FORM 10-Q. - QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
X Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 1998
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. (The registrant became subject to
filing requirements on July 16, 1998).
Yes No X
On August 28, 1998, 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.
2
TABLE OF CONTENTS
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1. CONSOLIDATED CONDENSED FINANCIAL STATEMENTS . . . . . . 3
Consolidated Balance Sheets (unaudited) as of
December 31, 1997 and June 30, 1998. . . . . . . . . . 3
Consolidated Statements of Operations (unaudited) for
the Three Months and Six Months Ended June 30, 1997
and 1998 . . . . . . . . . . . . . . . . . . . . . . . 5
Consolidated Statement of Stockholders' Equity
(unaudited) for the Six Months Ended June 30, 1998 . . 6
Consolidated Statements of Cash Flows (unaudited) for
the Six Months Ended June 30, 1997 and 1998 . . . . . 7
Notes to Consolidated Financial Statements (unaudited) . 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . . . 13
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
ITEM 1. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . 22
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. . . . . . . . 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES . . . . . . . . . . . . 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . . 22
ITEM 5. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K . . . . . . . . . . . . 22
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . 22
Reports on Form 8-K . . . . . . . . . . . . . . . . . . 23
3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited)
December 31, 1997 and June 30, 1998
December 31, June 30,
1997 1998
---------------- -----------------
(in thousands)
Assets
Current assets:
Cash and cash equivalents $ 63,368 507,192
Short-term investments available for sale - 16,000
Receivables:
Trade, net of allowance of $1,628 and $2,080 at
December 31, 1997 and June 30, 1998, respectively 2,397 2,778
Due from ICG (note 5) - 27,133
Other - 1,025
---------------- -----------------
2,397 30,936
---------------- -----------------
Inventory 341 652
Prepaid expenses and deposits 3,554 3,098
---------------- -----------------
Total current assets 69,660 557,878
---------------- -----------------
Property and equipment 122,007 190,144
Less accumulated depreciation (49,062) (65,049)
---------------- -----------------
Net property and equipment 72,945 125,095
---------------- -----------------
Other assets, net of accumulated amortization:
Deferred financing costs - 16,695
Deferred subscriber acquisition costs 3,115 6,671
Other 1,127 861
---------------- -----------------
4,242 24,227
================ =================
Total assets $ 146,847 707,200
================ =================
(Continued)
4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, June 30,
1997 1998
------------------ -------------------
(in thousands)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 9,314 37,291
Accrued liabilities 13,987 16,027
Deferred revenue 5,170 5,613
Current portion of capital lease obligations 2,491 2,895
------------------ -------------------
Total current liabilities 30,962 61,826
------------------ -------------------
Capital lease obligations, less current portion 3,550 3,654
Long-term debt, net of discount, less current portion (note 4) - 566,388
------------------ -------------------
Total liabilities 34,512 631,868
------------------ -------------------
Stockholders' equity:
Common stock 117 -
Additional paid-in capital 207,208 207,798
Accumulated deficit (95,134) (132,534)
Accumulated other comprehensive income 144 68
------------------ -------------------
Total stockholders' equity 112,335 75,332
------------------ -------------------
Commitments and contingencies (notes 3, 4, 5, and 6)
Total liabilities and stockholders' equity $ 146,847 707,200
================== ===================
See accompanying notes to consolidated financial statements.
5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months and Six Months Ended June 30, 1997 and 1998
Three months ended Six months ended
June 30, June 30,
-------------------------------- ---------------------------------
1997 1998 1997 1998
-------------- ------------- -------------- ---------------
(in thousands)
Revenue (note 7):
Internet services $ 41,020 40,529 80,025 81,063
Leasing services to ICG (note 5) - 452 - 452
-------------- ------------- -------------- ---------------
Total revenue 41,020 40,981 80,025 81,515
-------------- ------------- -------------- ---------------
Operating costs and expenses:
Cost of Internet services revenue (excluding
depreciation) 23,957 26,190 47,337 51,844
Selling, marketing, general and administrative
expenses, including amounts allocated
from ICG (note 5) 19,772 18,132 40,009 35,789
Depreciation and amortization 5,880 7,912 11,724 15,179
Net (gain) loss on disposal of long-lived
assets (256) 143 (578) 143
Merger and restructuring costs, including
amounts allocated from ICG (note 5) 1,712 1,632 1,712 9,378
-------------- ------------- -------------- ---------------
Total operating costs and expenses 51,065 54,009 100,204 112,333
-------------- ------------- -------------- ---------------
Operating loss (10,045) (13,028) (20,179) (30,818)
Other income (expense):
Interest expense (110) (12,759) (152) (17,119)
Interest income 1,010 7,305 1,974 10,565
Other expense, net (28) (3) (20) (3)
-------------- ------------- -------------- ---------------
872 (5,457) 1,802 (6,557)
-------------- ------------- -------------- ---------------
Loss before income taxes (9,173) (18,485) (18,377) (37,375)
Income tax expense (6) (12) (13) (25)
-------------- ------------- -------------- ---------------
Net loss $ (9,179) (18,497) (18,390) (37,400)
============== ============= ============== ===============
Other comprehensive income (loss):
Foreign currency translation adjustment 144 (181) (234) (76)
Unrealized loss on investment securities (84) - (305) -
-------------- ------------- -------------- ---------------
Other comprehensive income (loss) 60 (181) (539) (76)
-------------- ------------- -------------- ---------------
Comprehensive loss $ (9,119) (18,678) (18,929) (37,476)
============== ============= ============== ===============
See accompanying notes to consolidated financial statements.
6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity (unaudited)
Six Months Ended June 30, 1998
Accumulated
Common stock Additional other Total
---------------------- paid-in Accumulated comprehensive stockholders'
Shares Amount capital deficit income equity
----------- ---------- ------------- ---------------- ---------------- --------------
(in thousands)
Balances at January 1, 1998 11,783 $ 117 207,208 (95,134) 144 112,335
Shares issued for cash in connection
with the exercise of NETCOM's
options and warrants (note 3) 10 - 341 - - 341
Shares issued for cash in connection
with NETCOM's employee stock
purchase plan (note 3) 28 1 131 - - 132
Elimination of NETCOM's historical
equity in connection with NETCOM's
merger with ICG (note 3) (11,821) (118) (102,349) - - (102,467)
Contribution of ICG's investment in
NETCOM to ICG Services, Inc.
(note 3) - - 102,467 - - 102,467
Cumulative foreign currency
translation adjustment - - - (76) (76)
Net loss - - - (37,400) - (37,400)
----------- ---------- ------------- ---------------- ---------------- --------------
Balances at June 30, 1998 - $ - 207,798 (132,534) 68 75,332
=========== ========== ============= ================ ================ ==============
See accompanying notes to consolidated financial statements.
7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 1997 and 1998
Six months ended June 30,
-----------------------------------
1997 1998
--------------- ---------------
(in thousands)
Cash flows from operating activities:
Net loss $ (18,390) (37,400)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization 11,724 15,179
Interest expense deferred and included in long-term debt - 15,814
Amortization of deferred subscriber acquisition costs included in
selling, marketing, general and administrative expenses 5,799 3,510
Amortization of deferred financing costs included in interest expense - 422
Write-off of non-operating assets 992 -
Net (gain) loss on disposal of long-lived assets (578) 143
Change in operating assets and liabilities:
Receivables (724) (28,539)
Inventory 95 (311)
Prepaid expenses and deposits (396) 456
Deferred subscriber acquisition costs (3,160) (7,066)
Accounts payable and accrued liabilities 1,988 30,017
Deferred revenue 1,430 443
--------------- ---------------
Net cash used by operating activities (1,220) (7,332)
--------------- ---------------
Cash flows from investing activities:
Acquisition of property, equipment and other assets (5,340) (64,869)
Proceeds from disposition of property, equipment and other assets 1,089 -
Purchase of short-term investments - (16,000)
--------------- ---------------
Net cash used by investing activities (4,251) (80,869)
--------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of common stock:
Exercise of options and warrants - 341
Employee stock purchase plan 868 132
Proceeds from issuance of long-term debt 1,578 550,574
Deferred long-term debt issuance costs - (17,205)
Principal payments on capital lease obligations (601) (1,807)
--------------- ---------------
Net cash provided by financing activities 1,845 532,035
--------------- ---------------
Net (decrease) increase in cash and cash equivalents (3,626) 443,834
Effect of exchange rates on cash (168) (10)
Cash and cash equivalents, beginning of period 73,408 63,368
--------------- ---------------
Cash and cash equivalents, end of period $ 69,614 507,192
=============== ===============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 172 883
=============== ================
Cash paid for income taxes $ 13 25
=============== ================
Supplemental schedule of non-cash financing and investing activity - assets
acquired under capital leases $ 5,533 2,315
=============== ================
See accompanying notes to consolidated financial statements.
8
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997 and June 30, 1998 (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"). The
Company owns all of the issued and outstanding common stock of NETCOM
On-Line Communication Services, Inc. ("NETCOM"), as described in note 3.
NETCOM was incorporated in the State of California in August 1992 and
reincorporated in the State of Delaware in October 1994. NETCOM is
considered to be a predecessor entity to the Company and, accordingly, the
financial statements of the Company prior to January 23, 1998 are the
historical consolidated financial statements of NETCOM.
Through NETCOM, the Company provides Internet access services, World Wide
Web (the "Web") site hosting services and other value-added connectivity
services, which are primarily targeted to small and medium-sized business
customers in the United States, Canada and the United Kingdom.
On January 23, 1998, ICG Equipment, Inc., a Colorado corporation ("ICG
Equipment") and wholly owned subsidiary of the Company, was formed for the
principal purpose of purchasing telecommunications equipment, software and
capacity and related services for sale and lease to other operating
subsidiaries of ICG. ICG Equipment completed its first significant
transaction on June 30, 1998, as described in note 5.
(2) Significant Accounting Policies
(a) Basis of Presentation
These financial statements should be read in conjunction with NETCOM's
audited consolidated financial statements for the fiscal year ended
December 31, 1997, 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, 1998 are not necessarily indicative
of the results that may be expected for the fiscal year ending
December 31, 1998.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
(b) Net Loss Per Share
The Company has 10 shares of common stock issued and outstanding,
which are owned entirely by ICG. Accordingly, the Company does not
present net loss per share in its consolidated financial statements as
such disclosure is not meaningful.
(3) Business Combination
On January 21, 1998, ICG completed a merger with NETCOM, accounted for by
ICG as a pooling of interests. At the effective time of the merger, each
outstanding share of NETCOM common stock became automatically convertible
into shares of ICG common stock at an exchange ratio of 0.8628 shares of
ICG common stock per share of NETCOM common stock. In conjunction with the
merger between ICG and
9
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Business Combination (continued)
NETCOM, NETCOM's employee stock purchase plan was dissolved and all
outstanding options to purchase common stock of NETCOM were converted into
options to purchase common stock of ICG.
For the six months ended June 30, 1998, the Company recorded approximately
$9.4 million of costs related to NETCOM's merger with ICG. These costs
consist of $4.4 million of investment advisory and legal and accounting
fees, $3.7 million relating to penalties and abandonment of projects
resulting from the merger and $1.3 million of other costs associated with
the merger.
In conjunction with the merger, NETCOM established an incentive bonus plan
to retain certain key employees through the critical period of business
integration. For those participating employees who remain in service at key
milestone dates after the merger date, the bonus plan provides for payment
of a designated percentage of the employee's total bonus. NETCOM paid
approximately $0.4 million to employees under the incentive bonus plan
during the six months ended June 30, 1998, approximately $0.6 million
subsequent to June 30, 1998 and expects to pay an additional $0.3 million
in 1999 under the incentive bonus plan. The Company charges incentive bonus
payments, as incurred, to selling, marketing, general and administrative
expenses in the statement of operations.
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.
(4) Long-term Debt
The Company had no long-term debt outstanding at December 31, 1997.
Long-term debt at June 30, 1998 is summarized as follows (in thousands):
9 7/8% Senior discount notes, net of discount (a) $ 254,338
10% Senior discount notes, net of discount (b) 312,050
=================
$ 566,388
=================
(a) 9 7/8% Notes
On April 27, 1998, the Company completed a private placement of 9 7/8%
Senior Discount Notes due 2008 (the "9 7/8% Notes") for gross proceeds
of approximately $250.0 million. Net proceeds from the offering, after
underwriting and other offering costs of approximately $7.6 million,
were approximately $242.4 million.
The 9 7/8% Notes are unsecured senior obligations of the Company that
mature on May 1, 2008, at a maturity value of $405.3 million. Interest
will accrue at 9 7/8% per annum, beginning May 1, 2003, and is payable
each May 1 and November 1, commencing November 1, 2003. The indenture
for the 9 7/8% Notes contains certain covenants which provide
limitations on indebtedness, dividends, asset sales and certain other
transactions.
10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(4) Long-term Debt (continued)
The 9 7/8% Notes were originally recorded at approximately $250.0
million. The discount on the 9 7/8% Notes will be accreted through May
1, 2003, the date on which the 9 7/8% Notes may first be redeemed. The
accretion of the discount and debt issuance costs is included in
interest expense in the accompanying consolidated financial
statements.
(b) 10% Notes
On February 12, 1998, the Company completed a private placement of 10%
Senior Discount Notes due 2008 (the "10% Notes") for gross proceeds of
approximately $300.6 million. Net proceeds from the offering, after
underwriting and other offering costs of approximately $9.6 million,
were approximately $291.0 million.
The 10% Notes are unsecured senior obligations of the Company that
mature on February 15, 2008, at a maturity value of $490.0 million.
Interest will accrue at 10% per annum, beginning February 15, 2003,
and is payable each February 15 and August 15, commencing August 15,
2003. The indenture for the 10% Notes contains certain covenants which
provide limitations on indebtedness, dividends, assets sales and
certain other transactions.
The 10% Notes were originally recorded at approximately $300.6
million. The discount on the 10% Notes is being accreted through
February 15, 2003, the date on which the 10% Notes may first be
redeemed. The accretion of the discount and debt issuance costs is
included in interest expense in the accompanying consolidated
financial statements.
(5) Related Party Transactions
Upon the formation of ICG Services, the Company, including ICG Equipment,
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 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 of each party. All
transactions between the Company and its subsidiaries and ICG and its
Restricted Subsidiaries are approved by the disinterested members of the
Board of Directors of the Company and of ICG and are settled in cash on a
quarterly basis.
For the three months and six months ended June 30, 1998, ICG charged
approximately $1.6 million and $3.2 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 $0.7 million and $1.2 million are included in the Company's
selling, marketing, general and administrative expenses for the three
months and six months ended June 30, 1998, respectively, and approximately
$1.2 million is included in merger and restructuring costs for both the
three months and the six months ended June 30, 1998. In addition, for the
three months and six months ended June 30, 1998, the Company charged
approximately $28.6 million and $29.3 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
11
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Related Party Transactions (continued)
Restricted Subsidiaries. The resulting net receivable from ICG is included
in due from ICG in the Company's consolidated balance sheet at June 30,
1998.
ICG Equipment was formed for the principal purpose of purchasing
telecommunications equipment, software and capacity and related services
for sale and lease to other operating subsidiaries of ICG. On June 30,
1998, ICG Equipment purchased certain fiber optic equipment from a
Restricted Subsidiary of ICG, ICG Telecom Group, Inc. ("ICG Telecom"), for
an aggregate purchase price of approximately $21.9 million. Also on June
30, 1998, ICG Equipment entered into a series of agreements to lease $14.8
million of the same fiber optic equipment back to ICG Telecom under 10-year
operating leases, with annual lease payments commencing on June 29, 1999.
ICG Equipment will recognize revenue from the lease payments ratably over
the lease term. The purchase price and defined lease payments are subject
to adjustment, based on the results of an independent appraisal which may
be requested at the option of ICG Equipment on or before September 30,
1998.
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%, based on the average daily
balance of assets purchased by ICG Equipment and intended for future lease
to ICG Telecom, but not yet placed into service. For the six months ended
June 30, 1998, ICG Equipment recorded approximately $0.5 million of monthly
service fee revenue under this agreement. At June 30, 1998, the amount of
assets purchased by ICG Equipment and intended for future lease to ICG
Telecom, but not yet placed into service, was approximately $37.5 million.
In the normal course of business, ICG Telecom provides the use of certain
of its local access lines to NETCOM and, accordingly, charges NETCOM for
costs of any installation and recurring access to its network. For both the
three months and six months ended June 30, 1998, NETCOM incurred
approximately $1.1 million for installation and recurring local access
charges from ICG Telecom.
(6) Commitments and Contingencies
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.
Additionally, the Company has entered into certain commitments to purchase
capital assets with an aggregate purchase price of approximately $78.9
million at June 30, 1998.
NETCOM 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.
(7) Business Segments
For the three months and six months ended June 30, 1998, the Company's
Leasing Services, consisting solely of the operations of ICG Equipment,
generated approximately $0.5 million in revenue and had, at June 30, 1998,
approximately $52.2 million of long-lived assets, net of accumulated
depreciation. Revenue from international operations represented
approximately 13% of the Company's revenue for both the three
12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(7) Business Segments (continued)
months and six months ended June 30, 1998, compared to 8% and 7% for the
three months and six months ended June 30, 1997, respectively. At June 30,
1998, the Company's international operations had $10.7 million of
long-lived assets, net of accumulated depreciation.
(8) Subsequent Events
On July 1, 1998, ICG Equipment purchased certain fiber optic capacity from
ICG Telecom for approximately $15.9 million. Also on July 1, 1998, ICG
Equipment entered into an agreement to lease the same fiber optic capacity
back to ICG Telecom under a 10-year operating lease, with annual lease
payments commencing June 30, 1999. ICG Equipment will recognize revenue
from the lease payments ratably over the lease term. The purchase price and
lease payment are subject to adjustment, based on the results of an
independent appraisal which may be requested at the option of ICG Equipment
on or before October 1, 1998.
On August 27, 1998, the Company purchased, for $9.0 million in cash, the
remaining 20% equity interest in ICG Ohio LINX, Inc. ("ICG Ohio LINX")
which ICG did not already own. ICG Ohio LINX is a facilities-based
competitive local exchange carrier which operates a fiber optic
telecommunications network in Cleveland and Dayton, Ohio. The Company will
account for its investment in ICG Ohio LINX under the equity method of
accounting.
13
ITEM 2. MANAGEMENT=S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion includes certain forward-looking statements which
are affected by important factors including, but not limited to, the Company's
lack of operating history, historical operating losses of NETCOM and lack of
credit support from ICG. The results of operations for the six months ended June
30, 1998 represent the consolidated operating results of the Company. See the
unaudited consolidated financial statements of the Company for the six months
ended June 30, 1998 included elsewhere herein. For all periods prior to January
21, 1998, the results of operations represent the historical operating results
of NETCOM, the predecessor business to the Company. The historical operating
results of NETCOM were prepared using the unaudited consolidated financial
statements of NETCOM for the three months and six months ended June 30, 1997,
however, these historical operating results have been reclassified to conform
with the classification and presentation of the consolidated statements of
operations of the Company for the three months and six months ended June 30,
1998. The terms "fiscal" and "fiscal year" refer to the Company's fiscal year
ending December 31.
Company Overview
The Company was formed in January 1998 and conducts operations through its
two operating subsidiaries, NETCOM and ICG Equipment. NETCOM is a leading
provider of high quality Internet solutions to individual and small and
medium-sized businesses in the United States and also provides the same high
quality Internet solutions in Canada and the United Kingdom. NETCOM offers a
broad spectrum of Internet solutions designed to enhance customer productivity
through the integration and application of technologies by providing a
comprehensive software platform to interface with the Web, premium quality
Internet access and support services and on-line tools to automate Web site
creation and development.
NETCOM owns and operates a data communications network consisting of 17
hubs containing frame relay switches and high-performance routers connecting a
backbone of leased asynchronous transfer mode ("ATM") switches and leased
high-speed dedicated data lines in the United States, Canada and the United
Kingdom. NETCOM maintains 246 points of presence ("POPs") in the United States
and Canada and also offers virtual local access numbers in Canada and the United
Kingdom. The design and architecture of the physical network permits NETCOM to
offer highly flexible, reliable high-speed services to its customers and support
significant subscriber growth. The NETCOM infrastructure is monitored by network
operating centers in San Jose, Dallas, Toronto and London.
NETCOM derives revenue from dial-up access, direct access and Web site
hosting services. In January 1997, NETCOM announced plans to migrate its
customer focus away from high volume, low margin consumer customers to higher
margin products for small and medium-sized business customers. Although the
primary focus has been and will continue to be on small and medium-sized
business customers, the Company recently decided, in light of NETCOM's merger
with ICG, to continue the acquisition of high volume, lower margin consumer
customers as new technology and marketing opportunities exist to increase
revenue and operating margin from these customers. During fiscal 1997, average
revenue per subscriber increased by 19% measured on a quarterly consolidated
basis. This result is primarily due to a higher proportion of dedicated access
and Web site hosting subscribers during fiscal 1997 and the introduction of
premium-priced dial-up products. For the six months ended June 30, 1998, revenue
from dial-up access, direct access and Web site hosting services was $64.4
million, $10.8 million and $4.7 million, respectively, representing
approximately 80%, 13% and 6%, respectively, of NETCOM's total revenue. The
percentage of dial-up subscribers who subscribed to premium-priced accounts
represented approximately 12% of the total number of dial-up subscribers and the
end of fiscal 1997 and at June 30, 1998. Management believes that the majority
of the customers subscribing to premium-priced services are small to
medium-sized businesses. Direct access customers typically purchase equipment
and generate nonrecurring start-up revenue. This initial nonrecurring revenue
was approximately 1% of NETCOM's revenue for the six months ended June 30, 1998.
In August 1998, ICG announced its launch of Internet Protocol ("IP")
telephony service in 31 U.S. cities, in which ICG will provide long distance
voice and data services to customers, at competitively low prices, via NETCOM's
backbone network. ICG plans to expand its offering of IP telephony services to
14
166 U.S. cities by the end of the year. Also in August 1998, ICG announced that
NETCOM will begin offering symmetric digital subscriber line ("SDSL") service to
small and medium-sized businesses in ICG's service areas in California and
Colorado during the third quarter of 1998 and in non-ICG service areas during
the fourth quarter of 1998. NETCOM is currently completing trials of asymmetric
digital subscriber line ("ADSL") service to be offered to small businesses and
individuals later this year. DSL technology uses existing copper infrastructure,
which enables customers to obtain high-speed, dedicated telecommunications
service at a lower cost than other broadband solutions.
The Company formed ICG Equipment in January 1998 for the principal purpose
of purchasing telecommunications equipment for sale or lease to other operating
subsidiaries of ICG. ICG Equipment completed its first significant transaction
on June 30, 1998, whereby ICG Equipment purchased $21.9 million of fiber optic
equipment from ICG Telecom and entered into a series of agreements to lease back
the same equipment to ICG Telecom under 10-year operating leases. 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 based on
the average daily balance of assets purchased by ICG Equipment and intended for
future lease to ICG Telecom, but not yet placed into service. The Company's
results of operations and financial condition will change as the operations of
ICG Equipment become more significant and as it consummates acquisitions, if
any.
Cost of revenue (excluding depreciation) from Internet Services principally
consists of costs of leased long distance transmission capacity, labor costs,
customer support costs, costs of equipment sold to customers and other
miscellaneous costs. Transmission capacity is the largest component. NETCOM
acquires transmission capacity through month-to-month (or longer) leases.
Selling, marketing, general and administrative ("SG&A") expenses consist
principally of commissions and advertising expenses paid to third party
marketing organizations, advertising expenditures made directly by NETCOM and
labor costs of NETCOM's internal sales force. NETCOM defers the costs of
acquiring Internet subscribers pursuant to Statement of Position 93-7,
"Reporting on Advertising Costs," and amortizes those costs over a 12-month
period or the estimated life of the customer's subscription, whichever is
shorter. The amortization of deferred subscriber acquisition costs is included
in SG&A expenses in the Company's consolidated statements of operations. Also
included in SG&A expenses are product development expenses which are principally
labor costs for programmers and engineers. These personnel are employed to
integrate NETCOM's software with software of third party vendors and software
and applications used on the Internet. The labor market for computer programmers
is highly competitive and labor costs for such personnel have increased and are
expected to continue to increase. Additionally, the Company is allocated a
portion of ICG's general and administrative expenses for certain direct and
indirect costs incurred by ICG on behalf of the Company. In future periods, SG&A
expenses are expected to substantially increase in absolute dollars as the
Company increases its marketing and advertising activities, as well as its
leasing operations under ICG Equipment.
Depreciation and amortization expense is primarily composed of the
depreciation of network equipment. As the operations of ICG Equipment become
more significant, the Company expects depreciation and amortization expense to
increase substantially.
NETCOM recorded merger costs of approximately $9.4 million for the six
months ended June 30, 1998 as a result of its merger with ICG completed in
January 1998, which includes deferred expenses incurred prior to the effective
date of the merger, aggregating approximately $1.8 million. The total merger
costs recorded consist of $4.4 million of investment advisory and legal and
accounting fees, $3.7 million relating to penalties and the abandonment of
projects resulting from the merger and $1.3 million of other costs associated
with the merger.
Historically, NETCOM has not had significant interest expense. However, as
a result of the 10% Notes and the 9 7/8% Notes issued in February and April
1998, respectively, the Company's interest expense will increase substantially
in future periods. Additionally, the Company's interest expense will increase
because the principal amount of its indebtedness increases until the Company's
senior indebtedness begins to pay interest in cash. The Company also expects
interest income to increase in the near term until the proceeds from the 9 7/8%
Notes and the 10% Notes, which are currently held in short-term investments, are
fully invested in the Company's operations.
15
The Company expects to acquire telecommunications, Internet and related
businesses that complement ICG's business strategy to offer a wide array of
telecommunications, Internet and related services primarily to
communications-intensive business customers. Acquisition targets could include
U.S. or foreign competitive local exchange carriers, Internet service providers
and long distance companies, among others. The Company intends to make future
acquisitions primarily through the use of ICG common stock, cash on hand and the
proceeds from securities offerings. 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.
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 shows revenue, operating costs and expenses, operating loss, EBITDA
and EBITDA (before nonrecurring charges) as a percentage of the Company's
revenue.
Three months ended June 30, Six months ended June 30,
------------------------------------------ -----------------------------------------
1997 1998 1997 1998
-------------------- --------------------- -------------------- --------------------
$ % $ % $ % $ %
--------- --------- --------- --------- --------- --------- --------- ----------
(unaudited)
(in thousands)
Statement of Operations Data:
Revenue:
Internet services 41,020 100 40,529 99 80,025 100 81,063 99
Leasing services - - 452 1 - - 452 1
--------- --------- --------- --------- --------- --------- --------- ---------
Total revenue 41,020 100 40,981 100 80,025 100 81,515 100
Cost of Internet services
revenue (excluding depreciation) 23,957 58 26,190 64 47,337 59 51,844 64
Selling, marketing, general and
administrative 19,772 48 18,132 44 40,009 50 35,789 44
Depreciation and amortization 5,880 15 7,912 19 11,724 15 15,179 19
Net (gain) loss on disposal of
long-lived assets (256) (1) 143 1 (578) (1) 143 -
Merger and restructuring costs 1,712 4 1,632 4 1,712 2 9,378 11
--------- --------- --------- --------- --------- --------- --------- ---------
Operating loss (10,045) (24) (13,028) (32) (20,179) (25) (30,818) (38)
Other Data:
Net cash provided (used)by
operating activities 1,295 (3,982) (1,220) (7,332)
Net cash used by investing
activities (2,951) (61,298) (4,251) (80,869)
Net cash (used) provided by
financing activities (105) 241,522 1,845 532,035
EBITDA (1) (4,165) (10) (5,116) (12) (8,455) (11) (15,639) (19)
EBITDA (before nonrecurring
charges) (1) (2,709) (7) (3,341) (8) (7,321) (9) (6,118) (8)
Capital expenditures (2) 5,592 58,552 10,873 67,184
June 30, September 30, December 31, March 31, June 30,
1997 1997 1997 1998 1998
---------- ----------------- ---------------- ------------ ------------
(unaudited)
Statistical Data (3):
Direct access and Web site
hosting services subscribers 9,070 10,630 12,275 14,976 18,638
Average monthly revenue per
subscriber $ 23.95 24.24 25.01 25.12 25.87
(1) EBITDA consists of earnings (loss) before interest, income taxes,
16
depreciation and amortization, and other expenses net, or simply, operating
loss plus depreciation and amortization. EBITDA (before nonrecurring
charges) represents EBITDA before certain nonrecurring charges such as net
(gain) loss on disposal of long-lived assets and merger and restructuring
costs. EBITDA and EBITDA (before nonrecurring charges) are provided because
they are measures commonly used in the Internet and telecommunications
industries. EBITDA and EBITDA (before nonrecurring charges) are presented
to enhance the understanding of the Company's operating results and are not
intended to represent cash flows or results of operations in accordance
with generally accepted accounting principles ("GAAP") for the periods
indicated. EBITDA and EBITDA (before nonrecurring charges) are not
measurements under GAAP and are not necessarily comparable with similarly
titled measures of other companies. Net cash flows from operating,
investing and financing activities as determined using GAAP are also
presented in Other Data.
(2) Capital expenditures includes assets acquired under capital leases.
(3) Amounts presented are for the three-month periods ended, or as of the end
of the period presented.
Three Months Ended June 30, 1998 Compared to Three Months Ended June 30, 1997
Revenue. The Company recorded revenue of approximately $41.0 million for
both the three months ended June 30, 1997 and 1998. Between the comparative
periods, NETCOM experienced increases in direct access and Web site hosting
services revenue of 15% and 51%, respectively, offset by a decrease in dial-up
services revenue. The average monthly revenue per subscriber increased 8% from
$23.95 for the three months ended June 30, 1997 to $25.87 for the three months
ended June 30, 1998. The total number of subscribers decreased by 9% to
approximately 512,000 as of June 30, 1998 from approximately 560,000 as of June
30, 1997. International revenue increased by $2.4 million to $5.5 million for
the three months ended June 30, 1998 from $3.1 million for the three months
ended June 30, 1997. The increase in international revenue is due to the
increased subscriber base for NETCOM's international operations which began in
1996. In January 1997, NETCOM announced plans to migrate its customer focus away
from high volume, low margin consumer customers to higher margin products for
small and medium-sized business customers. Although the primary focus has been
and will continue to be on small and medium-sized business customers, the
Company recently decided, in light of NETCOM's merger with ICG, to continue the
acquisition of high volume, lower margin consumer customers as new technology
and marketing opportunities exist to increase revenue and operating margin from
these customers. NETCOM anticipates that the number of total subscribers will
continue to decline in 1998, while Internet Services revenue per subscriber will
continue to increase. There can be no assurance that revenue per subscriber will
continue to increase.
Also included in revenue for the three months ended June 30, 1998 is
approximately $0.5 million of Leasing Services revenue, consisting entirely of
monthly lease service fees charged by ICG Equipment to ICG Telecom for the cost
of carrying assets not yet placed into service.
Cost of Internet services revenue (excluding depreciation). Cost of revenue
(excluding depreciation) from Internet Services was $26.2 million, or 64% of
revenue, for the three months ended June 30, 1998 and $24.0 million, or 58% of
revenue, for the three months ended June 30, 1997. The increase in cost of
revenue (excluding depreciation) in absolute dollars and as a percentage of
revenue is primarily attributable to NETCOM's increased network and data
communication costs associated with network improvements and with the expansion
of NETCOM's operations and customer support staff. International cost of revenue
(excluding depreciation) for the three months ended June 30, 1998 was $3.2
million, or 59% of international revenue, compared to $2.9 million, or 93% of
international revenue, for the three months ended June 30, 1997. The increase in
international cost of revenue (excluding depreciation) in absolute dollars is
due primarily to increased network and payroll related costs. The decrease in
international cost of revenue (excluding depreciation) as a percentage of
international revenue is due to increases in revenue generated from NETCOM's
expanding international subscriber base, without corresponding increases in cost
of revenue. NETCOM experienced additional direct costs of operations during the
initial period of providing its Internet services in international markets. As
the subscriber base of NETCOM's international operations continues to increase,
the Company expects that international cost of revenue (excluding depreciation)
as a percentage of international revenue will continue to decrease. However, the
Company expects that cost of revenue (excluding depreciation) for international
operations will continue to increase in absolute dollars in the foreseeable
future.
17
Selling, marketing, general and administrative expenses. SG&A expenses
decreased $1.7 million, or 9%, from $19.8 million for the three months ended
June 30, 1997 to $18.1 million for the three months ended June 30, 1998. SG&A
expenses represent approximately 48% and 44% of revenue for the three months
ended June 30, 1997 and 1998, respectively. The decrease in SG&A expenses is
primarily attributable to the decrease in consulting costs, amortization of
deferred subscriber acquisition costs and costs incurred relating to NETCOM's
international operations. In addition, NETCOM adopted Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," during the six months ended June 30, 1998, resulting in the
capitalization of salaries and wages and related costs of personnel involved in
the internal development of software, which costs were included in SG&A expenses
in 1997. NETCOM deferred subscriber acquisition costs of $1.9 million and $5.0
million for the three months ended June 30, 1997 and 1998, respectively, and
recorded amortization of such costs (including certain write-offs in 1997) of
$2.8 million and $1.9 million for the three months ended June 30, 1997 and 1998,
respectively. During the three months ended June 30, 1997, NETCOM also recorded
$0.5 million of SG&A expenses under its joint marketing agreement with Grupo
Itamarati. NETCOM transferred its ownership interest in the related joint
venture company to its partner in December 1997. Offsetting the decrease in
NETCOM's SG&A expenses between the comparative periods is $0.7 million in SG&A
expenses allocated by ICG for the three months ended June 30, 1998.
Depreciation and amortization. Depreciation and amortization expense
increased $2.0 million, or 34%, from $5.9 million for the three months ended
June 30, 1997 to $7.9 million for the three months ended June 30, 1998,
primarily as a result of the increase in depreciable assets.
Net (gain) loss on disposal of long-lived assets. Net (gain) loss on
disposal of long-lived assets fluctuated from a net gain of $0.3 million for the
three months ended June 30, 1997 to a net loss of $0.1 million for the three
months ended June 30, 1998. Net gain on disposal of long-lived assets for the
three months ended June 30, 1997 primarily represents a gain on the sale of
NETCOM's investment in Excite, Inc. For the three months ended June 30, 1998,
net loss on disposal of long-lived assets relates to the loss on the sale of
certain Internet equipment.
Merger and restructuring costs. Merger and restructuring costs for the
three months ended June 30, 1997 of $1.7 million relates to the restructuring of
NETCOM's subsidiary in the United Kingdom and consists of a $0.4 million
write-off of deferred subscriber acquisition costs and $1.4 million in accrued
expenses for costs to terminate excess leased office facilities and a write-off
of office equipment, furniture and building improvements as a result of
consolidating office space. For the three months ended June 30, 1998, merger and
restructuring costs includes $1.6 million of merger costs associated with
NETCOM's merger with ICG, completed in January 1998, and consists of additional
severance and line termination costs.
Interest expense. Interest expense increased $12.7 million, from $0.1
million for the three months ended June 30, 1997 to $12.8 million for the three
months ended June 30, 1998, which includes $12.3 million of non-cash interest.
The increase in interest expense is attributable to an increase in long-term
debt, primarily the 10% Notes and the 9 7/8% Notes issued in February and April
1998, respectively.
Interest income. Interest income increased $6.3 million, from $1.0 million
for the three months ended June 30, 1997 to $7.3 million for the three months
ended June 30, 1998. The increase is attributable to the increase in cash and
invested cash balances from the proceeds from the issuance of the 10% Notes and
the 9 7/8% Notes.
Other expense, net. Other expense, net recorded for the three months ended
June 30, 1997 primarily consists of net losses on foreign currency transactions.
Other expense, net recorded for the three months ended June 30, 1998 represents
miscellaneous gains and losses.
Income tax expense. Income tax expense for the three months ended June 30,
1997 and 1998 is attributable to state and foreign income taxes incurred and
paid by NETCOM.
Net loss. Net loss increased $9.3 million, or 102%, due to the increases in
cost of revenue (excluding depreciation), depreciation and amortization and
interest expense, offset by the increase in interest income, as noted above.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30, 1997
Revenue. Revenue increased $1.5 million, or 2%, to $81.5 million for the
18
six months ended June 30, 1998 from $80.0 million for the six months ended June
30, 1997. NETCOM experienced an 8% increase in average monthly revenue per
subscriber, from $23.95 for the three months ended June 30, 1997 to $25.87 for
the three months ended June 30, 1998, due to an increase in the mix of direct
access and Web site hosting subscribers relative to dial-up subscribers. Between
the comparative periods, NETCOM experienced increases in direct access and Web
site hosting services revenue of 15% and 72%, respectively, offset by a decrease
in dial-up services revenue. International revenue increased by $5.0 million to
$10.5 million for the six months ended June 30, 1998 from $5.5 million for the
six months ended June 30, 1997. The increase in international revenue is due to
the increased subscriber base for NETCOM's international operations which began
in 1996.
Also included in revenue for the six months ended June 30, 1998 is
approximately $0.5 million of Leasing Services revenue, consisting entirely of
monthly lease service fees charged by ICG Equipment to ICG Telecom for the cost
of carrying assets not yet placed in service.
Cost of Internet services revenue (excluding depreciation). Cost of revenue
(excluding depreciation) from Internet Services was $51.8 million, or 64% of
revenue, for the six months ended June 30, 1998 and $47.3 million, or 59% of
revenue, for the six months ended June 30, 1997. The increase in cost of revenue
(excluding depreciation) in absolute dollars and as a percentage of revenue is
primarily attributable to increased network and data communication costs
associated with network improvements and with expansion of NETCOM's operations
and customer support staff. International cost of revenue (excluding
depreciation) for the six months ended June 30, 1998 was $6.4 million, or 61% of
international revenue, compared to $5.6 million, or 101% of international
revenue, for the six months ended June 30, 1997. The increase in international
cost of revenue (excluding depreciation) in absolute dollars is due primarily to
increased network and payroll related costs. The decrease in international cost
of revenue (excluding depreciation) as a percentage of international revenue is
due to increases in revenue generated from NETCOM's expanding international
subscriber base, without corresponding increases in cost of revenue.
Selling, marketing, general and administrative expenses. SG&A expenses
decreased $4.2 million, or 11%, from $40.0 million for the six months ended June
30, 1997 to $35.8 million for the six months ended June 30, 1998. SG&A expenses
represent approximately 50% and 44% of revenue for the six months ended June 30,
1997 and 1998, respectively. The decrease in SG&A expenses is primarily
attributable to the decrease in consulting costs, amortization of deferred
subscriber acquisition costs and costs incurred relating to NETCOM's
international operations. In addition, NETCOM adopted Statement of Position
98-1, "Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," during the six months ended June 30, 1998, resulting in the
capitalization of salaries and wages and related costs of personnel involved in
the internal development of software, which costs were included in SG&A expenses
in 1997. NETCOM deferred subscriber acquisition costs of $3.2 million and $7.1
million for the six months ended June 30, 1997 and 1998, respectively, and
recorded amortization of such costs (including certain write-offs in 1997) of
$5.8 million and $3.5 million for the six months ended June 30, 1997 and 1998,
respectively. During the six months ended June 30, 1997, NETCOM also recorded
$1.1 million of SG&A expenses under its joint marketing agreement with Grupo
Itamarati. NETCOM transferred its ownership interest in the related joint
venture company to its partner in December 1997. Offsetting the decrease in
NETCOM's SG&A expenses between the comparative periods is $1.2 million in SG&A
expenses allocated by ICG for the six months ended June 30, 1998. Also included
in SG&A expenses for the six months ended June 30, 1998 is a nonrecurring charge
of $0.4 million for retention payments to key employees of NETCOM as a result of
NETCOM's merger with ICG in January 1998. Subsequent to June 30, 1998, NETCOM
paid approximately $0.6 million and expects to pay an additional $0.3 million in
retention payments to key employees in 1999.
Depreciation and amortization. Depreciation and amortization expense
increased $3.5 million, or 29%, from $11.7 million for the six months ended June
30, 1997 to $15.2 million for the six months ended June 30, 1998, primarily as a
result of the increase in depreciable assets.
Net (gain) loss on disposal of long-lived assets. Net (gain) loss on
disposal of long-lived assets fluctuated from a net gain of $0.6 million for the
six months ended June 30, 1997 to a net loss of $0.1 million for the six months
ended June 30, 1998. Net gain on disposal of long-lived assets for the six
months ended June 30, 1997 primarily represents a gain on the sale of NETCOM's
investment in Excite, Inc. For the six months ended June 30, 1998, net loss on
disposal of long-lived assets relates to the loss on the sale of certain
Internet equipment.
19
Merger and restructuring costs. Merger and restructuring costs for the six
months ended June 30, 1997 of $1.7 million relates to the restructuring of
NETCOM's subsidiary in the United Kingdom and consists of a $0.4 million
write-off of deferred subscriber acquisition costs and $1.4 million in accrued
expenses for costs to terminate excess leased office facilities and a write-off
of office equipment, furniture and building improvements as a result of
consolidating office space. For the six months ended June 30, 1998, merger and
restructuring costs includes $9.4 million of merger costs associated with
NETCOM's merger with ICG, completed in January 1998. These costs consist of $4.4
million of investment advisory and legal and accounting fees, $3.7 million
relating to penalties and abandonment of projects resulting from the merger and
$1.3 million of other costs associated with the merger.
Interest expense. Interest expense increased $16.9 million, from $0.2
million for the six months ended June 30, 1997 to $17.1 million for the six
months ended June 30, 1998, which includes $16.2 million of non-cash interest.
The increase in interest expense is attributable to an increase in long-term
debt, primarily the 10% Notes and the 9 7/8% Notes issued in February and April
1998, respectively.
Interest income. Interest income increased $8.6 million, from $2.0 million
for the six months ended June 30, 1997 to $10.6 million for the six months ended
June 30, 1998. The increase is attributable to the increase in cash and invested
cash balances from the proceeds from the issuance of the 10% Notes and the 9
7/8% Notes.
Other expense, net. Other expense, net recorded for the six months ended
June 30, 1997 and 1998 represents miscellaneous gains and losses.
Income tax expense. Income tax expense for the six months ended June 30,
1997 and 1998 is attributable to state and foreign income taxes incurred and
paid by NETCOM.
Net loss. Net loss increased $19.0 million, or 103%, primarily due to the
increases in depreciation and amortization, merger and restructuring costs and
interest expense, offset by the increase in interest income, as noted above.
Liquidity and Capital Resources
NETCOM's historical growth has been funded through cash generated from its
operations and public offerings of its equity securities, while the Company's
near term growth will be funded through its recently completed debt financings
(the 10% Notes and the 9 7/8% Notes issued in February and April 1998,
respectively). As of June 30, 1998, the Company had current assets of $557.9
million, including $523.2 million of cash, cash equivalents and short-term
investments, which exceeded current liabilities of $61.8 million, providing
working capital of $496.1 million. The Company invests excess funds in
short-term, interest-bearing, investment-grade securities until such funds are
used to fund the capital investments and operating needs of the Company's
business. The Company's short-term investment objectives are safety, liquidity
and yield, in that order.
Cash Used By Operating Activities
The Company's operating activities used $1.2 million and $7.3 million for
the six months ended June 30, 1997 and 1998, respectively. Cash used by
operations is primarily due to net losses, which are partially offset by
non-cash expenses, such as depreciation and amortization and deferred interest
expense, and changes in working capital items.
The Company expects to continue to generate negative cash flows from
operating activities over the near term as it increases sales and marketing
expenses in order to expand its subscriber base. Consequently, the Company does
not anticipate that cash provided by operations will be sufficient to fund
operating activities in the near term. The Company anticipates that cash used by
operating activities will improve when the Company expands leasing operations
under ICG Equipment, generates more revenue from higher margin Internet
services, principally direct access and Web site hosting services, and realizes
the benefit of synergies and combined marketing efforts between ICG and NETCOM,
while experiencing decelerating increases in personnel and other SG&A expenses
supporting its Internet operations, any or all of which may not occur.
20
Cash Used By Investing Activities
The Company's investing activities used $4.3 million and $80.9 million for
the six months ended June 30, 1997 and 1998, respectively. Cash used by
investing activities includes cash expended for the acquisition of property,
equipment and other assets of $5.3 million and $64.9 million for the six months
ended June 30, 1997 and 1998, respectively. The Company will continue to use
cash in 1998 and subsequent periods for the expansion of new and existing
Internet networks, the purchase of telecommunications equipment by ICG Equipment
for sale or lease to other operating subsidiaries of ICG and, potentially, for
acquisitions. The Company acquired assets under capitalized leases of $5.5
million and $2.3 million for the six months ended June 30, 1997 and 1998,
respectively.
Cash Provided By Financing Activities
NETCOM's financing activities provided $1.8 million for the six months
ended June 30, 1997. Cash provided by financing activities for this period
consists of proceeds from purchases under NETCOM's employee stock purchase plan
(which was dissolved in conjunction with NETCOM's merger with ICG in January
1998), and proceeds from the issuance of long-term debt, offset by payments on
capital lease obligations.
The Company's financing activities provided $532.0 million for the six
months ended June 30, 1998. On February 12, 1998, the Company completed a
private placement of 10% Notes for net proceeds, after underwriting and other
offering costs, of approximately $291.0 million. Interest will accrue at 10% per
annum, beginning February 15, 2003, and is payable each February 15 and August
15, commencing August 15, 2003. The 10% Notes will be redeemable at the option
of the Company, in whole or in part, on or after February 15, 2003. On April 27,
1998, the Company completed a private placement of 9 7/8% Notes for net
proceeds, after underwriting and other offering costs, of approximately $242.4
million. Interest will accrue at 9 7/8% per annum, beginning May 1, 2003, and is
payable each May 1 and November 1, commencing November 1, 2003. The 9 7/8% Notes
will be redeemable at the option of the Company, in whole or in part, on or
after May 1, 2003. On an aggregate basis, the Company's senior indebtedness
matures at a value of approximately $895.3 million.
As of June 30, 1998, the Company had an aggregate of approximately $6.5
million of capitalized lease obligations and an aggregate accreted value of
approximately $566.4 million was outstanding under the 10% Notes and the 9 7/8%
Notes. Management believes that the Company's cash on hand and amounts expected
to be available through vendor financing arrangements will provide sufficient
funds necessary for the Company to expand NETCOM's and ICG Equipment's
businesses and to fund its operating deficits as currently planned. With respect
to indebtedness outstanding on June 30, 1998, the Company has cash interest
payment obligations of approximately $44.5 million in 2003, and $89.3 million in
2004 and each year thereafter through 2007. Accordingly, the Company may have to
refinance a substantial amount of indebtedness and obtain substantial additional
funds prior to August 2003. The Company's ability to do so will depend on, among
other things, its financial condition at the time, restrictions in the
instruments governing its indebtedness, and other factors, including market
conditions, beyond the control of the Company. There can be no assurance that
the Company will be able to refinance such indebtedness, including capitalized
leases, or obtain additional funds, and if the Company is unable to effect such
refinancings or obtain additional funds, the Company's ability to make principal
and interest payments on its indebtedness would be adversely affected.
Other Cash Commitments and Capital Requirements
The Company's capital expenditures (including assets acquired under capital
leases) were $5.6 million and $58.6 million for the three months ended June 30,
1997 and 1998 respectively, and were $10.9 million and $67.2 million for the six
months ended June 30, 1997 and 1998, respectively. The Company anticipates that
the expansion of existing and new Internet networks as well as the expansion of
leasing operations of ICG Equipment will require capital expenditures of
approximately $285.0 million during the second half of 1998. 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 the nature of future
21
expansion and acquisition opportunities, economic conditions, competition,
regulatory developments and the availability of equity, debt and lease
financing.
In addition to the Company's planned capital expenditures, the Company has
capital lease obligations of $6.5 million as of June 30, 1998 and NETCOM has
guaranteed monthly usage levels with WorldCom, its primary communications
vendor, and has certain termination liabilities with other such vendors. The
annual commitments (exclusive of certain usage discounts) in the years 1998,
1999, 2000 and 2001 are $9.3 million, $9.3 million, $7.6 million and $4.2
million, respectively. The aggregate termination liabilities as of June 30, 1998
are approximately $9.5 million. In addition, NETCOM has minimum future rental
payments under noncancelable operating leases of $13.6 million as of June 30,
1998.
Management believes that the Company's cash on hand and amounts expected to
be available through vendor financing arrangements will provide sufficient funds
necessary for the Company to expand NETCOM's and ICG Equipment's businesses and
to fund its operating deficits as currently planned. Additional sources of cash,
if needed, may include public and private debt financings, capitalized leases
and other financing arrangements. To date, the Company has been able to secure
sufficient amounts of financing to meet its capital expenditure 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.
Year 2000 Compliance
The Company is performing a comprehensive review of its information and
support systems to determine whether such systems will properly function in the
year 2000 and thereafter. Systems under review principally include the Company's
network operations and monitoring systems, billing and financial systems and
systems supporting the Company's communications equipment premises, building
facilities and other office equipment. Although the Company relies primarily on
systems developed with current technology and many of the systems currently in
operation were designed to be year 2000 compliant, the Company expects that it
will have to replace, upgrade or reprogram certain systems to ensure that all
interfacing technology will be year 2000 compliant when running jointly. The
Company's due diligence also includes an evaluation of vendor-provided
technology and the implementation of new policies to require vendors to confirm
that they have disclosed and will correct any year 2000 compliance issues.
The Company's evaluation process is expected to be complete during 1998.
Certain minor conversions and system upgrades are already under way and the
Company plans to have all identified compliance issues resolved by mid-1999. The
costs associated with resolving year 2000 compliance issues are expensed as
incurred and, in the aggregate, are not expected to have a material impact on
the Company's financial condition or results of operations. While the Company
believes that its software applications will be year 2000 compliant, there can
be no assurance until the year 2000 occurs that all systems will then function
adequately. Further, if the software applications of local exchange carriers,
long distance carriers or others on whose services the Company depends are not
year 2000 compliant, it could have a material adverse effect on the Company's
financial condition and results of operations.
22
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 6 to the Company's unaudited Consolidated Financial
Statements for the quarterly period ended June 30, 1998 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
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits.
(3) Corporate Organization.
3.1: Certificate of Incorporation of ICG Services, Inc.
[Incorporated by reference to Exhibit 3.1 to
Registration Statement on Form S-4 of ICG Services,
Inc., File No. 333-51037, as amended].
3.2: By-laws of ICG Services, Inc. [Incorporated by
reference to Exhibit 3.2 to Registration Statement on
Form S-4 of ICG Services, Inc., File No. 333-51037, as
amended].
(4) Instruments Defining the Rights of Security Holders,
Including Indentures.
4.1: Indenture, dated April 27, 1998, between ICG Services,
Inc. and Norwest Bank Colorado, National Association
[Incorporated by reference to Exhibit 4.4 to
Registration Statement on Form S-4 of ICG Services,
Inc., File No. 333-60653].
4.2: Indenture, dated February 12, 1998, between ICG
Services, Inc. and Norwest Bank Colorado, National
Association [Incorporated by reference to Exhibit 4.4
to Registration Statement on Form S-4 of ICG Services,
Inc., File No. 333-51037].
(27) Financial Data Schedules.
27.1:Financial Data Schedule of ICG Services, Inc. for the
Six Months Ended June 30, 1998.
23
27.2:Financial Data Schedule of ICG Services, Inc. for the
Six Months Ended June 30, 1997.
(B) Reports on Form 8-K.
None.
24
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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.
ICG SERVICES, INC.
Date: August 28, 1998 By: /s/ Harry R. Herbst
----------------------------------------
Harry R. Herbst,
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: August 28, 1998 By: /s/ Richard Bambach
----------------------------------------
Richard Bambach,
Vice President and Corporate
Controller (Principal Accounting
Officer)