UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
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) CO.
(Commission File Number 33-96540)
ICG HOLDINGS, INC.
(Exact names of registrants as specified in their charters)
- ----------------------------------------- -------------------------------------
Delaware 84-1342022
Nova Scotia Not Applicable
Colorado 84-1158866
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
- ----------------------------------------- -------------------------------------
161 Inverness Drive West Not applicable
Englewood, Colorado 80112
161 Inverness Drive West c/o ICG Communications, Inc.
Englewood, Colorado 80112 161 Inverness Drive West
Englewood, Colorado 80112
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 May 14, 1999
were 46,999,988, 31,931,558 and 1,918, respectively. ICG Canadian Acquisition,
Inc., a wholly owned subsidiary of ICG Communications, Inc., owns all of the
issued and outstanding common shares of ICG Holdings (Canada) Co. ICG Holdings
(Canada) Co. owns all of the issued and outstanding shares of ICG Holdings, Inc.
TABLE OF CONTENTS
PART I .................................................................... 3
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ................. 3
Consolidated Balance Sheets as of December 31, 1998 and
March 31, 1999 (unaudited).................................. 3
Consolidated Statements of Operations (unaudited) for the
Three Months Ended March 31, 1998 and 1999.................. 5
Consolidated Statement of Stockholders' Deficit (unaudited)
for the Three Months Ended March 31, 1999 .................. 7
Consolidated Statements of Cash Flows (unaudited) for the
Three Months Ended March 31, 1998 and 1999 ................. 8
Notes to Consolidated Financial Statements, December 31,
1998 and March 31, 1999 (unaudited)......................... 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS .................................. 23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .. 38
PART II .................................................................. 40
ITEM 1. LEGAL PROCEEDINGS ........................................... 40
ITEM 2. CHANGES IN SECURITIES ....................................... 40
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ............................. 40
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS ....... 40
ITEM 5. OTHER INFORMATION ........................................... 40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ............................ 40
Exhibits .................................................... 40
Reports on Form 8-K ......................................... 41
2
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and March 31, 1999 (unaudited)
December 31, March 31,
1998 1999
------------------ ----------------
Assets (in thousands)
Current assets:
Cash, cash equivalents and restricted cash $ 210,831 291,876
Short-term investments available for sale 52,000 46,660
Marketable trading securities (note 4) - 30,439
Receivables:
Trade, net of allowance of $15,473 and
$18,355 at December 31, 1998 and March
31, 1999, respectively (note 6) 132,920 174,105
Revenue earned, but unbilled 11,063 12,557
Other 1,156 11,040
------------------ ----------------
145,139 197,702
Inventory 2,821 3,223
Prepaid expenses and deposits 12,036 15,697
------------------ ----------------
Total current assets 422,827 585,597
------------------ ----------------
Property and equipment 1,112,067 1,282,273
Less accumulated depreciation (177,933) (215,106)
------------------ ----------------
Net property and equipment 934,134 1,067,167
------------------ ----------------
Restricted cash 16,912 15,527
Investments in debt securities available for
sale and restricted preferred stock (note 4) - 27,466
Other assets, net of accumulated amortization:
Goodwill 130,503 129,184
Deferred financing costs 35,958 34,818
Transmission and other licenses 5,659 1,920
Deposits and other 25,189 15,580
------------------ ----------------
197,309 181,502
------------------ ----------------
Net non-current assets of discontinued
operations (note 3) 54,243 -
------------------ ----------------
Total assets (note 7) $ 1,625,425 1,877,259
================== ================
(Continued)
3
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, March 31,
1998 1999
------------------- -------------------
Liabilities and Stockholders' Deficit (in thousands)
Current liabilities:
Accounts payable $ 33,781 36,003
Accrued liabilities 55,816 92,625
Deferred revenue 9,892 10,337
Deferred gain on sale (note 3) - 22,195
Current portion of capital lease obligations
(note 6) 5,086 8,311
Current portion of long-term debt (note 5) 46 861
Net current liabilities of discontinued operations
(note 3) 23,272 934
------------------- -------------------
Total current liabilities 127,893 171,266
------------------- -------------------
Capital lease obligations, less current portion
(note 6) 63,359 68,227
Long-term debt, net of discount, less current portion
(note 5) 1,598,998 1,676,954
------------------- -------------------
Total liabilities 1,790,250 1,916,447
------------------- -------------------
Redeemable preferred stock of subsidiary ($358.5
million liquidation value at March 31, 1999) (note 5) 338,310 350,787
Company-obligated mandatorily redeemable preferred
securities of subsidiary limited liability
company which holds solely Company preferred
stock ($133.4 million liquidation value at March
31, 1999) 128,042 128,137
Stockholders' deficit:
Common stock, $0.01 par value, 100,000 shares authorized;
46,360,185 and 46,771,679 shares issued and outstanding at
December 31, 1998 and March 31, 1999, respectively 584 468
Additional paid-in capital 577,820 584,170
Accumulated deficit (1,209,462) (1,102,750)
Accumulated other comprehensive loss (119) -
------------------- -------------------
Total stockholders' deficit (631,177) (518,112)
------------------- -------------------
Commitments and contingencies (notes 5 and 6)
Total liabilities and stockholders' deficit $ 1,625,425 1,877,259
=================== ===================
See accompanying notes to consolidated financial statements.
4
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months Ended March 31, 1998 and 1999
Three months ended March 31,
---------------------------------------
1998 1999
----------------- -----------------
(in thousands, except per share data)
Revenue (note 7) $ 78,867 129,519
Operating costs and expenses:
Operating costs 61,515 70,176
Selling, general and administrative expenses 42,326 48,893
Depreciation and amortization (note 7) 13,603 39,031
Net loss (gain) on disposal of long-lived assets 505 (908)
----------------- -----------------
Total operating costs and expenses 117,949 157,192
----------------- -----------------
Operating loss (39,082) (27,673)
Other income (expense):
Interest expense (note 7) (34,471) (47,441)
Interest income 5,502 4,105
Other expense, net, including unrealized gain on marketable
trading securities (321) (504)
----------------- -----------------
(29,290) (43,840)
----------------- -----------------
Loss from continuing operations before preferred dividends and
extraordinary gain (68,372) (71,513)
Accretion and preferred dividends on preferred securities of
subsidiaries (13,192) (14,804)
----------------- -----------------
Loss from continuing operations before extraordinary gain (81,564) (86,317)
Loss from discontinued operations (20,191) -
Extraordinary gain on sales of operations of NETCOM, net of income
taxes of $6.4 million (note 3) - 193,029
----------------- -----------------
Net (loss) income $ (101,755) 106,712
================= =================
Other comprehensive income - foreign currency translation adjustment 105 -
----------------- -----------------
Comprehensive (loss) income $ (101,650) 106,712
================= =================
Net (loss) earnings per share - basic and diluted:
Loss from continuing operations $ (1.84) (1.85)
Loss from discontinued operations (0.46) -
Extraordinary gain on sales of operations of NETCOM - 4.14
----------------- -----------------
Net (loss) earnings per share - basic and diluted $ (2.30) 2.29
================= =================
Weighted average number of shares outstanding - basic and diluted 44,311 46,538
================= =================
See accompanying notes to consolidated financial statements.
5
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Deficit (unaudited)
Three Months Ended March 31, 1999
Accumulated
Common stock Additional other Total
----------------------- paid-in Accumulated comprehensive stockholders'
Shares Amount capital deficit loss deficit
----------- ----------- ------------- ------------- --------------- --------------
(in thousands)
Balances at January 1, 1999 46,360 $ 584 577,820 (1,209,462) (119) (631,177)
Shares issued for cash in connection with the
exercise of options and warrants 232 2 2,767 - - 2,769
Shares issued for cash in connection with the
employee stock purchase plan 82 1 1,387 - - 1,388
Shares issued as contribution to 401(k) plan 98 1 2,076 - - 2,077
Exchange of ICG Holdings (Canada) Co.
common shares for ICG common stock - (120) 120 - - -
Reversal of cumulative foreign currency
translation adjustment (note 3) - - - - 119 119
Net income - - - 106,712 - 106,712
----------- ----------- ------------- ------------- --------------- --------------
Balances at March 31, 1999 46,772 $ 468 584,170 (1,102,750) - (518,112)
=========== =========== ============= ============= =============== ==============
See accompanying notes to consolidated financial statements.
6
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Three Months Ended March 31, 1998 and 1999
Three months ended March 31,
-------------------------------------
1998 1999
---------------- ----------------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ (101,755) 106,712
Loss from discontinued operations 20,191 -
Extraordinary gain on sales of operations - (193,029)
Adjustments to reconcile net (loss) income to net cash used by operating
activities:
Recognition of deferred gain - (3,805)
Accretion and preferred dividends on preferred securities of
subsidiaries 13,192 14,804
Depreciation and amortization 13,603 39,031
Provision for uncollectible accounts 2,582 3,651
Interest expense deferred and included in long-term debt 31,885 46,283
Interest expense deferred and included in capital lease obligations 1,528 1,082
Amortization of deferred financing costs included in interest expense 701 1,406
Interest expense capitalized on assets under construction (3,000) (3,168)
Contribution to 401(k) plan through issuance of common stock 464 2,077
Net loss (gain) on disposal of long-lived assets 505 (908)
Unrealized gain on marketable trading securities - (439)
Change in operating assets and liabilities, excluding the effects of
dispositions and non-cash transactions:
Receivables (6,054) (47,767)
Inventory (215) (197)
Prepaid expenses and deposits 1,155 (2,873)
Accounts payable and accrued liabilities 16,549 (8,330)
Deferred revenue 2,130 1,637
---------------- ----------------
Net cash used by operating activities (6,539) (43,833)
---------------- ----------------
Cash flows from investing activities:
Increase in long-term notes receivable from affiliates and others (4,943) -
Acquisition of property, equipment and other assets (65,748) (101,957)
Payments for construction of corporate headquarters (4,944) -
Proceeds from sales of operations of NETCOM, net of cash included in sale - 252,881
Proceeds from disposition of property, equipment and other assets 283 4,302
Proceeds from sale of corporate headquarters, net of selling and other costs 26,859 -
Proceeds from sales of short-term investments available for sale 83,281 5,340
Decrease in restricted cash 1,893 1,385
Purchase of investments - (27,466)
Purchase of minority interest in subsidiary - (4,189)
---------------- ----------------
Net cash provided by investing activities 36,681 130,296
---------------- ----------------
(Continued)
7
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited), Continued
Three months ended March 31,
----------------------------------------
1998 1999
------------------ -----------------
(in thousands)
Cash flows from financing activities:
Proceeds from issuance of common stock:
Sale by subsidiary $ 3,385 -
Exercise of options and warrants 4,836 2,769
Employee stock purchase plan 411 1,388
Proceeds from issuance of long-term debt 300,571 -
Deferred long-term debt issuance costs (9,575) -
Principal payments on capital lease obligations (2,787) (1,858)
Principal payments on long-term debt (413) (589)
Payments of preferred dividends (2,231) (2,231)
------------------ -----------------
Net cash provided (used) by financing activities 294,197 (521)
------------------ -----------------
Net increase in cash, cash equivalents and restricted cash 324,339 85,942
Net cash used by discontinued operations (393) (4,897)
Cash, cash equivalents and restricted cash, beginning of period 118,569 210,831
------------------ =================
Cash, cash equivalents and restricted cash, end of period $ 442,515 291,876
================== =================
Supplemental disclosure of cash flows information of continuing operations:
Cash paid for interest $ 3,357 1,838
================== =================
Cash paid for income taxes $ - 409
================== =================
Supplemental schedule of non-cash investing and financing activities of
continuing operations:
Acquisition of corporate headquarters assets through the issuance
of long-term debt and conversion of security deposit (note 5) $ - 33,719
================== =================
Assets acquired under capital leases $ - 3,760
================== =================
See accompanying notes to consolidated financial statements.
8
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and March 31, 1999 (unaudited)
(1) Organization and Nature of Business
ICG Communications, Inc., a Delaware corporation ("ICG"), was
incorporated on April 11, 1996 and is the publicly-traded U.S. parent
company of ICG Funding, LLC, a special purpose Delaware limited
liability company ("ICG Funding"), ICG Holdings (Canada) Co., a Nova
Scotia unlimited liability company ("Holdings-Canada"), ICG Holdings,
Inc., a Colorado corporation ("Holdings"), and ICG Services, Inc., a
Delaware corporation ("ICG Services"), and their subsidiaries. ICG and
its subsidiaries are collectively referred to as the "Company."
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,
was automatically converted 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 Company issued
approximately 10.2 million shares of ICG Common Stock in connection
with the merger, valued at approximately $284.9 million on the date of
the merger. The business combination was accounted for as a pooling of
interests. On February 17 and March 16, 1999, the Company completed the
sales of the operations of NETCOM (see note 3) and, accordingly, the
Company's consolidated financial statements prior to March 16, 1999
reflect the operations and net assets of NETCOM as discontinued. In
conjunction with the sales, the legal name of the NETCOM subsidiary was
changed to ICG PST, Inc. ("PST") (see note 3).
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 local, long
distance and data services to business end users, Internet service
providers ("ISPs") and long distance carriers and resellers.
Additionally, in February 1999, the Company began marketing Internet
access and enhanced network services to ISPs and other
telecommunications providers. 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.
(2) Significant Accounting Policies
(a) Basis of Presentation
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, 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 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 three months ended
March 31, 1999 are not necessarily indicative of the results that
may be expected for the fiscal year ending December 31, 1999.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
9
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Significant Accounting Policies (continued)
(b) Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents.
Restricted cash of $19.9 million, held as collateral by a third
party and remitted to the Company subsequent to March 31, 1999,
is included in cash, cash equivalents and restricted cash in the
accompanying consolidated balance sheet.
(c) Investments
The Company invests primarily in high grade short-term
investments which consist of money market instruments, commercial
paper, certificates of deposit, government obligations and
corporate bonds, all of which are considered to be available for
sale. Available for sale investments are carried at amortized
cost, which approximates fair market value, with unrealized gains
and losses, net of tax, reported in accumulated other
comprehensive income or loss. Realized gains and losses and
declines in value judged to be other than temporary are included
in the statement of operations.
Marketable securities consist of investments in common stock and
are stated at fair market value as determined by the most
recently traded price of the securities at the balance sheet
date, net of estimated costs of disposition. The Company's
marketable securities are accounted for as trading securities,
with realized and unrealized gains and losses included in the
statement of operations.
Investments in common or preferred stock for which there is no
public trading market and which represent less than a 20% equity
interest in the investee company are accounted for using the cost
method, unless the Company exercises significant influence and/or
control over the operations of the investee company, in which
case the equity method is used.
(d) Net (Loss) Earnings Per Share
Basic and diluted net (loss) earnings per share is calculated by
dividing net (loss) earnings by the weighted average number of
shares of common stock outstanding. Weighted average number of
shares outstanding represents ICG Common Stock outstanding for
the three months ended March 31, 1999 and combined ICG Common
Stock and Holdings-Canada Class A common shares outstanding for
the three months ended March 31, 1998. Potential common stock,
which include options, warrants and convertible subordinated
notes and preferred securities, are not included in the net
(loss) earnings per share calculation as their effect is
anti-dilutive. The Company has presented net (loss) earnings per
share from discontinued operations and extraordinary gain on
sales of operations of NETCOM in the consolidated statement of
operations for all periods presented.
(e) Reclassifications
Certain 1998 amounts have been reclassified to conform with the
1999 presentation.
10
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations
Loss from discontinued operations consists of the following:
Three months ended
March 31,
-----------------------------------
1998 1999
---------------- ---------------
(in thousands)
Zycom (a) $ (2,397) -
NETCOM (b) (17,794) -
---------------- ---------------
Loss from discontinued operations $ (20,191) -
================ ===============
(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 represented approximately 86% of
Zycom's revenue for the year ended December 31, 1998. 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. On January 4, 1999, the
Company completed the sale of the remainder of Zycom's long-lived
operating assets to an unrelated third party for total proceeds
of $0.2 million. As Zycom's assets were recorded at estimated
fair market value at December 31, 1998, no gain or loss was
recorded on the sale during the three months ended March 31,
1999. Zycom anticipates the disposition of its remaining assets
and the discharge of its remaining operating liabilities will be
completed in 1999.
The Company's consolidated financial statements reflect the
operations of Zycom as discontinued for all periods presented.
Zycom reported net losses from operations of approximately $1.2
million for the period from August 25, 1998 to December 31, 1998
and reported no income or losses from operations for the three
months ended March 31, 1999. The Company has accrued for all
expected future net losses of Zycom. Included in net current
liabilities and net non-current assets of discontinued operations
in the Company's consolidated balance sheets are the following
accounts of Zycom:
11
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
December 31, March 31,
1998 1999
------------------- ------------------
(in thousands)
Cash, cash equivalents and restricted cash $ 47 -
Receivables, net 90 -
Prepaid expenses and deposits 11 1
Accounts payable and accrued liabilities (1,092) (935)
------------------- ------------------
Net current liabilities of Zycom $ (944) (934)
=================== ==================
Net non-current assets of Zycom - property and
equipment, net $ 220 -
=================== ==================
(b) NETCOM
On February 17, 1999, the Company sold certain of the operating
assets and liabilities of NETCOM to MindSpring Enterprises, Inc.,
an ISP located in Atlanta, Georgia ("MindSpring"). Total proceeds
from the sale were $245.0 million, consisting of $215.0 million
in cash and 376,116 shares of common stock of MindSpring, valued
at approximately $79.76 per share at the time of the transaction.
Assets and liabilities sold to MindSpring include those directly
related to the domestic operations of NETCOM's Internet dial-up,
dedicated access and Web site hosting services. In conjunction
with the sale to MindSpring, the Company entered into an
agreement to lease to MindSpring for a one-year period the
capacity of certain network operating assets formerly owned by
NETCOM and retained by the Company. MindSpring is utilizing the
Company's network capacity to provide Internet access to the
dial-up services customers formerly owned by NETCOM. Over the
term of the one-year agreement, MindSpring is required to pay the
Company a minimum of $27.0 million for the Company's network
capacity, although such minimum is subject to increase dependent
upon network usage. In addition, the Company is receiving for a
one-year period 50% of the gross revenue earned by MindSpring
from the dedicated access customers formerly owned by NETCOM,
estimated to be approximately $10.0 million for the term of the
agreement. The Company, through PST, is currently utilizing the
retained network operating assets to provide wholesale capacity
and other enhanced network services to MindSpring and intends to
provide similar services to other ISPs and telecommunications
providers in the future. The carrying value of the assets
retained by the Company was approximately $21.7 million,
including approximately $17.5 million of network equipment, on
February 17, 1999. The Company also retained approximately $11.3
million of accrued liabilities and capital lease obligations.
On March 16, 1999, the Company sold all of the capital stock of
NETCOM's international operations for total proceeds of
approximately $41.1 million. MetroNET Communications Corp., a
Canadian entity, and Providence Equity Partners, located in
Providence, Rhode Island ("Providence"), together purchased the
80% interest in NETCOM Canada Inc. owned by NETCOM for
approximately $28.9 million in cash. Additionally, Providence
purchased all of the capital stock of NETCOM Internet Access
Services Limited, NETCOM's operations in the United Kingdom, for
approximately $12.2 million in cash.
During the three months ended March 31, 1999, the Company
recorded a combined gain on the sales of the operations of NETCOM
of approximately $193.0 million, net of income taxes of
approximately $6.4 million. Offsetting the gain on the sales is
approximately $16.6 million of net losses from operations of
12
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
NETCOM from November 3, 1998 (the date on which the Company's
board of directors adopted the formal plan to dispose of the
operations of NETCOM) through the dates of the sales.
Additionally, since the Company expects to generate operating
costs in excess of revenue under its network capacity agreement
with MindSpring and the terms of the sale agreement were
dependent upon and negotiated in conjunction with the terms of
the network capacity agreement, the Company deferred
approximately $26.0 million of the proceeds from the sale
agreement to be applied on a periodic basis to the network
capacity agreement. The deferred proceeds will be recognized in
the Company's statement of operations as the Company incurs cash
operating losses under the network capacity agreement.
Accordingly, the Company does not expect to recognize any
revenue, operating costs or selling, general and administrative
expenses from services provided to MindSpring for the term of the
agreement. Any incremental revenue or costs generated by other
customers, or by other services provided to MindSpring, will be
recognized in the Company's consolidated statement of operations
as incurred. Since the operations sold were acquired by ICG in a
transaction accounted for as a pooling of interests, the gain on
the sales of the operations of NETCOM is classified as an
extraordinary item in the Company's consolidated statement of
operations. For fiscal 1996, 1997 and 1998, NETCOM reported
revenue of $120.5 million, $160.7 million and $164.6 million,
respectively.
(4) Investments
As discussed in note 3, the Company received 376,116 shares of common
stock of MindSpring, valued at $79.76 per share, or $30.0 million, at
the time of the transaction, as partial consideration for the sale of
the domestic operations of NETCOM. In April 1999, the Company sold its
investment in MindSpring for net proceeds of approximately $30.4
million. The Company has recorded an unrealized gain of approximately
$0.4 million in its statement of operations for the three months ended
March 31, 1999. The Company's investment in MindSpring is included in
marketable trading securities in the accompanying consolidated balance
sheet.
On March 30, 1999, the Company purchased, for approximately $10.0
million in cash, 454,545 shares of restricted Series D-1 Preferred
Stock (the "NorthPoint Preferred Stock") of NorthPoint Communications
Holdings, Inc., a Delaware corporation and competitive local exchange
carrier ("CLEC") based in San Francisco, California ("NorthPoint"). The
NorthPoint Preferred Stock has no voting rights and is ultimately
convertible into a voting class of common stock of NorthPoint, at an
exchange price which represents a discount, as provided in the relevant
documentation, to the initial public offering price of NorthPoint's
common stock. The Company is restricted from selling the NorthPoint
Preferred Stock or securities obtained upon conversion of the
NorthPoint Preferred Stock until March 23, 2000. On May 5, 1999,
NorthPoint completed the initial public offering of its common stock,
at which time the NorthPoint Preferred Stock, and additional shares of
NorthPoint Preferred Stock obtained as a result of stock splits, were
automatically converted into shares of Class B common stock, a
nonvoting class of common stock of NorthPoint (the "NorthPoint Class B
Shares"), which are convertible on or after March 23, 2000 on a
one-for-one basis into a voting class of common stock of NorthPoint.
The Company will account for its investment in NorthPoint under the
cost method of accounting until the NorthPoint Class B Shares are
converted into voting and tradable common stock of NorthPoint, after
which the investment will be classified as a trading security.
13
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Long-term Debt and Redeemable Preferred Stock of Subsidiary
Long-term debt is summarized as follows:
December 31, March 31,
1998 1999
--------------------- -----------------
(in thousands)
9 7/8% Senior discount notes of ICG Services, net of discount $ 266,918 273,401
10% Senior discount notes of ICG Services, net of discount 327,699 335,793
11 5/8% Senior discount notes of Holdings, net of discount 122,528 126,006
12 1/2% Senior discount notes of Holdings, net of discount 414,864 427,565
13 1/2% Senior discount notes of Holdings, net of discount 465,886 481,412
Mortgage payable with interest at 8 1/2%, due monthly
into 2009, secured by building 1,084 1,073
Mortgage payable with variable rate of interest (14.34% at
March 31, 1999), due monthly into 2013, secured by
corporate headquarters (a) - 32,500
Other 65 65
--------------------- -----------------
1,599,044 1,677,815
Less current portion (46) (861)
--------------------- -----------------
$ 1,598,998 1,676,954
===================== =================
(a) Note Payable
Effective January 1, 1999, the Company purchased ICG's
corporate headquarters building, land and improvements
(collectively, the "Corporate Headquarters") for approximately
$43.7 million, which amount represents historical cost and
approximates fair value. The Company, through a newly formed
subsidiary, financed the purchase primarily through a mortgage
secured by the Corporate Headquarters. Payments on the
mortgage are due monthly through January 31, 2013, at an
initial interest rate of 14.34% per annum, which rate
increases annually by 0.003%. The seller of the Corporate
Headquarters has retained an option to repurchase the
Corporate Headquarters at the original sales price, which
option is exercisable from January 1, 2004 through January 31,
2012.
Redeemable preferred stock of subsidiary is summarized as follows:
December 31, March 31,
1998 1999
---------------------- -------------------
(in thousands)
14% Exchangeable preferred stock of Holdings,
mandatorily redeemable in 2008 $ 124,867 129,444
14 1/4% Exchangeable preferred stock of Holdings,
mandatorily redeemable in 2007 213,443 221,343
---------------------- -------------------
$ 338,310 350,787
====================== ===================
14
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) 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 $134.5 million at March 31, 1999.
The agreement has been accounted for as a capital lease in the
accompanying consolidated balance sheets.
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 in 1999. The Company is responsible for
payment on the construction as segments of the network are
completed and has incurred approximately $20.2 million as of
March 31, 1999, with remaining costs anticipated to be
approximately $14.8 million. Additionally, the Company has
committed to purchase $6.0 million in network capacity from Qwest
prior to the end of 1999, of which the Company has purchased $2.5
million as of March 31, 1999.
(b) Network Capacity and Line Purchase Commitments
In November 1998, the Company entered into two service agreements
with WorldCom Network Services, Inc. ("WorldCom"). Both of the
agreements have three-year terms and were effective in September
1998. Under the Telecom Services Agreement, WorldCom provides, at
designated rates, switched telecommunications services and other
related services to the Company, including termination services,
toll-free origination, switched access, dedicated access and
travel card services. Under the Carrier Digital Services
Agreement, WorldCom provides the Company, at designated rates,
with the installation and operation of dedicated digital
telecommunications interexchange services, local access and other
related services, which the Company believes expedites service
availability to its customers. Both agreements require that the
Company provide WorldCom with certain minimum monthly revenue,
which if not met, would require payment by the Company for the
difference between the minimum commitment and the actual monthly
revenue. Additionally, both agreements limit the Company's
ability to utilize vendors other than WorldCom for certain
telecommunications services specified in the agreements. The
Company's policy is to accrue and include in operating costs the
effect of any shortfall in minimum revenue commitments under
these agreements in the period in which the shortfall occurred.
The Company has successfully achieved all minimum revenue
commitments to WorldCom under these agreements through March 31,
1999.
In March 1999, the Company entered into an agreement with
NorthPoint, which designates NorthPoint as the Company's
exclusive digital subscriber line ("DSL") provider through June
1, 2001. Under the agreement, the Company is required to purchase
49,000 digital subscriber lines before June 1, 2001 at designated
intervals. In return, the Company receives substantial DSL
service price discounts and enhanced market access from
NorthPoint. Price discounts are determined pursuant to a
graduated schedule based on the number of digital subscriber
lines purchased by the Company, with maximum discounts achieved
by purchasing 75,000 digital subscriber lines over the two-year
term.
15
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
The Company's policy is to accrue and include in operating costs
the effect of any shortfall in DSL installations under its
agreement with NorthPoint in the period in which the shortfall
occurred. The 49,000 digital subscriber line purchase requirement
and the price discounts are adjustable based on NorthPoint's
compliance with a commitment schedule of DSL service availability
for various U.S. locations.
Additionally, the Company agreed to sell its existing DSL
equipment to NorthPoint, for total proceeds of approximately $2.7
million.
(c) 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 $91.9 million at March 31, 1999.
(d) Transport and Termination Charges
The Company has recorded revenue of approximately $4.9 million,
$58.3 million and $30.8 million for fiscal 1997, fiscal 1998 and
the three months ended March 31, 1999, respectively, for
reciprocal compensation relating to the transport and termination
of local traffic to 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 31 state public utility commissions that ISP traffic
is subject to the payment of reciprocal compensation under current
interconnection agreements. Many of these state commission
decisions have been appealed by the ILECs. On February 25, 1999,
the FCC issued a decision that ISP-bound traffic is largely
jurisdictionally interstate traffic. The decision relies on the
long-standing federal policy that ISP traffic, although
jurisdictionally interstate, is treated as though it is local
traffic for pricing purposes. The decision also emphasizes that
because there are no federal rules governing intercarrier
compensation for ISP traffic, the determination as to whether such
traffic is subject to reciprocal compensation under the terms of
interconnection agreements properly is made by the state
commissions and that carriers are bound by their interconnection
agreements and state commission decisions regarding the payment of
reciprocal compensation for ISP traffic. The FCC has initiated a
rulemaking proceeding regarding the adoption of prospective
federal rules for intercarrier compensation for ISP traffic. In
its notice of rulemaking, the FCC expresses its preference that
compensation rates for this traffic continue to be set by
negotiations between carriers, with disputes resolved by
arbitrations conducted by state commissions pursuant to the
Telecommunications Act of 1996 (the "Telecommunications Act").
Since the issuance of the FCC's decision on February 25, 1999,
nine state utility commissions have either ruled or reaffirmed
that ISP traffic is subject to reciprocal compensation under
current interconnection agreements. On May 5, 1999,
16
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
the Public Utilities Commission of Ohio ("PUCO") issued a decision
affirming its August 1998 decision that ISP traffic is subject to
reciprocal compensation under the Company's current
interconnection agreement with Ameritech Corporation
("Ameritech"). The PUCO also denied Ameritech's request for a stay
of its obligation to remit payment to the Company and directed
Ameritech to remit the amounts owed to the Company within 45 days
of May 5, 1999. The Company expects that Ameritech will seek
judicial review of the PUCO decision and that Ameritech will
request the reviewing court to stay the decision pending appeal.
The Company cannot predict how the reviewing court would rule on
Ameritech's stay request, or the final outcome on the merits of
the court appeal. On March 4, 1999, the Alabama Public Service
Commission (the "Alabama PSC") issued a decision that found that
reciprocal compensation is owed for Internet traffic under four
CLEC interconnection agreements with BellSouth Corporation
("BellSouth"), which agreements were at issue in the proceeding.
With respect to the Company's interconnection agreement, which was
also at issue, the state commission interpreted certain language
in the Company's agreement to exempt ISP-bound traffic from
reciprocal compensation under certain conditions. The Company
believes that the Alabama PSC failed to consider (i) the intent of
the parties in negotiating and executing the Company's
interconnection agreement, and (ii) the specific language of the
Company's interconnection agreement and the impact of Alabama PSC
and FCC policies, and thereby misinterpreted the agreement. The
Company has filed a request with the Alabama PSC seeking
determination that the ruling with respect to the Company's
agreement be reconsidered, and that the Company should be treated
the same as the other CLECs that participated in the proceeding
and for which the Alabama PSC ordered the payment of reciprocal
compensation. While the Company intends to pursue vigorously the
petition for reconsideration with the Alabama PSC, and if the
Company deems it necessary, judicial review, the Company cannot
predict the final outcome of this issue.
The Company has also recorded revenue of approximately $19.1
million and $5.2 million for fiscal 1998 and the three months
ended March 31, 1999, respectively, related to other transport and
termination charges to the ILECs, pursuant to the Company's
interconnection agreements with these ILECs. Included in the
Company's trade receivables at December 31, 1998 and March 31,
1999 are $72.8 million and $105.5 million, respectively, for all
receivables related to transport and termination charges. The
receivables balance at March 31, 1999 is net of an allowance of
$8.1 million for disputed amounts.
As the Company's interconnection agreements expire or are
extended, rates for transport and termination charges are being
and will continue to be renegotiated. Some of the Company's
agreements are already being affected. Although the Company's
interconnection agreement with BellSouth has expired, the Company
has received written notification from BellSouth that the Company
may continue operating under the expired interconnection
agreement, until such agreement is renegotiated or arbitrated by
the relevant state commissions. Additionally, the Company's
interconnection agreement with Ameritech recently was extended
from June 15, 1999 to February 15, 2000. The Company's remaining
interconnection agreements expire in 1999 and 2000. The Company's
extension of its interconnection agreement with Ameritech includes
reduced rates for transport and termination charges, and the
Company expects that its negotiations with BellSouth will also
affect the rates for transport and termination charges included in
its existing interconnection agreement with BellSouth. While the
Company believes that all revenue recorded through March 31, 1999
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 and judicial rulings will be
favorable to the Company, that the Alabama PSC will reconsider its
ruling, or that different pricing plans for transport and
17
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
termination charges between carriers will not be adopted when the
Company's interconnection agreements are renegotiated or
arbitrated, or as a result of the FCC's rulemaking proceeding on
future compensation methods. In fact, the Company believes that
different pricing plans will be considered and adopted, and
although the Company expects that revenue from transport and
termination charges likely will decrease as a percentage of total
revenue from local services in periods after the expiration of
current interconnection agreements, the Company's local
termination services still will be required by the ILECs and must
be provided under the Telecommunications Act, and likely will
result in increasing volume in minutes due to the growth of the
Internet and related services markets. The Company expects to
negotiate reasonable compensation and collection terms for local
termination services, although there is no assurance that such
compensation will remain consistent with current levels.
(e) 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 by
the trial court and this decision has been appealed. Trial has
been tentatively set for August 1999. 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.
(7) Business Units
The Company conducts transactions with external customers through the
operations of its Telecom Services, Network Services and Satellite
Services business units. Shared administrative services are provided to
the business units by Corporate Services. Corporate Services consists
of the operating activities of ICG Communications, Inc., ICG Funding,
LLC, ICG Canadian Acquisition, Inc., ICG Holdings (Canada) Co., ICG
Holdings, Inc. and ICG Services, Inc., which primarily hold securities
and provide certain legal, accounting and finance, personnel and other
administrative support services to the business units.
Direct and certain indirect costs incurred by Corporate Services on
behalf of the business units are allocated among the business units
based on the nature of the underlying costs. Transactions between the
business units for services performed in the normal course of business
are recorded at amounts which are intended to approximate fair value.
Set forth below are revenue, EBITDA (before nonrecurring charges),
which represents the measure of operating performance used by
management to evaluate operating results, depreciation and
amortization, interest expense, capital expenditures of continuing
operations and total assets for each of the Company's business units
and for Corporate Services. As described in note 3, the operating
results of the Company reflect the operations of Zycom and NETCOM as
discontinued for all periods presented.
18
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Business Units (continued)
Three months ended March 31,
--------------------------------------
1998 1999
----------------- -------------------
(in thousands)
Revenue:
Telecom Services $ 58,841 105,727
Network Services 13,430 17,592
Satellite Services 8,949 11,688
Elimination of intersegment revenue (2,353) (5,488)
----------------- -------------------
Total revenue $ 78,867 129,519
================= ===================
EBITDA (before nonrecurring charges) (a):
Telecom Services $ (17,861) 12,614
Network Services (2,574) 490
Satellite Services 833 2,427
Corporate Services (4,418) (4,384)
Eliminations (954) (697)
----------------- -------------------
Total EBITDA (before nonrecurring charges) $ (24,974) 10,450
================= ===================
Depreciation and amortization (b):
Telecom Services $ 11,730 35,111
Network Services 598 529
Satellite Services - 2,127
Corporate Services 1,203 800
Eliminations 72 464
----------------- -------------------
Total depreciation and amortization $ 13,603 39,031
================= ===================
Interest expense (b):
Telecom Services $ 1,816 -
Network Services 1 3
Satellite Services 48 -
Corporate Services 32,606 47,438
----------------- -------------------
Total interest expense $ 34,471 47,441
================== ==================
Capital expenditures of continuing operations (c):
Telecom Services $ 64,072 103,180
Network Services 147 87
Satellite Services 182 2,718
Corporate Services 2,300 -
Eliminations (953) (268)
----------------- -------------------
Total capital expenditures of continuing operations $ 65,748 105,717
================= ==================
(Continued)
19
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Business Units (continued)
December 31, March 31,
1998 1999
--------------------- --------------------
(in thousands)
Total assets:
Telecom Services (d) $ 1,135,937 1,285,406
Network Services 34,378 35,113
Satellite Services (d) 46,760 45,841
Corporate Services (d) 376,796 545,291
Eliminations (22,689) (34,392)
Net current assets of discontinued operations (e) - -
Net non-current assets of discontinued operations 54,243 -
--------------------- --------------------
Total assets $ 1,625,425 1,877,259
===================== ====================
(a) EBITDA (before nonrecurring charges) consists of (loss) from
continuing operations before interest, income taxes, depreciation
and amortization, provision for impairment of long-lived assets,
net loss (gain) on disposal of long-lived assets, other expense,
net and accretion and preferred dividends on preferred securities
of subsidiaries, or simply, revenue less operating costs and
selling, general and administrative expenses. EBITDA (before
nonrecurring charges) is presented as the Company's measure of
operating performance because it is a measure commonly used in
the telecommunications industry. EBITDA (before nonrecurring
charges) is presented to enhance an understanding of the
Company's operating results and is not intended to represent cash
flows or results of operations in accordance with generally
accepted accounting principles for the periods indicated. EBITDA
(before nonrecurring charges) is not a measurement under
generally accepted accounting principles and is not necessarily
comparable with similarly titled measures of other companies.
(b) Although not included in EBITDA (before nonrecurring charges),
which represents the measure of operating performance used by
management to evaluate operating results, the Company has
supplementally provided depreciation and amortization and
interest expense for each of the Company's business units and
Corporate Services. Interest expense excludes amounts charged for
interest on outstanding cash advances and expense allocations
among the business units and Corporate Services.
(c) Capital expenditures include assets acquired under capital leases
and excludes payments for construction of the Company's corporate
headquarters and corporate headquarters assets acquired through
the issuance of long-term debt.
(d) Total assets of Telecom Services, Satellite Services and
Corporate Services excludes investments in consolidated
subsidiaries which eliminate in consolidation.
(e) At December 31, 1998, the Company had net current liabilities of
discontinued operations of $23.3 million, and accordingly, such
amount was not included within net current assets of discontinued
operations on that date.
20
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(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:
Summarized Consolidated Balance Sheet Information
December 31, March 31,
1998 1999
-------------------- ---------------------
(in thousands)
Current assets $ 277,098 270,315
Property and equipment, net 636,747 650,250
Other non-current assets, net 170,151 140,318
Net non-current assets of discontinued operations 220 -
Current liabilities 81,299 93,027
Net current liabilities of discontinued operations 944 934
Long-term debt, less current portion 1,004,316 1,036,010
Capital lease obligations, less current portion 63,359 63,651
Due to parent 191,889 209,020
Due to ICG Services 137,762 123,368
Redeemable preferred stock 338,311 350,787
Stockholder's deficit (733,664) (815,914)
Summarized Consolidated Statement of Operations Information
Three months ended March 31,
---------------------------------------------
1998 1999
--------------------- ---------------------
(in thousands)
Total revenue $ 79,221 130,922
Total operating costs and expenses 116,471 163,398
Operating loss (37,250) (32,476)
Loss from continuing operations (78,044) (69,637)
Net loss (79,575) (82,250)
21
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) Condensed Financial Information of ICG Holdings (Canada) Co.
Condensed financial information for Holdings-Canada only is as follows:
Condensed Balance Sheet Information
December 31, March 31,
1998 1999
------------------- ------------------
(in thousands)
Current assets $ 162 162
Advances to subsidiaries 191,889 209,020
Non-current assets, net 2,414 1,810
Current liabilities 73 73
Long-term debt, less current portion 65 65
Due to parent 182,101 199,231
Share of losses of subsidiaries 733,664 815,914
Shareholders' deficit (721,438) (804,291)
Condensed Statement of Operations Information
Three months ended March 31,
------------------------------------------
1998 1999
------------------- -------------------
Total revenue $ - -
Total operating costs and expenses 33 603
Operating loss (33) (603)
Losses of subsidiaries (79,575) (82,250)
Net loss attributable to common shareholders (79,608) (82,853)
(10) Condensed Financial Information of ICG Communications, Inc. (Parent
company)
The primary assets of ICG are its investments in ICG Services, ICG
Funding and Holdings-Canada, including advances to those subsidiaries.
Certain corporate expenses of the parent company are included in ICG's
statement of operations and were approximately $0.5 million for both
the three months ended March 31, 1998 and 1999. ICG has no operations
other than those of ICG Services, ICG Funding and Holdings-Canada and
their subsidiaries.
22
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 enhanced telephony
and network 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 ended March 31, 1998 and 1999
represent the consolidated operating results of the Company. See the unaudited
condensed consolidated financial statements of the Company for the three months
ended March 31, 1999 included elsewhere herein. The Company's consolidated
financial statements reflect the operations of Zycom and NETCOM as discontinued
for all periods presented. 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 1998 revenue. ICPs seek to provide an alternative to the incumbent
local exchange carriers ("ILECs"), long distance carriers and other
communications service providers for a full range of communications services in
the increasingly deregulated telecommunications industry. The Company's Telecom
Services primarily include its competitive local exchange carrier ("CLEC")
operations, in which the Company operates fiber networks in regional clusters
covering major metropolitan statistical areas in California, Colorado, Ohio,
Texas and the Southeast, offering local, long distance, data and enhanced
telephony services to business end users and ISPs. Additionally, in February
1999, the Company began providing wholesale network services over its nationwide
data network. The Company also provides a wide range of network systems
integration services and maritime and international satellite transmission
services. Network Services consists of information technology services and
selected networking products, focusing on network design, installation,
maintenance and support. Satellite Services consists of satellite voice, data
and video services provided to major cruise lines, the U.S. Navy, the offshore
oil and gas industry and ICPs. As a leading participant in the rapidly growing
competitive local telecommunications industry, the Company has experienced
significant growth, with total revenue increasing from approximately $154.1
million for fiscal 1996 to approximately $448.3 million for the 12-month period
ended March 31, 1999. 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.
Under the Telecommunications Act, the Company is permitted to offer all
interstate and intrastate telephone services, including competitive local dial
tone. In early 1997, the Company began marketing and selling local dial tone
services in major metropolitan areas in California, Colorado, Ohio and the
Southeast and, in December 1998, began offering services in Texas through an
acquired business. During fiscal 1997, fiscal 1998 and the three months ended
March 31, 1999, the Company sold 178,470, 206,458 and 63,690 local access lines,
respectively, net of cancellations, of which 418,610 were in service at March
31, 1999. In addition, the Company's regional fiber networks have grown from
2,143 fiber route miles at the end of fiscal 1996 to 4,351 fiber route miles at
March 31, 1999. The Company had 29 operating high capacity digital voice
switches and 17 data communications switches at March 31, 1999, and plans to
install additional switches as demand warrants. As a complement to its local
exchange services offered to business end users, the Company markets bundled
service offerings provided over its regional fiber network which include long
distance, enhanced telecommunications services and data services. Additionally,
the Company owns and operates a nationwide data network with 236 points of
presence ("POPs") over which the Company recently began providing wholesale
Internet access and enhanced network services to MindSpring Enterprises, Inc.,
an Internet service provider ("ISP") located in Atlanta, Georgia ("MindSpring"),
and intends to offer similar services to other ISPs and telecommunications
providers in the future.
To better focus its efforts on its core Telecom Services operations,
the Company disposed of certain assets which management believes do not
complement its overall business strategy. Due primarily to the loss of a major
customer, which generated a significant obligation under a volume discount
23
agreement with its call transport provider, the board of directors of Zycom
Corporation ("Zycom") approved a plan on August 25, 1998 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 on January 4, 1999,
the Company completed the sale of the remainder of Zycom's long-lived operating
assets to an unrelated third party. On February 17, 1999, the Company sold
certain of the operating assets and liabilities of NETCOM On-Line Communication
Services, Inc. ("NETCOM") to MindSpring for total proceeds of $245.0 million,
and on March 16, 1999, the Company sold all of the capital stock of NETCOM's
international operations in Canada and the United Kingdom to other unrelated
third parties for total proceeds of approximately $41.1 million. During the
three months ended March 31, 1999, the Company recorded a combined gain on the
sales of the operations of NETCOM of approximately $193.0 million, net of income
taxes of approximately $6.4 million. Offsetting the gain on the sales is
approximately $16.6 million of net losses from operations of NETCOM from
November 3, 1998 (the date on which the Company's board of directors adopted the
formal plan to dispose of the operations of NETCOM) through the dates of the
sales. Since the operations sold were acquired by the Company in a transaction
accounted for as a pooling of interests, the gain on the sales of the operations
of NETCOM is classified as an extraordinary item in the Company's consolidated
statement of operations. For fiscal 1996, 1997 and 1998, Zycom and NETCOM
combined reported revenue of $135.4 million, $189.0 million and $181.6 million,
respectively, and EBITDA losses (before nonrecurring charges) of $(30.4)
million, $(12.1) million and $(18.0) million, respectively. The Company's
consolidated financial statements reflect the operations of Zycom and NETCOM as
discontinued for all periods presented. The Company will from time to time
evaluate all of its assets as to their core need and, based on such analysis,
may sell or otherwise dispose of assets which do not complement its overall
business strategy.
In conjunction with the sale to MindSpring, the legal name of the
NETCOM subsidiary was changed to ICG PST, Inc. ("PST"). PST has retained the
domestic Internet backbone assets formerly owned by NETCOM which include 236
POPs serving approximately 700 cities nationwide. PST intends to utilize the
retained network operating assets to provide wholesale Internet access and
enhanced network services to MindSpring and other ISPs and telecommunications
providers. On February 17, 1999, the Company entered into an agreement to lease
to MindSpring for a one-year period the capacity of certain network operating
assets formerly owned by NETCOM and retained by the Company. MindSpring is
utilizing the Company's network capacity to provide Internet access to the
dial-up services customers formerly owned by NETCOM. Over the term of the
one-year agreement, MindSpring is required to pay the Company a minimum of $27.0
million, although such minimum is subject to increase dependent upon network
usage. In addition, the Company is receiving for a one-year period 50% of the
gross revenue earned by MindSpring from the dedicated access customers formerly
owned by NETCOM, estimated to be approximately $10.0 million for the term of the
agreement. Although the Company expects to generate cash operating losses under
this agreement, any such losses will be offset by the periodic recognition of
approximately $26.0 million of the proceeds from the sale of certain of NETCOM's
domestic operating assets and liabilities to MindSpring, which the Company
deferred on February 17, 1999. Accordingly, the Company does not expect to
recognize any revenue, operating costs or selling, general and administrative
expenses from services provided to MindSpring for the term of the agreement. Any
incremental revenue or costs generated by other customers, or by other services
provided to MindSpring, will be recognized in the Company's consolidated
statement of operations as incurred.
Additionally, the Company intends to provide network capacity and
enhanced data services to ISPs and other telecommunications providers, as
required. In December 1998, the Company announced plans to offer several new
network services to its business and ISP customers by utilizing its nationwide
data network and service capabilities to carry out-of-region traffic and enhance
data services provided. One of the services currently being offered is modemless
remote access service ("RAS"). RAS, also known as managed modem service, allows
the Company to provide modem access at its own switch location, thereby
eliminating the need for ISPs to deploy modems physically at each of their POPs.
The benefits to ISPs, including reduced capital expenditures and the shift of
network management responsibility from the ISPs to the Company, will allow the
Company to act as an aggregator of ISP traffic. In offering RAS, the Company
provides radius routing and proxy services at the modem bank connected to the
Company's local switch, which services are the authentication services necessary
to validate and accurately route incoming call traffic to the ISP. The Company
also provides transport services to deliver all Internet protocol ("IP") data
packets either directly to the ISP, if the ISP is not collocated at the
Company's local switch, or directly to the Internet, bypassing the ISP.
Additionally, through its network operations center, the Company monitors the
24
usage of each port and is responsible for the administration of all network
repair and maintenance. The Company is currently offering Internet RAS services,
or expanded originating services, to MindSpring and expects to extend such
services offerings to other ISPs in the future. In August 1998, the Company
began offering enhanced telephony services via IP technology. The Company
currently offers this service in 230 major cities in the United States, covering
more than 90% of the commercial long distance market. The Company carries the IP
traffic over its nationwide data network and terminates a large portion of the
traffic via its own POPs. The Company also began offering integrated access
service ("IAS") which allows voice and data traffic to be carried on the same
circuit. Through equipment installed by the Company at the customers' premises
and in the Company's central offices, IAS provides expanded bandwidth for small
to medium-sized business customers as an alternative to purchasing additional
circuits. Data traffic, including Internet traffic, from IAS service offerings
will be carried over the Company's nationwide network. The Company's nationwide
network will also be utilized in offering peering services to its ISP customers,
in which service offerings the Company will become the general backbone provider
for its customers. Additionally, the Company intends to provide other enhanced
network services as demand warrants.
The Company will continue to expand its network and service offerings
through construction, leased facilities, strategic alliances and mergers and
acquisitions. For example, on December 31, 1998, the Company purchased from
Central and South West Corporation ("CSW") 100% of the partnership interests in
ICG ChoiceCom, L.P. ("ChoiceCom"), a strategic alliance with CSW formed for the
purpose of developing and marketing telecommunications services in certain
cities in Texas. ChoiceCom is based in Austin, Texas and currently provides
local exchange and long distance services in Austin, Corpus Christi, Dallas,
Houston and San Antonio, Texas. For fiscal 1997 and 1998, ChoiceCom reported
revenue of $0.3 million and $5.8 million, respectively, and EBITDA losses
(before nonrecurring charges) of $(5.5) million and $(13.6) million,
respectively. Additionally, on the acquisition date, ChoiceCom had five
operating high capacity digital voice switches and two data communications
switches and had 19,569 access lines in service, including 15,282 access lines
previously sold by ICG on behalf of ChoiceCom. In March 1999, the Company
entered into an agreement with NorthPoint Communications, Inc., a data CLEC
based in San Francisco, California ("NorthPoint"), which designates NorthPoint
as the Company's preferred digital subscriber line ("DSL") provider through June
1, 2001. A significant portion of the Company's DSL traffic will be routed by
NorthPoint to the Company's asynchronous transfer mode ("ATM") switches and
transported by the Company either to the ISP, via a point to point connection or
via IP technology, or directly to the Internet, as required. The Company expects
to purchase a minimum of 75,000 digital subscriber lines from NorthPoint during
the term of the agreement. In April 1999, the Company signed a nonbinding letter
of intent with a large national ISP which is currently a local exchange customer
of the Company. If the agreement is finalized, the Company will provide Internet
RAS to the ISP for a seven-year period for an estimated $290.0 million over the
term of the agreement. The Company is currently converting the ISP's existing
primary rate interface ("PRI") lines to accommodate RAS service and expects to
convert a total of 60,000 PRI lines in conjunction with the agreement.
Additionally, the letter of intent contains pricing provisions which, if the
agreement is finalized, will reduce the Company's reliance in future periods on
revenue from transport and termination charges generated by local exchange
services provided to customers of the ISP. See "Liquidity Transport and
Termination Charges." Also in April 1999, the Company announced its intention to
expand its RAS and other network service offerings during 1999 to the major U.S.
markets of Boston, New York, Washington D.C., Miami, Chicago and Seattle.
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, EBITDA (before nonrecurring charges), and
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, through and
including the quarter ended March 31, 1999 for which the Company reported
positive EBITDA before nonrecurring charges of $10.5 million. 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 performance will continue to improve
in the near term.
25
Results of Operations
The following table provides a breakdown of revenue, operating costs
and selling, general and administrative expenses 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,
expenses, operating loss, EBITDA and EBITDA (before nonrecurring charges) as a
percentage of the Company's total revenue.
Three months ended March 31,
---------------------------------------------------------------------------
1998 1999
---------------------------------- -------------------------------------
$ % $ %
--------------- -------------- -------------------- -------------
(unaudited)
Statement of Operations Data: (in thousands)
Revenue:
Telecom services 58,487 74 104,331 81
Network services 11,431 15 13,500 10
Satellite services 8,949 11 11,688 9
--------------- --------------- ----------------- ----------------
Total revenue 78,867 100 129,519 100
Operating costs:
Telecom services 45,658 53,649
Network services 10,865 10,303
Satellite services 4,992 6,224
--------------- --------------- ----------------- ----------------
Total operating costs 61,515 78 70,176 54
Selling, general and administrative:
Telecom services 30,964 38,424
Network services 3,818 3,049
Satellite services 3,126 3,036
Corporate services (1) 4,418 4,384
--------------- --------------- ----------------- ----------------
Total selling, general and administrative 42,326 54 48,893 38
Depreciation and amortization 13,603 17 39,031 30
Net loss (gain) on disposal of long-lived
assets 505 1 (908) (1)
--------------- --------------- ----------------- ----------------
Operating loss (39,082) (50) (27,673) (21)
Other Data:
Net cash used by operating activities (6,539) (43,833)
Net cash provided by investing activities 36,681 130,296
Net cash provided (used) by financing
activities 294,197 (521)
EBITDA (2) (25,479) (32) 11,358 9
EBITDA (before nonrecurring charges) (2) (24,974) (32) 10,450 8
Capital expenditures of continuing
operations (3) 65,748 105,717
Capital expenditures of discontinued
operations (3) 6,511 -
(Continued)
26
March 31, June 30, September 30, December 31, March 31,
1998 1998 1998 1998 1999
--------------- ------------- ---------------- -------------- --------------
(unaudited)
Statistical Data (4):
Full time employees 3,050 3,089 3,251 3,415 2,665
Telecom services:
Access lines in service (5) 186,156 237,458 290,983 354,482 418,610
Buildings connected:
On-net 637 665 684 777 789
Hybrid (6) 3,294 3,733 4,217 4,620 5,337
--------------- -------------- ------------- ------------- --------------
Total buildings connected 3,931 4,398 4,901 5,397 6,126
Operational switches:
Voice 20 20 21 29 29
Data 15 15 15 16 17
--------------- -------------- ------------- ------------- --------------
Total operational switches 35 35 36 45 46
Fiber route miles (7):
Operational 3,194 3,812 3,995 4,255 4,351
Under construction - - - - 533
Fiber strand miles (8):
Operational 118,074 124,642 127,756 134,152 155,788
Under construction - - - - 15,863
Collocations with ILECs 35 45 47 59 111
Satellite services:
C-Band installations (9) 59 66 69 76 78
(1) Corporate Services consists of the operating activities of ICG
Communications, Inc., ICG Funding, LLC, ICG Canadian Acquisition, Inc.,
ICG Holdings (Canada) Co., ICG Holdings, Inc., ICG Services, Inc. and
ICG Equipment, Inc., which primarily hold securities and provide certain
legal, accounting and finance, personnel and other administrative
support services to the business units.
(2) EBITDA consists of earnings (loss) from continuing operations before
interest, income taxes, depreciation and amortization, other expense,
net and accretion and preferred dividends on preferred securities of
subsidiaries, or simply, operating loss plus depreciation and
amortization. EBITDA (before nonrecurring charges) represents EBITDA
before certain nonrecurring charges such as the net loss (gain) on
disposal of long-lived assets. 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.
(3) Capital expenditures include assets acquired under capital leases and
excludes payments for construction of the Company's corporate
headquarters and corporate headquarters assets acquired through the
issuance of long-term debt. Capital expenditures of discontinued
operations includes the capital expenditures of Zycom and NETCOM
combined for all periods presented.
(4) Amounts presented are for three-month periods ended, or as of the end of
the period presented.
(5) Access lines in service at March 31, 1999 includes 331,146 lines which
are provisioned through the Company's switch and 87,464 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.
(6) Hybrid buildings connected represent buildings connected to the
Company's network via another carrier's facilities.
27
(7) Fiber route miles refers to the number of miles of fiber optic cable,
including leased fiber. As of March 31, 1999, the Company had 4,351
fiber route miles, of which 48 fiber route miles were leased under
operating leases. Fiber route miles under construction represents fiber
under construction which is expected to be operational within six
months.
(8) 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 March 31, 1999, the Company had
15,863 fiber strand miles, of which 856 fiber strand miles were leased
under operating leases. Fiber strand miles under construction represents
fiber under construction which is expected to be operational within six
months.
(9) C-Band installations service cruise ships, U.S. Navy vessels and
offshore oil platform installations.
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998
Revenue. Total revenue for the three months ended March 31, 1999
increased $50.7 million, or 64%, from the three months ended March 31, 1998.
Telecom Services revenue increased 78% to $104.3 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 $24.3 million
(42% of Telecom Services revenue) for the three months ended March 31, 1998 to
$67.4 million (65% of Telecom Services revenue) for the three months ended March
31, 1999, primarily due to an increase in local access lines from 186,156 lines
in service at March 31, 1998 to 418,610 lines in service at March 31, 1999. In
addition, local access revenue includes revenue of approximately $8.5 million
and $30.8 million for the three months ended March 31, 1998 and 1999,
respectively, for reciprocal compensation relating to the transport and
termination of local traffic to ISPs from customers of ILECs pursuant to various
interconnection agreements. These agreements are subject to renegotiation over
the next several months. While management believes that these agreements will be
replaced by agreements offering the Company some form of compensation for ISP
traffic, the renegotiated agreements may reflect rates for reciprocal
compensation which are lower than the rates under the current contracts. See
"Liquidity - Transport and Termination Charges." Revenue from long distance
services increased from $3.9 million for the three months ended March 31, 1998
to $5.1 million for the three months ended March 31, 1999. Special access
revenue increased from $16.1 million (28% of Telecom Services revenue) for the
three months ended March 31, 1998 to $22.6 million (22% of Telecom Services
revenue) for the three months ended March 31, 1999. Switched access (terminating
long distance) revenue decreased to $9.2 million for the three months ended
March 31, 1999, compared to $14.2 million for the three months ended March 31,
1998. The Company has raised prices on its wholesale switched services product
in order to improve margins. Revenue from data services did not generate a
material portion of total revenue during either period.
Network Services revenue increased 18% to $13.5 million for the three
months ended March 31, 1999, compared to $11.4 million for the three months
ended March 31, 1998. The increase in Network Services revenue is primarily due
to an increase in the volume of integrated cabling services in addition to an
overall increase in other service installations. In addition, Network Services
provides certain cabling and other service installation on behalf of Telecom
Services, as Telecom Services provisions new customers and services. Due to the
growth of Telecom Services during fiscal 1998 and into 1999, Network Services
has been and will continue to be required to spend increasing management
attention and resources on providing cabling and other service installation for
Telecom Services. Amounts received from Telecom Services for work performed is
eliminated in consolidation.
Satellite Services revenue increased $2.7 million, or 31%, to $11.7
million for the three months ended March 31, 1999. This increase is due to the
operations of Maritime Telecommunications Network, Inc. ("MTN"), which comprised
all of Satellite Services revenue for the three months ended March 31, 1999,
compared to $5.4 million for the same period in 1998. MTN's C-band
installations, which include both military and cruise vessels, increased from 59
at March 31, 1998 to 78 at March 31, 1999, an increase of 32%. The Company sold
the remaining operating subsidiaries of Satellite Services, other than MTN, in
August and November 1998.
Operating costs. Total operating costs for the three months ended March
31, 1999 increased $8.7 million, or 14%, from the three months ended March 31,
28
1998. Telecom Services operating costs increased from $45.7 million, or 78% of
Telecom Services revenue, for the three months ended March 31, 1998 to $53.6
million, or 51% of Telecom Services revenue, for the three months ended March
31, 1999. 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 increase in 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 Telecom Services 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 5% to $10.3 million and
decreased as a percentage of Network Services revenue from 95% for the three
months ended March 31, 1998 to 76% for the three months ended March 31, 1999.
The decrease in operating costs in absolute dollars and as a percentage of
revenue is due to the decrease in cost overruns between the comparative periods
and the decentralization of Network Services in fiscal 1998 which eliminated
certain duplicate costs. Network Services operating costs include the cost of
equipment sold, direct hourly labor and other indirect project costs.
Satellite Services operating costs increased to $6.2 million for the
three months ended March 31, 1999, from $5.0 million for the three months ended
March 31, 1998. Satellite Services operating costs as a percentage of Satellite
Services revenue decreased from 56% for the three months ended March 31, 1998 to
53% for the three months ended March 31, 1999 as a result of the increase in
revenue of MTN which provides relatively higher margins than the other maritime
services operations which the Company sold in August 1998. Satellite Services
operating costs consist primarily of transponder lease costs and the cost of
equipment sold.
Selling, general and administrative expenses. Total selling, general
and administrative ("SG&A") expenses for the three months ended March 31, 1999
increased $6.6 million, or 16%, compared to the three months ended March 31,
1998, and decreased as a percentage of total revenue from 54% for the three
months ended March 31, 1998 to 38% for the three months ended March 31, 1999.
Telecom Services SG&A expense increased from $31.0 million, or 53% of Telecom
Services revenue, for the three months ended March 31, 1998 to $38.4 million, or
37% of Telecom Services revenue, for the three months ended March 31, 1999. The
increase in absolute dollars is 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. 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, Telecom Services has experienced and expects to continue to
experience declining SG&A expenses as a percentage of Telecom Services revenue.
Network Services SG&A expense decreased $0.8 million, from $3.8
million, or 33% of Network Services revenue, for the three months ended March
31, 1998 to $3.0 million, or 23% of Network Services revenue, for the three
months ended March 31, 1999. This decrease is primarily due to a reduction in
personnel as a result of the decentralization of Network Services during fiscal
1998. In addition, certain long-term operating leases on field offices expired
during fiscal 1998 and were not renewed or replaced.
Satellite Services SG&A expense decreased from $3.1 million for the
three months ended March 31, 1998 to $3.0 million for the three months ended
March 31, 1999. Additionally, SG&A expense decreased as a percentage of
Satellite Services revenue from 35% for the three months ended March 31, 1998 to
26% for the three months ended March 31, 1999 due to the growth of MTN revenue,
without proportional increases in SG&A expenses, and the sales of the remaining
operating subsidiaries of Satellite Services other than MTN, in August and
November 1998, which companies generated higher SG&A expenses in relation to
revenue than MTN.
Corporate Services SG&A expense for both the three months ended March
31, 1998 and 1999 was $4.4 million.
29
Depreciation and amortization. Depreciation and amortization increased
$25.4 million, or 187%, for the three months ended March 31, 1999, compared to
the three months ended March 31, 1998, 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 three purchase business combinations completed during the
second half of fiscal 1998. The Company expects that depreciation and
amortization will continue to increase as the Company continues to invest in the
expansion and upgrade of its regional fiber and nationwide data networks.
Net loss (gain) on disposal of long-lived assets. Net loss (gain) on
disposal of long-lived assets fluctuated from a net loss of $0.5 million for the
three months ended March 31, 1998 to a net gain of $0.9 million for the three
months ended March 31, 1999. Net loss on disposal of long-lived assets for the
three months ended March 31, 1998 relates to the write-off of certain
installation costs of disconnected special access customers. For the three
months ended March 31, 1999, net gain on disposal of long-lived assets relates
primarily to the sale of certain of the Company's Federal Communications
Commission ("FCC") licenses.
Interest expense. Interest expense increased $12.9 million, from $34.5
million for the three months ended March 31, 1998, to $47.4 million for the
three months ended March 31, 1999, which includes $45.6 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 decreased $1.4 million, from $5.5
million for the three months ended March 31, 1998, to $4.1 million for the three
months ended March 31, 1999. The decrease is attributable to the decrease in
cash, cash equivalents and short-term investments as the Company funds operating
losses and continues to invest available cash balances in telecommunications
equipment and other assets.
Other expense, net. Other expense, net increased from $0.3 million for
the three months ended March 31, 1998 to $0.5 million for the three months ended
March 31, 1999. Other expense, net recorded in the three months ended March 31,
1998 consists of litigation settlement costs. For the three months ended March
31, 1999, other expense, net primarily includes litigation settlement costs,
offset by an unrealized gain on the common stock of MindSpring which the Company
received as partial consideration for the sale of the domestic operations of
NETCOM.
Accretion and preferred dividends on preferred securities of
subsidiaries. Accretion and preferred dividends on preferred securities of
subsidiaries increased $1.6 million, from $13.2 million for the three months
ended March 31, 1998 to $14.8 million for the three months ended March 31, 1999.
The increase is due primarily to the periodic payment of dividends on the 14%
Exchangeable Preferred Stock Mandatorily Redeemable 2008 (the "14% Preferred
Stock") and the 14 1/4% Exchangeable Preferred Stock Mandatorily Redeemable 2009
(the "14 1/4% Preferred Stock") in additional shares of 14% Preferred Stock and
14 1/4% of Preferred Stock. Accretion and preferred dividends on preferred
securities of subsidiaries recorded during the three months ended March 31, 1999
consists of the accretion of issuance costs ($0.3 million) and the accrual of
the preferred securities dividends ($14.5 million) associated with the 6 3/4%
Exchangeable Limited Liability Company Preferred Securities Mandatorily
Redeemable 2009 (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 $4.8 million, or 6%, from $81.6 million for the three months ended
March 31, 1998 to $86.3 million for the three months ended March 31, 1999 due to
the increases in depreciation and amortization and interest expense, offset by
an increase in operating margin, as noted above.
Loss from discontinued operations. For the three months ended March 31,
1998, loss from discontinued operations was $20.2 million, or 20%, of the
Company's net loss and consists of the combined net loss of Zycom and NETCOM for
the three-month period. Zycom terminated its normal operations on October 22,
1998 and, accordingly, the Company reported no loss from discontinued operations
30
of Zycom for the three months ended March 31, 1999. Since the Company expected
to report a gain on the disposition of NETCOM, the Company deferred the net
losses from operations of NETCOM from November 3, 1998 (the date on which the
Company's board of directors adopted the formal plan to dispose of the
operations of NETCOM) through the dates of the sales and, accordingly, the
Company reported no loss from discontinued operations of NETCOM for the three
months ended March 31, 1999.
Extraordinary gain on sales of operations of NETCOM. The Company
reported an extraordinary gain on the sales of the operations of NETCOM during
the three months ended March 31, 1999 of $193.0 million, net of income taxes of
$6.4 million. Offsetting the gain on the sales is approximately $16.6 million of
net losses of operations of NETCOM from November 3, 1998 through the dates of
the sales and $26.0 million of deferred sales proceeds from the sale of certain
of the domestic operating assets and liabilities of NETCOM to MindSpring. The
deferred proceeds will be recognized on a periodic basis over the term of the
Company's network capacity agreement with MindSpring.
Liquidity and Capital Resources
The Company's growth has been funded through a combination of equity,
debt and lease financing. As of March 31, 1999, the Company had current assets
of $585.6 million, including $338.5 million of cash, cash equivalents,
restricted cash and short-term investments available for sale, which exceeded
current liabilities of $171.3 million, providing working capital of $414.3
million. The Company invests excess funds primarily 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
The Company's operating activities used $6.5 million and $43.8 million
for the three months ended March 31, 1998 and 1999, respectively. Net cash used
by operating activities is primarily due to losses from continuing operations
and increases in receivables, which are partially offset by changes in working
capital items and non-cash expenses, such as depreciation and amortization,
deferred interest expense and accretion and preferred dividends on subsidiary
preferred securities.
The Company does not anticipate that cash provided by operations will
be sufficient to fund operating activities, 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 will improve in the near
term.
Net Cash Provided By Investing Activities
Investing activities provided $36.7 million and $130.3 million in the
three months ended March 31, 1998 and 1999, respectively. Net cash provided by
investing activities includes cash expended for the acquisition of property,
equipment and other assets of $65.7 million and $102.0 million for the three
months ended March 31, 1998 and 1999, respectively. Also included in net cash
provided by investing activities for the three months ended March 31, 1999 is
the purchase of long-term investments of $27.5 million, offset by proceeds from
the sales of the operations of NETCOM of $252.9 million. For the three months
ended March 31, 1998, the Company received net proceeds from the sale of the
Company's corporate headquarters of $26.9 million and proceeds from the sales of
short-term investments available for sale of $83.3 million. The Company will
continue to use cash in 1999 and subsequent periods for the construction of new
networks, the expansion of existing networks and, potentially, for acquisitions.
The Company acquired assets under capital leases of $3.8 million during the
three months ended March 31, 1999.
Net Cash Provided (Used) By Financing Activities
Financing activities provided $294.2 million and used $0.5 million in
the three months ended March 31, 1998 and 1999, respectively. Net cash provided
by financing activities for the three months ended March 31, 1998 includes net
proceeds from the private placement of the 10% Notes in February 1998.
Historically, the funds to finance the Company's business acquisitions, capital
expenditures, working capital requirements and operating losses have been
31
obtained through public and private offerings of ICG and ICG Holdings (Canada)
Co. ("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. Net cash provided (used) by financing activities for the three months
ended March 31, 1998 and 1999 also include proceeds from the issuance of common
stock in conjunction with the exercise of options and warrants and the Company's
employee stock purchase plan, offset by principal payments on long-term debt and
capital leases and payments of preferred dividends on preferred securities of
subsidiaries.
As of March 31, 1999, the Company had an aggregate of approximately
$76.5 million of capital lease obligations and an aggregate accreted value of
approximately $1.6 billion was outstanding under the 13 1/2% Senior Discount
Notes due 2005 (the "13 1/2 % Notes"), the 12 1/2% Senior Discount Notes due
2006 (the "12 1/2 % Notes"), the 11 5/8% Senior Discount Notes due 2007 (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 March 15, 2001 and mature on
September 15, 2005. The 12 1/2% Notes require payments of interest to be made in
cash commencing November 1, 2001 and mature on May 1, 2006. The 11 5/8% Notes
require payments of interest to be made in cash commencing September 15, 2002
and mature on March 15, 2007. The 10% Notes require payments of interest in cash
commencing August 15, 2003 and mature on February 15, 2008. The 9 7/8% Notes
require payments of interest in cash commencing November 1, 2003 and mature on
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 March 31, 1999,
the Company had $33.6 million of other indebtedness outstanding. With respect to
senior indebtedness outstanding on March 31, 1999, the Company has cash interest
payment obligations of approximately $113.3 million in 2001, $158.0 million in
2002, $212.6 million in 2003 and $257.2 million in 2004. With respect to
preferred securities currently outstanding, the Company has cash dividend
obligations of approximately $6.7 million remaining in 1999 and $8.9 million in
2000, for which the Company has restricted cash balances available for such
dividend payments, $10.7 million in 2001 and $35.4 million in 2002 and each year
thereafter through 2007. 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 capital 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 securities, 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 corporate headquarters) were $65.7 million and $105.7 million for
the three months ended March 31, 1998 and 1999, respectively. The Company
anticipates that the expansion of existing networks, construction of new
networks and further development of the Company's products and services will
require capital expenditures of approximately $345.0 million during the
remainder of 1999, including approximately $40.0 million which the Company
expects to incur under its letter of intent with a large national ISP to provide
Internet RAS. 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.
32
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 footnotes to the Company's
unaudited consolidated financial statements for the three months ended March 31,
1999 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, including the collection of receivables from transport and
termination charges, vendor financing arrangements and credit facilities will
provide sufficient funds necessary for the Company to expand its business as
currently planned and to fund its operations through 2000. Additional sources of
cash may include public and private equity and debt financings, sales of
non-strategic assets, capital leases and other financing arrangements. In the
past, the Company has been able to secure sufficient amounts of financing to
meet its capital 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 and sales of non-strategic assets until the Company
establishes a sufficient revenue-generating customer base could have a material
adverse effect on the Company's liquidity.
Transport and Termination Charges
The Company has recorded revenue of approximately $4.9 million, $58.3
million and $30.8 million for fiscal 1997, fiscal 1998 and the three months
ended March 31, 1999, respectively, for reciprocal compensation relating to the
transport and termination of local traffic to ISPs from customers of 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. As a result, the Company expects receivables from transport and
termination charges will continue to increase until these disputes have been
resolved.
The resolution of these disputes will be based on rulings by state
public utility commissions and/or by the FCC. To date, there have been favorable
final rulings from 31 state public utility commissions that ISP traffic is
subject to the payment of reciprocal compensation under current interconnection
agreements. Many of these state commission decisions have been appealed by the
ILECs. On February 25, 1999, the FCC issued a decision that ISP-bound traffic is
largely jurisdictionally interstate traffic. The decision relies on the
long-standing federal policy that ISP traffic, although jurisdictionally
interstate, is treated as though it is local traffic for pricing purposes. The
decision also emphasizes that because there are no federal rules governing
intercarrier compensation for ISP traffic, the determination as to whether such
traffic is subject to reciprocal compensation under the terms of interconnection
agreements properly is made by the state commissions and that carriers are bound
by their interconnection agreements and state commission decisions regarding the
payment of reciprocal compensation for ISP traffic. The FCC has initiated a
rulemaking proceeding regarding the adoption of prospective federal rules for
intercarrier compensation for ISP traffic. In its notice of rulemaking, the FCC
expresses its preference that compensation rates for this traffic continue to be
set by negotiations between carriers, with disputes resolved by arbitrations
conducted by state commissions, pursuant to the Telecommunications Act. Since
the issuance of the FCC's decision on February 25, 1999, nine state utility
commissions have either ruled or reaffirmed that ISP traffic is subject to
reciprocal compensation under current interconnection agreements. On May 5,
1999, the Public Utilities Commission of Ohio ("PUCO") issued a decision
affirming its August 1998 decision that ISP traffic is subject to reciprocal
compensation under the Company's current interconnection agreement with
Ameritech Corporation ("Ameritech"). The PUCO also denied Ameritech's request
for a stay of its obligation to remit payment to the Company and directed
33
Ameritech to remit the amounts owed to the Company within 45 days of May 5,
1999. The Company expects that Ameritech will seek judicial review of the PUCO
decision and that Ameritech will request the reviewing court to stay the
decision pending appeal. The Company cannot predict how the reviewing court
would rule on Ameritech's stay request, or the final outcome on the merits of
the court appeal. On March 4, 1999, the Alabama Public Service Commission (the
"Alabama PSC") issued a decision that found that reciprocal compensation is owed
for Internet traffic under four CLEC interconnection agreements with BellSouth
Corporation ("BellSouth"), which agreements were at issue in the proceeding.
With respect to the Company's interconnection agreement, which also was at
issue, the state commission interpreted certain language in the Company's
agreement to exempt ISP-bound traffic from reciprocal compensation under certain
conditions. The Company believes that the Alabama PSC failed to consider (i) the
intent of the parties in negotiating and executing the Company's interconnection
agreement, and (ii) the specific language of the Company's interconnection
agreement and the impact of Alabama PSC and FCC policies, and thereby
misinterpreted the agreement. The Company has filed a request with the Alabama
PSC seeking determination that the ruling with respect to the Company's
agreement be reconsidered, and that the Company should be treated the same as
the other CLECs that participated in the proceeding and for which the Alabama
PSC ordered the payment of reciprocal compensation. While the Company intends to
pursue vigorously the petition for reconsideration with the Alabama PSC, and if
the Company deems it necessary, judicial review, the Company cannot predict the
final outcome of this issue.
The Company has also recorded revenue of approximately $19.1 million
and $5.2 million for fiscal 1998 and the three months ended March 31, 1999,
respectively, related to other transport and termination charges to the ILECs,
pursuant to the Company's interconnection agreements with these ILECs. Included
in the Company's trade receivables at December 31, 1998 and March 31, 1999 are
$72.8 million and $105.5 million, respectively, for all receivables related to
transport and termination charges. The receivables balance at March 31, 1999 is
net of an allowance of $8.1 million for disputed amounts.
As the Company's interconnection agreements expire or are extended,
rates for transport and termination charges are being and will continue to be
renegotiated. Some of the Company's agreements are already being affected.
Although the Company's interconnection agreement with BellSouth has expired, the
Company has received written notification from BellSouth that the Company may
continue operating under the expired interconnection agreement, until such
agreement is renegotiated or arbitrated by the relevant state commissions.
Additionally, the Company's interconnection agreement with Ameritech recently
was extended from the June 15, 1999 to February 15, 2000. The Company's
remaining interconnection agreements expire in 1999 and 2000. The Company's
extension of its interconnection agreement with Ameritech includes reduced rates
for transport and termination charges, and the Company expects that its
negotiations with BellSouth will also affect the rates for transport and
termination charges included in its existing interconnection agreement with
BellSouth. While the Company believes that all revenue recorded through March
31, 1999 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 and judicial rulings
will be favorable to the Company, that the Alabama PSC will reconsider its
ruling, or that different pricing plans for transport and termination charges
between carriers will not be adopted when the Company's interconnection
agreements are renegotiated or arbitrated, or as a result of the FCC's
rulemaking proceeding on future compensation methods. In fact, the Company
believes that different pricing plans will be considered and adopted, and
although the Company expects that revenue from transport and termination charges
likely will decrease as a percentage of total revenue from local services in
periods after the expiration of current interconnection agreements, the
Company's local termination services still will be required by the ILECs and
must be provided under the Telecommunications Act, and likely will result in
increasing volume in minutes due to the growth of the Internet and related
services markets. The Company expects to negotiate reasonable compensation and
collection terms for local termination services, although there is no assurance
that such compensation will remain consistent with current levels. Additionally,
the Company expects to supplement its current operations with revenue, and
ultimately EBITDA, from new services offerings such as RAS and DSL services,
however, the Company may or may not be successful in its efforts to deploy such
services profitably.
34
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:
o Networks and Products, 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 collocation and telecommunications
products;
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 corporate 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.
35
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.
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.
36
- ------------------------------- ----------------------------------------------------------------------------------------------
Phase
- ------------------------------- ----------------------------------------------------------------------------------------------
I II III IV
System and Level of Priority Assessment Remediation Testing Implementation
- ------------------------------- ----------------------------------------------------------------------------------------------
Networks and Products
- ------------------------------- ----------------------------------------------------------------------------------------------
High Complete In progress In progress In progress
To complete Q2 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress In progress In progress
To complete Q2 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete Complete Complete
- ------------------------------- ----------------------------------------------------------------------------------------------
IT Systems
- ------------------------------- ----------------------------------------------------------------------------------------------
High Complete In progress In progress In progress
To complete Q2 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress In progress In progress
To complete Q2 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete In progress In progress
To complete Q3 1999 To complete Q3 1999
- ------------------------------- ----------------------------------------------------------------------------------------------
Building and Facilities
- ------------------------------- ----------------------------------------------------------------------------------------------
High In progress In progress To be determined based on the results of
To complete Q2 1999 To complete Q2 1999 Phase II
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Medium In progress To be determined based on the results of Phase I
To complete Q2 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low To begin Q2 1999 To be determined based on the results of Phase I
To complete Q3 1999
- ------------------------------- ----------------------------------------------------------------------------------------------
Office Equipment
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
High Complete Complete In progress In progress
To complete Q2 1999 To complete Q2 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete Complete Complete Complete
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete Complete Complete
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
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.
Costs
The Company expenses all incremental costs to the Company associated
with Year 2000 compliance issues as incurred. Through March 31, 1999, such costs
incurred were approximately $0.6 million, consisting of approximately $0.4 of
replacement hardware and software and approximately $0.2 million of consulting
fees and other miscellaneous costs of Year 2000 compliance reference and
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 March 31, 1999. 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.
37
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial position and cash flows are subject to a
variety of risks in the normal course of business, which include market risks
associated with movements in interest rates and equity prices. The Company
routinely assesses these risks and has established policies and business
practices to protect against the adverse effects of these and other potential
exposures. The Company does not, in the normal course of business, use
derivative financial instruments for trading or speculative purposes.
Interest Rate Risk
The Company's exposure to market risk associated with changes in
interest rates relates primarily to the Company's investments in marketable
securities and its senior indebtedness.
The Company invests primarily in high grade short-term investments
which consist of money market instruments, commercial paper, certificates of
deposit, government obligations and corporate bonds, all of which are considered
to be available for sale and generally have maturities of one year or less. The
Company's short-term investment objectives are safety, liquidity and yield, in
that order. As of March 31, 1999, the Company had approximately $338.5 million
in cash, cash equivalents, restricted cash and short-term investments available
for sale and approximately $17.5 million in long-term debt securities available
for sale, at a weighted average fixed interest rate of 4.5% for the three months
ended March 31, 1999. A hypothetical 10% fluctuation in market rates of interest
would cause a change in the fair value of the Company's investment in marketable
38
securities at March 31, 1999 of approximately $0.1 million and, accordingly,
would not cause a material impact on the Company's financial position, results
of operations or cash flows.
At March 31, 1999, the Company's indebtedness included $1.6 billion
under the 13 1/2% Notes, 12 1/2% Notes, 11 5/8% Notes, 10% Notes and 9 7/8%
Notes and $478.9 million under the 14 1/4% Preferred Stock, 14% Preferred Stock
and 6 3/4% Preferred Securities. These instruments contain fixed annual interest
and dividend rates, respectively, and, accordingly, any change in market
interest rates would have no impact on the Company's financial position, results
of operations or cash flows. Future increases in interest rates could increase
the cost of any new borrowings by the Company. The Company does not hedge
against future changes in market rates of interest.
Equity Price Risk
On February 17, 1999, the Company completed the sale of the domestic
operations of NETCOM to MindSpring, in exchange for a combination of cash and
376,116 shares of common stock of MindSpring, valued at approximately $79.76 per
share, or $30.0 million, at the time of the transaction. Through April 16, 1999,
the Company bore some risk of market price fluctuations in its investment in
MindSpring. In order to mitigate the risk associated with a decrease in the
market value of the Company's investment in MindSpring, the Company entered into
a hedging contract. In April 1999, the Company sold its investment in MindSpring
for net proceeds of approximately $30.4 million. The Company recorded an
unrealized gain on its investment in MindSpring of approximately $0.4 million in
its statement of operations for the three months ended March 31, 1999. The
hedging contract was terminated upon the sale of the common stock of MindSpring.
On March 30, 1999, the Company purchased, for approximately $10.0
million in cash, 454,545 shares of NorthPoint Preferred Stock. The NorthPoint
Preferred Stock has no voting rights and is ultimately convertible into a voting
class of common stock of NorthPoint, at an exchange price which represents a
discount, as provided in the relevant documentation, to the initial public
offering price of NorthPoint's common stock. The Company is restricted from
selling the NorthPoint Preferred Stock or securities obtained upon conversion of
the NorthPoint Preferred Stock until March 23, 2000. Accordingly, the Company
will be subject to the effects of fluctuations in the fair value of the common
stock of NorthPoint until such time when the Company is permitted to liquidate
its investment in NorthPoint. Although changes in the fair market value of the
common stock of NorthPoint may affect the fair market value of the Company's
investment in NorthPoint and cause unrealized gains or losses, such gains or
losses will not be realized until the securities are sold.
39
PART II
ITEM 1. LEGAL PROCEEDINGS
-----------------
See Note 6 (e) to the Company's unaudited condensed consolidated
financial statements for the three months ended March 31, 1999
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 REPORTS ON FORM 8-K
--------------------------------
(A) Exhibits.
(10) Material Contracts.
10.1: Extension and Amendment to Employment Agreement, dated as
of March 10, 1999, by and between ICG Communications, Inc.
and J. Shelby Bryan.
10.2: Deferred Compensation Agreement, dated as of April 1, 1999,
by and between ICG Communications, Inc. and J. Shelby Bryan.
10.3: Loan Agreement, dated as of January 1, 1999, by and among
TriNet Realty Capital, Inc. and ICG Services, Inc.
10.4: Promissory Note, dated as of January 1, 1999, by and among
TriNet Realty Capital, Inc. and ICG Services, Inc.
10.5: Deed of Trust, Assignment of Rents and Security Agreement,
made as of January 1, 1999, granted by ICG Services, Inc.
for the benefit of TriNet Realty Capital, Inc.
10.6: Purchase Agreement, dated as of January 1, 1999, by and
among TriNet Essential Facilities X, Inc. and ICG Services,
Inc.
(27) Financial Data Schedule.
27.1: Financial Data Schedule of ICG Communications, Inc. for the
Three Months Ended March 31, 1999.
40
(B) Reports on Form 8-K. The following reports on Form 8-K were filed by
the registrants during the three months ended March 31, 1999:
ICG Communications, Inc.
------------------------
(i) Current Report on Form 8-K dated January 6, 1999, regarding the
announcement of the Company's definitive agreement to sell the
domestic operations of NETCOM On-Line Communication Services,
Inc. to MindSpring Enterprises, Inc.
(ii) Current Report on Form 8-K dated March 4, 1999, regarding the
disposition of NETCOM On-Line Communication Services, Inc.,
including pro forma financial information.
ICG Communications, Inc.
ICG Holdings (Canada) Co.
ICG Holdings, Inc.
-------------------------
(iii)Current Report on Form 8-K dated February 26, 1999, regarding
the announcement of the Company's earnings information and
results of operations for the quarter and year ended December 31,
1998.
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
INDEX TO EXHIBITS
10.1: Extension and Amendment to Employment Agreement, dated as of March 10,
1999, by and between ICG Communications, Inc. and J. Shelby Bryan.
10.2: Deferred Compensation Agreement, dated as of April 1, 1999, by and
between ICG Communications, Inc. and J. Shelby Bryan.
10.3: Loan Agreement, dated as of January 1, 1999, by and among TriNet
Realty Capital, Inc. and ICG Services, Inc.
10.4: Promissory Note, dated as of January 1, 1999, by and among TriNet
Realty Capital, Inc. and ICG Services, Inc.
10.5: Deed of Trust, Assignment of Rents and Security Agreement, made as of
January 1, 1999, granted by ICG Services, Inc. for the benefit of
TriNet Realty Capital, Inc.
10.6: Purchase Agreement, dated as of January 1, 1999, by and among TriNet
Essential Facilities X, Inc. and ICG Services, Inc.
27.1: Financial Data Schedule of ICG Communications, Inc. for the Three
Months Ended March 31, 1999.
EXHIBIT 10.1
Extension and Amendment to Employment Agreement, dated as of March 10, 1999, by
and between ICG Communications, Inc. and J. Shelby Bryan.
EXHIBIT 10.2
Deferred Compensation Agreement, dated as of April 1, 1999, by and between ICG
Communications, Inc. and J. Shelby Bryan.
EXHIBIT 10.3
Loan Agreement, dated as of January 1, 1999, by and among TriNet Realty
Capital, Inc. and ICG Services, Inc.
EXHIBIT 10.4
Promissory Note, dated as of January 1, 1999, by and among TriNet Realty
Capital, Inc. and ICG Services, Inc.
EXHIBIT 10.5
Deed of Trust, Assignment of Rents and Security Agreement, made as of January 1,
1999, granted by ICG Services, Inc. for the benefit of TriNet Realty
Capital, Inc.
EXHIBIT 10.6
Purchase Agreement, dated as of January 1, 1999, by and among TriNet Essential
Facilities X, Inc. and ICG Services, Inc.
EXHIBIT 27.1
Financial Data Schedule of ICG Communications, Inc. for the Three Months Ended
March 31, 1999.
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 May 14, 1999.
ICG COMMUNICATIONS, INC.
Date: May 14, 1999 By: /s/ Harry R. Herbst
-------------------------------------------
Harry R. Herbst, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer)
Date: May 14, 1999 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 May 14, 1999.
ICG HOLDINGS (CANADA) CO.
Date: May 14, 1999 By: /s/ Harry R. Herbst
----------------------------------------------
Harry R. Herbst, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer)
Date: May 14, 1999 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 May 14, 1999.
ICG HOLDINGS, INC.
Date: May 14, 1999 By: /s/ Harry R. Herbst
----------------------------------------------
Harry R. Herbst, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer)
Date: May 14, 1999 By: /s/ Richard Bambach
----------------------------------------------
Richard Bambach, Vice President and Corporate
Controller (Principal Accounting Officer)