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 September 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 September 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
October 31, 2001 were:
Common Stock Class A 35,375,345
Common Stock Class B 15,881,312
________________________________________________________________________________
Electric Lightwave, Inc.
INDEX
Page No.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets at September 30, 2001 (unaudited) and December 31, 2000 2
Statements of Operations for the Three and Nine Months Ended
September 30, 2001 and 2000 (unaudited) 3
Condensed Statements of Cash Flows for the Nine Months Ended
September 30, 2001 and 2000 (unaudited) 4
Statements of Shareholders' Equity (Deficiency) for the Nine Months Ended
September 30, 2001 (unaudited) and the Year Ended December 31, 2000 5
Notes to Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANAYLSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 19
PART II. OTHER INFORMATION 20
SIGNATURE 22
1
PART I. FINANCIAL INFORMATION
-----------------------------
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS
(In thousands)
------------
(Unaudited)
September 30, December 31,
Assets 2001 2000
--------------- ----------------
Current assets:
Cash $ 6,876 $ 10,318
Trade receivables, net 17,848 35,491
Other receivables 6,403 6,001
Other current assets 4,582 5,080
--------------- ----------------
Total current assets 35,709 56,890
Property, plant and equipment, net 844,249 846,716
Goodwill, net 40,509 42,601
Other assets 3,009 3,567
--------------- ----------------
Total assets $ 923,476 $ 949,774
=============== ================
Liabilities and Shareholders' Deficiency
Current liabilities:
Accounts payable and accrued liabilities $ 33,268 $ 60,851
Current portion of capital lease obligations 7,286 28,798
Due to Citizens Communications Company 7,939 7,684
Other accrued taxes 21,535 16,377
Interest payable 16,156 13,244
Other current liabilities 6,313 5,718
--------------- ----------------
Total current liabilities 92,497 132,672
Deferred revenue 15,706 14,847
Other long-term liabilities 1,336 3,295
Deferred income taxes payable 3,507 3,058
Capital lease obligations 130,664 103,404
Long-term debt 875,000 763,000
--------------- ----------------
Total liabilities 1,118,710 1,020,276
Shareholders' deficiency (195,234) (70,502)
--------------- ----------------
Total liabilities and shareholders' deficiency $ 923,476 $ 949,774
=============== ================
2
STATEMENTS OF OPERATIONS
(In thousands, except per-share amounts)
--------------------------------------
(Unaudited)
For the three months ended Sept. 30, For the nine months ended Sept. 30,
2001 2000 2001 2000
----------------- ----------------- ----------------- -----------------
Revenue $ 53,330 $ 63,610 $ 176,321 $ 181,008
----------------- ----------------- ----------------- -----------------
Operating expenses:
Network access 17,232 17,821 51,014 56,811
Operations 14,442 13,473 40,820 38,494
Selling, general and administrative 22,361 27,430 76,112 88,875
Severance expense 1,418 110 3,141 152
Depreciation and amortization 19,919 16,306 58,647 43,782
----------------- ----------------- ----------------- -----------------
Total operating expenses 75,372 75,140 229,734 228,114
----------------- ----------------- ----------------- -----------------
Loss from operations (22,042) (11,530) (53,413) (47,106)
Interest expense, net 25,424 20,745 71,788 54,603
Loss (gain) on disposal of assets (94) 117 (61) 893
Interest income and other (99) (259) (326) (853)
----------------- ----------------- ----------------- -----------------
Net loss before income taxes (47,273) (32,133) (124,814) (101,749)
Income tax expense 22 459 449 940
----------------- ----------------- ----------------- -----------------
Net loss $ (47,295) $ (32,592) $ (125,263) $ (102,689)
================= ================= ================= =================
Net loss per common share:
Basic $ (0.92) $ (0.64) $ (2.46) $ (2.04)
Diluted $ (0.92) $ (0.64) $ (2.46) $ (2.04)
Weighted average shares outstanding 51,168 50,606 50,995 50,404
3
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
------------
(Unaudited)
For the nine months ended Sept. 30,
2001 2000
--------------- ---------------
Net cash used in operating activities $(44,307) $ (38,983)
--------------- ---------------
Cash flows used in investing activities:
Capital expenditures (43,906) (90,864)
Cash proceeds from sale of fixed assets 547 -
--------------- ---------------
Net cash used in investing activities (43,359) (90,864)
--------------- ---------------
Cash flows from financing activities:
Revolving bank credit facility proceeds - 150,000
Revolving bank credit facility repayments - (10,000)
Long term funding from Citizens 112,000 -
Payments of capital lease obligation (28,239) (23,676)
Stock issuances 485 5,884
Other (22) (100)
--------------- ---------------
Net cash provided by financing activities 84,224 122,108
--------------- ---------------
Net decrease in cash (3,442) (7,739)
Cash at January 1, 10,318 21,378
--------------- ---------------
Cash at September 30, $ 6,876 $ 13,639
=============== ===============
Supplemental cash flow information:
Non-cash increase in capital lease asset $ 33,985 $ 98,555
4
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIENCY)
(In thousands, except share data)
-------------------------------
(Unaudited)
Common Stock
------------------------------ Additional Shareholders'
Class A Class B Paid-in- Equity
$.01 par $.01 par Capital Deficiency (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 minority
interest by Citizens - - 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
Conversion of common stock 253 (253) - - -
Issuance of restricted stock 1 - (1) - -
Forfeiture of restricted stock - - (346) - (346)
Amortization of restricted stock - - 368 - 368
Stock units payable to non-
employee director - - 24 - 24
Net loss - - - (125,263) (125,263)
----------- -------------- -------------- -------------- -----------------
Balance, September 30, 2001 $ 353 $ 159 $373,457 $ (569,203) $ (195,234)
=========== ============== ============== ============== =================
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 the 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 $1,236,000 and $1,628,000 of interest costs
were capitalized in the three months ended September 30, 2001 and
2000, respectively, and approximately $3,464,000 and $4,898,000 were
capitalized in the nine months ended September 30, 2001 and 2000,
respectively.
c. REVENUE RECOGNITION
We recognize revenue 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. At September 30, 2001, we have 3,970,707 potentially
dilutive stock options at a range of $22.81 to $2.86 per share that
are not included in the calculation as they are antidilutive.
6
2. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are as follows:
($ In thousands) September 30, 2001 December 31, 2000
------------------ -----------------
Property, plant and equipment $ 1,029,724 $ 978,327
Accumulated depreciation and amortization (185,475) (131,611)
----------------- -----------------
Property, plant and equipment, net $ 844,249 $ 846,716
================= =================
Depreciation expense was $19,090,000 and $16,115,000 for the three
months ended September 30, 2001 and 2000, respectively, and
$56,153,000 and $43,263,000 for the nine months ended September 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 27,571,332 shares of
our Class A Common Stock, in total representing an 85% economic
interest and a 96% voting 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
December 31, 2002. The remaining available balance may be drawn to pay
interest expense due under the Citizens Credit Facility until
maturity. As of September 30, 2001, there was $150 million outstanding
under the Citizens Credit Facility, of which $8.6 million was drawn to
pay interest expense and $141.4 million was drawn for general
corporate purposes. Under this facility, $300 million remains
available to be drawn, of which $181.4 million is available to pay
interest expense and $118.6 million is available for general corporate
purposes.
7
This table summarizes the activity in the current liability account
due to Citizens for the nine months ended September 30 and year ended
December 31, 2000.
Nine Months
Ended Year Ended
September 30, December 31,
($ In thousands) 2001 2000
---------------- ----------------
Balance beginning of period $ 7,684 $ 14,650
Guarantee fees 22,121 27,790
Interest expense on Citizens Credit Facility 9,812 663
Administrative services:
Services provided by Citizens 5,384 7,413
ELI expenses paid by Citizens 5,568 6,759
Payments to Citizens (42,630) (49,591)
---------------- ----------------
Balance end of period $ 7,939 $ 7,684
================ ================
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
$22,000 and $459,000 for the three months ended September 30, 2001 and
2000, respectively, and $449,000 and $940,000 for the nine months
ended September 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.
8
PRODUCT 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
nine months ended September 30 were:
For the three months ended Sept. 30, For the nine months ended Sept. 30,
------------------------------------ -----------------------------------
($ In thousands) 2001 2000 2001 2000
---------------- ----------------- --------------- -----------------
Network services $ 26,077 $ 21,627 $ 77,966 $ 54,804
Local telephone services 14,450 25,187 58,114 75,412
Long distance services 3,131 3,728 9,314 12,590
Data services 9,672 13,068 30,927 38,202
---------------- ---------------- ---------------- -----------------
Total $ 53,330 $ 63,610 $ 176,321 $ 181,008
================ ================ ================ =================
We do not currently provide products or services outside the United
States.
MAJOR CUSTOMERS
Qwest Communications (Qwest) accounted for 6.4% and 16.4% of our total
revenue for the three months ended September 30, 2001 and 2000,
respectively, and 10.6% and 19.3% of our total revenue for the nine
months ended September 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 nine months ended September 30, 2001 or
2000.
Included in revenue for the three and nine months ended September 30,
2001 is approximately $0.2 million and $4.0 million, respectively, 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 $0.4 million of revenue monthly.
9
6. 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 would have provided us with fiber
from Salt Lake City to Denver, continuing on to Dallas. Under the
agreement, we were to pay the other carrier approximately $96.9
million over 20 years. Accordingly, we reported a capital lease asset
and related obligation of approximately $34.0 million in our balance
sheet on June 30, 2001, of which $4.6 million is presented in current
portion of long-term debt. Multiple disputes regarding the agreement
have arisen. In September 2001, both ELI and the other carrier
notified each other of potential breaches of the agreement. If the
breaches are valid and not cured, the agreement could terminate by its
terms.
In September 2001, we entered into a 20-year fiber lease agreement
with Sierra Pacific Communications, in which we will lease from them a
specified number of optical fibers. The leased fiber will consist of
five continuous segments located throughout the city of Las Vegas,
Nevada. Estimated completion dates for all segments are scheduled from
November 2001 to March 2002. We will pay a specified amount for each
completed segment, totaling $1.5 million when all segments are
completed.
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.
10
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 the
following possibilities:
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;
o if we are not able to correctly identify future markets or
successfully expand existing ones;
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.
11
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
December 31, 2002. The remaining available balance may be drawn to pay
interest expense due under the Citizens Credit Facility until
maturity.
We drew $112 million from the Citizens Credit Facility to fund
operating and capital expenditures during the nine months ended
September 30, 2001. As of September 30, 2001, there was $150 million
outstanding under the Citizens Credit Facility, of which $8.6 million
was drawn to pay interest expense and $141.4 million was drawn for
general corporate purposes. Under this facility, $300 million remains
available to be drawn, of which $181.4 million is available to pay
interest expense and $118.6 million is available for general corporate
purposes. 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.
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 2002. Citizens has committed to continue to
finance our cash requirements, at market terms and conditions, until
December 31, 2002. Absent the Citizens commitment, we do not believe
there is currently a market to further finance or refinance our
existing indebtedness.
12
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 $8.6 million and
$43.9 million for the three and nine months ended September 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.
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 $2.0 million from
October 1, 2001 through April 30, 2002 and, assuming exercise of the
purchase option, a final payment of approximately $110 million in
April 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 purchase, sell or
re-lease the assets under the lease.
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. The adoption of SFAS
No. 141 is not anticipated to have any impact on our financial
position or results of operations.
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. For
the nine months ended September 30, 2001, we recognized $2.1 million
in goodwill amortization. We will be required to test for impairment
of goodwill annually starting January 1, 2002 and annually thereafter.
The amount of any future impairment, if any, cannot be estimated at
this time.
13
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement addresses the financial
accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the
period in which it is incurred if a reasonable estimate of fair value
can be made. The associated asset retirement costs are capitalized as
part of the carrying amount of the long-lived asset and reported as a
liability. This statement is effective for fiscal years beginning
after June 15, 2002. The adoption of SFAS No. 143 is not anticipated
to have a material impact on our financial position or results of
operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-lived Assets." This statement
establishes a single accounting model, based on the framework
established in SFAS No. 121, for long-lived assets to be disposed of
by sale, whether previously held and used or newly acquired, and
broadens the presentation of discontinued operations to include more
disposal transactions. This statement is effective for fiscal years
beginning after December 15, 2001. We are currently evaluating the
impact of the adoption of SFAS No. 144.
OTHER MATTERS
RECIPROCAL COMPENSATION
We have various interconnection agreements with Qwest, Verizon
Communications (Verizon), Pacific Bell Telephone Company (Pac Bell)
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 $2.7 million and $9.2 million for
the three months ended September 30, 2001 and 2000, respectively, and
$18.4 million and $29.2 million for the nine months ended September
30, 2001 and 2000, respectively. Net trade accounts receivable
relating to reciprocal compensation totaled $2.1 million and $7.7
million at September 30, 2001 and December 31, 2000, respectively.
These agreements are scheduled to expire by December 31, 2001. The
Verizon interconnection agreements expired in May and June 2001 for
Washington and Oregon, respectively. 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.
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 of inbound
to outbound traffic. The rate for above ratio traffic is capped at .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. The effect of implementing the FCC
transitional rates resulted in a reduction of the composite rate of
.088 cents per minute, or 43%, from .203 cents per minute for the six
months ended June 30, 2001 to .115 cents per minute for the third
quarter 2001.
Currently pending before the 9th Circuit Court of Appeals is Verizon's
appeal of the US District Court decision upholding the Oregon Public
Utility Commission decision requiring Verizon to pay reciprocal
compensation for ISP bound traffic terminating to ELI and that
reciprocal compensation payments to ELI should be made at the tandem
rate as opposed to the end office rate. Verizon has paid ELI's
invoices per the terms of the approved interconnection agreement since
the agreement's effective date in June 1999.
14
b. RESULTS OF OPERATIONS
REVENUE
Revenue for the three and nine months ended September 30, 2001
decreased $10.3 million, or 16%, and $4.7 million, or 3%,
respectively, as compared with the prior year periods. The decline in
revenue is primarily due to a net decline in the number of customers
and a decrease in reciprocal compensation. Average number of customers
declined 21%, from 2,852 to 2,256 and 12%, from 2,643 to 2,323, for
the three and nine months ended September 30, 2001, respectively, as
compared with the prior year periods.
For the three months ended Sept. 30, For the nine months ended Sept. 30,
---------------------------------------- ----------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ------------- ------------- ----------
Network services $ 26,077 $ 21,627 21% $ 77,966 $ 54,804 42%
Local telephone services 14,450 25,187 (43%) 58,114 75,412 (23%)
Long distance services 3,131 3,728 (16%) 9,314 12,590 (26%)
Data services 9,672 13,068 (26%) 30,927 38,202 (19%)
------------- ------------- ------------- -------------
Total $ 53,330 $ 63,610 (16%) $ 176,321 $ 181,008 (3%)
============= ============= ============= =============
Major Customers
Included in revenue for the three and nine months ended September 30,
2001 is approximately $0.2 million and $4.0 million, respectively, 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 $0.4 million in revenue monthly.
Network Services
Network services include Private Line Interstate (Long Haul) and
Private Line Intrastate (MAN). Network services revenue for the three
and nine months ended September 30, 2001 increased $4.4 million, or
21%, and $23.2 million, or 42%, 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.
Revenue for the three and nine months ended September 30, 2001
from our Long Haul services decreased $0.1 million, or .4%, and
increased $5.8 million, or 21%, respectively, as compared with
the prior year periods.
Revenue for the three and nine months ended September 30, 2001
from our MAN services increased $4.5 million, or 43%, and $17.4
million, or 63%, respectively, as compared with the prior year
periods.
15
Local Telephone Services
Local telephone services revenue for the three and nine months ended
September 30, 2001 decreased $10.7 million, or 43%, and $17.3 million,
or 23%, respectively, as compared with the prior year periods. Local
telephone services include ISDN PRI, dial tone, Carrier Access
Billings and reciprocal compensation.
For the three months ended Sept. 30, For the nine months ended Sept. 30,
---------------------------------------- ----------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ----------- ------------ ------------- -----------
ISDN PRI $ 6,788 $ 9,296 (27%) $ 21,572 $ 25,527 (15%)
Dial tone 3,614 5,509 (34%) 12,845 14,258 (10%)
Carrier access billings 1,351 1,180 14% 5,275 6,399 (18%)
Reciprocal compensation 2,697 9,202 (71%) 18,422 29,228 (37%)
------------- ------------- ------------- -------------
Total $ 14,450 $ 25,187 (43%) $ 58,114 $ 75,412 (23%)
============= ============= ============= =============
ISDN PRI revenue for the three and nine months ended September
30, 2001 decreased $2.5 million, or 27%, and $3.9 million, or
15%, respectively, as compared with the prior year periods
primarily due to a decrease in ISDN revenue to three customers
resulting from less demand for ISDN PRI trunks servicing internet
routers.
Dial tone revenue decreased $1.9 million, or 34%, and $1.4
million, or 10%, respectively, as compared with the prior year
periods, primarily due to the bankruptcy of a customer, and
decreased installation fees resulting from fewer new customers.
Reciprocal compensation revenue for the three and nine months
ended September 30, 2001 decreased $6.5 million, or 71%, and
$10.8 million, or 37%, respectively, as compared with the prior
year periods. The decrease is due to a decrease in average
monthly minutes processed of 211.0 million, or 18%, and 93.3
million, or 8%, for the three and nine months ended September 30,
2001, respectively, as compared with the prior year periods and
lower weighted average rates per minute. 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 nine months ended
September 30, 2001 decreased $0.6 million, or 16%, and $3.3 million,
or 26%, respectively, as compared with the prior year periods. The
decrease is due to a decrease in wholesale average monthly minutes
processed of 3.3 million, or 20%, and 4.5 million or 25%, for the
three and nine months ended September 30, 2001, as compared to prior
year periods. The decrease is also attributable to the discontinuation
of the Voice Solutions portion of our business.
Data Services
Data services include Internet, RSVP, Frame Relay and other services.
Data services revenue for the three and nine months ended September
30, 2001 decreased $3.4 million, or 26%, and $7.3 million, or 19%,
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.
16
OPERATING EXPENSES
Operating expenses for the three and nine months ended September 30,
2001 increased $0.2 million, 0%, and $1.6 million, or 1%,
respectively, as compared with the prior year period.
For the three months ended Sept. 30, For the nine months ended Sept. 30,
---------------------------------------- ----------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ------------- ------------- ----------
Network access $ 17,232 $ 17,821 (3%) $ 51,014 $ 56,811 (10%)
Operations 14,442 13,473 7% 40,820 38,494 6%
Selling, general and administrative 22,361 27,430 (18%) 76,112 88,875 (14%)
Severance expense 1,418 110 1,189% 3,141 152 1,966%
Depreciation and amortization 19,919 16,306 22% 58,647 43,782 34%
------------- ------------- ------------- -------------
Total $ 75,372 $ 75,140 0% $229,734 $228,114 1%
============= ============= ============= =============
Network Access
Network access expenses include circuit and usage-based charges for
carrying and terminating traffic on another carrier's network and are
primarily fixed in nature.
Network access expenses for the three and nine months ended September
30, 2001 decreased $0.6 million, or 3%, and $5.8 million, or 10%,
respectively, as compared with the prior year periods. The $5.8
million decrease for the nine months ended September 30, 2001 is
attributable to the completion of our coastal long haul network, which
has allowed us to focus on providing on-net services resulting in
reduced variable 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.
Operations expense for the three and nine months ended September 30,
2001 increased $1.0 million, or 7%, and $2.3 million, or 6%,
respectively, as compared with the prior year periods, primarily due
to increases in maintenance costs and related expenses, as well as a
reduction in capitalized overheads. The increase is partially offset
by lower personnel costs due to staffing reductions.
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 nine
months ended September 30, 2001 decreased $5.1 million, or 18%, and
$12.8 million, or 14%, respectively, as compared with the prior year
periods. The decrease is primarily due to a reduction in personnel,
partially offset by an increase in bad debt expense.
Severance Expense
Severance costs for the three and nine months ended September 30, 2001
increased $1.3 million, or 1,189%, and $3.0 million, or 1,966%,
respectively, as compared with the prior year periods. These headcount
reductions, which were made as part of our on-going effort to reduce
costs throughout the business, resulted in a reduction of 233
employees throughout 2001, from 1,161 employees at the beginning of
the year to 928 at September 30, 2001.
17
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 nine months
ended September 30, 2001 increased $3.6 million, or 22%, and $14.9
million, or 34%, respectively, as compared with the prior year
periods. This was primarily due to higher plant in service balances
for newly completed telecommunications network facilities and
electronics and the amortization of goodwill.
INTEREST EXPENSE, NET
For the three months ended Sept. 30, For the nine months ended Sept. 30,
---------------------------------------- ----------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ------------- ------------- ----------
Gross interest expense $ 26,660 $ 22,373 19% $ 75,252 $ 59,501 26%
Capitalized interest (1,236) (1,628) (24%) (3,464) (4,898) (29%)
------------- ------------- ------------- -------------
Interest expense, net $ 25,424 $ 20,745 23% $ 71,788 $ 54,603 31%
============= ============= ============= =============
Gross interest expense for the three and nine months ended September
30, 2001 increased $4.3 million, or 19%, and $15.8 million, or 26%,
respectively, as compared with the prior year periods primarily due to
higher levels of outstanding long-term debt and capital leases. As of
September 30, 2001, we had debt and capital leases outstanding of
$1,012.9 million at a composite rate of 7.3% compared to $862.0
million at a composite rate of 7.2% at September 30, 2000, exclusive
of guarantee fees. The higher balances led to increased interest and
guarantee fees.
Capitalized interest for the three and nine months ended September 30,
2001 decreased $0.4 million, or 24%, and $1.4 million, or 29%,
respectively, as compared with the prior year periods. The decreases
are a result of our efforts to reduce capital expenditures. Our
average Construction Work In Process was reduced by $30.4 million, or
48%, and $53.6 million, or 54%, respectively, as compared with the
prior year periods, partially offset by higher interest rates.
INCOME TAX EXPENSE
For the three months ended Sept. 30, For the nine months ended Sept. 30,
---------------------------------------- ----------------------------------------
($ In thousands) 2001 2000 % Change 2001 2000 % Change
------------- ------------- ---------- ------------- ------------- ----------
Income tax expense $ 22 $ 459 (95%) $ 449 $ 940 (52%)
Income tax expense for the three and nine months ended September 30,
2001 decreased $0.4 million, or 95%, and $0.5 million, or 52%,
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.
18
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 and operating
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 agreement.
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 December 31, 2002 or the completion
of a public or private financing which would satisfy such needs
through that date.
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 September 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 September 30, 2001, the fair value of our long-term debt and
capital lease obligations was estimated to be $999.4 million compared
to $1,005.7 million carrying value, based on our overall weighted
average rate of 7.3% 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
decreased by approximately 11 basis points during the nine month
period. A hypothetical increase of 73 basis points (10% of our overall
weighted average borrowing rate) would result in an approximate $15.5
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 September
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.
19
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 1., 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
None
ITEM 5. OTHER INFORMATION
On April 2, 2001, we received a notice from the Nasdaq Stock Market,
Inc. that our stock would be subject to delisting from the Nasdaq
National Market after July 2, 2001 because our Class A Common Stock
failed to maintain a minimum bid price.
On June 29, 2001, we filed an application for our listing to be
transferred to the Nasdaq SmallCap Market. As part of the application
process, Citizens Communications converted approximately 25.3 million
shares of its Class B Common Stock into the same number of shares of
its Class A Common Stock on August 27, 2001.
On August 31, 2001, we received a notice from Nasdaq indicating that
we had failed to comply with the shareholders' equity, market
capitalization, market value/total assets and revenue and minimum bid
price requirements for continued listing, and that our stock was,
therefore, subject to delisting from the Nasdaq National Market. We
were granted a hearing before a Nasdaq Listing Qualifications Panel to
review the delisting.
On September 27, 2001, Nasdaq implemented a moratorium on the minimum
bid price and market value of public float requirements for continued
listing on the Nasdaq Stock Market until January 2, 2002. We received
a notice from Nasdaq on that date stating that as a result of that
action the hearing scheduled regarding the delisting of our stock had
been canceled and our hearing file closed for now.
As of January 2, 2002, compliance with the minimum requirements for
listing on the Nasdaq National and SmallCap Markets will start anew.
If we do not meet these requirements for 30 consecutive days, and are
unable to regain compliance within 90 days of January 2, our stock
could be subject to delisting at that time. It is uncertain whether we
will be able to meet the applicable listing requirements. 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. 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.
20
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 July 2, 2001, we filed Form 8-K under Item 5, "Other Events" and
Item 7, "Financial Statements and Exhibits," a press release
announcing we filed an application with the Nasdaq Stock Market, Inc.
to trade our Class A Common Stock on the SmallCap Market.
On August 10, 2001, we filed Form 8-K under Item 5, "Other Events" and
Item 7, "Financial Statements and Exhibits," a press release
announcing earnings for the three and six months ended June 30, 2001.
On August 28, 2001, we filed Form 8-K under Item 5, "Other Events" and
Item 7, "Financial Statements and Exhibits," a press release
announcing Citizens Communications' conversion of 25,283,688 shares of
our Class B Common Stock into Class A Common Stock on a one for one
basis.
On September 10, 2001, we filed Form 8-K under Item 5, "Other Events"
and Item 7, "Financial Statements and Exhibits", a press release
announcing that we had received a Nasdaq staff determination that we
had failed to comply with the shareholders' equity, market
capitalization, market value/total assets and revenue and minimum bid
price requirements for continued listing and that our securities were
subject to delisting from the Nasdaq national market, and that we had
requested a hearing before a Nasdaq Listing Qualifications Panel to
review the staff determination.
21
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
November 13, 2001
22