ELECTRIC LIGHTWAVE, INC. FORM 10-Q
Quarterly Report Pursuant To Section 13 or 15(d)
of The Securities Exchange Act of 1934
For The Quarterly Period Ended June 30, 2001
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, 2001
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission file number 0-23393
ELECTRIC LIGHTWAVE, INC.
(Exact name of registrant as specified in its charter)
Delaware 93-1035711
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
3 High Ridge Park
P. O. Box 3801
Stamford, CT 06905
(Address, zip code of principal executive offices)
Registrant's telephone number, including area code (203) 614-5600
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days.
Yes |X| No |_|
The number of shares outstanding of the registrant's class of common stock as of
July 31, 2001 were:
Common Stock Class A 10,091,657
Common Stock Class B 41,165,000
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets at June 30, 2001 and December 31, 2000 (unaudited) 2
Statements of Operations for the Three and Six Months Ended 3
June 30, 2001 and 2000 (unaudited)
Condensed Statements of Cash Flows for the Six Months Ended 4
June 30, 2001 and 2000 (unaudited)
Statements of Shareholders' Equity (Deficiency) for the Six
Months Ended 5 June 30, 2001 and the Year Ended December
31, 2000 (unaudited) 5
Notes to Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 10
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 17
PART II. OTHER INFORMATION 18
SIGNATURE 20
1
Electric Lightwave, Inc.
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS BALANCE SHEETS
BALANCE SHEETS
(In thousands)
(Unaudited)
June 30, December 31,
Assets 2001 2000
--------------- ----------------
Current assets:
Cash $ 7,504 $ 10,318
Trade receivables, net 27,129 35,491
Other receivables 9,282 6,001
Other current assets 4,609 5,080
--------------- ----------------
Total current assets 48,524 56,890
Property, plant and equipment, net 856,923 846,716
Goodwill, net 41,207 42,601
Other assets 3,142 3,567
--------------- ----------------
Total assets $ 949,796 $ 949,774
=============== ================
Liabilities and Shareholders' Deficiency
Current liabilities:
Accounts payable and accrued liabilities $ 29,262 $ 60,851
Current portion of capital lease obligations 27,110 28,798
Due to Citizens Communications Company 16,571 7,684
Other accrued taxes 18,531 16,377
Interest payable 10,012 13,244
Other current liabilities 7,028 5,718
--------------- ----------------
Total current liabilities 108,514 132,672
Deferred revenue 16,029 14,847
Other long-term liabilities 2,055 3,295
Deferred income taxes payable 3,485 3,058
Capital lease obligations 130,690 103,404
Long-term debt 837,000 763,000
--------------- ----------------
Total liabilities 1,097,773 1,020,276
Shareholders' deficiency (147,977) (70,502)
--------------- ----------------
Total liabilities and shareholders' deficiency $ 949,796 $ 949,774
=============== ================
See accompanying notes
2
STATEMENTS OF OPERATIONS
(In thousands, except per-share amounts)
(UNAUDITED)
For the three months ended June 30, For the six months ended June 30,
2001 2000 2001 2000
------------------ ------------------ ------------------ ------------------
Revenue $ 60,429 $ 60,620 $ 122,991 $ 117,398
------------------ ------------------ ------------------ ------------------
Operating expenses:
Network access 17,051 18,294 33,782 38,990
Operations 13,759 13,446 26,735 25,021
Selling, general and administrative 25,555 30,315 55,117 61,487
Depreciation and amortization 19,834 14,721 38,728 27,476
------------------ ------------------ ------------------ ------------------
Total operating expenses 76,199 76,776 154,362 152,974
------------------ ------------------ ------------------ ------------------
Loss from operations (15,770) (16,156) (31,371) (35,576)
Interest expense, net 24,315 18,662 46,365 33,858
Loss on disposal of assets 45 209 33 775
Interest income and other (119) (315) (227) (593)
------------------ ------------------ ------------------ ------------------
Net loss before income taxes (40,011) (34,712) (77,542) (69,616)
Income tax expense 264 246 427 481
------------------ ------------------ ------------------ ------------------
Net loss $ (40,275) $ (34,958) $ (77,969) $ (70,097)
================== ================== ================== ==================
Net loss per common share:
Basic $ (0.79) $ (0.69) $ (1.53) $ (1.39)
Diluted $ (0.79) $ (0.69) $ (1.53) $ (1.39)
Weighted average shares outstanding 50,969 50,418 50,906 50,289
See accompanying notes
3
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For the six months ended June 30,
2001 2000
--------------- ----------------
Net cash used in operating activities $ (33,744) $ (18,349)
--------------- ----------------
Cash flows used in investing activities:
Capital expenditures (35,304) (70,215)
Cash proceeds from sale of fixed assets 157 331
--------------- ----------------
Net cash used in investing activities (35,147) (69,884)
--------------- ----------------
Cash flows from financing activities:
Revolving bank credit facility proceeds - 104,000
Revolving bank credit facility repayments - (10,000)
Long term funding from Citizens 74,000 -
Payments of capital lease obligation (8,386) (9,576)
Stock issuance 485 3,558
Other (22) (100)
--------------- ----------------
Net cash provided by financing activities 66,077 87,882
--------------- ----------------
Net decrease in cash (2,814) (351)
Cash at January 1, 10,318 21,378
--------------- ----------------
Cash at June 30, $ 7,504 $ 21,027
=============== ================
Supplemental cash flow information:
Non-cash increase in capital lease asset $ 33,985 $ 96,510
See accompanying notes
4
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIENCY)
(In thousands, except share data)
(Unaudited)
Common Stock
------------------------------ Additional
Class A Class B Paid-in- Shareholders'
$.01 par $.01 par Capital Deficiency Equity (Deficiency)
--------------- -------------- ---------------- ---------------- -------------------
Balance, January 1, 2000 $ 90 $ 412 $ 326,477 $ (307,478) $ 19,501
Issuance of common stock 7 - 7,008 - 7,015
Issuance of restricted stock 1 - (1) - -
Forfeiture of restricted stock (1) - (75) - (76)
Purchase of common stock (1) - (704) - (705)
Amortization of restricted stock - - 1,422 - 1,422
Stock units payable to non-
employee director - - 56 - 56
Acquisition of Citizens
minority interest - - 38,747 - 38,747
Net loss - - - (136,462) (136,462)
--------------- -------------- ---------------- ---------------- -------------------
Balance, December 31, 2000 $ 96 $ 412 $ 372,930 $ (443,940) $ (70,502)
Issuance of common stock 3 - 482 - 485
Issuance of restricted stock 1 - (1) - -
Forfeiture of restricted stock - - (346) - (346)
Amortization of restricted stock - - 337 - 337
Stock units payable to non-
employee director - - 18 - 18
Net loss - - - (77,969) (77,969)
--------------- -------------- ---------------- ---------------- -------------------
Balance, June 30, 2001 $ 100 $ 412 $ 373,420 $ (521,909) $ (147,977)
=============== ============== ================ ================ ===================
See accompanying notes
5
NOTES TO FINANCIAL STATEMENTS
-----------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. BASIS OF PRESENTATION AND USE OF ESTIMATES
Electric Lightwave, Inc. is referred to as "we", "us" or "our" in this
report. We have prepared these unaudited financial statements in accordance
with generally accepted accounting principles (GAAP) for interim financial
information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, we have condensed or omitted certain
information and footnote disclosures. In our opinion, these financial
statements include all adjustments and recurring accruals necessary to
present fairly the results for the interim periods shown.
Preparing financial statements in conformity with GAAP requires us to make
estimates and assumptions which affect the amounts of assets, liabilities,
revenue and expenses we have reported and our disclosure of contingent
assets and liabilities at the date of the financial statements. The results
of the interim periods are not necessarily indicative of the results for
the full year. We have made certain reclassifications of balances
previously reported to conform to the current financial statement
presentation. You should read these financial statements in conjunction
with the audited financial statements and the related notes included in our
Annual Report on Form 10-K for the year ended December 31, 2000.
b. CAPITALIZED INTEREST
Property, plant and equipment include interest costs capitalized during the
installation and expansion of our telecommunications network. Approximately
$1,271,000 and $1,237,000 of interest costs were capitalized in the three
months ended June 30, 2001 and 2000, respectively, and approximately
$2,229,000 and $3,270,000 were capitalized in the six months ended June 30,
2001 and 2000, respectively.
c. REVENUE RECOGNITION
We recognize revenues from communications services when the services are
provided. Long-term prepaid network services revenue agreements are
deferred and recognized on a straight-line basis over the terms of the
related agreements. Installation fees and related costs (up to the amount
of installation revenue) are deferred and recognized over the average
customer life. Installation related costs in excess of installation fees
are expensed when incurred.
d. NET LOSS PER SHARE
We follow the provisions of SFAS No. 128, "Earnings Per Share" which
requires presentation of both basic and diluted earnings per share (EPS) on
the face of the statements of operations. Basic EPS excludes dilution and
is computed using the weighted average number of common shares outstanding
during the period. The diluted EPS calculation assumes that all dilutive
stock options or contracts to issue common stock were exercised or
converted into common stock at the beginning of the period. We have
excluded certain common stock equivalents from our diluted EPS calculation
during the quarters ended June 30, 2001 and 2000 as their effect would have
reduced our net loss per share.
6
2. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are as follows:
($ In thousands) June 30, 2001 December 31, 2000
----------------- --------------------
Property, plant and equipment $ 1,023,783 $ 978,327
Accumulated depreciation and amortization (166,860) (131,611)
----------------- --------------------
Property, plant and equipment, net $ 856,923 $ 846,716
================= ====================
Depreciation expense was $19,006,000 and $14,592,000 for the three months
ended June 30, 2001 and 2000, respectively, and $37,062,000 and $27,148,000
for the six months ended June 30, 2001 and 2000, respectively.
3. RELATED PARTY TRANSACTIONS
On December 1, 1997, we entered into an Administrative Services Agreement
(Agreement) under which Citizens Communications Company (Citizens) provides
us with certain administrative services including, but not limited to,
financial management services, information services, legal and contract
services, planning and human resources services. Under the terms of the
Agreement, Citizens bills us for direct costs and an allocation of indirect
costs, plus an administrative charge. The current practice of allocating
indirect costs is based on four factors: our plant assets, operating
expenses, number of customers and payroll expenses. We believe that this
allocation method and the resultant amounts are reasonable as contemplated
by the Agreement. In addition, we reimburse third party costs incurred by
Citizens on our behalf. We believe that the amounts charged by Citizens do
not exceed comparable amounts that would be charged by an unaffiliated
third party and that the accompanying financial statements include all of
our costs of doing business.
Citizens owns all of our Class B Common Stock and 2,287,644 shares of our
Class A Common Stock, in total representing an 85% economic interest in us.
We have entered into a revolving credit facility with Citizens for $450
million with an interest rate of 15% and a final maturity of October 30,
2005 (Citizens Credit Facility). Funds of $260 million are available for
general corporate purposes and may be drawn until June 30, 2002. The
remaining available balance may be drawn to pay interest expense due under
the Citizens Credit Facility until maturity. As of June 30, 2001, there was
$112 million outstanding under the Citizens Credit Facility and $338
million available to be drawn upon.
This table summarizes the activity in the current liability account due to
Citizens for the six months ended June 30,
($ In thousands) 2001 2000
----------------- -----------------
Balance beginning of period $ 7,684 $ 14,650
Guarantee 14,666 13,072
Interest expense on Citizens Credit Facility 4,829 -
Administrative services:
Services provided by Citizens 4,245 2,929
ELI expenses paid by Citizens 3,652 4,183
Payments to Citizens (18,505) (28,011)
----------------- -----------------
Balance end of period $ 16,571 $ 6,823
================= =================
7
4. INCOME TAXES
Citizens includes us in their consolidated federal income tax return, which
uses a calendar year reporting period. We record income taxes as if we were
a stand-alone company. We recorded income tax expense of $264,000 and
$246,000 for the three months ended June 30, 2001 and 2000, respectively,
and $427,000 and $481,000 for the six months ended June 30, 2001 and 2000,
respectively. This expense represents the deferred tax effect of the
increase in temporary differences between our GAAP financial statements and
our tax return that may not be fully offset with the use of tax loss
carryforwards when the temporary differences reverse in future periods.
The income taxes payable by Citizens' consolidated group have been reduced
as a consequence of our losses for tax purposes in past years. We would
have been able to carry-forward our tax losses to future periods to offset
taxable income in these future periods had we been a stand-alone company.
In accordance with our tax sharing agreement, Citizens has agreed to
reimburse us for the taxes we would be required to pay in the future, if we
have taxable income, to the extent that these loss carryforwards would have
otherwise remained available on a stand-alone basis.
5. SEGMENT DISCLOSURES
We operate in a single industry segment, communications services. We
provide services utilizing our centrally planned, monitored and operated
telecommunications network. Operations are managed and financial
performance is evaluated based on the delivery of multiple services to
customers over our single fiber-optic network. As a result, there are many
shared expenses generated by the various revenue streams and geographic
locations. Management believes that any allocation of the expenses incurred
on a single network to multiple revenue streams would be impractical,
arbitrary and inconsistent with the way the business is currently evaluated
by management. As a result, we do not presently have systems or procedures
in place to derive all the operating costs and expenses relating to a
particular product group or service area.
PRODUCTS AND SERVICES
We group our products and services into Network Services, Local Telephone
Services, Long Distance Services and Data Services. The revenue generated
by these products and services for the three and six months ended June 30
were:
For the three months ended June 30, For the six months ended June 30,
-------------------------------------- --------------------------------------
($ In thousands) 2001 2000 2001 2000
----------------- ----------------- ----------------- -----------------
Network services $ 26,121 $ 17,173 $ 51,889 $ 33,177
Local telephone services 21,868 25,951 43,664 50,225
Long distance services 3,098 4,265 6,183 8,862
Data services 9,342 13,231 21,255 25,134
----------------- ----------------- ----------------- -----------------
Total $ 60,429 $ 60,620 $ 122,991 $ 117,398
================= ================= ================= =================
We do not currently provide products or services outside the United States.
MAJOR CUSTOMERS
Qwest Communications (Qwest) accounted for 14% and 21% of our total revenue
for the three months ended June 30, 2001 and 2000, respectively, and 13%
and 21% of our total revenue for the six months ended June 30, 2001 and
2000, respectively. In 2001, most of the Qwest revenue was generated from
reciprocal compensation agreements. No other customer accounted for 10% or
more of our total revenue for the three and six months ended June 30, 2001
or 2000.
8
Included in revenue for the three months ended June 30, 2001 is
approximately $3.8 million of revenue representing a "net settlement" of
past billing disputes between ELI and Qwest. Additionally, we are currently
providing service to customers that have filed for protection under Chapter
11 of the bankruptcy code. Of our largest twenty-five customers, two are
under Chapter 11 protection. These two customers contribute approximately
$1.1 million of revenue monthly; amounts due from such customers are
current.
6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities."
This statement establishes accounting and reporting standards for
derivative instruments and hedging activities and, as amended, is effective
for all fiscal quarters of fiscal years beginning after June 15, 2000. The
statement requires balance sheet recognition of derivatives as assets or
liabilities measured at fair value. Accounting for gains and losses
resulting from changes in the values of derivatives is dependent on the use
of the derivative and whether it qualifies for hedge accounting. The
adoption of SFAS 133 could increase the volatility of reported earnings and
other comprehensive income in the future. In general, the amount of
volatility will vary with the level of derivative activities during any
period. We adopted SFAS 133 on January 1, 2001. As of June 30, 2001 we have
not identified any derivative instruments subject to the provisions of SFAS
133. Therefore, SFAS 133 did not have any impact on our first and second
quarter 2001 financial statements.
7. COMMITMENTS AND CONTINGENCIES
We have entered into various capital and operating leases for fiber optic
cable to interconnect our local networks with long-haul fiber optic routes.
The terms of the various agreements range from 20 to 25 years, with varying
optional renewal periods.
In addition to the long-haul agreements above, we have also entered into
certain operating and capital leases to develop our local networks. The
terms of the various agreements range from 15 to 30 years, with varying
optional renewal periods. One of these contracts provides us with an
exclusive right to use the facilities as long as certain minimum
requirements are satisfied.
In March 1999, we entered into a 20-year fiber agreement, in which we will
exchange unused fiber on our network for unused fiber on another carrier's
network. This exchange will provide us with fiber from Salt Lake City to
Denver, continuing on to Dallas. We incorporated the other carrier's fiber
into our network during April of 2001. We will pay the other carrier
approximately $97.3 million over the next 20 years based on estimated route
miles. Accordingly, we reported a capital lease asset and related
obligation of approximately $34.0 million in our balance sheet, of which
$4.6 million is presented in current portion of long-term debt.
We are involved in various claims and legal actions arising in the ordinary
course of business. In the opinion of management, the ultimate disposition
of these matters will not have a material adverse effect on our results of
operations, financial position or liquidity.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Statements contained in this quarterly report on Form 10-Q that are not
historical facts are forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Reform Act of 1995. In
addition, words such as "believes," "anticipates," "expects" and similar
expressions are intended to identify forward-looking statements. These
forward-looking statements are subject to:
o if there are changes in the nature and pace of technological advances
in our industry;
o if competitive pressure in the telecommunications industry increases
in any of our markets because of the entrance of new competitors, the
combination of existing competitors and/or the more effective
provision of products and services from our competitors, including
incumbent local exchange carriers (ILECs), or other public utilities;
o if our business strategy or its execution, including financial
performance goals, is not as successful as we anticipate;
o if state or federal regulatory changes are implemented that assist our
competitors, impair our competitive position, threaten our costs or
impact our rate structures, including the ability to bill and collect
reciprocal compensation for calls terminated to internet service
providers (ISPs);
o if we do not receive the services and support which we require from
the ILECs operating in our markets or cannot maintain our current
relationships with ILECs;
o if a significant number or volume of our clients, particularly ISPs,
experience financial difficulty and are unable to continue operating
in the manner which they have in the past, are unable to pay their
bills when they become due, cease operating or seek bankruptcy
protection;
o if we are not able to effectively manage rapid growth, including
integrating any businesses acquired;
o if we are not able to correctly identify future markets, successfully
expand existing ones, or successfully expand through acquisitions;
o if the mix of products and services we are able to offer in our target
markets is not appropriate to the demands of our customers;
o if we are not able to obtain additional financing or obtain additional
financing on favorable terms;
o if our stock price is volatile; or
o the effects of more general factors including, but not limited to,
changes in economic conditions, changes in industry conditions and
changes in accounting policies and practices adopted voluntarily or as
required by generally accepted accounting principles.
You should consider these important factors in evaluating any statement in
this Form 10-Q or otherwise made by us or on our behalf. These
forward-looking statements are made as of the date of this report based
upon current expectations, and we undertake no obligation to update this
information. The following information is unaudited and should be read in
conjunction with the consolidated financial statements and related notes
included in this report and as presented in our 2000 Annual Report on Form
10-K.
10
OVERVIEW
We have built an extensive fiber-optic network in the western United
States, which includes expansive local networks in seven major cities and
their surrounding areas, connected by our long-haul routes. In addition, we
provide data services in certain strategic markets across the nation. Our
product offerings include:
o Network services - dedicated service between two points for a
customer's exclusive use. We offer this in both local and long haul
applications and collocation facilities to meet us directly in our
hub.
o Local telephone services - the delivery of local dial tone and related
services, and related carrier and local access revenue, as well as
Integrated Services Digital Network Primary Rate Interface (ISDN PRI).
ISDN PRI provides customers with a high-speed access connection to the
public switched telephone network for voice, video and data
applications.
o Long distance services - retail and wholesale long distance phone
services.
o Data services - a wide range of products to deliver large quantities
of data from one location to another through Asynchronous Transfer
Mode (ATM), Frame Relay and Internet Protocol (IP) packet
technologies. These technologies group data (voice, video, images and
character-based data) into small packets of information and transmit
the packets over a network.
Refer to Note 3 in Part I, Item 1, for a discussion concerning our
relationship with Citizens, which owns approximately 85% of our common
stock.
a. LIQUIDITY AND CAPITAL RESOURCES
We have entered into a revolving credit facility with Citizens for $450
million with an interest rate of 15% and a final maturity of October 30,
2005 (Citizens Credit Facility). Funds of $260 million are available for
general corporate purposes and may be drawn until June 30, 2002. The
remaining available balance may be drawn to pay interest expense due under
the Citizens Credit Facility until maturity.
We drew $74 million from the Citizens Credit Facility to fund operating and
capital expenditures during the six months ended June 30, 2001. As of June
30, 2001, we have outstanding $112 million under the Citizens Credit
Facility and have $338 million remaining available to be drawn.
Additionally, we have outstanding $325 million of 6.05% senior unsecured
notes that mature on May 14, 2004 and a $400 million revolving bank credit
facility (Bank Credit Facility). No principal payment on the Bank Credit
Facility is due until its expiration date in November 2002. Citizens has
guaranteed both the Bank Credit Facility and our senior unsecured notes for
fees of 3.25% and 4.0%, respectively, based on the respective outstanding
balances.
We anticipate that our existing cash balances and cash to be generated from
operations will not be adequate to fund operating leases, working capital
deficiencies, capital expenditures, capital lease obligations and debt
service through 2001. Citizens has committed to continue to finance our
cash requirements, at market terms and conditions, until June 30, 2002.
Absent the Citizens commitment, we do not believe there is currently a
market to further finance or refinance our existing indebtedness.
In order to continue the growth of our customer base and revenue stream, we
must continue to invest in the installation, development and expansion of
our existing telecommunications network. A significant portion of these
expenditures is incurred before any revenue is realized. Our cash capital
expenditures were approximately $15.0 million and $35.3 million for the
three and six months ended June 30, 2001, respectively. These expenditures,
combined with our operating expenses, have resulted in operating losses and
negative cash flows. We expect to continue incurring operating losses and
negative cash flows until we can establish an adequate customer base
necessary to generate a revenue stream sufficient to support our
operations, capital requirements and debt service. We cannot be sure that
we will achieve or sustain profitability or that we will generate
sufficient positive cash flow to fund our operating, capital expenditure
and debt service requirements.
11
During 1995, we entered into a $110 million construction agency agreement
and an operating lease agreement in connection with the construction of
certain network facilities. We have the option to purchase the facilities
at the end of the lease term. Payments under the lease depend on current
interest rates. Assuming continuation of current interest rates, payments
would approximate $6.7 million annually through April 30, 2002 and,
assuming exercise of the purchase option, a final payment of approximately
$110 million in 2002. If we choose not to exercise the purchase option, we
are obligated to arrange for the sale of the facilities to an unrelated
party and are required to pay the lessor any difference between the net
sales proceeds and the lessor's investment in the facilities. However, any
amount required to be paid to the lessor is subject generally to a maximum
of approximately $88 million. Citizens has guaranteed all of our
obligations under this operating lease. We have agreed to pay to Citizens a
guarantee fee at the rate of 3.25% per annum based on the amount of the
lessor's investment in the leased assets. We are currently evaluating our
options to refinance this obligation.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 141, "Business
Combinations." This statement requires that all business combinations be
accounted for under the purchase method of accounting. SFAS No. 141
requires that the purchase method of accounting be used for business
combinations initiated after June 30, 2001 and prohibits the use of the
pooling-of-interests method of accounting.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement requires that goodwill no longer be amortized to
earnings, but instead be reviewed for impairment. Impairment tests are
required to be performed at least annually. The amortization of goodwill
ceases upon adoption of the statement. The statement is effective for
fiscal years beginning after December 15, 2001 for companies whose annual
reporting period ends on December 31, 2001 and applies to all goodwill and
other intangible assets recognized in the statement of financial position
at that date, regardless of when the assets were initially recognized. We
will cease to recognize amortization of goodwill starting January 1, 2002.
We will be required to test for impairment of goodwill annually starting in
2002. The amount of any future impairment, if any, cannot be estimated at
this time.
OTHER MATTERS
RECIPROCAL COMPENSATION
We have various interconnection agreements with Qwest, Verizon
Communications (Verizon), Pacific Bell Telephone Company (PacBell) and
Roseville Telephone, the ILECs in the areas in which we operate. These
agreements govern reciprocal compensation relating to the transport and
termination of traffic between the ILECs' networks and our network. We
recognize reciprocal compensation revenues as earned, based on the terms of
the interconnection agreements. We recognized reciprocal compensation
revenues of $8.0 million and $10.4 million for the three months ended June
30, 2001 and 2000, respectively. Reciprocal compensation recognized
revenues were $15.7 million and $20.0 million for the six months ended June
30, 2001 and 2000, respectively. Net trade accounts receivable relating to
reciprocal compensation totaled $8.6 million and $7.7 million at June 30,
2001 and December 31, 2000, respectively. These agreements are scheduled to
expire between June 30 and December 31, 2001. The Verizon interconnection
agreements expired in May and June 2001 for Washington and Oregon,
respecitvely. The existing terms will remain in effect for 180 days or
until a new agreement is reached. We cannot provide assurance that renewal
of the interconnection agreements will be in the same form, or at rates
comparable to the current interconnection agreements.
12
The FCC adopted new rules concerning intercarrier compensation for
ISP-bound traffic effective June 14, 2001. The FCC set transitional rates
for reciprocal compensation that exceeds a 3:1 ratio. The rate for above
ratio traffic is .15 cents per minute for the first six months after the
effective date of the commission order, .10 cents per minute for the next
18 months and .07 cents per minute after that, through June 2004. Below
ratio traffic remains at the state established rate level. Implementation
of the FCC's transitional rates for ISP-bound traffic is expected to take
place over the next few months via amendments to existing interconnection
agreements. Based on our preliminary analysis, we do not anticipate the
FCC's action to cause any material deviations in anticipated reciprocal
compensation revenue for 2001.
b. RESULTS OF OPERATIONS
REVENUE
Revenue for the three and six months ended June 30, 2001 decreased $0.2
million, or 0%, and increased $5.6 million, or 5%, respectively, as
compared with the prior year periods.
For the three months ended June 30, For the six months ended June 30,
------------------------------------------- --------------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- -------------- ------------ ------------- ---------------
Network services $ 26,121 $ 17,173 52% $ 51,889 $ 33,177 56%
Local telephone services 21,868 25,951 (16%) 43,664 50,225 (13%)
Long distance services 3,098 4,265 (27%) 6,183 8,862 (30%)
Data services 9,342 13,231 (29%) 21,255 25,134 (15%)
------------- ------------- ------------ -------------
Total $ 60,429 $ 60,620 (0%) $122,991 $ 117,398 5%
============= ============= ============ =============
Major Customers
Included in revenue for the three months ended June 30, 2001 is
approximately $3.8 million of revenue representing a "net settlement" of
past billing disputes between ELI and Qwest. Additionally, we are currently
providing service to customers that have filed for protection under Chapter
11 of the bankruptcy code. Of our largest twenty-five customers, two are
under Chapter 11 protection. These two customers contribute approximately
$1.1 million of revenue monthly; amounts due from such customers are
current.
Network Services
Network services revenue for the three and six months ended June 30, 2001
increased $8.9 million, or 52%, and $18.7 million, or 56%, respectively, as
compared with the prior year periods. The increase is due to continued
growth in our network and sales of additional circuits to new and existing
customers.
Local Telephone Services
Local telephone services revenue for the three and six months ended June
30, 2001 decreased $4.1 million, or 16%, and $6.6 million, or 13%,
respectively, as compared with the prior year periods. Local telephone
services include ISDN PRI, dial tone, Carrier Access Billings and
reciprocal compensation.
13
For the three months ended June 30, For the six months ended June 30,
---------------------------------------- ------------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ------------ ------------- -------------
ISDN PRI $ 6,755 $ 8,402 (20%) $ 14,785 $ 16,231 (9%)
Dial tone 4,528 4,201 8% 9,231 8,749 6%
Carrier access billings 2,574 2,948 (13%) 3,923 5,219 (25%)
Reciprocal compensation 8,011 10,400 (23%) 15,725 20,026 (21%)
------------- ------------- ------------- ------------
Total $ 21,868 $ 25,951 (16%) $ 43,664 $ 50,225 (13%)
============= ============= ============= ============
ISDN PRI revenue for the three and six months ended June 30, 2001 decreased
$1.6 million, or 20%, and $1.4 million, or 9%, respectively, as compared
with the prior year periods primarily due to the decline in the consumer
dial-up market.
Dial tone revenue increased $0.3 million, or 8%, and $0.5 million, or 6%,
respectively, as compared with the prior year periods. Increases in revenue
for dial tone are the result of an increase in the average access line
equivalents of 14,747, or 16%, and 5,379, or 5% for the three and six
months ended June 30, 2001, respectively.
Carrier Access Billings revenue for the three and six months ended June 30,
2001 decreased $0.4 million, or 13%, and $1.3 million, or 25%,
respectively, as compared with the prior year periods. The decrease is the
result of lower average rates per minute due to competitive pressures in
the markets in which we operate, offset by an increase in average monthly
minutes processed of 1.7 million, or 5%, and 8.7 million, or 31%, for the
three and six months ended June 30, 2001, respectively, as compared with
the prior year periods.
Reciprocal compensation revenue for the three and six months ended June 30,
2001 decreased $2.4 million, or 23%, and $4.3 million, or 21%,
respectively, as compared with the prior year periods. The decrease is due
to a decrease in average monthly minutes processed of 110 million, or 9%,
and 35 million, or 3%, for the three and six months ended June 30, 2001,
respectively, as compared with the prior year periods and lower average
rates per minute due to competitive pressures in the markets in which we
operate. See "Part I., Item 2., Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital
Resources - Other Matters - Reciprocal Compensation" for further discussion
of reciprocal compensation.
Long Distance Services
Long distance services revenue for the three and six months ended June 30, 2001
decreased $1.2 million, or 27%, and $2.7 million, or 30%, respectively, as
compared with the prior year periods. Long distance services include retail and
wholesale long distance.
Retail long distance revenue for the three and six months ended June 30,
2001 decreased $0.2 million, or 9%, and $0.5 million, or 10%, respectively,
as compared with the prior year periods. The decrease is due to a decrease
in average monthly minutes processed of 0.3 million, or 3%, and 0.2
million, or 2%, for the three and six months ended June 30, 2001 and lower
average rates per minute.
Wholesale long distance revenue for the three and six months ended June 30,
2001 decreased $0.5 million, or 34%, and $1.5 million, or 43%,
respectively, as compared with the prior year periods. The decrease is due
to a decrease in average monthly minutes processed of 4.3 million, or 25%,
and 5 million or 28%, for the three and six months ended June 30, 2001 and
lower average rates per minute.
14
Data Services
Data services revenue for the three and six months ended June 30, 2001
decreased $3.9 million, or 29%, and $3.9 million, or 15%, respectively, as
compared with the prior year periods. Data services include Internet, RSVP,
Frame Relay and other services.
Revenue for the three and six months ended June 30, 2001 from our
Internet services product decreased $0.4 million, or 9%, and increased
$0.2 million, or 2.9%, respectively, as compared with the prior year
periods.
Revenue for the three and six months ended June 30, 2001 from our RSVP
products increased $0.4 million, or 52%, and $1.1 million, or 76%,
respectively, as compared with the prior year periods.
Revenue for the three and six months ended June 30, 2001 from our
Frame Relay product decreased $0.1 million, or 7%, and increased $0.1
million, or 3%, respectively, as compared with the prior year periods.
Revenue for the three and six months ended June 30, 2001 from other
services revenue decreased $3.8 million, or 70%, and $5.4 million, or
51%, respectively, as compared with the prior year periods, primarily
due to the expiration on February 28, 2001 of an 18-month take-or-pay
contract with a significant customer. This take-or-pay contract was
not renewed.
OPERATING EXPENSES
Operating expenses for the three and six months ended June 30, 2001
decreased $0.6 million, or 1%, and increased $1.4 million, or 1%,
respectively, as compared with the prior year period.
For the three months ended June 30, For the six months ended June 30,
--------------------------------------- ----------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------ ----------- ----------- ------------ ------------ ------------
Network access $ 17,051 $ 18,294 (7%) $ 33,782 $ 38,990 (13%)
Operations 13,759 13,446 2% 26,735 25,021 7%
Selling, general and administrative 25,555 30,315 (16%) 55,117 61,487 (10%)
Depreciation and amortization 19,834 14,721 35% 38,728 27,476 41%
------------ ----------- ------------ ------------
Total $ 76,199 $ 76,776 (1%) $ 154,362 $ 152,974 1%
============ =========== ============ ============
Network Access
Network access expenses include circuit and usage-based charges for
carrying and terminating traffic on another carrier's network.
Network access expenses for the three and six months ended June 30, 2001
decreased $1.2 million, or 7%, and $5.2 million, or 13%, respectively, as
compared with the prior year periods. The decrease is a result of the
completion of our inland and coastal long-haul network, which has allowed
us to focus on providing on-net services resulting in reduced variable
costs. The decrease is also attributable to decreased long distance revenue
and decreased long distance per minute costs.
Operations
Operations expenses consist of costs related to providing facilities based
network and enhanced communications services other than network access
costs. The primary components of these expenses are right-of-way and
telecommunications equipment leases as well as operations and engineering
personnel costs.
15
Operations expenses for the three and six months ended June 30, 2001
increased $0.3 million, or 2%, and $1.7 million, or 7%, respectively, as
compared with the prior year period, primarily due to increases in
maintenance, operating rents and related expenses to support the expanded
delivery of services.
Selling, General and Administrative
Selling, general and administrative expenses include all direct and
indirect sales channel expenses and commissions, as well as all general and
administrative expenses.
Selling, general and administrative expenses for the three and six months
ended June 30, 2001 decreased $4.8 million, or 16%, and $6.4 million, or
10%, respectively, as compared with the prior year period. The decrease is
primarily due to a reduction in personnel, partially offset by increases in
property taxes.
Depreciation and Amortization
Depreciation and amortization expenses include depreciation of
telecommunications network assets including fiber-optic cable, network
electronics, network switching and network data equipment and amortization
of goodwill.
Depreciation and amortization expense for the three and six months ended
June 30, 2001 increased $5.1 million, or 35%, and $11.3 million, or 41%,
respectively, as compared with the prior year period. This was primarily
due to higher plant in service balances for newly completed
telecommunications network facilities and electronics.
INTEREST EXPENSE, NET
For the three months ended June 30, For the six months ended June 30,
---------------------------------------- ----------------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ---------------- ------------- -------------
Gross interest expense $ 25,586 $ 19,899 29% $ 48,594 $ 37,128 31%
Capitalized interest (1,271) (1,237) 3% (2,229) (3,270) (32%)
------------- ------------- ------------- -------------
Interest expense, net $ 24,315 $ 18,662 30% $ 46,365 $ 33,858 37%
============= ============= ============= =============
Gross interest expense for the three and six months ended June 30, 2001
increased $5.7 million, or 29%, and $11.5 million, or 31%, respectively, as
compared with the prior year periods, primarily due to higher levels of
outstanding long-term debt and higher average interest rates. As of June
30, 2001, we had debt and capital leases outstanding of $994.8 million at a
composite rate of 7.5% compared to $828.1 million at a composite rate of
7.1% at June 30, 2000. The higher balance led to increased interest and
guarantee fees.
Capitalized interest for the three months ended June 30, 2001 increased
$0.03 million, or 3%, as compared with the prior year period. The increase
is due to higher interest rates, partially offset by a reduction in average
Construction Work In Process of $18.2 million, or 34.9%, as compared with
the prior year period. Capitalized interest for the six months ended June
30, 2001 decreased $1.0 million, or 32%, as compared with the prior year
period. The decrease is due to a reduction in average Construction Work In
Process of $38.9 million, or 56.7%, as compared with the prior year period,
partially offset by higher interest rates.
INCOME TAX EXPENSE
For the three months ended June 30, For the six months ended June 30,
---------------------------------------- ------------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ------------- ------------- ------------
Income tax expense $ 264 $ 246 7% $ 427 $ 481 (11%)
Income tax expense for the three and six months ended June 30, 2001
increased $0.02 million, or 7%, and decreased $0.05 million, or 11%,
respectively, as compared with the prior year periods. In both 2001 and
2000, the benefit of our tax loss carryforwards is not able to fully offset
the deferred tax expense associated with current year temporary
differences.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DISCLOSURE OF PRIMARY MARKET RISK AND HOW IT IS MANAGED
We are exposed to market risk in the normal course of our business
operations due to ongoing funding activities. Market risk refers to the
potential change in fair value of a financial instrument as a result of
fluctuations in interest rates and equity and commodity prices. Our primary
market risk exposure is interest rate risk, which relates primarily to our
long-term debt and capital lease obligations. We do not hold or issue
derivative instruments or other financial instruments for trading purposes.
Financial instruments that are held for other than trading purposes do not
impose a material market risk. As a result, we do not undertake any
specific actions to cover our exposure to interest rate risk and we are not
party to any interest rate risk management agreements.
We are exposed to interest rate risk since debt financing is needed to fund
the operating losses and capital expenditures associated with establishing
and expanding our telecommunications network. The interest rates that we
will be able to obtain on debt financing will depend on market conditions
at that time, and may differ from the rates we have secured on our current
debt. Citizens has committed to continue to finance our cash requirements,
at market terms and conditions, until the earlier of completion of a public
or private financing or June 30, 2002.
We have no material future earnings or cash flow exposures from changes in
interest rates on our long-term debt and capital lease obligations, as a
majority of our obligations are fixed and most of our obligations are
guaranteed by Citizens. A hypothetical 10% adverse change in interest rates
would increase the amount that we pay on our variable obligations and could
result in fluctuations in the fair value of our fixed rate obligations.
Based upon our overall interest rate exposure at June 30, 2001, a near-term
change in interest rates would not materially affect our consolidated
financial position, results of operations or cash flows.
SENSITIVITY ANALYSIS
At June 30, 2001, the fair value of our long-term debt and capital lease
obligations was estimated to be $938.5 million compared to $967.7 million
carrying value, based on our overall weighted average rate of 7.5%
excluding guarantee fees and our overall weighted maturity of 4 years.
There has been no material change in the weighted average maturity
applicable to our obligations since December 31, 2000. However, the overall
weighted average interest rate has increased by approximately 3 basis
points during the six month period. A hypothetical increase of 75 basis
points (10% of our overall weighted average borrowing rate) would result in
an approximate $14.7 million decrease in the fair value of our fixed rate
obligations.
DISCLOSURE OF LIMITATIONS OF SENSITIVITY ANALYSIS
Certain shortcomings are inherent in the method of analysis presented in
the computation of fair value of financial instruments. Actual values may
differ from those presented should market conditions vary from assumptions
used in the calculation of the fair value. This analysis incorporates only
those exposures that exist as of June 30, 2001. It does not consider those
exposures or positions that could arise after that date. As a result, our
ultimate exposure with respect to our interest rate risk will depend on the
exposures that arise during the period, the ratio of variable to fixed debt
outstanding and the fluctuation of interest rates.
17
PART II: OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
We are party to routine litigation arising in the normal course of
business. We do not expect these matters, individually or in the aggregate,
to have a material adverse effect on our financial position, results of
operations or cash flows. We are also party to various proceedings before
state Public Utilities Commissions. These proceedings typically relate to
authority to operate in a state and regulatory arbitration proceedings
concerning our interconnection agreements. See "Part I., Item 2.,
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources - Other Matters - Reciprocal
Compensation".
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) We held our 2001 Annual Meeting of the Stockholders on May 17, 2001.
(b) Proxies for the Annual Meeting were solicited pursuant to Regulation
14A; there was no solicitation in opposition to management's nominees
for directors as listed in the Proxy Statement. All such nominees were
elected pursuant to the following votes:
Number of Votes
---------------
Directors For (*) Abstain
--------- --------- -------
R. Braden 419,789,651 328,346
R.J. Graf 419,790,356 327,641
G.E. Greiner 419,979,019 138,978
S. Harfenist 419,791,535 326,462
W.M. Krauss 419,977,019 140,978
S.N. Schneider 419,791,480 326,517
R.A. Stanger 419,793,626 324,371
L. Tow 419,780,389 337,608
M. Wilderotter 419,985,003 132,994
(*) Includes votes from the 41,165,000 shares of Class B common stock.
Citizens owns all Class B Common Stock and each share is entitled to
10 votes on each matter to be voted upon by holders of the Common
Stock.
(c) At the 2001 Annual Meeting of the Stockholders, the shareholders
approved an amendment to our 1997 Equity Incentive Plan solely to
increase the number of shares of common stock reserved for issuance
thereunder. The following sets forth the number of votes on this
proposal.
For Against Abstain
--- ------- -------
415,738,556 657,217 18,968
18
ITEM 5. OTHER INFORMATION
On April 2, 2001, we received a notice from The Nasdaq Stock Market, Inc.
that our common stock would be subject to delisting after July 2, 2001 from
The Nasdaq National Market because our Class A common stock failed to
maintain a $5 minimum bid price. Nasdaq suggested that we may consider
filing an application to have our Class A common stock listed on The Nasdaq
SmallCap Market. On June 29, 2001, we filed an application to have our
Class A common stock listed on The Nasdaq SmallCap Market. We are currently
in discussions with Nasdaq as to the application and our ability to meet
the applicable listing requirements. In order to meet a separate
requirement concerning market capitalization of our Class A common stock,
Citizens may convert sufficient shares of Class B common stock to Class A
common stock to provide a market capitalization of the Class A common stock
of $35 million. It is uncertain whether we will be able to meet the
applicable listing requirements including the requirement that a minimum
bid price of $1.00 per share be maintained. If the requirements are not
met, our Class A common stock may not be eligible for trading on Nasdaq and
we expect we would trade in the over-the-counter market. We continue to
have discussions with Nasdaq and do have the ability to appeal any
determination of Nasdaq. In addition, we continue to review alternative
resolutions to this matter. There can be no assurance of the outcome of
these discussions or of any appeal if we determine to seek one. If our
Class A common stock fails to remain included on Nasdaq, the delisting may
have a material adverse impact on the market value of our Class A common
stock.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) The exhibits below are filed as part of this report:
None.
b) Reports on Form 8-K
On May 9, 2001, we filed on Form 8-K under Item 5, "Other Events", a press
release announcing earnings for the quarter ended March 31, 2001.
19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ELECTRIC LIGHTWAVE, INC.
(Registrant)
By: /s/ Robert J. Larson
-------------------------------
Robert J. Larson
Vice President and Chief Accounting Officer
August 10, 2001
20