UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number 0-30218
TIME WARNER TELECOM INC.
------------------------
(Exact name of Registrant as specified in its charter)
State of Delaware 84-1500624
- ------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
10475 Park Meadows Drive
Littleton, Colorado 80124
- ---------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 566-1000
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 [_]
The number of shares outstanding of Time Warner Telecom Inc.'s common stock as
of May 2, 2000 was:
Time Warner Telecom Inc. Class A common stock -- 33,029,635 shares
Time Warner Telecom Inc. Class B common stock -- 72,214,285 shares
TIME WARNER TELECOM INC.
INDEX TO FORM 10-Q
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Page
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Part I. Financial Information
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Item 1. Financial Statements:
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Consolidated and Condensed Balance Sheets at March 31,
2000 and December 31, 1999 1
Consolidated Statements of Operations for the three
months ended March 31, 2000 and 1999 2
Consolidated Statements of Cash Flows for the three
months ended March 31, 2000 and 1999 3
Consolidated Statement of Changes in Stockholders'
Equity for the three months ended March 31, 2000 4
Notes to Consolidated and Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Part II. Other Information
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Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 6. Exhibits and Reports on Form 8-K 21
TIME WARNER TELECOM INC.
CONSOLIDATED AND CONDENSED BALANCE SHEETS
March 31, December 31,
2000 1999
----------- ------------
(unaudited)
(amounts in thousands, except share amounts)
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 82,014 90,586
Marketable securities.................................................... 139,525 173,985
Receivables, less allowances of $10,577 and $7,857 ...................... 59,720 52,652
Prepaid expenses......................................................... 3,223 2,938
----------- ------------
Total current assets............................................... 284,482 320,161
----------- ------------
Property, plant and equipment.............................................. 931,099 868,770
Less accumulated depreciation............................................ (212,722) (191,664)
----------- ------------
718,377 677,106
----------- ------------
Intangible and other assets, net of accumulated amortization (note 2)...... 47,879 45,745
----------- ------------
Total assets....................................................... $ 1,050,738 1,043,012
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................................... $ 59,075 64,678
Deferred revenue......................................................... 56,192 37,913
Other current liabilities................................................ 80,957 86,752
----------- ------------
Total current liabilities.......................................... 196,224 189,343
----------- ------------
Long-term debt and capital lease obligations (note 3)...................... 403,536 403,627
Deferred income taxes...................................................... 21,414 27,126
Stockholders' equity (note 1):
Preferred stock, $0.01 par value, 20,000,000 shares authorized, no
shares issued and outstanding.......................................... - -
Class A common stock, $0.01 par value, 277,300,000 shares authorized,
24,006,261 and 23,543,422 shares issued and outstanding in 2000
and 1999, respectively................................................. 240 235
Class B common stock, $0.01 par value, 162,500,000 shares authorized,
81,214,285 shares issued and outstanding in 2000 and 1999.............. 812 812
Additional paid-in capital............................................... 569,453 559,950
Accumulated deficit...................................................... (140,941) (138,081)
----------- ------------
Total stockholders' equity......................................... 429,564 422,916
----------- ------------
Total liabilities and stockholders' equity......................... $ 1,050,738 1,043,012
=========== ============
See accompanying notes.
1
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
March 31,
------------------------------------------------
2000 1999
------------ ------------
(amounts in thousands, except per share amounts)
Revenue:
Dedicated transport services............................ $ 51,938 29,664
Switched services....................................... 48,200 17,925
------------ ------------
Total revenue..................................... 100,138 47,589
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Costs and expenses (a):
Operating............................................... 38,989 23,995
Selling, general and administrative..................... 37,691 24,136
Depreciation and amortization........................... 21,864 14,994
------------ ------------
Total costs and expenses.......................... 98,544 63,125
------------ ------------
Operating income (loss)................................... 1,594 (15,536)
Interest expense (a)...................................... (9,727) (13,511)
Interest income........................................... 3,520 4,217
Equity in income of unconsolidated affiliate (note 2)..... - 188
------------ ------------
Net loss before income taxes.............................. (4,613) (24,642)
Income tax benefit........................................ (1,753) -
------------ ------------
Net loss.................................................. $ (2,860) (24,642)
============ ============
Basic and diluted loss per common share................... $ (0.03) (0.30)
============ ============
Average common shares outstanding......................... 104,975 81,250
============ ============
(a) Includes expenses resulting from transactions with affilitates (note 4):
Operating......................................... $ 388 508
============ ============
Selling, general and administrative............... $ 303 473
============ ============
Depreciation and amortization..................... $ 3,172 2,595
============ ============
Interest expense.................................. $ - 3,389
============ ============
See accompanying notes.
2
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
------------------------
2000 1999
--------- ---------
(amounts in thousands)
Cash flows from operating activities:
Net loss.................................................................................... $ (2,860) (24,642)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization............................................................. 21,864 14,994
Equity in income of unconsolidated affiliate.............................................. - (188)
Deferred income tax benefit............................................................... (1,753) -
Changes in operating assets and liabilities, net of the effect of acquisitions:
Receivables and prepaid expenses........................................................ (7,353) (2,394)
Accounts payable, deferred revenue and other current liabilities........................ 6,881 (17,390)
Other balance sheet changes............................................................. 60 330
--------- ---------
Net cash provided by (used in) operating activities................................... 16,839 (29,290)
--------- ---------
Cash flows from investing activities:
Capital expenditures........................................................................ (62,329) (43,262)
Purchases of marketable securities.......................................................... (66,315) (26,744)
Proceeds from maturities of marketable securities........................................... 100,775 70,421
Other investing activities.................................................................. (3,000) -
--------- ---------
Net cash provided by (used in) investing activities................................... (30,869) 415
--------- ---------
Cash flows from financing activities:
Payment of capital lease obligations........................................................ (91) -
Net proceeds from issuance of common stock upon exercise of stock options................... 5,549 -
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Net cash provided by financing activities............................................. 5,458 -
--------- ---------
Decrease in cash and cash equivalents................................................. (8,572) (28,875)
Cash and cash equivalents at beginning of period...................................... 90,586 105,140
--------- ---------
Cash and cash equivalents at end of period............................................ $ 82,014 76,265
--------- ---------
Supplemental disclosures of cash flow information:
Cash paid for interest $ 19,164 18,908
--------- ---------
Tax benefit related to exercise of non-qualified stock options........................ $ 3,959 -
--------- ---------
See accompanying notes.
3
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Three Months Ended March 31, 2000
(Unaudited)
Common Stock
-----------------------------------------
Class A Class B Additional Total
------------------- ------------------- paid-in Accumulated stockholders'
Shares Amount Shares Amount capital deficit equity
-------- -------- -------- -------- ---------- ----------- -------------
(amounts in thousands)
Balance at January 1, 2000........ 23,543 $ 235 81,214 $ 812 559,950 (138,081) 422,916
Issuance of common stock upon
exercise of stock options..... 463 5 - - 9,503 - 9,508
Net loss........................ - - - - - (2,860) (2,860)
-------- -------- -------- -------- ---------- ----------- -------------
Balance at March 31, 2000......... 24,006 $ 240 81,214 $ 812 569,453 (140,941) 429,564
======== ======== ======== ======== ========== =========== =============
See accompanying notes.
4
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS
March 31, 2000
(unaudited)
1. Organization and Summary of Significant Accounting Policies
Description of Business and Capital Structure
Time Warner Telecom Inc. (the "Company"), a Delaware corporation, is
a leading fiber facilities-based integrated communications provider in
selected metropolitan markets across the United States, offering local
businesses "last-mile" broadband connections for data, high-speed Internet
access, local voice and long distance services.
Time Warner Cable, as defined below, began the Company's business in
1993 by providing telephony services through cable systems owned by Time
Warner Entertainment Company, L.P. ("TWE"), Time Warner Entertainment-
Advance/Newhouse Partnership ("TWE-A/N") and Time Warner Inc. ("Time
Warner"), collectively referred to as the ''Former Parent Companies.''
"Time Warner Cable" refers to the cable systems owned by TWE, TWE-A/N and
Time Warner.
TWE and TWE-A/N are owned as follows:
(1) TWE is a partnership of subsidiaries of Time Warner and
MediaOne Group, Inc. ("MediaOne"); and
(2) TWE-A/N is a partnership of TWE, Time Warner and
Advance/Newhouse Partnership ("Advance").
On July 14, 1998, Time Warner Telecom LLC ("TWT LLC") succeeded to
the ownership of the Company's business. At that time, Time Warner,
MediaOne and Advance (collectively referred to as the "Class B
Stockholders") formed TWT LLC to acquire the assets and liabilities of the
Company's business from the Former Parent Companies and to conduct the
offering on July 21, 1998 of $400 million principal amount 9 3/4% Senior
Notes due July 2008 (the "Senior Notes"). In the transaction, referred to
as the "Reorganization," the Class B Stockholders (either directly or
through subsidiaries) became the owners of all the limited liability
company interests in TWT LLC. The Reorganization has been reflected as of
July 1, 1998 for accounting purposes.
On May 10, 1999, in preparation for the Company's initial public
offering, TWT LLC was reconstituted as a Delaware corporation (the
"Reconstitution") under the name Time Warner Telecom Inc. by merging into a
newly formed Delaware corporation. The Company accounted for the
Reorganization and the Reconstitution at each of the Class B Stockholders'
historical cost basis and, except as noted below, the Reorganization and
Reconstitution had no effect on the Company's total stockholders' equity,
which has been presented on a consistent basis. In connection with the
Reconstitution, the Company's capitalization was authorized to include two
classes of common stock, Class A common stock and Class B common stock. As
part of the merger, the outstanding Class A limited liability company
interests were converted into Class A common stock and the Class B
Stockholders exchanged their Class B limited liability company interests in
TWT LLC for Class B common stock of the newly formed corporation, Time
Warner Telecom Inc. Prior to the Reconstitution, the only outstanding Class
A interests were those held by the former shareholders of Internet Connect,
Inc. ("Inc.Net"), which the Company acquired in April 1999 (see note 2).
Following the Reconstitution, the Class B Stockholders held all of the
Company's Class B common stock. Accordingly, the accompanying financial
statements have been adjusted to retroactively reflect the authorization
and issuance of the shares of Class A common stock and Class B common stock
for all periods presented.
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A common
stock at a price of $14 per share (the
5
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
"IPO"). The IPO generated $270.2 million in proceeds for the Company, net
of underwriting discounts and expenses. The net proceeds were used
primarily to repay indebtedness to the Former Parent Companies (see note
4). The proceeds of the IPO remaining after repayment of that indebtedness
were used to repay assumed debt from acquisitions and to fund capital
expenditures.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. Holders of
Class A common stock have one vote per share and holders of Class B common
stock have ten votes per share. Each share of Class B common stock is
convertible, at the option of the holder, into one share of Class A common
stock. Holders of Class A common stock and Class B common stock generally
vote together as a single class. However, some matters require the
approval of 100% of the holders of the Class B common stock voting
separately as a class, and some matters require the approval of a majority
of the holders of the Class A common stock, voting separately as a class.
Upon completion of the IPO, the Class B Stockholders owned all of the
81,250,000 shares of outstanding Class B common stock. Subsequent to the
IPO, 35,715 shares of Class B common stock were converted into Class A
common stock. As of March 31, 2000, the Class B Stockholders had
approximately 97.1% of the combined voting power of the outstanding common
stock.
The Company also is authorized to issue shares of Preferred Stock.
The Company's Board of Directors has the authority to establish the voting
powers, the preferences and special rights for the Preferred Stock. No
such voting powers, preferences or special rights have been established and
no shares of Preferred Stock have been issued as of March 31, 2000.
On May 6, 1999, MediaOne and AT&T Corp. ("AT&T") entered into a
merger agreement providing for MediaOne to be acquired by AT&T. The
MediaOne stockholders have approved the merger, but the merger is subject
to various regulatory approvals. There is no assurance that the approvals
will be obtained or that the merger will be consummated. If the merger is
completed, the Class B common stock beneficially owned by MediaOne (through
a subsidiary) will be beneficially owned by AT&T. However, the transaction
will not affect the rights of MediaOne's subsidiary as a Class B
Stockholder.
MediaOne completed an underwritten offering on May 1, 2000 of
9,000,000 shares of Class A common stock of the Company that were converted
from shares of Class B common stock. MediaOne granted the underwriters an
over-allotment option on 500,000 additional shares. As a result of this
transaction, MediaOne is no longer entitled to appoint three members of the
Company's Board of Directors and the three directors designated by MediaOne
have resigned. Assuming the underwriters' over-allotment option is
exercised, MediaOne will hold 5,789,842 shares of Class B common stock
after the transaction, representing 5.5% of the Company's total outstanding
common stock and 7.7% of the total voting power. After the transaction and
assuming the underwriters' over-allotment option is exercised, the Class B
Stockholders had approximately 95.5% of the combined voting power of the
outstanding common stock as of May 2, 2000. The Company will not receive
any proceeds nor will total shares outstanding change as a result of this
transaction.
On January 10, 2000, Time Warner announced an agreement to merge
with America Online, Inc. ("AOL") in a stock-for-stock transaction that
would create a new company called AOL Time Warner Inc. As a result of the
merger, both AOL and Time Warner will become wholly owned subsidiaries of
AOL Time Warner. If the merger is completed, the Class B common stock
beneficially owned by Time Warner will be beneficially owned by AOL Time
Warner and its subsidiaries. However, the transaction will not affect the
rights of Time Warner subsidiaries as Class B Stockholders. The merger is
subject to customary closing conditions, including regulatory clearance and
stockholder approvals. There is no assurance that the approvals will be
obtained or that the merger will be consummated.
6
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
Basis of Presentation
Until July 14, 1998, the historical financial statements of the
Company reflected the "carved out" historical financial position, results
of operations, cash flows and changes in stockholders' equity of the
commercial telecommunications operations of the Former Parent Companies, as
if they had been operating as a separate company. Although these financial
statements are presented as if the Company had operated as a corporation,
the Company operated as a partnership for tax purposes and continued to
operate in a partnership structure through May 10, 1999. The consolidated
statements of operations have been adjusted to retroactively reflect an
allocation of certain expenses pursuant to the final terms of agreements
related to the Reorganization, primarily relating to office rent, overhead
charges for various administrative functions performed by Time Warner Cable
and certain facility maintenance and pole rental costs. These allocations
were required to reflect all costs of doing business and have been based on
various methods which management believes result in reasonable allocation
of these costs.
The accompanying interim consolidated and condensed financial
statements are unaudited, but in the opinion of management, reflect all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the results for such periods. The results of operations
for any interim period are not necessarily indicative of results for the
full year. The accompanying financial statements should be read in
conjunction with the audited consolidated financial statements and notes
thereto for the year ended December 31, 1999.
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 at
the date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Actual results could differ from
those estimates.
Basis of Consolidation and Accounting for Investments
The consolidated financial statements include the accounts of the
Company and all entities in which the Company has a controlling voting
interest ("subsidiaries"). Significant intercompany accounts and
transactions have been eliminated. Significant accounts and transactions
with Time Warner Cable are disclosed as related party transactions.
Investments in entities in which the Company has significant
influence, but less than a controlling voting interest, are accounted for
using the equity method. During the first quarter of 1999, the Company's
investment in unconsolidated affiliate consisted solely of a 50% investment
in MetroComm AxS, L.P. ("MetroComm L.P."), a joint venture providing
commercial telecommunications services in the central Ohio area. Under the
equity method, only the Company's investment in and amounts due to and from
the equity investee were included in the consolidated balance sheets, and
only the Company's share of the investee's income (losses) was included in
the consolidated statements of operations. During the second quarter of
1999, the remaining 50% of MetroComm L.P. was acquired (see note 2) and,
accordingly, is accounted for on a consolidated basis as of May 31, 1999.
Revenue
The Company's revenue has been derived primarily from business
telephony services, including dedicated transport, local switched, long
distance, data and high-speed Internet access services. The Company's
customers are principally telecommunications-intensive business end-users,
long distance carriers, Internet service providers ("ISPs"), wireless
communications companies and governmental entities.
Revenue for dedicated transport services is generally billed in
advance on a fixed rate basis and recognized over the period the services
are provided. Revenue for switched services, data and
7
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
Internet services and long distance are generally billed on a transactional
basis determined by customer usage with some fixed rate elements. The
transactional elements of switched services are billed in arrears and
estimates are used to recognize revenue in the period earned. The fixed
rate elements are billed in advance and recognized over the period
provided.
Reciprocal compensation revenue is an element of switched services
revenue, which represents compensation from local exchange carriers
("LECs") for local exchange traffic terminated on the Company's facilities
originated by other LECs. Reciprocal compensation is based on contracts
between the Company and LECs. The Company recognizes reciprocal
compensation revenue as it is earned, except in such cases where the
revenue is under dispute. Under several of its contracts, the LECs have
disputed the payment of reciprocal compensation for traffic terminating to
ISP customers contending that such traffic was not local. As a result, the
Company initiated the dispute resolution process under the applicable
contracts to collect these amounts and filed complaints with various public
utility commissions ("PUCs") contending that the ISP traffic is local.
Various of these state PUCs have ruled in favor of the Company, but all of
these favorable decisions have subsequently been appealed by the LECs.
While the Company believes that these disputes will ultimately be resolved
in its favor, the Company only recognizes revenue on a portion of the cash
received and defers recognition of a significant portion of this revenue
pending outcome of the dispute. As of March 31, 2000, the Company deferred
recognition of $49.4 million in reciprocal compensation revenue for
payments received associated with these disputes. Switched services
revenue for the three months ended March 31, 2000 includes the recognition
of $3.9 million of non-recurring reciprocal compensation. The Company
pays reciprocal compensation expense to the other LECs for local exchange
traffic it terminates on the LEC's facilities. These costs are recognized
as incurred and are reported as a component of operating expenses in the
accompanying consolidated statements of operations.
Significant Customers
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. For the three
months ended March 31, 2000 and 1999, the Company's top 10 customers
accounted for 40% and 36%, respectively, of the Company's consolidated
revenue. AT&T accounted for more than 10% of the Company's total revenue
in the first quarter of 2000 and 1999. However, a substantial portion of
this revenue results from traffic that is directed to the Company by the
Company's customers who have selected AT&T as their long distance provider.
Revenue includes sales to AT&T (including sales directed to the Company by
the Company's customers) of approximately $10.1 million and $6.2 million
for the three months ended March 31, 2000 and 1999, respectively.
Segment Reporting
The Company operates in 21 service areas and the Company's
management makes decisions on resource allocation and assesses performance
based on total revenue, EBITDA and capital spending of these operating
locations. Each of the service areas offers the same products and
services, has similar customers and networks, is regulated by the same type
of authorities, and is managed directly by the Company's executives,
allowing the 21 service areas to be aggregated, resulting in one reportable
line of business.
Loss Per Common Share
The basic and diluted loss per common share for all periods
presented herein was computed by dividing the net loss attributable to
common shares by the weighted average outstanding common shares for the
period. Potential common shares were not included in the computation of
weighted average shares outstanding because their inclusion would be anti-
dilutive.
8
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
2. Acquisitions
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Inc.Net, an Internet service provider, for
consideration consisting of $3.8 million of Class A limited liability
interests in TWT LLC, the Company's predecessor, approximately $3.5 million
in net cash and the assumption of $1.9 million in liabilities. At the time
of the IPO, these Class A limited liability interests were converted into
307,550 shares of Class A common stock of the Company. The Class A common
stock of the Company into which the limited liability interests were
converted are being held in escrow to be released to the former Inc.Net
shareholders over a period of three years, beginning in April 2000.
Through the acquisition of this subsidiary, the Company plans to manage
current and future data networks and provide new Internet products. The
transaction was accounted for under the purchase method of accounting and
generated $6.9 million in goodwill, which is being amortized on a straight-
line basis over a ten-year period. Amortization expense for the three-
month period ended March 31, 2000, was approximately $173,000.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm, Inc. ("MetroComm") through the
issuance of 2,190,308 shares of Class A common stock of the Company valued
at $24.1 million, and the assumption of $20.1 million in liabilities.
Through the acquisition of MetroComm, the Company acquired the 50% interest
of MetroComm L.P. not already owned by the Company. After the acquisition,
the Company's Columbus, Ohio assets were transferred to MetroComm L.P. and
all operations in Columbus, Ohio are now reported under the new entity.
The transaction was accounted for under the purchase method of accounting
and generated $18.8 million in goodwill, which is being amortized on a
straight-line basis over a ten-year period. Amortization expense for the
three-month period ended March 31, 2000, was approximately $470,000.
Since both acquisitions are accounted for as purchases, the results
of operations of Inc.Net and MetroComm are consolidated with the Company's
results of operations from their respective acquisition dates.
3. Long-Term Debt
The Senior Notes are unsecured, unsubordinated obligations of the
Company. Interest on the Senior Notes is payable semi-annually on January
15 and July 15, and began on January 15, 1999. Interest expense, including
amortization of debt discount, relating to the Senior Notes totaled
approximately $10.1 million for both the three months ended March 31, 2000
and 1999. At March 31, 2000, the fair market value for the $400 million of
Senior Notes was $404 million, based on market prices.
The Senior Notes are governed by an Indenture that contains certain
restrictive covenants. These restrictions affect, and in many respects
significantly limit or prohibit, among other things, the ability of the
Company to incur indebtedness, make prepayments of certain indebtedness,
pay dividends, make investments, engage in transactions with shareholders
and affiliates, issue capital stock of subsidiaries, create liens, sell
assets and engage in mergers and consolidations.
On April 10, 2000, the Company executed a $475 million Senior
Secured Revolving Credit Facility (the "Revolver"). The Revolver has a
final maturity of December 31, 2007 and initial borrowings will be at the
Eurodollar rate plus a margin of 2.0%. Applicable margins may be reduced
based upon the Company's financial performance. The Company is required to
pay commitment fees on a quarterly basis ranging from 0.875% to 0.500% per
annum on the undrawn available commitment. It is anticipated that the
Revolver will primarily be used for the build-out of the Company's network
and working capital needs.
The Revolver requires the Company to prepay any amounts that have
been borrowed with the proceeds received from a number of specified events
or transactions. In addition, obligations
9
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
under the Revolver are subject to various covenants that limit the
Company's ability to: (i) borrow and incur liens on its property; (ii) pay
dividends or make other distributions; and (iii) make capital expenditures.
The Revolver also contains financial covenants, including a consolidated
leverage ratio, a consolidated interest coverage ratio and a consolidated
debt service coverage ratio. In addition, the Revolver contains customary
events of default, including cross default provisions. Under the cross
default provisions, the Company is deemed to be in default under the
Revolver if the Company has defaulted under any of the other material
outstanding obligations, such as the Senior Notes.
4. Related Party Transactions
In the normal course of business, the Company engages in various
transactions with the Former Parent Companies, generally on negotiated
terms among the affected units that, in management's opinion, result in
reasonable allocations.
The Company benefits from its strategic relationship with Time
Warner Cable both through access to local right-of-way and construction
cost-sharing. The Company's networks have been constructed primarily
through the use of fiber capacity licensed from Time Warner Cable. Under
this licensing arrangement, the Company paid Time Warner Cable $1.1 million
for both the three months ended March 31, 2000 and 1999. These costs have
been capitalized by the Company. The amortization expense of these costs
and fiber previously capitalized in the amount of $3.2 million and $2.6
million for the three months ended March 31, 2000 and 1999, respectively,
has been classified as a component of depreciation and amortization expense
in the accompanying consolidated statements of operations. In addition,
under this licensing arrangement, the Company reimburses Time Warner Cable
for facility maintenance and pole rental costs, which aggregated $388,000
and $508,000 for the three months ended March 31, 2000 and 1999,
respectively.
The Company's operations, which in certain cases are co-located with
Time Warner Cable's divisions, are allocated a charge for various overhead
expenses for services provided by these divisions. Prior to the
Reorganization, the allocations were based on direct labor, total expenses
or headcount relative to each operating unit. The Company is also
allocated rent based on the square footage of space occupied by the Company
at Time Warner Cable's facilities. After the Reorganization, these costs
are based on contracts with Time Warner Cable. The charges aggregated
$303,000 and $473,000 for the three months ended March 31, 2000 and 1999,
respectively.
During the period from July 1, 1997 through July 14, 1998, all of
the Company's financing requirements were funded with subordinated loans
from the Former Parent Companies. These loans remained outstanding,
accruing interest, through May 14, 1999. The loans from the Former Parent
Companies were subordinated in right of payment to the Senior Notes, except
for a provision allowing repayment prior to maturity with the net proceeds
of any offering of common stock or equivalent interest of the Company.
These loans bore interest (payable in kind) at The Chase Manhattan Bank's
prime rate, which was 7.75% from January 1, 1999 through the payoff of the
loan in May 1999. Interest expense relating to these loans totaled
approximately $3.4 million for the three months ended March 31, 1999. On
May 14, 1999, approximately $180 million of the proceeds from the IPO were
used to repay the subordinated loans payable to the Former Parent Companies
in full, including accrued interest.
5. Commitments and Contingencies
Pending legal proceedings are substantially limited to litigation
incidental to the business of the Company. In the opinion of management,
the ultimate resolution of these matters will not have a material adverse
effect on the Company's financial statements.
10
TIME WARNER TELECOM INC.
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Cautions Concerning Forward Looking Statements
The following discussion and analysis provides information concerning
the results of operations and financial condition of Time Warner Telecom Inc.
(the "Company") and should be read in conjunction with the accompanying
financial statements and notes thereto. Additionally, the following discussion
and analysis should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations and the consolidated
financial statements included in Part II of Time Warner Telecom Inc.'s Annual
Report on Form 10-K for the year ended December 31, 1999.
The Securities and Exchange Commission encourages companies to
disclose forward-looking information so that investors can better understand a
company's future prospects and make informed investment decisions. Certain
information included in this report contains ''forward-looking statements''
within the meaning of the Private Securities Litigation Reform Act of 1995,
including statements anticipating future growth in revenue, EBITDA and cash
flow. Words such as ''anticipate,'' ''estimate,'' ''expects,'' ''projects,''
''intends,'' ''plans,'' ''believes,'' ''target'' and words and terms of similar
substance used in connection with any discussion of future operating or
financial performance identify such forward-looking statements. Those forward-
looking statements are management's present expectation of future events. As
with any projection or forecast, they are inherently susceptible to changes in
circumstances, and the Company is under no obligation to (and expressly
disclaims any such obligation to) update or alter its forward-looking statements
despite such changes. Important factors that could cause actual results to
differ materially from these expectations are set forth under "Risk Factors" in
the Company's Registration Statement on Form S-1 (Registration No. 333-33166).
Overview
The Company is a leading fiber facilities-based integrated
communications provider offering local businesses "last-mile" broadband
connections for data, high-speed Internet access, local voice and long distance
services. The Company serves customers in 21 metropolitan markets in the United
States. The markets include: Austin, Dallas, Houston and San Antonio, Texas;
Charlotte, Greensboro and Raleigh, North Carolina; Albany, Binghamton, New York
City and Rochester, New York; Northern New Jersey; Cincinnati and Columbus,
Ohio; Memphis, Tennessee; Orlando and Tampa, Florida; Indianapolis, Indiana;
Milwaukee, Wisconsin; San Diego, California and Honolulu, Hawaii. The Company
plans to enter Los Angeles/Orange County, California; Fayetteville, North
Carolina and Dayton, Ohio during 2000. The Company recently announced its
intentions to commence construction in five additional markets as part of its
previously announced expansion plans. These markets include: Denver, Colorado;
Atlanta, Georgia; Chicago, Illinois; Minneapolis, Minnesota; and Columbia, South
Carolina.
The Company began its business in 1993 by providing telephony services
through cable systems owned by Time Warner Entertainment Company, L.P. ("TWE"),
Time Warner Entertainment-Advance/Newhouse Partnership ("TWE-A/N") and Time
Warner Inc. ("Time Warner"), collectively referred to as the "Former Parent
Companies." The Company's original business was to provide certain telephony
services together with cable television. In January 1997, the Company put in
place a new management team that implemented a business strategy focused
exclusively on serving business customers, rapidly providing switched services
in the Company's service areas and expanding the range of business telephony
services offered by the Company.
TWE and TWE-A/N are owned as follows:
(1) TWE is a partnership of subsidiaries of Time Warner and MediaOne
Group, Inc. ("MediaOne"); and
(2) TWE-A/N is a partnership of TWE, Time Warner and Advance/Newhouse
Partnership ("Advance").
On July 14, 1998, Time Warner Telecom LLC ("TWT LLC") succeeded to the
ownership of the Company's business. At that time, Time Warner, MediaOne and
Advance (collectively referred to as the
11
TIME WARNER TELECOM INC.
"Class B Stockholders") formed TWT LLC to acquire the assets and liabilities of
the Company's business from the Former Parent Companies and to conduct the
offering on July 21, 1998 of $400 million principal amount 9 3/4% Senior Notes
due July 2008 (the "Senior Notes"). In the transaction, referred to as the
"Reorganization," the Class B Stockholders (either directly or through
subsidiaries) became the owners of all the limited liability company interests
in TWT LLC.
On May 10, 1999, in preparation for the Company's initial public
offering, TWT LLC was reconstituted as a Delaware corporation (the
"Reconstitution") under the name Time Warner Telecom Inc. by merging into a
newly formed Delaware corporation. As part of the merger, the outstanding Class
A limited company interests were converted into Class A common stock and the
Class B Stockholders exchanged their Class B limited liability company interests
in TWT LLC for Class B common stock of the newly formed corporation, Time Warner
Telecom Inc. Prior to the Reconstitution, the only outstanding Class A
interests were those held by former shareholders of Internet Connect, Inc.
("Inc.Net"), which the Company acquired in April 1999. The Company accounted
for the Reorganization and the Reconstitution at each of the Class B
Stockholders' historical cost basis and, except as noted below, the
Reorganization and the Reconstitution had no effect on the Company's total
stockholders' equity, which has been presented on a consistent basis.
The primary change to the Company's operating structure since the
Reconstitution is that the management of the Company became accountable to the
Board of Directors, instead of to the management committee of TWT LLC. In
addition, all future net operating loss carryforwards from the date of the
Reconstitution can be utilized against future earnings of the Company as a
result of the change in the Company's operating and legal structure from a
limited liability company to a corporation. Prior to the Reconstitution, all
net operating losses were allocated to and utilized primarily by the Class B
Stockholders. The Company has not been, and will not be compensated for net
operating losses utilized by the Class B Stockholders. As a result of the
Reconstitution, which occurred during the second quarter of 1999, the Company
recorded a non-recurring charge to earnings for a net deferred tax liability of
approximately $39.4 million.
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A common
stock at a price of $14 per share (the "IPO"). The IPO generated approximately
$270.2 million in proceeds for the Company, net of underwriting discounts and
expenses. A portion of the proceeds of the IPO was used to repay $180 million
of loans from the Former Parent Companies that were generated from the financing
requirements of the Company from July 1, 1997 through July 14, 1998, which had
remained outstanding, accruing interest, through May 14, 1999.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. In general, holders
of Class A common stock have one vote per share and holders of Class B common
stock have ten votes per share. Each share of Class B common stock is
convertible, at the option of the holder, into one share of Class A common
stock. Holders of Class A common stock and Class B common stock generally vote
together as a single class. However, some matters require the approval of 100%
of the holders of the Class B common stock voting separately as a class, and
some matters require the approval of a majority of the holders of the Class A
common stock, voting separately as a class. Upon completion of the IPO, the
Class B Stockholders owned all of the 81,250,000 shares of outstanding Class B
common stock. Subsequent to the IPO, 35,715 shares of Class B common stock were
converted into Class A common stock. As of March 31, 2000, the Class B
Stockholders had approximately 97.1% of the combined voting power of the
outstanding common stock.
On May 6, 1999, MediaOne and AT&T Corp. ("AT&T") entered into a merger
agreement providing for MediaOne to be acquired by AT&T. The MediaOne
stockholders have approved the merger, but the merger is subject to various
regulatory approvals. There is no assurance that the approvals will be obtained
or that the merger will be consummated. If the merger is completed, the Class B
common stock beneficially owned by MediaOne (through a subsidiary) will be
beneficially owned by AT&T. However, the transaction will not affect the rights
of MediaOne's subsidiary as a Class B Stockholder.
MediaOne completed an underwritten offering on May 1, 2000 of
9,000,000 shares of Class A common stock of the Company that were converted from
shares of Class B common stock. MediaOne
12
TIME WARNER TELECOM INC.
granted the underwriters an over-allotment option on 500,000 additional shares.
As a result of this transaction, MediaOne is no longer entitled to appoint three
members of the Company's Board of Directors and the three directors designated
by MediaOne have resigned. Assuming the underwriters' over-allotment option is
exercised, MediaOne will hold 5,789,842 shares of Class B common stock after the
transaction, representing 5.5% of the Company's total outstanding common stock
and 7.7% of the total voting power. After the transaction and assuming the
underwriters' over-allotment option is exercised, the Class B Stockholders had
approximately 95.5% of the combined voting power of the outstanding common stock
as of May 2, 2000. The Company will not receive any proceeds nor will total
shares outstanding change as a result of this transaction.
On January 10, 2000, Time Warner announced an agreement to merge with
America Online, Inc. ("AOL") in a stock-for-stock transaction that would create
a new company called AOL Time Warner Inc. As a result of the mergers, both AOL
and Time Warner will become wholly owned subsidiaries of AOL Time Warner. If
the merger is completed, the Class B common stock beneficially owned by Time
Warner will be beneficially owned by AOL Time Warner and its subsidiaries.
However, the transaction will not affect the rights of Time Warner subsidiaries
as Class B Stockholders. The merger is subject to customary closing conditions,
including regulatory clearance and stockholder approvals. There is no assurance
that the approvals will be obtained or that the merger will be consummated.
Acquisitions
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Inc.Net, an Internet service provider, for
consideration consisting of $3.8 million of Class A limited liability interests
in TWT LLC, the Company's predecessor, approximately $3.5 million in net cash
and the assumption of $1.9 million in liabilities. At the time of the IPO,
these Class A limited liability interests were converted into 307,550 shares of
Class A common stock of the Company. The Class A common stock of the Company
into which the limited liability interests were converted are being held in
escrow to be released to the former Inc.Net shareholders over a period of three
years, beginning in April 2000. Through the acquisition of this subsidiary, the
Company plans to manage current and future data networks and provide new
Internet products.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm, Inc. ("MetroComm") through the issuance
of 2,190,308 shares of Class A common stock of the Company valued at $24.1
million, and the assumption of $20.1 million in liabilities. Through the
acquisition of MetroComm, the Company acquired the 50% interest of MetroComm
AxS, L.P., a competitive local exchange carrier in Columbus, Ohio, not already
owned by the Company.
13
TIME WARNER TELECOM INC.
Results of Operations
The following table sets forth certain consolidated statements of
operations data of the Company, in thousands of dollars and expressed as a
percentage of total revenue, for each of the periods presented. This table
should be read together with the Company's financial statements, including the
notes thereto, appearing elsewhere in this report:
Three Months Ended March 31,
-----------------------------------------
2000 1999
----------------- -----------------
(amounts in thousands, except per share amounts)
Statements of Operations Data:
Revenue:
Dedicated transport services $ 51,938 52 % 29,664 62 %
Switched services (1) 48,200 48 17,925 38
-------- ----- -------- -----
Total revenue 100,138 100 47,589 100
-------- ----- -------- -----
Costs and expenses (2):
Operating 38,989 39 23,995 50
Selling, general and administrative 37,691 37 24,136 51
Depreciation and amortization 21,864 22 14,994 32
-------- ----- -------- -----
Total costs and expenses 98,544 98 63,125 133
-------- ----- -------- -----
Operating income (loss) 1,594 2 (15,536) (33)
Interest expense (2) (9,727) (10) (13,511) (28)
Interest income 3,520 3 4,217 9
Equity in income of unconsolidated affiliate - - 188 -
-------- ----- -------- -----
Net loss before income taxes (4,613) (5) (24,642) (52)
Income tax benefit (1,753) (2) - -
-------- ----- -------- -----
Net loss $ (2,860) (3)% (24,642) (52)%
======== ===== ======== =====
Basic and diluted loss per common share $ (0.03) (0.30)
Basic and diluted loss per common share before income taxes $ (0.04) (0.30)
Average common shares outstanding 104,975 81,250
EBITDA (1) (3) $ 23,458 23 % (542) (1)%
Net cash provided by (used in) operating activities 16,839 (29,290)
Net cash provided by (used in) investing activities (30,869) 415
Net cash provided by financing activities 5,458 -
(1) Includes the recognition of $3.9 million of non-recurring reciprocal
compensation in the first quarter of 2000.
(2) Includes expenses resulting from transactions with affiliates of $3.9
million and $7.0 million for the three months ended March 31, 2000 and
1999, respectively.
(3) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income (loss), cash flow and other measures of
financial performance and liquidity reported in accordance with generally
accepted accounting principles. Rather, EBITDA is a measure of operating
performance and liquidity that investors may
14
TIME WARNER TELECOM INC.
consider in addition to these measures. Management believes that
EBITDA is a standard measure of operating performance and liquidity
that is commonly reported and widely used by analysts, investors and
other interested parties in the telecommunications industry because it
eliminates many differences in financial, capitalization, and tax
structures, as well as non-operating one-time charges to earnings.
EBITDA is used internally by the Company's management to assess
ongoing operations and is a component of a covenant of the Senior
Notes that limits the Company's ability to incur certain additional
future indebtedness. However, EBITDA as used in this report may not be
comparable to similarly titled measures reported by other companies
due to differences in accounting policies.
General
The Company's revenue has been derived primarily from business
telephony services, including dedicated transmission, local switched, long
distance, data and high-speed Internet access services. The Company's customers
are principally telecommunications-intensive business end-users, long distance
carriers, Internet service providers ("ISPs"), wireless communications companies
and governmental entities. Since its inception in 1993, the Company has
experienced significant growth in revenue and the geographic scope of its
operations. An increasing portion of the Company's growth in revenue has come
from the provision of local switched services as a result of the 21 digital
voice switches deployed as of March 31, 2000. The Company believes that
switched services provide the opportunity for a greater incremental return on
invested capital than that expected from dedicated transport services. The
shift of the revenue growth to switched services may cause the Company's revenue
to become less predictable since a portion of the services are billed to
customers on a usage basis. Dedicated transport customers are typically billed
a flat monthly rate which produces a less variable stream of revenue for the
Company. Furthermore, it is expected that the growth in the switched service
offerings, as well as data and Internet services, will expand the Company's
customer base to customers that are generally smaller than those who purchase
dedicated transport services. Key to the Company's strategy is leveraging its
existing fiber optic networks by adding additional services such as data and
Internet and an integrated product for smaller customers. The Company expects
to experience a higher churn rate for these customers than it has traditionally
experienced with dedicated transport services. The Company intends to minimize
churn in services to smaller customers by offering these services under minimum
one-year contracts.
Reciprocal compensation revenue is an element of switched services
revenue, which represents compensation from local exchange carriers (''LECs'')
for local exchange traffic terminated on the Company's facilities originated by
other LECs. Reciprocal compensation is based on contracts between the Company
and LECs. The Company recognizes reciprocal compensation revenue as it is
earned, except in such cases where the revenue is under dispute. Under several
of its contracts, the LECs have disputed the payment of reciprocal compensation
for traffic terminating to ISP customers contending that such traffic was not
local. As a result, the Company initiated the dispute resolution process under
the applicable contracts to collect these amounts and filed complaints with
various public utility commissions (''PUCs'') contending that the ISP traffic is
local. Various of these state PUCs have ruled in favor of the Company, but all
of these favorable decisions have subsequently been appealed by the LECs. While
the Company believes that these disputes will ultimately be resolved in its
favor, the Company only recognizes revenue on a portion of the cash received and
defers recognition of a significant portion of this revenue pending outcome of
the dispute. As of March 31, 2000, the Company has deferred recognition of
$49.4 million in reciprocal compensation revenue for payments received
associated with these disputes. Switched services revenue for the three months
ended March 31, 2000 includes the recognition of $3.9 million of non-recurring
reciprocal compensation. The Company pays reciprocal compensation expense to
the other LECs for local exchange traffic it terminates on the LEC's facilities.
These costs are recognized as incurred.
Reciprocal compensation is a component of switched services that is
rate sensitive. Rates are established by interconnection agreements between the
parties based on regulatory and judicial ruling in each of the states. Several
significant agreements have expired or will be expiring over the next year.
These contracts are being or will be renegotiated in 2000. In most of the
states, regulatory bodies have established lower traffic termination rates than
the rates provided under the Company's previous agreements. While the Company
expects that it will negotiate reasonable interconnection agreements with the
LECs, pricing
15
TIME WARNER TELECOM INC.
structures are not likely to remain at their current levels. As discussed below,
reciprocal compensation represented 8% of revenue, excluding the effects of the
recognition of $3.9 million of non-recurring reciprocal compensation in the
first quarter of 2000. Although the renegotiated interconnection agreements are
likely to result in lower rates, management believes that the volume in minutes
driven by the growth in Internet and related markets will partially mitigate the
impact of the rate reduction. The outcome of regulatory and judicial rulings on
reciprocal compensation for ISP traffic may also negatively impact the Company's
revenue from reciprocal compensation. The Company cannot predict the outcome of
these rulings. Accordingly, there is no assurance that the Company will be able
to compensate for the reduction in reciprocal compensation with increased volume
of terminating local traffic.
The Company benefits from its strategic relationship with Time Warner
Cable both through access to local right-of-way and construction cost-sharing.
The Company's networks have been constructed primarily through the use of fiber
capacity licensed from Time Warner Cable. As of March 31, 2000, the Company
operated networks in 21 metropolitan areas that spanned 8,960 route miles,
contained 336,843 fiber miles and offered service to 5,968 buildings.
The Company plans to continue expanding its revenue base by fully
utilizing available network capacity in its existing markets, by adding networks
in new markets and by continuing to develop and selectively tailor new services
in competitively-priced packages to meet the needs of its medium and large-sized
business customers. The Company intends to expand its product offerings on a
continuous basis to achieve a diverse revenue base. As part of that process,
the Company is targeting the expansion of data and Internet products that can be
offered on the Company's existing network.
Operating expenses consist of costs directly related to the operation
and maintenance of the networks and the provision of the Company's services.
This includes the salaries and related expenses of operations and engineering
personnel, as well as costs incurred from the incumbent local exchange carriers,
other competitors and long distance providers for facility leases and
interconnection. These costs have increased over time as the Company has
increased its operations and revenue. The Company expects these costs to
continue to increase as the Company's revenue growth continues, but generally at
a slower rate than revenue growth.
Selling, general and administrative expenses consist of salaries and
related costs for employees other than those involved in operations and
engineering. These expenses include costs related to sales and marketing,
information technology, billing, regulatory and legal costs. These costs have
increased over time as the Company has increased its operations and revenue.
The Company expects these costs to continue to increase as the Company's revenue
growth continues, but generally at a slower rate than revenue growth.
In the normal course of business, the Company engages in various
transactions with Time Warner Cable, generally on negotiated terms among the
affected units that, in management's view, result in reasonable allocations. In
connection with the Reorganization, the Company entered into several contracts
with Time Warner Cable with respect to certain of these transactions. The
Company's selling, general and administrative expenses include charges allocated
from Time Warner Cable for office rent and overhead charges for various
administrative functions they perform for the Company. These charges are
required to reflect all costs of doing business and are based on various
methods, which management believes result in reasonable allocations of the costs
that are necessary to present the Company's operations as if they are operated
on a stand alone basis. In addition, the Company licenses the right to use the
majority of its fiber optic cable facilities from Time Warner Cable through
prepaid right-to-use agreements and reimburses Time Warner Cable for facility
maintenance and pole rental costs. The maintenance and pole rental costs are
included in the Company's operating expenses.
Three Months Ended March 31, 2000 Compared to Three Months Ended March 31, 1999
Revenue. Revenue increased $52.5 million, or 110%, to $100.1 million
for the three months ended March 31, 2000, from $47.6 million for the comparable
period in 1999. Revenue from the provision of dedicated transport services
increased $22.3 million, or 75%, to $51.9 million for the three months ended
March 31, 2000, from $29.7 million for the comparable period in 1999. Switched
service revenue increased
16
TIME WARNER TELECOM INC.
$30.3 million, or 169%, to $48.2 million for the three months ended March 31,
2000, from $17.9 million for the comparable period in 1999. Exclusive of the
effects of acquisitions and the effects of the recognition of $3.9 million of
non-recurring reciprocal compensation in the first quarter of 2000, dedicated
transport service and switched service revenue increased 63% and 165%,
respectively. The increase in revenue from dedicated transport services
primarily reflects a 32% increase in average dedicated transport customers and a
broader array of products and services offered in existing markets. The increase
in switched service revenue reflects a 82% increase in average switched service
customers, increased revenue from switched access services and reciprocal
compensation, and a broader array of products and services offered in existing
markets. Reciprocal compensation represented 8% and 7% of total revenue for the
three months ended March 31, 2000 and 1999, respectively, excluding the effects
of the recognition of $3.9 million of non-recurring reciprocal compensation in
the first quarter of 2000. At March 31, 2000 the Company offered dedicated
transport services in 21 metropolitan areas, 20 of which also offered switched
services. At March 31, 1999, the Company offered dedicated transport services in
18 consolidated metropolitan areas, 16 of which also offered switched services.
Operating Expenses. Operating expenses increased $15.0 million, or
62%, to $39.0 million for the three months ended March 31, 2000, from $24.0
million for the comparable period in 1999. Exclusive of the effects of
acquisitions, these expenses increased 51%. The increase in operating expenses
was primarily attributable to the Company's expansion of its business,
principally switched services, the ongoing development of existing markets
resulting in higher local exchange carrier charges for circuit leases and
interconnection, and higher headcount for technical personnel. As a percentage
of revenue, operating expenses decreased to 39% for the three months ended March
31, 2000 from 50% for the comparable period in 1999.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $13.6 million, or 56%, to $37.7 million for
the three months ended March 31, 2000, from $24.1 million for the comparable
period in 1999. Exclusive of the effects of acquisitions, these expenses
increased 51%. The increase in selling, general and administrative expenses was
primarily attributable to an increase in employee headcount and higher direct
sales costs associated with the increase in revenue, higher property tax expense
and an increase in the provision for doubtful accounts related to the increase
in revenue. Included in selling, general and administrative expenses is
approximately $0.8 million in costs related to a Form S-1 filing with the
Securities and Exchange Commission to facilitate the sale of shares by a Class B
Stockholder. As a percentage of revenue, selling, general and administrative
expenses decreased to 37% for the three months ended March 31, 2000 from 51% for
the comparable period in 1999.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $6.9 million, or 46%, to $21.9 million for the three months
ended March 31, 2000, from $15.0 million for the comparable period in 1999.
Exclusive of the effects of acquisitions, this expense increased 41%. The
increase in depreciation and amortization expense was primarily attributable to
increased capital expenditures and increased goodwill generated from
acquisitions.
EBITDA. EBITDA for the three months ended March 31, 2000 increased
$24.0 million to $23.5 million, from a loss of $0.5 million in 1999. The
increase was $19.7 million, exclusive of the effects of acquisitions and the
effects of the recognition of $3.9 million of non-recurring reciprocal
compensation in the first quarter of 2000. This improvement was primarily the
result of economies of scale as more revenue was generated in existing markets,
increased utilization of networks and facilities and a more skilled and
productive workforce.
Interest Expense. During the period July 1, 1997 through July 14,
1998, all of the Company's financing requirements were funded with subordinated
loans payable from the Former Parent Companies. These loans remained
outstanding, accruing interest, through May 14, 1999. On July 21, 1998, the
Company issued $400 million in Senior Notes in a public offering. On May 14,
1999, the subordinated loans of approximately $180 million, including accrued
interest, were repaid in full to the Former Parent Companies from the IPO
proceeds. Interest expense relating to the Senior Notes was $10.1 million for
the three months ended March 31, 2000 and interest expense relating to the
Senior Notes and subordinated loans payable aggregated $13.5 million for the
three months ended March 31, 1999. The decrease of $3.4 million is primarily
due to the lower weighted average debt balance during the three months ended
March 31, 2000.
17
TIME WARNER TELECOM INC.
Net Loss. Net loss decreased $21.8 million, or 88% to $2.9 million
for the three months ended March 31, 2000, from a net loss of $24.6 million for
the comparable period in 1999. The net loss decrease is primarily due to the
improvement in EBITDA.
Loss per Common Share. The basic and diluted loss per common share
was computed by dividing the net loss applicable to common shares by the
weighted average outstanding common shares for the period. Potential common
shares were not included in the computation of weighted average shares
outstanding because their inclusion would be anti-dilutive. The increase in the
weighted average shares outstanding is due to the issuance of Class A common
stock for the IPO, for acquisitions and upon the exercise of stock options. For
the three months ended March 31, 2000, the basic and diluted loss per common
share decreased ($0.27) per share or 90% to ($0.03) per share from ($0.30) per
share for the comparable period in 1999.
Liquidity and Capital Resources
Operations. The Company's cash provided by operating activities was
$16.8 million for the three months ended March 31, 2000, as compared to cash
used in operating activities of $29.3 million for the comparable period in 1999.
This increase in cash provided by operating activities of $46.1 million
principally resulted from increases in EBITDA of $24.0 million, accounts payable
and other current liabilities, and depreciation and amortization expense. As
the Company continues its expansion plan to enter into new markets, the
expenditures incurred, together with initial operating expenses, will generally
result in negative EBITDA and operating losses from a network until an adequate
customer base and revenue stream for the network have been established.
Accordingly, the Company expects that the network constructed in each new market
will generally produce negative EBITDA for at least two and a half years after
operations commence in each market. Although overall the Company expects to
continue to have positive EBITDA for the near future as it develops and expands
its business, there can be no assurance that the Company will sustain sufficient
positive EBITDA to meet its working capital requirements and to service its
indebtedness.
Investing. Cash used in investing activities was $30.9 million for
the three months ended March 31, 2000, as compared to cash provided by investing
activities of $0.4 million for the comparable period in 1999. During both the
three months ended March 31, 2000 and 1999, proceeds from the maturities of
marketable securities were primarily used to fund capital expenditures.
During the three months ended March 31, 2000, capital expenditures
were $62.3 million, an increase of $19.1 million from the comparable period in
1999. The largest commitment of capital was related to the installation of
transport and switch related electronics to support the increase in sales
activity and the addition of 88 route miles of fiber since December 31, 1999.
Based on historic capital requirements for network construction in relation to
sales volumes and network expansion plans, the Company anticipates it will
commit approximately $350 million in 2000 to fund its capital expenditures.
This target spending includes requirements for current operating markets and the
Company's expansion plans.
The facilities-based telecommunications business is a capital
intensive business. The Company's operations have required and will continue to
require substantial capital investment for:
. the purchase and installation of switches, electronics, fiber and
other technologies in existing networks and in additional networks
to be constructed in new service areas;
. the acquisition and expansion of networks currently owned and
operated by other companies; and
. the evolution of the network to support new products, services and
technologies.
The Company's expected capital expenditures for general corporate
and working capital purposes include:
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TIME WARNER TELECOM INC.
. expenditures with respect to the Company's management information
system and corporate service support infrastructure; and
. operating and administrative expenses with respect to new networks
and debt service.
The Company plans to make substantial capital investments in
connection with plans to construct and develop new networks, as well as for
technology upgrades. Expansion of the Company's networks will include the
geographic expansion of the Company's existing operations, and the Company will
consider the development of new markets. In addition, the Company may acquire
existing networks in the future.
The Company regularly evaluates potential acquisitions of, and joint
ventures relating to, networks currently owned and operated by other companies,
including affiliates of the Class B Stockholders, and expects to continue to do
so. In the event the Company enters into a definitive agreement with respect to
any acquisition or joint venture, it may require additional financing or it may
elect to use a portion of the proceeds from the sale of the Senior Notes not
theretofore expended for other purposes, including but not limited to, capital
expenditures and working capital requirements.
While the Company intends to continue to leverage its relationship
with Time Warner Cable in pursuing expansion opportunities, to the extent the
Company seeks to expand into service areas where Time Warner Cable does not
conduct cable operations, the Company may incur significant additional costs in
excess of those historically incurred by the Company when expanding into
existing Time Warner Cable service areas. In addition, Time Warner Cable is not
obligated to construct or provide additional fiber optic capacity in excess of
what is already licensed to the Company under certain operating agreements.
Accordingly, if the Company is unable to lease additional capacity at the same
rates as are currently provided for under certain operating agreements, the
Company may be required to obtain additional capacity on more expensive terms.
The development and expansion of the Company's existing and future
networks and services will require significant capital to fund these capital
expenditures. The Company expects that its future cash requirements will
principally be for funding future growth and capital expenditures. In light of
the expected future cash requirements, the Company, on April 12, 2000, executed
a $475 million Senior Secured Revolving Credit Facility with The Chase Manhattan
Bank, as Administrative Agent, Bank of America, N.A., as Syndication Agent and
ABN Amro Bank N.V., as Documentation Agent (the "Revolver"). The Revolver has a
final maturity of December 31, 2007 and initial borrowings will be at the
Eurodollar rate plus a margin of 2.0%. Applicable margins may be reduced based
upon the Company's financial performance. It is anticipated that the Revolver
will primarily be used for the build-out of the Company's network and working
capital needs, and that the Company may begin drawing on the Revolver during the
second half of 2000. The Company expects that the $221.5 million in cash, cash
equivalents and marketable securities at March 31, 2000, borrowings under the
Revolver along with internally generated funds, will provide sufficient funds
for the Company to meet its expected capital and liquidity needs to expand its
business as currently planned and pay interest on the Senior Notes. In the
event that the Company's plans or assumptions change or prove to be inaccurate,
or the foregoing sources of funds prove to be insufficient to fund the Company's
growth and operations, or if the Company consummates acquisitions or joint
ventures, the Company may be required to seek additional capital sooner than
currently anticipated. The Company's revenue and costs are dependent upon
factors that are not within the Company's control, for example regulatory
changes, changes in technology and increased competition. Due to the
uncertainty of these and other factors, actual revenue and costs may vary from
expected amounts, possibly to a material degree, and these variations are likely
to affect the level of the Company's future capital expenditures and expansion
plans. Sources of additional financing may include public or private debt,
equity financing by the Company or its subsidiaries or other financing
arrangements.
Financing. Net cash provided by financing activities for the three
months ended March 31, 2000 was $5.5 million and was primarily due to the net
proceeds from the issuance of common stock upon exercise of stock options.
19
TIME WARNER TELECOM INC.
During the period from July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with subordinated loans from the
Former Parent Companies. These loans remained outstanding, accruing interest,
through May 14, 1999. The loans from the Former Parent Companies were
subordinated in right of payment to the Senior Notes, except for a provision
allowing repayment prior to maturity with the net proceeds of any offering of
common stock or equivalent interest of the Company. The $400 million principal
amount in Senior Notes that the Company issued in July 1998 are unsecured,
unsubordinated obligations of the Company. Interest on the Senior Notes is
payable semiannually on January 15 and July 15, and began on January 15, 1999.
Aggregate annual interest payments on the Senior Notes through 2008 are expected
to be approximately $39 million. The Senior Notes are required to be repaid on
July 15, 2008. On May 14, 1999, approximately $180 million of the proceeds from
the IPO were used to repay the subordinated loans payable to the Former Parent
Companies in full, including accrued interest. The proceeds of the IPO
remaining after repayment of the subordinated loans payable, combined with the
proceeds from the Senior Notes, have been used to continue funding the Company's
continued growth, which includes expansion of the Company's networks, and for
general corporate purposes. The Former Parent Companies are not under any
obligation to make any additional equity investments or loans to the Company.
The Senior Notes are governed by an Indenture that contains certain
restrictive covenants. These restrictions affect, and in many respects
significantly limit or prohibit, among other things, the ability of the Company
to incur indebtedness, make prepayments of certain indebtedness, pay dividends,
make investments, engage in transactions with shareholders and affiliates, issue
capital stock of subsidiaries, create liens, sell assets and engage in mergers
and consolidations.
The Revolver requires the Company to prepay outstanding loans when its
cash flow exceeds certain levels and with the proceeds received from a number of
specified events or transactions, including certain asset sales and insurance
recoveries for assets not replaced. In addition, obligations under the Revolver
are subject to various covenants that limit the Company's ability to:
. borrow and incur liens on its property;
. pay dividends or make other distributions; and
. make capital expenditures.
The Revolver also contains financial covenants, including a
consolidated leverage ratio, a consolidated interest coverage ratio and a
consolidated debt service coverage ratio. In addition, the Revolver contains
customary events of default, including cross default provisions. Under the
cross defaults provisions, the Company is deemed to be in default under the
Revolver if the Company has defaulted under any of the other material
outstanding obligations, such as the Senior Notes.
The Company continues to evaluate potential acquisitions and joint
ventures that would extend the Company's geographic markets, expand the
Company's products and services and/or enlarge the capacity of its networks.
Some of these transaction may be considerably larger than the transactions it
has completed in the past. If the Company enters into a definitive agreement
with respect to any material transaction, it could results in the Company
increasing its leverage or issuing additional common stock or both. There can
be no assurance, however, that the Company will enter into any transaction or,
if it does, on what terms.
20
TIME WARNER TELECOM INC.
Part II
Other Information
Item 1. Legal Proceedings
Southwestern Bell Telephone Company v. Public Utility Commission of Texas et al.
The Company filed a complaint with the Texas Public Utility Commission
("PUC") in October 1997 as a result of Southwestern Bell Telephone's ("SWBT"')
refusal to pay the Company reciprocal compensation under the Interconnection
Agreement between the parties for calls terminated to the Company's Internet
service provider ("ISP") customers in Texas based on SWBT's contention that such
traffic was not "local". The PUC ruled that calls to ISPs are local and
required SWBT to compensate the Company for those calls under the
Interconnection Agreement. SWBT then sought to enjoin and stay the PUC's order
in Federal District Court for the Western District of Texas and sought a
declaration that calls to ISPs are not local. On April 16, 1998, the District
Court denied all relief sought by SWBT and SWBT appealed that decision. SWBT's
appeal to the Fifth Circuit Court of Appeals is still pending. Following the
PUC's order, SWBT began to make reciprocal compensation payments for ISP traffic
under the Interconnection Agreement.
On March 30, 2000, the Fifth Circuit Court of Appeals affirmed the
decision of the PUC that modem calls within a local calling area to Internet
service providers are "local" calls and therefore subject to reciprocal
compensation under the Interconnection Agreement between the parties.
Southwestern Bell has filed a petition with the Fifth Circuit for rehearing. If
SWBT prevails upon rehearing, the Company may be required to repay the amounts
received from SWBT since April 1997 in respect of ISP traffic with interest as
well as reverse amounts previously recognized into income (see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
General").
Item 2. Changes in Securities and Use of Proceeds.
(c) The Company issued 211 shares of Class A common stock to each of
its independent directors as a portion of their compensation for
services as directors during the third and fourth quarters of
1999. The shares were issued in a private placement under Section
4 (2) of the Securities Act of 1933.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
The exhibits listed on the accompanying Exhibit Index are filed or
incorporated by reference as part of this report and the Exhibit Index
is incorporated herein by reference.
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TIME WARNER TELECOM INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
- ------ ----------------------
2.1 -- Reorganization Agreement among Time Warner Companies, Inc.,
MediaOne Group, Inc., Advance/Newhouse Partnership, Time Warner
Entertainment Company, L.P., and Time Warner Entertainment-
Advance/Newhouse Partnership (filed as Exhibit 2.1 to Time Warner
Telecom ("TWT") LLC's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998.*
2.2 -- Merger Agreement among the Company, TWT LLC and TWT Inc. (filed as
Exhibit 2.2 to the Company's Registration Statement on Form S-1
(Registration No. 333-49439)).*
3.1 -- Restated Certificate of Incorporation of the Company (filed as
Exhibit 2.2 to Company's Registration Statement on Form S-1
(Registration No. 333-49439)).*
3.2 -- Restated By-Laws of the Company (filed as Exhibit 3.2 to Company's
Registration Statement on Form S-1 (Registration No. 333-49439)).*
4.1 -- Stockholders' Agreement, among the Company, Time Warner Companies,
Inc., American Television and Communications Corporation, Warner
Communications Inc., TW/TAE Inc., FibrCOM Holdings, L.P., Paragon
Communications, MediaOne Group, Inc., Multimedia Communications,
Inc. and Advance/Newhouse Partnership (filed as Exhibit 4.1 to
Company's Registration Statement on Form S-1 (Registration No. 333-
49439)).*
4.2 -- Indenture, between TWT LLC, TWT Inc. and The Chase Manhattan Bank,
as Trustee (filed as Exhibit 4.1 to TWT LLC's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998).*
10.1 -- Credit Agreement among Time Warner Telecom Inc., Time Warner
Telecom Holdings Inc., the several lenders from time to time
parties hereto, The Chase Manhattan Bank, as Administrative Agent,
Bank of America, N.A., as Syndication Agent and ABN Amro Bank N.V.,
as Documentation Agent.
27 -- Financial Data Schedule
* Incorporated by reference.
22
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TIME WARNER TELECOM INC.
Date: May 12, 2000 By: /s/ Jill R. Stuart
-------------------------------
Jill R. Stuart
Vice President, Accounting
and Finance and Chief
Accounting Officer