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, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Commission File Number 333-51037)
ICG SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 84-1448147
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
161 Inverness Drive West
Englewood, Colorado 80112
(888) 424-1144 or (303) 414-5000
(Address of principal executive offices and registrant's telephone numbers,
including area codes)
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 12 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 90 days. Yes X No
On May 10, 2000, ICG Services, Inc. had 10 shares of common stock
outstanding. ICG Communications, Inc. owns all of the issued and outstanding
shares of common stock of ICG Services, Inc.
TABLE OF CONTENTS
PART I ........................................................................3
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS ...............................3
Consolidated Balance Sheets as of December 31, 1999
and March 31, 2000 (unaudited)................................3
Consolidated Statements of Operations for the Three Months
Ended March 31, 1999 and 2000 (unaudited).....................5
Consolidated Statement of Stockholders' Equity for
the Three Months Ended March 31, 2000 (unaudited).............6
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 1999 and 2000 (unaudited) ....................7
Notes to Consolidated Financial Statements (unaudited) ..........9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .....23
PART II ......................................................................25
ITEM 1. LEGAL PROCEEDINGS ..............................................25
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ......................25
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ................................25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............25
ITEM 5. OTHER INFORMATION ..............................................25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ..............................25
Exhibits .......................................................25
Reports on Form 8-K ............................................25
2
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1999 and March 31, 2000 (unaudited)
December 31, March 31,
1999 2000
------------- -------------
Assets (in thousands)
Current assets:
Cash and cash equivalents $ 43,222 11,361
Short-term investments available for
sale 10,442 22,635
Receivables:
Network services, including
amounts due from ICG (notes
5 and 6) 7,412 10,828
Leasing services, due from ICG
(notes 5 and 6) 66,652 63,324
Due from ICG (notes 5 and 6) 128,893 121,690
Other 500 2,700
------------- -------------
203,457 198,542
------------- -------------
Prepaid expenses, deposits and
inventory 2,942 3,178
------------- -------------
Total current assets 260,063 235,716
------------- -------------
Property and equipment 916,953 1,037,460
Less accumulated depreciation (64,273) (88,536)
------------- -------------
Net property and equipment 852,680 948,924
------------- -------------
Restricted cash 1,030 1,041
Investments in partnership interests,
common stock, and restricted and
exchangeable preferred stock (note 4) 11,250 2,400
Investments, accounted for under the
equity method (note 4) 41,152 35,944
Deferred financing and lease
administration costs, net of
accumulated amortization of $3.9
million and $4.7 million at December
31, 1999 and March 31, 2000,
respectively 20,663 20,590
Other assets 919 866
------------- -------------
Total assets (note 8) $ 1,187,757 1,245,481
============= =============
(Continued)
3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, March 31,
1999 2000
------------- -------------
Liabilities and Stockholders' Equity (in thousands)
Current liabilities:
Accounts payable $ 113,372 64,522
Payable pursuant to IRU agreement 135,322 157,618
Accrued liabilities, including amounts
due to ICG (note 6) 38,718 19,529
Deferred gain on sale (note 3) 5,475 -
Current portion of capital lease
obligations 1,951 5,053
Current portion of long-term debt (note 5) 750 750
------------- -------------
Total current liabilities 295,588 247,472
------------- -------------
Capital lease obligations, less current
portion 5,784 13,302
Long-term debt, net of discount, less
current portion (note 5) 767,167 878,042
Other long-term liabilities (note 6) 2,500 2,500
------------- -------------
Total liabilities 1,071,039 1,141,316
------------- -------------
Stockholders' equity:
Common stock, $.01 par value, 1,000
shares authorized; 10 shares issued and
outstanding at December 31, 1999 and
March 31, 2000 - -
Additional paid-in capital 129,402 129,402
Accumulated deficit (12,684) (27,566)
Accumulated other comprehensive income - 2,329
------------- -------------
Total stockholders' equity 116,718 104,165
------------- -------------
Commitments and contingencies (notes 5 and 6)
Total liabilities and stockholders'
equity $ 1,187,757 1,245,481
============= =============
See accompanying notes to consolidated financial statements.
4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Three Months Ended March 31, 1999 and 2000 (unaudited)
Three months ended
March 31,
-----------------------
1999 2000
---------- -----------
(in thousands)
Revenue (notes 6 and 8) $ 14,603 43,826
Operating costs and expenses:
Operating costs 586 9,446
Selling, general and administrative
expenses, including amounts allocated
from ICG (note 6) 389 2,093
Depreciation (note 8) 7,130 21,184
---------- -----------
Total operating costs and expenses 8,105 32,723
---------- -----------
Operating income 6,498 11,103
Other (expense) income:
Interest expense (notes 5 and 8) (15,638) (24,879)
Interest income, including amounts earned
from ICG (note 6) 8,315 3,922
Other income, net, including unrealized
gain on marketable trading securities
in 1999 and realized gain on
available for sale securities in 2000 439 180
---------- -----------
(6,884) (20,777)
---------- -----------
Loss before share of losses of equity
investees and extraordinary gain (386) (9,674)
Share of losses of equity investees (note 8) (1,262) (5,208)
---------- -----------
Loss before extraordinary gain (1,648) (14,882)
---------- -----------
Extraordinary gain on sales of operations
of NETCOM, net of income taxes of $6.4
million (notes 3 and 8) 193,029 -
---------- -----------
Net (loss) income $ 191,381 (14,882)
========== ===========
Other comprehensive income:
Unrealized gain on available for sale
securities - 2,329
---------- -----------
Comprehensive (loss) income $ 191,381 (12,553)
========== ===========
See accompanying notes to consolidated financial statements.
5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
Three Months Ended March 31, 2000 (unaudited)
Accumulated
Common stock Additional other Total
----------------- paid-in Accumulated comprehensive stockholders'
Shares Amount capital deficit income equity
------- -------- ----------- ------------- --------------- ---------------
(in thousands)
Balances at January 1, 2000 - $ - 129,402 (12,684) - 116,718
Unrealized holding gain on
available for sale
securities, arising
during the period,
net of tax - - - - 2,810 2,810
Reclassification adjustment,
realized gain on available
for sale securities - - - - (481) (481)
Net loss - - - (14,882) - (14,882)
------- -------- ----------- ------------- --------------- ---------------
Balances at March 31, 2000 - $ - 129,402 (27,566) 2,329 104,165
======= ======== =========== ============= =============== ===============
See accompanying notes to consolidated financial statements.
6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three Months Ended March 31, 1999 and 2000 (unaudited)
Three months ended
March 31,
------------------------
1999 2000
----------- -----------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ 191,381 (14,882)
Extraordinary loss (gain) on sales of
operations (193,029) -
Adjustments to reconcile net (loss)
income to net cash (used) provided by
operating activities:
Recognition of deferred gain (3,805) (6,239)
Share of losses of equity investees 1,262 5,208
Depreciation 7,130 21,184
Provision for uncollectible accounts - 207
Interest expense deferred and included in
long-term debt 14,578 16,062
Amortization of deferred financing costs
included in interest expense 441 619
Amortization of deferred lease
administration costs included in selling,
general and administrative expenses 63 118
Unrealized gain on marketable trading
securities in 1999 and realized
gain on available for sale securities
in 2000 (439) (481)
Other noncash expenses - 301
Change in operating assets and liabilities:
Receivables (3,827) 2,711
Prepaid expenses, deposits and inventory (148) (192)
Accounts payable and accrued liabilities (9,987) (67,575)
----------- -----------
Net cash (used) provided by operating
activities 3,620 (42,959)
----------- -----------
Cash flows from investing activities:
Acquisition of property, equipment and other
assets (64,054) (44,778)
Payments for construction of corporate
headquarters - (1,699)
Proceeds from sale of available for sale
securities - 2,201
Proceeds from sales of short-term
investments available for sale 4,353 (1,584)
Investment in equity investee (35,093) -
Proceeds from sales of operations of NETCOM,
net of cash included in sale 252,881 -
Purchase of investments (27,466) (1,150)
Increase in restricted cash - (11)
----------- -----------
Net cash (used) provided by investing
activities 130,621 (47,021)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt - 95,000
Deferred financing and lease administration
costs (863) (664)
Principal payments on capital lease
obligations (1,131) (832)
Payments on IRU agreement - (35,198)
Principal payments on long-term debt (578) (187)
----------- -----------
Net cash provided (used) by financing
activities (2,572) 58,119
----------- -----------
Net increase (decrease) in cash and cash
equivalents 131,669 (31,861)
Net cash provided (used) by discontinued
operations (5,107) -
Cash and cash equivalents, beginning of period 114,380 43,222
----------- -----------
Cash and cash equivalents, end of period $ 240,942 11,361
=========== ===========
(Continued)
7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Three Months Ended March 31, 1999 and 2000 (unaudited)
Three months ended
March 31,
------------------------
1999 2000
----------- -----------
(in thousands)
Supplemental disclosure of cash flows information
of continuing operations:
Cash paid for interest $ 619 5,975
=========== ===========
Cash paid for taxes $ 409 220
=========== ===========
Supplemental disclosure of noncash investing and
financing activities of continuing operations:
Acquisition of corporate headquarters assets
through the issuance of long-term debt
and conversion of security deposit $ 33,719 -
=========== ===========
Assets acquired pursuant to IRU agreement - 57,494
Assets acquired under capital leases $ 3,760 11,454
----------- -----------
Total $ 3,760 68,948
=========== ===========
See accompanying notes to consolidated financial statements.
8
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and March 31, 2000 (unaudited)
(1) Organization and Nature of Business
ICG Services, Inc., a Delaware corporation ("ICG Services" or "the
Company"), was incorporated on January 23, 1998 and is a wholly owned
subsidiary of ICG Communications, Inc., a Delaware corporation ("ICG"). On
January 21, 1998, ICG completed a merger with NETCOM On-Line Communication
Services, Inc., a Delaware corporation and Internet service provider
("ISP") located in San Jose, California ("NETCOM"), accounted for as a
pooling of interests. Upon the formation of ICG Services on January 23,
1998, ICG contributed its investment in NETCOM to ICG Services and NETCOM
became a wholly owned subsidiary of, and predecessor entity to, ICG
Services. Accordingly, the financial statements of the Company prior to
January 23, 1998 consist solely of the accounts of NETCOM and its
subsidiaries. Effective November 3, 1998, the Company's board of directors
adopted the formal plan to dispose of the operations of NETCOM (see note
3). On February 17 and March 16, 1999, the Company completed the sales of
the operations of NETCOM and, accordingly, the Company's consolidated
financial statements prior to March 16, 1999 reflect the operations and
net assets of NETCOM as discontinued. In conjunction with the sales, the
legal name of the NETCOM subsidiary was changed to ICG NetAhead, Inc.
("NetAhead"). NetAhead has retained the domestic Internet backbone assets
formerly owned by NETCOM which it is utilizing for the provision of newly
developed wholesale network services to ISPs and other telecommunications
providers. The Company's consolidated financial statements reflect the
operations of NETCOM as discontinued for all periods presented.
On January 23, 1998, ICG Equipment, Inc., a Colorado corporation and
wholly owned subsidiary of the Company ("ICG Equipment"), was formed for
the principal purpose of providing financing of telecommunications
equipment and services to ICG Telecom Group, Inc., an indirect wholly
owned subsidiary of ICG and provider of competitive local exchange
services, and its subsidiaries ("ICG Telecom"). Such financing is provided
through ICG Equipment's purchase of telecommunications equipment,
software, network capacity and related services from original equipment
manufacturers, providers of intercity network facilities and ICG Telecom,
and subsequent lease of such assets to ICG Telecom.
The Company's objective is to acquire and invest in telecommunications
equipment, software, network capacity and businesses that complement ICG's
business strategy. By leveraging its relationship with ICG, the Company
intends to capitalize on the growth in demand for telecommunications
equipment and services provided by the Company.
(2) Significant Accounting Policies
(a) Basis of Presentation
These financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December 31,
1999, as certain information and note disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to the
rules and regulations of the United States Securities and Exchange
Commission. The interim financial statements reflect all adjustments
which are, in the opinion of management, necessary for a fair
presentation of financial position, results of operations and cash
flows as of and for the interim periods presented. Such adjustments
are of a normal recurring nature. Operating results for the three
months ended March 31, 2000 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2000.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
9
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Significant Accounting Policies (continued)
(b) Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. 44 "Accounting for Certain Transactions
involving Stock Compensation - and interpretation of APB Opinion No.
25 ("FIN 44"). This opinion provides guidance on the accounting for
certain stock option transactions and subsequent amendments to sock
option transactions. FIN 44 is effective July 1, 2000, but certain
conclusions cover specific events that occur after either December 15,
1998 or January 12, 2000. To the extent that FIN 44 covers events
occurring during the period from December 15, 1998 and January 12,
2000, but before January 1, 2000, the effects of applying this
Interpretation are to be recognized on a prospective basis. The
Company has not yet assessed the impact, if any, that FIN 44 might
have on its financial position or results of operations.
In December 1999, the SEC released Staff Accounting Bulletin ("SAB")
No. 101, "Revenue Recognition in Financial Statements", which provides
guidance on the recognition, presentation and disclosure of revenue in
financial statements filed with the SEC. Subsequently, the SEC
released SAB 101A, which delayed the implementations date of SAB 101
for registrants with fiscal years beginning between December 16, 1999
and March 15, 2000. The Company has not yet assessed the impact, if
any, that SAB 101 might have on its financial position or results of
operations.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133
establishes accounting and reporting standards for derivative
instruments and hedging activities. As amended by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities-Deferral
of the Effective Date of FASB Statement No. 133", SFAS 133 is
effective for all fiscal years beginning after June 15, 2000. The
Company will adopt SFAS 133 effective at the beginning of its fiscal
year end 2001. The Company does not believe that the adoption of SFAS
133 will have a material effect on the Company's financial position or
results of operations.
(c) Reclassifications
Certain 1999 amounts have been reclassified to conform with the 2000
presentation.
(3) Discontinued Operations
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., an ISP located in
Atlanta, Georgia and predecessor to Earthlink, Inc. ("MindSpring"). Total
proceeds from the sale were $245.0 million, consisting of $215.0 million
in cash and 376,116 shares of common stock of MindSpring, valued at
approximately $79.76 per share at the time of the transaction. Assets and
liabilities sold to MindSpring included those directly related to the
domestic operations of NETCOM's Internet dial-up, dedicated access and Web
site hosting services. In conjunction with the sale to MindSpring, the
Company entered into an agreement to lease to MindSpring for a one-year
period the capacity of certain network operating assets formerly owned by
NETCOM and retained by the Company (the "MindSpring Capacity Agreement").
The MindSpring Capacity Agreement was amended during the first quarter of
2000 to extend the terms of the agreement through May 2000. MindSpring
utilized the Company's network capacity under this agreement to provide
Internet access to the dial-up services customers formerly owned by
NETCOM. In addition, the Company received for a one-year period 50% of the
gross revenue earned by MindSpring from the dedicated access customers
formerly owned by NETCOM. The carrying value of the assets retained by the
Company was approximately $21.7 million, including approximately $17.5
million of network equipment, on February 17, 1999. The Company also
retained approximately $11.3 million of accrued liabilities and capital
lease obligations.
10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
On March 16, 1999, the Company sold all of the capital stock of NETCOM's
international operations for total proceeds of approximately $41.1
million. MetroNET Communications Corp., a Canadian entity, and Providence
Equity Partners, located in Providence, Rhode Island ("Providence"),
together purchased the 80% interest in NETCOM Canada Inc. owned by NETCOM
for approximately $28.9 million in cash. Additionally, Providence
purchased all of the capital stock of NETCOM Internet Access Services
Limited, NETCOM's operations in the United Kingdom, for approximately
$12.2 million in cash.
During the three months ended March 31, 1999, the Company recorded a
combined gain on the sales of the operations of NETCOM of approximately
$193.0 million, net of income taxes of approximately $6.4 million. The
gain and related income taxes were adjusted during the nine months ended
December 31, 1999 to reflect actual results. Offsetting the gain on the
sales during the three months ended March 31, 1999 is approximately $16.6
million of net losses from operations of NETCOM from November 3, 1998 (the
date on which the Company's board of directors adopted the formal plan to
dispose of the operations of NETCOM) through the dates of the sales.
Additionally, since the Company expected to generate operating costs in
excess of revenue under the MindSpring Capacity Agreement and the terms of
the sale agreement were dependent upon and negotiated in conjunction with
the terms of the network capacity agreement, the Company deferred
approximately $35.5 million of the proceeds from the sale agreement to be
applied on a periodic basis to the network capacity agreement. The
deferred proceeds were recognized in the Company's statement of operations
as the Company incurred cash operating losses under the network capacity
agreement. Accordingly, the Company did not recognize any revenue,
operating costs or selling, general and administrative expenses from
services provided to MindSpring for the term of the agreement. Any
incremental revenue or costs generated by other customers, or by other
services provided to MindSpring, was recognized in the Company's
consolidated statement of operations as incurred. During the three months
ended March 31, 2000, $6.2 million in losses related to the MindSpring
customers were offset against the deferred amount. As of March 31, 2000,
all amounts deferred in relation to the MindSpring Capacity Agreement have
been offset by losses incurred under the agreement. The Company, through
NetAhead, is currently utilizing the retained network operating assets to
provide wholesale capacity and other enhanced network services on an
ongoing basis to MindSpring under an extension of the original network
capacity agreement as well as to other ISPs and telecommunications
providers. Operating results from such services have been included in the
Company's statement of operations as incurred. Since the operations sold
were acquired by ICG in a transaction accounted for as a pooling of
interests, the gain on the sales of the operations of NETCOM is classified
as an extraordinary item in the Company's consolidated statement of
operations.
(4) Investments
On February 22, 2000, the Company purchased 61,845 shares of restricted
Series D Preferred Stock ("Cyras Preferred Stock") of Cyras Systems, Inc.,
("Cyras"), for approximately $1.0 million. Cyras is a manufacturer of
telecommunications equipment. Dividends on the Cyras Preferred Stock are
8% per annum, noncumulative and payable in cash or any Cyras assets
legally available and as declared by the board of directors of Cyras. The
Cyras Preferred Stock is automatically convertible into shares of common
stock of Cyras upon the initial public offering of the common stock of
Cyras or upon the election to convert by more than 66% of all of the
preferred stockholders of Cyras.
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock (the
"NorthPoint Preferred Stock") of NorthPoint Communications Holdings, Inc.,
a Delaware corporation and competitive local exchange carrier ("CLEC")
based in San Francisco, California ("NorthPoint") which was converted into
555,555 shares of Class B Common Stock of NorthPoint (the "NorthPoint
Class B Shares") on May 5, 1999. The NorthPoint Class B Shares were
converted on March 30, 2000 on a one-for-one basis into a voting class of
common stock of NorthPoint.
11
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Investments (continued)
The Company accounted for its investment in NorthPoint under the cost
method of accounting until the NorthPoint Class B Shares were converted
into voting and tradable common stock of NorthPoint, after which the
investment was classified as an available for sale security. During the
three months ended March 31, 2000, the Company sold 95,555 of the
NorthPoint common shares for proceeds of approximately $2.2 million. A
gain of approximately $0.5 million was recognized on the sale. All shares
remaining at March 31, 2000 are classified as available for sale with
unrealized gains on the investment of $2.3 million recorded as a component
of stockholders' equity.
Investments accounted for under the equity method include the Company's
20% and 49% investments in ICG Ohio LINX, Inc. and ICG ChoicCom, L.P.,
respectively.
(5) Long-term Debt
Long-term debt is summarized as follows:
December 31, March 31,
1999 2000
------------- -------------
(in thousands)
Senior Facility due on scheduled maturity
dates, secured by substantially all of
the assets of ICG Equipment and NetAhead
at weighted average interest rates ranging
from 9.26% to 9.65% for the three months
ended March 31, 2000 (a) $ 79,625 174,438
9 7/8% Senior discount notes, net of discount 293,925 301,064
10% Senior discount notes, net of discount 361,290 370,213
Mortgage loan payable with adjustable rate
of interest (15.21% at March 31, 2000),
due monthly into 2013, secured by
corporate headquarters 33,077 33,077
------------- -------------
767,917 878,792
Less current portion (750) (750)
------------- -------------
$ 767,167 878,042
============= =============
(a) Senior Facility
During the quarter ended March 31, 2000, the Company borrowed the
remaining $95.0 million available under the $100.0 million term loan.
The $100.0 million outstanding under the $100.0 million term loan
bears interest at a weighted average interest rate of 9.26% for the
three months ended March 31, 2000.
(6) Related Party Transactions
The Company and its subsidiaries have entered into certain intercompany
and shared services agreements with ICG, whereby ICG allocates to the
Company direct and certain indirect costs incurred by ICG or its other
subsidiaries (the "Restricted Subsidiaries") on behalf of the Company.
Allocated expenses generally include a portion of salaries and related
benefits of legal, accounting and finance, information systems support and
other ICG employees, certain overhead costs and reimbursement for invoices
of the Company paid by ICG. Conversely, any cash collected by ICG on
behalf of the Company or invoices paid by the Company on behalf of ICG are
in turn reimbursed to the Company by ICG. As the Company and its
subsidiaries and ICG and its Restricted Subsidiaries jointly enter into
12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Related Party Transactions (continued)
service offerings and other transactions, joint costs incurred are
generally allocated to each of the Company and ICG according to the
relative capital invested and efforts expended by each party. All
transactions between the Company, including its subsidiaries, and ICG,
including its Restricted Subsidiaries, contain fair and reasonable terms.
All such transactions are settled in cash on a quarterly basis.
For the three months ended March 31, 1999 and 2000, ICG charged
approximately $2.8 million and $53.6 million, respectively, to the Company
for intercompany transfers and direct and indirect costs incurred by ICG
and its Restricted Subsidiaries on behalf of the Company. Of these
amounts, approximately $0.3 million and $1.2 million are included in the
Company's selling, general and administrative expenses for the three
months ended March 31, 1999 and 2000, respectively. In addition, for the
three months ended March 31, 1999 and 2000, the Company charged
approximately $125.2 million and $181.4 million, respectively, to ICG and
its Restricted Subsidiaries for intercompany transfers and direct and
indirect costs incurred by the Company on behalf of ICG and its Restricted
Subsidiaries. The net receivable from ICG for all intercompany charges
combined is included in due from ICG in the Company's consolidated balance
sheets. Net interest income accrued by the Company on outstanding balances
from ICG and its Restricted Subsidiaries is included in interest income in
the Company's consolidated statement of operations and was approximately
$5.9 million and $3.2 million for the three months ended March 31, 1999
and 2000, respectively. Interest has been accrued on outstanding balances
of intercompany transfers and direct and indirect costs between ICG
Services and ICG and its Restricted Subsidiaries at 12.5% and 10.15% per
annum for 1999 and 2000, respectively, which represents the Company's
approximate weighted average cost of capital at the beginning of the
respective fiscal year.
During the three months ended March 31, 1999 and 2000, ICG Equipment
purchased certain telecommunications equipment both from and for ICG
Telecom for an aggregate purchase price of approximately $64.1 million and
$39.9 million, respectively. Additionally, ICG Equipment entered into
separate agreements to lease $96.5 million and $53.7 million during the
three months ended March 31, 1999 and 2000, respectively, of
telecommunications equipment to ICG Telecom under operating leases, with
annual lease payments commencing one year from the date of the lease. ICG
Equipment recognizes revenue from the lease payments ratably over the
lease terms. ICG Equipment recognized approximately $11.1 million and
$30.6 million during the three months ended March 31, 1999 and 2000,
respectively, in revenue under its operating leases with ICG Telecom. The
purchase prices and lease payments for all leases are subject to
adjustment, based on the results of an independent appraisal which may be
requested at the option of ICG Telecom and ICG Equipment on or before 90
days from the purchase date.
Additionally, under a master lease agreement between ICG Equipment and ICG
Telecom, ICG Telecom is required to pay ICG Equipment a monthly lease
service fee, at an annual rate of prime plus 4% (13.0% at March 31, 2000),
based on the average monthly balance of assets purchased by ICG Equipment
and intended for future lease to ICG Telecom, but not yet placed into
service. ICG Equipment places assets in service upon the commencement of
the respective lease term. For the three months ended March 31, 1999 and
2000, ICG Equipment recognized approximately $2.3 million and $5.0
million, respectively, of monthly service fee revenue under this
agreement. The amount of assets purchased by ICG Equipment and intended
for future lease to ICG Telecom, but not yet placed into service, was
approximately $75.2 million and $151.6 million at March 31, 1999 and 2000,
respectively. The Company begins depreciation on property and equipment at
the time the assets are placed in service.
NetAhead also earned revenue from a subsidiary of ICG, DataChoice Network
Services, L.L.C. ("DataChoice"), of $2.7 million for the three months
ended March 31, 2000 for DataChoice's use of NetAhead's RAS assets.
13
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Related Party Transactions (continued)
Effective January 1, 1999, the Company purchased ICG's Corporate
Headquarters and subsequently assumed the prior lessor's operating lease
of the Corporate Headquarters assets to a Restricted Subsidiary of ICG.
For both the three months ended March 31, 1999 and 2000, the Company
earned leasing revenue from the Restricted Subsidiary of ICG of
approximately $1.2 million, under the operating lease, which is included
in revenue and due from ICG in the Company's consolidated financial
statements.
(7) Commitments and Contingencies
During the first quarter of 2000, the Company signed a letter of intent
with Cisco Systems, Inc. for financing of future capital expenditures. The
Company believes that the proposed financing agreement will better enable
the Company to fund its scheduled network expansion through the purchase
of Cisco equipment. The proposed Cisco credit facility will provide the
Company with up to $180.0 million of capital lease financing with a
three-year repayment term. During the first quarter of 2000, $50.0 million
of the capital lease financing with Cisco was finalized and $11.5 million
was drawn down under the facility.
The Company has entered into various other equipment purchase agreements
with certain of its vendors. Under these agreements, if the Company does
not meet a minimum purchase level in any given year, the vendor may
discontinue certain discounts, allowances and incentives otherwise
provided to the Company. In addition, the agreements may be terminated by
either the Company or the vendor upon prior written notice.
The Company has entered into certain commitments to purchase capital
assets with an aggregate purchase price of approximately $386.9 million at
March 31, 2000.
NETCOM, now NetAhead, is a party to certain other litigation which has
arisen in the ordinary course of business. In the opinion of management,
the ultimate resolution of these matters will not have a material adverse
effect on the Company's financial condition, results of operations or cash
flows.
(8) Business Units
The Company conducts transactions with external customers through the
operations of its Network Services (NetAhead) and Leasing Services
(primarily ICG Equipment) business units. Direct and certain indirect
costs incurred by ICG Services, Inc., the parent company, on behalf of
Network Services and Leasing Services are allocated among those business
units based on the nature of the underlying costs. The operations of
Network Services are not considered to be significant for purposes of
business segment reporting and, accordingly, are included with the
remaining corporate subsidiaries of the Company, which primarily hold
securities.
Set forth below are revenue, EBITDA (which represents the measure of
operating performance used by management to evaluate operating results),
depreciation, operating income (loss), interest expense, capital
expenditures of continuing operations and total assets for Leasing
Services and all other subsidiaries of the Company combined.
14
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Business Units (continued)
Three months ended
March 31,
-----------------------
1999 2000
----------- -----------
(in thousands)
Revenue:
Leasing Services $ 14,603 36,787
All other - 7,039
----------- -----------
Total revenue $ 14,603 43,826
=========== ===========
EBITDA (a):
Leasing Services $ 14,494 35,984
All other (866) (3,697)
----------- -----------
Total EBITDA $ 13,628 32,287
=========== ===========
Operating income (loss):
Leasing Services $ 8,141 21,289
All other (1,643) (10,186)
----------- -----------
Total operating income (loss) $ 6,498 11,103
=========== ===========
Depreciation (b):
Leasing Services $ 6,353 14,695
All other 777 6,489
----------- -----------
Total depreciation $ 7,130 21,184
=========== ===========
Interest expense (b):
Leasing Services $ 621 5,151
All other 15,017 19,728
----------- -----------
Total interest expense $ 15,638 24,879
=========== ===========
Share of net earnings (losses)
of equity inestees:
Leasing Services $ - -
All other - (5,208)
----------- -----------
Total share of net earnings
(losses) of equity investees $ - (5,208)
=========== ===========
Extraordinary gain:
Leasing Services $ - -
All other 193,029 -
----------- -----------
Total extraordinary gain $ 193,029 -
=========== ===========
(continued)
15
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Business Units (continued)
Three months ended
March 31,
-----------------------
1999 2000
----------- -----------
(in thousands)
Capital expenditures (c):
Leasing Services $ 63,937 39,944
All other 3,877 73,782
----------- -----------
Total capital expenditures $ 67,814 113,726
=========== ===========
December 31, March 31,
1999 2000
------------- -------------
(in thousands)
Total assets:
Leasing Services $ 713,166 754,028
All other (d) 355,406 369,763
Due from ICG 119,185 121,690
------------- -------------
Total assets $ 1,187,757 1,245,481
============= =============
(a) EBITDA consists of loss before interest, income taxes, depreciation,
other expense, net, and share of losses of equity investees, or,
revenue less operating costs and selling, general and administrative
expenses. EBITDA is presented as the Company's measure of operating
performance because it is a measure commonly used in the
telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended
to represent cash flows or results of operations in accordance with
generally accepted accounting principles for the periods indicated.
EBITDA is not a measurement under generally accepted accounting
principles and is not necessarily comparable with similarly titled
measures of other companies.
(b) Although not included in EBITDA (which represents the measure of
operating performance used by management to evaluate operating
results) the Company has supplementally provided depreciation and
interest expense for each of the Company's Leasing Services and all
other Company subsidiaries combined. Interest expense excludes amounts
charged by ICG Services, Inc. to ICG Equipment, Inc. (Leasing
Services) for interest on outstanding cash advances and expense
allocations.
(c) Capital expenditures include assets acquired with cash, under capital
leases and pursuant to IRU agreement and excludes payments for
construction of corporate headquarters of $1.7 million for the three
months ended March 31, 2000 and corporate headquarters assets acquired
through the issuance of long-term debt of $33.7 million for the three
months ended March 31, 1999.
(d) Total assets excludes the investment in ICG Equipment, Inc. (Leasing
Services) which eliminates in consolidation.
(9) Event Subsequent to March 31, 2000
On April 10, 2000, the Company's parent, ICG, sold 75,000 shares of 8%
Series A-1, A-2 and A-3 Convertible Preferred Stock of ICG (the
"Convertible Preferred Stock") and 10,000,000 warrants to purchase ICG
Common Stock to affiliates of Liberty Media Corporation ("Liberty Media"),
Hicks, Muse, Tate & Furst Incorporated ("Hicks Muse") and Gleacher Capital
Partners ("Gleacher Capital") (collectively, "the Investors"). The sale of
the Convertible Preferred Stock resulted in proceeds to the Company's
parent, ICG, of $750.0 million (before cash fees and expenses of
approximately $36.0 million).
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion includes certain forward-looking statements and
information that is based on the beliefs of management as well as assumptions
made by and information currently available to the Company. When used in this
document, the words "anticipate", "believe", "estimate" and "expect" and similar
expressions, as they relate to the Company or its management, are intended to
identify forward-looking statements. Such statements reflect the current views
of the Company with respect to future events and are subject to certain risks,
uncertainties and assumptions. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those described in this document. These
forward-looking statements are affected by important factors, including, but not
limited to, the Company's ability to obtain financing necessary to fund its
planned expansion, the Company's lack of operating history, the successful
implementation of the Company's strategy of offering wholesale network services
to ISPs, ICG Telecom and other telecommunications providers and its lack of
credit support from ICG that could cause actual results to differ materially
from the forward-looking statements. The results of operations for the three
months ended March 31, 1999 and 2000 represent the consolidated operating
results of the Company and its subsidiaries. See the unaudited consolidated
financial statements of the Company for the three months ended March 31, 2000
included elsewhere herein. The Company's consolidated financial statements
reflect the operations of NETCOM as discontinued for all periods presented. The
terms "fiscal" and "fiscal year" refer to the Company's fiscal year ending
December 31.
Company Overview
ICG Services, Inc. ("ICG Services" or the "Company") was formed on January
23, 1998 and is a wholly owned subsidiary of ICG Communications, Inc. ("ICG").
The Company's Leasing Services and Network Services operations are currently
conducted through its two operating subsidiaries, ICG Equipment, Inc. ("ICG
Equipment") and ICG NetAhead, Inc. ("NetAhead") (formerly NETCOM On-Line
Communication Services, Inc. ("NETCOM")).
On January 21, 1998, ICG acquired NETCOM, a Delaware corporation and
provider of Internet connectivity and Web site hosting services located in San
Jose, California, in a transaction accounted for as a pooling of interests. As
consideration for the acquisition, ICG issued approximately 10.2 million shares
of common stock of ICG ("ICG Common Stock"), valued at approximately $284.9
million on the date of the merger. Upon the formation of ICG Services, ICG
contributed its investment in NETCOM to ICG Services and NETCOM became a wholly
owned subsidiary of, and predecessor entity to, ICG Services. Accordingly, the
historical consolidated financial statements of the Company prior to January 23,
1998 consist solely of the accounts of NETCOM.
In January 1998, the Company formed ICG Equipment, a Colorado corporation,
for the principal purpose of providing financing of telecommunications equipment
and services to ICG Telecom Group, Inc., an indirect wholly owned subsidiary of
ICG and provider of competitive local exchange services, and its subsidiaries
("ICG Telecom"). Such financing is provided through ICG Equipment's purchase of
telecommunications equipment, software, network capacity and related services
from original equipment manufacturers, providers of intercity network facilities
and ICG Telecom, and subsequent lease of such assets to ICG Telecom. The
equipment and services provided to ICG Telecom are utilized to upgrade and
expand ICG's network infrastructure. Management believes that all leasing and
other arrangements between ICG Equipment and ICG Telecom contain fair and
reasonable terms and are intended to be conducted on the basis of fair market
value and on comparable terms that the Company would be able to obtain from a
comparable third party. ICG Equipment completed its first significant
transaction on June 30, 1998 and, accordingly, ICG Equipment's operations prior
to that date are not significant. During the second half of 1998 through March
31, 2000, ICG Equipment entered into a series of agreements whereby ICG
Equipment purchased telecommunications equipment and fiber optic capacity from
and for ICG Telecom and leased back the same telecommunications equipment and
fiber optic capacity to ICG Telecom under operating leases. Additionally, under
master lease agreements between ICG Equipment and ICG Telecom, ICG Telecom is
required to pay ICG Equipment a monthly lease service fee based on the average
monthly balance of assets purchased by ICG Equipment and intended for future
lease to ICG Telecom, but not yet placed into service. At March 31, 2000, ICG
Equipment had approximately $608.1 million of telecommunications equipment,
software, network capacity and related services under lease to ICG Telecom and
approximately $151.6 million of such assets intended for future lease to ICG
Telecom, but not yet placed into service.
17
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., an Internet service
provider ("ISP") located in Atlanta, Georgia and predecessor to EarthLink, Inc.
("MindSpring"), for total proceeds of $245.0 million, and on March 16, 1999, the
Company sold all of the capital stock of NETCOM's international operations in
Canada and the United Kingdom to other unrelated third parties for total
proceeds of approximately $41.1 million. During the three months ended March 31,
1999, the Company recorded a combined gain on the sales of the operations of
NETCOM of approximately $193.0 million, net of income taxes of approximately
$6.4 million. The gain and related income taxes were adjusted during the nine
months ended December 31, 1999 to reflect actual results. Offsetting the gain on
the sales during the three months ended March 31, 1999 is approximately $16.6
million of net losses from operations of NETCOM from November 3, 1998 (the date
on which the Company's board of directors adopted the formal plan to dispose of
the operations of NETCOM) through the dates of the sales. Since the operations
sold were acquired by ICG in a transaction accounted for as a pooling of
interests, the gain on the sales of the operations of NETCOM is classified as an
extraordinary item in the Company's consolidated statement of operations. The
Company's consolidated financial statements reflect the operations of NETCOM as
discontinued for all periods presented.
In conjunction with the sale to MindSpring, the legal name of the NETCOM
subsidiary was changed to ICG NetAhead, Inc. ("NetAhead"). NetAhead has retained
the domestic Internet backbone assets formerly owned by NETCOM which include 227
points of presence ("POPs") serving approximately 700 cities nationwide.
NetAhead is utilizing the retained network operating assets to provide wholesale
Internet access and enhanced network services to MindSpring and other ISPs, ICG
Telecom and other telecommunications providers. On February 17, 1999, NetAhead
entered into an agreement to lease to MindSpring for a one-year period the
capacity of certain network operating assets formerly owned by NETCOM and
retained by the Company (the "MindSpring Capacity Agreement"). The MindSpring
Capacity Agreement was amended during the first quarter of 2000 to extend the
terms of the agreement through May 2000. MindSpring is utilizing the Company's
network capacity under this agreement to provide Internet access to the dial-up
services customers formerly owned by NETCOM. In addition, the Company received
for a one-year period 50% of the gross revenue earned by MindSpring from the
dedicated access customers formerly owned by NETCOM. All cash operating losses
under this agreement were offset by the periodic recognition of approximately
$35.5 million of the proceeds from the sale of certain of NETCOM's domestic
operating assets and liabilities to MindSpring, which the Company deferred in
connection with the sale. Accordingly, the Company did not recognize any
revenue, operating costs or selling, general and administrative expenses from
services provided under the MindSpring Capacity Agreement through February 17,
2000. Any incremental revenue or costs generated by other customers were
recognized in the Company's consolidated statement of operations as incurred.
NetAhead provides network capacity and enhanced data services to ISPs, ICG
Telecom and other telecommunications providers. In December 1998, ICG announced
plans to offer several new network services available to its business and ISP
customers which utilize ICG's and, consequently, NetAhead's nationwide data
network and service capabilities to carry out-of-region traffic and enhanced
data services provided. Modemless remote access service ("RAS") also known as
managed modem service, allows NetAhead to provide modem access at ICG's and the
Company's switch locations, thereby eliminating the need for ISPs to deploy
modems physically at each of their POPs. RAS benefits the ISPs by reducing
capital expenditures and shifting network management responsibility from the
ISPs to NetAhead. NetAhead also provides transport services to deliver all
Internet protocol (IP) data packets either directly to the ISP, if the ISP is
not collocated at the telecommunications provider's local switch, or directly to
the Internet, bypassing the ISP. Additionally, through its network operations
center, NetAhead monitors the usage of each line and is responsible for the
administration of all network repair and maintenance.
In August 1998, ICG Telecom began offering enhanced telephony services via
IP technology. ICG Telecom currently offers this service in certain major cities
in the United States, which cities account for a large part of the commercial
long distance market. ICG Telecom carries the IP traffic over NetAhead's
nationwide data network and terminates a large portion of the traffic via
NetAhead's POPs. NetAhead charges ICG Telecom for calls carried and terminated
on NetAhead's network.
The Company has and will continue to enter into agreements with ICG
Telecom to provide network services at negotiated rates. Management believes
that all such arrangements have and will contain fair and reasonable terms and
are intended to be conducted on the basis of fair market value and on comparable
terms that the Company would be able to obtain from a comparable third party.
The Company is not presently able to determine the impact that the offerings of
its newly developed network services will have on revenue or EBITDA in 2000 or
18
future years. The nature, volume and consideration received for network services
from ISPs and other telecommunications providers as well as that received under
its agreements with ICG Telecom are ultimately dependent upon demand from ISPs
and other telecommunications providers. Thus, while ICG Telecom and NetAhead
believe the Internet services market sector will benefit from these new
services, there is no assurance that ICG Telecom and NetAhead will be able to
successfully deploy and market their new services efficiently, or obtain and
retain new customers in a competitive marketplace.
The Company may acquire telecommunications and related businesses that
complement ICG's business strategy to offer a wide array of telecommunications
and related services primarily to communications-intensive business customers.
Additionally, the Company may acquire businesses from ICG which ICG currently
owns and operates. Any further acquisitions would be primarily through the use
of cash on hand and the proceeds from securities offerings, including offerings
of ICG Common Stock. However, there is no assurance that acquisitions at
favorable prices to the Company will occur or that the Company will have
sufficient sources of funding to make such acquisitions. The Company's results
of operations and financial condition will change as the operations of ICG
Equipment and NetAhead become more significant and as it consummates
acquisitions, if any.
Results of Operations
The following table provides certain statement of operations data and
certain other financial data for the Company for the periods indicated. The
table also presents revenue, operating costs and expenses, operating (loss)
income and EBITDA as a percentage of the Company's revenue.
Three months ended March 31,
--------------------------------------
1999 2000
------------------ ------------------
$ % $ %
-------- --------- -------- ---------
(unaudited)
(in thousands)
Statement of Operations Data:
Revenue 14,603 100 43,826 100
Operating costs and expenses:
Operating costs 586 4 9,446 22
Selling, general and
administrative 389 3 2,093 5
Depreciation 7,130 49 21,184 48
-------- --------- -------- ---------
Total operating expenses 8,105 56 32,723 75
Operating income 6,498 44 11,103 25
Other Data:
Net cash (used) provided by
operating activities 3,620 (42,959)
Net cash (used) provided by
investing activities 130,621 (47,021)
Net cash (used) provided by
financing activities (2,572) 58,119
EBITDA (1) 13,628 93 32,287 74
Capital expenditures (2) 67,814 113,726
(1) EBITDA consists of earnings (loss) from continuing operations before
interest, income taxes, depreciation, other expense, net and share of
losses of equity investees, or, operating income (loss) plus depreciation.
EBITDA is provided because it is a measure commonly used in the
telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended to
represent cash flows or results of operations in accordance with generally
accepted accounting principles ("GAAP") for the periods indicated. EBITDA
is not a measurement under GAAP and is not necessarily comparable with
similarly titled measures of other companies. Net cash flows from
operating, investing and financing activities of continuing operations as
determined using GAAP are also presented in Other Data.
(2) Capital expenditures includes assets acquired with cash, under capital
leases and assets acquired pursuant to an indefeasible right of use ("IRU")
agreement and excludes payments for construction of corporate headquarters
of $1.7 million for the three months ended March 31, 2000 and corporate
headquarters assets acquired through the issuance of long-term debt of
$33.7 million for the three months ended March 31, 1999.
19
Three Months Ended March 31, 2000 Compared to Three Months Ended March 31, 1999
Revenue. The Company recorded revenue of approximately $14.6 million and
$43.8 million for the three months ended March 31, 1999 and 2000, respectively.
The increase in revenue relates primarily to the continued expansion of ICG
Equipment's operations since June 30, 1998 as well as revenue for the period
from February 18, 2000 through March 31, 2000 from the MindSpring Capacity
Agreement which prior to February 17, 2000 had been offset against the deferred
gain on the sale of NETCOM assets. Revenue recorded on operating leases of
property and equipment to ICG Telecom was $11.1 million and $30.6 million for
the three months ended March 31, 1999 and 2000, respectively. Additionally, the
Company charges lease service fees to ICG Telecom for the cost of carrying
assets not yet placed into service. For the three months ended March 31, 1999
and 2000, lease service fee revenue was $2.3 million and $5.0 million,
respectively. The Company also received rental income from ICG under the
operating lease for ICG's corporate headquarters, which the Company purchased
and simultaneously leased to ICG, effective January 1, 1999. For both the three
months ended March 31, 1999 and 2000, the Company recorded revenue on the
operating lease for the corporate headquarters of $1.2 million. For the three
months ended March 31, 2000, NetAhead generated revenue of approximately $7.0
million including revenue of approximately $4.3 million for the period from
February 18, 2000 through March 31, 2000 from the MindSpring Capacity Agreement
which prior to February 17, 2000 had been offset against the deferred gain on
the sale of NETCOM assets, and $2.7 million of revenue from a subsidiary of ICG,
DataChoice Network Services, L.L.C. ("DataChoice"), for DataChoice's use of
NetAhead's RAS assets. Revenue earned of $5.7 million and $5.0 million for the
three months ended March 31, 1999 and the period from January 1, 2000 through
February 17, 2000, respectively, under the Company's network capacity agreement
with MindSpring was offset by cost of services and selling, general and
administrative expenses of $9.5 million and $11.2 million, respectively,
incurred under the same agreement. Both the $3.8 million and $6.2 million
operating deficit were equally offset by the recognition of $3.8 million and
$6.2 million of the deferred proceeds from the sale of certain of the domestic
operating assets and liabilities of NETCOM during the three months ended March
31, 1999 and the period from January 1, 2000 through February 17, 2000,
respectively.
Cost of services. Cost of services of $0.6 million and $9.4 million for
the three months ended March 31, 1999 and 2000, respectively, consist of line
costs and other direct costs of NetAhead associated with NetAhead's and ICG
Telecom's joint service offering of IP telephony services. Additionally, the
increase in cost of services during the three months ended March 31, 2000 over
1999 is due to the recognition of approximately $9.4 million of operating
expenses for the period from February 18, 2000 through March 31, 2000 from the
MindSpring Capacity Agreement which prior to February 17, 2000 had been offset
against the deferred gain on the sale of NETCOM assets.
Selling, general and administrative expenses. Selling, general and
administrative (SG&A) expenses were approximately $0.4 million and $2.1 million
for the three months ended March 31, 1999 and 2000, respectively. SG&A expenses
include allocations of a portion of ICG's general and administrative expenses
for certain direct and indirect costs incurred by ICG on behalf of the Company.
Such allocations were $0.3 million and $0.1 million, representing approximately
75% and 45% of total SG&A expenses for the three months ended March 31, 1999 and
2000, respectively. Remaining SG&A expenses include general corporate
administrative expenses, including professional and cash management fees.
Additionally, the increase in selling, general and administrative expenses
during the three months ended March 31, 2000 over 1999 is primarily due to the
recognition of approximately $1.0 million of selling, general and administrative
expenses for the period from February 18, 2000 through March 31, 2000 from the
MindSpring Capacity Agreement which prior to February 17, 2000 had been offset
against the deferred gain on the sale of NETCOM assets. SG&A expenses are
expected to increase in absolute dollars as NetAhead obtains new customers.
Depreciation. Depreciation increased $14.1 million, from $7.1 million for
the three months ended March 31, 1999 to $21.2 million for the three months
ended March 31, 2000. Depreciation consists primarily of depreciation of ICG
Equipment's property and equipment purchased from and for ICG Telecom and leased
to ICG Telecom under long-term operating leases, in addition to depreciation of
property and equipment of NetAhead. The increase in depreciation is primarily
due to the continued expansion of ICG Equipment's operations as well as a
reduction in the overall weighted-average useful life of depreciable assets in
service. The Company's depreciation expense will continue to increase as
NetAhead purchases additional property and equipment, ICG Equipment places in
service equipment that has already been purchased and purchases additional
property and equipment for lease to ICG's other operating subsidiaries.
20
Interest expense. Interest expense increased $9.3 million, from $15.6
million for the three months ended March 31, 1999 to $24.9 million for the three
months ended March 31, 2000, which includes $16.7 million of noncash interest.
Interest expense is primarily attributable to the 10% Senior Discount Notes due
2008 (the "10% Notes") issued in February 1998, the 9 7/8% Senior Discount Notes
due 2008 (the "9 7/8% Notes") issued in April 1998 and the senior secured
financing facility (the "Senior Facility") completed in August 1999. The
Company's interest expense has and will continue to increase as the principal
amounts of the 10% Notes and the 9 7/8% Notes increase and as additional amounts
are borrowed under the Senior Facility until the 10% Notes and the 9 7/8% Notes
begin to pay interest in cash in 2003.
Interest income. Interest income decreased $4.4 million, from $8.3 million
for the three months ended March 31, 1999 to $3.9 million for the three months
ended March 31, 2000 and primarily represents net interest income from ICG of
approximately $5.9 million and $3.2 million during the three months ended March
31, 1999 and 2000, respectively, for invoices paid by the Company on behalf of
ICG and its other operating subsidiaries and repaid on a quarterly basis. The
Company also earned interest on invested cash balances during both the three
months ended March 31, 1999 and 2000. The decrease in interest income from
invested cash balances is attributable to the decrease in cash, cash equivalents
and short-term investments available for sale during the three months ended
March 31, 2000, as the Company invests available cash balances in
telecommunications equipment and other assets.
Other income, net, including unrealized gain on marketable trading
securities in 1999 and realized gain on available for sale securities in 2000.
During the three months ended March 31, 1999, the Company recorded an unrealized
gain of $0.4 million on the common stock of MindSpring which the Company
received as partial consideration for the sale of the domestic operations of
NETCOM. During the three months ended March 31, 2000, the Company recorded a
realized gain of approximately $0.5 million on the sale of a portion of the
NorthPoint Common Stock net of other nonoperating expenses.
Share of net losses of equity investees. The Company's share of net losses
of equity investees increased $3.9 million, from a net loss of $1.3 million for
the three months ended March 31, 1999 to net a loss of $5.2 million for the
three months ended March 31, 2000. The Company's share of net losses of equity
investees for the three months ended March 31, 2000 consists of the Company's
share of net losses of ICG Ohio LINX, Inc. ("ICG Ohio LINX") of $0.8 million and
the Company's share of net losses of ICG ChoiceCom, L.P. ("ChoiceCom") of $4.4
million. For the three months ended March 31, 1999, share of net losses of
equity investees consists of the Company's share of net losses of ICG Ohio LINX
of $0.5 million and the Company's share of net losses of ChoiceCom of $0.8
million. The Company purchased a 20% equity interest in ICG Ohio LINX in August
1998 and a 49% equity interest in ChoiceCom in March 1999.
Loss before extraordinary gain. Loss before extraordinary gain increased
$13.3 million, from $1.6 million for the three months ended March 31, 1999 to
$14.9 million for the three months ended March 31, 2000 primarily due to
increases in operating costs, depreciation and interest expense, as noted above.
Extraordinary gain on sales of operations of NETCOM. The Company reported
an extraordinary gain on the sales of operations of NETCOM during the three
months ended March 31, 1999 of $193.0 million, net of income taxes of $6.4
million. The gain and related income taxes were adjusted during the nine months
ended December 31, 1999 to reflect actual results. Offsetting the gain on the
sales during the three months ended March 31, 1999 is approximately $16.6
million of net losses of operations of NETCOM from November 3, 1998 through the
dates of the sales. Additionally, $35.5 million of the proceeds from the sale of
certain of the domestic operating assets and liabilities of NETCOM to MindSpring
were deferred. The deferred proceeds were recognized on a periodic basis over
the term of the MindSpring Capacity Agreement.
Liquidity and Capital Resources
The Company's growth to date has been funded through a combination of
equity, debt and lease financing and non-core asset sales. The Company has also
incurred losses from continuing operations since inception and, as of March 31,
2000, had a working capital deficit of $11.8 million. As of March 31, 2000, the
Company had approximately $34.0 million of cash and short-term investments
available for sale, $198.5 million of accounts receivable including amounts due
from ICG and approximately $25.0 million of credit available under the Senior
Facility.
21
The Company and/or its parent, ICG, has entered into several financing
agreements subsequent to and during the three months ended March 31, 2000 to
provide additional capital to support the Company's net losses and planned
capital expansion, including:
i) On April 10, 2000 the Company's parent, ICG, completed the sale of
75,000 shares of 8% Series A-1, A-2 and A-3 Convertible Preferred
Stock and warrants (see note 9, "Event Subsequent to March 31, 2000"
in the unaudited consolidated financial statements of the Company for
the three months ended March 31, 2000 included elsewhere herein) to
affiliates of Liberty Media Corporation, Hicks, Muse, Tate & Furst
Incorporated and Gleacher Capital Partners. The transaction resulted
in proceeds to ICG of $750.0 million (before cash expenses and fees of
approximately $36.0 million).
ii) During the three months ended March 31, 2000, the Company signed
letters of intent with two major vendors, Cisco Systems, Inc. and
Lucent Technologies, Inc., to provide financing for the acquisition of
equipment. The proposed Cisco credit facility will provide the Company
with up to $180.0 million of capital lease financing and is expected
to close in the second quarter of 2000. Given the closing of the
equity transaction described in (i) above, the Company has postponed
finalizing the arrangements with Lucent.
Management believes that with the completion of the preferred stock
transaction noted above, additional financing including bank financing, vendor
financing, and/or the issuance of high yield debt will be available to fund
operations and achieve the Company's targeted future growth through early 2001.
While the Company believes that it could obtain requisite additional financing,
there can be no assurance that such financing would be available on a timely
basis or on acceptable terms.
Net Cash (Used) Provided By Operating Activities
The Company's operating activities provided $3.6 million and used $43.0
million for the three months ended March 31, 1999 and 2000, respectively. Net
cash provided by operating activities during the three months ended March 31,
1999 is primarily due to net losses, which are more than offset by changes in
working capital items and noncash expenses, such as deferred interest expense
and depreciation. Net cash used by operating activities during the three months
ended March 31, 2000 is primarily due to net losses, decreases in accounts
payable and accrued liabilities partially offset by noncash expenses, such as
deferred interest expense and depreciation.
Net Cash (Used) Provided By Investing Activities
The Company's investing activities provided $130.6 million and used $47.0
million for the three months ended March 31, 1999 and 2000, respectively. Net
cash provided by investing activities for the three months ended March 31, 1999
includes proceeds from the sales of the operations of NETCOM of $252.9 million
and the sale of short-term investments of $4.4 million, offset by the
acquisition of property, equipment and other assets of $64.1 million, the
purchase of the 49% equity interest in ChoiceCom of $35.1 million and the
purchase of long-term investments of $27.5 million. Net cash used by investing
activities during the three months ended March 31, 2000 is primarily from the
acquisition of property, equipment and other assets of $44.8 million. The
Company will continue to use cash in 2000 and subsequent periods for the
purchase of telecommunications equipment by ICG Equipment for lease to ICG
Telecom, the expansion of NetAhead's operations and, potentially, for
acquisitions. The Company acquired assets under capital leases of $11.5 million
during the three months ended March 31, 2000.
Net Cash (Used) Provided By Financing Activities
The Company's financing activities used $2.6 million and provided $58.1
million for the three months ended March 31, 1999 and 2000, respectively. For
the three months ended March 31, 1999, the Company's financing activities
consist of principal payments on long-term debt and capital leases. Net cash
provided by financing activities for the three months ended March 31, 2000 is
primarily from the proceeds from the Senior Facility partially offset by
principal payments on the IRU agreement, long-term debt and capital leases.
On August 12, 1999, ICG Equipment and NetAhead entered into a $200.0
million senior secured financing facility (the "Senior Facility") consisting of
a $75.0 million term loan, a $100.0 million term loan and a $25.0 million
22
revolving line of credit. As of March 31, 2000, the Company had $174.4 million
outstanding under the loans at weighted average interest rates ranging from
9.26% to 9.65% for the three months ended March 31, 2000. Quarterly repayments
on the debt commence at various dates beginning September 30, 1999 with
remaining outstanding balances maturing on June 30, 2005 for the $100.0 million
term loan and the $25.0 million line of credit and March 31, 2006 for the $75.0
million term loan.
As of March 31, 2000, the Company had an aggregate accreted value of
approximately $671.3 million outstanding under the 10% Notes and the 9 7/8%
Notes. The 10% Notes require payments of interest to be made in cash commencing
August 15, 2003 and mature February 15, 2008. The 9 7/8% Notes require payments
of interest to be made in cash commencing November 1, 2003 and mature May 1,
2008. As of March 31, 2000, the Company had $18.4 million of capital lease
obligations and $35.6 million of other indebtedness outstanding. With respect to
fixed rate senior indebtedness outstanding on March 31, 2000, the Company has
cash interest payment obligations of approximately $44.5 million in 2003 and
$89.0 million in 2004, 2005 and each year thereafter through 2007.
During the first quarter of 2000, the Company entered into a letter of
intent with Cisco Systems, Inc. The Company believes that this financing
agreement will better enable the Company to fund its scheduled network expansion
through the purchase of Cisco equipment. The Cisco credit facility provides for
up to $180.0 million of capital lease financing with a three-year repayment
term. The Company anticipates that the Cisco transaction will close during the
second quarter of 2000. There is no assurance, however, that these transactions
will close during those time periods, or at all.
Other Cash Commitments and Capital Requirements
The Company's capital expenditures of continuing operations, including
assets acquired with cash, under capital leases and pursuant to IRU agreement
and excluding payments for construction of corporate headquarters of $1.7
million for the three months ended March 31, 2000 and the acquisition of
corporate headquarters assets of $33.7 million for the three months ended March
31, 1999, were $67.8 million and $113.7 million for the three months ended March
31, 1999 and 2000, respectively. The Company anticipates that the expansion of
the Company's businesses as currently planned will require capital expenditures
of approximately $800.0 million for the remainder of 2000. In the event that
ICG's and the Company's efforts to acquire new customers and deploy new services
are more successful than planned, the Company may be required to expand capital
resources earlier than expected to accommodate customer demands. To facilitate
the expansion of its services and networks, the Company has entered into
equipment purchase agreements with various vendors under which the Company will
purchase equipment and other assets, including a full range of switching
systems, fiber optic cable, network electronics, software and services. If the
Company fails to meet the minimum purchase level in any given year, the vendor
may discontinue certain discounts, allowances and incentives otherwise provided
to the Company. Actual capital expenditures will depend on numerous factors,
including certain factors beyond the Company's control. These factors include
economic conditions, competition, regulatory developments and the availability
of equity, debt and lease financing.
Changes in the Company's business plan may require additional sources of
cash which may be obtained through public and private debt or equity financings,
capital leases and other financing arrangements. To date, the Company has been
able to secure sufficient amounts of financing to meet its capital and operating
needs. There can be no assurance that additional financing will be available to
the Company or, if available, that it can be obtained on terms acceptable to the
Company. The failure to obtain sufficient amounts of financing could result in
the delay or abandonment of some or all of the Company's development and
expansion plans, which could have a material adverse effect on the Company's
business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial position and cash flows are subject to a variety
of risks in the normal course of business, which include market risks associated
with movements in interest rates and equity prices. The Company routinely
assesses these risks and has established policies and business practices to
protect against the adverse effects of these and other potential exposures. The
Company does not, in the normal course of business, use derivative financial
instruments for trading or speculative purposes.
23
Interest Rate Risk
The Company's exposure to market risk associated with changes in interest
rates relates primarily to the Company's investments in marketable securities
and its senior indebtedness.
The Company invests primarily in high grade short-term investments which
consist of money market instruments, commercial paper, certificates of deposit,
government obligations and corporate bonds, all of which are considered to be
available for sale and generally have maturities of one year or less. The
Company's short-term investment objectives are safety, liquidity and yield, in
that order. As of March 31, 2000, the Company had approximately $23.4 million in
cash, cash equivalents and short-term investments available for sale (excluding
the $10.6 million available for sale investment in NorthPoint common stock as
discussed below) at a weighted average fixed interest rate of 5.74% for the
three months ended March 31, 2000. A hypothetical 10% fluctuation in market
rates of interest would not cause a material change in the fair value of the
Company's investment in marketable securities at March 31, 2000 and,
accordingly, would not cause a material impact on the Company's financial
position, results of operations or cash flows.
At March 31, 2000, the Company's indebtedness included $671.3 million
under the 10% Notes and 9 7/8% Notes. These instruments contain fixed annual
interest rates and, accordingly, any change in market interest rates would have
no impact on the Company's financial position, results of operations or cash
flows. Future increases in interest rates could increase the cost of any new
borrowings by the Company. The Company does not hedge against future changes in
market rates of interest.
On August 12, 1999, the Company entered into the Senior Facility,
consisting of two term loans and a revolving line of credit. All components of
the Senior Facility bear variable annual rates of interest, based on changes in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate.
Consequently, additional borrowings under the Senior Facility and increases in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate will
increase the Company's indebtedness and may increase the Company's interest
expense in future periods. Additionally, under the terms of the Senior Facility,
the Company is required to hedge the interest rate risk on $100.0 million of the
Senior Facility if LIBOR exceeds 9.0% for 15 consecutive days. As of March 31,
2000, the Company had $174.4 million outstanding under the Senior Facility. A
hypothetical change in annual interest rate of 1% per annum would result in a
change in interest expense of approximately $0.4 million for the three months
ended March 31, 2000.
Equity Price Risk
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock of NorthPoint
Communications Holdings, Inc. ("NorthPoint") which was converted into 555,555
shares of Class B common stock of NorthPoint (the "NorthPoint Class B Shares")
on May 5, 1999. The NorthPoint Class B Shares were converted on March 30, 2000
on a one-for-one basis into a voting class of common stock of NorthPoint. On
March 30 and 31, 2000, the Company sold 95,555 of the NorthPoint common shares
for proceeds of approximately $2.2 million. The remaining investment is stated
at fair market value and is included in short-term investments available for
sale at March 31, 2000. Accordingly, the Company will be subject to the effects
of fluctuations in the fair value of the common stock of NorthPoint until such
time as the Company liquidates its investment in NorthPoint. Although changes in
the fair market value of the common stock of NorthPoint may affect the fair
market value of the Company's investment in NorthPoint and cause unrealized
gains or losses, such gains or losses will not be realized until the securities
are sold.
The Company also has investments in International ThinkLink Corporation,
Cyras Systems, Inc., and Centennial Strategic Partners VI, L.P. totaling $2.4
million at March 31, 2000. Changes in the fair market value of these investments
would not cause a material impact on the Company's financial position, results
of operations or cash flows.
Market Price Risk
The fair value of the Company's Senior Discount Notes outstanding was
$472.9 million as of March 31, 2000 compared to the carrying value of $671.3
million. A hypothetical 10% fluctuation in market rates of interest would not
cause a material change in the fair value of the Company's Senior Discount Notes
at March 31, 2000.
24
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 7 to the Company's unaudited consolidated financial statements
for the quarterly period ended March 31, 2000 contained elsewhere in
this Quarterly Report.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES AND USE OF PROCEEDS
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) Exhibits.
(10) Material Contracts.
None
(27) Financial Data Schedule.
27.1: Financial Data Schedule of ICG Services, Inc. for the
Three Months Ended March 31, 2000.
(B) Reports on Form 8-K.
(i) Current Report on Form 8-K dated March 7, 2000, regarding the
announcement of ICG's consolidated earnings information and
results of operations for ICG's 1999 fourth quarter and year
end.
(ii) Current Report on Form 8-K dated March 8, 2000, regarding the
announcement of ICG's definitive preferred stock and warrant
purchase agreement with Liberty Media Corporation, HMTF Bridge
ICG, LLC and Gleacher/ICG Investors LLC.
25
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
INDEX TO EXHIBITS
27.1: Financial Data Schedule of ICG Services, Inc. for the Three Months Ended
March 31, 2000.
EXHIBIT 27.1
Financial Data Schedule of ICG Services, Inc. for the Three
Months Ended March 31, 2000.
SIGNATURES
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, on May 11, 2000.
ICG SERVICES, INC.
Date: May 11, 2000 By: /s/ Harry R. Herbst
--------------------------------
Harry R. Herbst, Executive Vice
President and Chief Financial
Officer (Principal Financial Officer)
Date: May 11, 2000 By: /s/ John V. Colgan
--------------------------------
John V. Colgan, Vice President
and Controller (Principal
Accounting Officer)