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 June 30, 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 August 13,
1999 were 47,342,835, 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
June 30, 1999 (unaudited)...................................... 3
Consolidated Statements of Operations (unaudited) for the
Three Months and Six Months Ended June 30, 1998 and 1999....... 5
Consolidated Statement of Stockholders' Deficit (unaudited)
for the Six Months Ended June 30, 1999 ........................ 7
Consolidated Statements of Cash Flows (unaudited) for the
Six Months Ended June 30, 1998 and 1999 ....................... 8
Notes to Consolidated Financial Statements, December 31, 1998
and June 30, 1999 (unaudited)..................................10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ........................................26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .......43
PART II ....................................................................45
ITEM 1. LEGAL PROCEEDINGS ................................................45
ITEM 2. CHANGES IN SECURITIES ............................................45
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ..................................45
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS ............45
ITEM 5. OTHER INFORMATION ................................................45
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K ..................................45
Exhibits .........................................................45
Report on Form 8-K ...............................................46
2
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and June 30, 1999 (unaudited)
December 31, June 30,
1998 1999
-------------------- --------------------
Assets (in thousands)
Current assets:
Cash and cash equivalents $ 210,307 234,713
Short-term investments available for sale 52,000 30,646
Receivables:
Trade, net of allowance of $14,351 and $20,823 at December 31,
1998 and June 30, 1999, respectively (note 6) 113,030 160,990
Other 529 587
-------------------- --------------------
113,559 161,577
Inventory - 67
Prepaid expenses and deposits 11,530 11,520
Net current assets of discontinued operations (note 3) 66 10,980
-------------------- --------------------
Total current assets 387,462 449,503
-------------------- --------------------
Property and equipment 1,064,112 1,299,116
Less accumulated depreciation (156,054) (195,747)
-------------------- --------------------
Net property and equipment 908,058 1,103,369
-------------------- --------------------
Restricted cash 16,912 13,372
Investments in debt securities available for sale and restricted
preferred stock (note 4) - 27,686
Other assets, net of accumulated amortization:
Goodwill 110,513 105,575
Deferred financing costs 35,958 33,678
Transmission and other licenses 5,646 1,207
Deposits and other 22,324 14,152
-------------------- -------------------
174,441 154,612
-------------------- -------------------
Net non-current assets of discontinued operations (note 3) 102,774 48,475
-------------------- -------------------
Total assets (note 7) $ 1,589,647 1,797,017
==================== ===================
(Continued)
3
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, June 30,
1998 1999
------------------- -------------------
Liabilities and Stockholders' Deficit (in thousands)
Current liabilities:
Accounts payable $ 30,424 22,193
Accrued liabilities 51,565 75,443
Deferred revenue (note 6) 5,647 38,545
Deferred gain on sale (note 3) - 15,502
Current portion of capital lease obligations (note 6) 4,846 8,535
Current portion of long-term debt (note 5) 46 46
------------------- -------------------
Total current liabilities 92,528 160,264
------------------- -------------------
Capital lease obligations, less current portion (note 6) 62,946 63,314
Long-term debt, net of discount, less current portion (note 5) 1,598,998 1,726,525
Other long-term liabilities - 431
------------------- -------------------
Total liabilities 1,754,472 1,950,534
------------------- -------------------
Redeemable preferred stock of subsidiary ($371.2 million liquidation
value at June 30, 1999) (note 5) 338,310 363,700
Company-obligated mandatorily redeemable preferred securities
of subsidiary limited liability company which holds solely Company
preferred stock ($133.4 million liquidation value at June 30, 1999) 128,042 128,233
Stockholders' deficit:
Common stock, $0.01 par value, 100,000 shares authorized;
46,360,185 and 47,110,309 shares issued and outstanding at
December 31, 1998 and June 30, 1999, respectively 464 471
Additional paid-in capital 577,940 589,239
Accumulated deficit (1,209,462) (1,235,160)
Accumulated other comprehensive loss (119) -
------------------- -------------------
Total stockholders' deficit (631,177) (645,450)
------------------- -------------------
Commitments and contingencies (notes 5 and 6)
Total liabilities and stockholders' deficit $ 1,589,647 1,797,017
=================== ===================
See accompanying notes to consolidated financial statements.
4
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months and Six Months Ended June 30, 1998 and 1999
Three months ended June 30, Six months ended June 30,
------------------------------- -------------------------------
1998 1999 1998 1999
--------------- -------------- --------------- --------------
(in thousands, except per share data)
Revenue (note 7) $ 64,215 117,654 122,702 221,985
Operating costs and expenses:
Operating costs 43,310 59,458 88,968 113,107
Selling, general and administrative expenses 37,832 42,975 73,214 85,783
Depreciation and amortization (note 7) 18,589 44,683 31,595 81,058
Provision for impairment of long-lived assets (note 8) - 29,300 - 29,300
Other, net (7) 398 498 (535)
--------------- -------------- --------------- --------------
Total operating costs and expenses 99,724 176,814 194,275 308,713
--------------- -------------- --------------- --------------
Operating loss (35,509) (59,160) (71,573) (86,728)
Other income (expense):
Interest expense (note 7) (41,482) (51,308) (75,904) (98,746)
Interest income 8,490 3,793 13,985 7,897
Other expense, net, including realized and unrealized
gains and losses on marketable trading securities
(note 4) (320) (1,843) (612) (2,343)
--------------- -------------- --------------- --------------
(33,312) (49,358) (62,531) (93,192)
--------------- -------------- --------------- --------------
Loss from continuing operations before preferred dividends
and extraordinary gain (68,821) (108,518) (134,104) (179,920)
Accretion and preferred dividends on preferred securities of
subsidiaries (13,595) (15,241) (26,787) (30,045)
--------------- -------------- --------------- --------------
Loss from continuing operations before extraordinary gain (82,416) (123,759) (160,891) (209,965)
Discontinued operations (note 3):
Net loss from discontinued operations (18,420) (692) (41,700) (803)
Loss on disposal of discontinued operations, including
provision of $0.3 million for operating losses during
phase out period - (7,959) - (7,959)
--------------- -------------- --------------- --------------
(18,420) (8,651) (41,700) (8,762)
--------------- -------------- --------------- --------------
Extraordinary gain on sales of operations of NETCOM, net of
income taxes of $6.4 million (note 3) - - - 193,029
--------------- -------------- --------------- --------------
Net loss $ (100,836) (132,410) (202,591) (25,698)
=============== ============== =============== ==============
Other comprehensive income - foreign currency translation
adjustment (181) - (76) -
--------------- -------------- --------------- --------------
Comprehensive loss $ (101,017) (132,410) (202,667) (25,698)
=============== ============== =============== ==============
(Continued)
5
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited), Continued
Three months ended June 30, Six months ended June 30,
------------------------------- -------------------------------
1998 1999 1998 1999
--------------- -------------- --------------- --------------
(in thousands, except per share data)
Net loss per share - basic and diluted:
Loss from continuing operations $ (1.84) (2.63) (3.61) (4.49)
Net loss from discontinued operations (0.41) (0.19) (0.93) (0.19)
Extraordinary gain on sales of operations of NETCOM - - - 4.13
--------------- -------------- --------------- --------------
Net loss per share - basic and diluted $ (2.25) (2.82) (4.54) (0.55)
=============== ============== =============== ==============
Weighted average number of shares outstanding - basic and
diluted 44,865 46,988 44,588 46,763
=============== ============== =============== ==============
See accompanying notes to consolidated financial statements.
6
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Deficit (unaudited)
Six Months Ended June 30, 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 $ 464 577,940 (1,209,462) (119) (631,177)
Shares issued for cash in connection with the
exercise of options and warrants 525 5 7,090 - - 7,095
Shares issued for cash in connection with the
employee stock purchase plan 127 1 2,133 - - 2,134
Shares issued as contribution to 401(k) plan 98 1 2,076 - - 2,077
Reversal of cumulative foreign currency
translation adjustment (note 3) - - - - 119 119
Net loss - - - (25,698) - (25,698)
=========== =========== ============= ============== ============= ==============
Balances at June 30, 1999 47,110 $ 471 589,239 (1,235,160) - (645,450)
=========== =========== ============= ============== ============= ==============
See accompanying notes to consolidated financial statements.
7
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 1998 and 1999
Six months ended June 30,
-----------------------------------
1998 1999
-------------- ---------------
(in thousands)
Cash flows from operating activities:
Net loss $ (202,591) (25,698)
Loss from discontinued operations 41,700 8,762
Extraordinary gain on sales of discontinued operations - (193,029)
Adjustments to reconcile net loss to net cash used by operating activities:
Recognition of deferred gain - (10,498)
Accretion and preferred dividends on preferred securities of subsidiaries 26,787 30,045
Depreciation and amortization 31,595 81,058
Provision for impairment of long-lived assets - 29,300
Deferred compensation - 431
Net loss (gain) on disposal of long-lived assets 498 (966)
Gain on marketable trading securities - (439)
Provision for uncollectible accounts 3,645 8,103
Interest expense deferred and included in long-term debt 73,164 94,473
Interest expense deferred and included in capital lease obligations 2,831 2,672
Amortization of deferred financing costs included in interest expense 1,820 2,283
Interest expense capitalized on assets under construction (5,469) (6,708)
Contribution to 401(k) plan through issuance of common stock 1,509 2,077
Change in operating assets and liabilities, excluding the effects of
dispositions and non-cash transactions:
Receivables (25,103) (60,100)
Inventory - 139
Prepaid expenses and deposits 555 3,104
Deferred advertising costs (1,361) -
Accounts payable and accrued liabilities 18,780 (21,095)
Deferred revenue 787 34,090
-------------- ---------------
Net cash used by operating activities (30,853) (21,996)
-------------- ---------------
Cash flows from investing activities:
Increase in long-term notes receivable from affiliates and others (4,910) -
Acquisition of property, equipment and other assets (150,044) (229,747)
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 145 4,302
Proceeds from sale of corporate headquarters, net of selling and other costs 29,094 -
Proceeds from sales of short-term investments available for sale 96,281 21,354
Proceeds from sale of marketable securities - 30,439
Decrease in restricted cash 3,813 3,540
Purchase of investments - (27,686)
Purchase of minority interest in subsidiary - (4,189)
-------------- ---------------
Net cash (used) provided by investing activities (30,565) 50,894
-------------- ---------------
(Continued)
8
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited), Continued
Six months ended June 30,
-------------------------------------
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 11,668 7,095
Employee stock purchase plan 884 2,134
Proceeds from issuance of long-term debt 550,574 -
Deferred long-term debt issuance costs (17,205) -
Principal payments on capital lease obligations (8,952) (9,589)
Principal payments on long-term debt (2,350) (23)
Payments of preferred dividends (4,463) (4,463)
------------------- ---------------
Net cash provided (used) by financing activities 533,541 (4,846)
------------------- ---------------
Net increase in cash and cash equivalents 472,123 24,052
Net cash (used) provided by discontinued operations (14,484) 354
Cash and cash equivalents, beginning of period 120,574 210,307
=================== ===============
Cash and cash equivalents, end of period $ 578,213 234,713
=================== ===============
Supplemental disclosure of cash flows information of continuing operations:
Cash paid for interest $ 3,558 6,026
=================== ================
Cash paid for income taxes $ - 931
=================== ================
Supplemental schedule of non-cash investing and activities of continuing operations:
Acquisition of corporate headquarters assets through the issuance of long-term debt
and conversion of security deposit (note 5) $ - 33,077
=================== ================
Assets acquired under capital leases $ - 6,190
=================== ================
See accompanying notes to consolidated financial statements.
9
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and June 30, 1999 (unaudited)
(1) Organization and Basis of Presentation
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."
The Company's principal business activity is telecommunications
services, including Telecom Services, and until the completion of the
sales of such operations, 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.
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 NetAhead, Inc. ("NetAhead") (see note 3).
On July 15, 1999, the Company's board of directors adopted a formal
plan to dispose of the Company's investments in Network Services and
Satellite Services (see note 3) and, accordingly, the Company's
consolidated financial statements reflect the operations and net
assets of Network Services and Satellite Services as discontinued for
all periods presented.
(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.
10
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Significant Accounting Policies (continued)
Operating results for the six months ended June 30, 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.
(b) Net Loss Per Share
Basic and diluted net loss per share is calculated by dividing
net loss by the weighted average number of shares of common stock
outstanding. Weighted average number of shares outstanding
represents ICG Common Stock outstanding for the six months ended
June 30, 1999 and combined ICG Common Stock and Holdings-Canada
Class A common shares outstanding for the six months ended June
30, 1998. Potential common stock, which includes options,
warrants and convertible subordinated notes and preferred
securities, are not included in the net loss per share
calculation as their effect is anti-dilutive. The Company has
presented net loss per share from discontinued operations and
extraordinary gain on sales of operations of NETCOM in the
consolidated statement of operations for all periods presented.
(c) Reclassifications
Certain 1998 amounts have been reclassified to conform with the
1999 presentation.
(3) Discontinued Operations
Net loss from discontinued operations consists of the following:
Three months ended Six months ended
June 30, June 30,
------------------------------- -------------------------------
1998 1999 1998 1999
------------- ------------- -------------- -------------
(in thousands)
Network Services (a) $ (2,355) (703) (6,180) (1,115)
Satellite Services (b) (4,664) 11 (3,927) 312
Zycom (c) (801) - (3,199) -
NETCOM (d) (10,600) - (28,394) -
------------- ------------- -------------- -------------
Net loss from discontinued operations $ (18,420) (692) (41,700) (803)
============= ============= ============== =============
(a) Network Services
On July 15, 1999, the Company's board of directors adopted a
formal plan to dispose of the Company's investments in its
wholly-owned subsidiaries, ICG Fiber Optic Technologies, Inc. and
Fiber Optic Technologies of the Northwest, Inc. (collectively,
"Network Services"). The Company's plan of disposal consists of a
sale for cash proceeds of the business of Network Services. On
July 19, 1999, the Company signed a letter of intent to sell all
of the capital stock of Network Services to a third party for
cash proceeds of approximately $24.0 million. The Company
anticipates the sale of Network Services will be completed within
the next 12 months.
The Company's consolidated financial statements reflect the
operations of Network Services as discontinued for all periods
presented. Additionally, during the three months ended June 30,
11
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
1999, the Company accrued approximately $8.0 million for
estimated losses on disposal of Network Services, including
approximately $0.3 million for estimated operating losses of
Network Services during the phase out period. Included in net
current assets and net non-current assets of discontinued
operations in the Company's consolidated balance sheets are the
following accounts of Network Services:
December 31, June 30,
1998 1999
------------------- ------------------
(in thousands)
Cash and cash equivalents $ 846 1,519
Receivables, net 21,237 21,849
Inventory, prepaid expenses and deposits 1,888 2,812
Accounts payable, accrued liabilities and
other current liabilities (5,752) (16,106)
------------------- ------------------
Net current assets of Network Services $ 18,219 10,074
=================== ==================
Property and equipment, net $ 3,686 3,103
Goodwill, net 9,865 9,275
Other assets 93 79
Capital lease obligations, less current portion (413) (329)
------------------- ------------------
Net non-current assets of Network Services $ 13,231 12,128
=================== ==================
(b) Satellite Services
On July 15, 1999, the Company's board of directors adopted a
formal plan to dispose of the Company's investments in ICG
Satellite Services, Inc. and Maritime Telecommunications Network,
Inc. (collectively, "Satellite Services"). The Company's plan of
disposal consists of a sale for cash proceeds of the business of
Satellite Services. On August 11, 1999, the Company entered into
a definitive agreement to sell all of the capital stock of
Satellite Services to a third party for cash proceeds of
approximately $100.0 million. The company expects to record a
gain on the sale of Satellite Services, which gain will be
included in the Company's consolidated financial statements in
the period of disposal. The Company anticipates the sale of
Satellite Services will be completed within the next 12 months.
The Company's consolidated financial statements reflect the
operations of Satellite Services as discontinued for all periods
presented. Included in net current assets and net non-current
assets of discontinued operations in the Company's consolidated
balance sheets are the following accounts of Satellite Services:
12
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
December 31, June 30,
1998 1999
------------------- ------------------
(in thousands)
Receivables, net $ 10,342 5,266
Inventory, prepaid expenses and deposits 1,440 2,212
Accounts payable and accrued liabilities (6,664) (5,753)
------------------- ------------------
Net current assets of Satellite Services $ 5,118 1,725
=================== ==================
Property and equipment, net $ 22,390 24,416
Goodwill, net 10,125 9,300
Other assets, net 2,785 2,631
------------------- ------------------
Net non-current assets of Satellite Services $ 35,300 36,347
=================== ==================
(c) 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 six months ended June 30, 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 six
months ended June 30, 1999. The Company has accrued for all
expected future net losses of Zycom. Included in net current
13
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
liabilities and net non-current assets of discontinued operations
in the Company's consolidated balance sheets are the following
accounts of Zycom:
December 31, June 30,
1998 1999
------------------- --------------------
(in thousands)
Cash and cash equivalents $ 47 -
Receivables, net 90 -
Prepaid expenses and deposits 11 1
Accounts payable and accrued liabilities (1,092) (820)
------------------- --------------------
Net current liabilities of Zycom $ (944) (819)
=================== ====================
Net non-current assets of Zycom - property and
equipment, net $ 220 -
=================== ====================
(d) 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 NetAhead, 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.
14
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
During the six months ended June 30, 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.
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 are 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, are
recognized in the Company's consolidated statement of operations
as incurred. During the three months and six months ended June
30, 1999, the Company applied $3.8 million and $10.5 million,
respectively, of deferred proceeds from the sale of the operating
assets and liabilities of NETCOM to the network capacity
agreement with MindSpring, which entirely offset the costs of the
Company's operations under the agreement. 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.
(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 a gain of approximately $0.4 million
in its statement of operations for the six months ended June 30, 1999.
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.
15
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, June 30,
1998 1999
------------------- -----------------
(in thousands)
9 7/8% Senior discount notes of ICG Services, net of discount $ 266,918 280,096
10% Senior discount notes of ICG Services, net of discount 327,699 344,087
11 5/8% Senior discount notes of Holdings, net of discount 122,528 129,650
12 1/2% Senior discount notes of Holdings, net of discount 414,864 440,794
13 1/2% Senior discount notes of Holdings, net of discount 465,886 497,741
Mortgage loan payable with interest at 8 1/2%, due monthly
into 2009, secured by building 1,084 1,061
Mortgage loan payable with variable rate of interest (14.77% at
June 30, 1999) due in full on January 31, 2013, secured by
corporate headquarters (a) - 33,077
Other 65 65
------------------- -----------------
1,599,044 1,726,571
Less current portion (46) (46)
------------------- -----------------
$ 1,598,998 1,726,525
=================== =================
(a) Mortgage Loan Payable
Effective January 1, 1999, the Company purchased its corporate
headquarters building, land and improvements (collectively,
the "Corporate Headquarters") for approximately $43.4 million,
which amount represents historical cost and approximates fair
value. The Company, through a newly formed subsidiary,
financed the purchase primarily through a loan secured by a
mortgage on the Corporate Headquarters, guaranteed by ICG
Services, Inc. The amended loan agreement, dated May 1, 1999,
requires monthly interest payments at an initial interest rate
of 14.77% per annum which rate increases annually by 0.003%,
with the mortgage balance due January 31, 2013. 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.
(b) Senior Facility
On August 12, 1999, ICG Equipment and NetAhead entered into a
$200.0 million senior secured financing facility (the "Senior
Facility") consisting of a $75.0 million term loan, a $100.0
million term loan and a $25.0 million revolving line of
credit. The Senior Facility is guaranteed by ICG Services and
is secured by the assets of ICG Equipment and NetAhead.
As required under the terms of the loan, the Company borrowed
on August 12, 1999 the available $75.0 million on the $75.0
million term loan. The loan bears interest at an annual
interest rate of LIBOR plus 3.5% or the base rate, as defined
in the credit agreement, plus 2.5%, at the Company's option
(10.5% on August 12, 1999). Quarterly repayments commence
September 30, 1999 and require quarterly loan balance
reductions of 0.25% through June 30, 2005 with the remaining
outstanding balance to be repaid during the final three
quarters of the loan term. The $75.0 million term loan matures
on March 31, 2006.
16
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Long-term Debt and Redeemable Preferred Stock of Subsidiary (continued)
On August 12, 1999, the Company borrowed $5.0 million on the
$100.0 million term loan, which is available through August
10, 2000 at an initial annual interest rate of LIBOR plus 3.5%
or the base rate, as defined in the credit agreement, plus
2.125%, at the Company's option (10.125% on August 12, 1999).
Quarterly repayments commence September 30, 2002 and require
aggregate loan balance reductions of 25% through June 30,
2003, 35% through June 30, 2004 and 40% through June 30, 2005.
The $100.0 million term loan matures on June 30, 2005.
The $25.0 million revolving line of credit is available
through the maturity date of June 30, 2005 at an initial
annual interest rate of LIBOR plus 3.5% or the base rate, as
defined in the credit agreement, plus 2.125%, at the Company's
option.
The terms of the Senior Facility provide certain limitations
on the use of proceeds, additional indebtedness, dividends,
prepayment of the Senior Facility and other indebtedness and
certain other transactions. Additionally, the Company is
subject to certain financial covenants based on its results
and the results of ICG Services. The Company is required to
pay commitment fees ranging from 0.625% to 1.375% for the
unused portion of available borrowings under the Senior
Facility.
Redeemable preferred stock of subsidiary is summarized as follows:
December 31, June 30,
1998 1999
---------------------- -------------------
(in thousands)
14% Exchangeable preferred stock of Holdings,
mandatorily redeemable in 2008 $ 124,867 134,179
14 1/4% Exchangeable preferred stock of Holdings,
mandatorily redeemable in 2007 213,443 229,521
---------------------- -------------------
$ 338,310 363,700
====================== ===================
(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 $126.9 million at June 30, 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 $24.9 million as of June
17
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
30, 1999, with remaining costs anticipated to be approximately
$10.1 million. As part of this agreement, the Company also
committed to purchase $6.0 million in network capacity from Qwest
prior to the end of 1999. The Company's capacity purchase
commitment was cancelled by Qwest, without further obligation by
the Company, in conjunction with the Company's additional IRU
agreement with Qwest, signed on June 25, 1999.
On June 25, 1999, the Company signed an agreement to lease fiber
optic capacity to Qwest for a minimum 10-year term. The Company
will account for the capacity agreement as a sales-type lease.
Revenue will be recognized on a percentage-of-completion basis,
as the network build-out is completed and is available for use by
Qwest. The $32.0 million received by the Company on June 29, 1999
for Qwest's total payment on the capacity agreement is included
in deferred revenue in the Company's consolidated balance sheet
at June 30, 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 June 30,
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. 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.
18
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
(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 $117.1 million at June 30, 1999.
(d) Transport and Termination Charges
The Company has recorded revenue of approximately $4.9 million,
$58.3 million and $70.9 million for fiscal 1997, fiscal 1998 and
the six months ended June 30, 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. Some of 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 not subject to payment of transport and termination charges
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 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.
To date, four federal district court decisions, one federal
circuit court of appeals decision and one state court decision
have been issued upholding state commission decisions ordering
the payment of reciprocal compensation for ISP traffic. 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 currently 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 is
properly 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, 15 state utility commissions,
including four states in which the Company provides CLEC
services, have either ruled or reaffirmed that ISP traffic is
subject to reciprocal compensation under current interconnection
agreements, and two state commissions have declined to apply
reciprocal compensation for ISP traffic.
19
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
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. After the
PUCO issued the May 5, 1999 ruling, the Company received $43.1
million during the three months ended June 30, 1999 for amounts
owed by Ameritech for reciprocal compensation. Ameritech has
filed for judicial review of the PUCO decision. The Company
cannot predict the final outcome on the merits of the court
appeal. Additionally, on June 4, 1999, Southwestern Bell
Telephone Company ("SWBT") remitted payment to the Company of
$1.8 million for reciprocal compensation owed to the Company for
traffic from SWBT customers in Texas to ISPs served by the
Company. On June 21, 1999, the Alabama Public Service Commission
("PSC") issued a decision that BellSouth Corporation
("BellSouth") is required to pay the Company reciprocal
compensation for ISP traffic. The PSC's June 21, 1999 decision
modified its March 1999 decision that had found that reciprocal
compensation is owed for Internet traffic under certain CLEC
interconnection agreements at issue in the proceeding. The June
21, 1999 PSC decision held that the Company should be treated the
same as the other CLECs that participated in the proceeding and
for which the Alabama PSC previously ordered the payment of
reciprocal compensation. BellSouth has filed for judicial review
of both the March 4, 1999 and June 21, 1999 PSC decisions. On
July 26, 1999 the California Public Utilities Commission issued a
decision affirming a previous decision, issued October 1998, that
held that reciprocal compensation must be paid by Pacific Bell
and GTE California for the termination of ISP traffic by CLECs
under existing interconnection agreements. On July 28, 1999, the
Colorado Public Utilities Commission approved a decision that
orders US WEST Communications, Inc. ("US WEST") to pay the
Company reciprocal compensation for calls from US WEST customers
to ISPs served by the Company. The decision resolves in the
Company's favor a complaint that was filed by the Company in June
1998.
The Company has also recorded revenue of approximately $19.1
million and $7.6 million for fiscal 1998 and the six months ended
June 30, 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 June 30,
1999 are $72.8 million and $100.7 million, respectively, for all
receivables related to reciprocal compensation and other
transport and termination charges. The receivables balance at
June 30, 1999 is net of an allowance of $9.6 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. On May 27, 1999, the Company
filed petitions with the state commissions of Alabama, Georgia,
North Carolina, Kentucky, Tennessee and Florida for arbitration
with BellSouth. The arbitration proceedings are ongoing in each
of these states. Additionally, the Company's interconnection
agreement with Ameritech recently was extended from June 15, 1999
to February 15, 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 and arbitrations with BellSouth will also
affect the rates for transport and termination charges included
20
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Commitments and Contingencies (continued)
in its existing interconnection agreement with BellSouth. The
Company's remaining interconnection agreements expire in 1999 and
2000, and the Company has commenced renegotiations with the
ILECs. While the Company believes that all revenue recorded
through June 30, 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, 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.
(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 the Court of Appeals affirmed the trial
court's decision. Trial has been tentatively set for October
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 Segments
The Company conducts transactions with external customers through the
operations of its Telecom Services business unit. Shared administrative
services are provided to Telecom Services 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., ICG Services, Inc., ICG
Corporate Headquarters, L.L.C. and ICG 161, L.P., which primarily hold
securities and other nonoperating assets 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 Telecom Services are allocated to Telecom Services based on
the nature of the underlying costs. Transactions between Telecom
Services and Corporate Services for services performed in the normal
course of business are recorded at amounts which are intended to
approximate fair value.
21
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Business Segments (continued)
Set forth below are revenue, EBITDA (before nonrecurring and noncash
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 Telecom Services and Corporate
Services. As described in note 3, the operating results of the Company
reflect the operations of Network Services, Satellite Services, Zycom
and NETCOM as discontinued for all periods presented.
Three months ended June 30, Six months ended June 30,
------------------------------- ------------------------------
1998 1999 1998 1999
-------------- -------------- -------------- ---------------
(in thousands)
Revenue:
Telecom Services $ 64,215 117,654 122,702 221,985
Corporate Services - - - -
-------------- -------------- -------------- ---------------
Total revenue $ 64,215 117,654 122,702 221,985
============== ============== ============== =============
EBITDA (before nonrecurring and noncash charges) (a):
Telecom Services $ (11,085) 20,364 (29,220) 32,622
Corporate Services (5,842) (5,143) (10,260) (9,527)
-------------- -------------- -------------- ---------------
Total EBITDA (before nonrecurring and noncash
charges) $ (16,927) 15,221 (39,480) 23,095
============== ============== ============== =============
Depreciation and amortization (b):
Telecom Services $ 17,151 43,910 28,953 79,139
Corporate Services 1,438 773 2,642 1,919
-------------- -------------- -------------- ---------------
Total depreciation and amortization $ 18,589 44,683 31,595 81,058
============== ============== ============== =============
Interest expense (b):
Telecom Services $ 908 - 908 -
Corporate Services 40,574 51,308 74,996 98,746
-------------- -------------- -------------- ---------------
Total interest expense $ 41,482 51,308 75,904 98,746
============== ============== ============== ==============
Capital expenditures of continuing operations (c):
Telecom Services $ 81,652 133,012 144,771 235,924
Corporate Services 2,973 13 5,273 13
-------------- -------------- -------------- ---------------
Total capital expenditures of continuing operations $ 84,625 133,025 150,044 235,937
============== ============== ============== ==============
22
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Business Segments (continued)
December 31, June 30,
1998 1999
--------------------- --------------------
(in thousands)
Total assets:
Telecom Services (d) $ 1,135,937 1,379,567
Corporate Services (d) 371,157 389,242
Eliminations (20,287) (31,247)
Net assets of discontinued operations 102,840 59,455
--------------------- --------------------
Total assets $ 1,589,647 1,797,017
===================== ====================
(a) EBITDA (before nonrecurring and noncash charges) consists of loss
from continuing operations before interest, income taxes,
depreciation and amortization, provision for impairment of
long-lived assets and other, net operating costs and expenses,
including deferred compensation and 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 and noncash
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 and
noncash 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 and noncash 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 and noncash
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 Telecom Services and Corporate Services.
Interest expense excludes amounts charged for interest on
outstanding cash advances and expense allocations between Telecom
Services 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 and Corporate Services excludes
investments in consolidated subsidiaries which eliminate in
consolidation.
(8) Provision for Impairment of Long-Lived Assets
During the three months ended June 30, 1999, the Company recorded a
provision for impairment of long-lived assets of $29.3 million, which
relates to the impairment of software and other capitalized costs
associated with Telecom Services' in-process billing and provisioning
system development projects. The provision for impairment of long-lived
assets was based on management's decision to select new vendors for
each of these systems, which vendors are expected to provide the
Company with billing and provisioning solutions with improved
functionality and earlier delivery dates at significantly lower costs.
The Company's in-process billing and provisioning systems were either
not operational or were serving minimal customers at the time
management determined the carrying value of the underlying assets was
not recoverable.
23
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(9) 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, June 30,
1998 1999
-------------------- ---------------------
(in thousands)
Current assets $ 241,667 329,277
Net current assets of discontinued operations 22,392 10,980
Property and equipment, net 610,671 507,909
Other non-current assets, net 147,283 134,442
Net non-current assets of discontinued operations 48,751 48,475
Current liabilities 69,204 108,880
Capital lease obligations, less current portion 62,946 56,766
Long-term debt, less current portion 1,004,316 1,069,200
Due to parent 191,889 257,743
Due to ICG Services 137,762 113,420
Redeemable preferred stock 338,311 363,700
Stockholder's deficit (733,664) (938,626)
Summarized Consolidated Statement of Operations Information
Three months ended June 30, Six months ended June 30,
------------------------------ ------------------------------
1998 1999 1998 1999
-------------- --------------- -------------- --------------
(in thousands)
Total revenue $ 64,989 119,026 123,830 224,759
Total operating costs and expenses 99,458 181,509 192,530 319,614
Operating loss (34,469) (62,483) (68,700) (94,855)
Loss from continuing operations (60,574) (101,381) (124,798) (168,751)
Net loss (80,735) (122,712) (160,238) (204,962)
24
ICG COMMUNICATIONS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(10) Condensed Financial Information of ICG Holdings (Canada) Co.
Condensed financial information for Holdings-Canada only is as follows:
Condensed Balance Sheet Information
December 31, June 30,
1998 1999
------------------- ------------------
(in thousands)
Current assets $ 162 162
Advances to subsidiaries 191,889 257,743
Non-current assets, net 2,414 1,207
Current liabilities 73 73
Long-term debt, less current portion 65 65
Due to parent 182,101 247,954
Share of losses of subsidiaries 733,664 938,626
Shareholders' deficit (721,438) (927,606)
Condensed Statement of Operations Information
Three months ended June 30, Six months ended June 30,
------------------------------ ------------------------------
1998 1999 1998 1999
-------------- -------------- -------------- --------------
(in thousands)
Total revenue - - - -
Total operating costs and expenses 48 603 81 1,206
Operating loss (48) (603) (81) (1,206)
Losses of subsidiaries (80,735) (122,712) (160,238) (204,962)
Net loss attributable to common shareholders (80,783) (123,315) (160,319) (206,168)
(11) 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 and $1.0
million for the three months and six months ended June 30, 1998,
respectively, and $0.4 million and $0.9 million for the three months
and six months ended June 30, 1999, respectively. ICG has no operations
other than those of ICG Services, ICG Funding and Holdings-Canada and
their subsidiaries.
25
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 and six months ended June 30, 1998 and 1999 represent the
consolidated operating results of the Company. See the unaudited condensed
consolidated financial statements of the Company for the six months ended June
30, 1999 included elsewhere herein. The Company's consolidated financial
statements reflect the operations of Network Services, Satellite Services, Zycom
and NETCOM as discontinued for all periods presented. The Company changed its
fiscal year end to December 31 from September 30, effective January 1, 1997. 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. Until the completion of the sales of such operations, 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 $72.7 million for fiscal 1996 to approximately
$402.6 million for the 12-month period ended June 30, 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 six months ended June 30, 1999, the
Company sold 178,470, 206,458 and 132,122 local access lines, respectively, net
of cancellations of which 494,405 were in service at June 30, 1999. In addition,
the Company's regional fiber networks have grown from 2,143 fiber route miles at
the end of fiscal 1996 to 4,406 fiber route miles at June 30, 1999. The Company
had 29 operating high capacity digital circuit switches and 16 operational data
communications switches at June 30, 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 certain other
ISPs, and intends to offer similar services to more ISPs and telecommunications
providers in the future.
26
To better focus its efforts on its core Telecom Services operations, the
Company made further progress toward the disposal of certain assets which
management believes do not complement its overall business strategy. On July 15,
1999, the Company's board of directors adopted a formal plan to dispose of the
operations of the Company's wholly-owned subsidiaries, ICG Fiber Optic
Technologies, Inc. and Fiber Optic Technologies of the Northwest, Inc.
(collectively, "Network Services") and ICG Satellite Services, Inc. and Maritime
Telecommunications Network, Inc. (collectively, "Satellite Services"), through
the sales of such businesses for cash proceeds. The Company has signed a letter
of intent to a third party to sell all of the capital stock of Network Services.
On August 11, 1999, the Company entered into a definitive agreement to sell all
of the capital stock of Satellite Services to a third party for cash proceeds of
approximately $100.0 million. The Company anticipates the sales of Network
Services and Satellite Services will be completed during the next 12 months. Due
primarily to the loss of a major customer, which generated a significant
obligation under a volume discount agreement with its call transport provider,
the board of directors of Zycom Corporation ("Zycom") 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 six months ended June 30,
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, Network Services, Satellite Services, Zycom and
NETCOM combined reported revenue of $216.8 million, $284.7 million and $275.9
million, respectively, and EBITDA losses (before nonrecurring and noncash
charges) of $(36.0) million, $(13.4) million and $(16.7) million, respectively.
The Company's consolidated financial statements reflect the operations of
Network Services, Satellite Services, 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 NetAhead, Inc. ("NetAhead"). NetAhead has retained
the domestic Internet backbone assets formerly owned by NETCOM which include 236
POPs serving approximately 700 cities nationwide. NetAhead is utilizing the
retained network operating assets to provide wholesale Internet access and
enhanced network services to MindSpring and other ISPs 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, are 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
27
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 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, which cities account for 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 and noncash charges) of $(5.5) million and $(13.6) million,
respectively. Additionally, on the acquisition date, ChoiceCom had five
operating high capacity digital circuit switches and two operational 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 August 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 five-year period for a
minimum of $160.0 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 100,000 PRI lines in
conjunction with the agreement. In June 1999, the Company entered into a
five-year agreement with Qwest Communications Corporation ("Qwest"), whereby
Qwest has agreed to purchase 100,000 RAS circuits from the Company. The Company
expects to install a minimum of 80,000 of Qwest's RAS circuits by September 30,
1999, with the remaining 20,000 RAS circuits to be installed prior to June 29,
2000. The Company also entered into two long-term fiber optic capacity
agreements with Qwest in June 1999. Under the first agreement, the Company will
lease more than 7,600 miles of fiber optic capacity from Qwest for a term of
between 8 and 20 years, as determined by the Company. The Company believes that
the additional capacity will increase the speed and national presence of the
Company's fiber optic network. Under the second agreement, Qwest will lease
certain fiber optic capacity from the Company, for a 10-year minimum term for
28
total proceeds of $32.0 million. 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 and noncash 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 and noncash charges) have improved for each consecutive quarter,
through and including the quarter ended June 30, 1999 for which the Company
reported positive EBITDA (before nonrecurring and noncash charges) of $15.2
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.
Results of Operations
The following table provides a breakdown of revenue, operating costs and
selling, general and administrative expenses for Telecom 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 and noncash charges) as a percentage of the Company's total
revenue.
Three months ended June 30, Six months ended June 30,
------------------------------------------------ ----------------------------------------------
1998 1999 1998 1999
----------------------- ------------------------ ----------------------- ----------------------
$ % $ % $ % $ %
------------- --------- ------------- ---------- ------------- --------- ------------- --------
(unaudited)
(in thousands)
Statement of Operations Data:
Revenue 64,215 100 117,654 100 122,702 100 221,985 100
Operating costs 43,310 67 59,458 51 88,968 72 113,107 51
Selling, general and administrative:
Telecom services 31,990 37,832 62,954 76,256
Corporate services (1) 5,842 5,143 10,260 9,527
------------- --------- ------------- ---------- ------------- ---------- ------------- -------
Total selling, general and
administrative 37,832 59 42,975 36 73,214 60 85,783 39
Depreciation and amortization 18,589 29 44,683 38 31,595 26 81,058 36
Provision for impairment of
long-lived assets - - 29,300 25 - - 29,300 13
Other, net (7) - 398 - 498 - (535) -
------------- --------- ------------- ---------- ------------- ----------- ------------ -------
Operating loss (35,509) (55) (59,160) (50) (71,573) (58) (86,728) (39)
Other Data:
Net cash (used) provided by
operating activities (25,568) 25,910 (30,853) (21,996)
Net cash used by investing
activities (67,411) (82,206) (30,565) 50,894
Net cash provided (used) by
financing activities 238,725 (4,390) 533,541 (4,846)
EBITDA (2) (16,920) (26) (14,477) (12) (39,978) (33) (5,670) (3)
EBITDA (before nonrecurring and
noncash charges) (2) (16,927) (26) 15,221 13 (39,480) (32) 23,095 10
Capital expenditures of continuing
operations (3) 84,625 133,025 150,044 235,937
Capital expenditures of discontinued
operations (3) 11,237 3,354 18,077 6,159
29
June 30, September 30, December 31, March 31, June 30,
1998 1998 1998 1999 1999
--------------- --------------- ---------------- -------------- --------------
(unaudited)
Statistical Data (4):
Full time employees 3,089 3,251 3,415 2,665 2,753
Telecom services:
Access lines in service (5) 237,458 290,983 354,482 418,610 494,405
Buildings connected:
On-net 665 684 777 789 874
Hybrid (6) 3,733 4,217 4,620 5,337 5,915
--------------- -------------- ------------- ------------- --------------
Total buildings connected 4,398 4,901 5,397 6,126 6,789
Operational switches:
Circuit 20 21 29 29 29
Data 15 15 16 17 16
--------------- -------------- ------------- ------------- --------------
Total operational switches 35 36 45 46 45
Fiber route miles (7):
Operational 3,812 3,995 4,255 4,351 4,406
Under construction - - - - 526
Fiber strand miles (8):
Operational 124,642 127,756 134,152 155,788 164,416
Under construction - - - - 17,363
Collocations with ILECs 45 47 59 111 126
Satellite services:
C-Band installations (9) 66 69 76 78 81
(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., ICG
Corporate Headquarters, L.L.C. and ICG 161, L.P., which primarily hold
securities and other nonoperating assets and provide certain legal,
accounting and finance, personnel and other administrative support
services to the business units.
(2) EBITDA consists of 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 and noncash charges)
represents EBITDA before certain nonrecurring and noncash charges such
as the provision for impairment of long-lived assets and other, net
operating costs and expenses, including deferred compensation and net
loss (gain) on disposal of long-lived assets. EBITDA and EBITDA (before
nonrecurring and noncash charges) are provided because they are measures
commonly used in the telecommunications industry. EBITDA and EBITDA
(before nonrecurring and noncash 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 and noncash 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 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 Network Services,
Satellite Services, 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 June 30, 1999 includes 413,715 lines which
are provisioned through the Company's switch and 80,690 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.
30
(6) Hybrid buildings connected represent buildings connected to the
Company's network via another carrier's facilities.
(7) Fiber route miles refers to the number of miles of fiber optic cable,
including leased fiber. As of June 30, 1999, the Company had 4,406 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 June 30, 1999, the Company had
164,416 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) The Company's C-Band installations are provided by Satellite Services.
C-Band installations service cruise ships, U.S. Navy vessels and
offshore oil platform installations. The Company's consolidated
financial statements reflect the operations of Satellite Services as
discontinued for all periods presented.
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
Revenue. Revenue, which consists solely of revenue from Telecom Services,
increased $53.5 million, or 83%, from $64.2 million for the three months ended
June 30, 1998 to $117.7 million for the three months ended June 30, 1999. Local
services revenue increased from $29.5 million, or 46% of revenue, for the three
months ended June 30, 1998 to $76.8 million, or 65% of revenue, for the three
months ended June 30, 1999, primarily due to an increase in local access lines
from 237,458 lines in service at June 30, 1998 to 494,405 lines in service at
June 30, 1999. In addition, local access revenue includes revenue of
approximately $6.6 million and $40.1 million for the three months ended June 30,
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." Special access
revenue increased from $17.5 million, or 27% of revenue, for the three months
ended June 30, 1998 to $23.4 million, or 20% of revenue, for the three months
ended June 30, 1999. Switched access (terminating long distance) revenue
increased to $12.4 million for the three months ended June 30, 1999, compared to
$11.4 million for the three months ended June 30, 1998. The Company has raised
prices on its wholesale switched services product in order to improve margins.
Revenue from long distance services decreased from $5.8 million for the three
months ended June 30, 1998 to $5.1 million for the three months ended June 30,
1999. The decrease in long distance revenue is primarily attributable to the
Company's planned attrition of resale access lines which had high long distance
service penetration rates. Revenue from data services did not generate a
material portion of total revenue during either period.
Operating costs. Operating costs, which consists solely of operating costs
from Telecom Services, increased $16.1 million, or 37%, from $43.3 million for
the three months ended June 30, 1998 to $59.5 million for the three months ended
June 30, 1999. Additionally, operating costs decreased as a percentage of
revenue from 67% for the three months ended June 30, 1998 to 51% for the three
months ended June 30, 1999. 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 revenue is due primarily to a greater volume of higher margin
services, principally local exchange services. The Company expects the 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.
Selling, general and administrative expenses. Total selling, general and
administrative ("SG&A") expenses increased $5.1 million, or 14%, from $37.8
31
million for the three months ended June 30, 1998 to $43.0 million for the three
months ended June 30, 1999. Total SG&A expenses decreased as a percentage of
revenue from 59% for the three months ended June 30, 1998 to 36% for the three
months ended June 30, 1999. Telecom Services SG&A expenses increased from $32.0
million, or 50% of revenue, for the three months ended June 30, 1998 to $37.8
million, or 32% of revenue, for the three months ended June 30, 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 declining SG&A expenses as a
percentage of revenue. From time to time, the Company will experience increases
in SG&A expenses as the Company prepares for offerings of newly developed
services. Corporate Services SG&A expenses decreased $0.7 million, from $5.8
million for the three months ended June 30, 1998 to $5.1 million for the three
months ended June 30, 1999, primarily due to the Company's purchase of the
corporate headquarters, effective January 1, 1999, which was leased under an
operating lease during 1998.
Depreciation and amortization. Depreciation and amortization increased
$26.1 million, or 140%, for the three months ended June 30, 1999, compared to
the three months ended June 30, 1998, primarily due to increased investment in
depreciable assets resulting from the continued expansion of the Company's
networks and services, in addition to 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.
Provision for impairment of long-lived assets. For the three months ended
June 30, 1999, provision for impairment of long-lived assets of $29.3 million
relates to the impairment of software and other capitalized costs associated
with Telecom Services' in-process billing and provisioning system development
projects. The provision for impairment of long-lived assets was based on
management's decision to select new vendors for these systems, which vendors are
expected to provide the Company with billing and provisioning solutions with
improved functionality and earlier delivery dates at significantly lower costs.
The Company's in-process billing and provisioning systems were either not
operational or were serving minimal customers at the time management determined
the carrying value of the underlying assets was not recoverable.
Other, net. Other, net operating costs and expenses increased $0.4 million
for the three months ended June 30, 1999, compared to the three months ended
June 30, 1998. For the three months ended June 30, 1999, other, net operating
costs and expenses primarily includes deferred compensation expense of $0.4
million related to the Company's deferred compensation arrangement with its
chief executive officer. Other amounts included in other, net operating costs
and expenses for the three months ended June 30, 1998 and 1999 include net gains
and losses on disposal of miscellaneous long-lived assets.
Interest expense. Interest expense increased $9.8 million, from $41.5
million for the three months ended June 30, 1998, to $51.3 million for the three
months ended June 30, 1999, which includes $47.1 million of noncash interest.
The Company's interest expense increases, 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, beginning in 2001. Additionally,
interest expense increased due to the increase in long-term debt associated with
the Company's purchase of the corporate headquarters, effective January 1, 1999.
Interest income. Interest income decreased $4.7 million, from $8.5 million
for the three months ended June 30, 1998 to $3.8 million for the three months
ended June 30, 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 June 30, 1998 to $1.8 million for the three months ended June
30, 1999. Other expense, net recorded during both the three months ended June
30, 1998 and 1999 primarily consists of litigation settlement costs.
32
Accretion and preferred dividends on preferred securities of subsidiaries.
Accretion and preferred dividends on preferred securities of subsidiaries
increased $1.6 million, from $13.6 million for the three months ended June 30,
1998 to $15.2 million for the three months ended June 30, 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 June 30, 1999 consists of
the accretion of issuance costs ($0.3 million) and the accrual of the preferred
securities dividends ($14.9 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
$41.4 million, or 50%, from $82.4 million for the three months ended June 30,
1998 to $123.8 million for the three months ended June 30, 1999 due to the
increases in operating costs, SG&A expenses, depreciation and amortization and
provision for impairment of long-lived assets, offset by an increase in revenue,
as noted above.
Net loss from discontinued operations. Net loss from discontinued
operations decreased $9.7 million or 53%, from $18.4 million for the three
months ended June 30, 1998 to $8.7 million for the three months ended June 30,
1999. Net loss from discontinued operations for the three months ended June 30,
1998 consists of the combined net losses of Network Services, Satellite
Services, Zycom and NETCOM. Net loss from discontinued operations for the three
months ended June 30, 1999 consists of the combined net losses of Network
Services and Satellite Services. Zycom terminated its normal operations on
October 22, 1998 and, accordingly, the Company reported no loss from
discontinued operations of Zycom for the three months ended June 30, 1999. The
Company sold the operations of NETCOM in February and March 1999. Net loss from
discontinued operations for the three months ended June 30, 1999 includes an
estimated loss on the disposal of Network Services of $8.0 million.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Revenue. Revenue, which consists solely of revenue from Telecom Services,
increased $99.3 million, or 81%, from $122.7 million for the six months ended
June 30, 1998 to $222.0 million for the six months ended June 30, 1999. Local
services revenue increased from $52.6 million, or 43% of revenue, for the six
months ended June 30, 1998 to $144.2 million, or 65% of revenue, for the six
months ended June 30, 1999. In addition, local access revenue includes revenue
of approximately $15.1 million and $70.9 million for the six months ended June
30, 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. Special access revenue increased
from $33.7 million, or 27% of revenue, for the six months ended June 30, 1998 to
$46.0 million, or 21% of revenue, for the six months ended June 30, 1999.
Switched access (terminating long distance) revenue decreased to $21.6 million
for the six months ended June 30, 1999, compared to $25.6 million for the six
months ended June 30, 1998. The Company has raised prices on its wholesale
switched services product in order to improve margins and to de-emphasize its
wholesale switched services. Revenue from long distance decreased to $10.2
million for the six months ended June 30, 1999, compared to $10.9 million for
the six months ended June 30, 1998. The decrease in long distance revenue is
primarily attributable to the Company's planned attrition of resale access lines
which had high long distance service penetration rates. Revenue from data
services did not generate a material portion of total revenue during either
period.
Operating costs. Operating costs, which consists solely of operating costs
from Telecom Services, increased $24.1 million, or 27%, from $89.0 million for
the six months ended June 30, 1998 to $113.1 million for the six months ended
June 30, 1999. Additionally, operating costs decreased as a percentage of
revenue from 73% for the six months ended June 30, 1998 to 51% for the six
months ended June 30, 1999. 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 revenue is due
primarily to a greater volume of higher margin services, principally local
exchange services.
33
Selling, general and administrative expenses. Total SG&A expenses increased
$12.6 million, or 17%, from $73.2 million for the six months ended June 30, 1998
to $85.8 million for the six months ended June 30, 1999. Total SG&A expenses
decreased as a percentage of revenue from 60% for the six months ended June 30,
1998 to 39% for the six months ended June 30, 1999. Telecom Services SG&A
expenses increased from $63.0 million, or 51% of revenue, for the six months
ended June 30, 1998 to $76.3 million, or 34% of revenue, for the six months
ended June 30, 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 declining SG&A
expenses as a percentage of revenue. Corporate Services SG&A expenses decreased
$0.7 million, from $10.3 million for the six months ended June 30, 1998 to $9.5
million for the six months ended June 30, 1999, primarily due to the Company's
purchase of the corporate headquarters, effective January 1, 1999, which was
leased under an operating lease during 1998.
Depreciation and amortization. Depreciation and amortization increased
$49.5 million, or 157%, for the six months ended June 30, 1999, compared to the
six months ended June 30, 1998, primarily due to increased investment in
depreciable assets resulting from the continued expansion of the Company's
networks and services, in addition to increased amortization arising from
goodwill recorded in conjunction with three purchase business combinations
completed during the second half of fiscal 1998.
Provision for impairment of long-lived assets. For the six months ended
June 30, 1999, provision for impairment of long-lived assets of $29.3 million
relates to the impairment of software and other capitalized costs associated
with Telecom Services' in-process billing and provisioning system development
projects. The provision for impairment of long-lived assets was based on
management's decision to select new vendors for these systems, which vendors are
expected to provide the Company with billing and provisioning solutions with
improved functionality and earlier delivery dates at significantly lower costs.
The Company's in-process billing and provisioning systems were either not
operational or were serving minimal customers at the time management determined
the carrying value of the underlying assets was not recoverable.
Other, net. Other, net operating costs and expenses fluctuated from $0.5
million net expense to $0.5 million net income. Other, net operating costs and
expenses for the six months ended June 30, 1999 includes deferred compensation
expenses of $0.4 million, offset primarily by a net gain on disposal of
long-lived assets of $0.9 million relating primarily to the sale of certain of
the Company's Federal Communications Commission ("FCC") licenses. Other, net
operating costs and expenses for the six months ended June 30, 1998 consists
primarily of a net loss on disposal of long-lived assets related to the
write-off of certain installation costs of disconnected special access
customers.
Interest expense. Interest expense increased $22.8 million, from $75.9
million for the six months ended June 30, 1998, to $98.7 million for the six
months ended June 30, 1999, which includes $92.7 million of noncash interest.
The Company's interest expense increases, 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, beginning in 2001. Additionally,
interest expense increased due to the increase in long-term debt associated with
the Company's purchase of the corporate headquarters, effective January 1, 1998.
Interest income. Interest income decreased $6.1 million, from $14.0 million
for the six months ended June 30, 1998 to $7.9 million for the six months ended
June 30, 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 $0.6 million for the
six months ended June 30, 1998 to $2.3 million for the six months ended June 30,
1999 and primarily consists of litigation settlement costs. For the six months
ended June 30, 1999, other expense, net is offset by the gain on the common
stock of MindSpring which the Company received as partial consideration for the
sale of the domestic operations of NETCOM. The Company sold its investment in
MindSpring in April 1999.
34
Accretion and preferred dividends on preferred securities of subsidiaries.
Accretion and preferred dividends on preferred securities of subsidiaries
increased $3.2 million, from $26.8 million for the six months ended June 30,
1998 to $30.0 million for the six months ended June 30, 1999. The increase is
due primarily to the periodic payment of dividends on the 14% Preferred Stock
and 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 six months ended June 30, 1999
consists of the accretion of issuance costs ($0.6 million) and the accrual of
the preferred securities dividends ($29.4 million) associated with the 6 3/4%
Preferred Securities, the 14% Preferred Stock and the 14 1/4% Preferred Stock.
Loss from continuing operations. Loss from continuing operations increased
$49.1 million, or 31%, from $160.9 million for the six months ended June 30,
1998 to $210.0 million for the six months ended June 30, 1999 due to the
increases in operating costs, SG&A expenses, depreciation and amortization,
provision for impairment of long-lived assets and interest expense, offset by an
increase in revenue, as noted above.
Net loss from discontinued operations. Net loss from discontinued
operations decreased $32.9 million or 79%, from $41.7 million for the six months
ended June 30, 1998 to $8.8 million for the six months ended June 30, 1999. Net
loss from discontinued operations for the six months ended June 30, 1998
consists of the combined net losses of Network Services, Satellite Services,
Zycom and NETCOM. Net loss from discontinued operations for the six months ended
June 30, 1999 consists of the combined net losses of Network Services and
Satellite Services. Zycom terminated its normal operations on October 22, 1998
and, accordingly, the Company reported no loss from discontinued operations of
Zycom for the six months ended June 30, 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 six months ended June 30,
1999. Net loss from discontinued operations for the six months ended June 30,
1999 includes an estimated loss on the disposal of Network Services of $8.0
million.
Extraordinary gain on sales of operations of NETCOM. The Company reported
an extraordinary gain on the sales of the operations of NETCOM during the six
months ended June 30, 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 are 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 June 30, 1999, the Company had current assets of
$449.5 million, including $265.4 million of cash, cash equivalents and
short-term investments available for sale, which exceeded current liabilities of
$160.3 million, providing working capital of $289.2 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 $30.9 million and $22.0 million for
the six months ended June 30, 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 noncash 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
35
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 (Used) Provided By Investing Activities
Investing activities used $30.6 million and provided $50.9 million in the
six months ended June 30, 1998 and 1999, respectively. Net cash used by
investing activities for the six months ended June 30, 1998 primarily includes
cash expended for the acquisition of property, equipment and other assets of
$150.0 million, offset by the proceeds from the sale of corporate headquarters
of $29.1 million and proceeds from the sale of short-term investments available
for sale of $96.3 million. Net cash provided by investing activities for the six
months ended June 30, 1999 includes proceeds from the sales of the operations of
NETCOM of $252.9 million and proceeds from the sales of short-term investments
available for sale and marketable securities of $51.8 million, offset by cash
expended for the acquisition of property, equipment and other assets of $229.7
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 $6.2 million during the six months ended June 30, 1999.
Net Cash Provided (Used) By Financing Activities
Financing activities provided $533.5 million and used $4.8 million in the
six months ended June 30, 1998 and 1999, respectively. Net cash provided by
financing activities for the six months ended June 30, 1998 includes the net
proceeds from the private placement of the 10% Notes and 9 7/8% Notes in
February and April 1998, respectively. Historically, the funds to finance the
Company's business acquisitions, capital expenditures, working capital
requirements and operating losses have been obtained through public and private
offerings of ICG and ICG Holdings (Canada) 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 six months ended June 30, 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.
On August 12, 1999, ICG Equipment and NetAhead entered into a $200.0
million senior secured financing facility (the "Senior Facility") consisting of
a $75.0 million term loan, a $100.0 million term loan and a $25.0 million
revolving line of credit. As required under the terms of the loan, the Company
borrowed on August 12, 1999 the available $75.0 million on the $75.0 million
term loan. The loan bears interest at an annual interest rate of LIBOR plus 3.5%
or the base rate, as defined in the credit agreement, plus 2.5%, at the
Company's option (10.5% on August 12, 1999). Quarterly repayments commence
September 30, 1999 and require quarterly loan balance reductions of 0.25%
through June 30, 2005 with the remaining outstanding balance to be repaid during
the final three quarters of the loan term. The $75.0 million term loan matures
on March 31, 2006. On August 12, 1999, the Company borrowed $5.0 million on the
$100.0 million term loan, which is available for borrowing through August 10,
2000 at an initial annual interest rate of LIBOR plus 3.125% or the base rate,
as defined in the credit agreement, plus 2.125%, at the Company's option
(10.125% on August 12, 1999). Quarterly repayments commence September 30, 2002
and require aggregate loan balance reductions of 25% through June 30, 2003, 35%
through June 30, 2004 and 40% through June 30, 2005. The $100.0 million term
loan matures on June 30, 2005. The $25.0 million revolving line of credit is
available through the maturity date of June 30, 2005 at an initial annual
interest rate of LIBOR plus 3.125% or the base rate, as defined in the credit
agreement, plus 2.125%, at the Company's option.
As of June 30, 1999, the Company had an aggregate of approximately $71.8
million of capital lease obligations and an aggregate accreted value of
approximately $1.7 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
36
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 June 30, 1999,
the Company had $34.6 million of other indebtedness outstanding. With respect to
senior indebtedness outstanding on June 30, 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 $4.5 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 $150.0 million and $235.9 million for
the six months ended June 30, 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 $284.0 million during the
remainder of 1999. 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.
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 six months ended June 30,
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.
37
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 $70.9 million for fiscal 1997, fiscal 1998 and the six months ended
June 30, 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. Some of 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 not subject to payment of
transport and termination charges 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. To
date, four federal district court decisions, one federal circuit court of
appeals decision and one state court decision have been issued upholding state
commission decisions ordering the payment of reciprocal compensation for ISP
traffic. 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 currently 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 is properly 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, 15 state utility commissions, including four states in which the Company
provides CLEC services, have either ruled or reaffirmed that ISP traffic is
subject to reciprocal compensation under current interconnection agreements, and
two state commissions have declined to apply reciprocal compensation for ISP
traffic.
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. After the
PUCO issued the May 5, 1999 ruling, the Company received $43.1 million during
the three months ended June 30, 1999 for amounts owed by Ameritech for
reciprocal compensation. Ameritech has filed for judicial review of the PUCO
decision. The Company cannot predict the final outcome on the merits of the
court appeal. Additionally, on June 4, 1999, Southwestern Bell Telephone Company
("SWBT") remitted payment to the Company of $1.8 million for reciprocal
compensation owed to the Company for traffic from SWBT customers in Texas to
ISPs served by the Company. On June 21, 1999, the Alabama Public Service
Commission ("PSC") issued a decision that BellSouth Corporation ("BellSouth") is
required to pay the Company reciprocal compensation for ISP traffic. The PSC's
June 21, 1999 decision modified its March 1999 decision that had found that
reciprocal compensation is owed for Internet traffic under certain CLEC
interconnection agreements at issue in the proceeding. The June 21, 1999 PSC
decision held that the Company should be treated the same as the other CLECs
that participated in the proceeding and for which the Alabama PSC previously
ordered the payment of reciprocal compensation. BellSouth has filed for judicial
review of both the March 4, 1999 and June 21, 1999 PSC decisions. On July 26,
1999 the California Public Utilities Commission issued a decision affirming a
previous decision, issued October 1998, that held that reciprocal compensation
38
must be paid by Pacific Bell and GTE California for the termination of ISP
traffic by CLECs under existing interconnection agreements. On July 28, 1999,
the Colorado Public Utilities Commission approved a decision that orders US WEST
Communications, Inc. ("US WEST") to pay the Company reciprocal compensation for
calls from US WEST customers to ISPs served by the Company. The decision
resolves in the Company's favor a complaint that was filed by the Company in
June 1998.
The Company has also recorded revenue of approximately $19.1 million and
$7.6 million for fiscal 1998 and the six months ended June 30, 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 June 30, 1999 are
$72.8 million and $100.7 million, respectively, for all receivables related to
reciprocal compensation and other transport and termination charges. The
receivables balance at June 30, 1999 is net of an allowance of $9.6 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. On
May 27, 1999, the Company filed petitions with the state commissions of Alabama,
Georgia, North Carolina, Kentucky, Tennessee and Florida for arbitration with
BellSouth. The arbitration proceedings are ongoing in each of these states.
Additionally, the Company's interconnection agreement with Ameritech recently
was extended from June 15, 1999 to February 15, 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
and arbitrations with BellSouth will also affect the rates for transport and
termination charges included in its existing interconnection agreement with
BellSouth. The Company's remaining interconnection agreements expire in 1999 and
2000, and the Company has commenced renegotiations with the ILECs. While the
Company believes that all revenue recorded through June 30, 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, 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.
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
39
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
circuit 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 is applying 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 performed an
inventory of all components currently in use by the Company. Based
upon this inventory, the Company's business executives and technology
staff jointly classified each component as a "high," "medium" or "low"
priority item, determined primarily by the relative importance that
the particular component has to the Company's normal business
operations, the number of people internally and externally which would
be affected by any failure of such component and the interdependence
of such component with other components used by the Company that may
be of higher or lower priority.
Based upon such classifications, the Company's business executives and
information technology staff 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
40
- 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.
The Company has completed all areas of Phase I.
o Phase II - Remediation
During this phase, the Company is developing and executing 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 is performing testing sufficient to
confirm that the component meets the desired state of Year 2000
readiness. This phase consists 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 is implementing each act of
remediation developed and tested for each component, as well as
implementing 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 either already completed or has commenced all of the phases
within its Year 2000 compliance strategy for each of its functional system
categories, as shown by the table set forth below. Since the Company has not
waited until the completion of a phase for all functional category components
together before commencing the next phase, the information set forth below
represents only a general description of the phase status for each functional
category. For systems and products which the Company intends to abandon or
replace prior to January 1, 2000, the Company has currently terminated all Year
2000 compliance efforts.
41
- - ------------------------------- ----------------------------------------------------------------------------------------------
Phase
- - ------------------------------- ----------------------------------------------------------------------------------------------
I II III IV
System and Level of Priority Assessment Remediation Testing Implementation
- - ------------------------------- ----------------------------------------------------------------------------------------------
Networks and Products
- - ------------------------------- ----------------------------------------------------------------------------------------------
High Complete Complete In progress In progress
To complete Q3 1999 To complete Q3 1999
- - ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete Complete In progress In progress
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 Q3 1999 To complete Q3 1999 To complete Q3 1999
- - ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress In progress In progress
To complete Q3 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 Complete Complete In progress In progress
To complete Q3 1999 To complete Q3 1999
- - ------------------------------- ---------------------- -----------------------------------------------------------------------
Medium Complete Based on the results of Phase I, further remediation not considered
necessary
- - ------------------------------- ---------------------- -----------------------------------------------------------------------
Low Complete Based on the results of Phase I, further remediation not considered
necessary
- - ------------------------------- ----------------------------------------------------------------------------------------------
Office Equipment
- - ------------------------------- ----------------------------------------------------------------------------------------------
High Complete Complete Complete Complete
- - ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete Complete Complete Complete
- - ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete Complete Complete
- - ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
41 (continued)
Costs
The Company expenses all incremental costs to the Company associated with
Year 2000 compliance issues as incurred. Through June 30, 1999, such costs
incurred were approximately $1.1 million, consisting of approximately $0.6
million of replacement hardware and software and approximately $0.5 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 June 30, 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.
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's four-phase approach has demonstrated 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 is using 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.
The Company believes that a reasonably likely worst case scenario of a Year
2000 compliance failure could include the temporary failure of a minimal number
of operating systems, despite the Company's execution and satisfactory
completion of its comprehensive Year 2000 compliance plan. However, under this
scenario, the Company also believes that any such failed systems or components
would be fully recovered within a short period subsequent to failure and,
accordingly, the Company does not expect to experience any significant or long
term operational disruption as a result of the failure of any systems or
components directly within the Company's control.
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.
42
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 June 30, 1999, the Company had approximately $265.3 million in
cash, cash equivalents and short-term investments available for sale, at a
weighted average fixed interest rate of 4.83% for the six months ended June 30,
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 securities at
June 30, 1999 of approximately $0.7 million and, accordingly, would not cause a
material impact on the Company's financial position, results of operations or
cash flows.
At June 30, 1999, the Company's indebtedness included $1.7 billion under
the 13 1/2% Notes, 12 1/2% Notes, 11 5/8% Notes, 10% Notes and 9 7/8% Notes and
$491.9 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.
On August 12, 1999, the Company entered into the Senior Facility,
consisting of two term loans and a revolving line of credit. All components of
the Senior Facility bear variable annual rates of interest, based on changes in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate.
Consequently, additional borrowings under the Senior Facility and increases in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate will
increase the Company's indebtedness and may increase the Company's interest
expense in future periods. Additionally, under the terms of the Senior Facility,
the Company is required to hedge the interest rate risk on $100.0 million of the
Senior Facility if LIBOR exceeds 9.0% for 15 consecutive days. As of August 13,
1999, the Company had $80.0 million outstanding under the Senior Facility.
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 a gain on
its investment in MindSpring of approximately $0.4 million in its statement of
operations for the six months ended June 30, 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
43
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.
44
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 6 (e) to the Company's unaudited condensed consolidated
financial statements for the six months ended June 30, 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
The Annual Meeting of stockholders of ICG Communications, Inc. was
held on June 9, 1999 (the "Annual Meeting"). At the Annual Meeting,
two matters were considered and acted upon: (1) the election of two
directors to serve until the 2002 Annual Meeting of Stockholders and
until their successors have been duly elected and qualified; (2) the
ratification of the appointment of KPMG LLP as independent auditors of
ICG Communications, Inc. and its subsidiaries for the fiscal year
ending December 31, 1999.
Indicated below are the total votes in favor of each director nominee
and the total votes withheld:
Votes
----------------------------------------
For Withheld
----------------- -------------------
William J. Laggett 38,003,699 209,760
J. Shelby Bryan 38,003,599 209,860
In connection with the vote on the ratification of the appointment of
the independent auditors, 38,138,209 votes were cast in favor of the
appointment and 35,841 votes were cast in opposition thereto.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
(A) Exhibits.
(10) Material Contracts.
10.1: Amended and Restated Loan Agreement, dated as of May 1,
1999, by and among TriNet Realty Capital, Inc. and ICG
161, L.P.
10.2: Assumption and Modification Agreement, dated as of May
1, 1999, by and among ICG Services, Inc., ICG 161, L.P.
and TriNet Realty Capital, Inc.
10.3: Employment Agreement, dated as of May 19, 1999,
between ICG Communications, Inc. and Harry R. Herbst.
10.4: Employment Agreement, dated as of May 19, 1999,
between ICG Communications, Inc. and H. Don Teague.
45
10.5: Employment Agreement, dated as of May 19, 1999,
between ICG Communications, Inc. and John Kane.
10.6: Employment Agreement, dated as of June 1, 1999,
between ICG Communications, Inc. and Douglas I. Falk.
10.7: Amendment to Employment Agreement, dated as of June 9,
1999, between ICG Communications, Inc. and John Kane.
10.8: Employment Agreement, dated as of June 28, 1999,
between ICG Communications, Inc. and William S. Beans,
Jr.
10.9: Share Price Appreciation Vesting Non-Qualified Stock
Option Agreement, dated as of June 28, 1999, between
ICG Communications, Inc. and William S. Beans, Jr.
10.10: Employment Agreement, dated as of July 1, 1999,
between ICG Communications, Inc. and Michael D. Kallet.
10.11: Credit Agreement, dated as of August 12, 1999, among
ICG Equipment, Inc. and ICG NetAhead, Inc., as
Borrowers, ICG Services, Inc., as Parent, the Initial
Lenders and the Initial Issuing Bank, as Initial
Lenders and Initial Issuing Bank, Royal Bank of Canada,
as Administrative Agent and Collateral Agent, Morgan
Stanley Senior Funding, Inc., as Sole Book-Runner and
Lead Arranger and Bank of America, N.A. and Barclays
Bank PLC, as Co-Documentation Agents.
10.12: Security Agreement, dated August 12, 1999, from ICG
Equipment, Inc. and ICG NetAhead, Inc., as Grantors to
Royal Bank of Canada, as Collateral Agent.
(27) Financial Data Schedule.
27.1: Financial Data Schedule of ICG Communications, Inc. for
the Six Months Ended June 30, 1999.
(B) Report on Form 8-K. The following report on Form 8-K was filed
by the registrants during the six months ended June 30, 1999:
(i) Current Report on Form 8-K dated April 30, 1999,
regarding the announcement of the Company's earnings
information and results of operations for the quarter
ended March 31, 1999.
46
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
INDEX TO EXHIBITS
10.1: Amended and Restated Loan Agreement, dated as of May 1, 1999, by
and among TriNet Realty Capital, Inc. and ICG 161, L.P.
10.2: Assumption and Modification Agreement, dated as of May 1, 1999,
by and among ICG Services, Inc., ICG 161, L.P. and TriNet Realty
Capital, Inc.
10.3: Employment Agreement, dated as of May 19, 1999, between ICG
Communications, Inc. and Harry R. Herbst.
10.4: Employment Agreement, dated as of May 19, 1999, between ICG
Communications, Inc. and H. Don Teague.
10.5: Employment Agreement, dated as of May 19, 1999, between ICG
Communications, Inc. and John Kane.
10.6: Employment Agreement, dated as of June 1, 1999, between ICG
Communications, Inc. and Douglas I. Falk.
10.7: Amendment to Employment Agreement, dated as of June 9, 1999,
between ICG Communications, Inc. and John Kane.
10.8: Employment Agreement, dated as of June 28, 1999, between ICG
Communications, Inc. and William S. Beans, Jr.
10.9: Share Price Appreciation Vesting Non-Qualified Stock Option
Agreement, dated as of June 28, 1999, between ICG Communications,
Inc. and William S. Beans, Jr.
10.10: Employment Agreement, dated as of July 1, 1999, between ICG
Communications, Inc. and Michael D. Kallet.
10.11: Credit Agreement, dated as of August 12, 1999, among ICG
Equipment, Inc. and ICG NetAhead, Inc., as Borrowers, ICG
Services, Inc., as Parent, the Initial Lenders and the Initial
Issuing Bank, as Initial Lenders and Initial Issuing Bank, Royal
Bank of Canada, as Administrative Agent and Collateral Agent,
Morgan Stanley Senior Funding, Inc., as Sole Book-Runner and Lead
Arranger and Bank of America, N.A. and Barclays Bank PLC, as
Co-Documentation Agents.
10.12: Security Agreement, dated August 12, 1999, from ICG Equipment,
Inc. and ICG NetAhead, Inc., as Grantors to Royal Bank of Canada,
as Collateral Agent.
27.1: Financial Data Schedule of ICG Communications, Inc. for the Six
Months Ended June 30, 1999.
EXHIBIT 10.1
Amended and Restated Loan Agreement, dated as of May 1, 1999, by and among
TriNet Realty Capital, Inc. and ICG 161, L.P.
EXHIBIT 10.2
Assumption and Modification Agreement, dated as of May 1, 1999, by and among ICG
Services, Inc., ICG 161, L.P. and TriNet Realty Capital, Inc.
EXHIBIT 10.3
Employment Agreement, dated as of May 19, 1999, between ICG Communications, Inc.
and Harry R. Herbst.
EXHIBIT 10.4
Employment Agreement, dated as of May 19, 1999, between ICG Communications, Inc.
and H. Don Teague.
EXHIBIT 10.5
Employment Agreement, dated as of May 19, 1999, between ICG Communications, Inc.
and John Kane.
EXHIBIT 10.6
Employment Agreement, dated as of June 1, 1999, between ICG Communications, Inc.
and Douglas I. Falk.
EXHIBIT 10.7
Amendment to Employment Agreement, dated as of June 9, 1999, between ICG
Communications, Inc. and John Kane.
EXHIBIT 10.8
Employment Agreement, dated as of June 28, 1999, between ICG Communications,
Inc. and William S. Beans, Jr.
EXHIBIT 10.9
Share Price Appreciation Vesting Non-Qualified Stock Option Agreement, dated as
of June 28, 1999, between ICG Communications, Inc. and William S. Beans, Jr.
EXHIBIT 10.10
Employment Agreement, dated as of July 1, 1999, between ICG Communications, Inc.
and Michael D. Kallet.
EXHIBIT 10.11
Credit Agreement, dated as of August 12, 1999, among ICG Equipment, Inc. and ICG
NetAhead, Inc., as Borrowers, ICG Services, Inc., as Parent, the Initial Lenders
and the Initial Issuing Bank, as Initial Lenders and Initial Issuing Bank, Royal
Bank of Canada, as Administrative Agent and Collateral Agent, Morgan Stanley
Senior Funding, Inc., as Sole Book-Runner and Lead Arranger and Bank of America,
N.A. and Barclays Bank PLC, as Co-Documentation Agents.
EXHIBIT 10.12
Security Agreement, dated August 12, 1999, from ICG Equipment, Inc. and ICG
NetAhead, Inc., as Grantors to Royal Bank of Canada, as Collateral Agent.
EXHIBIT 27.1
Financial Data Schedule of ICG Communications, Inc. for the Six Months Ended
June 30, 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 August 13, 1999.
ICG COMMUNICATIONS, INC.
Date: August 13, 1999 By: /s/ Harry R. Herbst
----------------------------------------------
Harry R. Herbst, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer)
Date: August 13, 1999 By: /s/ John V. Colgan
----------------------------------------------
John V. Colgan, Vice President of Finance and
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 August 13, 1999.
ICG HOLDINGS (CANADA) CO.
Date: August 13, 1999 By: /s/ Harry R. Herbst
----------------------------------------------
Harry R. Herbst, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer)
Date: August 13, 1999 By: /s/ John V. Colgan
---------------------------------------------
John V. Colgan, Vice President of Finance and
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 August 13, 1999.
ICG HOLDINGS, INC.
Date: August 13, 1999 By: /s/ Harry R. Herbst
----------------------------------------------
Harry R. Herbst, Executive Vice President and
Chief Financial Officer (Principal Financial
Officer)
Date: August 13, 1999 By: /s/ John V. Colgan
----------------------------------------------
John V. Colgan, Vice President of Finance and
Controller (Principal Accounting Officer)