
loss from discontinued operations in 1997. Those consolidated financial
statements were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for NETCOM in
1997, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of ICG Services, Inc. and subsidiaries
as of December 31, 1998 and 1999, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
1999, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Denver, Colorado
February 16, 2000
F-2
Report of Ernst & Young LLP, Independent Auditors
-------------------------------------------------
The Board of Directors and Stockholders
NETCOM On-Line Communication Services, Inc.
We have audited the consolidated statements of operations, stockholders' equity
and cash flows of NETCOM On-Line Communication Services, Inc. for the year ended
December 31, 1997 (not presented separately herein). These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of NETCOM On-Line Communication Services, Inc. for the year ended
December 31, 1997, in conformity with accounting principles generally accepted
in the United States.
/s/ Ernst & Young LLP
San Jose, California
February 13, 1998
F-3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and 1999
- --------------------------------------------------------------------------------------------------
December 31,
-------------------------------------------
1998 1999
-------------------- ------------------
Assets (in thousands)
- ------
Current assets:
Cash and cash equivalents $ 114,380 43,222
Short-term investments available for sale (note 4) 41,000 10,442
Receivables:
Network services, including amounts due from
ICG (notes 8 and 10) - 7,412
Leasing services, due from ICG (notes 8 and 10) 7,753 66,652
Due from ICG (notes 8 and 10) 137,762 128,893
Other - 500
------------- -------------
Total receivables 145,515 203,457
------------- -------------
Prepaid expenses, deposits and inventory 20 2,942
------------- -------------
Total current assets 300,915 260,063
------------- -------------
Property and equipment (notes 5, 8, 10 and 11) 301,969 916,953
Less accumulated depreciation (4,064) (64,273)
------------- -------------
Net property and equipment 297,905 852,680
------------- -------------
Restricted cash - 1,030
Investments in partnership interests, common stock and
restricted and exchangeable preferred stock (note 6) - 11,250
Investments, accounted for under the equity method
(notes 6 and 12) 10,179 41,152
Deferred financing and lease administration costs, net
of accumulated amortization of $1.5 million and $3.9
million at December 31, 1998 and 1999, respectively
(notes 8 and 10) 16,727 20,663
Other assets - 919
Net non-current assets of discontinued operations
(note 3) 54,023 -
------------- -------------
Total assets (note 12) $679,749 1,187,757
============= =============
(Continued)
F-4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
- -------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------------------
1998 1999
--------------------- ---------------------
Liabilities and Stockholder's Equity (in thousands)
- ------------------------------------
Current liabilities:
Accounts payable $ 28,840 113,372
Payable pursuant to IRU agreement (note 7) - 135,322
Accrued liabilities, including amounts due to ICG
(note 10) 1,309 38,718
Deferred gain on sale (note 3) - 5,475
Current portion of capital lease obligations (note 7) - 1,951
Current portion of long-term debt (note 8) - 750
Net current liabilities of discontinued operations
(note 3) 22,328 -
------------ ------------
Total current liabilities 52,477 295,588
------------ ------------
Capital lease obligations, less current portion (note 7) - 5,784
Long-term debt, net of discount (note 8) 594,617 767,167
Other long-term liabilities (note 10) - 2,500
------------ ------------
Total liabilities 647,094 1,071,039
------------ ------------
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares authorized; 10
shares issued and outstanding at December 31, 1998 and
1999 (note 2) - -
Additional paid-in capital 207,798 129,402
Accumulated deficit (175,024) (12,684)
Accumulated other comprehensive loss (119) -
------------ ------------
Total stockholder's equity 32,655 116,718
------------ ------------
Commitments and contingencies (notes 6, 7, 8, 10 and 11)
Total liabilities and stockholder's equity $ 679,749 1,187,757
============ ============
See accompanying notes to consolidated financial statements.
F-5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended December 31, 1997, 1998 and 1999
- ------------------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
-----------------------------------------------------------------------
1997 1998 1999
-------------------- -------------------- -------------------
(in thousands)
Revenue (note 12):
From services provided to ICG (note 10) $ - 9,911 99,738
Other - - 377
------------ ---------- -----------
Total revenue - 9,911 100,115
------------ ---------- -----------
Cost of services and expenses:
Cost of services - - 3,613
Selling, general and administrative expenses:
Amounts allocated from ICG (note 10) - 2,396 916
Other - 1,365 1,032
Depreciation (notes 5 and 12) - 4,064 55,334
------------ ---------- -----------
Total cost of services and expenses - 7,825 60,895
------------ ---------- -----------
Operating income - 2,086 39,220
Other (expense) income:
Interest expense (notes 8 and 12) - (45,522) (74,351)
Interest income:
Amounts earned from ICG (note 10) - 4,625 18,638
Other - 18,811 7,495
Other income, net, including realized gain on
marketable trading securities
(note 6) - - 440
------------ ---------- -----------
- (22,086) (47,778)
------------ ---------- -----------
Loss from continuing operations before share of
net earnings (losses) of equity investees - (20,000) (8,558)
Share of net earnings (losses) of equity investees
(note 12) - 1,075 (8,019)
------------ ---------- -----------
Loss from continuing operations - (18,925) (16,577)
------------ ---------- -----------
Loss from discontinued operations (note 3) (33,092) (60,965) -
------------ ---------- -----------
Extraordinary gain on sales of operations of
NETCOM, net of income taxes (notes 3 and 12) - - 178,917
------------ ---------- -----------
Net (loss) income $(33,092) (79,890) 162,340
============ ========== ===========
(Continued)
F-6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations, Continued
- -----------------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
-----------------------------------------------------------------------
1997 1998 1999
-------------------- -------------------- -------------------
(in thousands)
Other comprehensive loss:
Foreign currency translation adjustment $ (527) (263) -
Unrealized loss on short-term investments
available for sale (540) - -
-------------------- -------------------- -------------------
Other comprehensive loss (1,067) (263) -
-------------------- -------------------- -------------------
Comprehensive (loss) income $ (34,159) (80,153) 162,340
==================== ==================== ===================
See accompanying notes to consolidated financial statements.
F-7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholder's Equity
Years Ended December 31, 1997, 1998 and 1999
- ---------------------------------------------------------------------------------------------------------------------------------
Accumulated
Common stock Additional other Total
-------------------- paid-in Accumulated comprehensive stockholder's
Shares Amount capital deficit income (loss) equity
---------------------------------------------------------------------------------------------
(in thousands)
Balances at January 1, 1997 11,631 $ 116 205,506 (62,042) 1,211 144,791
Shares issued for cash in
connection with NETCOM's employee
stock purchase plan and the
exercise of NETCOM's stock options 152 1 1,702 - - 1,703
Reversal of unrealized gains on
short-term investments
available for sale - - - - (540) (540)
Cumulative foreign currency
translation adjustment - - - - (527) (527)
Net loss - - - (33,092) - (33,092)
------ ----- -------- --------- ------- ---------
Balances at December 31, 1997 11,783 117 207,208 (95,134) 144 112,335
Shares issued for cash in
connection with NETCOM's employee
stock purchase plan and the
exercise of NETCOM's stock
options (note 1) 38 1 472 - - 473
Elimination of NETCOM's historical
equity in connection with
NETCOM's merger with ICG (note 1) (11,821) (118) (102,349) - - (102,467)
Contribution of ICG's investment in
NETCOM to ICG Services, Inc. in
exchange for 10 shares of common
stock of ICG Services, Inc.
(note 1) - - 102,467 - - 102,467
Cumulative foreign currency
translation adjustment - - - - (263) (263)
Net loss - - - (79,890) - (79,890)
------ ----- -------- --------- ------- ---------
Balances at December 31, 1998 - - 207,798 (175,024) (119) 32,655
Excess of book value of net assets
acquired over consideration
paid (note 6) - - 3,899 - - 3,899
Excess of fair value of assets
acquired over book value (note 10) - - (82,295) - - (82,295)
Reversal of foreign currency
translation adjustment (note 3) - - - - 119 119
Net income - - - 162,340 - 162,340
------ ------ -------- --------- ------- ---------
Balances at December 31, 1999 - $ - 129,402 (12,684) - 116,718
====== ====== ======== ========= ======= =========
See accompanying notes to consolidated financial statements.
F-8
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 1997, 1998 and 1999
- ---------------------------------------------------------------------------------------------------------------------------------
Years ended December 31,
------------------------------------------------------------
1997 1998 1999
------------------ ---------------- -----------------
(in thousands)
Cash flows from operating activities:
Net (loss) income $(33,092) (79,890) 162,340
Loss from discontinued operations 33,092 60,965 -
Extraordinary gain on sales of discontinued operations - - (178,917)
Adjustments to reconcile net (loss) income to net cash (used)
provided by operating activities:
Recognition of deferred gain - - (29,250)
Share of net (earnings) losses of equity investees - (1,075) 8,019
Depreciation - 4,064 55,334
Interest expense deferred and included in long-term debt - 44,040 60,599
Amortization of deferred financing costs included in
interest expense - 1,482 2,058
Amortization of deferred lease administration costs included
in selling, general and administrative expenses - 36 355
Change in operating assets and liabilities:
Receivables - (145,515) (62,643)
Prepaid expenses, deposits and inventory - (20) (1,873)
Accounts payable and accrued liabilities - 30,149 99,581
------------------ ---------------- -----------------
Net cash (used) provided by operating activities - (85,764) 115,603
------------------ ---------------- -----------------
Cash flows from investing activities:
Acquisition of property, equipment and other assets - (301,969) (503,925)
Purchase of corporate headquarters - - (10,528)
Payments for construction of corporate headquarters - - (3,300)
Investment in equity investees - (9,104) (35,093)
Investment in partnership interests and restricted
preferred stock - - (11,250)
Proceeds from sales of operations of NETCOM, net of
cash included in sale - - 252,881
(Purchase) sale of short-term investments available for sale - (41,000) 30,558
Proceeds from sale of marketable securities, net of
realized gain - - 30,000
Increase in restricted cash - - (1,030)
------------------ ---------------- -----------------
Net cash used by investing activities $ - (352,073) (251,687)
------------------ ---------------- -----------------
(Continued)
F-9
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
- -------------------------------------------------------------------------------------------------------------
Years ended December 31,
-------------------------------------------------
1997 1998 1999
---------------- ------------- -------------
(in thousands)
Cash flows from financing activities:
Proceeds from issuance of common stock:
Exercise of stock options $ - 341 -
Employee stock purchase plan - 132 -
Proceeds from issuance of long-term debt - 550,574 80,000
Deferred financing and lease administration costs - (18,245) (6,349)
Principal payments on capital lease obligations - - (3,241)
Principal payments on long-term debt - - (376)
-------------- ------------- -------------
Net cash provided by financing activities - 532,802 70,034
-------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents - 94,965 (66,050)
Net cash provided (used) by discontinued operations - 19,415 (5,108)
Cash and cash equivalents, beginning of year - - 114,380
Cash and cash equivalents, end of year $ - 114,380 43,222
============== ============= =============
Supplemental disclosure of cash flows information of
continuing operations:
Cash paid for interest $ - - 10,725
============== ============= =============
Cash paid for taxes $ - - 1,220
============== ============= =============
Supplemental disclosure of non-cash investing and financing
activities of continuing operations:
Acquisition of corporate headquarters assets
through the issuance of long-term debt (note 8) $ - - 33,077
============== ============= =============
Assets acquired pursuant to IRU agreement - - 135,322
Assets acquired under capital leases $ - - 6,190
-------------- ------------- -------------
Total (notes 7 and 11) $ - - 141,512
============== ============= =============
See accompanying notes to consolidated financial statements.
F-10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
______________________________________________________________________________
(1) Organization and Nature of Business
ICG Services, Inc., a Delaware corporation (ICG Services or the Company),
was incorporated on January 23, 1998 and is a wholly owned subsidiary of
ICG Communications, Inc., a Delaware corporation (ICG). On January 21,
1998, ICG completed a merger with NETCOM On-Line Communication Services,
Inc., a Delaware corporation and Internet service provider (ISP) located in
San Jose, California (NETCOM), in a transaction accounted for as a pooling
of interests. In conjunction with the merger between ICG and NETCOM,
NETCOM's employee stock purchase plan was dissolved and all outstanding
options to purchase common stock of NETCOM were converted into options to
purchase ICG Common Stock. Upon the formation of ICG Services on January
23, 1998, ICG contributed its investment in NETCOM to ICG Services and
NETCOM became a wholly owned subsidiary of, and predecessor entity to, ICG
Services. Accordingly, the financial statements of the Company prior to
January 23, 1998 consist solely of the accounts of NETCOM and its
subsidiaries.
Effective November 3, 1998, the Company's board of directors adopted the
formal plan to dispose of the operations of NETCOM (see note 3) and,
accordingly, the Company's consolidated financial statements reflect the
operations of NETCOM as discontinued for all periods presented. The
Company completed the sales of the operations of NETCOM on February 17 and
March 16, 1999. In conjunction with the sales, the legal name of the
NETCOM subsidiary was changed to ICG NetAhead, Inc. (NetAhead). NetAhead
has retained the domestic Internet backbone assets formerly owned by NETCOM
which it is utilizing for the provision of newly developed wholesale
network services to ISPs and other telecommunications providers.
On January 23, 1998, ICG Equipment, Inc., a Colorado corporation and wholly
owned subsidiary of the Company (ICG Equipment), was formed for the
principal purpose of providing financing of telecommunications equipment
and services to ICG Telecom Group, Inc., an indirectly wholly owned
subsidiary of ICG and provider of competitive local exchange services, and
its subsidiaries (ICG Telecom). Such financing is provided through ICG
Equipment's purchase of telecommunications equipment, software, network
capacity and related services from original equipment manufacturers,
providers of intercity network facilities and ICG Telecom, and subsequent
lease of such assets to ICG Telecom.
The Company's objective is to acquire and invest in telecommunications
equipment, software, network capacity and businesses that complement ICG's
business strategy. By leveraging its relationship with ICG, the Company
intends to capitalize on the growth in demand for telecommunications
equipment and services provided by the Company.
F-11
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(2) Significant Accounting Policies
(a) Basis of Presentation
The accompanying consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
(b) Cash Equivalents
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents.
(c) Investments
The Company's short-term investment objectives are safety, liquidity and
yield, in that order. The Company invests primarily in high grade short-
term investments which consist of money market instruments, commercial
paper, certificates of deposit, government obligations and corporate
bonds, all of which are considered to be available for sale and
generally have maturities of one year or less. Available for sale
investments are carried at amortized cost, which approximates fair
market value, with unrealized gains and losses, net of tax, reported as
other comprehensive loss in stockholder's equity. Realized gains and
losses and declines in value judged to be other than temporary are
included in the statement of operations.
Investments in partnership interests and common or preferred stock for
which there is no public trading market and which represent less than a
20% equity interest are accounted for using the cost method, unless the
Company exercises significant influence and/or control over the
operations of the investee company, in which case the equity method is
used. Investments representing an equity interest of 20% or more, but
less than 50%, are accounted for using the equity method of accounting,
whereby the Company's share of earnings or losses in the investee
company is included in results of operations. Losses recognized in
excess of the Company's investment due to an additional investment or
financing requirements, or guarantees, are recorded as a liability in
the consolidated financial statements.
(d) Inventory
Inventory, consisting of equipment to be utilized in the installation of
telecommunications systems, services and networks for customers, is
recorded at the
F-12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(2) Significant Accounting Policies (continued)
lower of cost or market.
(e) Property and Equipment
Property and equipment are stated at cost. Equipment held under capital
leases is stated at the lower of the fair value of the asset or the net
present value of the minimum lease payments at the inception of the
lease. For equipment held under capital leases, depreciation is
provided using the straight-line method over the estimated useful lives
of the assets owned, or the related lease term, whichever is shorter.
Estimated useful lives of major categories of property and equipment are
as follows:
Furniture, fixtures and office equipment 3 to 7 years
Machinery and equipment 3 to 8 years
Fiber optic equipment 8 years
Switch equipment 10 years
Fiber optic network 20 years
Buildings and improvements 31.5 years
(f) Deferred Costs
The Company defers the incremental costs of obtaining financing
instruments and of lease administration. Amortization of deferred costs
is provided on a straight-line basis, which approximates the interest
method, over the life of the related financing or lease agreement, the
maximum term of which is ten years.
(g) Impairment of Long-Lived Assets
The Company provides for the impairment of long-lived assets pursuant to
Statement of Financial Accounting Standards No. 121, Accounting for the
Impairment of Long- Lived Assets and for Long-Lived Assets to Be
Disposed Of (SFAS 121), which requires that long-lived assets and
certain identifiable intangibles held and used by an entity be reviewed
for impairment whenever events or changes in circumstances indicate that
the carrying value of an asset may not be recoverable. An impairment
loss is recognized when estimated undiscounted future cash flows
expected to be generated by the asset is less than its carrying value.
Measurement of the impairment loss is based on the fair value of the
asset, which is generally determined using valuation techniques such as
the discounted present value of expected future cash flows.
F-13
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(2) Significant Accounting Policies (continued)
(h) Foreign Currency Translation Adjustments
The functional currency for all foreign operations of NETCOM, which were
sold during the year ended December 31, 1999, was the local currency.
As such, all assets and liabilities denominated in foreign currencies
were translated through March 16, 1999 at the exchange rate on the
balance sheet date. Revenue and costs and expenses were translated at
weighted average exchange rates prevailing during the period.
Translation adjustments are included in other comprehensive loss, which
is a separate component of stockholder's equity. Gains and losses
resulting from foreign currency transactions are included in
discontinued operations and are not significant for the periods
presented.
(i) Revenue Recognition
ICG Equipment recognizes monthly leasing revenue from ICG on a straight-
line basis, according to the terms of the lease. Lease service revenue
earned on assets purchased by ICG Equipment and intended for future
lease to other subsidiaries of ICG, but not yet placed in service, is
recognized monthly based on the terms of ICG Equipment's master lease
agreement with ICG.
Prior to the sales of the operations of NETCOM, monthly subscription
service revenue was recognized over the period services were provided.
One-time set-up fees and equipment revenue, which required the use of
Company-provided installation of equipment at an Internet subscriber's
location, were recognized when the monthly subscription service was
commenced. The Company sold equipment to customers without future
obligation to purchase service. A provision for estimated equipment
returns was recorded in the period the revenue was recognized.
Prior to the sales of the operations of NETCOM, deferred revenue
included monthly advance billings to customers for Internet services
provided and also, to a lesser extent, billings to customers for
equipment shipped that had not been installed at customer locations.
(j) Income Taxes
The Company accounts for income taxes under the provisions of Statement
of Financial Accounting Standards No. 109, Accounting for Income Taxes
(SFAS 109). Under the asset and liability method of SFAS 109, deferred
tax assets and
F-14
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(2) Significant Accounting Policies (continued)
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. Deferred
tax assets and liabilities are measured using enacted tax rates expected
to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS 109, the
effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date.
Effective January 1, 1999, the Company entered into a tax sharing
agreement with ICG and its other subsidiaries. Together, the Company
and ICG make up an affiliated group of corporations as defined in
Section 1504 of the Internal Revenue Code and Treasury Regulations (the
"Code"), and join in filing a consolidated federal income tax return.
According to the tax sharing arrangement, the parties have mutually
agreed to reimburse other members of the affiliated group should one
member's income tax attributes be used to offset income or gains of
another member through the filing of consolidated federal and combined
state income tax returns.
(k) Net (Loss) Income Per Share
Shares outstanding prior to the Company's inception on January 23, 1998
consist solely of the common stock of NETCOM. At December 31, 1998 and
1999, the Company has 10 shares of common stock issued and outstanding,
which are owned entirely by ICG. Accordingly, the Company does not
present net (loss) income per share in its consolidated financial
statements as such disclosure is not considered to be meaningful.
(l) Stock-Based Compensation
The Company participates in ICG's stock-based employee compensation
plans. ICG accounts for its stock-based employee compensation plans
using the intrinsic value based method prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations (APB 25). The Company has
provided pro forma disclosures of net (loss) income for all periods
presented as if the fair value based method of accounting for these
plans, as prescribed by Statement of Financial Accounting Standards No.
123, Accounting for Stock-Based Compensation (SFAS 123), had been
applied and had the pro rata portion of compensation expense based on
Company employee participation been allocated to the Company by ICG.
Pro forma disclosures of net (loss) income per share is not presented as
such disclosure is not considered to be meaningful.
F-15
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
________________________________________________________________________________
(2) Significant Accounting Policies (continued)
(m) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosures of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenue and expenses
during the reporting periods. Actual results could differ from those
estimates.
(n) Reclassifications
Certain prior period amounts have been reclassified to conform with the
current period's presentation.
(3) Discontinued Operations
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., an ISP located in
Atlanta, Georgia and predecessor to EarthLink, Inc. (MindSpring). Total
proceeds from the sale were $245.0 million, consisting of $215.0 million in
cash and 376,116 shares of common stock of MindSpring, valued at
approximately $79.76 per share at the time of the transaction. Assets and
liabilities sold to MindSpring included those directly related to the
domestic operations of NETCOM's Internet dial-up, dedicated access and Web
site hosting services. In conjunction with the sale to MindSpring, the
Company entered into an agreement to lease to MindSpring for a one-year
period the capacity of certain network operating assets formerly owned by
NETCOM and retained by the Company. MindSpring utilized the Company's
network capacity under this agreement to provide Internet access to the
dail-up services customers formerly owned by NETCOM. In addition, the
Company received for a one-year period 50% of the gross revenue earned by
MindSpring from the dedicated access customers formerly owned by NETCOM. The
carrying value of the assets retained by the Company was approximately $21.7
million, including approximately $17.5 million of network equipment, on
February 17, 1999. The Company also retained approximately $11.3 million of
accrued liabilities and capital lease obligations.
On March 16, 1999, the Company sold all of the capital stock of NETCOM's
international operations for total proceeds of approximately $41.1 million.
MetroNET Communications Corp., a Canadian entity, and Providence Equity
Partners, located in Providence, Rhode Island (Providence), together
purchased the 80% interest in
F-16
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(3) Discontinued Operations (continued)
NETCOM Canada Inc. owned by NETCOM for approximately $28.9 million in cash.
Additionally, Providence purchased all of the capital stock of NETCOM
Internet Access Services Limited, NETCOM's operations in the United Kingdom,
for approximately $12.2 million in cash.
During the year ended December 31, 1999, the Company recorded a combined
gain on the sales of the operations of NETCOM of approximately $178.9
million, net of income taxes of approximately $2.0 million, and payments
required to be made under the tax sharing agreement of $16.3 million.
Offsetting the gain on the sales is approximately $16.6 million of net
losses from operations of NETCOM from November 3, 1998 (the date on which
the Company's board of directors adopted the formal plan to dispose of the
operations of NETCOM) through the dates of the sales. Additionally, since
the Company expected to generate operating costs in excess of revenue under
its network capacity agreement with MindSpring and the terms of the sale
agreement were dependent upon and negotiated in conjunction with the terms
of the network capacity agreement, the Company deferred approximately $34.7
million of the proceeds from the sale agreement to be applied on a periodic
basis to the network capacity agreement. The deferred proceeds were
recognized in the Company's statement of operations as the Company incurred
cash operating losses under the network capacity agreement. Accordingly, the
Company did not recognize any revenue, operating costs or selling, general
and administrative expenses from services provided to MindSpring for the
term of the agreement. Any incremental revenue or costs generated by other
customers were recognized in the Company's consolidated statement of
operations as incurred. During the year ended December 31, 1999, the Company
applied $29.3 million of deferred proceeds from the sale of the operating
assets and liabilities of NETCOM to the network capacity agreement with
MindSpring, which entirely offset the cost of the Company's operations under
the agreement. The Company, through NetAhead, is currently utilizing the
retained network operating assets to provide similar wholesale capacity and
other enhanced network services on an ongoing basis to MindSpring under a
new agreement as well as to other ISPs and telecommunications providers.
Operating results from such services will be included in the Company's
statement of operations as incurred. Since the operations sold were acquired
by ICG in a transaction accounted for as a pooling of interests, the gain on
the sales of the operations of NETCOM is classified as an extraordinary item
in the Company's consolidated statement of operations.
F-17
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(4) Short-term Investments Available for Sale
Short-term investments available for sale are comprised of the following:
December 31,
------------------------------
1998 1999
---------- ----------
(in thousands)
Certificates of deposit $ 31,000 10,442
Commercial paper 5,000 -
U.S. Treasury securities 5,000 -
---------- ----------
$ 41,000 10,442
========== ==========
At December 31, 1998 and 1999, the estimated fair value of the Company's
certificates of deposit, commercial paper and U.S. Treasury securities
approximated cost. All certificates of deposit, commercial paper and U.S.
Treasury securities included in short-term investments available for sale
mature within one year.
(5) Property and Equipment
Property and equipment, including assets held under capital leases, is
comprised of the following:
December 31,
------------------------
1998 1999
--------- --------
(in thousands)
Land $ - 10,794
Buildings and improvements - 36,203
Furniture, fixtures and office equipment - 6,862
Machinery and equipment 2,997 13,451
Fiber optic equipment 76,523 241,166
Switch equipment 36,602 158,252
Fiber optic network 78,881 282,469
Site improvements - 810
Construction in progress 106,966 166,946
-------- --------
301,969 916,953
Less accumulated depreciation (4,064) (64,273)
-------- --------
$297,905 852,680
======== ========
Construction in progress consists of approximately $166.9 million of
property and equipment which has not been placed in service at December 31,
1999 and, accordingly,
F-18
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(5) Property and Equipment (continued)
is not being depreciated. This amount primarily relates to
telecommunications equipment and other assets purchased by ICG Equipment,
but not yet leased to other subsidiaries of ICG.
Substantially all of the assets described above have been pledged as
security for long-term debt.
The following is a summary of property and equipment held under capital
leases or acquired pursuant to an IRU agreement as of December 31, 1999:
December 31,
--------------------------------
1998 1999
----------- ------------
(in thousands)
Fiber optic network $ - 141,633
Switch equipment - 1,911
---------- ----------
- 143,544
Less accumulated depreciation - (2,645)
---------- ----------
$ - 140,899
========== ==========
Amortization of capital leases is included in depreciation and amortization
or in loss from discontinued operations in the Company's consolidated
statements of operations for all periods presented.
F-19
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(5) Property and Equipment (continued)
The Company's property and equipment which is leased under operating leases
to other subsidiaries of ICG is as follows:
December 31,
------------------------
1998 1999
---------- ----------
(in thousands)
Furniture, fixtures and office equipment $ - 4,631
Machinery and equipment 2,997 13,507
Fiber optic equipment 76,523 280,142
Switch equipment 36,602 129,792
Fiber optic network 78,881 132,509
--------- ----------
195,003 560,581
Less accumulated depreciation (4,069) (54,473)
--------- ----------
$ 190,934 506,108
========= ==========
Minimum future rentals on non-cancelable operating leases with other
subsidiaries of ICG are as follows at December 31, 1999 (in thousands):
2000 $ 107,131
2001 108,295
2002 108,826
2003 107,310
2004 90,976
Thereafter 105,822
----------
$ 628,360
==========
(6) Investments
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock of
NorthPoint Communications Holdings, Inc., a Delaware corporation and
competitive local exchange carrier based in San Francisco, California
(NorthPoint) which was converted into 555,555 shares of Class B common
stock of NorthPoint (the NorthPoint Class B Shares) on May 5, 1999. The
NorthPoint Class B shares are convertible on or after March 31, 2000 on a
one-for- one basis into a voting class of common stock of NorthPoint. The
Company is accounting for its investment in NorthPoint under the cost
method of accounting until the NorthPoint Class B Shares are converted into
voting and tradable common stock of NorthPoint.
F-20
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(6) Investments (continued)
On August 11, 1999, the Company purchased 1,250,000 shares of Series C
Preferred Stock (the ThinkLink Preferred Stock) of International ThinkLink
Corporation (ThinkLink), for $1.0 million in cash. The ThinkLink Preferred
Stock will automatically convert to common stock upon the completion of the
initial public offering of the common stock of ThinkLink or upon election
to convert by the holders of a majority of the ThinkLink Preferred Stock.
The conversion rate from the ThinkLink Preferred Stock to common stock of
ThinkLink is initially one-for-one; however, such conversion rate is
subject to adjustment. The Company has accounted for its investment in
ThinkLink under the cost method of accounting. Dividends on the ThinkLink
Preferred Stock will be included in income when paid. ThinkLink is an
Internet and enhanced services provider.
On November 15, 1999, the Company entered into an agreement to purchase a
limited partnership interest in Centennial Strategic Partners VI, L.P.
(Centennial). The primary purpose of the partnership is to invest in
venture capital investments, principally by investing in equity or equity-
oriented securities of privately held companies in the electronic
communications industry. The Company has capital contribution commitments
to Centennial of $1.0 million to be funded in installments through January
15, 2002. Through December 31, 1999, the Company had contributed
approximately $0.3 million to the partnership. The Company has accounted
for its investment in Centennial under the cost method of accounting.
On August 27, 1998, the Company purchased, for $9.1 million in cash, the
remaining 20% equity interest in ICG Ohio LINX, Inc. (ICG Ohio LINX) which
ICG Telecom did not already own, including incremental costs of obtaining
that investment of $0.1 million. ICG Ohio LINX is a facilities-based
competitive local exchange carrier which operates a fiber optic
telecommunications network in Cleveland and Dayton, Ohio. The Company has
accounted for its investment in ICG Ohio LINX under the equity method of
accounting. For the years ended December 31, 1998 and 1999, the Company
included approximately $1.1 million and $1.8 million, respectively, in its
consolidated statements of operations for its proportionate share of
earnings of ICG Ohio LINX.
On March 1, 1999, the Company purchased from ICG Telecom, for $35.1 million
in cash, a 49% equity interest in ICG ChoiceCom, L.P. (ChoiceCom). Based
in Austin, Texas, ChoiceCom currently provides local exchange and long
distance services in Austin, Corpus Christi, Dallas, Houston and San
Antonio, Texas. The Company accounts for its investment in ChoiceCom under
the equity method of accounting. The remaining 51% equity interest in
ChoiceCom is owned by ICG Telecom. Due to the related party nature
F-21
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(6) Investments (continued)
of the transaction, the Company has reflected the excess of ICG Telecom's
book value of the net assets acquired over the consideration paid of $3.9
million as a contribution to equity in the accompanying consolidated
financial statements. For the year ended December 31, 1999, the Company
included approximately $9.8 million in its consolidated statement of
operations for its proportionate share of losses of ChoiceCom.
(7) Capital Lease Obligations
The Company has payment obligations under various capital lease agreements
for property and equipment. Required payments due each year on or before
December 31 under the Company's capital lease obligations are as follows
(in thousands):
2000 $ 2,798
2001 1,004
2002 786
2003 786
2004 786
Thereafter 11,267
------------
Total minimum lease payments 17,427
Less amounts representing interest (9,692)
------------
Present value of net minimum lease payments 7,735
Less current portion (1,951)
------------
$ 5,784
============
In December 1999, the Company entered into a maximum 20-year agreement with
a major interexchange carrier to lease approximately 18,000 miles of long-
haul capacity in various regions of the United States for $140.1 million,
payable in installments through June 2000. The discounted value of the
Company's remaining payments on the lease of $135.3 million is included in
payable pursuant to IRU agreement in the accompanying consolidated balance
sheet at December 31, 1999.
F-22
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- --------------------------------------------------------------------------------------------------
(8) Long-term debt is summarized as follows:
December 31,
------------------------------------------
1998 1999
--------------------- -----------------
(in thousands)
Senior Facility with adjustable rate of interest due on
scheduled maturity dates, secured by assets of ICG
Equipment and NetAhead (a) $ - 79,625
9 7/8% Senior discount notes, net of discount (b) 266,918 293,925
10% Senior discount notes, net of discount (c) 327,699 361,290
Mortgage loan payable with adjustable rate of interest
(14.77% at December 31, 1999) due in full on January
31, 2013, secured by corporate headquarters (d)
- 33,077
--------------------- -----------------
594,617 767,917
Less current portion - (750)
--------------------- -----------------
$594,617 767,167
===================== =================
(a) Senior Facility
On August 12, 1999 and amended on December 29, 1999, ICG Equipment and
NetAhead entered into a $200.0 million senior secured financing facility
(the "Senior Facility") consisting of a $75.0 million term loan, a $100.0
million term loan and a $25.0 million revolving line of credit. The
Senior Facility is guaranteed by ICG Services and is secured by the
assets of ICG Equipment and NetAhead, which are substantially all of the
assets of ICG services.
As required under the terms of the loan, the Company borrowed on August
12, 1999 the available $75.0 million on the $75.0 million term loan. The
loan bears interest at an annual interest rate of LIBOR plus 3.5% or the
base rate, as defined in the credit agreement, plus 2.5%, at the
Company's option. At December 31, 1999, the $75.0 million term loan bears
annual interest at LIBOR plus 3.5%, or 9.67%. Quarterly repayments
commenced September 30, 1999 and require quarterly loan balance
reductions of 0.25% through June 30, 2005 with the remaining outstanding
balance to be repaid during the final three quarters of the loan term.
The $75.0 million term loan matures on March 31, 2006. At December 31,
1999, the Company had $74.6 million outstanding under the $75.0 million
term loan.
On August 12, 1999, the Company borrowed $5.0 million on the $100.0
million term loan. The $100.0 million term loan is available for
borrowing through August 10, 2000 at an initial annual interest rate of
LIBOR plus 3.125% or the base rate, as
F-23
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(8) Long-term Debt (continued)
defined in the credit agreement, plus 2.125%, at the Company's option.
At December 31, 1999, the $5.0 million outstanding under the $100.0
million term loan bears annual interest at LIBOR plus 3.125%, or 9.35%.
Quarterly repayments commence September 30, 2002 and require aggregate
loan balance reductions of 25% through June 30, 2003, 35% through June
30, 2004 and 40% through June 30, 2005. The $100.0 million term loan
matures on June 30, 2005.
The $25.0 million revolving line of credit is available through the
maturity date of June 30, 2005 at an initial annual interest rate of
LIBOR plus 3.125% or the base rate, as defined in the credit agreement,
plus 2.125%, at the Company's option.
The Company is required to pay commitment fees ranging from 0.625% to
1.375% for the unused portion of available borrowings under the Senior
Facility.
The terms of the Senior Facility provide certain limitations on the use
of proceeds, additional indebtedness, dividends, prepayment of the
Senior Facility and other indebtedness and certain other transactions.
Additionally, the Company is subject to certain financial covenants
based on its results of operations and the results of operations of ICG.
During the year ended December 31, 1999, certain defined terms in the
credit agreement for the Senior Facility were amended to ensure that the
Company would remain in compliance with the financial covenants of the
Senior Facility.
The amortization of the debt issuance costs is included in interest
expense in the accompanying consolidated statement of operations for the
year ended December 31, 1999.
(b) 9 7/8% Notes
On April 27, 1998, the Company completed a private placement of 9 7/8%
Senior Discount Notes due 2008 (the "9 7/8% Notes") for gross proceeds
of approximately $250.0 million. Net proceeds from the offering, after
underwriting and other offering costs of approximately $7.9 million,
were approximately $242.1 million.
The 9 7/8% Notes are unsecured senior obligations of the Company that
mature on May 1, 2008, at a maturity value of $405.3 million. Interest
will accrue at 9 7/8% per annum, beginning May 1, 2003, and is payable
each May 1 and November 1, commencing November 1, 2003. The indenture
for the 9 7/8% Notes contains certain covenants which provide
limitations on indebtedness, dividends, asset sales
F-24
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(8) Long-term Debt (continued)
and certain other transactions.
The 9 7/8% Notes were originally recorded at approximately $250.0
million. The discount on the 9 7/8% Notes is being accreted through May
1, 2003, the date on which the 9 7/8% Notes may first be redeemed. The
accretion of the discount and the amortization of the debt issuance
costs is included in interest expense in the accompanying consolidated
statements of operations.
(c) 10% Notes
On February 12, 1998, the Company completed a private placement of 10%
Senior Discount Notes due 2008 (the "10% Notes") for gross proceeds of
approximately $300.6 million. Net proceeds from the offering, after
underwriting and other offering costs of approximately $9.7 million,
were approximately $290.9 million.
The 10% Notes are unsecured senior obligations of the Company that
mature on February 15, 2008, at a maturity value of $490.0 million.
Interest will accrue at 10% per annum, beginning February 15, 2003, and
is payable each February 15 and August 15, commencing August 15, 2003.
The indenture for the 10% Notes contains certain covenants which provide
limitations on indebtedness, dividends, asset sales and certain other
transactions.
The 10% Notes were originally recorded at approximately $300.6 million.
The discount on the 10% Notes is being accreted through February 15,
2003, the date on which the 10% Notes may first be redeemed. The
accretion of the discount and the amortization of the debt issuance
costs is included in interest expense in the accompanying consolidated
statements of operations.
(d) Mortgage Loan Payable
Effective January 1, 1999, the Company purchased ICG's corporate
headquarters building, land and improvements (collectively, the
"Corporate Headquarters") for approximately $43.4 million. The Company,
through a newly formed subsidiary, financed the purchase primarily
through a loan secured by a mortgage on the Corporate Headquarters,
guaranteed by the Company. The amended loan agreement, dated May 1,
1999, requires monthly interest payments at an initial interest rate of
14.77% per annum, which rate increases annually by 0.003%, with the
mortgage balance due in full on January 31, 2013. The seller of the
Corporate Headquarters has retained an option to repurchase the
Corporate Headquarters at the
F-25
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(8) Long-term Debt (continued)
original sales price, which option is exercisable from January 1, 2004
through January 31, 2012.
Scheduled principal maturities of long-term debt as of December 31, 1999
are as follows (in thousands):
Year:
2000 $ 750
2001 750
2002 750
2003 750
2004 750
Thereafter 1,004,202
-------------
1,007,952
Less unaccreted discount (240,035)
Less current portion (750)
-------------
$ 767,167
=============
(9) Stock Options and Employee Stock Purchase Plan
The NETCOM 1993 Stock Option Plan was assumed by ICG at the time of the
merger, and approved by ICG's board of directors as an incentive and non-
qualified stock option plan which provides for the granting of options to
certain directors, officers and employees to purchase 2,720,901 shares of
ICG Common Stock. A total of 2,073,277 options, net of cancellations, have
been granted under this plan through December 31, 1999 at exercise prices
ranging from $0.56 to $79.50, none of which were less than 100% of the fair
market value of the shares underlying options on the date of grant, and
accordingly, no compensation expense was recorded for these options under
APB 25. The options granted under this plan are subject to various vesting
requirements, generally three and five years, and expire within ten years
from the date of grant.
During the year ended December 31, 1998, ICG's board of directors approved
incentive and non-qualified stock option plans and replenishments to those
plans which provide for the granting of options to certain directors,
officers and employees, including officers and employees of the Company, to
purchase 3,400,000 shares of ICG Common Stock. A total of 487,552 options,
net of cancellations, have been granted to employees of the Company under
this plan at original exercise prices ranging from $11.38 to $35.75, none
of which were less than 100% of the fair market value of the shares
underlying options on the date of grant, and accordingly, no compensation
expense was recorded for these options under
F-26
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(9) Stock Options and Employee Stock Purchase Plan (continued)
APB 25. The options granted under these plans are subject to various
vesting requirements and expire in five and ten years from the date of
grant.
Additionally, during the year ended December 31, 1999, ICG's board of
directors granted 5,150 non-qualified stock options, net of cancellations
through December 31, 1999, to certain officers and employees of the Company
at exercise prices ranging from $14.75 to $22.38, none of which were less
than 100% of the fair market value of the shares underlying options on the
date of the grant, and accordingly, no compensation expense was recorded
for these options under APB 25. The non-qualified options granted during
the year ended December 31, 1999 are subject to various vesting
requirements and expire in ten years from the date of grant.
In order to continue to provide non-cash incentives and retain key
employees, all employee stock options outstanding on September 18, 1998
with exercise prices at or in excess of $22.00 were canceled by the Stock
Option Committee of ICG's Board of Directors and regranted with an exercise
price of $16.875, the closing price of ICG Common Stock on the Nasdaq
National Market on September 18, 1998. A total of 757,058 options held by
employees of the Company, with original exercise prices ranging from $22.02
to $35.75 were canceled and regranted on September 18, 1998. There was no
effect on ICG's or the Company's consolidated financial statements as a
result of the cancellation and regranting of options.
During the year ended December 31, 1994, NETCOM's board of directors
approved and adopted an Employee Stock Purchase Plan which was dissolved
upon NETCOM's merger with ICG. Shares purchased under this plan were
converted into an estimated 119,000 shares of ICG Common Stock.
During the year ended December 31, 1998, the Company's employees became
eligible to participate in ICG's Employee Stock Purchase Plan whereby
employees can elect to designate 1% to 30% of their annual salary, to be
used to purchase shares of ICG Common Stock, up to a limit of $25,000 in
ICG Common Stock each year, at a 15% discount to fair market value. Stock
purchases occur four times a year on February 1, May 1, August 1 and
November 1, with the price per share equaling the lower of 85% of the
market price at the beginning or end of the offering period. ICG is
authorized to issue a total of 1,000,000 shares of ICG Common Stock to
participants in the plan. During the years ended December 31, 1998 and
1999, ICG sold 10,080 and 13,589 shares, respectively, of ICG Common Stock
to employees of the Company under this plan.
ICG accounts for its stock-based employee and non-employee director
compensation plans pursuant to the intrinsic value based method of APB 25.
Had compensation
F-27
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(9) Stock Options and Employee Stock Purchase Plan (continued)
expense for ICG's plans been determined based on the fair market value of
the options at the grant dates for awards under those plans consistent with
the provisions of SFAS 123 and had the pro rata portion of compensation
expense based on Company employee participation been allocated to the
Company, the Company's pro forma net (loss) income would have been as
presented below.
Years ended December 31,
-----------------------------------
1997 1998 1999
-------- -------- ---------
(in thousands)
Net (loss) income:
As reported $ (33,092) (79,890) 162,340
Pro forma (37,962) (85,379) 160,910
The fair value of each option grant to employees was estimated on the date
of grant using the Black-Scholes option-pricing model with the following
assumptions: an expected option life of 1.6 years for the year ended
December 31, 1997, and three years for officers and other executives and
two years for other employees for the years ended December 31, 1998 and
1999; expected volatility of 80% for the year ended December 31, 1997, and
70% for the years ended December 31, 1998 and 1999; and risk-free interest
rates of 6% for the year ended December 31, 1997 and risk-free interest
rates ranging from 4.11% to 5.66% for the year ended December 31, 1998 and
4.67% to 6.25% for the year ended December 31, 1999. Risk-free interest
rates, as were currently available on the grant date, were assigned to each
granted option based on the zero-coupon rate of U.S. Treasury bills to be
held for the same period as the assumed option life. Since ICG does not
anticipate issuing any dividends on the ICG Common Stock, the dividend
yield for all options granted was assumed to be zero. The weighted average
fair market value of options granted to Company employees during the years
ended December 31, 1997, 1998 and 1999 was approximately $13.84, $12.96 and
$11.19 per option, respectively.
As options outstanding at December 31, 1999 will continue to vest in
subsequent periods and additional options are expected to be awarded under
existing and new plans, the above pro forma results are not necessarily
indicative of the impact on net (loss) income in future periods.
F-28
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(9) Stock Options and Employee Stock Purchase Plan (continued)
The following table summarizes the status of ICG's stock-based compensation
plans for Company employees:
Shares underlying Weighted average Options
options exercise price exercisable
------------------- -------------------- -------------------
(in thousands) (in thousands)
Outstanding at January 1, 1997 1,631 $30.24 507
Granted 1,831 16.11
Exercised (77) 12.96
Canceled (1,744) 29.84
------------
Outstanding at December 31, 1997 1,641 15.67 495
Granted 1,661 23.04
Exercised (706) 14.90
Canceled (1,282) 25.04
------------
Outstanding at December 31, 1998 1,314 16.27 442
Granted 375 21.53
Exercised (372) 15.20
Canceled (739) 18.61
Transfers to parent (8) 17.29
------------
Outstanding at December 31, 1999 570 16.89 149
============
F-29
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(9) Stock Options and Employee Stock Purchase Plan (continued)
The following table summarizes information about options granted to Company
employees outstanding at December 31, 1999:
Options outstanding Options exercisable
-------------------------------------------------------- -------------------------------------
Weighted
average Weighted Weighted
Range of remaining average average
exercise Number contractual exercise Number exercise
prices outstanding life price exercisable price
- --------------------- ----------------- --------------- ---------------- ----------------- ----------------
(in thousands) (in years) (in thousands)
$ 5.20 - 15.65 50 6.13 $13.98 26 $6.17
15.73 - 16.13 62 7.11 15.25 13 7.08
16.44 - 18.25 320 8.19 17.10 106 7.30
18.33 - 30.00 138 8.85 19.65 4 8.62
-------- -------
570 149
======== =======
(10) Related Party Transactions
The Company and its subsidiaries have entered into certain intercompany and
shared services agreements with ICG, whereby ICG allocates to the Company
direct and certain indirect costs incurred by ICG or its other subsidiaries
(the "Restricted Subsidiaries") on behalf of the Company. Allocated
expenses generally include a portion of salaries and related benefits of
legal, accounting and finance, information systems support and other ICG
employees, certain overhead costs and reimbursement for invoices of the
Company paid by ICG. Conversely, any cash collected by ICG on behalf of
the Company or its subsidiaries or invoices paid by the Company on behalf
of ICG or its Restricted Subsidiaries are in turn reimbursed to the Company
by ICG. As the Company and its subsidiaries and ICG and its Restricted
Subsidiaries jointly enter into service offerings and other transactions,
joint costs incurred are generally allocated to each of the Company and ICG
according to the relative capital invested and efforts expended by each
party. Management believes that all transactions between the Company,
including its subsidiaries, and ICG, including its Restricted Subsidiaries,
contain fair and reasonable terms. All such transactions are settled in
cash on a quarterly basis.
ICG charged approximately $8.0 million and $46.8 million for the years
ended December 31, 1998 and 1999, respectively, to the Company for
intercompany transfers and direct and indirect costs incurred by ICG and
its Restricted Subsidiaries on behalf of the
F-30
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(10) Related Party Transactions (continued)
Company. Of these amounts, approximately $2.4 million and $0.9 million is
included in the Company's selling, general and administrative expenses for
the years ended December 31, 1998 and 1999, respectively. The Company
charged to ICG and its Restricted Subsidiaries for intercompany transfers
and direct and indirect costs incurred by the Company on behalf of ICG and
its Restricted Subsidiaries approximately $284.5 million and $607.9 million
for the years ended December 31, 1998 and 1999, respectively. The net
receivable of $145.5 and $203.0 as of December 31, 1998 and 1999,
respectively, from ICG for intercompany charges is included in due from ICG
in the Company's consolidated balance sheets. Accrued liabilities includes
amounts due to ICG of approximately $22.5 million as of December 31, 1999
for accrued line costs and costs related to the purchase of equipment from
ICG. Net interest income earned by the Company on outstanding balances
from ICG and its Restricted Subsidiaries is included in interest income in
the Company's consolidated statements of operations and was approximately
$4.6 million and $18.6 million for the years ended December 31, 1998 and
1999, respectively. Interest has been accrued on outstanding balances of
intercompany transfers and direct and indirect costs between ICG Services
and ICG and its Restricted Subsidiaries at 10% and 12 1/2% per annum for
the years ended December 31, 1998 and 1999, respectively, which represents
the Company's approximate weighted average cost of capital at the beginning
of the respective years.
ICG Equipment purchased certain telecommunications equipment both from and
for ICG Telecom for an aggregate purchase price of approximately $195.0
million and $466.7 million during the years ended December 31, 1998 and
1999, respectively. Additionally, ICG Equipment entered into separate
agreements to lease $195.0 million and $374.1 million during the years
ended December 31, 1998 and 1999, respectively, of telecommunications
equipment to ICG Telecom under operating leases, with annual lease payments
commencing one year from the date of the lease. ICG Equipment recognizes
revenue from the lease payments ratably over the lease terms. ICG
Equipment recognized approximately $4.9 million and $79.1 million for the
years ended December 31, 1998 and 1999, respectively, in revenue under its
operating leases with ICG Telecom. The purchase prices and lease payments
for all leases are subject to adjustment, based on the results of an
independent appraisal which may be requested at the option of ICG Equipment
on or before 90 days from the purchase date. ICG Equipment submitted a
request to ICG Telecom for independent appraisals of certain of the
telecommunications equipment and fiber optic capacity purchased through
June 30, 1999. The Company received the appraisals for certain transactions
completed during the years ended December 31, 1998 and 1999 which
determined the fair value of the purchased telecommunications equipment and
fiber optic capacity exceeded the book value, and accordingly, the original
purchase price, by $82.3 million. The Company has reflected the payment of
the excess
F-31
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(10) Related Party Transactions (continued)
of fair value over the original purchase price as a reduction of equity in
the accompanying consolidated financial statements.
Additionally, under a master lease agreement between ICG Equipment and ICG
Telecom, ICG Telecom is required to pay ICG Equipment a monthly lease
service fee, at an annual rate of prime plus 4% (12.50% at December 31,
1999), based on the average monthly balance of assets purchased by ICG
Equipment and intended for future lease to ICG Telecom, but not yet placed
into service. ICG Equipment places assets in service upon the commencement
of the respective lease term. ICG Equipment recognized approximately $5.0
million and $14.6 million for the years ended December 31, 1998 and 1999,
respectively, of service fee revenue under this agreement. The amount of
assets purchased by ICG Equipment and intended for future lease to ICG
Telecom, but not yet placed into service, was approximately $165.8 million
at December 31, 1999. The Company begins depreciation on property and
equipment at the time the assets are placed in service.
In the normal course of business, ICG Telecom provides the use of certain
of its local access lines to NETCOM (prior to the disposition of the
operations of NETCOM) and NetAhead and, accordingly, charges NETCOM and
NetAhead for costs of any installation and recurring access to its network.
For the year ended December 31, 1998, NETCOM incurred approximately $2.3
million for installation and recurring local access charges
from ICG Telecom, which is included in loss from discontinued operations in
the accompanying consolidated financial statements. For the year ended
December 31, 1999, NETCOM and NetAhead together incurred approximately $4.3
million for installation and recurring local access charges from ICG
Telecom, which is included in the extraordinary gain on the sales of the
operations of NETCOM for those charges relating to NETCOM, and in operating
costs for those charges relating to NetAhead, a portion of which were
applied against the deferred gain on the sale of certain of NETCOM's
domestic operating assets and liabilities, in the Company's consolidated
financial statements for the year ended December 31, 1999. Conversely,
NetAhead provides the use of its network to ICG Telecom in NetAhead's and
ICG Telecom's joint service offerings. For the year ended December 31,
1999, NetAhead recognized approximately $1.2 million of revenue from ICG
Telecom for network services provided to ICG Telecom in conjunction with
NetAhead's and ICG Telecom's joint service offerings of Internet protocol
(IP) telephony services and other enhanced data services. Additionally,
included in cost of services of NetAhead is approximately $1.4 million for
the year ended December 31, 1999 for costs incurred by NetAhead associated
with NetAhead's and ICG Telecom's joint service offerings of IP telephony
services and other enhanced data services.
F-32
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(10) Related Party Transactions (continued)
Effective January 1, 1999, the Company purchased ICG's Corporate
Headquarters. The Company assumed the lease from the prior owner upon
acquisition and is leasing the Corporate Headquarters to a subsidiary of
ICG under an operating lease. For the year ended December 31, 1999, the
Company earned leasing revenue from the Restricted Subsidiary of ICG of
approximately $4.8 million under the operating lease, which is included in
revenue and due from ICG in the Company's consolidated financial
statements. The Company received $2.5 million from the subsidiary as a
security deposit on the operating lease, which is included in other long-
term liabilities in the Company's consolidated financial statements.
During the year ended December 31, 1999, the Company recorded a liability
of $16.3 million to reimburse ICG for income tax losses generated by ICG's
other subsidiaries which were used to offset current income tax liabilities
of the Company in accordance with the tax sharing agreement.
(11) Commitments and Contingencies
(a) Network Construction and Capital Purchase Commitments
The Company has entered into various equipment purchase agreements
with certain of its vendors. Under these agreements, if the Company
does not meet a minimum purchase level in any given year, the vendor
may discontinue certain discounts, allowances and incentives
otherwise provided to the Company. In addition, the agreements may be
terminated by either the Company or the vendor upon prior written
notice.
The Company has entered into certain commitments to purchase capital
assets with an aggregate purchase price of approximately $159.5
million at December 31, 1999.
F-33
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(11) Commitments and Contingencies (continued)
(b) Litigation
NETCOM, now NetAhead, is a party to certain litigation which has
arisen in the ordinary course of business. In the opinion of
management, the ultimate resolution of these matters will not have a
material adverse effect on the Company's financial condition, results
of operations or cash flows.
(c) Operating Leases
The Company leases office space and equipment under non-cancelable
operating leases. Lease expense was approximately $3.2 million for
the year ended December 31, 1999, however, all rent expense during
the year ended December 31, 1999 was incurred by NetAhead and was
entirely offset against the deferred proceeds from the sale of the
operating assets and liabilities of NETCOM allocated to the network
capacity agreement with MindSpring. Minimum lease payments due each
year on or before December 31 under the Company's operating leases
are as follows (in thousands):
2000 $ 2,057
2001 1,661
2002 1,367
2003 1,228
2004 1,303
Thereafter 6,387
---------
$ 14,003
=========
(12) Business Units
The Company conducts transactions with external customers through the
operations of its Network Services (NetAhead) and Leasing Services
(primarily ICG Equipment). Direct and certain indirect costs incurred by
ICG Services, Inc., the parent company, on behalf of Network Services and
Leasing Services are allocated among those business units based on the
nature of the underlying costs. The operations of Network Services are not
considered to be significant for purposes of business segment reporting
and, accordingly, are included with the remaining corporate subsidiaries of
the Company which primarily hold securities.
Set forth below are revenue, EBITDA (which represents the measure of
operating performance used by management to evaluate operating results),
depreciation, interest expense, capital expenditures of continuing
operations and total assets for Leasing Services and all other subsidiaries
of the Company combined. As described in note 3, the
F-34
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(12) Business Units (continued)
operating results of the Company reflect the operations of NETCOM as
discontinued for all periods presented.
Years ended December 31,
--------------------------------------------------
1997 1998 1999
-------------- -------------- ---------------
(in thousands)
Revenue:
Leasing Services $ - 9,911 98,511
All other - - 1,604
-------------- -------------- ---------------
Total revenue $ - 9,911 100,115
============== ============== ===============
EBITDA (a):
Leasing Services $ - 9,379 97,621
All other - (3,229) (3,067)
-------------- -------------- ---------------
Total EBITDA $ - 6,150 94,554
============== ============== ===============
Depreciation (b):
Leasing Services $ - 4,064 46,633
All other - - 8,701
-------------- -------------- ---------------
Total depreciation $ - 4,064 55,334
============== ============== ===============
Interest expense (b):
Leasing Services $ - - 7,956
All other - 45,522 66,395
-------------- -------------- ---------------
Total interest expense $ - 45,522 74,351
============== ============== ===============
Share of net earnings (losses) of
equity investees:
Leasing Services $ - - -
All other - 1,075 (8,019)
-------------- -------------- ---------------
Total share of net earnings
(losses) of equity
investees $ - 1,075 (8,019)
============== ============== ===============
(Continued)
F-35
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(12) Business Units (continued)
Years ended December 31,
------------------------------------------------
1997 1998 1999
------------ ------------ -------------
(in thousands)
Extraordinary gain on sales of
operations of NETCOM:
Leasing Services $ - - -
All other - - 178,917
------------ ------------ -------------
Total extraordinary gain on sales
of operations of NETCOM $ -
============ ============ =============
Capital expenditures of continuing
operations (c):
Leasing Services $ - 301,969 468,047
All other - - 177,390
------------ ------------ -------------
Total capital
expenditures of
continuing operations $ - 301,969 645,437
============ ============ =============
December 31,
-------------------------------
1998 1999
------------- -----------
(in thousands)
Investments accounted for under the
equity method:
Leasing Services $ - -
All other 10,179 41,152
---------- --------
Total investments accounted
for under the equity method $ 10,179 41,152
========== ========
Total assets:
Leasing Services $ 292,300 713,166
All other (d) 195,664 355,406
Net non-current assets of discontinued
operations 54,023 -
Due from ICG 137,762 119,185
---------- ---------
Total assets $ 679,749 1,187,757
========== ===========
F-36
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(12) Business Units (continued)
(a) EBITDA consists of loss from continuing operations before interest,
income taxes, depreciation, other expense, net, and share of net
earnings (losses) of equity investees, or operating income plus
depreciation. EBITDA is presented as the Company's measure of
operating performance because it is a measure commonly used in the
telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended
to represent cash flows from operating activities or results of
operations in accordance with generally accepted accounting
principles for the periods indicated. EBITDA is not a measurement
under generally accepted accounting principles and is not necessarily
comparable with similarly titled measures of other companies.
(b) Although not included in EBITDA (which represents the measure of
operating performance used by management to evaluate operating
results), the Company has supplementally provided depreciation and
interest expense for each of the Company's Leasing Services and all
other Company subsidiaries combined. Interest expense excludes
amounts charged by ICG Services, Inc. to ICG Equipment, Inc. (Leasing
Services) for interest on outstanding cash advances and expense
allocations.
(c) Capital expenditures includes assets acquired under capital leases
and excludes payments for construction of the Company's headquarters
and corporate headquarters assets acquired through the issuance of
long-term debt.
(d) Total assets excludes the investment in ICG Equipment, Inc. (Leasing
Services) which eliminates in consolidation.
(13) Income Taxes
Current income taxes paid during the years ended December 31, 1997, 1998
and 1999 represents foreign and state income taxes relating to operations
of NETCOM in foreign countries and in states requiring separate entity tax
returns, and is included in loss from discontinued operations or the
extraordinary gain in the Company's consolidated financial statements.
Income tax benefit differs from the amounts computed by applying the U.S.
federal income tax rate to loss before income taxes primarily because the
Company has not recognized the income tax benefit of certain of its net
operating loss carryforwards and other deferred tax assets due to the
uncertainty of realization.
F-37
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(13) Income Taxes (continued)
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1999 are as follows:
December 31,
----------------------------
1998 1999
------------ ----------
(in thousands)
Deferred income tax liabilities:
Property and equipment, due to excess
purchase price of tangible assets and
differences in depreciation for book
and tax purposes $ 2,252 26,515
-------- -------
Deferred income tax assets:
Net operating loss carryforwards (64,186) (67,770)
Accrued expenses not currently deductible
for tax purposes - (1,281)
Less valuation allowance 61,934 42,536
-------- -------
Net deferred income tax assets (2,252) (26,515)
-------- -------
Net deferred income tax liability $ - -
======== =======
As of December 31, 1999, the Company has federal net operating loss
carryforwards (NOLs) of approximately $169.4 million which expire in
varying amounts through December 31, 2018. Due to the provisions of
Section 382 and certain other provisions of the Code, the utilization of
these NOLs may be limited. The Company is also subject to certain state
income tax laws, which will also limit the utilization of NOLs for state
income tax purposes.
A valuation allowance has been provided for the full amount of the deferred
tax asset as management is not presently able to determine when the Company
will generate future taxable income.
(14) Employee Benefit Plans
Prior to the merger with ICG, NETCOM established salary reduction savings
plans under Section 401(k) of the Code which NETCOM administered for
participating employees.All full-time employees were covered under the plan
after meeting minimum service and age requirements. Under the plans
available to NETCOM employees from January 1, 1997 through June 30, 1998,
NETCOM made a matching contribution of 100% of each
F-38
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(14) Employee Benefit Plans (continued)
employee's contribution up to a maximum of 3% of the employee's eligible
earnings. Aggregate matching contributions under NETCOM's employee benefit
plans were approximately $0.6 million and $0.3 million for the years ended
December 31, 1997 and 1998, respectively, which is included in loss from
discontinued operations in the Company's statements of operations.
(15) Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value:
Cash and cash equivalents and short-term investments available for sale:
The carrying amount approximates fair value because of the short maturities
of such instruments.
Long-term investments:
The fair values of long-term investments for which it is practicable are
estimated based on the quoted market prices for those or similar
investments. The long-term investments for which it is not practicable to
estimate the fair value relate to cost and equity investments in unrelated
entities for which there is no market.
Long-term debt:
The fair value of the Company's long-term debt is estimated based on the
quoted market prices for the same or similar issues for the Senior Discount
Notes which are publicly traded. The fair value of both the Senior
Facility and the mortgage loan payable are estimated to be the carrying
amount of the debt as the debt instruments are not publicly traded and have
stated fixed or LIBOR plus a fixed percent interest rates.
F-39
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(15) Fair Value of Financial Instruments (continued)
The estimated fair values of the Company's financial instruments are as
follows:
December 31,
--------------------------------------------------------------------
1998 1999
--------------------------------- ----------------------------
(in thousands)
Carrying Carrying
Amount Fair Value Amount Fair Value
-------- -------------- -------- --------------
Cash and cash equivalents
and short-term investments
available for sale $ 155,380 $ 155,380 $ 53,664 $ 53,664
Restricted Cash - - 1,030 1,030
Long-term investments
Not practicable 10,179 - 42,402 -
Practicable - - 10,000 13,333
Long-term debt:
Senior Facility - - (79,625) (79,625)
Senior Discount Notes (594,617) (467,103) (655,215) (462,712)
Mortgage loan payable - - (33,077) (33,077)
(16) Events Subsequent to Date of Independent Auditors' Report (Unaudited)
On February 22, 2000, the Company purchased 61,845 shares of restricted
Series D Preferred Stock (Cyras Preferred Stock) of Cyras Systems, Inc.,
(Cyras), for approximately $1.0 million. Cyras is a manufacturer of
telecommunications equipment. Dividends on the Cyras Preferred Stock are 8%
per annum, noncumulative and payable in cash or any Cyras assets legally
available and as declared by the board of directors of Cyras. The Cyras
Preferred Stock is automatically convertible into shares of common stock of
Cyras upon the initial public offering of the common stock of Cyras or upon
the election to convert by more than 66% of all of the preferred
stockholders of Cyras.
During the first quarter of 2000, the Company signed letters of intent with
its two biggest vendors, Lucent Technologies, Inc. and Cisco Systems, Inc.
for financing of future capital expenditures. The Company believes that
these proposed financing agreements will better enable the Company to fund
its scheduled network expansion through the purchase of Lucent and Cisco
equipment. It is anticipated that the Lucent credit agreement will provide
the Company with up to $250.0 million of long-term debt financing which can
be drawn down during the year following the closing to purchase network
equipment. Under the terms of the Lucent letter of intent, the Company will
commit to purchase a minimum of $175.0 million of equipment with principal
amounts outstanding required to be repaid in quarterly installments over a
five-year period beginning 2001. The proposed Cisco credit facility will
F-40
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
______________________________________________________________________________
(16) Events Subsequent to Date of Independent Auditors' Report (Unaudited)
(continued)
provide the Company with up to $180 million of capital lease financing with
a three-year repayment term. During the first quarter of 2000, $50.0
million of the capital lease financing with Cisco was finalized, however,
no amounts have been drawn down under this facility.
In February 2000, the Company's parent, ICG, announced that it had entered
into an agreement to sell approximately $750.0 million (before estimated
expenses and fees of $45 million) of convertible preferred stock in ICG to
three investors: affiliates of Liberty Media Corporation (Liberty), Hicks,
Muse, Tate & Furst Incorporated (Hicks Muse) and Gleacher Capital Partners
(Gleacher). Under the terms of the transaction, Liberty will invest $500.0
million, Hicks Muse will invest $230.0 million and Gleacher will invest
$20.0 million in exchange for a total of 750,000 shares of Series A
convertible preferred stock at $1,000 per share. The preferred stock will
be convertible into ICG's common stock at a conversion rate of $28.00 per
common share. ICG will also issue 10 million common stock warrants which
will be exercisable at $34.00 per share. The proceeds from this new equity
investment will be used principally by ICG and the Company to fund network
expansion.
F-41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ICG Services, Inc.
By: /s/ J. Shelby Bryan
--------------------------------
J. Shelby Bryan
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: March 29, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
Chairman of the Board of Directors and Chief
Executive Officer (Principal Executive
/s/ J. Shelby Bryan Officer) March 29, 2000
- ------------------------------------
J. Shelby Bryan
Executive Vice President, Chief Financial
Officer (Principal Financial Officer) and March 29, 2000
/s/ Harry R. Herbst Director
- ------------------------------------
Harry R. Herbst
Vice President, Controller (Principal
/s/ John V. Colgan Accounting Officer) and Director March 29, 2000
- ------------------------------------
John V. Colgan
/s/ William S. Beans, Jr. President and Director March 29, 2000
- -----------------------------------
William S. Beans, Jr.
Executive Vice President, General Counsel,
/s/ H. Don Teague Secretary and Director March 29, 2000
- -----------------------------------
H. Don Teague
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
4.10: Amendment and Waiver No. 2 to the Loan Documents, dated as of
December 29, 1999, among ICG Equipment, Inc., ICG NetAhead, Inc.,
ICG Services, Inc., certain Initial Lender Parties party thereto,
Morgan Stanley Senior Funding, Inc., as Sole Book-Runner and Lead
Arranger, Royal Bank of Canada, as Collateral Agent and as
Administrative Agent for such Lender Parties, Bank of America,
N.A., as Documentation Agent and Barclays Bank Plc, as Co-
Documentation Agent.
4.11: Amendment No. 3 to the Loan Documents, dated as of February 11,
2000, among ICG Equipment, Inc., ICG NetAhead, Inc., ICG
Services, Inc., as Parent, certain Initial Lender Parties party
thereto, Morgan Stanley Senior Funding, Inc., as Sole Book-Runner
and Lead Arranger, Royal Bank of Canada, as Collateral Agent and
as Administrative Agent for such Lender Parties, Bank of America,
N.A., as Documentation Agent and Barclays Bank Plc, as Co-
Documentation Agent.
10.5: Employment Agreement, dated as of July 1, 1999, between ICG
Communications, Inc. and Michael D. Kallet.
21.1: Subsidiaries of the Registrant.
27.1: Financial Data Schedule of ICG Services, Inc. for the Year Ended
December 31, 1999.