UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 August 11, 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.
1
TABLE OF CONTENTS
PART I .................................................................... 3
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS ........................... 3
Consolidated Balance Sheets as of December 31, 1999 and June
30, 2000 (unaudited)....................................... 3
Consolidated Statements of Operations for the Three Months
and Six Months Ended June 30, 1999 and 2000 (unaudited).... 5
Consolidated Statement of Stockholder's Equity for the Six
Months Ended June 30, 2000 (unaudited) ................... 6
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 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 ................................... 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .. 27
PART II ................................................................... 28
ITEM 1. LEGAL PROCEEDINGS ........................................... 28
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ................... 28
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ............................. 28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ......... 28
ITEM 5. OTHER INFORMATION ........................................... 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ........................... 28
Exhibits .................................................... 28
Reports on Form 8-K ......................................... 28
2
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1999 and June 30, 2000 (unaudited)
December 31, June 30,
1999 2000
------------- ------------
Assets (in thousands)
------
Current assets:
Cash and cash equivalents $ 43,222 186,690
Short-term investments available for sale 10,442 -
Receivables (note 5):
Trade, net of allowance for doubtful
accounts of $0.0 million and $0.6
million at December 31, 1999 and June 30,
2000, respectively, including amounts
due from ICG 74,064 92,496
Due from ICG 128,893 -
Other 500 10,634
------------ ------------
203,457 103,130
------------ ------------
Prepaid expenses, deposits and inventory 2,942 6,415
------------ ------------
Total current assets 260,063 296,235
------------ ------------
Property and equipment 916,953 1,252,268
Less accumulated depreciation (64,273) (110,017)
------------ ------------
Net property and equipment 852,680 1,142,251
------------ ------------
Restricted cash 1,030 1,272
Investment in partnership interests, common
stock and restricted and exchangeable
preferred stock 11,250 2,400
Investments, accounted for under the equity
method 41,152 31,499
Deferred financing and lease administration
costs, net of accumulated amortization of
$3.9 million and $5.5 million at December
31, 1999 and June 30, 2000, respectively 20,663 20,065
Other assets 919 829
------------ ------------
Total assets $ 1,187,757 1,494,551
============ ============
(Continued)
3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, June 30,
1999 2000
-------------- ------------
Liabilities and Stockholder's Equity (in thousands)
- - ------------------------------------
Current liabilities:
Accounts payable $ 113,372 38,442
Pre-payment from ICG, net(note 5) - 244,103
Payable pursuant to IRU agreement 135,322 84,516
Accrued liabilities 38,718 14,439
Deferred gain on sale (note 3) 5,475 -
Current portion of capital lease obligations 1,951 40,655
Current portion of long-term debt (note 4) 750 750
-------------- ------------
Total current liabilities 295,588 422,905
-------------- ------------
Capital lease obligations, less current portion 5,784 76,646
Long-term debt, net of discount, less current
portion (note 4) 767,167 894,370
Other long-term liabilities 2,500 2,500
-------------- ------------
Total liabilities 1,071,039 1,396,421
-------------- ------------
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares
authorized; 10 shares issued and outstanding
at December 31, 1999 and June 30, 2000 - -
Additional paid-in capital 129,402 129,402
Accumulated deficit (12,684) (31,272)
-------------- ------------
Total stockholder's equity 116,718 98,130
-------------- ------------
Commitments and contingencies (note 6)
Total liabilities and stockholder's equity $ 1,187,757 1,494,551
============== ============
See accompanying notes to consolidated financial statements.
4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months and Six Months Ended June 30, 1999 and 2000
Three months ended Six months ended
June 30, June 30,
------------------------- ------------------------
1999 2000 1999 2000
----------- ------------- ------------ -----------
(in thousands)
Revenue
From services provided to ICG (note 5) $ 19,789 56,954 34,392 96,410
Other 252 8,413 252 12,783
------------- ------------ ---------- ------------
Total Revenue 20,041 65,367 34,644 109,193
------------- ------------ ---------- ------------
Cost of services and expenses:
Cost of services 848 13,800 1,434 23,246
Selling, general and administrative expenses: -
Amounts allocated from ICG (note 5) 201 994 485 2,233
Other 246 873 351 1,726
Depreciation 13,813 21,244 20,943 42,428
------------- ------------ ----------- ------------
Total cost of services and expenses 15,108 36,911 23,213 69,633
------------- ------------ ----------- ------------
Operating income 4,933 28,456 11,431 39,560
Other income (expense):
Interest expense:
Amounts due to ICG (note 5) - (1,896) - (1,896)
Other (17,499) (27,751) (33,137) (52,630)
Interest income:
Amounts earned from ICG (note 5) 4,101 - 10,034 3,171
Other 2,866 1,813 5,248 2,565
Other income (expense), net - 116 439 295
------------- -------------- ----------- ------------
(10,532) (27,718) (17,416) (48,495)
------------- -------------- ----------- ------------
Income (loss) before share of losses of equity
investees and extraordinary gain (5,599) 738 (5,985) (8,935)
Share of net losses of equity investees (3) (4,445) (1,265) (9,653)
------------- -------------- ----------- ------------
Loss before extraordinary gain (5,602) (3,707) (7,250) (18,588)
------------- -------------- ----------- ------------
Extraordinary gain on sales of operations of
NETCOM, net of income taxes of $6.4 million
(note 3) - - 193,029 -
------------- -------------- ----------- ------------
Net income (loss) $ (5,602) (3,707) 185,779 (18,588)
============= ============== =========== ============
See accompanying notes to consolidated financial statements.
5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholder's Equity
Six Months Ended June 30, 2000 (unaudited)
Common stock Additional Accumulated Total
------------- paid-in (deficit) stockholder's
Shares Amount capital earnings equity
------ ------- ----------- ---------- ----------
(in thousands)
Balances at January 1, 2000 - $ - 129,402 (12,684) 116,718
Net loss - - - (18,588) (18,588)
------ ------- --------- ------------ ----------
Balances at June 30, 2000 - $ - 129,402 (31,272) 98,130
====== ======= ========== ============ ==========
See accompanying notes to consolidated financial statements.
6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Six Months Ended June 30, 1999 and 2000 (unaudited)
Six months ended June 30,
-------------------------
1999 2000
----------- ------------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ 185,779 (18,588)
Extraordinary gain on sales of discontinued operations (193,029) -
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Recognition of deferred gain (10,498) (6,239)
Share of net losses of equity investees 1,265 9,653
Depreciation 20,943 42,428
Provision for uncollectible accounts - 577
Interest expense deferred and included in long-term debt 29,566 32,577
Amortization of deferred financing costs included in
interest expense 879 1,240
Amortization of deferred lease administration
costs included in selling, general and
administrative expenses 146 281
Gain on sale of securities (439) (634)
Other noncash expenses - 301
Change in operating assets and liabilities:
Receivables (18,492) 105,294
Prepaid expenses, deposits and inventory 46 (1,060)
Accounts payable and accrued liabilities (9,831) (97,972)
----------- -----------
Net cash provided by operating activities 6,335 67,858
----------- -----------
Cash flows from investing activities:
Acquisition of property, equipment and other assets (290,799) (117,293)
Payments for construction of corporate headquarters - (5,492)
Investment in equity investee (35,093) -
Investment in restricted preferred stock (10,000) -
Proceeds from sales of operations of NETCOM, net of cash
included in sale 252,881 -
Sale of short-term investments available for sale 36,057 10,442
Purchase of long-term investments - (1,150)
Proceeds from sale of short-term investments available for sale 30,439 10,634
Increase in restricted cash - (242)
----------- -----------
Net cash used by investing activities (16,515) (103,101)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt - 95,000
Net pre-payment from ICG - 235,953
Deferred financing and lease administration costs (997) (922)
Principal payments on long-term debt - (374)
Principal payments on capital lease obligations (1,422) (1,217)
Payments on IRU agreement - (149,729)
----------- -----------
Net cash provided (used) by financing activities (2,419) 178,711
----------- -----------
Net increase (decrease) in cash and cash equivalents (12,599) 143,468
Net cash used by discontinued operations (5,107) -
Cash and cash equivalents, beginning of period 114,380 43,222
----------- -----------
Cash and cash equivalents, end of period $ 96,674 186,690
=========== ===========
(continued)
7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
Six months ended June 30,
-------------------------
1999 2000
----------- ------------
(in thousands)
Supplemental disclosure of cash flows information of
continuing operations:
Cash paid for interest $ 2,692 17,202
=========== ============
Cash paid for taxes $ 931 16,470
=========== ============
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 $ 33,077 -
=========== ============
Assets acquired pursuant to IRU agreement $ - 98,147
Assets acquired under capital leases 6,190 108,453
----------- ------------
Total $ 6,190 206,600
=========== ============
See accompanying notes to consolidated financial statements.
8
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1999 and June 30, 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
Communications and its subsidiaries are herein referred to as "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 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 are integral to
ICG's business strategy. 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 six months
ended June 30, 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 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 101B,
which delayed the implementation date of SAB 101 for the Company until the
quarter ended December 31,2000. 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 to the 2000
presentation.
(3) Sale of Assets and Discontinued Operations
To better focus its efforts on its core operations, the Company has
disposed of certain assets which management believes did not complement
its overall business strategy. The Company will from time to time
evaluate all of its assets as to its core needs and, based on such
analysis, may sell or otherwise dispose of assets which management does
not believe complement its overall business strategy.
NETCOM
On November 3, 1998 the Company's board of directors adopted the formal
plan to dispose of the operations of NETCOM. Once this formal plan was
adopted, all historical revenue, operating costs depreciation, interest,
and other costs of NETCOM's operations were classified as discontinued in
the Company's consolidated statements of operations.
10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(3) Sale of Assets and Discontinued Operations (continued)
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., predecessor to
EarthLink, Inc. ("MindSpring") for total proceeds of $245.0 million.
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. 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. Additionally, on March 16, 1999, the Company sold all
of the capital stock of NETCOM's international operations (including
NETCOM Canada and NETCOM U.K.) for total proceeds of approximately $41.1
million.
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"). Under the agreement,
MindSpring utilized the Company's network capacity 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. As the Company expected to generate operating losses
under the MindSpring Capacity Agreement, and the terms of the sale
agreement were dependent upon and negotiated in conjunction with the terms
of the sale of the operating assets of NETCOM, the Company deferred
approximately $35.5 million of the proceeds from the sale agreement to be
applied on a periodic basis to losses incurred under the MindSpring
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 twelve month term of the
agreement which expired February 17, 2000. 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.
As discussed above, the terms of the MindSpring Capacity Agreement were
negotiated in conjunction with and were dependent upon the terms of the
sale of the operating assets of NETCOM to MindSpring. As such, these
transactions are collectively referred to as "Sale of Operating Assets of
NETCOM".
11
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(4) Long-term Debt
Long-term debt is summarized as follows:
December 31, June 30,
1999 2000
--------------- ---------------
(in thousands)
Senior Facility due on scheduled
maturity dates, secured by
substantially all of the assets
of ICG Equipment and NetAhead at
the weighted average interest rates
ranging from 9.56% to 9.87% for the
six months ended June 30, 2000 $ 79,625 174,250
9 7/8% Senior discount notes, net of
discount 293,925 308,439
10% Senior discount notes, net of
discount 361,290 379,354
Mortgage loan payable with adjustable
rate of interest (15.21% at June
30, 2000) due in full on January
31, 2013, secured by corporate
headquarters 33,077 33,077
--------------- ---------------
767,917 895,120
Less current portion (750) (750)
--------------- ---------------
$ 767,167 894,370
=============== ===============
(5) Related Party Transactions
The following table illustrates related party transactions of ICG Services
for the three and six months ended June 30, 1999 and 2000 (all
transactions listed are between the Company (including its subsidiaries)
and ICG Communications (including its subsidiaries)):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ---------------------
1999 2000 1999 2000
---------- -------- --------- ----------
(in thousands)
Related Party Shared Services Activity:
Net charges to (from) ICG, including
pre-payments from ICG (a) $ 111,600 75,008 234,000 202,794
Charges from ICG included in expenses (b) (200) (994) (500) (2,233)
Related Party Leasing Activity:
Equipment purchased for ICG (c) 219,900 58,019 284,000 97,965
Value of new equipment on lease to ICG (d) 96,500 37,836 146,000 93,864
Operating lease revenue (d) 15,600 34,797 26,700 65,365
Lease service fee revenue (e) 3,000 5,524 5,300 10,523
Corporate headquarters lease revenue (f) 1,100 1,258 2,300 2,479
Related Party Interest Income (g) 4,101 - 10,034 3,171
Related Party Interest Expense (g) - (1,896) - (1,896)
12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Related Party Transactions (continued)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ---------------------
1999 2000 1999 2000
---------- -------- --------- ----------
(in thousands)
Related Party Operational Activity:
Installation & local access expenses (h) (1,400) - (2,800) -
DataChoice Revenue (i) - 15,375 - 18,043
(a) 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 its
subsidiaries 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 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 subsidiaries, contain fair and reasonable terms. All
such transactions are settled in cash on a quarterly basis.
During the three months ended June 30, 2000, the shared services
agreement between the Company and ICG was amended to allow for
pre-payments to the Company in order to offset the capital
expenditures made or to be made by the Company on behalf of ICG.
During the three months ended June 30, 2000, the Company received a
pre-payment in the amount of $300 million to pre-pay the anticipated
receivable from ICG through August 31, 2000. All amounts remaining
outstanding under the pre-payments are included in due to ICG in the
Company's consolidated balance sheet as of June 30, 2000.
(b) Certain of the amounts allocated as discussed in (a) above are
included in the Company's consolidated statement of operations as a
component of selling, general and administrative expenses ("SG&A"
expenses).
(c) ICG Equipment purchased certain telecommunications equipment both from
and for ICG 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 or ICG Equipment
on or before 90 days from the purchase date.
(d) ICG Equipment entered into separate agreements to lease
telecommunications equipment to ICG 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. As noted in (c) above, 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 or ICG Equipment on or before 90 days from the purchase
date.
(e) Under the master lease agreement between ICG Equipment and ICG
Telecom, ICG is required to pay ICG Equipment a monthly lease service
fee, at an annual rate of prime plus 4% (13.5% at June 30, 2000),
based on the average monthly balance of assets purchased by ICG
Equipment and intended for future lease to ICG , but not yet placed
into service. ICG Equipment places assets in service upon the
commencement of the respective lease term. The amount of assets
purchased by ICG Equipment and intended for future lease to ICG , but
not yet placed into service, was approximately $149.1 million and
$185.5 million at June 30, 1999 and 2000, respectively. The Company
begins depreciation on property and equipment at the time the assets
are placed in service.
(f) 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. The Company earned leasing revenue from the Restricted
Subsidiary of ICG under the operating lease, which is included in
revenue and due from ICG in the Company's consolidated financial
statements.
13
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Continued)
(5) Related Party Transactions (continued)
(g) Net interest income(expense) accrued by the Company on outstanding
balances due from or to ICG and its Restricted has been accrued on
outstanding balances of intercompany transfers and direct and indirect
costs between ICG Services and ICG and its Restricted Subsidiaries as
discussed in (a) above 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.
(h) In the normal course of business, ICG Telecom provides the use of
certain of its local access lines to NETCOM (prior to the disposition
of the operations of NETCOM) and NetAhead and, accordingly, charges
NETCOM and NetAhead for costs of any installation and recurring access
to its network. Theses expenses have been included in the
extraordinary gain on the sales of the operations of NETCOM for those
charges relating to NETCOM, and in operating costs for those charges
relating to NetAhead, a portion of which were applied against the
deferred gain on the sale of certain of NETCOM's domestic operating
assets and liabilities, in the Company's consolidated financial
statements.
(i) NetAhead earned revenue from a subsidiary of ICG, DataChoice Network
Services, L.L.C. ("DataChoice"), for DataChoice's use of NetAhead's
RAS assets.
(6) Commitments and Contingencies
During the six months ended June 30, 2000, the Company formalized two
agreements with Cisco Systems, Inc. for financing of future capital
expenditures. The Company believes that the financing agreements will
better enable the Company to fund its scheduled network expansion through
the purchase of Cisco equipment. The Cisco credit facilities provide the
Company with $180.0 million of financing with a three-year repayment term.
As of June 30, 2000, $99.1 million was drawn under the facilities.
The Company has entered into various equipment purchase agreements with
certain of its vendors. Under these agreements, if the Company does not
meet a minimum purchase level in any given year, the vendor may discontinue
certain discounts, allowances and incentives otherwise provided to the
Company. In addition, the agreements may be terminated by either the
Company or the vendor upon prior written notice.
The Company has entered into certain commitments to purchase capital assets
with an aggregate purchase price of approximately $272.3 million at June
30, 2000.
NETCOM, now NetAhead, is a party to certain 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.
14
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 management based on 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. These
forward-looking statements are intended to qualify as safe harbors from
liability as established by the Private Securities Litigation Reform Act of
1995. 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 and six months ended June 30, 1999 and
2000 represent the consolidated operating results of the Company and its
subsidiaries. See the unaudited condensed consolidated financial statements of
the Company for the three and six months ended June 30, 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 June
30, 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 June 30, 2000, ICG
Equipment had approximately $632.4 million of telecommunications equipment,
software, network capacity and related services under lease to ICG Telecom and
approximately $185.5 million of such assets intended for future lease to ICG
Telecom, but not yet placed into service.
15
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. 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. 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.
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
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.
16
Sale of Assets and Discontinued Operations
The Company has disposed of certain assets which management believes did
not complement its overall business strategy. The Company will from time to time
evaluate all of its assets as to its core needs and, based on such analysis, may
sell or otherwise dispose of assets which management does not believe complement
its overall business strategy. Following is a discussion of the Company's sale
of assets of NETCOM.
NETCOM
On November 3, 1998 the Company's board of directors adopted the formal
plan to dispose of the operations of NETCOM. Once this formal plan was adopted,
all historical revenue, operating costs, depreciation, interest, and other costs
of NETCOM's operations were classified as discontinued in the Company's
consolidated statements of operations.
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., predecessor to EarthLink,
Inc. ("MindSpring") for total proceeds of $245.0 million. 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. 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. Additionally, on March 16, 1999, the
Company sold all of the capital stock of NETCOM's international operations
(including NETCOM Canada and NETCOM U.K.) for total proceeds of approximately
$41.1 million.
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"). Under the agreement, MindSpring utilized
the Company's network capacity 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. As the Company expected to
generate operating losses under the MindSpring Capacity Agreement, and the terms
of the sale agreement were dependent upon and negotiated in conjunction with the
terms of the sale of the operating assets of NETCOM, the Company deferred
approximately $35.5 million of the proceeds from the sale agreement to be
applied on a periodic basis to losses incurred under the MindSpring 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 twelve month term of the agreement which expired February 17,
2000. 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.
As discussed above, the terms of the MindSpring Capacity Agreement were
negotiated in conjunction with and were dependent upon the terms of the sale of
the operating assets of NETCOM to MindSpring. As such, these transactions are
collectively referred to as "Sale of Operating Assets of NETCOM".
17
Financial Impacts of Asset Sales and Discontinued Operations
The following table illustrates the financial impacts of the sale ofassets
of NETCOM for the three and six months ended June 30, 1999 and 2000:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- -------------------
1999 2000 1999 2000
--------- --------- --------- --------
(in thousands)
Sale of Operating Assets of NETCOM:
Extraordinary gain recorded on the sale
of NETCOM operations (1) $ - - 193,029 -
Taxes on sale of NETCOM operations - - (6,400) -
Losses from discontinued operations
offset against gain (including losses
from November 3, 1998 - February 17,
1999) (1) - - (16,600) -
Recognition of Deferred Gain 3,800 - 10,500 6,239
Summary Results of Operations (February
17, 2000 - June 30, 2000):
Revenue - 8,300 - 12,600
Operating Costs - (13,800) - (23,200)
SG&A - (700) - (1,700)
(1) Offsetting the gain recorded on the Sale of Operating Assets of NETCOM
during the six months ended June 30, 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. Also, as 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.
18
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, cost of services and expenses, operating (loss)
income and EBITDA as a percentage of the Company's revenue.
Three months ended June 30, Six months ended June 30,
------------------------------ -----------------------------
1999 2000 1999 2000
-------------- --------------- ------------- --------------
$ % $ % $ % $ %
--------- ----- -------- ----- ------- ----- --------- -----
(unaudited)
Statement of Operations Data:
Revenue 20,041 100 65,367 100 34,644 100 109,193 100
Cost of services and expenses:
Cost of services 848 4 13,800 21 1,434 4 23,246 21
Selling, general and
administrative expenses 447 2 1,867 3 836 3 3,959 4
Depreciation 13,813 69 21,244 32 20,943 60 42,428 39
--------- ----- -------- ----- ------- ----- --------- -----
Total cost of services and
expenses 15,108 75 36,911 56 23,213 67 69,633 64
Operating income 4,933 25 28,456 44 11,431 33 39,560 36
Other Data:
Net cash provided by operating
activities 2,715 110,817 6,335 67,858
Net cash used by investing
activities (147,136) (56,080) (16,515) (103,101)
Net cash provided (used) by
financing activities 153 120,592 (2,419) 178,711
EBITDA (1) 18,746 94 49,700 76 32,374 93 81,988 75
Capital expenditures of
continuing operations (2) 229,175 210,167 296,989 323,893
(1) EBITDA consists of earnings (loss) from continuing operations before
interest, income taxes, depreciation, other expense, net and share of net
losses of equity investees, or otherwise defined as 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. Capital expenditures of discontinued operations includes the
capital expenditures of NETCOM.
19
THREE MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE MONTHS ENDED JUNE 30, 1999
Three Months Ended June 30,
---------------------------------------
1999 2000
------------------ -------------------
$ % $ %
-------- -------- -------- --------
($ values in thousands)
Revenue:
From services provided to ICG 19,789 99 56,954 87
Other 252 1 8,413 13
-------- -------- -------- --------
Total Revenue 20,041 100 65,367 100
======== ======== ======== ========
Cost of services 848 4 13,800 21
======== ======== ======== ========
Selling, general and administrative:
Amounts allocated from ICG 201 1 994 2
Other 246 1 873 1
-------- -------- -------- --------
Total SG&A 447 2 1,867 3
======== ======== ======== ========
Depreciation and amortization 13,813 69 21,244 32
========= ======== ======== ========
Revenue
A significant portion of the Company's revenue is through services provided
to ICG. Revenue earned from the services provided to ICG be can broken out as
follows:
Three Months Ended June 30,
---------------------------------------
1999 2000
------------------ -------------------
$ % $ %
-------- -------- -------- --------
($ values in thousands)
Revenue from services provided to ICG:
Operating lease revenue 15,644 79 34,797 61
Lease service fee revenue 3,045 15 5,524 10
Corporate headquarters lease revenue 1,100 6 1,258 2
NetAhead revenue with DataChoice
(a subsidiary of ICG) - - 15,355 27
NetAhead revenue with ICG - - 20 -
-------- -------- -------- --------
Total revenue from ICG 19,789 100 56,954 100
Revenue recorded on operating leases of property and equipment to ICG
increased from $15.6 million for the three months ended June 30, 1999 to $34.8
for the same period in 2000, a 123% increase. Leasing revenue increased over the
period as additional assets were leased to ICG Telecom from June 30, 1999
through June 30, 2000.
Lease service fee revenue earned from ICG for the cost of carrying assets
not yet placed into service increased from $3.0 million for the three months
ended June 30, 1999 to $5.5 million for the same period in 2000. The lease
service fee revenue increased primarily because the service fee is earned at a
rate of prime plus 4% (13.5% at June 30, 2000) and the prime rate increased from
June 30, 1999 to June 30, 2000 as well as the increase in the amount of assets
not yet placed into service.
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 the three months ended June 30,
1999 and 2000, the Company recorded revenue on the operating lease for the
corporate headquarters of $1.1 million and $1.3 million, respectively.
20
ICG Services also earned a significant amount of revenue from a subsidiary
of ICG, DataChoice Network Services, L.L.C. ("DataChoice"), for DataChoice's use
of NetAhead's RAS assets. During the three months ended June 30, 2000, the
Company earned $15.4 million in this manner.
Additionally, the increase in revenue during the three months ended June
30, 2000 over 1999 is also due to the recognition of approximately $8.3 million
of revenue for the three months ended June 30, 2000 which prior to February 17,
2000 had been offset against the deferred gain on the sale of NETCOM assets (see
further discussion in "Sale of Assets and Discontinued Operations" above).
Cost of services
Cost of services was $0.8 million for the three months ended June 30, 1999
and $13.8 million for the same period in 2000. Costs of services includes 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 June 30, 2000 over
1999 is due to the recognition of approximately $13.8 million of operating
expenses for the three months ended June 30, 2000 which prior to February 17,
2000 had been offset against the deferred gain on the sale of NETCOM assets (see
further discussion in "Sale of Assets and Discontinued Operations" above).
Selling, general and administrative expenses
Selling, general and administrative ("SG&A") expenses were approximately
$0.4 million for the three months ended June 30, 1999 and $1.9 million for the
same period in 2000. 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 $0.2 million and
$1.0 million, representing 45% and 53% of total SG&A expenses for the three
months ended June 30, 1999 and 2000, respectively. Remaining SG&A expenses
include general corporate administrative expenses, including professional and
cash management fees. Additionally, the increase in SG&A expenses during the
three months ended June 30, 2000 over 1999 is due to the recognition of $0.7
million of SG&A expenses which prior to February 17, 2000 had been off set
against the deferred gain on the sale of NETCOM assets (see further discussion
in "Sale of Assets and Discontinued Operations" above).
Depreciation
Depreciation increased from $13.8 million for the three months ended June
30, 1999 to $21.2 million for the same period in 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.
Interest expense
Interest expense increased from $17.5 million for the three months ended
June 30, 1999 to $29.6 million for the same period in 2000 (which includes $1.9
million in interest expense paid to ICG). Included in interest expense for the
three months ended June 30, 1999 and 2000 was $15.4 million and $17.1 million of
noncash interest, respectively. 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 will continue to
increase as the principal amounts of the indebtedness outstanding under the 10%
Notes and the 9 7/8% Notes increase due to the accretion of noncash interest.
The 10% Notes and the 9 7/8% Notes do not begin to pay interest in cash until
2003.
21
Interest income
Interest income decreased from $7.0 million for the three months ended
June 30, 1999 to $1.8 million for the same period in 2000. During the three
months ended June 30, 1999, the Company earned interest from ICG for invoices
paid by the Company on behalf of ICG and its other operating subsidiaries. The
Company also earned interest on invested cash balances during both the three
months ended June 30, 1999 and 2000.
Share of net losses of equity investees
ICG Services purchased a 20% equity interest in ICG Ohio LINX in August
1998 and a 49% equity interest in ChoiceCom in March 1999. The Company's share
of net losses of equity investees for the three months ended June 30, 1999
consists of the Company's share of net income of ICG Ohio LINX, Inc. ("ICG Ohio
LINX") of $2.8 million, offset by the Company's share of net losses of ICG
ChoiceCom L.P. ("ChoiceCom") of $2.8 million. For the same period in 2000, the
Company's share of net losses are comprised of the Company's share of net losses
of ICG Ohio LINX, Inc. ("ICG Ohio LINX") of $1.0 million and the Company's share
of net losses of ICG ChoiceCom L.P. ("ChoiceCom") of $3.4 million.
Loss before extraordinary gain
Losses before extraordinary gain decreased from a loss of $5.6 million for
the three months ended June 30, 1999 to loss of $3.7 million for the same period
in 2000 due to the increase in revenue, and increases in cost of services,
depreciation and interest expense, as noted above.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO SIX MONTHS ENDED JUNE 30, 1999
Six Months Ended June 30,
---------------------------------------
1999 2000
------------------ -------------------
$ % $ %
-------- -------- -------- --------
($ values in thousands)
Revenue:
From services provided to ICG 34,392 99 96,410 88
Other 252 1 12,783 12
-------- -------- -------- --------
Total Revenue 34,644 100 109,193 100
======== ======== ======== ========
Cost of services 1,434 4 23,246 21
======== ======== ======== ========
Selling, general and administrative:
Amounts allocated from ICG 485 2 2,233 2
Other 351 1 1,726 2
-------- -------- -------- --------
Total SG&A 836 3 3,959 4
======== ======== ======== ========
Depreciation and amortization 20,943 60 42,428 39
======== ======== ======== ========
22
Revenue
A significant portion of the Company's revenue is through services provided
to ICG. Revenue earned from the services provided to ICG can be broken out as
follows:
Six Months Ended June 30,
---------------------------------------
1999 2000
------------------ -------------------
$ % $ %
-------- -------- -------- --------
($ values in thousands)
Revenue from services provided to ICG:
Operating lease revenue 26,749 78 65,365 68
Lease service fee revenue 5,320 15 10,523 10
Corporate headquarters lease revenue 2,323 7 2,479 3
NetAhead revenue with DataChoice
(a subsidiary of ICG) - - 18,004 19
NetAhead revenue with ICG - - 39 -
-------- -------- -------- --------
Total revenue from ICG 34,392 100 96,410 100
Revenue recorded on operating leases of property and equipment to ICG
increased from $26.7 million for the six months ended June 30, 1999 to $65.4 for
the same period in 2000, a 145% increase. Leasing revenue increased over the
period as additional assets were leased to ICG Telecom from June 30, 1999
through June 30, 2000.
Lease service fee revenue earned from ICG for the cost of carrying assets
not yet placed into service increased from $5.3 million for the six months ended
June 30, 1999 to $10.5 million for the same period in 2000. The lease service
fee revenue increased primarily because the service fee is earned at a rate of
prime plus 4% (13.5% at June 30, 2000) and the prime rate increased from June
30, 1999 to June 30, 2000 as well as the increase in the amount of assets not
yet placed into service.
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 the six months ended June 30, 1999
and 2000, the Company recorded revenue on the operating lease for the corporate
headquarters of $2.3 million and $2.5 million, respectively.
ICG Services also earned a significant amount of revenue from a subsidiary
of ICG, DataChoice, for DataChoice's use of NetAhead RAS assets. During the six
months ended June 30, 2000, the Company earned $18.0 million in this manner.
Additionally, the increase in revenue during the six months ended June 30,
2000 over 1999 is also due to the recognition of approximately $12.6 million of
revenue for the six months ended June 30, 2000 which prior to February 17, 2000
had been offset against the deferred gain on the sale of NETCOM assets (see
further discussion in "Sale of Assets and Discontinued Operations" above).
Cost of services
Cost of services was $1.4 million for the six months ended June 30, 1999
and $23.2 million for the same period in 2000. Cost of services includes 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 six months ended June 30, 2000 over 1999
is due to the recognition of approximately $23.2 million of operating expenses
for the six months ended June 30, 2000 which prior to February 17, 2000 had been
offset against the deferred gain on the sale of NETCOM assets (see further
discussion in "Sale of Assets and Discontinued Operations" above).
23
Selling, general and administrative expenses
Selling, general and administrative ("SG&A") expenses were approximately
$0.8 million for the six months ended June 30, 1999 and $4.0 million for the
same period in 2000. 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 $0.5 million and
$2.2 million, representing 58% and 56% of total SG&A expenses for the six months
ended June 30, 1999 and 2000, respectively. Remaining SG&A expenses include
general corporate administrative expenses, including professional and cash
management fees. Additionally, the increase in SG&A expenses during the six
months ended June 30, 2000 over 1999 is due to the recognition of $1.7 million
of SG&A expenses which prior to February 17, 2000 had been offset against the
deferred gain on the sale of NETCOM assets (see further discussion in "Sale of
Assets and Discontinued Operations" above).
Depreciation
Depreciation increased from $20.9 million for the six months ended June
30, 1999 to $42.4 million for the same period in 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.
Interest expense
Interest expense increased from $33.1 million for the six months ended
June 30, 1999 to $54.5 million for the same period in 2000. Included in interest
expense for the six months ended June 30, 1999 and 2000 was $30.4 million and
$33.8 million of noncash interest, respectively. 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 will
continue to increase as the principal amounts of the indebtedness outstanding
under the 10% Notes and the 9 7/8% Notes increase due to the accretion of
noncash interest. The 10% Notes and the 9 7/8% Notes do not begin to pay
interest in cash until 2003.
Interest income
Interest income decreased from $15.3 million for the six months ended June
30, 1999 to $5.7 million for the same period in 2000 and represents net interest
income from ICG for invoices paid by the Company on behalf of ICG and its other
operating subsidiaries and repaid on a quarterly basis as well as interest
earned on invested cash balances.
Share of net losses of equity investees
ICG Services purchased a 20% equity interest in ICG Ohio LINX in August
1998 and a 49% equity interest in ChoiceCom in March 1999. The Company's share
of net losses of equity investees for the six months ended June 30, 1999
consists of the Company's share of net income of ICG Ohio LINX, Inc. ("ICG Ohio
LINX") of $2.3 million, offset by the Company's share of net losses of ICG
ChoiceCom L.P. ("ChoiceCom") of $3.6 million. For the same period in 2000, the
Company's share of net losses are comprised of the Company's share of net losses
of ICG Ohio LINX, Inc. ("ICG Ohio LINX") of $1.8 million and the Company's share
of net losses of ICG ChoiceCom L.P. ("ChoiceCom") of $7.8 million.
24
Loss before extraordinary gain
Losses before extraordinary gain increased from $7.3 million for the six
months ended June 30, 1999 to $18.6 million for the same period in 2000 due to
the increase in revenue, offset by increases in cost of services, 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 the operations
of NETCOM during the six months ended June 30, 1999 of $193.0 million, net of
income taxes of $6.4 million. Offsetting the gain on the sales is approximately
$16.6 million of net losses of operations of NETCOM from November 3, 1998
through the dates of the sales and approximately $35.5 million of the proceeds
was deferred and recognized over the one year term of the MindSpring Capacity
Agreement. (See "Sale of Assets and Discontinued Operations" above for further
discussion.)
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 June 30,
2000, had a working capital deficit of $126.7 million. As of June 30, 2000, the
Company had approximately $186.7 million of cash and short-term investments
available for sale, $103.1 million of accounts receivable including amounts due
from ICG and approximately $25.0 million of credit available under the Senior
Facility.
Management believes that resources are currently abailable to fund
operations and achieve targeted growth through early 2001. Subsequent to early
2001, management expects that 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. 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 Provided By Operating Activities
The Company's operating activities provided $6.3 million and $67.9 million
for the six months ended June 30, 1999 and 2000, respectively. Net cash provided
by operating activities during the six months ended June 30, 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 provided by operating activities during the six months ended June 30,
2000 is primarily due to net losses, which are more than offset by a significant
decrease in amounts due from ICG as well as noncash expenses, such as deferred
interest expense and depreciation.
Net Cash Used By Investing Activities
The Company's investing activities used $16.5 million and $103.1 million
for the six months ended June 30, 1999 and 2000, respectively. Net cash used by
investing activities for the six months ended June 30, 1999 includes proceeds
from the sales of the operations of NETCOM of $252.9 million and the sale of
short-term investments and marketable and available for sale securities of $66.5
million, offset by the acquisition of property, equipment and other assets of
$290.8 million, the purchase of the 49% equity interest in ChoiceCom of $35.1
million and the purchase of restricted preferred stock of $10.0 million. Net
cash used by investing activities during the six months ended June 30, 2000 is
primarily from the acquisition of property, equipment and other assets of $117.3
million partially offset by the sale of short-term and marketable and available
for sale securities of $21.1 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 and pursuant to IRU agreement of $206.6 million during the six months
ended June 30, 2000.
25
Net Cash Provided (Used) By Financing Activities
The Company's financing activities used $2.4 million and provided $178.7
million for the six months ended June 30, 1999 and 2000, respectively. For the
six months ended June 30, 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 six months ended June 30, 2000 is primarily from
the proceeds from the Senior Facility and the pre-payment from ICG which are
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
revolving line of credit. As of June 30, 2000, the Company had $174.3 million
outstanding under the loans at weighted average interest rates ranging from
9.56% to 9.87% for the six months ended June 30, 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 June 30, 2000, the Company had an aggregate accreted value of
approximately $687.8 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 June 30, 2000, the Company had $117.3 million of capital lease
obligations and $35.6 million of other indebtedness outstanding. With respect to
fixed rate senior indebtedness outstanding on June 30, 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 six months ended June 30, 2000, the Company formalized two
agreements with Cisco Systems, Inc. The Company believes that these financing
agreements will better enable the Company to fund its scheduled network
expansion through the purchase of Cisco equipment. The Cisco credit facilities
provide for $180.0 million of financing with a three-year repayment term.
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
were $297.0 million and $323.9 million for the six months ended June 30, 1999
and 2000, respectively. The Company anticipates that the expansion of the
Company's businesses as currently planned will require capital expenditures of
approximately $500.0 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.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial position and cash flows are subject to a variety
of risks in the normal course of business, which include market risks associated
with movements in interest rates and equity prices. The Company routinely
assesses these risks and has established policies and business practices to
protect against the adverse effects of these and other potential exposures. The
Company does not, in the normal course of business, use derivative financial
instruments for trading or speculative purposes.
Interest Rate Risk
The Company's exposure to market risk associated with changes in interest
rates relates primarily to the Company's investments in marketable securities
and its senior indebtedness.
The Company invests primarily in high grade short-term investments which
consist of money market instruments, commercial paper, certificates of deposit,
and government and agency obligations, all of which are considered to be
available for sale and generally have maturities of one year or less. The
Company's short-term investment objectives are safety, liquidity and yield, in
that order. As of June 30, 2000, the Company had approximately $186.7 million in
cash, cash equivalents and short-term investments available for sale at a
weighted average fixed interest rate of 6.58% for the six months ended June 30,
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 June 30, 2000 and, accordingly, would not cause a material impact
on the Company's financial position, results of operations or cash flows.
At June 30, 2000, the Company's indebtedness included $687.8 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 June 30,
2000, the Company had $174.3 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 six months
ended June 30, 2000.
Market Price Risk
The fair value of the Company's Senior Discount Notes outstanding was
$475.3 million as of June 30, 2000 compared to the carrying value of $687.8
million. The fair value of the Senior Discount Notes was calculated using the
quoted bid price per bond as of June 30,2000. 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 June 30, 2000.
27
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 6 to the Company's unaudited consolidated financial statements
for the quarterly period ended June 30, 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. EXHIBIT 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
Six Months Ended June 30, 2000.
(B) Reports on Form 8-K.
None.
28
INDEX TO EXHIBIT
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
INDEX TO EXHIBIT
27.1: Financial Data Schedule of ICG Services, Inc. for the Six Months Ended
June 30, 2000.
EXHIBIT 27.1
Financial Data Schedule of ICG Services, Inc. for the Six Months Ended June
30, 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 August 14, 2000.
ICG SERVICES, INC.
Date: August 14, 2000 By: /s/ Harry R. Herbst
------------------------------------
Harry R. Herbst, Executive Vice
President and
Chief Financial Officer (Principal
Financial Officer)
Date: August 14, 2000 By: /s/ John V. Colgan
------------------------------------
John V. Colgan, Vice President of
Finance and
Controller (Principal Accounting
Officer)