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 September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Commission File Number 1-11965)
ICG COMMUNICATIONS, INC.
(Commission File Number 1-11052)
ICG HOLDINGS (CANADA), INC.
(Commission File Number 33-96540)
ICG HOLDINGS, INC.
(Exact names of Registrants as Specified in their Charters)
- ------------------------------------------ ------------------------------------
Delaware 84-1342022
Canada Not Applicable
Colorado 84-1158866
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation)
- ------------------------------------------ ------------------------------------
161 Inverness Drive West Not applicable
Englewood, Colorado 80112
1710-1177 West Hastings Street c/o ICG Communications, Inc.
Vancouver, BC V6E 2L3 161 Inverness Drive West
Canada P.O. Box 6742
Englewood, Colorado 80155-6742
161 Inverness Drive West Not applicable
Englewood, Colorado 80112
(Address of principal executive offices) (Address of U.S. agent for service)
- ------------------------------------------ ------------------------------------
Registrants' telephone numbers, including area codes:
(888) 424-1144 or (303) 414-5000
Indicate by check mark whether the registrants (1) have 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
registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
The number of registrants' outstanding common shares as of November 12,
1998 were 46,010,518, 31,831,558 and 1,918, respectively. ICG Holdings (Canada),
Inc. owns all of the issued and outstanding shares of ICG Holdings, Inc.
2
TABLE OF CONTENTS
PART I .............................................................. 3
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS .............. 3
Consolidated Balance Sheets as of December 31, 1997 and
September 30, 1998 (unaudited).......................... 3
Consolidated Statements of Operations (unaudited) for the
Three Months and Nine Months Ended September 30, 1997
and 1998................................................ 5
Consolidated Statement of Stockholders' Deficit (unaudited)
for the Nine Months Ended September 30, 1998 ............ 7
Consolidated Statements of Cash Flows (unaudited) for the
Nine Months Ended September 30, 1997 and 1998 ........... 8
Notes to Consolidated Financial Statements, December 31,
1997 and September 30, 1998 (unaudited) ................. 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ................................. 20
PART II ............................................................... 35
ITEM 1. LEGAL PROCEEDINGS ......................................... 35
ITEM 2. CHANGES IN SECURITIES ..................................... 35
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ........................... 35
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS ..... 35
ITEM 5. OTHER INFORMATION ......................................... 35
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K ........................... 35
Exhibits .................................................. 35
Report on Form 8-K ........................................ 35
3
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1997 and September 30, 1998 (unaudited)
December 31, September 30,
1997 1998
------------------ ----------------
(in thousands)
Assets
Current assets:
Cash and cash equivalents $ 182,202 429,418
Short-term investments 112,281 41,000
Receivables:
Trade, net of allowance of $7,004 and $14,377 at
December 31, 1997 and September 30, 1998,
respectively (note 7) 61,439 102,351
Revenue earned, but unbilled 8,599 15,140
Due from affiliate 9,384 5,862
Other 1,696 1,664
------------------ ----------------
81,118 125,017
Inventory 3,901 3,259
Prepaid expenses and deposits 10,543 10,222
------------------ ----------------
Total current assets 390,045 608,916
------------------ ----------------
Property and equipment 736,700 963,649
Less accumulated depreciation (105,584) (158,993)
------------------ ----------------
Net property and equipment 631,116 804,656
------------------ ----------------
Long-term notes receivable from affiliate and others, net 10,375 15,002
Restricted cash 24,649 18,889
Other assets, net of accumulated amortization:
Goodwill 77,562 109,960
Deferred financing costs 23,196 37,374
Deferred advertising costs - 1,326
Transmission and other licenses 6,031 5,779
Deposits and other 9,404 24,001
------------------ ----------------
116,193 178,440
Net assets of discontinued operations (note 5) 76,092 78,254
------------------ ----------------
Total assets $ 1,248,470 1,704,157
================== ================
(Continued)
4
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, September 30,
1997 1998
------------------- -------------------
(in thousands)
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 38,457 59,122
Accrued liabilities 71,678 77,897
Deferred revenue 10,219 14,992
Current portion of capital lease obligations (note 7) 5,637 4,474
Current portion of long-term debt (note 2) 1,784 47
------------------- -------------------
Total current liabilities 127,775 156,532
------------------- -------------------
Capital lease obligations, less current portion (note 7) 66,939 60,429
Long-term debt, net of discount, less current portion (note 2) 890,568 1,553,097
------------------- -------------------
Total liabilities 1,085,282 1,770,058
------------------- -------------------
Redeemable preferred stock of subsidiary ($301.2 million and
$334.4 million liquidation value at December 31, 1997 and
September 30, 1998, respectively) (note 2) 292,442 326,248
Company-obligated mandatorily redeemable preferred securities of
subsidiary limited liability company which holds solely Company
preferred stock ($133.4 million liquidation value at December 31,
1997 and September 30, 1998) 127,729 127,944
Stockholders' deficit:
Common stock (note 3) 749 596
Additional paid-in capital 533,541 570,033
Accumulated deficit (791,417) (1,090,672)
Accumulated other comprehensive income (loss) 144 (50)
------------------- -------------------
Total stockholders' deficit (256,983) (520,093)
------------------- -------------------
Commitments and contingencies (notes 4, 5, 6 and 7)
Total liabilities and stockholders' deficit $ 1,248,470 1,704,157
=================== ===================
See accompanying notes to consolidated financial statements.
5
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months and Nine Months Ended September 30, 1997 and 1998
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
1997 1998 1997 1998
------------- -------------- ------------- --------------
(in thousands, except per share data)
Revenue:
Telecom services $ 36,543 82,567 101,637 205,269
Network services 16,432 14,550 50,059 40,740
Satellite services 7,640 9,350 22,306 29,982
------------- -------------- ------------- --------------
Total revenue 60,615 106,467 174,002 275,991
Operating costs and expenses:
Operating costs 52,602 64,680 156,893 187,964
Selling, general and administrative expenses 39,187 45,435 110,183 132,917
Depreciation and amortization 13,517 24,883 37,198 61,321
Net loss (gain) on disposal of long-lived
assets (note 4) 1,354 (814) 1,035 (316)
Restructuring costs - - - 553
------------- -------------- ------------- --------------
Total operating costs and expenses 106,660 134,184 305,309 382,439
Operating loss (46,045) (27,717) (131,307) (106,448)
Other income (expense):
Interest expense (28,834) (45,982) (82,290) (121,974)
Interest income 5,382 8,196 17,284 22,188
Other expense, net 237 (592) (36) (4,073)
------------- -------------- ------------- --------------
(23,215) (38,378) (65,042) (103,859)
------------- -------------- ------------- --------------
Loss from continuing operations before
preferred dividends (69,260) (66,095) (196,349) (210,307)
Accretion and preferred dividends on
preferred securities of subsidiaries,
net of minority interest in share of losses (10,112) (13,987) (24,981) (40,774)
------------- -------------- ------------- --------------
Loss from continuing operations (79,372) (80,082) (221,330) (251,081)
------------- -------------- ------------- --------------
Discontinued operations (note 5):
Loss from discontinued operations (7,502) (15,381) (28,285) (46,973)
Loss on disposal of discontinued operations,
including provision of $0.2 million for
operating losses during phase out period - (1,201) - (1,201)
------------- -------------- ------------- --------------
(7,502) (16,582) (28,285) (48,174)
------------- -------------- ------------- --------------
Net loss $ (86,874) (96,664) (249,615) (299,255)
============= ============== ============= ==============
Other comprehensive loss:
Foreign currency translation adjustment (266) (118) (500) (194)
Unrealized loss on short-term investments
available for sale (235) - (540) -
------------- -------------- ------------- --------------
Other comprehensive loss (501) (118) (1,040) (194)
------------- -------------- ------------- --------------
Comprehensive loss $ (87,375) (96,782) (250,655) (299,449)
============= ============== ============= ==============
(Continued)
6
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited), Continued
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
1997 1998 1997 1998
------------- -------------- ------------- --------------
(in thousands, except per share data)
Net loss per share - basic and diluted (note 3):
Net loss per share from continuing operations
- basic and diluted $ (1.87) (1.76) (5.25) (5.59)
Net loss per share from discontinued operations
- basic and diluted (0.18) (0.36) (0.67) (1.07)
------------- -------------- ------------- --------------
Net loss per share - basic and diluted $ (2.05) (2.12) (5.92) (6.66)
============= ============== ============= ==============
Weighted average number of shares outstanding
- basic and diluted 42,359 45,588 42,159 44,922
============= ============== ============= ==============
See accompanying notes to consolidated financial statements.
7
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Deficit (unaudited)
Nine Months Ended September 30, 1998
Accumulated
Common stock Additional other Total
---------------------- paid-in Accumulated comprehensive stockholders'
Shares Amount capital deficit income (loss) deficit
----------- ----------- ------------- --------------- ------------------ --------------
(in thousands)
Balances at January 1, 1998 43,974 $ 749 533,541 (791,417) 144 (256,983)
Shares issued for cash by subsidiary,
net of selling costs 127 1 3,384 - - 3,385
Shares issued in connection with
business combinations (note 6) 502 5 15,527 - - 15,532
Shares issued for cash in connection
with the exercise of options and
warrants 1,018 10 12,683 - - 12,693
Shares issued for cash in connection
with the employee stock purchase plan 107 1 2,135 - - 2,136
Shares issued as contribution to 401(k)
plan 85 1 2,592 - - 2,593
Exchange of ICG Holdings (Canada), Inc.
common shares for ICG common stock - (171) 171 - - -
Cumulative foreign currency translation
adjustment - - - - (194) (194)
Net loss - - - (299,255) - (299,255)
=========== =========== ============= =============== ================== ==============
Balances at September 30, 1998 45,813 $ 596 570,033 (1,090,672) (50) (520,093)
=========== =========== ============= =============== ================== ==============
See accompanying notes to consolidated financial statements.
8
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Nine Months Ended September 30, 1997 and 1998
Nine months ended September 30,
----------------------------------
1997 1998
--------------- ---------------
(in thousands)
Cash flows from operating activities:
Net loss $ (249,615) (299,255)
Non-cash operating activities of discontinued operations 25,915 33,551
Adjustments to reconcile net loss to net cash used by operating activities of continuing
operations:
Accretion and preferred dividends on preferred securities of subsidiaries, net of
minority interest in share of losses 24,981 40,774
Depreciation and amortization 37,198 61,321
Interest expense deferred and included in long-term debt, net of amounts capitalized on
assets under construction 75,000 109,850
Amortization of deferred advertising costs included in selling, general and
administrative expenses - 469
Amortization of deferred financing costs included in interest expense 1,988 3,307
Write-off of non-operating assets - 250
Contribution to 401(k) plan through issuance of common shares 2,171 2,593
Net loss (gain) on disposal of long-lived assets 1,035 (316)
Change in operating assets and liabilities, excluding the effects of
business combinations, dispositions and non-cash transactions:
Receivables (3,386) (44,168)
Inventory (2,367) 1,408
Prepaid expenses and deposits (7,140) 306
Deferred advertising - (1,795)
Accounts payable and accrued liabilities 23,038 23,309
Deferred revenue 2,330 4,773
--------------- ---------------
Net cash used by operating activities of continuing operations (68,852) (63,623)
--------------- ---------------
Cash flows from investing activities:
Increase in long-term notes receivable from affiliates and others (6,329) (4,877)
Proceeds from sale of subsidiary, net of cash included in sale - 824
Payments for business acquisitions, net of cash acquired - (14,307)
Acquisition of property, equipment and other assets, net (187,136) (260,022)
Payments for construction of new headquarters (16,675) (4,944)
Proceeds from disposition of property, equipment and other assets 3,009 172
Proceeds from sale of new headquarters, net of selling and other costs - 30,283
(Purchase) sale of short-term investments available for sale (88,233) 71,281
(Increase) decrease in restricted cash (8,833) 5,760
Purchase of minority interest in subsidiaries - (9,355)
--------------- ---------------
Net cash used by investing activities of continuing operations (304,197) (185,185)
--------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of common stock:
Sale by subsidiary - 3,385
Exercise of options and warrants 2,829 12,693
Employee stock purchase plan 2,145 2,136
Proceeds from issuance of subsidiary preferred stock, net of issuance costs 207,550 -
Proceeds from issuance of long-term debt 101,486 550,574
Deferred long-term debt issuance costs (3,554) (17,496)
Principal payments on capital lease obligations (23,318) (7,673)
Principal payments on long-term debt (1,179) (6,850)
Payments of preferred dividends - (6,695)
--------------- ---------------
Net cash provided by financing activities of continuing operations 285,959 530,074
--------------- ---------------
Net (decrease) increase in cash and cash equivalents of continuing operations (87,090) 281,266
Net cash used by discontinued operations (12,162) (34,050)
Cash and cash equivalents, beginning of period 433,342 182,202
--------------- ---------------
Cash and cash equivalents, end of period 334,090 429,418
=============== ===============
(Continued)
9
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited), Continued
Nine months ended September 30,
---------------------------------------
1997 1998
------------------ ------------------
(in thousands)
Supplemental disclosure of cash flows information of continuing operations:
Cash paid for interest $ 5,302 8,817
=================== =================
Supplemental schedule of non-cash investing and financing activities of
continuing operations:
Common stock issued in connection with business combinations $ - 15,532
=================== =================
See accompanying notes to consolidated financial statements.
10
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997 and September 30, 1998 (unaudited)
(1) Organization and Basis of Presentation
(a) Organization and Nature of Business
ICG Communications, Inc., a Delaware corporation ("ICG"), was
incorporated on April 11, 1996, for the purpose of becoming the new
publicly-traded U.S. parent company of ICG Holdings (Canada), Inc., a
Canadian federal corporation ("Holdings-Canada"), ICG Holdings, Inc.,
a Colorado corporation ("Holdings"), and its subsidiaries.
On January 21, 1998, the Company completed a merger with NETCOM
On-Line Communication Services, Inc. ("NETCOM"). At the effective time
of the merger, each outstanding share of NETCOM common stock, $.01 par
value, became automatically convertible into shares of ICG common
stock, $.01 par value ("ICG Common Stock"), at an exchange ratio of
0.8628 shares of ICG Common Stock per NETCOM common share. The
business combination was accounted for as a pooling of interests.
Effective November 3, 1998, the Company's board of directors adopted a
formal plan to dispose of the operations of NETCOM (see note 5) and,
accordingly, the Company's consolidated financial statements reflect
the operations and net assets of NETCOM as discontinued for all
periods presented.
On January 23, 1998, the Company formed ICG Services, Inc., a Delaware
corporation and wholly owned subsidiary of ICG ("ICG Services"). ICG
Services is the parent company of NETCOM and ICG Equipment, Inc., a
Colorado corporation formed on January 23, 1998 to purchase or lease
telecommunications equipment, software and capacity and related
services, and in turn, lease such assets to Holdings' subsidiaries.
ICG and its subsidiaries, including ICG Services and its subsidiaries,
are collectively referred to as the "Company."
The Company's principal business activity is telecommunications
services, including Telecom Services, Network Services and Satellite
Services. Telecom Services consists primarily of the Company's
competitive local exchange carrier operations which provide services
to business end users and long distance carriers and resellers.
Network Services supplies information technology services and selected
networking products, focusing on network design, installation,
maintenance and support for a variety of end users, including Fortune
1000 firms and other large businesses and telecommunications
companies. Satellite Services consists of satellite voice, data and
video services provided to major cruise ship lines, the U.S. Navy, the
offshore oil and gas industry and integrated communications providers.
(b) Reference to Annual and Transition Reports
The accompanying consolidated financial statements give retroactive
effect to the merger of ICG and NETCOM on January 21, 1998, which was
accounted for as a pooling of interests, and include the accounts of
NETCOM and its subsidiaries as of the end of and for the periods
presented. Additionally, the operating results of NETCOM have been
presented as discontinued for all periods presented.
The Company's financial statements should be read in conjunction with
ICG's Annual Report on Form 10-K for the fiscal year ended December
31, 1997, NETCOM's Annual Report on Form 10-KSB/A for the fiscal year
ended December 31, 1996 and the consolidated financial statements of
ICG and NETCOM combined for fiscal 1997 as filed on Form 8-K of ICG
Communications, Inc., ICG Funding, LLC, ICG Holdings (Canada), Inc.
and ICG Holdings, Inc., dated June 12, 1998, as certain information
and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to the rules and regulations
of the United States Securities and Exchange Commission. The interim
financial statements reflect all adjustments
11
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(1) Organization and Basis of Presentation (continued)
which are, in the opinion of management, necessary for a fair
presentation of financial position, results of operations and cash
flows as of and for the interim periods presented. Such adjustments
are of a normal recurring nature. Operating results for the nine
months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the fiscal year ending December 31,
1998.
(c) Reclassifications
Certain 1997 amounts have been reclassified to conform with the 1998
presentation.
(2) Long-term Debt and Redeemable Preferred Securities of Subsidiaries
Long-term debt is summarized as follows:
December 31, September 30,
1997 1998
--------------------- -----------------
(in thousands)
9 7/8% Senior discount notes of ICG Services, net of discount $ - 260,531
10% Senior discount notes of ICG Services, net of discount - 319,802
11 5/8% Senior discount notes of Holdings, net of discount 109,436 119,084
12 1/2% Senior discount notes of Holdings, net of discount 367,494 402,413
13 1/2% Senior discount notes of Holdings, net of discount 407,409 450,152
Note payable with interest at the 90-day commercial paper
rate plus 4 3/4%, paid in full on August 19, 1998 4,932 -
Note payable with interest at 11%, paid in full on June 12, 1998 1,860 -
Mortgage payable with interest at 8 1/2%, due monthly through
2009, secured by building 1,131 1,096
Other 90 66
--------------------- -----------------
892,352 1,553,144
Less current portion (1,784) (47)
--------------------- -----------------
$ 890,568 1,553,097
===================== =================
Redeemable preferred stock of subsidiary is summarized as follows:
December 31, September 30,
1997 1998
---------------------- -------------------
(in thousands)
14% Exchangeable preferred stock of Holdings, mandatorily
redeemable 2008 $ 108,022 120,440
14 1/4% Exchangeable preferred stock of Holdings,
mandatorily redeemable 2007 184,420 205,808
---------------------- -------------------
$ 292,442 326,248
====================== ===================
12
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Stockholders' Deficit
(a) Common Stock
Common stock outstanding at September 30, 1998 represents the issued
and outstanding common stock of ICG and Class A common shares of
Holdings-Canada (not owned by ICG) which are exchangeable at any time,
on a one-for-one basis, for ICG Common Stock. The following table sets
forth the number of shares outstanding for ICG and Holdings-Canada on
a separate company basis as of September 30, 1998:
Shares Shares
owned owned by third
by ICG parties
----------------- -----------------
ICG Common Stock, $.01 par value, 100,000,000 shares authorized;
45,810,896 shares issued and outstanding at September 30, 1998 - 45,810,896
Holdings-Canada Class A common shares, no par value, 100,000,000
shares authorized; 31,831,558 shares issued and outstanding
at September 30, 1998:
Class A common shares, exchangeable on a one-for-one basis for
ICG Common Stock at any time - 2,258
Class A common shares owned by ICG 31,829,300 -
-----------------
Total shares outstanding 45,813,154
=================
For various business purposes, Holdings-Canada has adopted a plan of
reorganization, dated November 4, 1998, whereby the minority
shareholders of Holdings-Canada will receive ICG Common Stock in
exchange for their Class A common shares. Also under the plan, any
warrants outstanding to purchase Class A common shares of
Holdings-Canada will be exchanged for warrants to purchase ICG Common
Stock on equivalent terms and conditions. The reorganization will be
concluded and effective January 1, 1999 and will have no effect on the
Company's reported net loss per share.
(b) Net Loss Per Share
Basic and diluted net loss per share is calculated by dividing the net
loss by the weighted average number of shares outstanding. Weighted
average number of shares outstanding represents combined ICG Common
Stock and Holdings-Canada Class A common shares outstanding. Potential
common stock, which include options, warrants and convertible
subordinated notes and preferred stock, are not included in the loss
per share calculation as their effect is anti-dilutive. The Company
has presented net loss per share from discontinued operations in the
consolidated statement of operations for all periods presented.
(4) Sale of Satellite Services Operating Subsidiaries
On July 17, 1998, the Company entered into separate definitive agreements
to sell the capital stock of MarineSat Communications, Inc. ("MCN") and
Nova-Net Communications, Inc. ("Nova-Net"), two subsidiaries within the
Company's Satellite Services operations. The sale of MCN was completed on
August 12, 1998 and, accordingly, the Company's consolidated financial
statements include the results of operations of MCN through that date. The
Company recorded a gain on the sale of MCN of approximately $0.8 million in
its statement of operations during the three months ended September 30,
1998. Regulatory approvals have been received and the sale of Nova-Net is
expected to close on November 18, 1998. The combined revenue, net loss or
net loss per share of MCN and Nova-Net do not represent a significant
portion of the Company's historical consolidated revenue, net loss or net
loss per share.
13
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Discontinued Operations
Loss from discontinued operations consists of the following:
Three months ended Nine months ended
September 30, September 30,
---------------------------- ------------------------------
1997 1998 1997 1998
------------- ----------- ------------ -------------
(in thousands)
Zycom (a) $ (675) (1,449) (3,068) (4,647)
NETCOM (b) (6,827) (13,932) (25,217) (42,326)
------------- ----------- ------------ -------------
Loss from discontinued operations $ (7,502) (15,381) (28,285) (46,973)
============= =========== ============ =============
(a) Zycom
The Company owns a 70% interest in Zycom Corporation ("Zycom") which,
through its wholly owned subsidiary, Zycom Network Services, Inc.
("ZNSI"), operated an 800/888/900 number services bureau and a switch
platform in the United States and supplied information providers and
commercial accounts with audiotext and customer support services. In
June 1998, Zycom was notified by its largest customer of the
customer's intent to transfer its call traffic to another service
bureau. In order to minimize the obligation that this loss in call
traffic would generate under Zycom's volume discount agreements with
AT&T Corp. ("AT&T"), its call transport provider, ZNSI entered into an
agreement on July 1, 1998 with an unaffiliated entity, ICN Limited
("ICN"), whereby ZNSI assigned the traffic of its largest audiotext
customer and its other 900-number customers to ICN, effective October
1, 1998. As part of this agreement, ICN assumed all minimum call
traffic volume obligations to AT&T.
The call traffic assigned to ICN represents approximately 86% of
Zycom's revenue for the year ended December 31, 1997. The loss of this
significant portion of Zycom's business, despite management's best
efforts to secure other sources of revenue, raised substantial doubt
as to Zycom's ability to operate in a manner which would benefit
Zycom's or the Company's shareholders. Accordingly, on August 25,
1998, Zycom's board of directors approved a plan to wind down and
ultimately discontinue Zycom's operations. On October 22, 1998, Zycom
completed the transfer of all customer traffic to other providers and
Zycom anticipates it will need approximately 30 to 60 days to dispose
of its remaining assets and discharge its remaining liabilities.
The Company's consolidated financial statements reflect the operations
of Zycom as discontinued for all periods presented. Zycom incurred net
losses from operations of approximately $1.0 million for the period
from August 25, 1998 to the end of the period presented. During the
three months ended September 30, 1998, the Company accrued
approximately $1.2 million for estimated losses on disposal of Zycom's
operations, including approximately $0.2 million for operating losses
of Zycom during the phase out period. Included in net assets of
discontinued operations in the Company's consolidated balance sheet at
September 30, 1998 is approximately $0.5 million of Zycom's net
property and equipment. Other remaining assets and liabilities of
Zycom included in the Company's consolidated balance sheet at
September 30, 1998 are cash of approximately $0.2 million, other
current assets of approximately $1.5 million and accounts payable and
accrued liabilities of approximately $3.4 million.
14
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Discontinued Operations (continued)
(b) NETCOM
Effective November 3, 1998, the Company's board of directors adopted a
formal plan to dispose of the operations of NETCOM and, accordingly,
the Company's consolidated financial statements reflect the operations
of NETCOM as discontinued for all periods presented. The Company's
plan of disposal consists of the sale to one or more third parties in
one or more transactions of all of the operating assets of NETCOM
which will not be used in future Telecom Services operations. At
September 30, 1998, net assets of NETCOM included in net assets of
discontinued operations in the Company's consolidated balance sheet
are approximately $3.0 million of inventory and prepaid expenses and
approximately $80.3 million of net property and equipment and other
non-current assets, offset by approximately $5.5 million of capital
lease obligations. The Company has commenced an active plan to locate
one or more buyers and intends to complete the sales within one year.
The Company expects to record a gain on the sale of NETCOM in the
period of disposition, although the amount of such gain is not
presently determinable.
Other remaining assets and liabilities of NETCOM included in the
Company's consolidated balance sheet at September 30, 1998 are net
accounts receivable of approximately $2.5 million and accounts payable
and accrued liabilities of approximately $7.5 million.
(6) Business Combinations
On July 27, 1998, the Company acquired DataChoice Network Services L.L.C.
("DataChoice") for total consideration of $5.9 million, consisting of
145,997 shares of ICG Common Stock and approximately $1.1 million in cash.
The Company accounted for the business combination as a purchase and,
accordingly, the net assets and the results of operations of DataChoice
have been included in the Company's consolidated financial statements since
the acquisition date. The excess of the purchase price over the fair value
of the net identifiable assets acquired of $5.7 million has been recorded
as goodwill and is being amortized on a straight-line basis over five
years. Revenue, net loss and loss per share on a pro forma basis, assuming
the acquisition of DataChoice was completed at the beginning of the periods
presented, are not significantly different from the Company's historical
results. DataChoice, a Colorado limited liability company, provides
point-to-point data transmission resale services through its long-term
agreements with multiple regional carriers and nationwide providers.
Additionally, the Company completed a series of transactions on July 30,
1998 to acquire NikoNET, Inc., CompuFAX Acquisition Corp. and Enhanced
Messaging Services, Inc. (collectively, "NikoNET"). The Company paid
approximately $13.8 million in cash, which included dividends payable by
NikoNET to its former owners and amounts to satisfy NikoNET's former line
of credit, assumed approximately $0.7 million in liabilities and exchanged
356,318 shares of ICG Common Stock with a fair market value of
approximately $10.7 million, for all the capital stock of NikoNET. The
Company accounted for the business combination as a purchase and,
accordingly, the net assets and the results of operations of NikoNET have
been included in the Company's consolidated financial statements since the
acquisition date. The excess of the purchase price over the fair value of
the net identifiable assets acquired of $22.6 million has been recorded as
goodwill and is being amortized on a straight-line basis over five years.
Revenue, net loss and loss per share on a pro forma basis, assuming the
acquisition of NikoNET was completed at the beginning of the periods
presented, are not significantly different from the Company's historical
results. Located in Atlanta, Georgia, NikoNET provides broadcast facsimile
services and value-added messaging services to financial institutions,
corporate investor and public relations departments and other customers.
The Company believes that the acquisition of NikoNET will enable the
Company to expand the service offerings currently available to its Telecom
Services customers.
15
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Business Combinations (continued)
On August 27, 1998, the Company purchased, for $9.0 million in cash, the
remaining 20% equity interest in ICG Ohio LINX, Inc. ("ICG Ohio LINX")
which it did not already own. 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's
additional investment in ICG Ohio LINX is included in goodwill in the
accompanying consolidated balance sheet at September 30, 1998.
In January 1997, the Company announced a strategic alliance with Central
and SouthWest Corporation ("CSW") which is developing and marketing
telecommunications services in certain cities in Texas. The venture entity,
a limited partnership named CSW/ICG ChoiceCom, L.P ("ChoiceCom"), is based
in Austin, Texas. Currently, CSW holds 100% of the interest in ChoiceCom,
and CSW and the Company each have two representatives on the Management
Committee of the general partner of ChoiceCom. On October 7, 1998, the
Company entered into a definitive agreement with CSW to purchase 100% of
the partnership interests in ChoiceCom. Cash consideration for the purchase
is estimated to be approximately $50.0 to $55.0 million. The transaction is
subject to regulatory approvals and is expected to close in late 1998 or
early 1999. The acquisition of ChoiceCom will be accounted for as a
purchase.
(7) Commitments and Contingencies
(a) Network Construction
In March 1996, the Company and Southern California Edison Company
("SCE") entered into a 25-year agreement under which the Company will
license 1,258 miles of fiber optic cable in Southern California, and
can install up to 500 additional miles of fiber optic cable. This
network, which will be maintained and operated primarily by the
Company, stretches from Los Angeles to southern Orange County. Under
the terms of this agreement, SCE is entitled to receive an annual fee
for ten years, certain fixed quarterly payments, a quarterly payment
equal to a percentage of certain network revenue, and certain other
installation and fiber connection fees. The aggregate fixed payments
remaining under the agreement totaled approximately $135.9 million at
September 30, 1998. The agreement has been accounted for as a capital
lease in the accompanying consolidated balance sheets.
In May 1997, the Company entered into a long-term agreement with the
Southern Company ("Southern") that will permit the Company to
construct a 100-mile fiber optic network in the Atlanta metropolitan
area. The Company paid $5.5 million upon execution of the agreement
and was responsible for reimbursement to Southern for costs of network
design, construction, installation, maintenance and repair.
Additionally, the Company is also required to pay Southern a quarterly
fee based on specified percentages of the Company's revenue derived
from services provided over this network. Network construction on the
initial 43-mile build was completed in September of 1998 at a total
cost of $9.0 million, including the cost for the initial build.
In June 1997, the Company entered into an indefeasible right of use
("IRU") agreement with Qwest Communications Corporation ("Qwest") for
approximately 1,800 miles of fiber optic network and additional
broadband capacity in California, Colorado, Ohio and the Southeast.
Network construction is ongoing and is expected to be completed by
December 1998. The Company is responsible for payment on the
construction as segments of the network are completed and has incurred
approximately $17.7 million as of September 30, 1998, with remaining
costs anticipated to be approximately $17.3 million. Additionally, the
Company has committed to purchase $6.0 million in network capacity
from Qwest prior to the end of 1999.
16
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Commitments and Contingencies (continued)
(b) Other 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.
Additionally, the Company has entered into certain commitments to
purchase capital assets with an aggregate purchase price of
approximately $82.0 million at September 30, 1998.
(c) Transport and Termination Charges
The Company has recorded revenue of approximately $4.9 million, $17.8
million and $32.9 million for fiscal 1997 and the three months and
nine months ended September 30, 1998, respectively, for reciprocal
compensation relating to the transport and termination of local
traffic to Internet service providers ("ISPs") from customers of
incumbent local exchange carriers ("ILECs") pursuant to various
interconnection agreements. The ILECs have not paid most of the bills
they have received from the Company and have disputed substantially
all of these charges based on the belief that such calls are not local
traffic as defined by the various agreements and under state and
federal laws and public policies. The resolution of these disputes
will be based on rulings by state public utility commissions and/or by
the Federal Communications Commission ("FCC"). To date, there have
been favorable final rulings from 23 states, favorable preliminary
decisions from one additional state and no unfavorable rulings by any
state public utility commission that would indicate that calls placed
by end users to ISPs would not qualify as local traffic subject to the
payment of reciprocal compensation. In addition to the one preliminary
ruling, cases are pending before three other states. Additionally,
three federal district court decisions have upheld favorable state
public utility commission rulings. On October 30, 1998, the FCC issued
a decision that found that certain high-speed dedicated access
connections, or digital subscriber line services, between end users
and ISPs are interstate communications. This decision did not consider
or address the issue of whether competitive local exchange carriers
are entitled to receive reciprocal compensation for the transport and
termination to ISPs of circuit-switched dial-up traffic originated by
the ILECs. Therefore, the recent FCC decision does not change the
obligations of the ILECs under existing interconnection agreements or
affect state regulatory decisions requiring the ILECs to pay
reciprocal compensation for ISP traffic using dial-up services. The
FCC has not yet issued a decision specifically addressing reciprocal
compensation issues, although the FCC has stated publicly that it will
issue such a decision in the near future. The Company has also
recorded revenue of approximately $4.1 million and $9.6 million for
the three months and nine months ended September 30, 1998,
respectively, related to other transport and termination charges to
the ILECs, pursuant to the Company's interconnection agreements with
these carriers. Included in the Company's trade receivables at
December 31, 1997 and September 30, 1998 is $4.4 million and $44.1
million, respectively, for all receivables related to transport and
termination charges. While the Company believes that all revenue
recorded through September 30, 1998 is collectible and that future
revenue from transport and termination charges billed under the
Company's current interconnection agreements will be realized, there
can be no assurance that future regulatory rulings will be favorable
to the Company, or that different pricing plans for transport and
termination charges between carriers will not be considered when the
Company's interconnection agreements are renegotiated, beginning in
1999.
17
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Commitments and Contingencies (continued)
(d) Litigation
On April 4, 1997, certain shareholders of Zycom filed a shareholder
derivative suit and class action complaint for unspecified damages,
purportedly on behalf of all of the minority shareholders of Zycom, in
the District Court of Harris County, Texas (Cause No. 97-17777)
against the Company, Zycom and certain of their subsidiaries. This
complaint alleges that the Company and certain of its subsidiaries
breached certain duties owed to the plaintiffs. The plaintiffs were
denied class certification, have appealed this decision and have
amended their petition to include approximately 150 named plaintiffs.
The Company is vigorously defending the claims. While it is not
possible to predict the outcome of this litigation, management
believes these proceedings will not have a material adverse effect on
the Company's financial condition, results of operations or cash
flows.
The Company is a party to certain other 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.
(8) Summarized Financial Information of ICG Holdings, Inc.
The 11 5/8% Senior Discount Notes due 2007 (the "11 5/8% Notes") issued by
Holdings during 1997 are guaranteed by ICG. The 12 1/2% Senior Discount
Notes due 2006 (the "12 1/2% Notes") and the 13 1/2% Senior Discount Notes
due 2005 (the "13 1/2% Notes") issued by Holdings during 1996 and 1995,
respectively, are guaranteed by ICG and Holdings-Canada.
The separate complete financial statements of Holdings have not been
included herein because such disclosure is not considered to be material to
the holders of the 11 5/8% Notes, the 12 1/2% Notes and the 13 1/2% Notes.
However, summarized combined financial information for Holdings and its
subsidiaries is as follows:
Condensed Balance Sheet Information
December 31, 1997 September 30, 1998
------------------------ ---------------------
(in thousands)
Current assets $ 215,817 254,385
Property and equipment, net 632,167 682,915
Other non-current assets, net 122,768 165,505
Current liabilities 98,351 87,076
Long-term debt, less current portion 890,503 973,538
Capital lease obligations, less current
portion 66,939 60,429
Due to parent 30,970 150,571
Due to ICG Services - 113,800
Preferred stock 292,442 326,248
Stockholder's deficit (408,453) (608,857)
18
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Summarized Financial Information of ICG Holdings, Inc.
Summarized Consolidated and Combined Statement of Operations Information
Three months ended September 30, Nine months ended September 30,
------------------------------------ ----------------------------------
1997 1998 1997 1998
----------------- --------------- -------------- ----------------
(in thousands)
Total revenue $ 67,736 112,676 195,552 294,852
Total operating costs and expenses 114,270 142,265 1,035 403,424
Operating loss (46,532) (29,589) (133,808) (108,572)
Net loss (79,884) (40,166) (224,003) (200,404)
(9) Condensed Financial Information of ICG Holdings (Canada), Inc.
Condensed financial information for Holdings-Canada only is as follows:
Condensed Balance Sheet Information
December 31, 1997 September 30, 1998
------------------------ ---------------------
(in thousands)
Current assets $ 162 162
Advances to subsidiaries 30,790 150,571
Non-current assets, net 3,800 2,477
Current liabilities 107 107
Long-term debt, less current portion 65 65
Due to parent 22,162 140,749
Share of losses of subsidiary 408,453 608,857
Shareholders' deficit (396,035) (596,568)
Condensed Statement of Operations Information
Three months ended September 30, Nine months ended September 30,
------------------------------------ ----------------------------------------
1997 1998 1997 1998
--------------- ------------------- ----------------- -------------------
(in thousands)
Total revenue $ - - - -
Total operating costs and expenses 47 48 147 129
Operating loss (47) (48) (147) (129)
Losses of subsidiaries (79,884) (40,166) (224,003) (200,404)
Net loss attributable to common
shareholders (79,931) (40,214) (224,150) (200,533)
19
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Condensed Financial Information of ICG Communications, Inc. (Parent
company)
The primary assets of ICG are its investments in ICG Services, ICG Funding,
LLC ("ICG Funding"), Holdings-Canada and NikoNET, including advances to
those subsidiaries. Certain corporate expenses of the parent company are
included in ICG's statement of operations and were approximately zero and
$0.1 million for the three months and nine months ended September 30, 1997,
respectively, and $1.0 million and $2.0 million for the three months and
nine months ended September 30, 1998, respectively. ICG has no operations
other than those of ICG Services, ICG Funding and Holdings-Canada and their
subsidiaries.
20
ITEM 2.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, dependence on
increased traffic on the Company's facilities, the successful implementation of
the Company's strategy of offering an integrated telecommunications package of
local, long distance, data and value added services, continued development of
the Company's network infrastructure and actions of competitors and regulatory
authorities that could cause actual results to differ materially from the
forward-looking statements. The results of operations for the three months and
nine months ended September 30, 1998 represent the consolidated operating
results of the Company. See the unaudited condensed consolidated financial
statements of the Company for the nine months ended September 30, 1998 included
elsewhere herein. The Company has reclassified its historical consolidated
financial statements to present the operations of Zycom and NETCOM as
discontinued. The terms "fiscal" and "fiscal year" refer to the Company's fiscal
year ending December 31. All dollar amounts are in U.S. dollars.
Company Overview
ICG Communications Inc., ("ICG" or the "Company") is one of the nation's
leading competitive integrated communications providers ("ICPs") based on the
industry's 1997 revenue. ICPs seek to provide an alternative to the incumbent
local exchange carriers ("ILECs"), long distance carriers and other
communication service providers for a full range of communications services in
the increasingly deregulated telecommunications industry. Through its
competitive local exchange carrier ("CLEC") operations, the Company operates
networks in four regional clusters covering major metropolitan statistical areas
in California, Colorado, Ohio and the Southeast. The Company also provides a
wide range of network systems integration services, maritime and international
satellite transmission services. Network Services consist of information
technology services and selected networking products, focusing on network
design, installation, maintenance and support. Satellite Services consist of
satellite voice, data and video services provided to major cruise lines, the
U.S. Navy, the offshore oil and gas industry and integrated communications
providers. As a leading participant in the rapidly growing competitive local
telecommunications industry, the Company has experienced significant growth,
with total revenue increasing from $110.2 million for fiscal 1995 to $347.0
million for the 12-month period ended September 30, 1998. The Company's rapid
growth is the result of the initial installation, acquisition and subsequent
expansion of its fiber optic networks and the expansion of its communications
service offerings.
The Federal Telecommunications Act of 1996 (the "Telecommunications Act")
and pro-competitive state regulatory initiatives have substantially changed the
telecommunications regulatory environment in the United States. Due to these
regulatory changes, the Company is now permitted to offer all interstate and
intrastate telephone services, including competitive local dial tone. The
Company is marketing and selling local dial tone services in major metropolitan
areas in the following regions: California, which began service in late January
1997, followed by Ohio in February 1997, Colorado in March 1997 and the
Southeast in May 1997. During fiscal 1997 and the nine months ended September
30, 1998, the Company sold 178,470 and 144,274 local access lines, respectively,
of which 290,983 were in service at September 30, 1998. In addition, the
Company's operating networks have grown from 627 fiber route miles at the end of
fiscal 1995 to 3,995 fiber route miles as of September 30, 1998. The Company has
21 operating high capacity digital voice switches and 15 data communications
switches, and plans to install additional switches as demand warrants. As a
complement to its local exchange services, the Company has begun marketing
bundled service offerings which include long distance, enhanced
telecommunications services and data services and plans to intensify the
offerings of such services in the near term.
The Company will continue to expand its network through construction,
leased facilities, strategic alliances and mergers and acquisitions. For
example, on October 7, 1998, the Company entered into a definitive agreement
with Central and SouthWest Corporation ("CSW") to purchase 100% of the
partnership interests in CSW/ICG ChoiceCom, L.P. ("ChoiceCom"). The Company
formed a strategic alliance with CSW to develop and market telecommunications
services in certain cities in Texas. The venture entity, ChoiceCom, is based in
Austin, Texas and offers a variety of telecommunications services, including
local exchange services, in San Antontio, Dallas, Austin, Houston and Corpus
Christi, Texas. For the nine months ended September 30, 1998, ChoiceCom reported
$1.9 million in revenue and 5,341 access lines in service sold by ChoiceCom and
4,476 access lines in service sold by ICG at the end of the period.
21
Additionally, ChoiceCom has 3 operating high capacity digital voice switches as
of September 30, 1998. The Company expects to complete the transaction in late
1998 or early 1999.
To better focus its efforts on its core Telecom Services operations, the
Company progressed toward the disposal of certain assets which management
believes do not complement its overall business strategy. On July 17, 1998, the
Company entered into a definitive agreement to sell the capital stock of
Nova-Net Communications, Inc. ("Nova-Net") and on August 12, 1998, the Company
completed the sale of MarineSat Communications, Inc. ("MCN"), two of the
operating subsidiaries within the Company's Satellite Services operations. The
results of operations of MCN have been included in the Company's consolidated
results of operations through the closing date of the sale. Due primarily to the
loss of a major customer, which generated a significant obligation under a
volume discount agreement with its call transport provider, the board of
directors of Zycom Corporation ("Zycom"), a 70%-owned subsidiary of the Company
which operated an 800/888/900 number services bureau and switch platform,
approved a plan on August 25, 1998 to wind down and ultimately discontinue
Zycom's operations. Effective October 22, 1998, Zycom completed the transfer of
all customer traffic to other providers and anticipates it will need
approximately 30 to 60 days to dispose of its remaining assets and discharge its
remaining liabilities. Additionally, effective November 3, 1998, the Company's
board of directors adopted a formal plan to dispose of the operations of NETCOM
On-Line Communication Services, Inc. ("NETCOM"), a provider of Internet
connectivity and Web site hosting services and other value-added services
located in San Jose, California. NETCOM is a wholly owned subsidiary of the
Company acquired on January 21, 1998 in a transaction accounted for as a pooling
of interests. The Company's plan of disposal consists of the sale to one of more
third parties in one or more transactions of all of the operating assets of
NETCOM which will not be used in future Telecom Services operations. The Company
has commenced an active plan to locate one or more buyers and intends to
complete the sales within one year. The Company expects to record a gain on the
sale of NETCOM in the period of disposition, although the amount of such gain is
not presently determinable. For fiscal 1997 and the nine months ended September
30, 1998, Zycom and NETCOM combined reported revenue of $189.0 million and
$138.9 million, respectively, and EBITDA losses (before nonrecurring charges) of
$(12.1) million and $(12.4) million, respectively. The Company has reclassified
its historical consolidated financial statements to present the operations of
Zycom and NETCOM as discontinued.
In conjunction with the increase in its service offerings, the Company has
and will continue to need to spend significant amounts on sales, marketing,
customer service, engineering and support personnel prior to the generation of
corresponding revenue. EBITDA, operating and net losses have generally increased
immediately preceding and during periods of relatively rapid network expansion
and development of new services. Since the quarter ended June 30, 1996, EBITDA
losses (before nonrecurring charges) have improved for each consecutive quarter.
As the Company provides a greater volume of higher margin services, principally
local exchange services, carries more traffic on its own facilities rather than
ILEC facilities and obtains the right to use unbundled ILEC facilities, while
experiencing decelerating increases in personnel and other selling, general and
administrative expenses supporting its operations, any or all of which may not
occur, the Company anticipates that EBITDA losses will continue to improve in
the near term.
22
Results of Operations
The following table provides a breakdown of revenue and operating costs for
Telecom Services, Network Services and Satellite Services, and certain other
financial data for the Company for the periods indicated. The table also shows
certain revenue, operating costs and expenses, operating loss, EBITDA and EBITDA
(before nonrecurring charges) as a percentage of the Company's total revenue.
Three months ended September 30, Nine months ended September 30,
------------------------------------------------- ------------------------------------------
1997 1998 1997 1998
----------------------- ------------------------ --------------------- --------------------
$ % $ % $ % $ %
----------- ---------- -------------- --------- ------------- ------- ----------- --------
(unaudited)
(in thousands)
Statement of Operations Data:
Revenue:
Telecom services 36,543 60 82,567 77 101,637 58 205,269 74
Network services 16,432 27 14,550 14 50,059 29 40,740 15
Satellite services 7,640 13 9,350 9 22,306 13 29,982 11
----------- ----------- -------------- --------- ------------- ------- ------------- -----
Total revenue 60,615 100 106,467 100 174,002 100 275,991 100
Operating costs:
Telecom services 35,215 48,145 104,135 137,113
Network services 13,151 12,177 40,569 35,632
Satellite services 4,236 4,358 12,189 15,219
----------- ----------- -------------- --------- ------------- ------- ------------- -----
Total operating costs 52,602 87 64,680 61 156,893 90 187,964 68
Selling, general and administrative 39,187 65 45,435 43 110,183 63 132,917 48
Depreciation and amortization 13,517 22 24,883 23 37,198 21 61,321 22
Net loss (gain) on disposal of long-
lived assets 1,354 2 (814) (1) 1,035 1 (316) -
Restructuring costs - - - - - - 553 -
----------- ----------- -------------- --------- ------------- ------- ------------- -----
Operating loss (46,045) (76) (27,717) (26) (131,307) (75) (106,448) (38)
Other Data:
Net cash used by operating activities
of continuing operations (33,088) (12,447) (68,852) (63,623)
Net cash used by investing activities
of continuing operations (193,446) (151,395) (304,197) (185,185)
Net cash provided (used) by financing
activities of continuing operations 112,270 (6,055) 285,959 530,074
EBITDA (1) (32,528) (54) (2,834) (3) (94,109) (54) (45,127) (16)
EBITDA (before nonrecurring charges) (31,174) (51) (3,648) (2) (93,074) (53) (44,890) (16)
(1)
Capital expenditures of continuing
operations (2) 64,347 107,108 187,136 260,022
Capital expenditures of discontinued
operations (2) 3,259 5,021 14,333 20,228
23
September 30, December 31, March 31, June 30, September 30,
1997 1997 1998 1998 1998
--------------- -------------- ------------- ------------- --------------
(unaudited)
Statistical Data (3):
Full time employees 2,861 3,032 3,050 3,089 3,251
Telecom services:
Access lines in service (4) 50,551 141,035 186,156 237,458 290,983
Buildings connected: (5)
On-net 590 596 637 665 684
Hybrid (6) 1,726 1,725 3,294 3,733 4,217
--------------- -------------- ------------- ------------- --------------
Total buildings connected 2,316 2,321 3,931 4,398 4,901
Customer circuits in service (VGEs)(7) 1,006,916 1,111,697 1,171,801 1,250,479 1,331,510
Operational switches:
Voice 18 19 20 20 21
Data 15 15 15 15 15
--------------- -------------- ------------- ------------- --------------
Total operational switches 33 34 35 35 36
Switched minutes of use (millions) 788 660 639 516 513
Fiber route miles (8):
Operational 3,021 3,043 3,194 3,812 3,995
Under construction - - - - 406
Fiber strand miles (9):
Operational 109,510 111,435 118,074 124,642 127,756
Under construction - - - - 13,930
Wireless miles (10) 511 511 511 511 415
Satellite services:
VSATs 934 957 921 928 966
C-Band installations (11) 54 57 59 66 69
Internet services (12) :
Direct access and Web site hosting
services subscribers 10,630 12,275 14,976 18,638 23,308
Average monthly revenue per
subscriber $ 24.24 25.01 25.12 25.87 26.52
(1) EBITDA consists of earnings (loss) from continuing operations before
interest, income taxes, depreciation and amortization, other expense, net
and minority interest in share of losses, or simply, operating loss plus
deprecation and amortization. EBITDA (before nonrecurring charges)
represents EBITDA before certain nonrecurring charges such as the net loss
(gain) on disposal of long-lived assets, provision for impairment of
long-lived assets and restructuring costs. EBITDA and EBITDA (before
nonrecurring charges) are provided because they are measures commonly used
in the telecommunications industry. EBITDA and EBITDA (before nonrecurring
charges) are presented to enhance an understanding of the Company's
operating results and are not intended to represent cash flows or results
of operations in accordance with generally accepted accounting principles
("GAAP") for the periods indicated. EBITDA and EBITDA (before nonrecurring
charges) are not measurements under GAAP and are not necessarily comparable
with similarly titled measures of other companies. Net cash flows from
operating, investing and financing activities of continuing operations as
determined using GAAP are also presented in Other Data.
(2) Capital expenditures include assets acquired under capital leases and
excludes payments for construction of the Company's new headquarters, which
the Company sold in January 1998 and leased back under a long-term
operating lease. Capital expenditures of discontinued operations includes
capital expenditures of Zycom and NETCOM.
(3) Amounts presented are for three-month periods ended, or as of the end of,
the period presented.
(4) Access lines in service at September 30, 1998 includes 199,152 lines which
are provisioned through the Company's switch and 91,831 lines which are
provisioned through resale and other agreements with various local exchange
carriers. Resale lines typically generate lower margins and are used
primarily to obtain customers. Although the Company plans to migrate lines
from resale to higher margin on-switch lines, there is no assurance that it
will be successful in executing this strategy.
24
(5) Prior to the first quarter of 1998, the Company reported only special
access buildings connected. Beginning March 31, 1998, buildings connected
includes both dial tone and special access buildings connected. The
combined special access and dial tone buildings connected at December 31,
1997 was 3,153.
(6) Hybrid buildings connected represent buildings connected to the Company's
network via another carrier's facilities.
(7) Customer circuits in service are measured in voice grade equivalents
("VGEs").
(8) Fiber route miles refers to the number of miles of fiber optic cable,
including leased fiber. As of September 30, 1998, the Company had 3,995
fiber route miles, of which 53 fiber route miles were leased under
operating leases. Fiber route miles under construction represents fiber
under construction and fiber which is expected to be operational within six
months.
(9) Fiber strand miles refers to the number of fiber route miles, including
leased fiber, along a telecommunications path multiplied by the number of
fiber strands along that path. As of September 30, 1998, the Company had
127,756 fiber strand miles, of which 2,028 fiber strand miles were leased
under operating leases. Fiber strand miles under construction represents
fiber under construction and fiber which is expected to be operational
within six months.
(10) Wireless miles represents the total distance of the digital microwave paths
between Company transmitters which are used in the Company's networks.
(11) C-Band installations service cruise ships, U.S. Navy vessels and offshore
oil platform installations.
(12) The Company's Internet Services are provided by NETCOM. The Company's
consolidated financial statements reflect the operations of NETCOM as
discontinued for all periods presented.
Three Months Ended September 30, 1998 Compared to Three Months Ended September
30, 1997
Revenue. Revenue for the three months ended September 30, 1998 increased
$45.9 million, or 76%, from the three months ended September 30, 1997. Telecom
Services revenue increased 126% to $82.6 million due to an increase in revenue
from local services (dial tone), long distance and special access services,
offset in part by a decline in average unit pricing and in wholesale switched
services revenue. Local services revenue increased from $3.1 million (9% of
Telecom Services revenue) for the three months ended September 30, 1997 to $44.1
million (53% of Telecom Services revenue) for the three months ended September
30, 1998. Revenue from long distance services generated $6.7 million for the
three months ended September 30, 1998, compared to no reported revenue for the
three months ended September 30, 1997. Special access revenue increased from
$14.4 million (39% of Telecom Services revenue) for the three months ended
September 30, 1997 to $20.2 million (24% of Telecom Services revenue) for the
three months ended September 30, 1998. Switched access (terminating long
distance) revenue decreased to approximately $11.6 million for the three months
ended September 30, 1998, compared to $19.1 million for the three months ended
September 30, 1997. The Company anticipates that switched access revenue will
continue to decline as it de-emphasizes its wholesale switched services. The
Company has recently raised prices on its wholesale switched services product in
order to improve margins and free up switch port capacity for its higher margin
dial tone product. Revenue from data services did not generate a material
portion of total revenue during either period.
Network Services revenue decreased 11% to $14.6 million for the three
months ended September 30, 1998 as compared to $16.4 million for the three
months ended September 30, 1997. The decrease in Network Services revenue is
primarily due to the decline in network integration services projects from new
and existing customers between the comparative periods, offset slightly by
increases in integrated cabling services revenue. In addition, two significant
customers delayed construction on major facilities during the three months ended
September 30, 1998.
25
Satellite Services revenue increased $1.7 million, or 22%, to $9.4 million
for the three months ended September 30, 1998. This increase is primarily due to
the operations of Maritime Telecommunications Network, Inc. ("MTN"), which
comprised $6.9 million of total Satellite Services revenue for the three months
ended September 30, 1998, an increase of $2.3 million compared to the same
period in 1997. The increase in revenue of MTN was offset by a decrease in
revenue of MCN of $0.8 million since the results of operations of MCN were
included in the Company's consolidated financial statements only through the
closing date of the sale of MCN on August 12, 1998.
Operating costs. Total operating costs for the three months ended September
30, 1998 increased $12.1 million, or 23%, from the three months ended September
30, 1997. Telecom Services operating costs increased from $35.2 million, or 96%
of Telecom Services revenue, for the three months ended September 30, 1997, to
$48.1 million, or 58% of Telecom Services revenue, for the three months ended
September 30, 1998. Telecom Services operating costs consist of payments to
ILECs for the use of network facilities to support special and switched access
services, network operating costs, right of way fees and other costs. The
increase in operating costs in absolute dollars is attributable to the increase
in volume of local and special access services and the addition of network
operating costs which include engineering and operations personnel dedicated to
the development and launch of local exchange services. The decrease in operating
costs as a percentage of total revenue is due primarily to a greater volume of
higher margin services, principally local exchange services. The Company expects
the Telecom Services ratio of operating costs to revenue will further improve as
the Company provides a greater volume of higher margin services, principally
local exchange services, carries more traffic on its own facilities rather than
the ILEC facilities and obtains the right to use unbundled ILEC facilities on
satisfactory terms, any or all of which may not occur.
Network Services operating costs decreased 7% to $12.2 million and
increased as a percentage of Network Services revenue from 80% for the three
months ended September 30, 1997 to 84% for the three months ended September 30,
1998. The decrease in operating costs in absolute dollars is due to the decrease
in general business volume between the comparative periods. Network Services
operating costs increased as a percentage of revenue due to the decline in
higher margin network integration services projects during the three months
ended September 30, 1998. Network Services operating costs include the cost of
equipment sold, direct hourly labor and other indirect project costs.
Satellite Services operating costs increased to $4.4 million for the three
months ended September 30, 1998, from $4.2 million for the three months ended
September 30, 1997. Satellite Services operating costs as a percentage of
Satellite Services revenue decreased from 55% for the three months ended
September 30, 1997 to 47% for the three months ended September 30, 1998 as a
result of the increase in revenue of MTN which provides relatively higher
margins than other maritime services. Satellite Services operating costs consist
primarily of transponder lease costs and the cost of equipment sold.
Selling, general and administrative expenses. Selling, general and
administrative ("SG&A") expenses for the three months ended September 30, 1998
increased $6.2 million, or 16%, compared to the three months ended September 30,
1997. This increase was principally due to the continued rapid expansion of the
Company's Telecom Services networks and related significant additions to the
Company's management information systems, customer service, marketing and sales
staffs dedicated to the expansion of the Company's networks and implementation
of the Company's expanded services strategy, primarily the development of local
and long distance telephone services. SG&A expenses as a percentage of total
revenue decreased from 65% for the three months ended September 30, 1997 to 43%
for the three months ended September 30, 1998, as the Company begins to benefit
from the revenue generated by newly developed services requiring substantial
administrative, selling and marketing expense prior to initial service
offerings. The Company expects SG&A expenses as a percentage of total revenue to
continue to decline over the near term.
Depreciation and amortization. Depreciation and amortization increased
$11.4 million, or 84%, for the three months ended September 30, 1998, compared
to the three months ended September 30, 1997, primarily due to increased
investment in depreciable assets resulting from the continued expansion of the
Company's networks and services and increased amortization arising from goodwill
recorded in conjunction with two purchase business combinations completed during
the three months ended September 30, 1998. The Company reports high levels of
depreciation expense relative to revenue during the early years of operation of
a new network because the full cost of a network is depreciated using the
straight-line method despite the low rate of capacity utilization in the early
stages of network operation.
26
Net loss (gain) on disposal of long-lived assets. Net loss (gain) on
disposal of long-lived assets fluctuated from a net loss of $1.4 million for the
three months ended September 30, 1997 to a net gain of $0.8 million for the
three months ended September 30, 1998. Net loss on disposal of long-lived assets
for the three months ended September 30, 1997 represents losses recorded on the
disposal of the Company's investment in its Melbourne network. For the three
months ended September 30, 1998, net gain on disposal of long-lived assets
relates primarily to the sale of MCN.
Interest expense. Interest expense increased $17.2 million, from $28.8
million for the three months ended September 30, 1997, to $46.0 million for the
three months ended September 30, 1998, which includes $43.7 million of non-cash
interest. The increase is primarily attributable to an increase in long-term
debt, primarily the 10% Senior Discount Notes due 2008 (the "10% Notes") issued
in February 1998 and the 9 7/8% Senior Discount Notes due 2008 (the "9 7/8%
Notes") issued in April 1998. In addition, the Company's interest expense
increased, and will continue to increase, because the principal amount of its
indebtedness increases until the Company's senior indebtedness begins to pay
interest in cash.
Interest income. Interest income increased $2.8 million, from $5.4 million
for the three months ended September 30, 1997, to $8.2 million for the three
months ended September 30, 1998. The increase is attributable to the increase in
cash and invested cash balances from the proceeds from the issuance of the 10%
Notes in February 1998 and the 9 7/8% Notes in April 1998.
Other expense, net. Other expense, net fluctuated from $0.2 million net
income for the three months ended September 30, 1997 to $0.5 million net expense
for the three months ended September 30, 1998. Other expense, net recorded in
the three months ended September 30, 1997 consists of miscellaneous other
income. For the three months ended September 30, 1998, other expense, net
primarily includes litigation settlement costs of $0.3 million and a write-off
of notes receivable of $0.2 million.
Accretion and preferred dividends on preferred securities of subsidiaries,
net of minority interest in share of losses. Accretion and preferred dividends
on preferred securities of subsidiaries, net of minority interest in share of
losses increased $3.9 million, from $10.1 million for the three months ended
September 30, 1997 to $14.0 million for the three months ended September 30,
1998. The increase is due primarily to the issuance of the 6 3/4% Preferred
Securities in September and October 1997. Accretion and preferred dividends on
preferred securities of subsidiaries, net of minority interest in share of
losses recorded during the three months ended September 30, 1998 consists of the
accretion of issuance costs ($0.3 million) and the accrual of the preferred
securities dividends ($13.7 million) associated with the 6 3/4% Exchangeable
Limited Liability Company Preferred Securities Mandatorily Redeemable 2009 (the
"6 3/4% Preferred Securities"), the 14% Exchangeable Preferred Stock Mandatorily
Redeemable 2008 (the "14% Preferred Stock") and the 14 1/4% Exchangeable
Preferred Stock Mandatorily Redeemable 2007 (the "14 1/4% Preferred Stock").
Loss from continuing operations. Loss from continuing operations increased
$0.7 million, or 1%, primarily due to the increases in operating costs, SG&A
expenses, depreciation and amortization, interest expense and accretion and
preferred dividends on preferred securities of subsidiaries, net of minority
interest in share of losses, offset by an increase in revenue, as noted above.
Loss from discontinued operations. For the three months ended September 30,
1997 and 1998, loss from discontinued operations was $7.5 million and $16.6
million, respectively, or 9% and 17%, respectively, of the Company's net loss.
Loss from discontinued operations consists of the net loss of Zycom and NETCOM
for the respective periods and, for the three months ended September 30, 1998,
includes $1.2 million for estimated losses on the disposal of Zycom, including
$0.2 million for operating losses during the phase out period. The remaining
increase in loss from discontinued operations between the comparative periods is
due to increases in SG&A expenses and depreciation and amortization incurred by
NETCOM.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997
Revenue. Revenue for the nine months ended September 30, 1998 increased
$102.0 million, or 59%, from the nine months ended September 30, 1997. Telecom
Services revenue increased 102% to $205.3 million due to an increase in revenue
from local services (dial tone), long distance and special access services,
offset in part by a decline in average unit pricing and in wholesale switched
services revenue. Local services revenue increased from $4.3 million (4% of
27
Telecom Services revenue) for the nine months ended September 30, 1997 to $96.6
million (47% of Telecom Services revenue) for the nine months ended September
30, 1998. Revenue from long distance services generated $17.5 million for the
nine months ended September 30, 1998, compared to no reported revenue for the
nine months ended September 30, 1997. Special access revenue increased from
$39.9 million (39% of Telecom Services revenue) for the nine months ended
September 30, 1997 to $53.9 million (26% of Telecom Services revenue) for the
nine months ended September 30, 1998. Switched access (terminating long
distance) revenue decreased to approximately $37.2 million for the nine months
ended September 30, 1998, compared to $57.4 million for the nine months ended
September 30, 1997. Revenue from data services did not generate a material
portion of total revenue during either period.
Network Services revenue decreased 19% to $40.7 million for the nine months
ended September 30, 1998, compared to $50.1 million for the nine months ended
September 30, 1997. The decrease in Network Services revenue is primarily due to
the decline in network integration services projects from new and existing
customers during the nine months ended September 30, 1998, offset slightly by
increases in integrated cabling services revenue. In addition, two significant
customers delayed construction on major facilities during the three months ended
September 30, 1998.
Satellite Services revenue increased $7.7 million, or 34%, to $30.0 million
for the nine months ended September 30, 1998. This increase is primarily due to
the operations of MTN, which comprised $20.4 million of total Satellite Services
revenue for the nine months ended September 30, 1998, an increase of $6.0
million compared to the same period in 1997. The remaining increase can be
attributed to the general growth of MCN and Nova-Net during the nine months
ended September 30, 1998.
Operating costs. Total operating costs for the nine months ended September
30, 1998 increased $31.1 million, or 20%, from the nine months ended September
30, 1997. Telecom Services operating costs increased from $104.1 million, or
102% of Telecom Services revenue, for the nine months ended September 30, 1997,
to $137.1 million, or 67% of Telecom Services revenue, for the nine months ended
September 30, 1998. The increase in operating costs in absolute dollars is
attributable to the increase in volume of local and special access services and
the addition of engineering and operations personnel dedicated to the
development of local exchange services. The decrease in operating costs as a
percentage of total revenue is due primarily to a greater volume of higher
margin services, principally local exchange services.
Network Services operating costs decreased 12% to $35.6 million and
increased as a percentage of revenue from 81% for the nine months ended
September 30, 1997 to 87% for the nine months ended September 30, 1998. The
decrease in operating costs in absolute dollars is due to a decrease in general
business volume between the comparative periods. Network Services operating
costs increased as a percentage of revenue due to cost overruns and the decline
in higher margin network integration services projects during the nine months
ended September 30, 1998.
Satellite Services operating costs increased to $15.2 million for the nine
months ended September 30, 1998, from $12.2 million for the nine months ended
September 30, 1997. Satellite Services operating costs as a percentage of
Satellite Services revenue decreased from 55% for the nine months ended
September 30, 1997 to 51% for the nine months ended September 30, 1998,
primarily as a result of the increase in revenue of MTN which provides
relatively higher margins than other maritime services.
Selling, general and administrative expenses. Selling, general and
administrative ("SG&A") expenses for the nine months ended September 30, 1998
increased $22.7 million, or 21%, compared to the nine months ended September 30,
1997. This increase was principally due to the continued rapid expansion of the
Company's Telecom Services networks and related significant additions to the
Company's management information systems, customer service, marketing and sales
staffs dedicated to the expansion of the Company's networks and implementation
of the Company's expanded services strategy, primarily the development of local
and long distance telephone services. SG&A expenses as a percentage of total
revenue decreased from 63% for the nine months ended September 30, 1997 to 48%
for the nine months ended September 30, 1998, as the Company begins to benefit
from the revenue generated by newly developed services requiring substantial
administrative, selling and marketing expense prior to initial service
offerings.
Depreciation and amortization. Depreciation and amortization increased
$24.1 million, or 65%, for the nine months ended September 30, 1998, compared to
the nine months ended September 30, 1997, primarily due to increased investment
28
in depreciable assets resulting from the continued expansion of the Company's
networks and services. Additionally, during the nine months ended September 30,
1998, the Company recorded a cumulative adjustment to depreciation and
amortization expense of approximately $3.7 million, for the aggregate
depreciation and amortization expense on capital and other assets of MTN which
was not recorded during the period in which MTN was held for sale. On July 1,
1998, the Company terminated an existing agreement to sell the capital stock of
MTN.
Net loss (gain) on disposal of long-lived assets. Net loss (gain) on
disposal of long-lived assets fluctuated from a net loss of $1.0 million for the
nine months ended September 30, 1997 to a net gain of $0.3 million for the nine
months ended September 30, 1998. Net loss on disposal of long-lived assets for
the nine months ended September 30, 1997 primarily relates to losses recorded on
the disposal of the Company's investment in its Melbourne network. For the nine
months ended September 30, 1998, net gain on disposal of long-lived assets
relates to the gain on the sale of MCN of $0.8 million, offset by the write-off
of certain installation costs of disconnected special access customers of $0.5
million.
Restructuring costs. For the nine months ended September 30, 1998,
restructuring costs include $0.6 million in costs, primarily severance costs,
related to the decentralization of the Company's Network Services subsidiary.
Interest expense. Interest expense increased $39.7 million, from $82.3
million for the nine months ended September 30, 1997, to $122.0 million for the
nine months ended September 30, 1998, which includes $113.2 million of non-cash
interest. This increase was primarily attributable to an increase in long-term
debt, primarily the 10% Notes issued in February 1998 and the 9 7/8% Notes
issued in April 1998. In addition, the Company's interest expense increased, and
will continue to increase, because the principal amount of its indebtedness
increases until the Company's senior indebtedness begins to pay interest in
cash.
Interest income. Interest income increased $4.9 million, from $17.3 million
for the nine months ended September 30, 1997, to $22.2 million for the nine
months ended September 30, 1998. The increase is attributable to the increase in
cash and invested cash balances from the proceeds from the issuance of the 10%
Notes in February 1998 and the 9 7/8% Notes in April 1998.
Other expense, net. Other expense, net increased from $0.1 million net
expense for the nine months ended September 30, 1997 to $4.0 million net expense
in the nine months ended September 30, 1998. Other expense, net recorded in the
nine months ended September 30, 1997 consists primarily of litigation settlement
costs. For the nine months ended September 30, 1998, other expense, net
primarily includes $2.7 million in settlement costs paid to the former minority
shareholders of MTN, $1.0 million in litigation settlement costs and a write-off
of notes receivable of $0.3 million.
Accretion and preferred dividends on preferred securities of subsidiaries,
net of minority interest in share of losses. Accretion and preferred dividends
on preferred securities of subsidiaries, net of minority interest in share of
losses increased $15.8 million, from $25.0 million for the nine months ended
September 30, 1997 to $40.8 million for the nine months ended September 30,
1998. The increase is due primarily to the issuance of the 6 3/4% Preferred
Securities in September and October 1997. Accretion and preferred dividends on
preferred securities of subsidiaries, net of minority interest in share of
losses recorded during the nine months ended September 30, 1998 consists of the
accretion of issuance costs ($1.0 million) and the accrual of the preferred
securities dividends ($39.8 million) associated with the 6 3/4% Preferred
Securities, the 14% Preferred Stock and the 14 1/4% Preferred Stock.
Loss from continuing operations. Loss from continuing operations increased
$29.8 million, or 13%, due to the increases in operating costs, SG&A expenses,
depreciation and amortization, interest expense and accretion and preferred
dividends on preferred securities of subsidiaries, net of minority interest in
share of losses, offset by an increase in revenue, as noted above.
Loss from discontinued operations. For the nine months ended September 30,
1997 and 1998, loss from discontinued operations was $28.3 million and $48.2
million, respectively, or 11% and 16%, respectively, of the Company's net loss.
Loss from discontinued operations consists of the net loss of Zycom and NETCOM
for the respective periods and, for the nine months ended September 30, 1998,
includes $1.2 million for estimated losses on the disposal of Zycom, including
$0.2 million for operating losses during the phase out period. The remaining
increase in loss from discontinued operations between the comparative periods is
29
due to increases in SG&A expenses and depreciation and amortization incurred by
NETCOM and approximately $9.4 million for merger costs incurred by NETCOM
relating to NETCOM's merger with ICG in January 1998.
Liquidity and Capital Resources
The Company's growth has been funded through a combination of equity, debt
and lease financing. As of September 30, 1998, the Company had current assets of
$608.9 million, including $470.4 million of cash, cash equivalents and
short-term investments, which exceeded current liabilities of $156.5 million,
providing working capital of $452.4 million. The Company invests excess funds in
short-term, interest-bearing investment-grade securities until such funds are
used to fund the capital investments and operating needs of the Company's
business. The Company's short-term investment objectives are safety, liquidity
and yield, in that order.
Net Cash Used By Operating Activities of Continuing Operations
The Company's operating activities of continuing operations used $68.9
million and $63.6 million for the nine months ended September 30, 1997 and 1998,
respectively. Net cash used by operating activities of continuing operations is
primarily due to net losses from continuing operations, which are partially
offset by non-cash expenses, such as depreciation and amortization expense,
deferred interest expense, preferred dividends on subsidiary preferred
securities and changes in working capital items.
The Company does not anticipate that cash provided by operations will be
sufficient to fund operating activities of continuing and discontinued
operations, the future expansion of existing networks or the construction and
acquisition of new networks in the near term. As the Company provides a greater
volume of higher margin services, principally local exchange services, carries
more traffic on its own facilities rather than ILEC facilities and obtains the
right to use unbundled ILEC facilities, while experiencing decelerating
increases in personnel and other SG&A expenses supporting its operations, any or
all of which may not occur, the Company anticipates that net cash used by
operating activities of continuing operations will continue to improve in the
near term.
Net Cash Used By Investing Activities of Continuing Operations
Investing activities of continuing operations used $304.2 million and
$185.2 million for the nine months ended September 30, 1997 and 1998,
respectively. Net cash used by investing activities of continuing operations
includes cash expended for the acquisition of property, equipment and other
assets, of $187.1 million and $260.0 million for the nine months ended September
30, 1997 and 1998, respectively. Additionally, net cash used by investing
activities of continuing operations includes payments for construction of the
Company's headquarters of $16.7 million and $4.9 million for the nine months
ended September 30, 1997 and 1998, respectively. During the nine months ended
September 30, 1998, the Company used $9.4 million to purchase the minority
interest of two of the Company's operating subsidiaries. Offsetting the
expenditures for investing activities of continuing operations for the nine
months ended September 30, 1998 are the proceeds from the sale of the Company's
new headquarters of $30.3 million and the sale of short-term investments of
$71.3 million. The Company will continue to use cash in 1998 and subsequent
periods for the construction of new networks, the expansion of existing networks
and, potentially, for acquisitions.
Net Cash Provided By Financing Activities of Continuing Operations
Financing activities of continuing operations provided $286.0 million and
$530.1 million in the nine months ended September 30, 1997 and 1998,
respectively. Net cash provided by financing activities of continuing operations
for these periods includes cash received in connection with the private
placement of the 11 5/8% Senior Discount Notes due 2007 (the "11 5/8% Notes")
and the 14% Preferred Stock in March 1997, the 6 3/4% Preferred Securities in
September and October 1997 and the 10% Notes and the 9 7/8% Notes in February
and April 1998, respectively. Historically, the funds to finance the Company's
business acquisitions, capital expenditures, working capital requirements and
operating losses have been obtained through public and private offerings of ICG
and ICG Holdings (Canada), Inc. ("Holdings-Canada") common shares, convertible
subordinated notes, convertible preferred shares of Holdings-Canada, capital
lease financings and various working capital sources, including credit
facilities, in addition to the private placement of the securities previously
mentioned and other securities offerings.
30
On February 12, 1998, ICG Services, Inc. ("ICG Services") completed a
private placement of 10% Notes, with a maturity value of approximately $490.0
million, for net proceeds, after underwriting and other offering costs, of
approximately $290.9 million. Interest will accrue at 10% per annum, beginning
February 15, 2003, and is payable in cash each February 15 and August 15,
commencing August 15, 2003. The 10% Notes will be redeemable at the option of
ICG Services, in whole or in part, on or after February 15, 2003.
On April 27, 1998, ICG Services completed a private placement of 9 7/8%
Notes, with a maturity value of approximately $405.3 million, for net proceeds,
after underwriting and other offering costs, of approximately $242.2 million.
Interest will accrue at 9 7/8% per annum, beginning May 1, 2003, and is payable
in cash each May 1 and November 1, commencing November 1, 2003. The 9 7/8% Notes
will be redeemable at the option of ICG Services, in whole or in part, on or
after May 1, 2003.
As of September 30, 1998, the Company had an aggregate of approximately
$64.9 million of capitalized lease obligations and an aggregate accreted value
of approximately $1.6 billion was outstanding under the 13 1/2% Notes, the 12
1/2% Notes, the 11 5/8% Notes, the 10% Notes and the 9 7/8% Notes. The 13 1/2%
Notes require payments of interest to be made in cash commencing on March 15,
2001 and mature on September 15, 2005. The 12 1/2% Notes require payments of
interest to be made in cash commencing on November 1, 2001 and mature on May 1,
2006. The 11 5/8% Notes require payments of interest to be made in cash
commencing on September 15, 2002 and mature on March 15, 2007. The 10% Notes
require payments of interest in cash commencing August 15, 2003 and mature
February 15, 2008. The 9 7/8% Notes require payments of interest in cash
commencing November 1, 2003 and mature May 1, 2008. The 6 3/4% Preferred
Securities require payments of dividends to be made in cash through November 15,
2000. In addition, the 14% Preferred Stock and 14 1/4% Preferred Stock require
payments of dividends to be made in cash commencing June 15, 2002 and August 1,
2001, respectively. As of September 30, 1998, the Company had $1.2 million of
other indebtedness outstanding. The Company's cash on hand and amounts expected
to be available through asset sales, cash flows from operations and vendor
financing arrangements will provide sufficient funds necessary for the Company
to expand its business as currently planned and to fund its operating deficits
through 1999. With respect to indebtedness outstanding on September 30, 1998,
the Company has cash interest payment obligations of approximately $113.3
million in 2001, $158.0 million in 2002 and $212.6 million in 2003. With respect
to preferred securities currently outstanding, the Company has cash dividend
obligations of approximately $2.2 million remaining in 1998 and $8.9 million in
each of 1999 and 2000, for which the Company has restricted cash balances for
such dividend payments, $21.5 million in 2001, $57.0 million in 2002 and $70.9
million in 2003. Accordingly, the Company may have to refinance a substantial
amount of indebtedness and obtain substantial additional funds prior to March
2001. The Company's ability to do so will depend on, among other things, its
financial condition at the time, restrictions in the instruments governing its
indebtedness, and other factors, including market conditions, beyond the control
of the Company. There can be no assurance that the Company will be able to
refinance such indebtedness, including such capitalized leases, or obtain such
additional funds, and if the Company is unable to effect such refinancings or
obtain additional funds, the Company's ability to make principal and interest
payments on its indebtedness or make payments of cash dividends on, or the
mandatory redemption of, its preferred stock, would be adversely affected.
Capital Expenditures
The Company's capital expenditures of continuing operations (including
assets acquired under capital leases and excluding payments for construction of
the Company's new headquarters) were $64.3 million and $107.1 million for the
three months ended September 30, 1997 and 1998, respectively, and $187.1 million
and $260.0 million for the nine months ended September 30, 1997 and 1998,
respectively. The Company anticipates that the expansion of existing networks,
construction of new networks and further development of the Company's products
and services for both continuing and discontinued operations will require
capital expenditures of approximately $120.0 million during the last quarter of
1998. To facilitate the expansion of its services and networks, the Company has
entered into equipment purchase agreements with various vendors under which the
Company has committed to purchase a substantial amount of 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 the nature of future expansion and
acquisition opportunities, economic conditions, competition, regulatory
developments and the availability of equity, debt and lease financing.
31
Other Cash Commitments and Capital Requirements
The Company's operations have required and will continue to require
significant capital expenditures for development, construction, expansion and
acquisition of telecommunications assets. Significant amounts of capital are
required to be invested before revenue is generated, which results in initial
negative cash flows. In addition to the Company's planned capital expenditures,
it has other cash commitments as described in the Company's unaudited
Consolidated Financial Statements for the nine months ended September 30, 1998
included elsewhere herein.
In view of the continuing development of the Company's products and
services, the expansion of existing networks and the construction, leasing and
licensing of new networks, the Company will require additional amounts of cash
in the future from outside sources. Management believes that the Company's cash
on hand and amounts expected to be available through asset sales, cash flows
from operations and vendor financing arrangements will provide sufficient funds
necessary for the Company to expand its business as currently planned and to
fund its operating deficits through 1999. Additional sources of cash may include
public and private equity and debt financings, sales of non-strategic assets,
capitalized leases and other financing arrangements. In the past, the Company
has been able to secure sufficient amounts of financing to meet its capital
expenditure 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. In
addition, the inability to fund operating deficits with the proceeds of
financings until the Company establishes a sufficient revenue-generating
customer base could have a material adverse effect on the Company's liquidity.
Year 2000 Compliance
Importance
Many computer systems, software applications and other electronics
currently in use worldwide are programmed to accept only two digits in the
portion of the date field which designates the year. The "Year 2000 problem"
arises because these systems and products cannot properly distinguish between a
year that begins with "20" and the familiar "19." If these systems and products
are not modified or replaced, many will fail, create erroneous results and/or
may cause interfacing systems to fail.
Year 2000 compliance issues are of particular importance to the Company
since its operations rely heavily upon computer systems, software applications
and other electronics containing date-sensitive embedded technology. Some of
these technologies were internally developed and others are standard purchased
systems which may or may not have been customized for the Company's particular
application. The Company also relies heavily upon various vendors and suppliers
that are themselves very reliant on computer systems, software applications and
other electronics containing date-sensitive embedded technology. These vendors
and suppliers include: (i) ILECs and other local and long distance carriers with
which the Company has interconnection or resale agreements; (ii) manufacturers
of the hardware and related operating systems that the Company uses directly in
its operations; (iii) providers that create custom software applications that
the Company uses directly in its operations; and (iv) providers that sell
standard or custom equipment or software which allow the Company to provide
administrative support to its operations.
Strategy
The Company's approach to addressing the potential impact of Year 2000
compliance issues is focused upon ensuring, to the extent reasonably possible,
the continued, normal operation of its business and supporting systems.
Accordingly, the Company has developed a four-phase plan which it is applying to
each functional category of the Company's computer systems and components. Each
of the Company's computer systems, software applications and other electronics
containing date-sensitive embedded technology is included within one of the
following four functional categories:
32
o Voice and Data Network, which consists of all components whether
hardware, software or embedded technology used directly in the
Company's operations, including components used by the Company's voice
and data switches and collocations;
o IT Systems, which consists of all components used to support the
Company's operations, including provisioning and billing systems;
o Building and Facilities, which consists of all components with
embedded technology used at the Company's headquarters building and
other leased facilities, including security systems, elevators and
internal use telephone systems;
o Office Equipment, which consists of all office equipment with
date-sensitive embedded technology.
For each of the categories described above, the Company will apply the
following four-phase approach to identifying and addressing the potential impact
of Year 2000 compliance issues:
o Phase I - Assessment
During this phase, the Company's technology staff will perform an
inventory of all components currently in use by the Company. Based
upon this inventory, the Company's business executives and technology
staff will jointly classify each component as a "high," "medium" or
"low" priority item, determined primarily by the relative importance
that the particular component has to the Company's normal business
operations, the number of people internally and externally which would
be affected by any failure of such component and the interdependence
of such component with other components used by the Company that may
be of higher or lower priority.
Based upon such classifications, the Company's business executives and
information technology staff will jointly set desired levels of Year
2000 readiness for each component inventoried, using the following
criteria, as defined by the Company:
- Capable, meaning that such computer system or component will be
capable of managing and expressing calendar years in four digits;
- Compliant, meaning that the Company will be able to use such
component for the purpose for which the Company intended it by
adapting to its ability to manage and express calendar years in
only two digits;
- Certified, meaning that the Company has received testing results
to demonstrate, or the vendor or supplier is subject to
contractual terms which requires, that such component requires no
Year 2000 modifications to manage and express calendar years in
four digits; or
- Non-critical, meaning that the Company expects to be able to
continue to use such component unmodified or has determined that
the estimated costs of modification exceed the estimated costs
associated with its failure.
o Phase II - Remediation
During this phase, the Company will develop and execute a remediation
plan for each component based upon the priorities set in Phase I.
Remediation may include component upgrade, reprogramming, replacement,
receipt of vendor and supplier certification or other actions as
deemed necessary or appropriate.
o Phase III - Testing
During this phase, the Company will perform testing sufficient to
confirm that the component meets the desired state of Year 2000
readiness. This phase will consist of: (i) testing the component in
isolation, or unit testing; (ii) testing the component jointly with
other components, or system testing; and (iii) testing interdependent
systems, or environment testing.
33
o Phase IV - Implementation
During the last phase, the Company will implement each act of
remediation developed and tested for each component, as well as
implement adequate controls to ensure that future upgrades and changes
to the Company's computer systems, for operational reasons other than
Year 2000 compliance, do not alter the Company's Year 2000 state of
readiness.
Current State of Readiness
The Company has commenced certain of the phases within its Year 2000
compliance strategy for each of its functional system categories, as shown by
the table set forth below. The Company does not intend to wait until the
completion of a phase for all functional category components together before
commencing the next phase. Accordingly, the information set forth below
represents only a general description of the phase status for each functional
category.
Phase
----------------------------------------------------------------------------------------------
I II III IV
System and Level of Priority Assessment Remediation Testing Implementation
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Voice and Data Network
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
High In progress In progress To begin Q1 1999 To begin Q1 1999
To complete Q1 1999 To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium In progress To begin Q4 1998 To begin Q1 1999 To begin Q1 1999
To complete Q1 1999 To complete Q2 1999 To complete Q3 1999 To complete Q4 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low To begin Q4 1998 To be determined based on the results of Phase I
To complete Q2 1999
- ------------------------------- ----------------------------------------------------------------------------------------------
IT Systems
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
High In progress In progress In progress In progress
To complete Q1 1999 To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium In progress In progress To begin Q1 1999 To begin Q1 1999
To complete Q1 1999 To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low In progress To be determined based on the results of Phase I
To complete Q2 1999
- ------------------------------- ----------------------------------------------------------------------------------------------
Building and Facilities
- ------------------------------- ---------------------- ----------------------- -----------------------------------------------
High In progress To begin Q4 1998 To be determined based on the results of
To complete Q1 1999 To complete Q2 1999 Phase II
- ------------------------------- ---------------------- ----------------------- -----------------------------------------------
Medium In progress To begin Q4 1998 To be determined based on the results of
To complete Q1 1999 To complete Q2 1999 Phase II
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low To begin Q1 1999 To be determined based on the results of Phase I
To complete Q2 1999
- ------------------------------- ----------------------------------------------------------------------------------------------
Office Equipment
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
High In progress In progress To begin Q1 1999 To begin Q1 1999
To complete Q1 1999 To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium In progress In progress To begin Q1 1999 To begin Q1 1999
To complete Q1 1999 To complete Q2 1999 To complete Q3 1999 To complete Q4 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low In progress To be determined based on the results of Phase I
To complete Q2 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Separately, the Company is in the process of reviewing the Company's
material contracts with contractors and vendors/suppliers and considering the
necessity of renegotiating certain existing contracts, to the extent that the
contracts fail to address the allocation of potential Year 2000 liabilities
between parties. Prior to entering into any new material contracts, the Company
will seek to address the allocation of potential Year 2000 liabilities as part
of the initial negotiation.
34
Costs
The Company expenses all incremental costs to the Company associated with
Year 2000 compliance issues as incurred. Through September 30, 1998, such costs
incurred have been less than $0.1 million and have primarily included
miscellaneous costs of reference and other Year 2000 compliance planning
materials. The Company has also incurred certain internal costs, including
salaries and benefits for employees dedicating various portions of their time to
Year 2000 compliance issues, of which costs the Company believes has not
exceeded $0.5 million through September 30, 1998. The Company expects that total
future incremental costs of Year 2000 compliance efforts will be approximately
$3.8 million, consisting of $2.3 million in consulting fees, $1.5 million in
replacement hardware and software and other miscellaneous costs. These
anticipated costs have been included in the Company's fiscal 1999 budget and
represent approximately 4% of the Company's budgeted expenses for information
technology through fiscal 1999. Such cost estimates are based upon presently
available information and may change as the Company continues with its Year 2000
compliance plan. The Company intends to use cash on hand for Year 2000
compliance costs, as necessary.
Risk, Contingency Planning and Reasonably Likely Worst Case Scenario
While the Company is heavily reliant upon its computer systems, software
applications and other electronics containing date-sensitive embedded technology
as part of its business operations, such components upon which the Company
primarily relies were developed with current state-of-the-art technology and,
accordingly, the Company has reasonably assumed that its four-phase approach
will demonstrate that many of its high-priority systems do not present material
Year 2000 compliance issues. For computer systems, software applications and
other electronics containing date-sensitive embedded technology that have met
the Company's desired level of Year 2000 readiness, the Company will use its
existing contingency plans to mitigate or eliminate problems it may experience
if an unanticipated system failure were to occur. For components that have not
met the Company's desired level of readiness, the Company will develop a
specific contingency plan to determine the actions the Company would take if
such component failed.
At the present time, the Company is unable to develop a most reasonably
likely worst case scenario for failure to achieve adequate Year 2000 compliance.
The Company will be better able to develop such a scenario once the status of
Year 2000 compliance of the Company's material vendors and suppliers is
complete. The Company will monitor its vendors and suppliers, particularly the
other telecommunications companies upon which the Company relies, to determine
whether they are performing and implementing an adequate Year 2000 compliance
plan in a timely manner.
The Company acknowledges the possibility that the Company may become
subject to potential claims by customers if the Company's operations are
interrupted for an extended period of time. However, it is not possible to
predict either the probability of such potential litigation, the amount that
could be in controversy or upon which party a court would place ultimate
responsibility for any such interruption.
The Company views Year 2000 compliance as a process that is inherently
dynamic and will change in response to changing circumstances. While the Company
believes that through execution and satisfactory completion of its Year 2000
compliance strategy its computer systems, software applications and electronics
will be Year 2000 compliant, there can be no assurance until the Year 2000
occurs that all systems and all interfacing technology when running jointly will
function adequately. Additionally, there can be no assurance that the
assumptions made by the Company within its Year 2000 compliance strategy will
prove to be correct, that the strategy will succeed or that the remedial actions
being implemented will be able to be completed by the time necessary to avoid
system or component failures. In addition, disruptions with respect to the
computer systems of vendors or customers, which systems are outside the control
of the Company, could impair the Company's ability to obtain necessary products
or services to sell to its customers. Disruptions of the Company's computer
systems, or the computer systems of the Company's vendors or customers, as well
as the cost of avoiding such disruption, could have a material adverse effect on
the Company's financial condition and results of operations.
35
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 7 (d) to the Company's unaudited condensed consolidated
financial statements for the nine months ended September 30, 1998
contained elsewhere in this Quarterly Report.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(A) Exhibits.
(10) Material Contracts.
10.1:Employment Agreement, dated September 23, 1998, between
ICG Communications, Inc. and Douglas I. Falk.
(27) Financial Data Schedules.
27.1:Restated Financial Data Schedule of ICG Communications,
Inc. for the Nine Months Ended September 30, 1997.
27.2:Financial Data Schedule of ICG Communications, Inc.
for the Nine Months Ended September 30, 1998.
(B) Report on Form 8-K. The following report on Form 8-K was filed by
the registrants during the three months ended September 30, 1998:
(i) Current Report on Form 8-K dated August 6, 1998, regarding
the announcement of the Company's earnings information and
results of operations for the quarter ended June 30, 1998.
36
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
INDEX TO EXHIBITS
10.1:Employment Agreement, dated September 23, 1998, between ICG Communications,
Inc. and Douglas I. Falk.
27.1:Restated Financial Data Schedule of ICG Communications, Inc. for the Nine
Months Ended September 30, 1997.
27.2:Financial Data Schedule of ICG Communications, Inc. for the Nine Months
Ended September 30, 1998.
EXHIBIT 10.1
Employment Agreement, dated September 23, 1998, between
ICG Communications, Inc. and Douglas I. Falk.
EXHIBIT 27.1
Restated Financial Data Schedule of ICG Communications, Inc. for the
Nine Months Ended September 30, 1997.
EXHIBIT 27.2
Financial Data Schedule of ICG Communications, Inc. for the
Nine Months Ended September 30, 1998.
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, on November 13, 1998.
ICG COMMUNICATIONS, INC.
Date: November 13, 1998 By: /s/ Harry R. Herbst
-------------------------------------
Harry R. Herbst, Executive Vice
President and Chief Financial Officer
(Principal Financial Officer)
Date: November 13, 1998 By: /s/ Richard Bambach
-------------------------------------
Richard Bambach, Vice President and
Corporate Controller
(Principal Accounting Officer)
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, on November 13, 1998.
ICG HOLDINGS (CANADA), INC.
Date: November 13, 1998 By: /s/ Harry R. Herbst
-------------------------------------
Harry R. Herbst, Executive Vice
President and Chief Financial Officer
(Principal Financial Officer)
Date: November 13, 1998 By: /s/ Richard Bambach
-------------------------------------
Richard Bambach, Vice President and
Corporate Controller
(Principal Accounting Officer)
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, on November 13, 1998.
ICG HOLDINGS, INC.
Date: November 13, 1998 By: /s/ Harry R. Herbst
-------------------------------------
Harry R. Herbst, Executive Vice
President and Chief Financial Officer
(Principal Financial Officer)
Date: November 13, 1998 By: /s/ Richard Bambach
-------------------------------------
Richard Bambach, Vice President and
Corporate Controller
(Principal Accounting Officer)