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 March 31, 2002
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2002
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
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
April 30, 2002 were:
Common Stock Class A 35,414,784
Common Stock Class B 15,881,312
INDEX
Page No.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets at March 31, 2002 (unaudited) and December 31, 2001 2
Statements of Operations for the Three Months Ended
March 31, 2002 and 2001 (unaudited) 3
Condensed Statements of Cash Flows for the Three Months Ended
March 31, 2002 and 2001 (unaudited) 4
Statements of Shareholders' Deficiency for the Three Months Ended
March 31, 2002 (unaudited) and the Year Ended December 31, 2001 5
Notes to Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 19
PART II. OTHER INFORMATION 20
SIGNATURE 21
1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
March 31, December 31,
Assets 2002 2001
---------------- ---------------
Current assets:
Cash $ 4,047 $ 5,285
Trade receivables, net 16,150 13,152
Other receivables 5,277 5,353
Other current assets 3,444 3,603
---------------- ---------------
Total current assets 28,918 27,393
Property, plant and equipment, net 815,478 832,704
Goodwill, net - 39,812
Other assets 2,034 2,439
---------------- ---------------
Total assets $ 846,430 $ 902,348
================ ===============
Liabilities and Shareholders' Deficiency
Current liabilities:
Current portion of Bank Credit Facility $ 400,000 $ 400,000
Accounts payable and accrued liabilities 19,993 24,153
Current portion of capital lease obligations 7,453 7,404
Due to Citizens Communications Company 12,981 9,586
Accrued taxes, other than income taxes 19,147 15,129
Interest payable 20,570 13,769
Other current liabilities 4,515 4,288
---------------- ---------------
Total current liabilities 484,659 474,329
Deferred revenue 15,055 15,427
Deferred income taxes payable 4,264 4,212
Other long-term liabilities 440 511
Capital lease obligations 129,423 129,978
Long-term debt 325,000 325,000
Due to Citizens Communications Company 212,500 194,500
---------------- ---------------
Total liabilities 1,171,341 1,143,957
---------------- ---------------
Shareholders' deficiency:
Common stock issued, $.01 par value
Class A, authorized 110,000,000 shares, 35,414,784 and
35,423,440 outstanding and 35,520,568 and 35,517,235 shares
issued at March 31, 2002 and December 31, 2001, respectively 354 354
Class B, authorized 60,000,000 shares, 15,881,312 shares
issued and outstanding at March 31, 2002 and
December 31, 2001 159 159
Additional paid-in-capital 373,591 373,510
Accumulated deficiency (699,015) (615,632)
---------------- ---------------
Total shareholders' deficiency (324,911) (241,609)
---------------- ---------------
Total liabilities and shareholders' deficiency $ 846,430 $ 902,348
================ ===============
The accompanying Notes are an integral part of these Financial Statements
2
STATEMENTS OF OPERATIONS
(In thousands, except per-share amounts)
(Unaudited)
For the three months ended March 31,
2002 2001
---------------- ----------------
Revenue $ 48,150 $ 62,562
---------------- ----------------
Operating expenses:
Network access 13,594 16,731
Operations 11,846 12,142
Selling, general and administrative 20,195 29,161
Severance expense 43 1,235
Depreciation and amortization 19,652 18,894
---------------- ----------------
Total operating expenses 65,330 78,163
---------------- ----------------
Loss from operations (17,180) (15,601)
Interest expense, net 26,163 22,050
Loss (gain) on disposal of assets 187 (11)
Interest income and other (11) (109)
---------------- ----------------
Net loss before income taxes (43,519) (37,531)
Income tax expense (See Note 4) 52 163
---------------- ----------------
Net loss before cumulative effect of change in accounting principle (43,571) (37,694)
Cumulative effect of change in accounting principle (39,812) -
---------------- ----------------
Net loss $ (83,383) $ (37,694)
================ ================
Net loss per share before cumulative effect of change in accounting principle:
Basic $ (0.85) $ (0.74)
Diluted $ (0.85) $ (0.74)
Net loss per common share:
Basic $ (1.63) $ (0.74)
Diluted $ (1.63) $ (0.74)
Weighted average shares outstanding 51,266 50,759
The accompanying Notes are an integral part of these Financial Statements
3
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
For the three months ended March 31,
2002 2001
--------------- ----------------
Net cash (used for) provided by operating activities $ (14,570) $ 2,599
--------------- ----------------
Cash flows used for investing activities:
Capital expenditures (4,247) (20,430)
Cash proceeds from sale of fixed assets 85 96
--------------- ----------------
Net cash used for investing activities (4,162) (20,334)
--------------- ----------------
Cash flows from financing activities:
Long term funding from Citizens 18,000 20,000
Payments of capital lease obligation (506) (2,611)
Other - (13)
--------------- ----------------
Net cash provided by financing activities 17,494 17,376
--------------- ----------------
Net decrease in cash (1,238) (359)
Cash at January 1, 5,285 10,318
--------------- ----------------
Cash at March 31, $ 4,047 $ 9,959
=============== ================
Supplemental cash flow information:
Cash paid for interest, net of capitalized portion $ 19,668 $ 16,156
The accompanying Notes are an integral part of these Financial Statements
4
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIENCY)
(In thousands, except share data)
(Unaudited)
Class A Common Stock, Class B Common Stock,
--------------------- --------------------- Additional
$.01 per share $.01 per share Paid-in- Accumulated Shareholders'
Shares Amount Shares Amount Capital Deficiency Deficiency
--------------------- --------------------- ----------- ------------ ------------
Balance, January 1, 2001 9,658,437 $ 96 41,165,000 $ 412 $ 372,930 $ (443,940) $ (70,502)
Issuance of common stock 505,628 5 - - 536 - 541
Conversion of common stock 25,283,688 253 (25,283,688) (253) - - -
Issuance of restricted stock 50,000 1 - - (1) - -
Forfeiture of restricted stock (26,667) - - - (259) - (259)
Common stock returned for taxes (47,646) (1) - - (22) - (23)
Amortization of restricted stock - - - - 281 - 281
Stock units payable to non-
employee director - - - - 45 - 45
Net loss - - - - - (171,692) (171,692)
--------------------- -------------------- ------------ ----------- ------------
Balance, December 31, 2001 35,423,440 $ 354 15,881,312 $ 159 $ 373,510 $ (615,632) $(241,609)
Common stock returned for taxes (8,656) - - - (4) - (4)
Amortization of restricted stock - - - - 85 - 85
Net loss - - - - - (83,383) (83,383)
--------------------- -------------------- ------------ ----------- ------------
Balance, March 31, 2002 35,414,784 $ 354 15,881,312 $ 159 $ 373,591 $ (699,015) $(324,911)
===================== ==================== ============ =========== ============
The accompanying Notes are an integral part of these Financial Statements
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 accounting principles generally accepted in the United States of
America (GAAP) for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. 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, 2001.
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 Communications Company ("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, which would provide the funds necessary to support our cash
requirements or March 31, 2003. Absent the Citizens commitments, we do not
believe there is currently a market to further finance or refinance our
indebtedness. Consequently, without the financial support of Citizens, we
could not fund our future capital requirements or service our debt and most
likely would not remain a going concern.
b. CAPITALIZED INTEREST
Property, plant and equipment includes interest costs capitalized during
the installation and expansion of our telecommunications network.
Approximately $306,000 and $958,000 of interest costs were capitalized in
the three months ended March 31, 2002 and 2001, respectively.
c. REVENUE RECOGNITION
We recognize revenues from communications services when the services are
provided. Prepaid network services revenue under long-term agreements
including Indefeasible Right to Use (IRU) and Fiber Swap 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.
We recognize reciprocal compensation revenues as earned, based on the terms
of the interconnection agreements and make subsequent adjustments to
revenue based upon management judgments as to realizability.
6
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 March 31,
2002, we have 3,725,204 potentially dilutive stock options at a range of
$0.32 to $22.81 per share that are not included in the calculation as they
are antidilutive. At March 31, 2002 and 2001, restricted stock awards of
33,333 shares and 85,000 shares, respectively, are excluded from our basic
weighted average shares outstanding until the shares are no longer
contingent upon the satisfaction of all specified conditions. These
restricted stock awards are also excluded from our dilutive weighted
average shares outstanding because their effect would be antidilutive.
2. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are as follows:
($ In thousands) March 31, 2002 December 31, 2001
-------------- -----------------
Property, plant and equipment $ 1,038,946 $ 1,037,349
Accumulated depreciation (223,468) (204,645)
-------------- ----------------
Property, plant and equipment, net $ 815,478 $ 832,704
============== ================
Depreciation expense was $19,521,000 and $18,056,000 for the three months
ended March 31, 2002 and 2001, 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. Also, we believe 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 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). As of March 31, 2002, there was $212.5
million outstanding under the Citizens Credit Facility. On April 30, 2002,
we borrowed an additional $110 million from Citizens under the Citizens
Credit Facility to fund the purchase of leased facilities. Citizens has
committed to continue to finance our cash requirements, at market terms and
conditions, until the earlier of completion of a public or private
financing, which would provide the funds necessary to support our cash
requirements or March 31, 2003. (See Note 8)
7
This table summarizes the activity in the liability account Due to Citizens
Communications Company for the three months ended March 31,
($ In thousands) 2002 2001
-------------- ----------------
Balance beginning of period $ 9,586 $ 7,684
Guarantee fees 7,292 7,292
Interest expense on Credit Facility 7,624 1,695
Administrative services:
Services provided by Citizens 1,592 2,223
ELI expenses paid by Citizens 5,364 1,692
Payments to Citizens (18,477) (11,156)
-------------- ----------------
Balance end of period $ 12,981 $ 9,430
============== ================
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 before cumulative
effect of a change in accounting principle of $52,000 and $163,000 for the
three months ended March 31, 2002 and 2001, 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
otherwise remain 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 the following categories:
* Network Services - includes point-to-point dedicated service between
two or more locations for our customers' exclusive use. We offer this
product in both local and long-haul applications.
8
* Local Telephone Services - includes local dial tone and related
services that provide incoming and outgoing calls over the public
switched network. This category includes reciprocal compensation
revenues.
* Long Distance Services - includes retail and wholesale long distance
phone services.
* Data Services - includes 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 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.
Revenue is generated from the following services for the three months ended
March 31, 2002 and March 31, 2001.
($ In thousands) 2002 2001
-------------- ----------------
Network services $ 23,787 $ 25,768
Local telephone services 12,933 21,797
Long distance services 3,082 3,084
Data services 8,348 11,913
-------------- ----------------
Total $ 48,150 $ 62,562
============== ================
We do not provide products or services outside the United States.
MAJOR CUSTOMERS
Qwest Communications (Qwest) accounted for 6% and 12% of our total revenue
for the three months ended March 31, 2002 and 2001, respectively. 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
months ended March 31, 2002 or 2001.
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 customers are under Chapter 11 protection. These
customers contributed approximately $0.3 million of revenue monthly.
6. EXIT COSTS
In the first half of 2002, we intend to redeploy our internet routers,
frame relay switches and ATM switches from the Atlanta, Cleveland, Denver,
Philadelphia and New York markets to other locations in our network. We
intend to cease leasing the collocation facilities and off-net circuits for
the backbone and local loops supporting the service delivery in these
markets. It was anticipated that this would lead to $4.2 million of
termination fees which were accrued for but not paid and included in our
Network Access expense for the year ended December 31, 2001. In the first
quarter 2002, we adjusted our original accrual down by $2.1 million due to
the favorable settlement of termination charges for an off-net circuit
agreement paid in April 2002. The remaining accrual of $2.1 million is
included in current liabilities at March 31, 2002 and the $2.1 million
reduction is included as a reduction to network access expense.
Beginning Amount
Accrual Paid Remaining
($ In thousands) Amount to Date Adjustments Accrual
--------------- -------------- -------------- -------------
2001 Exit Costs
For the year ended December 31, 2001 $ 4,179 - - $ 4,179
For the three months ended March 31, 2002 $ 4,179 - (2,100) $ 2,079
9
7. CHANGE IN ACCOUNTING PRINCIPLE AND NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets." SFAS 142 is effective January 1, 2002. We are
required to test for impairment of goodwill and assets deemed to have an
indefinite life as of January 1, 2002 and annually thereafter. As a result
of the adoption of SFAS 142, we recognized a transitional impairment loss
of our goodwill of $39.8 million as a cumulative effect of a change in
accounting principle in our statement of operations in the first quarter of
2002. As of the date of adoption, we had unamortized goodwill in the amount
of $39.8 million. We utilized a discounted cash flow valuation model in
reaching our conclusions regarding goodwill impairment. Subsequent to this
write-off, we have no intangibles with indefinite lives.
The amortization of goodwill ceased upon adoption of SFAS 142 on January 1,
2002, and applies to all goodwill and certain other intangible assets with
an indefinite useful life recognized in the statement of financial position
at that date, regardless of when the assets were initially recognized.
The following table presents a reconciliation between reported net loss and
adjusted net loss:
(In thousands, except per-share amounts) For the three months ended March 31,
-------------------------------------------
2002 2001
-------------------- -------------------
Reported net loss $ (83,383) $ (37,694)
Add back: Goodwill amortization - 697
-------------------- -------------------
Adjusted net loss $ (83,383) $ (36,997)
==================== ===================
Basic and Diluted earnings per share:
Reported net loss $ (1.63) $ (0.74)
Goodwill amortization, net of tax - 0.01
-------------------- -------------------
Adjusted net loss $ (1.63) $ (0.73)
==================== ===================
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 was adopted on January 1, 2002. We test for impairment of
long-lived assets on a quarterly basis. The test requires that we develop a
business plan that considers operating results, capital investment and
financing requirements necessary to achieve these results. Our performance
objectives assume that the Company will not be adversely impacted by
unknown external forces such as changes in the U.S. economy, rapid and
unanticipated technological changes, regulatory, tax and other changes. We
believe that the assumptions used in developing our overall business plan
are reasonable but we caution that they are subjective. The adoption of
SFAS 144 did not have a material impact on our financial statements.
8. COMMITMENTS AND CONTINGENCIES
In 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 served as agent for the construction of these
projects and upon completion of each project leased the facilities for a
three year term, with one year renewals available through April 30, 2002.
At March 31, 2002, we were leasing assets with an original cost of
approximately $108,541,000 under this agreement. In January 2002, we
exercised our option to purchase the facilities at the end of the lease
terms for the amount of the lessor's investment in the facilities. On April
30, 2002 a final payment of $110 million was made using funding from the
$450 million Citizens Credit Facility. Citizens had guaranteed our
obligations under this operating lease and we paid Citizens a guarantee fee
of 3.25% per annum on the $110 million through April 30, 2002.
10
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 - 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 were
to 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, a capital lease asset and related obligation of approximately
$34.0 million is included in our balance sheet on March 31, 2002, of which
$5.3 million is presented in current portion of capital lease obligations.
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.
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.
11
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:
* if there are changes in the nature and pace of technological advances
in our industry;
* if a restructuring occurs in the telecommunications industry generally
and its nature and effect;
* 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
ILECs;
* if our business strategy or its execution, including financial
performance goals, is not as successful as we anticipate;
* 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 ISPs;
* if we do not receive the services and support which we require from
the regional ILECs operating in our markets or cannot maintain our
current relationships with ILECs;
* if a significant number or volume of our customers, 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;
* 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;
* if we are not able to obtain additional financing from Citizens on
favorable terms;
* if the market price for telecommunications industry stocks, generally,
and our common stock specifically, remains depressed;
* 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 2001 Annual Report on Form
10-K.
12
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. Our product
offerings include:
* Network services - includes dedicated service between two points for a
customer's exclusive use. We offer this service in both local and
long-haul applications and collocation facilities to meet us directly
in our hub.
* Local telephone services - consists of 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.
* Long distance services - includes retail and wholesale long distance
phone services.
* Data services - includes 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
The Citizens Credit Facility provides up to $450 million with an interest
rate of 15% and a final maturity of October 30, 2005.
We drew $18 million from the Citizens Credit Facility to fund operating and
capital expenditures for the three months ended March 31, 2002. As of March
31, 2002, we have drawn $212.5 million from the Citizens Credit Facility.
On April 30, 2002, we borrowed an additional $110 million from Citizens
under the Citizens Credit Facility for the purchase of leased facilities.
Additionally, we have outstanding $325 million five-year 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 2002. 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, which would provide the funds
necessary to support our cash requirements or March 31, 2003. Absent the
Citizens commitment, we do not believe there is currently a market to
further finance or refinance our existing indebtedness.
Our cash capital expenditures were approximately $4.2 million in the first
quarter 2002. We originally budgeted $71.6 million of cash capital
expenditures for 2002, which we adjusted to $15.0 million in April 2002.
Our cash capital expenditures, combined with our operating expenses and
declining revenues, 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.
13
NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets." SFAS 142 is effective January 1, 2002. We are
required to test for impairment of goodwill and assets deemed to have an
indefinite life as of January 1, 2002 and annually thereafter. As a result
of the adoption of SFAS 142, we recognized a transitional impairment loss
of our goodwill of $39.8 million as a cumulative effect of a change in
accounting principle in our statement of operations in the first quarter of
2002. As of the date of adoption, we had unamortized goodwill in the amount
of $39.8 million. Subsequent to this write-off, we have no intangibles with
indefinite lives.
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. We are currently evaluating
the impact of the adoption of SFAS No. 143.
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 was adopted on January 1, 2002. We test for impairment of
long-lived assets on a quarterly basis. The test requires that we develop a
business plan that considers operating results, capital investment and
financing requirements necessary to achieve these results. Our performance
objectives assume that the Company will not be adversely impacted by
unknown external forces such as changes in the U.S. economy, rapid and
unanticipated technological changes, regulatory, tax and other changes. We
believe that the assumptions used in developing our overall business plan
are reasonable but we caution that they are subjective. The adoption of
SFAS 144 did not have a material impact on our financial statements.
OTHER MATTERS
RECIPROCAL COMPENSATION
We have various interconnection agreements with Qwest (formerly U S WEST),
Verizon (formerly GTE), SBC (PacBell) and Sprint, the dominant ILECs in the
states in which we operate. These agreements govern reciprocal compensation
relating to the transport and termination of traffic between the ILECs'
networks and our network. 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 which is generally higher.
Implementation of the FCC's transitional rates for ISP-bound traffic is
taking place via amendments to certain existing interconnection agreements.
14
We recognize reciprocal compensation revenue as earned, based on the terms
of the interconnection agreements. We recognized reciprocal compensation
revenues of $2.8 million and $7.7 million for the three months ended March
31, 2002 and 2001, respectively. Net trade accounts receivable relating to
reciprocal compensation totaled $2.3 million and $2.2 million at March 31,
2002 and December 31, 2001, respectively. The Verizon interconnection
agreements expired in May and June 2001 for Washington and Oregon,
respectively. We are currently negotiating a new agreement with Verizon.
The existing terms of the interconnection agreements remain in place during
the negotiations. We have completed negotiating a new interconnection
agreement with PacBell, effective April 2002. The new PacBell agreement
does not change current reciprocal compensation rates. As a result of
recent FCC mandates we do not anticipate that renewal of the
interconnection agreements will be at terms as favorable to us as in the
past.
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. The tandem rate is higher than the end office rate
because the traffic is serviced by a tandem switch. A tandem switch is an
intermediate switch; an end office switch is one which carries the traffic
to the end user. Verizon has paid ELI's invoices per the terms of the
approved interconnection agreement since the agreement's effective date in
June 1999.
b. RESULTS OF OPERATIONS
REVENUE
Revenue decreased $14.4 million, or 23%, for the first quarter 2002 over
the first quarter 2001. The decline in revenue is primarily due to a
decrease in reciprocal compensation, a downturn in economic conditions that
affected our internet service providers and wholesale customers, a decline
in data services due to the expiration of a material contract in February
2001 and lower demand for Network long haul services.
For the three months ended March 31,
--------------------------------------------
($ In thousands) 2002 2001 % Change
------------ ------------- -------------
Network services $ 23,787 $ 25,768 (8%)
Local telephone services 12,933 21,797 (41%)
Long distance services 3,082 3,084 (0%)
Data services 8,348 11,913 (30%)
------------ -------------
Total $ 48,150 $ 62,562 (23%)
============ =============
Network Services
Network services revenue decreased $2.0 million, or 8%, for the first
quarter 2002 over the first quarter 2001. Network services include Private
Line Interstate (Long Haul) and Private Line Intrastate (MAN).
* Revenue from our Long Haul services decreased $3.4 million, or 26%,
for the first quarter 2002 over the first quarter 2001. The decrease
is primarily due to lower demand from wholesale customers and current
market price pressures.
* Revenue from our MAN services increased $1.4 million, or 12%, for the
first quarter 2002 over the first quarter 2001. The increase is
primarily due to continued growth in our network and sales of
additional circuits to new and existing customers.
15
Local Telephone Services
Local telephone services revenue decreased $8.9 million, or 41%, for the
first quarter 2002 compared to the first quarter 2001. Local telephone
services include ISDN PRI, dial tone, Carrier Access Billings and
reciprocal compensation.
For the three months ended March 31,
-------------------------------------------
($ In thousands) 2002 2001 % Change
------------ ------------- ------------
ISDN PRI $ 5,300 $ 8,030 (34%)
Dial tone 3,581 4,703 (24%)
Carrier access billings 1,224 1,350 (9%)
Reciprocal compensation 2,828 7,714 (63%)
------------ -------------
Total $ 12,933 $ 21,797 (41%)
============ =============
* ISDN PRI revenue decreased $2.7 million, or 34%, for the first quarter
2002 over the first quarter 2001. Dial tone revenue decreased $1.1
million, or 24%, for the first quarter 2002 over the first quarter
2001. Decreases in revenue for both ISDN PRI and dial tone is the
result of a decrease in the average access line equivalents for the
first quarter 2002 over the first quarter 2001.
* Reciprocal compensation revenue decreased $4.9 million, or 63%, for
the first quarter 2002 compared to the first quarter 2001. The
decrease is primarily due to a decrease in average monthly minutes
processed of 400 million, or 34%, for the first quarter 2002 compared
to the first quarter 2001, and a 44% decrease in average rates per
minute due to the effect of implementing the FCC transitional rates.
See above for further discussion of reciprocal compensation.
Long Distance Services
Long distance services revenue remained flat for the first quarter 2002
compared to the first quarter 2001. Long distance services include retail
and wholesale long distance.
* Retail long distance revenue increased $0.4 million, or 18%, for the
first quarter 2002 compared to the first quarter 2001. The increase is
primarily due to an increase in average monthly minutes processed of
3.3 million, or 38%, offset by a 21% decrease in average rates per
minute for the three months ended March 31, 2002.
* Wholesale long distance revenue decreased $0.4 million, or 31%, for
the first quarter 2002 compared to the first quarter 2001. The
decrease is due to a decrease in average monthly minutes processed of
2.5 million, or 18%, and a decrease of 20% in average rates per minute
for the three months ended March 31, 2002.
Data Services
Data services revenue decreased $3.6 million, or 30%, for the first quarter
2002 compared to the first quarter 2001. Data services include Internet,
RSVP, Frame Relay and other services.
* Other Data Services revenue decreased $3.1 million, or 72%, for the
first quarter 2002 compared to the first quarter 2001, 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.
* Revenue from our Frame Relay product decreased $0.4 million, or 21%,
for the first quarter 2002 over the first quarter 2001.
16
* Revenue from our Internet services product decreased $0.3 million, or
8%, for the first quarter 2002 over the first quarter 2001.
* These decreases were offset by increased revenue from our RSVP
products of $0.3 million, or 24%, for the first quarter 2002 over the
first quarter 2001 primarily due to the increased number of ports
sold.
OPERATING EXPENSES
Operating expenses decreased $12.8 million, or 16%, for the first quarter
2002 over the first quarter 2001.
For the three months ended March 31,
--------------------------------------
($ In thousands) 2002 2001 % Change
----------- ----------- -----------
Network access $ 13,594 $ 16,731 (19%)
Operations 11,846 12,142 (2%)
Selling, general and administrative 20,195 29,161 (31%)
Severance expense 43 1,235 (97%)
Depreciation and amortization 19,652 18,894 4%
------------ -----------
Total $ 65,330 $ 78,163 (16%)
============ ===========
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 months ended March 31, 2002 decreased
$3.1 million, or 19%, compared to the same period in 2001. The decrease is
a result of a favorable settlement of termination charges of $2.1 million
and the disconnection of certain off-net circuits resulting from the
redeployment of internet routers, frame relay switches and ATM switches
from certain cities.
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 expenses decreased $0.3 million, or 2%, for the first quarter
2002 over the first quarter 2001, primarily due to decreases in personnel
and related costs, operating rents and related expenses to support the
delivery of services, partially offset by decreases in capitalized labor.
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 decreased $9.0 million, or
31%, for the first quarter 2002 over the first quarter 2001. The decrease
is primarily due to a reduction in personnel and related costs as well as
decreases in bad debt expense and outside services.
17
Severance Expense
Severance costs in 2002 and 2001 represent the impact of headcount
reductions, which were made as part of our on-going effort to reduce costs
throughout the business, and resulted in a reduction of 288 employees
throughout 2001.
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 in 2001.
Depreciation expense increased $1.5 million, or 8%, for the first quarter
2002 over the first quarter 2001. This was primarily due to higher plant in
service balances for newly completed telecommunications network facilities
and electronics and increased expense due to capital lease additions.
Amortization expense decreased $0.7 million, or 84%, for the first quarter
2002 over the first quarter 2001. This was primarily due to the adoption of
SFAS 142, which eliminates goodwill amortization.
INTEREST EXPENSE, NET
For the three months ended March 31,
--------------------------------------------
($ In thousands) 2002 2001 % Change
------------ ------------- -------------
Gross interest expense $ 26,469 $ 23,008 15%
Capitalized interest (306) (958) (68%)
------------ -------------
Interest expense, net $ 26,163 $ 22,050 19%
============ =============
Gross interest expense increased $3.5 million, or 15%, for the first
quarter 2002 over the first quarter 2001, primarily due to higher levels of
outstanding long-term debt. As of March 31, 2002, we had outstanding debt
and capital leases of $1,074.4 million compared to $912.6 million at March
31, 2001.
Capitalized interest decreased $0.7 million, or 68%, for the first quarter
2002 over the first quarter 2001. The decrease is due to a reduction in
average Construction Work In Process of $17.4 million, or 68%, for the
first quarter 2002 compared to the first quarter 2001.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
For the three months ended March 31,
---------------------------------------------
($ In thousands) 2002 2001 % Change
------------- ------------- -------------
Cumulative effect of change in accounting principle $ 39,812 $ - 100%
In July 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and
Other Intangible Assets." SFAS 142 is effective January 1, 2002. As a
result of the adoption of SFAS 142, we recognized a transitional impairment
loss of our goodwill of $39.8 million as a cumulative effect of a change in
accounting principle in our statement of operations in the first quarter of
2002.
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 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 March 31, 2003.
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 March 31, 2002, a
near-term change in interest rates would not materially affect our
financial position, results of operations or cash flows.
SENSITIVITY ANALYSIS
At March 31, 2002, the fair value of our long-term debt and capital lease
obligations was estimated to be $425.5 million compared to $666.9 million
carrying value, based on our overall weighted average rate of 7.2% and our
overall weighted maturity of 6 years. There has been no material change in
the weighted average maturity applicable to our obligations since December
31, 2001. However, the overall weighted average interest rate has declined
by approximately 6 basis points, consistent with the general decline of
interest rates during the first quarter 2002. A hypothetical increase of 72
basis points (10% of our overall weighted average borrowing rate) would
result in an approximate $6.0 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 March 31, 2002. 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 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
None.
ITEM 5. OTHER INFORMATION
None.
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 March 8, 2002, we filed a current report on Form 8-K, under Item 5,
"Other Events", to make available a press release dated March 7, 2002,
regarding our fourth quarter and fiscal 2001 financial results.
20
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
May 15, 2002