UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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)
ICG Services, Inc. has no securities registered pursuant to Sections 12 (b) or
12 (g) of the Act.
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
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
On April 15, 1999, ICG Services, Inc. had 10 shares of common stock
outstanding. ICG Communications, Inc. owns all of the issued and outstanding
shares of common stock of ICG Services, Inc.
TABLE OF CONTENTS
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . 3
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Significant Transactions . . . . . . . . . . . . . . . . . . . 4
Leasing Services . . . . . . . . . . . . . . . . . . . . . . . 6
Network Services . . . . . . . . . . . . . . . . . . . . . . . 7
Network Infrastructure . . . . . . . . . . . . . . . . . . . 7
Service Offerings, . . . . . . . . . . . . . . . . . . . . . 8
Customers and Marketing. . . . . . . . . . . . . . . . . . . . 9
Competition. . . . . . . . . . . . . . . . . . . . . . . . . . 10
Employees . . . . .. . . . . . . . . . . . . . . . . . . . . . 10
ITEM 2. ROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . . 10
ITEM 3. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . . . 10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . . . . 11
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SECURITYHOLDER MATTERS .. . . . . . . . . . . . . . . . . . 12
ITEM 6. SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . . . . 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . . . . 15
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK . . . . . . . . . . . . . . . . . . . . . . . . 30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA . . . . . . . . 31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES . . . . . . . . . . . 31
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT . . . . . . 32
ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . . 33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . . 42
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . . . 43
PART IV. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-. . . . . . . . . . . . . . 45
Financial Statements. . . . . . . . . . . . . . . . . . . . . . 45
Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . 46
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . F-1
2
PART I
Unless the context indicates otherwise, the term "Company" or "ICG
Services" means the combined business operations of ICG Services, Inc. ("ICG
Services") and its subsidiaries, including ICG Equipment, Inc. ("ICG Equipment")
and ICG PST, Inc. ("PST"). The terms "fiscal" and "fiscal year" refer to ICG
Services' fiscal year ended December 31.
ITEM 1. BUSINESS
Overview
ICG Services was formed on January 23, 1998 and is a wholly owned
subsidiary of ICG Communications, Inc., a Delaware corporation ("ICG"). ICG is
one of the nation's leading competitive integrated communications providers
("ICPs"), based on estimates of the industry's 1998 revenue. ICPs seek to
provide an alternative to incumbent local exchange carriers ("ILECs"), long
distance carriers and other communications service providers for a full range of
communications services in the increasingly deregulated telecommunications
industry. Through ICG's competitive local exchange carrier ("CLEC") operations
conducted by ICG Telecom Group, Inc. and its subsidiaries ("ICG Telecom"), ICG
operates fiber networks in regional clusters covering major metropolitan
statistical areas in California, Colorado, Ohio, the Southeast and Texas. ICG
also provides a wide range of network systems integration services and maritime
and international satellite transmission services through other subsidiaries.
ICG Services' Leasing Services and Network Services operations are currently
conducted through its two operating subsidiaries, ICG Equipment and PST
(formerly NETCOM On-Line Communication Services, Inc. ("NETCOM")), respectively.
On January 21, 1998, ICG acquired NETCOM, a Delaware corporation and
provider of Internet connectivity and Web site hosting services and other
value-added 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. Such financing is provided through ICG Equipment's
purchase of telecommunications equipment, software, network capacity and related
services 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.
The Company's objective is to acquire and invest in telecommunications
equipment, software, network capacity and businesses that complement ICG's
3
business strategy. By leveraging its relationship with ICG, the Company intends
capitalize on the growth in demand for telecommunications equipment and services
provided by the Company. In addition to providing Leasing Services and Network
Services, the Company intends to grow through acquisition or investment in
telecommunications related businesses, including investment in companies
currently owned by ICG.
Significant Transactions
Sales of the Operations of NETCOM. 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 ("MindSpring"). Total proceeds from the sale were $245.0 million,
consisting of $215.0 million in cash and 376,116 shares of common stock of
MindSpring, which were registered with the Securities and Exchange Commission
effective April 6, 1999 and valued at approximately $79.76 per share at the time
of the transaction. Assets and liabilities sold to MindSpring include those
directly related to the domestic operations of NETCOM's Internet dial-up,
dedicated access and Web site hosting services. On March 16, 1999, the Company
sold all of the capital stock of NETCOM's international operations for total
proceeds of approximately $41.1 million. MetroNET Communications Corp.
("MetroNET"), a Canadian entity, and Providence Equity Partners ("Providence"),
located in Providence, Rhode Island, together purchased the 80% interest in
NETCOM Canada Inc. owned by NETCOM for approximately $28.9 million in cash.
Additionally, Providence purchased the capital stock of NETCOM Internet Access
Services Limited, NETCOM's operations in the United Kingdom, for approximately
$12.2 million in cash. The Company expects to record a combined gain on the
NETCOM transactions of approximately $200 million, net of income taxes of
approximately $6.5 million, during the three months ended March 31, 1999.
In conjunction with the sale to MindSpring, the legal name of the NETCOM
subsidiary was changed to ICG PST, Inc. ("PST"). PST has retained the domestic
Internet backbone assets formerly owned by NETCOM which include 236 points of
presence ("POPs") serving approximately 700 cities nationwide. PST intends to
utilize the retained network operating assets to provide wholesale Internet
access and enhanced network services to MindSpring and other ISPs, ICG Telecom
and other telecommunications providers. On February 17, 1999, PST entered into
an agreement to lease to MindSpring for a one-year period the capacity of
certain network operating assets for a minimum of $27.0 million, although
subject to increase dependent upon network usage. MindSpring will utilize the
capacity to provide Internet access to the dial-up services customers formerly
owned by NETCOM. In addition, PST will receive for a one-year period 50% of the
gross revenue earned by MindSpring from the dedicated access customers formerly
owned by NETCOM, estimated to be approximately $10.0 million for the term of the
agreement.
The Company's consolidated financial statements reflect the operations of
NETCOM as discontinued for all periods presented. For fiscal 1996, 1997 and
1998, NETCOM reported revenue of $120.5 million, $160.7 million and $164.6
million, respectively, and EBITDA losses of $(31.0) million, $(9.4) million and
$(14.7) million, respectively.
4
Investments. On August 27, 1998, the Company purchased, for $9.1 million in
cash, the remaining 20% equity interest in ICG Ohio LINX, Inc. ("ICG Ohio LINX")
which ICG Telecom did not already own, including incremental costs of obtaining
that investment of $0.1 million. ICG Ohio LINX is a facilities-based competitive
local exchange carrier which operates a fiber optic telecommunications network
in Cleveland and Dayton, Ohio.
On March 1, 1999, the Company purchased from ICG Telecom, for $35.1 million
in cash, a 49% equity interest in ICG ChoiceCom, L.P., ICG's facilities-based
telecommunications services operations in Texas ("ChoiceCom"). Based in Austin,
Texas, ChoiceCom currently provides local exchange and long distance services in
Austin, Corpus Christi, Dallas, Houston and San Antonio, Texas. The remaining
51% equity interest in ChoiceCom is owned by ICG Telecom.
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock (the
"NorthPoint Preferred Stock") of NorthPoint Communications Holdings, Inc., a
privately held Delaware corporation and CLEC based in San Francisco, California
("NorthPoint"). The NorthPoint Preferred Stock has no voting rights and is
ultimately convertible into a voting class of common stock of NorthPoint, at an
exchange price which represents a discount, as defined in the agreement, to the
initial public offering price of NorthPoint's common stock. The Company is
restricted from selling the NorthPoint Preferred Stock or securities obtained
upon conversion of the NorthPoint Preferred Stock for one year from the date of
the initial public offering of NorthPoint's common stock.
In conjunction with the Company's purchase of the NorthPoint Preferred
Stock, NorthPoint has been designated as ICG's preferred digital subscriber line
("DSL") provider for a two-year period. Under this agreement, ICG Telecom will
purchase a minimum of 49,000 lines from NorthPoint over the two-year term and
allow NorthPoint access to ICG Telecom's collocation facilities in markets where
NorthPoint has limited or no operations. As part of the agreement, ICG Equipment
agreed to sell all of its existing DSL equipment for total proceeds of
approximately $2.7 million in cash.
Financings. 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 $9.7 million, were approximately
$290.9 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 10%
Notes have been registered under the Securities Act of 1933, as amended (the
"Securities Act").
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 $7.9 million, were approximately
$242.1 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
5
November 1, commencing November 1, 2003. The 9 7/8% Notes have been registered
under the Securities Act.
Leasing Services
ICG Equipment was formed for the principal purpose of providing financing
of telecommunications equipment and services to ICG Telecom. Such financing is
provided through ICG Equipment's purchase of telecommunications equipment,
software, network capacity and related services from original equipment
manufactures, providers of intercity network facilities and ICG Telecom and
subsequent lease of such assets to ICG Telecom. ICG Equipment has applied for,
and received or has pending, sales tax reseller certificates in all
jurisdictions in which it conducts business. By purchasing assets through ICG
Equipment, ICG Telecom defers sales tax on asset purchases over the term of its
leases with ICG Equipment, which sales tax would otherwise be paid in full by
ICG Telecom at the times of the purchase. The equipment and services provided to
ICG Telecom are utilized to upgrade and expand ICG's network infrastructure.
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 has engaged a third party to
conduct independent appraisals of the assets ICG Equipment purchases from ICG
Telecom. Such appraisals provide ICG Equipment with an independent evaluation of
the fair value of the assets at the time of purchase, the estimated economic
life of the various classes of assets and the estimated fair value of the assets
at points in time during their economic life. ICG Equipment purchases assets
strictly at the request of ICG Telecom and, accordingly, maintains only a
limited inventory of unleased assets on any date.
All of ICG Equipment's leases with ICG Telecom are structured as operating
leases, with non-cancelable initial terms ranging from 2 to 10 years. Although
lease revenue is recognized from the date the assets are placed in service,
lease payments are deferred for one year from the inception of the lease, after
which lease payments are due and payable on a monthly basis. Under master lease
agreements between ICG Equipment and ICG Telecom, ICG Telecom is also 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. The master lease agreements
require ICG Telecom to insure the leased assets against casualty loss, to pay
all related property, sales and other taxes and to maintain the assets in good
operating condition.
Residual values of leased assets are established at lease inception. In
estimating the residual value, ICG Equipment considers relevant facts regarding
the assets, including their potential obsolescence within the telecommunications
industry and the probability that the assets will continue to be installed and
in use by ICG Telecom at the end of the lease term. ICG Equipment has engaged a
third party to conduct substantially all of ICG Equipment's lease documentation
and administration activities.
6
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, ICG Equipment entered into a series
of agreements whereby ICG Equipment purchased telecommunications equipment and
fiber optic capacity from ICG Telecom and leased back the same
telecommunications equipment and fiber optic capacity to ICG Telecom under
operating leases. At December 31, 1998, ICG Equipment had $195.0 million of
telecommunications equipment, software, network capacity and related services
under lease to ICG Telecom and approximately $107.0 million of such assets
intended for future lease to ICG Telecom, but not yet placed into service.
Revenue from the Company's Leasing Services was approximately $9.9 million for
fiscal 1998.
Network Services
PST's principal objective is to create and deliver high quality network
services and enhanced data products to ISPs, ICG Telecom and other
telecommunications providers and, potentially, to business end users who elect
to outsource their networking and information technology functions. PST believes
the Internet business is one of the fastest growing segments of the
telecommunications service sector, thereby providing enormous growth
opportunities for network service providers supporting the growing base of ISPs
and their customers. PST plans to take advantage of these opportunities
initially by offering wholesale Internet access and other enhanced network
services directly to ISPs and by leveraging its relationship with ICG Telecom.
The Company believes that ICG Telecom will, in turn, leverage its relationship
with its end user ISP customers to expand ICG Telecom's current primary rate
interface ("PRI") offerings to include new services that will utilize PST's data
network. PST's management believes its planned integration of its data services
capability with ICG Telecom's local networks will position PST and ICG Telecom
together to lead in the development and provisioning of new services to this
emerging customer base. In providing its services, PST will utilize the domestic
Internet backbone assets formerly owned by NETCOM. Accordingly, the Company's
operations under its new wholesale network services format commenced upon the
initial sale of the operations of NETCOM on February 17, 1999.
Network Infrastructure
PST's nationwide data network consists of 236 POPs and 13 hubs containing
carrier grade frame relay switches and high capacity routers. The hubs are
connected via redundant leased Asynchronous Transfer Mode ("ATM") network
circuits across the nation with capacity ranging from 10 to 80 megabits per
second. The backbone connects to major public peering connections at MFS MAE
East NAP ("Network Access Point") (Washington, D.C.), MFS MAE West NAP (Santa
Clara, California), PacBell NAP (San Jose, California), Sprint NAP (Newark, New
Jersey) and Ameritech NAP (Chicago, Illinois). In addition, PST has several
private peering relationships with other major ISPs. The network carries and
will carry all Internet protocol ("IP"), or packetized data, traffic associated
with PST's business. The design and architecture of the physical network permits
PST to offer highly flexible, reliable, high-speed services to its customers.
The data network infrastructure is monitored by a network operations center in
San Jose, California.
7
During the first half of 1999, PST will begin migrating away from the
leased ATM network as it adds its own ATM switches connected by redundant DS-3
circuits. PST believes this will increase network visibility of the operations
center and create a more scalable network backbone.
Service Offerings
PST intends to provide wholesale network capacity and enhanced data
services to ICG Telecom and other telecommunications providers, as required. In
December 1998, ICG announced plans to offer several new network services to its
business and ISP customers by utilizing ICG's and, consequently, PST's
nationwide data network and service capabilities to carry out-of-region traffic
and enhance data services provided, which services are expected to be available
from ICG beginning in 1999. One of the services currently being offered is
modemless remote access service ("RAS"). RAS, known as managed modem service,
allows ICG to provide modem access at its own switch location, thereby
eliminating the need for ISPs to deploy modems physically at each of their POPs.
The benefits to ISPs, including reduced capital expenditures and the shift of
network management responsibility from the ISPs to ICG, will allow ICG to act as
an aggregator of ISP traffic.
PST participates in the offering of RAS by providing radius routing and
proxy services at the modem bank connected to ICG Telecom's or another
telecommunications provider's local switch, which services are the
authentication services necessary to validate and accurately route incoming call
traffic to the ISP. PST also provides transport services to deliver all 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, PST
monitors the usage of each port and is responsible for the administration of all
network repair and maintenance. The Company is currently offering Internet RAS
services, or expanded originating services, to MindSpring and expects to extend
such services offerings to other ISPs in the future.
In August 1998, ICG Telecom began offering enhanced telephony services via
IP technology. ICG Telecom currently offers this service in 230 major cities in
the United States, covering more than 90% of the commercial long distance
market. ICG Telecom carries the IP traffic over PST's nationwide data network
and terminates a large portion of the traffic via PST's POPs. PST charges ICG
Telecom for calls carried and terminated on PST's network.
ICG and PST together also began offering integrated access services ("IAS")
which allows voice and data traffic to be carried on the same circuit. Through
equipment installed by ICG Telecom at the customers' premises and in ICG
Telecom's central offices, IAS provides expanded bandwidth for small to
medium-sized business customers as an alternative to purchasing additional
circuits. Data traffic, including Internet traffic, from IAS service offerings
will be carried over PST's network.
In March 1999, ICG entered into an agreement with NorthPoint, which
designates NorthPoint as ICG's preferred DSL provider for a two-year period. All
8
of ICG's DSL traffic will be routed by NorthPoint to PST's ATM switches and
transported by PST either to the ISP, via a point to point connection or via IP
technology, or directly to the Internet, as required.
PST's network will also be utilized by ICG Telecom in offering peering
services to its ISP customers, in which service offerings ICG Telecom will
become the general backbone provider for its customers. Additionally, PST
intends to provide other enhanced network services as demand warrants.
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 1999, 2000 or future years. These service offerings are ultimately dependent
upon demand from ISPs and other telecommunications providers and, while ICG
Telecom and PST believe this market sector will benefit from these new services,
there is no assurance that ICG Telecom and PST will be able to successfully
deploy and market these services efficiently, or at all, or obtain and retain
new customers in a competitive marketplace.
Customers and Marketing
PST is currently utilizing its nationwide data network to provide Internet
access and other network services to MindSpring for a one-year period. During
the term of this agreement, PST plans to evaluate various marketing strategies
to identify and market similar and other enhanced services to primarily local
and regional ISPs, ICG Telecom and other telecommunications providers. PST's
primary marketing strategy is its ability to provide network management and
support services to its customers at cost-effective rates. As quality Internet
access services are increasingly becoming a commodity in the marketplace, ISPs
must offer their end user customers new enhanced services to promote product
differentiation and customer loyalty. Since ISPs are often constrained by their
ability to expend sufficient capital and management resources to continuously
monitor, manage and upgrade their networks to maintain or improve access speed
and reliability for end users, ISPs have limited resources available to invest
in developing new services. These resource constraints can make it more
difficult for small to medium-sized ISPs and new entrants to compete with
nationwide providers who benefit from scale economies. PST believes its network
service capabilities will offer ISPs expanded, higher quality and more efficient
network services at a discount to what they could otherwise provide on their
own, while also allowing ISPs the opportunity to focus on areas of product
differentation. PST initially intends to utilize the efforts of ICG's direct
sales force and sales agents to market its existing Network Services and
identify needs for new customized products. This strategy offers the Company the
immediate benefit of trained sales personnel who have existing relationships
with PST's targeted customers, while offering ICG the opportunity to expand its
service offerings to its own customers for a more full service approach.
As the Company intends at this time to provide Leasing Services only to ICG
Telecom, the Company is not currently involved in expanded marketing efforts for
these services. ICG Equipment has applied for and received, or has pending,
sales tax reseller certificates in all jurisdictions in which it conducts
business. By purchasing assets through ICG Equipment, ICG Telecom defers sales
tax on asset purchases over the terms of its leases with ICG Equipment, which
sales tax would otherwise be paid in full by ICG Telecom at the time of the
purchase.
9
Competition
As a recent entrant into the wholesale network services sector, the Company
faces competition from existing providers of PST's planned services, primarily
UUNet Technologies, Inc., PSINet, Inc. and, ultimately, Level 3 Communications,
Inc. and Qwest Communications International, Inc. once their networks have been
sufficiently developed. Other competitors also include GTE, AT&T, Sprint
Corporation and the Regional Bell Operating Companies that currently offer
similar wholesale network service product to ISPs. While strong competition
currently exists in this sector, the Company believes that the recent growth in
the Internet industry provides expanded opportunity and demand for new providers
such as the Company, and that early participants in this growing sector have
increased opportunity for establishing and, once experienced, growing market
share. There can be no assurance that sufficient demand will exist for PST's
wholesale network services in its selected markets, that market prices will not
dramatically decline or that PST will be successful in executing its strategy in
time to meet new competitors, or at all.
Employees
On December 31, 1998, the Company employed, through NETCOM, a total of 821
individuals on a full time basis, including 193 employees of NETCOM's
international operations. As of March 31, 1999, the Company employed, through
PST, a total of 121 individuals on a full time basis. None of the Company's
employees are represented by a labor union and the Company believes that its
relations with its employees are good.
ITEM 2. PROPERTIES
The Company currently leases approximately 245,000 square feet for offices
and storage sites, primarily in the metropolitan area of San Jose, California,
and also leases approximately 94,000 square feet in other areas of the United
States to house PST's telecommunications POP equipment.
As of December 31, 1998, ICG's corporate headquarters building, land and
improvements were leased by another subsidiary of ICG under an operating lease
from an unrelated third party. The Company has signed a letter of intent to
purchase the approximately 265,000 square foot facility located in Englewood,
Colorado, as well as the other previously leased assets. A newly formed
subsidiary of the Company expects to complete the purchase of those assets in
April 1999.
ITEM 3. LEGAL PROCEEDINGS
A putative class action lawsuit was filed on July 15, 1997 in Superior
Court of California, Orange County, alleging unfair business practices and
related causes of action against NETCOM in connection with its offers of free
trial periods and cancellation procedures. Claimed damages are at least $10.0
million. Although the case is plead as a class action, the class has not been
certified and plaintiffs have requested to substitute a new class
representative. The parties are currently conducting discovery. Trial has been
10
tentatively set for June 1999. The Company believes it has meritorious defenses
to such claims and intends to vigorously defend the action.
The Company is a party to certain other litigation which has arisen in the
ordinary course of business. In the opinion of management, the ultimate
resolution of these matters will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 12, 1998, the Board of Directors of ICG, the sole stockholder
of the Company, unanimously adopted resolutions authorizing the disposition of
the operations of NETCOM.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SECURITYHOLDER MATTERS
All of the Company's 10 shares of common stock issued and outstanding, $.01
par value per share, are owned by ICG. There exists no established public
trading market for the Company's common stock. Since the formation of the
Company and ICG's initial acquisition of the Company's common stock, there have
been no sales or transfers of the Company's common stock. No cash dividends have
been declared and the Company does not intend to pay cash dividends on the
Company's common stock.
In April 1998, the Company sold $405.3 million principal amount at maturity
($250.0 million original issue price) of 9 7/8% Notes. Morgan Stanley & Co.
Incorporated acted as placement agent for the offering and received placement
fees of approximately $7.5 million. In February 1998, the Company sold $490.0
million principal amount at maturity ($300.6 million original issue price) of
10% Notes. Morgan Stanley & Co. Incorporated acted as placement agent for the
offering and received placement fees of approximately $9.0 million.
Both of the foregoing offerings were exempt from registration pursuant to
Rule 144A under the Securities Act of 1933, as amended (the "Securities Act").
Sales were made only to "qualified institutional buyers," as defined in Rule
144A under the Securities Act, and other institutional accredited investors. The
securities sold in both of the foregoing offerings were subsequently registered
under the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data for fiscal 1994 through fiscal 1998 has been
derived from the audited consolidated financial statements of the Company. The
information set forth below should be read in conjunction with the Company's
audited consolidated financial statements and the notes thereto included
elsewhere in this Annual Report. 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. The Company's consolidated
financial statements reflect the operations of NETCOM as discontinued for all
periods presented. ICG owns all of the Company's issued and outstanding common
stock. The Company does not present loss per share from continuing operations or
net loss per share as such disclosure is not considered to be meaningful. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
12
Years Ended December 31,
---------------------------------------------------------------------------------
1994 1995 1996 1997 1998
--------------- --------------- --------------- --------------- ---------------
(in thousands)
Statement of Operations Data:
Revenue $ - - - - 9,911
Operating expenses:
Selling, general and administrative
expenses - - - - 3,761
Depreciation - - - - 4,064
--------------- --------------- --------------- --------------- ---------------
Total operating expenses - - - - 7,825
Operating income - - - - 2,086
Interest expense - - - - (45,522)
Interest income - - - - 23,436
--------------- --------------- --------------- --------------- ---------------
Loss from continuing operations before
share of earnings - - - - (20,000)
Share of earnings of ICG Ohio LINX - - - - 1,075
--------------- --------------- --------------- --------------- ---------------
Loss from continuing operations - - - - (18,925)
Loss from discontinued operations (100) (14,064) (44,265) (33,092) (60,965)
--------------- --------------- --------------- --------------- ---------------
Net loss $ (100) (14,064) (44,265) (33,092) (79,890)
=============== =============== =============== =============== ===============
Other Data:
Net cash used by operating activities
of continuing operations - - - - (85,764)
Cash used by investing activities of
continuing operations - - - - (352,073)
Net cash provided by financing activities
of continuing operations - - - - 532,802
EBITDA (1) - - - - 6,150
Capital expenditures of continuing
operations (2) - - - - 301,969
Capital expenditures of discontinued
operations (2) 11,143 43,601 53,992 17,258 25,971
13
December 31,
---------------------------------------------------------------------------------
1994 1995 1996 1997 1998
--------------- --------------- --------------- --------------- ---------------
(in thousands)
Balance Sheet Data:
Cash, cash equivalents and short-term
investments available for sale $ - - - - 155,380
Net current assets (liabilities)of
discontinued operations (3) 15,551 131,917 53,646 38,698 (22,328)
Working capital 15,551 131,917 53,646 38,698 248,438
Property and equipment, net - - - - 297,905
Net non-current assets of discontinued
operations (3) 12,413 53,549 91,145 73,637 54,023
Total assets 27,964 185,466 144,791 112,335 679,749
Long-term debt - - - - 594,617
Common stock and additional paid-in capital 31,677 203,271 205,622 207,325 207,798
Accumulated deficit (3,713) (17,777) (62,042) (95,134) (175,024)
Stockholders' equity 27,964 185,466 144,791 112,335 32,655
(1) EBITDA consists of earnings (loss) from continuing operations before
interest, income taxes, depreciation, other expense, net and share of
earnings, or simply, operating income plus depreciation. EBITDA is provided
because it is a measure commonly used in the telecommunications industry.
EBITDA is presented to enhance the 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 under capital leases. Capital
expenditures of discontinued operations includes the capital expenditures
of NETCOM for all periods presented.
(3) Net non-current assets of discontinued operations and net current assets
(liabilities) of discontinued operations represents the assets and
liabilities of NETCOM for all periods presented.
14
ITEM 7. 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, the successful implementation of the Company's new
strategy of offering wholesale network services to ISPs, ICG Telecom and other
telecommunications providers and 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 years ended December 31, 1996, 1997 and 1998
have been derived from the Company's audited financial statements 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
The Company was formed on January 23, 1998 and is a wholly owned subsidiary
of ICG. The Company's Leasing Services and Network Services operations are
currently conducted through its two operating subsidiaries, ICG Equipment and
PST (formerly NETCOM).
On January 21, 1998, ICG acquired NETCOM, a provider of Internet
connectivity and Web site hosting services and other value-added 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 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 for the principal purpose
of providing financing of telecommunications equipment and services to 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. ICG
Equipment has applied for, and received or has pending, sales tax reseller
certificates in all jurisdictions in which it conducts business. By purchasing
assets through ICG Equipment, ICG Telecom defers sales tax on asset purchases
over the terms of its leases with ICG Equipment, which sales tax would otherwise
be paid in full by ICG Telecom at the time of the purchase. The equipment and
services provided to ICG Telecom are utilized to upgrade and expand ICG's
network infrastructure. 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, ICG Equipment entered into a series of agreements whereby
ICG Equipment purchased telecommunications equipment and fiber optic capacity
15
from 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 December 31, 1998, ICG
Equipment had approximately $195.0 million of telecommunications equipment,
software, network capacity and related services under lease to ICG Telecom and
approximately $107.0 million of such assets intended for future lease to ICG
Telecom, but not yet placed into service.
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to 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. Since the
Company expects to record a gain on the disposition of NETCOM, the Company has
deferred the net losses from operations of NETCOM from November 3, 1998 (the
date on which the formal plan of disposition of NETCOM was approved by the Board
of Directors) through December 31, 1998 of approximately $10.8 million. The
Company expects to record a combined gain on the NETCOM transactions of
approximately $200 million, including the recognition of the deferred losses of
NETCOM from November 3, 1998 through the sale dates and net of income taxes of
approximately $6.5 million, during the three months ended March 31, 1999. Since
the operations sold were acquired by ICG in a transaction accounted for as a
pooling of interests, the gain on the NETCOM transactions will be classified in
the Company's consolidated statement of operations as an extraordinary item. For
fiscal 1996, 1997 and 1998, NETCOM reported revenue of $120.5 million, $160.7
million and $164.6 million, respectively, and EBITDA losses of $(31.0) million,
$(9.4) million and $(14.7) million, respectively. The Company's consolidated
financial statements reflect the operations of NETCOM as discontinued for all
periods presented.
In conjunction with the sale to MindSpring, the legal name of the NETCOM
subsidiary was changed to ICG PST, Inc. ("PST"). PST has retained the domestic
Internet backbone assets formerly owned by NETCOM which include 236 POPs serving
approximately 700 cities nationwide. PST intends to utilize the retained network
operating assets to provide wholesale Internet access and enhanced network
services to MindSpring and other ISPs, ICG Telecom and other telecommunications
providers. On February 17, 1999, PST entered into an agreement to lease to
MindSpring for a one-year period the capacity of certain network operating
assets for a minimum of $27.0 million, although subject to increase dependent
upon network usage. MindSpring will utilize the capacity to provide Internet
access to the dial-up services customers formerly owned by NETCOM. In addition,
PST will receive for a one-year period 50% of the gross revenue earned by
MindSpring from the dedicated access customers formerly owned by NETCOM,
estimated to be approximately $10.0 million for the term of the agreement.
Although the Company expects to generate cash operating losses under this
agreement, any such losses will be offset by the periodic recognition of the
portion of the gain on the sale of assets to MindSpring, which the Company
deferred on February 17, 1999. Accordingly, the Company does not expect to
recognize any revenue, operating costs or selling, general and administrative
expenses from services provided to MindSpring for the term of the agreement. Any
16
incremental revenue or costs generated by other customers will be recognized in
the Company's consolidated statement of operations as incurred.
Additionally, PST intends to provide wholesale network capacity and
enhanced data services to ICG Telecom and other telecommunications providers, as
required. In December 1998, ICG announced plans to offer several new network
services to its business and ISP customers by utilizing ICG's and, consequently,
PST's nationwide data network and service capabilities to carry out-of-region
traffic and enhance data services provided, which services are expected to be
available from ICG beginning in 1999. One of the services currently being
offered is RAS. RAS, known as managed modem service, allows ICG to provide modem
access at its own switch location, thereby eliminating the need for ISPs to
deploy modems physically at each of their POPs. The benefits to ISPs, including
reduced capital expenditures and the shift of network management responsibility
from the ISPs to ICG, will allow ICG to act as an aggregator of ISP traffic. PST
participates in offering RAS by providing radius routing and proxy services at
the modem bank connected to ICG Telecom's or another telecommunications
provider's local switch, which services are the authentication services
necessary to validate and accurately route incoming call traffic to the ISP. PST
also provides transport services to deliver all 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, PST monitors the usage of each port and
is responsible for the administration of all network repair and maintenance. The
Company is currently offering Internet RAS services, or expanded originating
services, to MindSpring and expects to extend such services offerings to other
ISPs in the future. In August 1998, ICG Telecom began offering enhanced
telephony services via IP technology. ICG Telecom currently offers this service
in 230 major cities in the United States, covering more than 90% of the
commercial long distance market. ICG Telecom carries the IP traffic over PST's
nationwide data network and terminates a large portion of the traffic via PST's
POPs. PST charges ICG Telecom for calls carried and terminated on PST's network.
ICG and PST together also began offering IAS which allows voice and data traffic
to be carried on the same circuit. Through equipment installed by ICG Telecom at
the customers' premises and in ICG Telecom's central offices, IAS provides
expanded bandwidth for small to medium-sized business customers as an
alternative to purchasing additional circuits. Data traffic, including Internet
traffic, from IAS service offerings will be carried over PST's network. In March
1999, ICG entered into an agreement with NorthPoint, which designates NorthPoint
as ICG's preferred DSL provider for a two-year period. All of ICG's DSL traffic
will be routed by NorthPoint to PST's ATM switches and transported by PST either
to the ISP, via a point to point connection or via IP technology, or directly to
the Internet, as required. PST's network will also be utilized by ICG Telecom in
offering peering services to its ISP customers, in which service offerings ICG
Telecom will become the general backbone provider for its customers.
Additionally, PST intends to provide other enhanced network services as demand
warrants.
The Company has and will continue to enter into agreements with ICG
Telecom to provide network services at negotiated rates. All such arrangements
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
17
will have on revenue or EBITDA in 1999, 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, and while ICG Telecom and PST believe the Internet
services market sector will benefit from these new services, there is no
assurance that ICG Telecom and PST will be able to successfully deploy and
market its new services efficiently, or at all, or obtain and retain new
customers in a competitive marketplace. In the event that ICG Telecom fails to
successfully deploy its new services utilizing PST's network, demands a lower
volume of network capacity services than originally anticipated or is unable to
adequately compensate PST for services provided or to be provided, PST will
market its services solely to unrelated third parties.
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, including the proceeds from the sales of the operations of
NETCOM, the proceeds from securities offerings and 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 PST become more significant and as
it consummates acquisitions, if any.
Results of Operations
The following table provides certain statement of operations data and
certain other financial data for the Company for the periods indicated. The
table also presents revenue, operating expenses, operating income and EBITDA as
a percentage of the Company's revenue.
18
Years Ended December 31,
------------------------------------------------------------------------
1996 1997 1998
---------------------- ------------------------ -----------------------
$ % $ % $ %
-------------- ------- ------------- --------- -------------- --------
(Dollars in thousands)
Statement of Operations Data:
Revenue - - - - 9,911 100
Operating expenses:
Selling, general and administrative - - - - 3,761 38
Depreciation - - - - 4,064 41
-------------- -------- ------------- ------- ------------- -------
Total operating expenses - - - - 7,825 79
Operating income - - - - 2,086 21
Other Data:
Net cash used by operating activities
of continuing operations - - (85,764)
Cash used by investing activities of
continuing operations - - (352,073)
Net cash provided by financing
activities of continuing operations - - 532,802
EBITDA (1) - - - - 6,150 62
Capital expenditures of continuing
operations (2) - - 301,969
Capital expenditures of discontinued
operations (2) 53,992 17,258 25,971
(1) (2) See notes 1 and 2 under "Selected Financial Data" for the
definitions of EBITDA and capital expenditures, respectively.
Revenue. The Company recorded revenue of approximately $9.9 million for
fiscal 1998, which consists entirely of revenue from Leasing Services provided
to ICG or ICG's other operating subsidiaries. Revenue recorded on operating
leases of property and equipment to ICG Telecom was $4.9 million for fiscal
1998. Additionally, the Company charged lease service fees to ICG Telecom during
the periods presented for the cost of carrying assets not yet placed into
service. For fiscal 1998, revenue earned on lease service fees was $5.0 million.
The Company anticipates that revenue will increase substantially in future
periods as the volume of ICG Equipment's operations increases.
Selling, general and administrative expenses. Selling, general and
administrative ("SG&A") expenses were approximately $3.8 million for fiscal
1998. SG&A expenses consist principally of 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 $2.4 million,
representing 64% of total SG&A expenses for fiscal 1998. Remaining SG&A expenses
include general corporate administrative expenses, including professional and
19
cash management fees. SG&A expenses are expected to increase in absolute dollars
as the volume of ICG Equipment's operations increases.
Depreciation. Depreciation was $4.1 million for fiscal 1998 and includes
depreciation of ICG Equipment's property and equipment purchased from and for
ICG Telecom and leased to ICG Telecom under long-term operating leases. The
Company's depreciation expense will continue to increase as ICG Equipment places
in service equipment that has already been purchased, purchases additional
property and equipment for lease to ICG's other operating subsidiaries and as
the Company recognizes the depreciation of assets formerly owned by NETCOM and
retained by PST, beginning in February 1999.
Interest expense. Interest expense was $45.5 million for fiscal 1998 and
consists entirely of non-cash interest. Interest expense is attributable to the
10% Notes and the 9 7/8% Notes issued in February and April 1998, respectively.
The Company's interest expense will continue to increase as the principal
amounts of the 10% Notes and the 9 7/8% Notes increase until the 10% Notes and
the 9 7/8% Notes begin to pay interest in cash.
Interest income. Interest income was $23.4 million for fiscal 1998 and
primarily represents interest earned on invested cash balances from the proceeds
from the issuance of the 10% Notes and the 9 7/8% Notes. The Company also earned
net interest income from ICG of approximately $4.6 million during fiscal 1998
for invoices paid by the Company on behalf of ICG and its other operating
subsidiaries and repaid on a quarterly basis. The Company expects interest
income to decline in future periods as the Company continues to invest its
available cash balances in telecommunications equipment and other assets.
Share of earnings of ICG Ohio LINX. The Company's share of earnings of ICG
Ohio LINX was $1.1 million for fiscal 1998. The Company purchased a 20% equity
interest in ICG Ohio LINX in August 1998.
Loss from continuing operations. Loss from continuing operations of $18.9
million for fiscal 1998 is primarily a result of interest expense, offset by
interest income, as described above. As the operations of ICG Equipment become
more significant, the Company's loss from continuing operations will be
increasingly impacted by the operating income of ICG Equipment.
Loss from discontinued operations and net loss. For fiscal 1996, 1997 and
1998, loss from discontinued operations was $44.3 million, $33.1 million and
$61.0 million, respectively, or 100%, 100% and 76%, respectively, of the
Company's net loss. Loss from discontinued operations consists of the net loss
of NETCOM. The decrease in the net loss of NETCOM between fiscal 1996 and 1997
is due to an increase in revenue and a decrease in operating costs as a
percentage of revenue. The increase in the net loss of NETCOM between fiscal
1997 and 1998 relates primarily to increases in SG&A expenses, depreciation and
amortization and approximately $9.4 million for merger costs incurred by NETCOM
during fiscal 1998, relating to NETCOM's merger with ICG in January 1998. Net
loss of $79.9 million for fiscal 1998 primarily includes interest expense and
loss from discontinued operations.
20
Quarterly Results
The following table presents selected unaudited operating results for
three-month quarterly periods during fiscal 1997 and 1998. The Company believes
that all necessary adjustments have been included in the amounts stated below to
present fairly the quarterly results when read in conjunction with the Company's
consolidated financial statements and related notes included elsewhere in this
Annual Report. Results of operations for any particular quarter are not
necessarily indicative of results of operations for a full year or predictive of
future periods. The Company's development and expansion activities during the
periods shown below materially affect the comparability of this data from one
period to another. ICG owns all of the Company's issued and outstanding common
stock. The Company does not present loss per share from continuing operations or
net loss per share as such disclosure is not considered to be meaningful.
Three Months Ended Three Months Ended
-------------------------------------------- ---------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1997 1997 1997 1997 1998 1998 1998 1998
----------- --------- ----------- ----------- ----------- ----------- ------------ ------------
(in thousands)
Statement of Operations Data:
Revenue $ - - - - - 452 3,104 6,355
Operating (loss) income - - - - (489) (711) 1,312 1,974
Loss from continuing operations - - - - (2,324) (6,703) (5,065) (4,833)
Loss from discontinued
operations (9,211) (9,179) (6,827) (7,875) (16,579) (11,794) (14,062) (18,530)
----------- --------- ----------- ----------- ----------- ----------- ------------ ------------
Net loss $ (9,211) (9,179) (6,827) (7,875) (18,903) (18,497) (19,127) (23,363)
=========== ========= =========== =========== =========== =========== ============ ============
Other Data:
Net cash provided (used) by
operating activities of
continuing operations - - - - 1,762 31,636 (75,347) (43,815)
Cash used by investing
activities of continuing - - - - (14,123) (54,113) (105,521) (178,316)
operations
Net cash provided (used) by
financing activities of
continuing operations - - - - 291,469 242,373 (384) (656)
EBITDA (1) - - - - (489) (563) 1,848 5,354
Capital expenditures of
continuing operations (2) - - - - 2,123 50,113 71,521 178,212
Capital expenditures of
discontinued operations (2) 5,281 5,592 3,117 3,268 6,509 8,439 5,270 5,753
(1) (2) See notes 1 and 2 under "Selected Financial Data" for the
definitions of EBITDA and capital expenditures, respectively.
Net Operating Loss Carryforwards
As of December 31, 1998, the Company had federal net operating loss
carryforwards ("NOLs") of approximately $160.5 million which expire at various
times in varying amounts through 2018. However, due to the provisions of Section
382, regulations issued under Section 1502 and certain other provisions of the
Internal Revenue Code of 1986, as amended (the "Code"), the utilization of the
Company's NOLs may be limited. In addition, the Company is also subject to
certain state income tax laws which may also limit the utilization of NOLs for
state income tax purposes. Even with the aforementioned limitations, the Company
anticipates that a significant portion of the Company's NOLs will be utilized to
21
offset net income expected during the first quarter of 1999, arising from the
extraordinary gain expected on the sales of the operations of NETCOM.
Section 382 of the Code limits the use of NOLs, as well as other tax
attributes, following significant changes in ownership of a corporation's stock,
as defined in the Code. The limitation is expressed as the amount of NOL or
other tax attributes arising during a period prior to the change in ownership
that may be used by the Company in any tax year subsequent to a change in
ownership. Other factors may act to increase or decrease the annual limitation
for any year subsequent to a change in ownership. Future events beyond the
control of the Company could reduce or eliminate the Company's ability to
utilize its NOLs. Future ownership changes under Section 382 will require a new
Section 382 computation which could further restrict the use of the NOLs. In
addition, the Section 382 limitation could be reduced to zero if the Company
fails to satisfy the continuity of business enterprise requirement for the
two-year period following an ownership change.
Liquidity and Capital Resources
The Company's growth has been funded from the proceeds of its 1998 debt
financings (the 10% Notes and the 9 7/8% Notes issued in February and April
1998, respectively). As of December 31, 1998, the Company had current assets of
$300.9 million, including $155.4 million of cash, cash equivalents and
short-term investments available for sale, which exceeded current liabilities of
$52.5 million, providing working capital of $248.4 million. On February 17 and
March 16, 1999, the Company received total proceeds of $245.0 million and $41.1
million, respectively, from the sales of the operations of NETCOM. 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.
Net Cash Used By Operating Activities of Continuing Operations
The Company's operating activities of continuing operations used $85.8
million in fiscal 1998, consisting primarily of net losses and increases in
receivables, which are partially offset by loss from discontinued operations,
changes in other working capital items and non-cash expenses, such as
depreciation and deferred interest expense.
The Company expects to continue to generate negative cash flows from
operating activities of continuing operations while the advances to ICG for
invoices paid by the Company on behalf of ICG and its other operating
subsidiaries continue to increase each consecutive period. Consequently, the
Company does not anticipate that cash provided by the continuing operations of
ICG Equipment alone will be sufficient to fund operating activities of
continuing operations, including the operations of PST, in the near term. The
Company anticipates that cash used by operating activities of continuing
operations will improve when the Company expands leasing operations under ICG
Equipment, increases revenue from services offered by PST and the advances to
ICG for invoices paid by the Company on behalf of ICG and its other operating
22
subsidiaries stabilize, any of which may not occur.
Cash Used By Investing Activities of Continuing Operations
The Company's investing activities of continuing operations used $352.1
million in fiscal 1998, consisting of cash expended for the acquisition of
property, equipment and other assets of $302.0 million, the purchase of
short-term investments available for sale of $41.0 million and the purchase of
the 20% equity interest in ICG Ohio LINX of $9.1 million. The Company will
continue to use cash in 1999 and subsequent periods for the purchase of
telecommunications equipment by ICG Equipment for lease to ICG Telecom, the
development and expansion of PST's operations and, potentially, for
acquisitions.
Net Cash Provided By Financing Activities of Continuing Operations
The Company's financing activities of continuing operations provided $532.8
million for fiscal 1998, consisting of net proceeds from the issuance of
long-term debt and 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 exercise of NETCOM stock options.
On February 12, 1998, the Company completed a private placement of 10%
Notes, with a maturity value of approximately $490.0 million, for net proceeds,
after underwriting and other offering costs, of approximately $290.9 million.
Interest will accrue at 10% per annum, beginning February 15, 2003, and is
payable in cash 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, with a maturity value of approximately $405.3 million, for net proceeds,
after underwriting and other offering costs, of approximately $242.1 million.
Interest will accrue at 9 7/8% per annum, beginning May 1, 2003, and is payable
in cash 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.
As of December 31, 1998, the Company had an aggregate accreted value of
approximately $594.6 million outstanding under the 10% Notes and the 9 7/8%
Notes. With respect to indebtedness outstanding on December 31, 1998, the
Company has cash interest payment obligations of approximately $44.5 million in
2003, and $89.3 million in 2004, and $89.0 million in 2005 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 or obtain additional funds, and if
the Company is unable to effect such refinancing or obtain additional funds, the
Company's ability to make principal and interest payments on its indebtedness
would be adversely affected.
23
Other Cash Commitments and Capital Requirements
The Company's capital expenditures of continuing operations were $302.0
million for fiscal 1998. The Company anticipates that the expansion of the
Company's businesses will require capital expenditures of approximately $300.0
million in 1999, including assets to be purchased by ICG Equipment from ICG
Telecom. 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. Additionally, the Company plans to invest
approximately $120.0 million in telecommunications businesses in 1999, including
its investments in ChoiceCom and NorthPoint of approximately $35.1 million and
$10.0 million, respectively, in March 1999. Actual capital and other
expenditures will depend on numerous factors, including certain factors beyond
the Company's control. These factors include the nature of future expansion and
acquisition opportunities, economic conditions, competition and the availability
of equity, debt and lease financing.
Management believes that the Company's cash on hand, including proceeds
from the sales of the operations of NETCOM, cash flows from operations, vendor
financing arrangements and credit facilities will provide sufficient funds
necessary for the Company to expand ICG Equipment's and PST's businesses and to
fund its operating deficits as currently planned. Changes in the Company's
business plan may require additional sources of cash, which may be obtained
through 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 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.
New Accounting Pronouncements
During 1998, the Company adopted Statements of Financial Accounting
Standards Nos. 128, "Earnings per Share," 129, "Disclosure of Information about
Capital Structure," 130, "Reporting Comprehensive Income," 131, "Disclosures
about Segments of an Enterprise and Related Information," 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" and 133,
"Accounting for Derivative Instruments and Hedging Activities" (collectively,
the "Statements"), none of which had any impact on the Company's financial
position, results of operations or cash flows for any periods presented. The
Company has incorporated any expanded financial statement disclosure required
under the Statements in its accompanying consolidated financial statements.
24
Year 2000 Compliance
As a wholly owned subsidiary of ICG, the Company's Year 2000 compliance
plan is embedded within ICG's Year 2000 compliance plan for its consolidated
operations. It is not practicable for ICG to address the state of Year 2000
readiness, compliance costs, risks or contingency plans of the Company, or for
any other legal entity on a stand-alone basis, as ICG's plan was designed to
resolve Year 2000 compliance issues for all entities combined, which is the most
cost-effective manner. Moreover, as a result of the Company's and ICG's shared
management and administrative personnel and ICG Equipment's dependence upon the
continuing successful operations of certain of ICG's subsidiaries, evaluating
the Company's plan for Year 2000 compliance on a stand-alone basis is not
meaningful. Accordingly, the following paragraphs describe ICG's plan for
addressing Year 2000 compliance issues, of which the issues facing the Company
are an integral part.
Importance
Many computer systems, software applications and other electronics
currently in use worldwide are programmed to accept only two digits in the
portion of the date field which designates the year. The "Year 2000 problem"
arises because these systems and products cannot properly distinguish between a
year that begins with "20" and the familiar "19." If these systems and products
are not modified or replaced, many will fail, create erroneous results and/or
may cause interfacing systems to fail.
Year 2000 compliance issues are of particular importance to ICG since its
operations rely heavily upon computer systems, software applications and other
electronics containing date-sensitive embedded technology. Some of these
technologies were internally developed and others are standard purchased systems
which may or may not have been customized for ICG's particular application. ICG
also relies heavily upon various vendors and suppliers that are themselves very
reliant on computer systems, software applications and other electronics
containing date-sensitive embedded technology. These vendors and suppliers
include: (i) ILECs and other local and long distance carriers with which ICG has
interconnection or resale agreements; (ii) manufacturers of the hardware and
related operating systems that ICG uses directly in its operations; (iii)
providers that create custom software applications that ICG uses directly in its
operations; and (iv) providers that sell standard or custom equipment or
software which allow ICG to provide administrative support to its operations.
Strategy
ICG's approach to addressing the potential impact of Year 2000 compliance
issues is focused upon ensuring, to the extent reasonably possible, the
continued, normal operation of its business and supporting systems. Accordingly,
ICG has developed a four-phase plan which it is applying to each functional
category of ICG's computer systems and components. Each of ICG's computer
systems, software applications and other electronics containing date-sensitive
embedded technology is included within one of the following four functional
categories:
25
o Networks and Products, which consists of all components whether
hardware, software or embedded technology used directly in ICG's
operations, including components used by ICG's voice and data switches
and collocations and telecommunications products;
o IT Systems, which consists of all components used to support ICG's
operations, including provisioning and billing systems;
o Building and Facilities, which consists of all components with
embedded technology used at ICG's headquarters building and other
leased facilities, including security systems, elevators and internal
use telephone systems;
o Office Equipment, which consists of all office equipment with
date-sensitive embedded technology.
For each of the categories described above, ICG will apply the following
four-phase approach to identifying and addressing the potential impact of Year
2000 compliance issues:
o Phase I - Assessment
During this phase, ICG's technology staff will perform an inventory of
all components currently in use by ICG. Based upon this inventory,
ICG's business executives and technology staff will jointly classify
each component as a "high," "medium" or "low" priority item,
determined primarily by the relative importance that the particular
component has to ICG's normal business operations, the number of
people internally and externally which would be affected by any
failure of such component and the interdependence of such component
with other components used by ICG that may be of higher or lower
priority.
Based upon such classifications, ICG's business executives and
information technology staff will jointly set desired levels of Year
2000 readiness for each component inventoried, using the following
criteria, as defined by ICG:
- Capable, meaning that such computer system or component will be
capable of managing and expressing calendar years in four digits;
- Compliant, meaning that ICG will be able to use such component
for the purpose for which ICG intended it by adapting to its
ability to manage and express calendar years in only two digits;
- Certified, meaning that ICG has received testing results to
demonstrate, or the vendor or supplier is subject to contractual
terms which requires, that such component requires no Year 2000
modifications to manage and express calendar years in four
digits; or
26
- Non-critical, meaning that ICG expects to be able to continue to
use such component unmodified or has determined that the
estimated costs of modification exceed the estimated costs
associated with its failure.
o Phase II - Remediation
During this phase, ICG will develop and execute a remediation plan for
each component based upon the priorities set in Phase I. Remediation
may include component upgrade, reprogramming, replacement, receipt of
vendor and supplier certification or other actions as deemed necessary
or appropriate.
o Phase III - Testing
During this phase, ICG will perform testing sufficient to confirm that
the component meets the desired state of Year 2000 readiness. This
phase will consist of: (i) testing the component in isolation, or unit
testing; (ii) testing the component jointly with other components, or
system testing; and (iii) testing interdependent systems, or
environment testing.
o Phase IV - Implementation
During the last phase, ICG will implement each act of remediation
developed and tested for each component, as well as implement adequate
controls to ensure that future upgrades and changes to ICG's computer
systems, for operational reasons other than Year 2000 compliance, do
not alter ICG's Year 2000 state of readiness.
Current State of Readiness
ICG has commenced certain of the phases within its Year 2000 compliance
strategy for each of its functional system categories, as shown by the table set
forth below. ICG does not intend to wait until the completion of a phase for all
functional category components together before commencing the next phase.
Accordingly, the information set forth below represents only a general
description of the phase status for each functional category.
27
- ------------------------------- ----------------------------------------------------------------------------------------------
Phase
- ------------------------------- ----------------------------------------------------------------------------------------------
I II III IV
System and Level of Priority Assessment Remediation Testing Implementation
- ------------------------------- ----------------------------------------------------------------------------------------------
Networks and Products
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
High Complete In progress In progress To begin Q2 1999
To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress To begin Q2 1999 To begin Q2 1999
To complete Q2 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete Complete Complete
- ------------------------------- ----------------------------------------------------------------------------------------------
IT Systems
- ------------------------------- ----------------------------------------------------------------------------------------------
High Complete In progress In progress In progress
To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress In progress In progress
To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- -----------------------------------------------
Low Complete In progress To be determined based on the results of
To complete Q2 1999 Phase II
- ------------------------------- ----------------------------------------------------------------------------------------------
Building and Facilities
- ------------------------------- ---------------------- ----------------------- -----------------------------------------------
High In progress In progress To be determined based on the results of
To complete Q2 1999 To complete Q2 1999 Phase II
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Medium In progress To be determined based on the results of Phase I
To complete Q2 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low To begin Q2 1999 To be determined based on the results of Phase I
To complete Q3 1999
- ------------------------------- ----------------------------------------------------------------------------------------------
Office Equipment
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
High Complete In progress To begin Q2 1999 To begin Q2 1999
To complete Q2 1999 To complete Q2 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress To begin Q2 1999 To begin Q2 1999
To complete Q2 1999 To complete Q3 1999 To complete Q4 1999
- ------------------------------- ---------------------- ----------------------- -----------------------------------------------
Low Complete In progress To be determined based on the results of
To complete Q2 1999 Phase II
- ------------------------------- ---------------------- ----------------------- -----------------------------------------------
Separately, ICG is in the process of reviewing ICG's material contracts
with contractors and vendors/suppliers and considering the necessity of
renegotiating certain existing contracts, to the extent that the contracts fail
to address the allocation of potential Year 2000 liabilities between parties.
Prior to entering into any new material contracts, ICG will seek to address the
allocation of potential Year 2000 liabilities as part of the initial
negotiation.
Costs
ICG expenses all incremental costs to ICG associated with Year 2000
compliance issues as incurred. Through December 31, 1998, such costs incurred
were approximately $0.5 million consisting of approximately $0.4 million of
replacement hardware and software and approximately $0.1 million of consulting
fees and other miscellaneous costs of Year 2000 compliance reference and
planning materials. ICG has also incurred certain internal costs, including
salaries and benefits for employees dedicating various portions of their time to
Year 2000 compliance issues, of which costs ICG believes has not exceeded $0.5
million through December 31, 1998. ICG expects that total future incremental
costs of Year 2000 compliance efforts will be approximately $3.8 million,
consisting of $2.3 million in consulting fees, $1.5 million in replacement
hardware and software and other miscellaneous costs. These anticipated costs
have been included in ICG's fiscal 1999 budget and represent approximately 4% of
ICG's budgeted expenses for information technology through fiscal 1999. Such
cost estimates are based upon presently available information and may change as
28
ICG continues with its Year 2000 compliance plan. ICG intends to use cash on
hand for Year 2000 compliance costs, as necessary.
Risk, Contingency Planning and Reasonably Likely Worst Case Scenario
While ICG is heavily reliant upon its computer systems, software
applications and other electronics containing date-sensitive embedded technology
as part of its business operations, such components upon which ICG primarily
relies were developed with current state-of-the-art technology and, accordingly,
ICG has reasonably assumed that its four-phase approach will demonstrate that
many of its high-priority systems do not present material Year 2000 compliance
issues. For computer systems, software applications and other electronics
containing date-sensitive embedded technology that have met ICG's desired level
of Year 2000 readiness, ICG will use its existing contingency plans to mitigate
or eliminate problems it may experience if an unanticipated system failure were
to occur. For components that have not met ICG's desired level of readiness, ICG
will develop a specific contingency plan to determine the actions ICG would take
if such component failed.
At the present time, ICG is unable to develop a most reasonably likely
worst case scenario for failure to achieve adequate Year 2000 compliance. ICG
will be better able to develop such a scenario once the status of Year 2000
compliance of ICG's material vendors and suppliers is complete. ICG will monitor
its vendors and suppliers, particularly the other telecommunications companies
upon which ICG relies, to determine whether they are performing and implementing
an adequate Year 2000 compliance plan in a timely manner.
ICG acknowledges the possibility that ICG may become subject to potential
claims by customers if ICG's operations are interrupted for an extended period
of time. However, it is not possible to predict either the probability of such
potential litigation, the amount that could be in controversy or upon which
party a court would place ultimate responsibility for any such interruption.
ICG views Year 2000 compliance as a process that is inherently dynamic and
will change in response to changing circumstances. While ICG believes that
through execution and satisfactory completion of its Year 2000 compliance
strategy its computer systems, software applications and electronics will be
Year 2000 compliant, there can be no assurance until the Year 2000 occurs that
all systems and all interfacing technology when running jointly will function
adequately. Additionally, there can be no assurance that the assumptions made by
ICG within its Year 2000 compliance strategy will prove to be correct, that the
strategy will succeed or that the remedial actions being implemented will be
able to be completed by the time necessary to avoid system or component
failures. In addition, disruptions with respect to the computer systems of
vendors or customers, which systems are outside the control of ICG, could impair
ICG's ability to obtain necessary products or services to sell to its customers.
Disruptions of ICG's computer systems, or the computer systems of ICG's vendors
or customers, as well as the cost of avoiding such disruption, could have a
material adverse effect on ICG's financial condition and results of operations.
29
ITEM 7A. 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, subsequent to February 17, 1999, 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,
government obligations and corporate bonds, all of which are considered to be
available for sale and generally have maturities of one year or less. The
Company's short-term investment objectives are safety, liquidity and yield, in
that order. As of December 31, 1998, the Company had approximately $155.4
million in cash and cash equivalents and short-term investments available for
sale, at a weighted average fixed interest rate of 5.15%. A hypothetical 10%
fluctuation in market rates of interest would cause a change in the fair value
of the Company's investment in marketable securities at December 31, 1998 of
approximately $0.4 million, and accordingly, would not cause a material impact
on the Company's financial position, results of operations or cash flows.
At December 31, 1998, the Company's indebtedness included $594.6 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.
Equity Price Risk
On February 17 1999, the Company completed the sale of the domestic
operations of NETCOM to MindSpring, in exchange for a combination of cash and
376,116 shares of common stock of MindSpring, which were registered with the
Securities and Exchange Commission effective April 6, 1999 and valued at
approximately $79.76 per share at the time of the transaction. Currently, the
Company bears some risk of market price fluctuations in its investment in
MindSpring. The common stock of MindSpring is traded on the Nasdaq National
Market and has, at April 13, 1999, a fair market value of $119.94 per share.
Although changes in the fair market value of MindSpring common stock may affect
the fair market value of the Company's investment and cause unrealized gains or
losses, such gains or losses will not be realized until the securities are sold.
In order to mitigate the risk associated with a decrease in the market value of
the Company's investment in MindSpring, the Company has entered into a hedging
30
contract. During the term of the hedging contract, a hypothetical 10%
fluctuation in the fair value of the common stock of MindSpring would not cause
a material impact on the Company's financial position, results of operations or
cash flows. The Company intends to liquidate its investment in MindSpring in the
near term.
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of NorthPoint Preferred Stock. The NorthPoint Preferred
Stock has no voting rights and is ultimately convertible into a voting class of
common stock of NorthPoint, at an exchange price which represents a discount, as
defined in the agreement, to the initial public offering price of NorthPoint's
common stock. The Company is restricted from selling the NorthPoint Preferred
Stock or securities obtained upon conversion of the NorthPoint Preferred Stock
for one year from the date of the initial public offering of NorthPoint's common
stock. Accordingly, the Company will be subject to the effects of fluctuations
in the fair value of the common stock of NorthPoint until such time when the
Company is permitted to liquidate its investment in NorthPoint. NorthPoint
intends to complete the initial public offering of its common stock in the
second quarter of 1999, although there is no assurance that the initial public
offering of NorthPoint's common stock will be completed within this timeframe,
or at all. Although changes in the fair market value of the common stock of
NorthPoint may affect the fair market value of the Company's investment in
NorthPoint and cause unrealized gains or losses, such gains or losses will not
be realized until the securities are sold.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company appear on page F-1 of
this Annual Report.
Selected quarterly financial data required under this Item is included
under Item 7 - Management's Discussion and Analysis of Financial Condition and
Results of Operations.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
31
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANTS
The Directors and executive officers of the Company are set forth below.
The Directors of ICG Services are appointed by ICG, the sole stockholder of the
Company, and hold office until the next annual meeting of stockholders of ICG
and thereafter, until their successors are appointed and qualified or until
their death, resignation or removal.
Set forth below are the names, ages and positions of the Directors and
executive officers of the Company.
Name Age Position
- ------------------------- ------------ ------------------------------------------------------------------------------
J. Shelby Bryan 53 President, Chief Executive Officer and Chairman of the Board of Directors
Harry R. Herbst 47 Executive Vice President, Chief Financial Officer and Director
H. Don Teague 56 Executive Vice President, General Counsel, Secretary and Director
John V. Colgan 54 Director
Douglas I. Falk 49 Director
John Kane 46 Director
J. Shelby Bryan was appointed President, Chief Executive Officer and Chairman of
the Board of Directors in January 1998 and has been President, Chief Executive
Officer and Director of ICG since May 1995. He has 19 years of experience in the
telecommunications industry, primarily in the cellular business. He co-founded
Millicom International Cellular S.A. ("Millicom"), a publicly owned corporation
providing cellular service internationally, served as its President and Chief
Executive Officer from 1985 to 1994 and served as a director through 1998.
Harry R. Herbst has been Executive Vice President of ICG and the Company since
July 1998 and Chief Financial Officer of ICG and the Company and Director of the
Company since August 1998. Mr. Herbst has been a member of the Board of
Directors of ICG since October 1995. He was Vice President of Finance and
Strategic Planning of Gulf Canada Resources Ltd. from November 1995 to July 1998
and Vice President and Treasurer of Gulf Canada Resources Ltd. from January to
November 1995. Previously, Mr. Herbst was Vice President of Taxation for Torch
Energy Advisors Inc. from 1991 to 1994, and tax manager for Apache Corp. from
1987 to 1990. Mr. Herbst is a certified public accountant, formerly with Coopers
& Lybrand, predecessor to PricewaterhouseCoopers LLP.
H. Don Teague joined ICG as Executive Vice President, General Counsel and
Secretary in May 1997 and was appointed to the same position of the Company and
Director of the Company in January 1998. Prior to these positions, Mr. Teague
was Senior Vice President, Administration and Legal with Falcon Seaboard
Holdings, L.P. and its predecessors from April 1994 through April 1997. From
1974 to April 1994, Mr. Teague was a partner in the law firm of Vinson & Elkins
L.L.P.
32
John V. Colgan was appointed a Director of the Company in August 1998. Mr.
Colgan is currently Vice President Shared Services of ICG and has held a number
of positions at ICG since 1994, including Vice President of Financial Planning
and Analysis of ICG and Senior Vice President of Finance for ICG Telecom Group,
Inc. Prior to joining ICG in 1994, Mr. Colgan held several executive positions
in the transportation and logistics industry, including Vice President and
General Manager of TLN, Inc., a logistic information systems integrator,
Executive Vice President of Administration and Treasurer for MNX, Inc. a
publicly held transportation services provider and Vice President of Finance of
Burlington Northern Motor Carriers. Mr. Colgan, a certified public accountant,
was employed for 10 years by Arthur Andersen & Co.
Douglas I. Falk was appointed a Director of the Company in September 1998 and
has been Executive Vice President - Telecom of ICG and President of ICG Telecom
Group, Inc. since September 1998. Prior to this position, Mr. Falk was Senior
Vice President of Sales and Marketing for NETCOM from May 1998 to August 1998,
President of ICG Satellite Services, Inc. from August 1996 to April 1998 and
Executive Vice President - Satellite from October 1996 to April 1998. Prior to
joining ICG, Mr. Falk held several positions in the cruise line industry,
including President of Norwegian Cruise Line, Senior Vice President - Marketing
and Sales with Holland America Lines/Westours and Executive Vice President of
Royal Viking Line. Prior to his work in the cruise line industry, Mr. Falk held
executive positions with MTI Vacations, Brown and Williamson Tobacco, Pepsico
International, Glendenning Associates and The Procter and Gamble Company.
John Kane was appointed a Director of the Company in February 1998 and has been
Executive Vice President Corporate Development and President of Fiber Optic
Technologies, Inc. of ICG since March 1998. Prior to joining ICG, Mr. Kane had
25 years of experience in the telecommunications industry. Most recently, Mr.
Kane was Executive Vice President, Business Development for AMNEX, Inc., a
specialty telecommunications services company. From 1992 to 1995, Mr. Kane was
Senior Vice President for WCT Communications, Inc., which built a national fiber
optic long distance network. Mr. Kane has also served as President of Americas
Carriers Telecommunications Association (ACTA) and is a frequent speaker at
industry conferences.
ITEM 11. EXECUTIVE COMPENSATION
Director Compensation
All of the Company's Directors are employees of ICG and therefore receive
no additional compensation for serving as Directors.
Compensation Committee Interlocks and Insider Participation
The Company has no compensation committee. However, the Compensation
Committee of the Board of Directors of ICG (the "Compensation Committee")
evaluates compensation levels of senior management and evaluates the various
factors affecting compensation of the Company's highest paid officers. The
Compensation Committee consists of four non-employee Directors: William J.
33
Laggett, Chairman of the ICG Board of Directors, John U. Moorhead II, Walter
Threadgill and Leontis Teryazos.
Board Compensation Committee Report on Executive Compensation
The compensation of senior management is paid by ICG. The Compensation
Committee believes that compensation to the Company's executive officers should
be designed to encourage and reward management's efforts to further strengthen
the Company's business and to create added value for the stockholders. Such a
compensation program helps to achieve the Company's business and financial
objectives and also provides incentives needed to attract and retain
well-qualified executives. The Company operates in a competitive marketplace and
needs to attract and retain highly qualified senior management and executive
personnel in order for the Company to achieve its goal of continued growth. The
Compensation Committee attributes a substantial portion of the Company's overall
performance, as well as the individual contributions of the executive officers,
to the executive officers' compensation.
PST, a subsidiary of the Company, has an employment agreement with Michael
D. Kallet, Senior Vice President, General Manager and Chief Operating Officer of
PST. All senior management, except for J. Shelby Bryan, President, Chief
Executive Officer and Chairman of the Board of Directors, are compensated with a
base salary and incentive bonus. The base salaries are intended to compensate
executives for their ongoing leadership skills and management responsibility.
The incentive bonuses are dependent upon ICG's and the Company's performance.
For purposes of determining incentive bonuses, the Compensation Committee
evaluates the accomplishment of goals set at the beginning of each fiscal year
and compares ICG's and the Company's performance in each year to those goals. As
a result of ICG's and the Company's performance during fiscal 1998, the
Compensation Committee approved bonuses for the Named Executive Officers of the
Company. See "-Executive Compensation" for the definition of Named Executive
Officers and the bonuses paid to executive officers.
In addition, the Stock Option Committee of ICG awarded stock options to
certain employees of the Company, including executive officers. These grants
were based on individual performance and responsibility and were related to the
executive officers' past performance as well as an incentive for continued
efforts and success. The Compensation Committee believes that stock options
serve as important long-term incentives for executive officers by encouraging
their continued employment and commitment to ICG's and the Company's
performance. The Compensation and Stock Option Committees do not consider the
number of options currently held by all executive officers in determining
individual grants because such consideration could create an incentive to
exercise options and sell the underlying stock. See "-Executive Compensation -
Summary Compensation Table" for the stock options granted to the executive
officers.
The compensation of the Company's President, Chief Executive Officer and
Chairman of the Board of Directors, J. Shelby Bryan, is paid by ICG and is set
forth in his employment contract. Mr. Bryan's base salary is computed as: the
sum of (i) one percent (1%) of the increase in Revenues of ICG for such month
over Revenues of ICG for the immediately prior month and (ii) three percent (3%)
of the increase in Earnings Before Income, Taxes, Depreciation and Amortization
34
(and other nonrecurring charges) ("EBITDA") of ICG for such month over EBITDA of
ICG for the immediately prior month. Mr. Bryan receives other benefits, as well.
See "-Executive Compensation - Summary Compensation Table" for the type and
amount of these payments.
Further, in the event any payments paid or payable by ICG or benefits
received or receivable by Mr. Bryan from ICG (collectively, the "Executive
Payments") are of the type encompassed within Section 280G of the Code, are
subject to tax imposed by Section 4999 of the Code, and/or any comparable tax
imposed by any state or local taxing authority, including any interest or
penalties (collectively, the "Excise Tax"), ICG will pay an additional amount in
cash (the "Gross-Up Payment") so that the net amount retained by Mr. Bryan after
deduction of the Excise Tax on the Gross-Up Payment, as well as any other taxes
due solely as a result of the Gross-Up Payment, shall be equal to the full
amount of the Executive Payments. The Compensation Committee believes that the
compensation paid to Mr. Bryan is appropriate based on Mr. Bryan's experience in
the communications industry and because his compensation is directly tied to the
performance of ICG and the Company.
The Compensation Committee has reviewed the compensation of ICG's and the
Company's executive officers and has concluded that their compensation is
reasonable and appropriate in view of ICG's and the Company's performance. The
Compensation Committee continually evaluates the compensation of ICG's and the
Company's executive officers, including an assessment of compensation reports
for comparable companies and for the telecommunications industry in general. The
Compensation Committee believes that maintaining suitable executive compensation
programs is necessary to support the future development of ICG and the Company
and growth in stockholder value.
William J. Laggett
John U. Moorhead II
Leontis Teryazos
Walter Threadgill
(Members of the ICG Compensation Committee)
Executive Compensation
The following table provides certain summary information concerning
compensation paid or accrued by ICG and the Company for fiscal 1998, the year of
the Company's inception, to or on behalf of J. Shelby Bryan, the Company's
President, Chief Executive Officer and Chairman of the Board of Directors, the
four other most highly compensated executive officers of the Company and one
additional officer for whom disclosure would have been required but for the fact
that the individual was not serving as executive officer at December 31, 1998
(the "Named Officers"). The Company has not maintained any long-term incentive
plans and the Company has not granted stock appreciation rights.
35
Summary Compensation Table
Long-term
Annual Compensation Compensation
---------------------------------------------- ---------------
Securities All Other
Fiscal Other Annual Underlying Compensation
Name and Principal Position Year Salary ($) Bonus ($) Compensation ($) Options ($)
- ------------------------------- --------- ------------ ----------- ------------------------- --------------- ---------------
J. Shelby Bryan 1998 1,435,191(1) - 159,554(2) - -
President, Chief Executive
Officer and Chairman of
the Board of Directors
Eric W. Spivey 1998 236,539 105,507 13,068(4) 100,000(5) -
Former President and Chief
Operating Officer of
NETCOM(3)
Michael D. Kallet 1998 198,846 83,919 9,577(6) 35,000(5) 37,500(7)
Senior Vice President,
General Manager and Chief
Operating Officer of PST
and former Senior Vice
President, Operations and
Engineering of NETCOM
Eric V. Goffney 1998 180,000 71,105 3,700(6) 10,000(5) 37,500(7)
Former Senior Vice
President, Customer
Support of NETCOM(8)
Kurt E. Johnson 1998 169,616 71,745 5,885(6) 10,000(5) 44,850(7)
Former Vice President and
Chief Financial Officer of
NETCOM(9)
David W. Garrison 1998 349,996 - 1,859(10) 100,000(11) 95,283(12)
Former Executive Vice
President and Chief
Executive Officer of
NETCOM and Director of the
Company
(1) Consists of amount earned pursuant to the compensation formula in Mr.
Bryan's employment agreement with ICG. All amounts earned have been paid by
ICG.
(2) Consists of $24,430 for car allowance, $46,964 for housing expenses and
Company contributions to ICG's 401(k) Defined Contribution Plan in the
amount of $88,160.
(3) Mr. Spivey resigned from the Company, effective February 28, 1999.
(4) Consists of $9,760 for car allowance and Company contributions to ICG's
401(k) Defined Contribution Plan in the amount of $3,308.
(5) Includes options regranted as a result of the repricing of ICG's options on
September 18, 1998. See "-Ten-Year Option/SAR Repricings."
(6) Consists of Company contributions to ICG's 401(k) Defined Contribution
Plan.
(7) Consists of an incentive bonus awarded for continued employment through the
date of the merger between ICG and NETCOM.
(8) Mr. Goffney resigned from the Company, effective February 28, 1999. (9) Mr.
Johnson resigned from the Company, effective February 28, 1999.
(10) Consists of payments for car allowance.
36
(11) As a result of Mr. Garrison's resignation on June 12, 1998, all 100,000
options granted to Mr. Garrison during fiscal 1998 were canceled.
(12) Consists of $7,000 for an incentive bonus awarded for continued employment
through the date of the merger between ICG and NETCOM, $29,167 for payment
under the Company's severance agreement with Mr. Garrison, $3,924 for COBRA
payments made by the Company under the Company's severance agreement with
Mr. Garrison and $55,192 for unused vacation and personal days upon Mr.
Garrison's resignation on June 12, 1998.
Option/SAR Grants in Last Fiscal Year
The Company granted no stock appreciation rights during fiscal 1998 to the
Named Officers or to other employees. The Company's employees are eligible to
participate in the stock option plans of ICG. The following table provides
information on option grants to purchase ICG Common Stock to the Named Officers
during fiscal 1998:
Potential realizable
Individual grants value at assumed
---------------------------------------- annual rates of stock
Number of Percent of total Exercise price appreciation for
Securities Options granted or base option term
underlying to employees in Price Expiration ------------------------
Name options granted(#) Fiscal year ($/Sh) date 5% ($) 10% ($)
- ------------------- --------------------- ------------------ --------- ------------ ----------- ------------
J. Shelby Bryan - - - - - -
Eric W. Spivey(1) 50,000 1.6 16.875(2) 2/28/00 86,484 177,188
50,000 1.6 16.875(2) 2/28/00 86,484 177,188
Michael D. Kallet 35,000 1.1 16.875(2) 1/21/08 341,066 848,245
Eric V. Goffney(3) 10,000 0.3 16.875(2) 5/28/99 8,437 16,875
Kurt E. Johnson(4) 10,000 0.3 16.875(2) 2/28/00 17,297 35,438
34,512 1.1 16.875(2) 2/28/00 59,695 122,304
David W. Garrison 100,000(5) 3.2 26.250 9/19/99 131,250 262,500
(1) Mr. Spivey resigned from the Company, effective February 28, 1999.
(2) In order to continue to provide non-cash incentives and retain key
employees, all employee stock options outstanding on September 18, 1998
with exercise prices at or in excess of $22.00 were repriced by the Stock
Option Committee of the Company's Board of Directors to $16.875, the
closing price of the ICG Common Stock on September 18, 1998. See "-Ten-Year
Option/SAR Repricings."
(3) Mr. Goffney resigned from the Company, effective February 28, 1999.
(4) Mr.Johnson resigned from the Company, effective February 28, 1999.
(5) As a result of Mr. Garrison's resignation on June 12, 1998, all 100,000
options granted to Mr. Garrison during fiscal 1998 were canceled.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values
The following table provides information on options to purchase ICG Common
Stock exercised during fiscal 1998 by the Named Officers and the value of such
officers' unexercised options at December 31, 1998:
37
Number of securities Value of unexercised in-the-
underlying unexercised money options at
Shares options at fiscal year end (#) fiscal year end ($)(1)
acquired on Value ------------------------------- ----------------------------
Name exercise (#) realized ($) Exercisable Unexercisable Exercisable Unexercisable
- -----------------------------------------------------------------------------------------------------------------
J. Shelby Bryan 150,000 1,478,750 1,737,500 112,500 23,178,125 1,293,750
Eric W. Spivey - - 38,826 100,000 226,097 462,500
Michael D. Kallet - - 95,826 35,270 485,883 163,433
Eric V. Goffney - - 47,454 10,000 276,571 46,250
Kurt E. Johnson - - 42,708 10,000 213,375 46,250
David W. Garrison 89,521 382,144 161,098 15,556 1,088,656 145,137
(1) Based on the closing price of ICG Common Stock of $21.50 on December 31,
1998.
Ten-Year Option/SAR Repricings
Report on Repricing of Options/SARs
The Stock Option Committee of the Board of Directors of ICG (the
"Committee") is responsible for administering ICG's Stock Option Plans, as well
as granting any stock options thereunder. The Committee is composed of four
independent, non-employee directors of ICG.
In 1998, ICG established the 1998 Stock Option Plan (the "Plan"). The
purpose of the Plan is to promote the success and enhance the value of ICG by
linking the personal interests of participants to those of ICG's stockholders by
providing participants with an incentive for outstanding performance. The Plan
is further intended to assist ICG in its ability to motivate, and retain the
services of, participants upon whose judgment, interest and special effort the
successful conduct of its operations is largely dependent. Up to an aggregate
number of 3,400,000 shares may be granted under the Plan. When awarding stock
options, the Committee takes into consideration the individual's past
performance and contribution to ICG, as well as future potential.
In September 1998, the Committee considered repricing certain existing
stock options that, as a result of various market circumstances, were at option
exercise prices substantially in excess of the then current market price of the
common stock of ICG. Because of the exercise prices, many of the stock options
issued to ICG's employees subsequent to October 1, 1997 did not effectively
serve as incentives for the employees. Further, because of the extremely
competitive marketplace for employees in the areas in which ICG is doing
business, there was a significant risk that ICG would lose many valuable
employees if it did not maintain a strong incentive compensation program.
Consequently, the Committee approved the repricing of all outstanding
employee stock options previously granted under the various employee stock
option plans of the Company issued subsequent to October 1, 1997 that were
priced at or in excess of $22.00 per share (collectively, the "Eligible
38
Options"). New stock options (the "Repriced Options") were granted as of
September 18, 1998, each of which were granted under the same stock option plan
under which the Eligible Options were originally granted. The transaction was
accomplished through the cancellation by the Stock Option Committee of the
Eligible Options and a grant of the Repriced Options. The Repriced Options are
exercisable at a price of $16.875 per share, which was the closing price of a
share of ICG Common Stock on the NASDAQ National Market on September 18, 1998.
William J. Laggett
John U. Moorhead II
Leontis Teryazos
Walter Threadgill
(Members of the ICG Stock Option Committee)
The following provides information on the repricing of stock options of the
Named Officers:
39
Number of
securities Length of original
underlying Market price of Exercise price option term
options stock at time at time of remaining at date
repriced or of repricing or repricing or New exercise of repricing or
Name Date amended (#) amendment ($) amendment ($) price ($) amendment
- -------------------------------- ----------- ---------------- ----------------- ----------------- -------------- ------------------
J. Shelby Bryan 9/18/98 - - - - -
President, Chief Executive
Officer and Chairman of the
Board of Directors
Eric W. Spivey 9/18/98 50,000 16.875 27.75 16.875 (1) 113 months
Former President and Chief 9/18/98 50,000 16.875 30.00 16.875 (1) 116 months
Operating Officer of NETCOM
Michael D. Kallet 9/18/98 35,000 16.875 26.25 16.875 (1) 112 months
Senior Vice President,
General Manager and Chief
Operating Officer of PST and
former Senior Vice
President, Operations and
Engineering of NETCOM
Eric V. Goffney 9/18/98 10,000 16.875 26.25 16.875 (1) 112 months
Former Senior Vice
President, Customer Support
of NETCOM
Kurt E. Johnson 9/18/98 10,000 16.875 26.25 16.875 (1) 112 months
Former Vice President and
Chief Financial Officer of
NETCOM
David W. Garrison - - - - - -
Former Executive Vice
President and Chief
Executive Officer of NETCOM
and Director of the Company
(1) Represents the closing price of ICG Common Stock on September 18, 1998.
Executive Employment Contracts
ICG has an employment agreement with Mr. J. Shelby Bryan, President, Chief
Executive Officer and Chairman of the Board of Directors of the Company. PST has
an employment agreement with Michael D. Kallet, Senior Vice President, General
Manager and Chief Operating Officer of PST.
ICG's amended employment agreement with Mr. Bryan provides for a term of
two years, which commenced June 1, 1997. As compensation, ICG will pay Mr. Bryan
a salary equal to the sum of one percent of the monthly increase in ICG's
revenue and three percent of the monthly increase in EBITDA. If Mr. Bryan's
salary exceeds $1,500,000 in any fiscal year, ICG may elect to pay such excess
in unregistered ICG Common Stock. Mr. Bryan is entitled to benefits as are
generally provided to executive officers of ICG, including options under stock
40
option plans, a leased automobile, private club membership fees and
reimbursement of reasonable out-of-pocket expenses incurred on behalf of ICG.
The employment agreement may be terminated by ICG with or without cause or after
a disability continuing for a six-month consecutive period, or by Mr. Bryan for
cause, including breach of the agreement or reduction in status or
responsibilities, or change of control. If the employment agreement is
terminated for any reason other than for cause, ICG is obligated to pay Mr.
Bryan a lump sum of $2.5 million and to continue benefits for a period equal to
the greater of the remainder of the employment term or 18 months. After
termination of the employment agreement, Mr. Bryan is subject to a
confidentiality covenant and a one-year non-competition commitment.
PST's employment contract with Michael D. Kallet, dated February 17, 1999,
continues until the earliest of: Mr. Kallet's death; termination by PST upon
written notice or by Mr. Kallet upon 30 days' prior written notice; termination
for cause; written notice by PST that Mr. Kallet has been unable to perform his
duties for a period of not less than three consecutive months as a result of
incapacity; one year's advance written notice of termination of the agreement;
or when all obligations under the agreement have been satisfied. The agreement
provides for an annual base salary and incentive bonus as determined by PST's
corporate officers. Mr. Kallet is also entitled to such other benefits as are
generally provided to executive officers of PST including options granted under
ICG's stock option plans and reimbursement of reasonable out-of-pocket expenses
incurred on behalf of PST. In the event PST adopts a phantom stock plan, Mr.
Kallet shall be entitled to participate in the plan. In the event of a change of
control of PST, 50% of all options granted to Mr. Kallet under ICG's stock
option plans shall vest upon the effective date of the change of control. If PST
terminates Mr. Kallet's employment for any reason other than cause or
disability, or if Mr. Kallet is constructively discharged (as defined in the
agreement), Mr. Kallet shall receive an amount equal to one times his base
compensation, 100% of the greater of his prior year's annual incentive bonus or
his annual incentive bonus earned on a quarterly basis as of the date of
termination, twelve months of life and health insurance and full vesting of all
stock options granted by PST or ICG. Mr. Kallet is subject to a confidentiality
covenant during and after the term of his employment contract.
Mr. Bryan also has an agreement that provides in the event any payments
paid or payable by ICG or benefits received or receivable by them from ICG
(collectively, the "Executive Payments") are of the type encompassed within
Section 280G of the Code, are subject to tax imposed by Section 4999 of the
Code, and/or any comparable tax imposed by any state or local taxing authority,
including any interest or penalties (collectively, the "Excise Tax") ICG will
pay an additional amount in cash (the "Gross-Up Payment") so that the net amount
retained by Mr. Bryan, after deduction of the Excise Tax on the Gross-Up
Payment, as well as any other taxes due solely as a result of the Gross-Up
Payment, shall be equal to the full amount of the Executive Payments. These
agreements survive the termination of employment and continue to be binding
until all obligations under the agreements have been satisfied. Mr. Kallet's
employment contract contains a similar gross-up provision.
41
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ICG owns all of the outstanding shares of common stock of the Company.
The following table sets forth, as of March 31, 1999, the number of shares
of ICG Common Stock owned by all executive officers and Directors of the
Company, individually and as a group. The persons named in the table below have
sole voting and investment power with respect to all of the shares of ICG Common
Stock owned by them, unless otherwise noted.
Amount/Nature of
Name and Address of Beneficial Owner Beneficial Ownership Percent(1)
- ------------------------------------------------------------------------ ---------------------- --------------
J. Shelby Bryan . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,919,293(2) 4.1%
President, Chief Executive Officer and Chairman of the Board of
Directors
Harry R. Herbst . . . . . . . . . . . . . . . . . . . . . . . . . . . 77,944(3) *
Executive Vice President, Chief Financial Officer and Director
H. Don Teague . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000(4) *
Executive Vice President, General Counsel, Secretary and Director
John V. Colgan . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,248(5) *
Director
Douglas I. Falk . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,044(6) *
Director
John Kane . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,102(7) *
Director
All executive officers and Directors of the Company as a group (6 persons) 2,077,631(8) 4.5%
- -------
* Less than one percent of the outstanding shares of ICG Common Stock.
(1) Based on 44,662,878 issued and outstanding shares of ICG Common Stock on
March 31, 1999, plus shares of ICG Common Stock which may be acquired by
the person or group indicated pursuant to any options and warrants
exercisable, or pursuant to any shares vesting under ICG's 401(k) Plan
within 60 days.
(2) Includes 165,000 shares of ICG Common Stock held by Mr. Bryan, 2,000 shares
of ICG Common Stock held in Mr. Bryan's spouse's name for which Mr. Bryan
disclaims beneficial ownership, 14,793 shares of ICG Common Stock held by
ICG's 401(k) Plan in Mr. Bryan's name and 1,737,500 shares of ICG Common
Stock that may be acquired pursuant to the exercise of outstanding stock
options.
(3) Includes 2,010 unrestricted shares of ICG Common Stock held by ICG's
Employee Stock Purchase Plan and 75,934 shares of ICG Common Stock that may
be acquired pursuant to the exercise of outstanding stock options.
(4) Includes shares of ICG Common Stock that may be acquired pursuant to the
exercise of outstanding stock options.
(5) Includes 5,500 shares of ICG Common Stock held by Mr. Colgan, 1,790 shares
of ICG Common Stock held by ICG's 401(k) Plan in Mr. Colgan's name, 2,083
unrestricted shares of ICG Common Stock held by ICG's Employee Stock
Purchase Plan and 18,875 shares of ICG Common Stock that may be acquired
pursuant to the exercise of outstanding stock options.
(6) Includes 582 shares of ICG Common Stock held by ICG's 401(k) Plan in Mr.
Falk's name, 1,587 unrestricted shares of ICG Common Stock held by ICG's
Employee Stock Purchase Plan and 6,875 shares of ICG Common Stock that may
be acquired pursuant to the exercise of outstanding stock options.
(7) Includes 2,500 shares of ICG Common Stock held by Mr. Kane, 602
unrestricted shares of ICG Common Stock held by ICG's Employee Stock
Purchase Plan and 5,000 shares of ICG Common Stock that may be acquired
pursuant to the exercise of outstanding stock options.
42
(8) Includes 175,000 shares of ICG Common Stock held directly by the executive
officers and Directors of ICG Services as a group, 17,165 shares of ICG
Common Stock held by ICG's 401(k) Plan in the names of the individual
executive officers and Directors of ICG Services, 6,282 shares of ICG
Common Stock held by ICG's Employee Stock Purchase Plan and 1,879,184
shares of ICG Common Stock that may be acquired pursuant to the exercise of
outstanding stock options.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED 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
by each party. All transactions between the Company, including its subsidiaries,
and ICG, including its Restricted Subsidiaries, contain fair and reasonable
conditions and are approved by the Board of Directors of the Company and of ICG.
All such transactions are settled in cash on a quarterly basis.
For fiscal 1998, ICG charged approximately $8.0 million to the Company for
intercompany transfers and direct and indirect costs incurred by ICG and its
Restricted Subsidiaries on behalf of the Company. Of this amount, approximately
$2.4 million is included in the Company's selling, general and administrative
expenses for fiscal 1998. In addition, for fiscal 1998, the Company charged
approximately $284.5 million to ICG and its Restricted Subsidiaries for
intercompany transfers and direct and indirect costs incurred by the Company on
behalf of ICG and its Restricted Subsidiaries. Included in this amount is
approximately $15.5 million for advances made to ChoiceCom, which business ICG
purchased from a third party on December 31, 1998. During fiscal 1998, ICG
Telecom and NETCOM jointly began offering certain telecommunications services.
For fiscal 1998, the Company charged approximately $1.3 million for the
reimbursement of expenses incurred by NETCOM for this joint service offering.
The net receivable from ICG for all intercompany charges combined is included in
due from ICG in the Company's consolidated balance sheet at December 31, 1998.
Net interest income accrued by the Company on outstanding balances from ICG and
its Restricted Subsidiaries is included in interest income in the Company's
consolidated statement of operations and was approximately $4.6 million for
fiscal 1998. For fiscal 1998, interest accrued on outstanding balances of
intercompany transfers and direct and indirect costs between ICG Services and
ICG and its Restricted Subsidiaries at 10% per annum, which represents the
Company's approximate weighted average cost of capital at the beginning of
fiscal 1998. Effective January 1, 1999, interest accrues on outstanding balances
of intercompany transfers and direct and indirect costs between the respective
entities at 12 1/2% per annum.
43
During fiscal 1998, ICG Equipment purchased certain telecommunications
equipment and fiber optic capacity both from and for ICG Telecom for an
aggregate purchase price of approximately $195.0 million. Simultaneously with
each of the purchases, ICG Equipment entered into separate agreements to lease
the same telecommunications equipment back to ICG Telecom under operating
leases, with annual lease payments commencing one year from the date of the
lease. ICG Equipment recognizes revenue from the lease payments ratably over the
lease terms. The Company recognized approximately $4.9 million in revenue under
these operating leases for fiscal 1998, all of which is included in lease
receivables at December 31, 1998. Subsequent to December 31, 1998, ICG Equipment
purchased certain telecommunications equipment from ICG Telecom for an aggregate
purchase price of approximately $116.3 million and simultaneously entered into
agreements to lease the same telecommunications equipment back to ICG Telecom
under operating leases, with annual lease payments commencing one year from the
date of the lease. The purchase prices and lease payments for all leases are
subject to adjustment, based on the results of an independent appraisal which
may be requested at the option of ICG Telecom and ICG Equipment on or before 90
days from the purchase date. On September 30, 1998, ICG Equipment submitted a
formal written request to ICG Telecom for independent appraisals of certain
telecommunications equipment and fiber optic capacity purchased through December
31, 1998. The Company expects the appraisals to be complete during the second
quarter of 1999.
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% (11 3/4% at December 31, 1998), 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. For fiscal
1998, ICG Equipment recognized approximately $5.0 million of monthly service fee
revenue under this agreement and approximately $2.8 million was included in
lease receivables at December 31, 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 $107.0 million at December 31, 1998.
In the normal course of business during fiscal 1998, ICG Telecom provided
the use of certain of its local access lines to NETCOM and, accordingly, charged
NETCOM for costs of any installation and recurring access to its network. For
fiscal 1998, NETCOM incurred approximately $2.3 million for installation and
recurring local access charges from ICG Telecom, which have been included in net
current liabilities of discontinued operations and loss from discontinued
operations in the Company's consolidated financial statements for fiscal 1998.
On March 1, 1999, the Company purchased from ICG Telecom, for $35.1 million
in cash, a 49% equity interest in ChoiceCom. Based in Austin, Texas, ChoiceCom
currently provides local exchange and long distance services in Austin, Corpus
Christi, Dallas, Houston and San Antonio, Texas. The Company will account for
its investment in ChoiceCom under the equity method of accounting. The remaining
51% equity interest in ChoiceCom is owned by ICG Telecom.
44
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
(A) (1) Financial Statements. The following financial statements are included
in Item 8 of Part II:
Page
Independent Auditors' Report - Report of KPMG LLP. . . . . . . . . F-2
Independent Auditors' Report - Report of Ernst & Young LLP . . . . F-3
Consolidated Balance Sheets, December 31, 1997 and 1998. . . . . . F-4
Consolidated Statements of Operations, Years Ended December 31,
1996, 1997 and 1998. . . . . . . . . . . . . . . . . . . . . . . F-6
Consolidated Statements of Stockholders' Equity, Years Ended
December 31, 1996, 1997 and 1998 . . . . . . . . . . . . . . . . F-7
Consolidated Statements of Cash Flows, Years Ended December 31,
1996, 1997 and 1998. . . . . . . . . . . . . . . . . . . . . . . F-8
Notes to Consolidated Financial Statements, December 31,
1997 and 1998. . . . . . . . . . . . . . . . . . . . . . . . . . F-9
(2) List of Exhibits.
(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or
Succession. None.
(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,
45
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].
(10) Material Contracts.
10.1:Office Building lease by and between Pacific Gateway
Properties, Inc. and NETCOM On-Line Communication Services,
Inc. ("NETCOM") dated February 1, 1994 [Incorporated by
reference to Exhibit 10.1 to NETCOM's Registration Statement
on Form SB-2, No. 33-86012-LA, as amended].
10.2:Office Building Lease between Pacific Gateway Properties,
Inc. and NETCOM dated May 11, 1994 [Incorporated by
reference to Exhibit 10.2 to NETCOM's Registration Statement
on Form SB-2, No. 33-86012-LA, as amended].
10.3 Office Building Lease between Pacific Gateway Properties,
Inc. and NETCOM dated August 26, 1994 [Incorporated by
reference to Exhibit 10.3 to NETCOM's Registration Statement
on Form SB-2, No. 33-86012-LA, as amended].
10.4 Shared Administrative and Operational Services Agreement,
dated as of January 23, 1998, between ICG Communications,
Inc. and ICG Services, Inc.
10.5 Form of Master Lease Agreement between ICG Equipment, Inc.
and each of ICG Telecom Group, Inc., ICG Ohio LINX, Inc.,
ICG Access Services, Inc., ICG Telecom of San Diego, L.P.
and Bay Area Teleport, Inc.
10.6 Amended and Restated Employment Agreement, dated as of
February 17, 1999, between ICG PST, Inc. and Michael D.
Kallet.
(21) Subsidiaries of the Registrant.
21.1: Subsidiaries of the Registrant.
(27) Financial Data Schedule.
27.1:Financial Data Schedule of ICG Services, Inc. for the Year
Ended December 31, 1998.
(B) Reports on Form 8-K.
None.
(C) Exhibits. The exhibits required by this Item are listed under Item
14(A)(2).
46
FINANCIAL STATEMENTS
Page
Independent Auditors' Report - Report of KPMG LLP . . . . . . . . . . . F-2
Independent Auditors' Report - Report of Ernst & Young LLP . . . . . . F-3
Consolidated Balance Sheets, December 31, 1997 and 1998 . . . . . . . . F-4
Consolidated Statements of Operations, Years Ended December 31, 1996,
1997 and 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6
Consolidated Statements of Stockholders' Equity, Years Ended December
31, 1996, 1997 and 1998 . . . . . . . . . . . . . . . . . . . . . . . F-7
Consolidated Statements of Cash Flows, Years Ended December 31, 1996,
1997 and 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-8
Notes to Consolidated Financial Statements, December 31, 1997 and 1998 F-9
F-1
Independent Auditors' Report - Report of KPMG LLP
The Board of Directors and Stockholder
ICG Services, Inc.:
We have audited the accompanying consolidated balance sheet of ICG Services,
Inc. and subsidiaries (the "Company") (wholly owned by ICG Communications, Inc.)
as of December 31, 1998 and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit, the consolidated financial statements
referred to above present fairly, in all material respects, the financial
position of ICG Services, Inc. and subsidiaries as of December 31, 1998, and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.
KPMG LLP
Denver, Colorado
February 15, 1999
F-2
Independent Auditors' Report - Report of Ernst & Young LLP
The Board of Directors and Stockholders
NETCOM On-Line Communication Services, Inc.
We have audited the consolidated balance sheet of NETCOM On-Line Communication
Services, Inc. as of December 31, 1997, and the related consolidated statements
of operations, stockholders' equity and cash flows for each of the two years in
the period ended December 31, 1997 (not presented separately herein). These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of NETCOM
On-Line Communication Services, Inc. at December 31, 1997 and the consolidated
results of its operations and its cash flows for each of the two years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
San Jose, California
February 13, 1998
F-3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1997 and 1998
- -------------------------------------------------------------------------------
December 31,
---------------------------------------------
1997 1998
-------------------- --------------------
(in thousands)
Assets
Current assets:
Cash and cash equivalents $ - 114,380
Short-term investments available for sale (note 4) - 41,000
Receivables:
Lease receivables, due from ICG (notes 9 and 13) - 7,753
Due from ICG (note 9) - 137,762
-------------------- --------------------
- 145,515
-------------------- --------------------
Prepaid expenses and deposits - 20
Net current assets of discontinued operations (note 3) 38,698 -
-------------------- --------------------
Total current assets 38,698 300,915
-------------------- --------------------
Property and equipment (notes 5, 9 and 10) - 301,969
Less accumulated depreciation - (4,064)
-------------------- --------------------
Net property and equipment - 297,905
-------------------- --------------------
Investment in ICG Ohio LINX, accounted for under the equity
method (note 6) - 10,179
Deferred financing and lease administration costs, net of
accumulated amortization of $1.5 million at December
31, 1998 - 16,727
-------------------- --------------------
- 26,906
-------------------- --------------------
Net non-current assets of discontinued operations (note 3) 73,637 54,023
==================== ====================
Total assets $ 112,335 679,749
==================== ====================
(Continued)
F-4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
- -------------------------------------------------------------------------------
December 31,
------------------------------------------
1997 1998
------------------- -------------------
(in thousands)
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ - 28,840
Accrued liabilities - 1,309
Net current liabilities of discontinued operations
(note 3) - 22,328
------------------- -------------------
Total current liabilities - 52,477
------------------- -------------------
Long-term debt, net of discount (note 7) - 594,617
------------------- -------------------
Total liabilities - 647,094
------------------- -------------------
Stockholders' equity:
Common stock, $.01 par value, 1,000 shares
authorized; 10 shares issued and outstanding at
December 31, 1998 (note 2) 117 -
Additional paid-in capital 207,208 207,798
Accumulated deficit (95,134) (175,024)
Accumulated other comprehensive income (loss) 144 (119)
------------------- -------------------
Total stockholders' equity 112,335 32,655
------------------- -------------------
Commitments and contingencies (notes 7, 9 and 10)
Total liabilities and stockholders' equity $ 112,335 679,749
=================== ===================
See accompanying notes to consolidated financial statements.
F-5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended December 31, 1996, 1997 and 1998
- -------------------------------------------------------------------------------
Years ended December 31,
--------------------------------------------------------------
1996 1997 1998
------------------ ------------------ ------------------
(in thousands)
Revenue from leasing services provided to ICG (notes
9 and 13) $ - - 9,911
Operating expenses:
Selling, general and administrative
expenses, including amounts allocated
from ICG (note 9) - - 3,761
Depreciation - - 4,064
------------------ ------------------ ------------------
Total operating expenses - - 7,825
------------------ ------------------ ------------------
Operating income - - 2,086
Other (expense) income:
Interest expense - - (45,522)
Interest income, including amounts
earned from ICG (note 9) - - 23,436
------------------ ------------------ ------------------
- - (22,086)
------------------ ------------------ ------------------
Loss from continuing operations before share of
earnings - - (20,000)
Share of earnings of ICG Ohio LINX
(note 6) - - 1,075
------------------ ------------------ ------------------
Loss from continuing operations - - (18,925)
------------------ ------------------ ------------------
Loss from discontinued operations
(notes 1, 3 and 11) (44,265) (33,092) (60,965)
------------------ ------------------ ------------------
Net loss $ (44,265) (33,092) (79,890)
================== ================== ==================
Other comprehensive income (loss):
Foreign currency translation adjustment 699 (527) (263)
Unrealized gain (loss) on short-term investments
available for sale 540 (540) -
------------------ ------------------ ------------------
Other comprehensive income (loss) 1,239 (1,067) (263)
------------------ ------------------ ------------------
Comprehensive loss $ (43,026) (34,159) (80,153)
================== ================== ==================
See accompanying notes to consolidated financial statements.
F-6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1996, 1997 and 1998
- -------------------------------------------------------------------------------
Accumulated
Common stock Additional other Total
------------------------ paid-in Accumulated comprehensive stockholders'
Shares Amount capital deficit (loss) income equity
------------- ---------- -------------- --------------- --------------------------------
(in thousands)
Balances at January 1, 1996 11,096 $ 111 203,160 (17,777) (28) 185,466
Shares issued for cash in connection
with NETCOM's employee stock
purchase plan and the exercise of
NETCOM's stock options 535 5 2,346 - - 2,351
Unrealized gains on short-term
investments available for sale - - - - 540 540
Cumulative foreign currency
translation adjustment - - - - 699 699
Net loss - - - (44,265) - (44,265)
------------- ---------- -------------- --------------- --------------------------------
Balances at December 31, 1996 11,631 116 205,506 (62,042) 1,211 144,791
Shares issued for cash in connection
with NETCOM's employee stock
purchase plan and the exercise of
NETCOM's stock options 152 1 1,702 - - 1,703
Reversal of unrealized gains on short-
term investments available for sale - - - - (540) (540)
Cumulative foreign currency
translation adjustment - - - - (527) (527)
Net loss - - - (33,092) - (33,092)
------------- ---------- -------------- --------------- --------------------------------
Balances at December 31, 1997 11,783 117 207,208 (95,134) 144 112,335
Shares issued for cash in connection
with NETCOM's employee stock
purchase plan and the exercise of
NETCOM's stock options (note 1) 38 1 472 - - 473
Elimination of NETCOM's historical
equity in connection with
NETCOM's merger with ICG
(note 1) (11,821) (118) (102,349) - - (102,467)
Contribution of ICG's investment in
NETCOM to ICG Services, Inc. in
exchange for 10 shares of common
stock of ICG Services, Inc. (note 1) - - 102,467 - - 102,467
Cumulative foreign currency
translation adjustment - - - - (263) (263)
Net loss - - - (79,890) - (79,890)
============= ========== ============== =============== ================================
Balances at December 31, 1998 - $ - 207,798 (175,024) (119) 32,655
============= ========== ============== =============== ================================
See accompanying notes to consolidated financial statements.
F-7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31, 1996, 1997 and 1998
- --------------------------------------------------------------------------------
Years ended December 31,
--------------------------------------------
1996 1997 1998
-------------- ------------- --------------
(in thousands)
Cash flows from operating activities:
Net loss $ (44,265) (33,092) (79,890)
Loss from discontinued operations 44,265 33,092 60,965
Adjustments to reconcile net loss to net cash used by operating
activities of continuing operations:
Share of earnings of ICG Ohio LINX - - (1,075)
Depreciation - - 4,064
Interest expense deferred and included in long-term debt - - 44,040
Amortization of deferred financing costs included in
interest expense - - 1,482
Amortization of deferred lease administration costs included in
selling, general and administrative expenses - - 36
Change in operating assets and liabilities:
Receivables - - (145,515)
Prepaid expenses and deposits - - (20)
Accounts payable and accrued liabilities - - 30,149
-------------- ------------- --------------
Net cash used by operating activities of continuing
operations - - (85,764)
-------------- ------------- --------------
Cash flows from investing activities:
Acquisition of property, equipment and other assets - - (301,969)
Purchase of short-term investments available for sale - - (41,000)
Investment in ICG Ohio LINX - - (9,104)
-------------- ------------- --------------
Cash used by investing activities of continuing operations - - (352,073)
-------------- ------------- --------------
Cash flows from financing activities:
Proceeds from issuance of common stock:
Exercise of stock options - - 341
Employee stock purchase plan - - 132
Proceeds from issuance of long-term debt - - 550,574
Deferred long-term debt issuance costs - - (18,245)
-------------- ------------- --------------
Net cash provided by financing activities of continuing
operations - - 532,802
-------------- ------------- --------------
Net increase in cash and cash equivalents of continuing
operations - - 94,965
Cash provided by discontinued operations - - 19,415
Cash and cash equivalents, beginning of period - - -
============== ============= ==============
Cash and cash equivalents, end of period $ - - 114,380
============== ============= ==============
See accompanying notes to consolidated financial statements.
F-8
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1997 and 1998
- ------------------------------------------------------------------------------
(1) Organization and Nature of Business
ICG Services, Inc., a Delaware corporation ("ICG Services" or "the
Company"), was incorporated on January 23, 1998 and is a wholly owned
subsidiary of ICG Communications, Inc., a Delaware corporation ("ICG"). On
January 21, 1998, ICG completed a merger with NETCOM On-Line Communication
Services, Inc., a Delaware corporation and Internet service provider
("ISP") located in San Jose, California ("NETCOM"), accounted for as a
pooling of interests. At the effective time of the merger, each outstanding
share of NETCOM common stock was automatically converted into shares of ICG
common stock at an exchange ratio of 0.8628 shares of ICG common stock per
NETCOM common share. In conjunction with the merger between ICG and 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. 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) and,
accordingly, the Company's consolidated financial statements reflect the
operations of NETCOM as discontinued for all periods presented. The Company
completed the sales of the operations of NETCOM on February 17 and March
16, 1999. In conjunction with the sales, the legal name of the NETCOM
subsidiary was changed to ICG PST, Inc. ("PST"). PST has retained the
domestic Internet backbone assets formerly owned by NETCOM which it intends
to use for the provision of newly developed wholesale network services to
ISPs and other telecommunications providers.
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 indirectly 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. As of December 31, 1998, the Company's
continuing operations consisted solely of the Leasing Services segment,
which is operated by ICG Equipment.
F-9
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(1) Organization and Nature of Business (continued)
The Company's objective is to acquire and invest in telecommunications
equipment, software, network capacity and businesses that complement ICG's
business strategy. By leveraging its relationship with ICG, the Company
intends to capitalize on the growth in demand for telecommunications
equipment and services provided by the Company. In addition to providing
Leasing Services and Network Services, the Company intends to grow through
acquisition or investment in telecommunications related businesses,
including investment in companies currently owned by ICG.
(2) Significant Accounting Policies
(a) Basis of Presentation
The accompanying consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
The terms "fiscal" or "fiscal year" relate to the Company's fiscal
year ending December 31.
(b) Cash Equivalents and Short-term Investments Available for Sale
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The Company
invests primarily in high grade short-term investments which consist
of money market instruments, commercial paper, certificates of
deposit, government obligations and corporate bonds, all of which are
considered to be available for sale and generally have maturities of
one year or less. The Company's short-term investment objectives are
safety, liquidity and yield, in that order. The Company carries all
cash equivalents at cost plus accrued interest, which approximates
fair value. Short-term investments available for sale are carried at
amortized cost, which approximates fair market value, with unrealized
gains and losses, net of tax, reported as other comprehensive income
(loss) in stockholders' equity. Realized gains and losses and declines
in value judged to be other than temporary are included in the
statement of operations.
(c) Investments
Investments representing an equity interest of 20% or more, but less
than 50%, are
F-10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(2) Significant Accounting Policies (continued)
accounted for using the equity method of accounting, whereby the
Company's share of earnings or losses in the investee company is
included in results of operations. Investments of less than a 20%
equity interest are accounted for using the cost method, unless the
Company exercises significant influence and/or control over the
operations of the investee company, in which case the equity method is
used.
(d) Property and Equipment
Property and equipment are stated at cost. Estimated useful lives of
major categories of property and equipment are as follows:
Furniture, fixtures and office equipment 3 to 7 years
Machinery and equipment 3 to 8 years
Fiber optic equipment 8 years
Switch equipment 10 years
Fiber optic network 20 years
Buildings and improvements 31.5 years
(e) Deferred Costs
The Company defers the incremental costs of obtaining financing
instruments and of lease administration. Amortization of deferred
costs is provided on a straight-line basis, which approximates the
interest method, over the life of the related financing or lease
agreement, the maximum term of which is 10 years.
(f) Impairment of Long-Lived Assets
The Company provides for the impairment of long-lived assets pursuant
to Statement of Financial Accounting Standards No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of ("SFAS 121") which requires that long-lived assets and
certain identifiable intangibles held and used by an entity be
reviewed for impairment whenever events or changes in circumstances
indicate that the carrying value of an asset may not be recoverable.
An impairment loss is recognized when estimated undiscounted future
cash flows expected to be generated by the asset is less than its
carrying value. Measurement of the impairment loss is based on the
fair value of the asset, which is generally determined using valuation
techniques such as the discounted present value of expected future
cash flows.
F-11
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(2) Significant Accounting Policies (continued)
(g) Foreign Currency Translation Adjustments
The functional currency for all foreign operations of NETCOM, which
were sold subsequent to December 31, 1998, is the local currency. As
such, all assets and liabilities denominated in foreign currencies are
translated at the exchange rate on the balance sheet date. Revenue and
costs and expenses are translated at weighted average exchange rates
prevailing during the period. Translation adjustments are included in
other comprehensive income and recorded as a separate component of
stockholders' equity. Gains and losses resulting from foreign currency
transactions are included in discontinued operations and were not
significant for the periods presented.
(h) Revenue Recognition
ICG Equipment recognizes monthly leasing revenue from ICG on a
straight-line basis, according to the terms of the lease. Lease
service revenue earned on assets purchased by ICG Equipment and
intended for future lease to other subsidiaries of ICG, but not yet
placed in service, is recognized monthly based on the terms of ICG
Equipment's master lease agreement with ICG.
Prior to the sales of the operations of NETCOM, monthly subscription
service revenue was recognized over the period services were provided.
One-time set-up fees and equipment revenue, which required the use of
Company-provided installation of equipment at an Internet subscriber's
location, were recognized when the monthly subscription service was
commenced. The Company sold equipment to customers without future
obligation to purchase service. A provision for estimated equipment
returns was recorded in the period the revenue was recognized.
Uncollectible trade receivables were accounted for using the allowance
method.
Prior to the sales of the operations of NETCOM, deferred revenue
included monthly advance billings to customers for Internet services
provided and also, to a lesser extent, billings to customers for
equipment shipped that had not been installed at customer locations.
(i) Income Taxes
The Company accounts for income taxes under the provisions of
Statement of Financial Accounting Standards No. 109, Accounting for
Income Taxes ("SFAS 109"). Under the asset and liability method of
SFAS 109, deferred tax assets and
12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(2) Significant Accounting Policies (continued)
liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
Under SFAS 109, the effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that
includes the enactment date.
(j) Net Loss Per Share
Shares outstanding prior to the Company's inception on January 23,
1998 consist solely of the common stock of NETCOM. As of December 31,
1998, 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 considered to be meaningful.
(k) Stock-Based Compensation
The Company participates in ICG's stock-based employee compensation
plans. ICG accounts for its stock-based employee compensation plans
using the intrinsic value based method prescribed by Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations ("APB 25"). The Company has
provided pro forma disclosures of net loss for all periods presented
as if the fair value based method of accounting for these plans, as
prescribed by Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation ("SFAS 123"), had been applied
and had the pro rata portion of compensation expense based on Company
employee participation been allocated to the Company by ICG. Pro forma
disclosures of net loss per share is not presented as such disclosure
is not considered to be meaningful.
(l) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenue and expenses during the reporting periods. Actual results
could differ from those estimates.
F-13
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- -------------------------------------------------------------------------------
(2) Significant Accounting Policies (continued)
(m) Reclassifications
Certain prior period amounts have been reclassified to conform with
the current period's presentation.
(3) Discontinued Operations
Effective November 3, 1998, the Company's board of directors adopted the
formal plan to dispose of the operations of NETCOM and, accordingly, the
Company's consolidated financial statements reflect the operations of
NETCOM as discontinued for all periods presented. Since the Company expects
to record a gain on the disposition of NETCOM, the Company has deferred the
net losses from operations of NETCOM from November 3, 1998, through
December 31, 1998, to be recognized as a component of the gain on the
disposition. For fiscal 1996, 1997 and 1998, NETCOM reported revenue of
$120.5 million, $160.7 million and $164.6 million, respectively. Included
in net current assets (liabilities) and net non-current assets of
discontinued operations in the Company's consolidated balance sheets are
the following accounts of NETCOM:
December 31,
-------------------------------------------
1997 1998
------------------- --------------------
(in thousands)
Cash $ 63,368 -
Receivables 2,397 3,936
Inventory 341 423
Prepaid expenses and deposits 3,554 2,436
Deferred losses of NETCOM - 10,847
Accounts payable and accrued liabilities (28,471) (37,009)
Current portion of capital lease obligations (2,491) (2,961)
------------------- --------------------
Net current assets (liabilities) of NETCOM $ 38,698 (22,328)
=================== ====================
Property and equipment, net $ 72,945 50,394
Other assets, net 4,242 5,703
Capital lease obligations, less current portion (3,550) (2,074)
------------------- --------------------
Net non-current assets of NETCOM $ 73,637 54,023
=================== ====================
F-14
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(3) Discontinued Operations (continued)
On February 17, 1999, the Company sold certain of the operating assets and
liabilities of NETCOM to MindSpring Enterprises, Inc., an ISP located in
Atlanta, Georgia ("MindSpring"). Total proceeds from the sale were $245.0
million, consisting of $215.0 million in cash and 376,116 shares of common
stock of MindSpring, which were registered with the Securities and Exchange
Commission effective April 6, 1999 and valued at approximately $79.76 per
share at the time of the transaction. Assets and liabilities sold to
MindSpring include those directly related to the domestic operations of
NETCOM's Internet dial-up, dedicated access and Web site hosting services.
On March 16, 1999, the Company sold all of the capital stock of NETCOM's
international operations for total proceeds of approximately $41.1 million.
MetroNET Communications Corp., a Canadian entity, and Providence Equity
Partners, located in Providence, Rhode Island ("Providence"), together
purchased the 80% interest in NETCOM Canada Inc. owned by NETCOM for
approximately $28.9 million in cash. Additionally, Providence purchased all
of the capital stock of NETCOM Internet Access Services Limited, NETCOM's
operations in the United Kingdom, for approximately $12.2 million in cash.
The Company expects to record a combined gain on the NETCOM transactions of
approximately $200 million, net of income taxes of approximately $6.5
million, during the three months ended March 31, 1999. Since the operations
sold were acquired by ICG in a transaction accounted for as a pooling of
interests, the gain on the NETCOM transactions will be classified in the
Company's consolidated statement of operations as an extraordinary item.
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 for a minimum of $27.0 million, although subject to increase
dependent upon network usage. MindSpring will utilize the capacity to
provide Internet access to the dial-up services customers formerly owned by
NETCOM. In addition, the Company will receive for a one-year period 50% of
the gross revenue earned by MindSpring from the dedicated access customers
formerly owned by NETCOM, estimated to be approximately $10.0 million for
the term of the agreement. The Company intends to utilize the retained
network operating assets to provide similar wholesale capacity and other
enhanced network services to MindSpring and other ISPs and
telecommunications providers, beginning in 1999.
F-15
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(4) Short-term Investments Available for Sale
Short-term investments available for sale at December 31, 1998 are
comprised of the following (in thousands):
Certificates of deposit $ 31,000
Commercial paper 5,000
U.S. Treasury securities 5,000
=================
$ 41,000
=================
At December 31, 1998, the estimated fair value of the Company's
certificates of deposit, commercial paper and U.S. Treasury securities
approximated cost. All certificates of deposit, commercial paper and U.S.
Treasury securities mature within one year.
(5) Property and Equipment
Property and equipment at December 31, 1998 is comprised of the following
(in thousands):
Machinery and equipment $ 2,997
Fiber optic equipment 76,523
Switch equipment 36,602
Fiber optic network 78,881
Construction in progress 106,966
-----------------
301,969
Less accumulated depreciation (4,064)
=================
$ 297,905
=================
Construction in progress consists of approximately $107.0 million of
property and equipment which has not been placed in service at December 31,
1998, and accordingly, is not being depreciated. This amount relates to
telecommunications equipment and other assets purchased by ICG Equipment,
but not yet leased to other subsidiaries of ICG.
All of the Company's property and equipment at December 31, 1998, excluding
amounts included in construction in progress, are under lease to other
subsidiaries of ICG. Minimum future rentals on non-cancelable operating
leases with other subsidiaries of ICG are as follows at December 31, 1998
(in thousands):
F-16
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(5) Property and Equipment (continued)
1999 $ 21,727
2000 34,416
2001 35,147
2002 35,254
2003 35,421
Thereafter 74,876
==================
$ 236,841
==================
(6) Investments
On August 27, 1998, the Company purchased, for $9.1 million in cash, the
remaining 20% equity interest in ICG Ohio LINX, Inc. ("ICG Ohio LINX")
which ICG Telecom did not already own, including incremental costs of
obtaining that investment of $0.1 million. 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
has accounted for its investment in ICG Ohio LINX under the equity method
of accounting. For fiscal 1998, the Company included approximately $1.1
million in its consolidated statement of operations for its proportionate
share of earnings of ICG Ohio LINX.
(7) Long-term Debt
Long-term debt at December 31, 1998 is summarized as follows (in
thousands):
9 7/8% Senior discount notes, net of discount (a) $ 266,918
10% Senior discount notes, net of discount (b) 327,699
====================
$ 594,617
====================
(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 $7.9 million,
were approximately $242.1 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,
F-17
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(7) Long-term Debt (continued)
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.
The 9 7/8% Notes were originally recorded at approximately $250.0
million. The discount on the 9 7/8% Notes is being accreted through
May 1, 2003, the date on which the 9 7/8% Notes may first be redeemed.
The accretion of the discount and the amortization of the debt
issuance costs is included in interest expense in the accompanying
consolidated statements of operations.
(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 $9.7 million,
were approximately $290.9 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, asset 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 the amortization of the
debt issuance costs is included in interest expense in the
accompanying consolidated statements of operations.
(8) Stock Options and Employee Stock Purchase Plan
The NETCOM 1993 Stock Option Plan was assumed by ICG at the time of the
merger, and approved by ICG's Board of Directors as an incentive and
non-qualified stock option plan which provides for the granting of options
to certain directors, officers and employees to purchase 2,720,901 shares
of ICG Common Stock. A total of 2,224,273 options, net of 2,155,826 of
cancellations, have been granted under this plan at exercise prices ranging
from $0.65 to $92.14, none of which were less than 100% of the fair market
value of the shares underlying options on the date of grant, and
accordingly, no
F-18
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(8) Stock Options and Employee Stock Purchase Plan (continued)
compensation expense was recorded for these options under APB 25. The
options granted under this plan are subject to various vesting
requirements, generally three and five years, and expire within ten years
from the date of grant.
During fiscal 1998, ICG's Board of Directors approved incentive and
non-qualified stock option plans and replenishments to those plans which
provide for the granting of options to certain directors, officers and
employees, including officers and employees of the Company, to purchase
3,400,000 shares of ICG Common Stock. A total of 650,775 options, net of
842,725 of cancellations, have been granted to employees of the Company
under this plan at original exercise prices ranging from $11.38 to $35.75,
none of which were less than 100% of the fair market value of the shares
underlying options on the date of grant, and accordingly, no compensation
expense was recorded for these options under APB 25. The options granted
under these plans are subject to various vesting requirements and expire in
five and ten years from the date of grant.
In order to continue to provide non-cash incentives and retain key
employees, all employee stock options outstanding on September 18, 1998
with exercise prices at or in excess of $22.00 were canceled by the Stock
Option Committee of ICG's Board of Directors and regranted with an exercise
price of $16.875, the closing price of ICG Common Stock on the Nasdaq
National Market on September 18, 1998. A total of 757,058 options held by
employees of the Company, with original exercise prices ranging from $22.02
to $35.75 were canceled and regranted on September 18, 1998. There was no
effect on ICG's or the Company's consolidated financial statements as a
result of the cancellation and regranting of options.
During fiscal 1994, NETCOM's Board of Directors approved and adopted an
Employee Stock Purchase Plan which was dissolved upon NETCOM's merger with
ICG. Shares purchased under this plan were converted into an estimated
119,000 shares of ICG Common Stock.
During fiscal 1998, the Company's employees became eligible to participate
in ICG's Employee Stock Purchase Plan whereby employees can elect to
designate 1% to 30% of their annual salary, to be used to purchase shares
of ICG Common Stock, up to a limit of $25,000 in ICG Common Stock each
year, at a 15% discount to fair market value. Stock purchases occur four
times a year on February 1, May 1, August 1 and November 1, with the price
per share equaling the lower of 85% of the market price at the beginning or
end of the offering period. ICG is authorized to issue a total of 1,000,000
shares of ICG Common Stock to participants in the plan. During fiscal 1998,
ICG sold 10,080 shares of ICG Common Stock to employees of the Company
under this plan.
F-19
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(8) Stock Options and Employee Stock Purchase Plan (continued)
ICG accounts for its stock-based employee and non-employee director
compensation plans pursuant to the intrinsic value based method of APB 25.
Had compensation expense for ICG's plans been determined based on the fair
market value of the options at the grant dates for awards under those plans
consistent with the provisions of SFAS 123 and had the pro rata portion of
compensation expense based on Company employee participation been allocated
to the Company, the Company's pro forma net loss would have been as
presented below.
Years ended December 31,
----------------------------------------------------
1996 1997 1998
----------------- -------------- --------------
(in thousands)
Net loss:
As reported $ (44,265) (33,092) (79,890)
Pro forma (56,143) (37,962) (85,379)
The fair value of each option grant to employees was estimated on the date
of grant using the Black-Scholes option-pricing model with the following
assumptions: an expected option life of 1.6 years for fiscal 1996 and 1997,
and three years for officers and other executives and two years for other
employees for fiscal 1998; expected volatility of 80% for fiscal 1996 and
1997, and 70% for fiscal 1998; and risk-free interest rates of 6% for
fiscal 1996 and 1997 and risk-free interest rates ranging from 4.11% to
5.66% for fiscal 1998. Risk-free interest rates, as were currently
available on the grant date, were assigned to each granted option based on
the zero-coupon rate of U.S. Treasury bills to be held for the same period
as the assumed option life. Since ICG does not anticipate issuing any
dividends on the ICG Common Stock, the dividend yield for all options
granted was assumed to be zero. The weighted average fair market value of
options granted to Company employees during fiscal 1996, 1997 and 1998 was
approximately $19.39, $13.84 and $12.96 per option, respectively.
As options outstanding at December 31, 1998 will continue to vest in
subsequent periods and additional options are expected to be awarded under
existing and new plans, the above pro forma results are not necessarily
indicative of the impact on net loss in future periods.
F-20
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(8) Stock Options and Employee Stock Purchase Plan (continued)
The following table summarizes the status of ICG's stock-based compensation
plans for Company employees: Shares underlying Weighted average Options
Shares underlying Weighted average Options
options exercise price exercisable
--------------------- ---------------------- ---------------------
(in thousands) (in thousands)
Outstanding at January 1, 1996 1,454 $ 28.46 290
Granted 732 30.08
Exercised (167) 7.05
Canceled (388) 33.26
---------------------
Outstanding at December 31, 1996 1,631 30.24 507
Granted 1,831 16.11
Exercised (77) 12.96
Canceled (1,744) 29.84
---------------------
Outstanding at December 31, 1997 1,641 15.67 495
Granted 1,661 23.04
Exercised (706) 14.90
Canceled (1,282) 25.04
---------------------
Outstanding at December 31, 1998 1,314 16.27 442
=====================
The following table summarizes information about options granted to Company
employees outstanding at December 31, 1998:
F-21
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(8) Stock Options and Employee Stock Purchase Plan (continued)
Options outstanding Options exercisable
--------------------------------------------------------- --------------------------------------
Weighted
average Weighted Weighted
Range of remaining average average
Exercise Number contractual exercise Number exercise
Prices outstanding life price exercisable price
------------------- ------------------ ----------------- ------------------ ------------------- -----------------
(in thousands) (in years) (in thousands)
$ 5.20 - 14.05 152 8.31 $ 12.20 77 $ 11.99
14.50 - 15.51 26 8.45 15.20 8 15.31
15.65 251 8.34 15.65 227 15.65
15.73 - 16.88 804 9.20 16.77 95 16.22
17.63 - 46.65 81 8.93 21.18 35 20.28
------------------ ------------------
1,314 8.90 16.27 442 15.49
================== ===================
(9) 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 by each party. All
transactions between the Company, including its subsidiaries, and ICG,
including its Restricted Subsidiaries, contain fair and reasonable terms
and are approved by the Board of Directors of the Company and of ICG. All
such transactions are settled in cash on a quarterly basis.
For fiscal 1998, ICG charged approximately $8.0 million to the Company for
intercompany transfers and direct and indirect costs incurred by ICG and
its Restricted Subsidiaries on behalf of the Company. Of this amount,
approximately $2.4 million is
F-22
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(9) Related Party Transactions (continued)
included in the Company's selling, general and administrative expenses for
fiscal 1998. In addition, for fiscal 1998, the Company charged
approximately $284.5 million to ICG and its Restricted Subsidiaries for
intercompany transfers and direct and indirect costs incurred by the
Company on behalf of ICG and its Restricted Subsidiaries. Included in this
amount is approximately $15.5 million for advances made to ICG ChoiceCom
L.P., ICG's facilities-based telecommunications services operations in
Texas ("ChoiceCom"), which business ICG purchased from a third party on
December 31, 1998. During fiscal 1998, ICG Telecom and NETCOM jointly began
offering certain telecommunications services. For fiscal 1998, the Company
charged approximately $1.3 million for the reimbursement of expenses
incurred by NETCOM for this joint service offering. The net receivable from
ICG for all intercompany charges combined is included in due from ICG in
the Company's consolidated balance sheet at December 31, 1998. Net interest
income accrued by the Company on outstanding balances from ICG and its
Restricted Subsidiaries is included in interest income in the Company's
consolidated statement of operations and was approximately $4.6 million for
fiscal 1998. For fiscal 1998, interest accrued on outstanding balances of
intercompany transfers and direct and indirect costs between ICG Services
and ICG and its Restricted Subsidiaries at 10% per annum, which represents
the Company's approximate weighted average cost of capital at the beginning
of fiscal 1998. Effective January 1, 1999, interest accrues on outstanding
balances of intercompany transfers and direct and indirect costs between
the respective entities at 12 1/2% per annum.
During fiscal 1998, ICG Equipment purchased certain telecommunications
equipment and fiber optic capacity both from and for ICG Telecom for an
aggregate purchase price of approximately $195.0 million. Simultaneously
with each of the purchases, ICG Equipment entered into separate agreements
to lease the same telecommunications equipment and fiber optic capacity
back to ICG Telecom under operating leases, with annual lease payments
commencing one year from the date of the lease. ICG Equipment recognizes
revenue from the lease payments ratably over the lease terms. The Company
recognized approximately $4.9 million in revenue under these operating
leases for fiscal 1998, all of which is included in lease receivables at
December 31, 1998. Subsequent to December 31, 1998, ICG Equipment purchased
certain telecommunications equipment from ICG Telecom for an aggregate
purchase price of approximately $116.3 million and simultaneously entered
into agreements to lease the same telecommunications equipment back to ICG
Telecom under operating leases, with annual lease payments commencing one
year from the date of the lease. The purchase prices and lease payments for
all leases are subject to adjustment, based on the results of an
independent appraisal which may be requested at the option of ICG Telecom
and ICG Equipment on or before 90 days from
F-23
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(9) Related Party Transactions (continued)
the purchase date. On September 30, 1998, ICG Equipment submitted a formal
written request to ICG Telecom for independent appraisals of certain
telecommunications equipment and fiber optic capacity purchased through
December 31, 1998. The Company expects the appraisals to be complete during
the second quarter of 1999.
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% (11 3/4% at December 31,
1998), 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. For fiscal 1998, ICG Equipment recognized approximately $5.0
million of monthly service fee revenue under this agreement and
approximately $2.8 million was included in lease receivables at December
31, 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 $107.0 million at December 31, 1998.
In the normal course of business during fiscal 1998, ICG Telecom provided
the use of certain of its local access lines to NETCOM and, accordingly,
charged NETCOM for costs of any installation and recurring access to its
network. For fiscal 1998, NETCOM incurred approximately $2.3 million for
installation and recurring local access charges from ICG Telecom, which
have been included in net current liabilities of discontinued operations
and loss from discontinued operations in the Company's consolidated
financial statements for fiscal 1998.
(10) Commitments and Contingencies
(a) Purchase Commitments
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 $76.4 million
at December 31, 1998.
F-24
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(10) Commitments and Contingencies (continued)
(b) Litigation
A putative class action lawsuit was filed on July 15, 1997 in Superior
Court of California, Orange County, alleging unfair business practices
and related causes of action against NETCOM in connection with its
offers of free trial periods and cancellation procedures. Claimed
damages are at least $10.0 million. Although the case is plead as a
class action, the class has not been certified and plaintiffs have
requested to substitute a new class representative. The parties are
currently conducting discovery. Trial has been tentatively set for
June 1999. The Company believes it has meritorious defenses to such
claims and intends to vigorously defend the action.
NETCOM is a party to certain other litigation which has arisen in the
ordinary course of business. In the opinion of management, the
ultimate resolution of these matters will not have a material adverse
effect on the Company's financial condition, results of operations or
cash flows.
(11) Income Taxes
Current income taxes paid during fiscal 1996, 1997 and 1998 represents
foreign and state income taxes relating to operations of NETCOM in foreign
countries and in states requiring separate entity tax returns, and is
included in loss from discontinued operations in the Company's consolidated
financial statements for all periods presented.
Income tax benefit differs from the amounts computed by applying the U.S.
federal income tax rate to loss before income taxes primarily because the
Company has not recognized the income tax benefit of certain of its net
operating loss carryforwards and other deferred tax assets due to the
uncertainty of realization.
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1997 and 1998 are as follows:
F-25
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(11) Income Taxes (continued)
December 31,
------------------------------------------
1997 1998
------------------- --------------------
(in thousands)
Deferred income tax liabilities:
Property and equipment, due to excess
purchase price of tangible assets and
differences in depreciation for book and
tax purposes $ - 2,252
------------------- --------------------
Deferred income tax assets:
Net operating loss carryforwards (36,414) (64,186)
Less valuation allowance 36,414 61,934
------------------- --------------------
Net deferred income tax assets - (2,252)
------------------- --------------------
Net deferred income tax liability $ - -
=================== ====================
As of December 31, 1998, the Company has federal net operating loss
carryforwards ("NOLs") of approximately $160.5 million which expire in
varying amounts through 2018. Due to the provisions of Section 382, Section
1502 and certain other provisions of the Internal Revenue Code (the
"Code"), the utilization of these NOLs may be limited. The Company is also
subject to certain state income tax laws, which will also limit the
utilization of NOLs for state income tax purposes.
A valuation allowance has been provided for the deferred tax asset relating
to the Company's NOLs as management cannot determine when the Company will
generate future taxable income. Even with the aforementioned limitations,
the Company anticipates that a significant portion of the Company's NOLs
will be utilized to offset net income expected during the first quarter of
1999, arising from the extraordinary gain expected on the sales of the
operations of NETCOM.
(12) Employee Benefit Plans
Prior to the merger with ICG, NETCOM established salary reduction savings
plans under Section 401(k) of the Code which NETCOM administered for
participating employees. All full-time employees were covered under the
plan after meeting minimum service and age requirements. Under the plans
available to NETCOM employees from January 1, 1997 through June 30, 1998,
NETCOM made a matching contribution of 100% of each employee's contribution
up to a maximum of 3% of the employee's eligible earnings.
F-26
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
- ------------------------------------------------------------------------------
(12) Employee Benefit Plans (continued)
Prior to 1997, the Company's matching contribution was limited to 50% of
each employee's contribution up to a maximum of 6% of the employee's
eligible earnings. Aggregate matching contributions under NETCOM's employee
benefit plans were approximately $0.4 million, $0.6 million and $0.3
million during fiscal 1996, 1997 and 1998, respectively.
(13) Events Subsequent to Date of Independent Auditors' Report (Unaudited)
On March 1, 1999, the Company purchased from ICG Telecom, for $35.1 million
in cash, a 49% equity interest in ChoiceCom. Based in Austin, Texas,
ChoiceCom currently provides local exchange and long distance services in
Austin, Corpus Christi, Dallas, Houston and San Antonio, Texas. The Company
will account for its investment in ChoiceCom under the equity method of
accounting. The remaining 51% equity interest in ChoiceCom is owned by ICG
Telecom.
On March 30, 1999, the Company purchased, for approximately $10.0 million
in cash, 454,545 shares of restricted Series D-1 Preferred Stock (the
"NorthPoint Preferred Stock") of NorthPoint Communications Holdings, Inc.,
a privately held Delaware corporation and CLEC based in San Francisco,
California ("NorthPoint"). The NorthPoint Preferred Stock has no voting
rights and is ultimately convertible into a voting class of common stock of
NorthPoint, at an exchange price which represents a discount, as defined in
the agreement, to the initial public offering price of NorthPoint's common
stock. The Company is restricted from selling the NorthPoint Preferred
Stock or securities obtained upon conversion of the NorthPoint Preferred
Stock for one year from the date of the initial public offering of
NorthPoint's common stock.
As of December 31, 1998, ICG's corporate headquarters building, land and
improvements (collectively, the "Corporate Headquarters") were leased by
ICG under an operating lease from an unrelated third party. Subsequent to
December 31, 1998, the Company signed a letter of intent to purchase the
Corporate Headquarters for approximately $43.7 million, which amount
represents historical cost and approximates fair value. The Company,
through a newly formed subsidiary, intends to finance the purchase through
the conversion of a $10.0 million security deposit previously deposited by
ICG as security for the existing operating lease and through a mortgage
secured by the Corporate Headquarters. Payments on the mortgage will be due
monthly through January 31, 2013, at an initial interest rate of
approximately 14% per annum. The seller of the Corporate Headquarters will
retain an option to repurchase the Corporate Headquarters, which option is
exercisable from January 1, 2004 through January 31, 2012.
F-27
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXHIBITS
10.4 Shared Administrative and Operational Services Agreement, dated as of
January 23, 1998, between ICG Communications, Inc. and ICG Services, Inc.
10.5:Form of Master Lease Agreement between ICG Equipment, Inc. and each of ICG
Telecom Group, Inc., ICG Ohio LINX, Inc., ICG Access Services, Inc., ICG
Telecom of San Diego, L.P. and Bay Area Teleport, Inc.
10.6:Amended and Restated Employment Agreement, dated as of February 17, 1999,
between ICG PST, Inc. and Michael D. Kallet.
21.1: Subsidiaries of the Registrant.
27.1:Financial Data Schedule of ICG Services, Inc. for the Year Ended December
31, 1998.
EXHIBIT 21.1
Subsidiaries of the Registrant
State of Incorporation Doing Business
Name of Subsidiary As
- ------------------------- ------------------------ ----------------------------
ICG Equipment, Inc. Colorado --
ICG PST, Inc. Delaware --
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/J. Shelby Bryan
---------------------------------------
J. Shelby Bryan
President, Chief Executive Officer and
Chairman of the Board of Directors
Date: April 14, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
Signature Title Date
President, Chief Executive Officer
and Chairman of the Board of Directors
/s/J. Shelby Bryan (Principal Executive Officer) April 14, 1999
- -----------------------
J. Shelby Bryan
Executive Vice President and Chief
Financial Officer
/s/Harry R. Herbst (Principal Financial Officer) April 14, 1999
- -----------------------
Harry R. Herbst
Vice President and Corporate Controller
/s/Richard Bambach (Principal Accounting Officer) April 14, 1999
- -----------------------
Richard Bambach
/s/John V. Colgan Director April 14, 1999
- -----------------------
John V. Colgan
/s/Douglas I. Falk Director April 14, 1999
- -----------------------
Douglas I. Falk
/s/John Kane Director April 14, 1999
- -----------------------
John Kane
/s/H. Don Teague Director April 14, 1999
- -----------------------
H. Don Teague