UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
(Commission File Number 333-51037)
ICG SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 84-1448147
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
161 Inverness Drive West
Englewood, Colorado 80112
(888) 424-1144 or (303) 414-5000
(Address of principal executive offices and registrant's telephone numbers,
including area codes)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
On August 16, 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. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS ..................... 3
Consolidated Balance Sheets as of December 31, 1998 and
June 30, 1999 (unaudited).................................... 3
Consolidated Statements of Operations (unaudited) for the
Three Months and Six Months Ended June 30, 1998 and 1999..... 5
Consolidated Statement of Stockholder's Equity (unaudited)
for the Six Months Ended June 30, 1999....................... 6
Consolidated Statements of Cash Flows (unaudited) for the
Six Months Ended June 30, 1998 and 1999 ..................... 7
Notes to Consolidated Financial Statements, December 31, 1998
and June 30, 1999 (unaudited)................................ 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS .......................................18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ......30
PART II ......................................................................32
ITEM 1. LEGAL PROCEEDINGS ...............................................32
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS .......................32
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .................................32
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .............32
ITEM 5. OTHER INFORMATION ...............................................32
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...............................32
Exhibits ........................................................32
Reports on Form 8-K .............................................32
2
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 1998 and June 30, 1999 (unaudited)
December 31, June 30,
1998 1999
------------------ ----------------
Assets (in thousands)
Current assets:
Cash and cash equivalents $ 114,380 96,674
Short-term investments available for sale 41,000 4,943
Receivables:
Network services, including amounts due from ICG
(note 6) - 8,029
Leasing services, due from ICG (note 6) 7,753 35,071
Due from ICG (note 6) 137,762 113,420
----------------- ----------------
145,515 156,520
----------------- ----------------
Inventory - 67
Prepaid expenses and deposits 20 613
----------------- ----------------
Total current assets 300,915 258,817
----------------- ----------------
Property and equipment 301,969 624,993
Less accumulated depreciation (4,064) (29,852)
----------------- ----------------
Net property and equipment 297,905 595,141
----------------- ----------------
Investment in restricted preferred stock (note 4) - 10,000
Investments, accounted for under the equity method (note 4) 10,179 47,906
Deferred financing and lease administration costs, net of
accumulated amortization of $1.5 million and $2.5 million at
December 31, 1998 and June 30, 1999, respectively 16,727 16,699
Deposits and other assets - 1,255
Net non-current assets of discontinued operations (note 3) 54,023 -
----------------- ----------------
Total assets (note 8) $ 679,749 929,818
================= ================
(Continued)
3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, June 30,
1998 1999
------------------- -----------------
Liabilities and Stockholder's Equity (in thousands)
Current liabilities:
Accounts payable, including amounts due to ICG (note 6) $ 28,840 26,617
Accrued liabilities 1,309 27,013
Deferred gain on sale (note 3) - 15,502
Current portion of capital lease obligations - 3,004
Net current liabilities of discontinued operations (note 3) 22,328 -
------------------- -----------------
Total current liabilities 52,477 72,136
------------------- -----------------
Capital lease obligations, less current portion - 6,548
Long-term debt, net of discount (note 5) 594,617 657,260
Other long-term liabilities (note 6) - 2,500
------------------- -----------------
Total liabilities 647,094 738,444
------------------- -----------------
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares authorized; 10 shares
issued and outstanding at December 31, 1998 and June 30, 1999 - -
Additional paid-in capital 207,798 180,619
Accumulated (deficit) earnings (175,024) 10,755
Accumulated other comprehensive loss (119) -
------------------- -----------------
Total stockholder's equity 32,655 191,374
------------------- -----------------
Commitments and contingencies (notes 5 and 7)
Total liabilities and stockholder's equity $ 679,749 929,818
=================== =================
See accompanying notes to consolidated financial statements.
4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months and Six Months Ended June 30, 1998 and 1999
Three months ended Six months ended
June 30, June 30,
------------------------------------- ----------------------------------
1998 1999 1998 1999
------------------- ----------------- ----------------------------------
(in thousands)
Revenue from network and leasing services provided
to ICG (notes 6 and 8) $ 452 20,041 452 34,644
Cost of services and expenses:
Cost of services - 848 - 1,434
Selling, general and administrative expenses,
including amounts allocated from ICG (note 6) 1,015 447 1,504 836
Depreciation (note 8) 148 13,813 148 20,943
------------------- ----------------- ----------------------------------
Total cost of services and expenses 1,163 15,108 1,652 23,213
------------------- ----------------- ----------------------------------
Operating (loss) income (711) 4,933 (1,200) 11,431
Other (expense) income:
Interest expense (note 8) (12,288) (17,499) (16,236) (33,137)
Interest income, including amounts earned from
ICG (note 6) 6,296 6,967 8,409 15,282
Gain on marketable trading securities, net of
unrealized gains and losses (note 4) - - - 439
------------------- ----------------- ----------------------------------
(5,992) (10,532) (7,827) (17,416)
------------------- ----------------- ----------------------------------
Loss from continuing operations before share of
net losses (6,703) (5,599) (9,027) (5,985)
Share of net losses of equity investees - (3) - (1,265)
------------------- ----------------- ----------------------------------
Loss from continuing operations (6,703) (5,602) (9,027) (7,250)
------------------- ----------------- ----------------------------------
Loss from discontinued operations (note 3) (11,794) - (28,373) -
------------------- ----------------- ----------------------------------
Extraordinary gain on sales of operations of
NETCOM, net of income taxes of $6.4 million
(note 3) - - - 193,029
------------------- ----------------- ----------------------------------
Net (loss) income and comprehensive (loss)
income $ (18,497) (5,602) (37,400) 185,779
=================== ================= ==================================
See accompanying notes to consolidated financial statements.
5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholder's Equity (unaudited)
Six Months Ended June 30, 1999
Accumulated
Common stock Additional Accumulated other Total
-------------------- paid-in (deficit) comprehensive stockholder's
Shares Amount capital earnings loss equity
-------- ----------- -------------- -------------- ---------------- ---------------
(in thousands)
Balances at January 1, 1999 - $ - 207,798 (175,024) (119) 32,655
Reversal of foreign currency translation
adjustment (note 3) - - - - 119 119
Excess of book value of net assets acquired
over consideration paid - - 3,899 - - 3,899
Excess of fair value of assets acquired over
book value (note 6) - - (31,078) - - (31,078)
Net income - - - 185,779 - 185,779
======== =========== ============== ============== ================ ===============
Balances at June 30, 1999 - $ - 180,619 10,755 - 191,374
======== =========== ============== ============== ================ ===============
See accompanying notes to consolidated financialstatements.
6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 1998 and 1999
Six months ended June 30,
------------------------------------
1998 1999
--------------- ----------------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ (37,400) 185,779
Loss from discontinued operations 28,373 -
Extraordinary gain on sales of discontinued operations - (193,029)
Adjustments to reconcile net (loss) income to net cash provided by
operating activities:
Recognition of deferred gain - (10,498)
Share of net losses of equity investees - 1,265
Depreciation 148 20,943
Interest expense deferred and included in long-term debt 15,814 29,566
Amortization of deferred financing costs included in interest expense 422 879
Amortization of deferred lease administration costs included in selling,
general and administrative expenses - 146
Gain on marketable trading securities - (439)
Change in operating assets and liabilities:
Receivables (27,889) (18,492)
Inventory - 139
Prepaid expenses and deposits - (93)
Accounts payable and accrued liabilities 26,941 (9,831)
--------------- ----------------
Net cash provided by operating activities 6,409 6,335
--------------- ----------------
Cash flows from investing activities:
Acquisition of property, equipment and other assets (52,236) (290,799)
Investment in equity investee - (35,093)
Investment in restricted preferred stock - (10,000)
Proceeds from sales of operations of NETCOM, net of cash included in sale - 252,881
(Purchase) sale of short-term investments available for sale (16,000) 36,057
Proceeds from sale of marketable securities - 30,439
--------------- ----------------
Net cash used by investing activities (68,236) (16,515)
--------------- ----------------
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 financing and lease administration costs (17,205) (997)
Principal payments on capital lease obligations - (1,422)
--------------- ----------------
Net cash provided (used) by financing activities 533,842 (2,419)
--------------- ----------------
Net increase (decrease) in cash and cash equivalents 472,015 (12,599)
Net cash used by discontinued operations (473) (5,107)
Cash and cash equivalents, beginning of period - 114,380
=============== ================
Cash and cash equivalents, end of period $ 471,542 96,674
=============== ================
(Continued)
7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Six Months Ended June 30, 1998 and 1999
Six months ended June 30,
------------------------------------
1998 1999
--------------- ----------------
(in thousands)
Supplemental disclosure of cash flows information of continuing operations:
Cash paid for interest $ - 2,692
=============== ================
Cash paid for taxes $ - 931
=============== ================
Supplemental disclosure of non-cash investing and financing activities of
continuing operations:
Acquisition of corporate headquarters assets through the issuance of
long-term debt (note 5) $ - 33,077
=============== ================
Assets acquired under capital leases $ - 6,190
=============== ================
See accompanying notes to consolidated financial statements.
8
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 1998 and June 30, 1999 (unaudited)
(1) Organization and Nature of Business
ICG Services, Inc., a Delaware corporation ("ICG Services" or "the
Company"), was incorporated on January 23, 1998 and is a wholly owned
subsidiary of ICG Communications, Inc., a Delaware corporation
("ICG"). On January 21, 1998, ICG completed a merger with NETCOM
On-Line Communication Services, Inc., a Delaware corporation and
Internet service provider ("ISP") located in San Jose, California
("NETCOM"), accounted for as a pooling of interests. Upon the
formation of ICG Services on January 23, 1998, ICG contributed its
investment in NETCOM to ICG Services and NETCOM became a wholly owned
subsidiary of, and predecessor entity to, ICG Services. Accordingly,
the financial statements of the Company prior to January 23, 1998
consist solely of the accounts of NETCOM and its subsidiaries. On
February 17 and March 16, 1999, the Company completed the sales of the
operations of NETCOM. In conjunction with the sales, the legal name of
the NETCOM subsidiary was changed to ICG NetAhead, Inc. ("NetAhead").
NetAhead has retained the domestic Internet backbone assets formerly
owned by NETCOM which it is utilizing for the provision of newly
developed wholesale network services to ISPs and other
telecommunications providers. The Company's consolidated financial
statements reflect the operations of NETCOM as discontinued for all
periods presented.
On January 23, 1998, ICG Equipment, Inc., a Colorado corporation and
wholly owned subsidiary of the Company ("ICG Equipment"), was formed
for the principal purpose of providing financing of telecommunications
equipment and services to ICG Telecom Group, Inc., an 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.
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, potentially including
investment in companies currently owned by ICG.
(2) Significant Accounting Policies
(a) Basis of Presentation
These financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December
31, 1998, as certain information and note disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the United
States Securities and Exchange Commission. The interim financial
statements reflect all adjustments which are, in the opinion of
management, necessary for a fair presentation of financial
position, results of operations and cash flows as of and for the
interim periods presented. Such adjustments are of a normal
recurring nature. Operating results for the six months ended June
30, 1999 are not necessarily indicative of the results that may
be expected for the year ending December 31, 1999.
All significant intercompany accounts and transactions have been
eliminated in consolidation.
9
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(2) Significant Accounting Policies (continued)
(b) (Loss) Income Per Share
The Company has 10 shares of common stock issued and outstanding,
which are owned entirely by ICG. Accordingly, the Company does
not present (loss) income per share in its consolidated financial
statements as such disclosure is not considered to be meaningful.
(c) Reclassifications
Certain 1998 amounts have been reclassified to conform with the
1999 presentation.
(3) Discontinued Operations
On February 17, 1999, the Company sold certain of the operating assets
and liabilities of NETCOM to MindSpring Enterprises, Inc., an ISP
located in Atlanta, Georgia ("MindSpring"). Total proceeds from the
sale were $245.0 million, consisting of $215.0 million in cash and
376,116 shares of common stock of MindSpring, valued at approximately
$79.76 per share at the time of the transaction. Assets and
liabilities sold to MindSpring include those directly related to the
domestic operations of NETCOM's Internet dial-up, dedicated access and
Web site hosting services. In conjunction with the sale to MindSpring,
the Company entered into an agreement to lease to MindSpring for a
one-year period the capacity of certain network operating assets
formerly owned by NETCOM and retained by the Company. MindSpring is
utilizing the Company's network capacity to provide Internet access to
the dial-up services customers formerly owned by NETCOM. Over the term
of the one-year agreement, MindSpring is required to pay the Company a
minimum of $27.0 million for the Company's network capacity, although
such minimum is subject to increase dependent upon network usage. In
addition, the Company is receiving 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, through NetAhead, is
currently utilizing the retained network operating assets to provide
wholesale capacity and other enhanced network services to MindSpring
and intends to provide similar services to other ISPs and
telecommunications providers in the future. The carrying value of the
assets retained by the Company was approximately $21.7 million,
including approximately $17.5 million of network equipment, on
February 17, 1999. The Company also retained approximately $11.3
million of accrued liabilities and capital lease obligations.
On March 16, 1999, the Company sold all of the capital stock of
NETCOM's international operations for total proceeds of approximately
$41.1 million. MetroNET Communications Corp., a Canadian entity, and
Providence Equity Partners, located in Providence, Rhode Island
("Providence"), together purchased the 80% interest in NETCOM Canada
Inc. owned by NETCOM for approximately $28.9 million in cash.
Additionally, Providence purchased all of the capital stock of NETCOM
Internet Access Services Limited, NETCOM's operations in the United
Kingdom, for approximately $12.2 million in cash.
During the six months ended June 30, 1999, the Company recorded a
combined gain on the sales of the operations of NETCOM of
approximately $193.0 million, net of income taxes of approximately
$6.4 million. Offsetting the gain on the sales is approximately $16.6
million of net losses from operations of NETCOM from November 3, 1998
(the date on which the Company's board of directors adopted the formal
plan to dispose of the operations of NETCOM) through the dates of the
sales. Additionally, since the Company expects to generate operating
costs in excess of revenue under its network capacity agreement with
MindSpring and the terms of the sale agreement were dependent upon and
negotiated in conjunction with the terms of the network capacity
10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
agreement, the Company deferred approximately $26.0 million of the
proceeds from the sale agreement to be applied on a periodic basis to
the network capacity agreement. The deferred proceeds are recognized
in the Company's statement of operations as the Company incurs cash
operating losses under the network capacity agreement. 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 incremental revenue
or costs generated by other customers, or by other services provided
to MindSpring, are recognized in the Company's consolidated statement
of operations as incurred. During the three months and six months
ended June 30, 1999, the Company applied $3.8 million and $10.5
million, respectively, of deferred proceeds from the sale of the
operating assets and liabilities of NETCOM to offset the costs of the
network capacity agreement with MindSpring, which entirely offset the
cost of the Company's operations under the agreement. Since the
operations sold were acquired by ICG in a transaction accounted for as
a pooling of interests, the gain on the sales of the operations of
NETCOM is classified as an extraordinary item in the Company's
consolidated statement of operations.
(4) Investments
As discussed in note 3, the Company received 376,116 shares of common
stock of MindSpring, valued at $79.76 per share, or $30.0 million, at
the time of the transaction, as partial consideration for the sale of
the domestic operations of NETCOM. In April 1999, the Company sold its
investment in MindSpring for net proceeds of approximately $30.4
million. The Company recorded a gain of approximately $0.4 million in
its statement of operations for the six months ended June 30, 1999.
On March 30, 1999, the Company purchased, for approximately $10.0
million in cash, 454,545 shares of restricted Series D-1 Preferred
Stock (the "NorthPoint Preferred Stock") of NorthPoint Communications
Holdings, Inc., a Delaware corporation and competitive local exchange
carrier ("CLEC") based in San Francisco, California ("NorthPoint").
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 provided in the
relevant documentation, 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 until March 23, 2000. On May 5, 1999,
NorthPoint completed the initial public offering of its common stock,
at which time the NorthPoint Preferred Stock, and additional shares of
NorthPoint Preferred Stock obtained as a result of stock splits, were
automatically converted into shares of Class B common stock, a
nonvoting class of common stock of NorthPoint (the "NorthPoint Class B
Shares"), which are convertible on or after March 23, 2000 on a
one-for-one basis into a voting class of common stock of NorthPoint.
The Company will account for its investment in NorthPoint under the
cost method of accounting until the NorthPoint Class B Shares are
converted into voting and tradable common stock of NorthPoint, after
which the investment will be classified as a trading security.
Investments, accounted for under the equity method include the
Company's 20% and 49% investments in ICG Ohio LINX, Inc. and ICG
ChoiceCom, L.P., respectively.
11
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Long-term Debt
Long-term debt is summarized as follows:
December 31, June 30,
1998 1999
--------------------- ---------------------
(in thousands)
9 7/8% Senior discount notes, net of discount $ 266,918 280,096
10% Senior discount notes, net of discount 327,699 344,087
Mortgage loan payable with adjustable rate of interest
(14.77% at June 30, 1999) due in full on January
31, 2013, secured by corporate headquarters (a) - 33,077
--------------------- ---------------------
$ 594,617 657,260
===================== =====================
(a) Mortgage Loan Payable
Effective January 1, 1999, the Company purchased ICG's corporate
headquarters building, land and improvements (collectively, the
"Corporate Headquarters") for approximately $43.4 million, which
amount represents historical cost and approximates fair value.
The Company, through a newly formed subsidiary, financed the
purchase primarily through a loan secured by a mortgage on the
Corporate Headquarters, guaranteed by ICG Services, Inc. The
amended loan agreement, dated May 1, 1999, requires monthly
interest payments at an initial interest rate of 14.77% per annum
which rate increases annually by 0.003%, with the mortgage
balance due in full on January 31, 2013. The seller of the
Corporate Headquarters has retained an option to repurchase the
Corporate Headquarters at the original sales price, which option
is exercisable from January 1, 2004 through January 31, 2012.
(b) Senior Facility
On August 12, 1999, ICG Equipment and NetAhead entered into a
$200.0 million senior secured financing facility (the "Senior
Facility") consisting of a $75.0 million term loan, a $100.0
million term loan and a $25.0 million revolving line of credit.
The Senior Facility is guaranteed by ICG Services and is secured
by the assets of ICG Equipment and NetAhead.
As required under the terms of the loan, the Company borrowed on
August 12, 1999 the available $75.0 million on the $75.0 million
term loan. The loan bears interest at an annual interest rate of
LIBOR plus 3.5% or the base rate, as defined in the credit
agreement, plus 2.5%, at the Company's option (10.5% on August
12, 1999). Quarterly repayments commence September 30, 1999 and
require quarterly loan balance reductions of 0.25% through June
30, 2005 with the remaining outstanding balance to be repaid
during the final three quarters of the loan term. The $75.0
million term loan matures on March 31, 2006.
On August 12, 1999, the Company borrowed $5.0 million on the
$100.0 million term loan which is available through August 10,
2000 at an initial annual interest rate of LIBOR plus 3.125% or
the base rate, as defined in the credit agreement, plus 2.125%,
at the Company's option (10.125% on August 12, 1999). Quarterly
repayments commence September 30, 2002 and require aggregate loan
balance reductions of 25% through June 30, 2003, 35% through June
30, 2004 and 40% through June 30, 2005. The $100.0 million term
loan matures on June 30, 2005.
12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Long-term Debt (continued)
The $25.0 million revolving line of credit is available through
the maturity date of June 30, 2005 at an initial annual interest
rate of LIBOR plus 3.125% or the base rate, as defined in the
credit agreement, plus 2.125%, at the Company's option.
The terms of the Senior Facility provide certain limitations on
the use of proceeds, additional indebtedness, dividends,
prepayment of the Senior Facility and other indebtedness and
certain other transactions. Additionally, the Company is subject
to certain financial covenants based on its results and the
results of ICG. The Company is required to pay commitment fees
ranging from 0.625% to 1.375% for the unused portion of available
borrowings under the Senior Facility.
(6) Related Party Transactions
The Company and its subsidiaries have entered into certain
intercompany and shared services agreements with ICG, whereby ICG
allocates to the Company direct and certain indirect costs incurred by
ICG or its other subsidiaries on behalf of the Company. Allocated
expenses generally include a portion of salaries and related benefits
of legal, accounting and finance, information systems support and
other ICG employees, certain overhead costs and reimbursement for
invoices of the Company paid by ICG. Conversely, any cash collected by
ICG on behalf of the Company or its subsidiaries or invoices paid by
the Company on behalf of ICG or its subsidiaries are in turn
reimbursed to the Company by ICG. As the Company and its subsidiaries
and ICG and its 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. Management believes that all
transactions between the Company, including its subsidiaries, and ICG,
including its subsidiaries, contain fair and reasonable terms. All
such transactions are approved by the board of directors of the
Company and of ICG and are settled in cash on a quarterly basis.
ICG charged approximately $1.6 million and $3.2 million for the three
months and six months ended June 30, 1998, respectively, and
approximately $32.8 million and $35.6 million for the three months and
six months ended June 30, 1999, respectively, to the Company for
intercompany transfers and direct and indirect costs incurred by ICG
and its Restricted Subsidiaries on behalf of the Company. Of these
amounts, approximately $0.6 million is included in the Company's
selling, general and administrative expenses for the three months and
six months ended June 30, 1998 and approximately $0.2 million and $0.5
million is included in selling, general and administrative expenses
for the three months and six months ended June 30, 1999, respectively.
The Company charged 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 approximately
$28.6 million and $29.3 million for the three months and six months
ended June 30, 1998, respectively, and approximately $144.4 million
and $269.6 million for the three months and six months ended June 30,
1999, respectively. The net receivable from ICG for all intercompany
charges combined is included in due from ICG in the Company's
consolidated balance sheets. Net interest income accrued by the
Company on outstanding balances from ICG and its Restricted
Subsidiaries is included in interest income in the Company's
consolidated statement of operations and was approximately $4.1
million and $10.0 million for the three months and six months ended
June 30, 1999, respectively. No significant interest income was
accrued by the Company during the six months ended June 30, 1998.
Interest has been accrued on outstanding balances of intercompany
transfers and direct and indirect costs between ICG Services and ICG
and its Restricted Subsidiaries at 10% and 12 1/2% per annum for 1998
and 1999, respectively, which represents the Company's approximate
weighted average cost of capital at the beginning of the respective
fiscal year.
13
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Related Party Transactions (continued)
ICG Equipment purchased certain telecommunications equipment both from
and for ICG Telecom for an aggregate purchase price of approximately
$21.9 million during the three months and six months ended June 30,
1998, and approximately $219.9 million and $284.0 million during the
three months and six months ended June 30, 1999, respectively.
Additionally, ICG Equipment entered into separate agreements to lease
$14.8 million during the three months and six months ended June 30,
1998 and $96.5 million and $146.0 million, during the three months and
six months ended June 30, 1999, respectively, of telecommunications
equipment to ICG Telecom under operating leases, with annual lease
payments commencing one year from the date of the lease. ICG Equipment
recognizes revenue from the lease payments ratably over the lease
terms. ICG Equipment recognized approximately $0.5 million for the
three months and six months ended June 30, 1998 and approximately
$15.6 million and $26.7 million for the three months and six months
ended June 30, 1999, respectively, in revenue under its operating
leases with ICG Telecom all of which is included in leasing services
receivables at June 30, 1998 and 1999, respectively. 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 Equipment on or before 90 days from the
purchase date. ICG Equipment submitted a request to ICG Telecom for
independent appraisals of certain of the telecommunications equipment
and fiber optic capacity purchased through June 30, 1999. The Company
received the appraisals for all transactions completed during fiscal
1998 which determined the fair value of the purchased
telecommunications equipment and fiber optic capacity exceeded the
book value, and accordingly, the original purchase price, by $31.1
million. The Company has reflected the payment of the excess of fair
value over the original purchase price as a reduction of equity in the
accompanying consolidated financial statements.
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% (11.75% at June
30, 1999), based on the average monthly balance of assets purchased by
ICG Equipment and intended for future lease to ICG Telecom, but not
yet placed into service. ICG Equipment recognized approximately $0.5
million for the three months and six months ended June 30, 1998 and
approximately $3.0 million and $5.3 million for the three months and
six months ended June 30, 1999, respectively, of monthly service fee
revenue under this agreement which was included in leasing services
receivables at June 30, 1998 and 1999, respectively. The amount of
assets purchased by ICG Equipment and intended for future lease to ICG
Telecom, but not yet placed into service, was approximately $149.1
million at June 30, 1999. The Company begins depreciation on property
and equipment at the time the assets are placed in service.
In the normal course of business, ICG Telecom provides the use of
certain of its local access lines to NETCOM (prior to the disposition
of the operations of NETCOM) and NetAhead and, accordingly, charges
NETCOM and NetAhead for costs of any installation and recurring access
to its network. For the three months and six months ended June 30,
1998, NETCOM incurred approximately $1.1 million for installation and
recurring local access charges from ICG Telecom, which have been
included in loss from discontinued operations in the accompanying
consolidated financial statements. For the three months and six months
ended June 30, 1999, NETCOM and NetAhead together incurred
approximately $1.4 million and $2.8 million, respectively, for
installation and recurring local access charges from ICG Telecom,
which have been included in the extraordinary gain on the sales of the
operations of NETCOM for those charges relating to NETCOM, and in
operating costs for those charges relating to NetAhead, a portion of
which were applied against the deferred gain on the sale of certain of
NETCOM's domestic operating assets and liabilities, in the Company's
consolidated financial statements for the six months ended June 30,
1999.
14
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Related Party Transactions (continued)
Conversely, NetAhead provides the use of its network to ICG Telecom in
NetAhead's and ICG Telecom's joint service offerings. For the three
months and six months ended June 30, 1999, NetAhead recognized
approximately $0.3 million of revenue from ICG Telecom for network
services provided to ICG Telecom in conjunction with NetAhead's and
ICG Telecom's joint service offerings of IP telephony services and
other enhanced data services. Additionally, included in cost of
services of NetAhead is approximately $0.3 million and $0.4 million
for the three months and six months ended June 30, 1999, respectively,
for costs incurred by NetAhead associated with NetAhead's and ICG
Telecom's joint service offerings of IP telephony services and other
enhanced data services.
Effective January 1, 1999, the Company purchased ICG's Corporate
Headquarters and assumed the prior lessor's operating lease of the
Corporate Headquarters assets to a subsidiary of ICG. For the three
months and six months ended June 30, 1999, the Company earned leasing
revenue from the Restricted Subsidiary of ICG of approximately $1.1
million and $2.3 million, respectively, under the operating lease,
which is included in revenue and due from ICG in the Company's
consolidated financial statements. As part of this transaction, the
subsidiary is obligated to pay the Company $2.5 million as a security
deposit on the operating lease, which is included in due from ICG in
the Company's consolidated financial statements.
(7) Commitments and Contingencies
The Company has entered into various equipment purchase agreements
with certain of its vendors. Under these agreements, if the Company
does not meet a minimum purchase level in any given year, the vendor
may discontinue certain discounts, allowances and incentives otherwise
provided to the Company. In addition, the agreements may be terminated
by either the Company or the vendor upon prior written notice.
The Company has entered into certain commitments to purchase capital
assets with an aggregate purchase price of approximately $81.1 million
at June 30, 1999.
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, now NetAhead, in
connection with its offers of free trial periods and cancellation
procedures. This litigation was settled in May 1999 for an amount
which was not significant to the Company's consolidated financial
statements.
NETCOM, now NetAhead, is a party to certain other litigation which has
arisen in the ordinary course of business. In the opinion of
management, the ultimate resolution of these matters will not have a
material adverse effect on the Company's financial condition, results
of operations or cash flows.
(8) Business Units
The Company conducts transactions with external customers through the
operations of its Network Services (NetAhead) and Leasing Services
(primarily ICG Equipment). Direct and certain indirect costs incurred
by ICG Services, Inc., the parent company, on behalf of Network
Services and Leasing Services are allocated among those business units
based on the nature of the underlying costs. As the operations of
Network Services commenced during the three months ended March 31,
1999, such operations are not considered to be significant for
purposes of business segment reporting and, accordingly, are included
with the remaining corporate subsidiaries of the Company which
primarily hold securities.
15
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Business Units (continued)
Set forth below are revenue, EBITDA (which represents the measure of
operating performance used by management to evaluate operating
results), depreciation, interest expense, capital expenditures of
continuing operations and total assets for Leasing Services and all
other subsidiaries of the Company combined. As described in note 3,
results of the Company reflect the operations of NETCOM as
discontinued for all periods presented.
Three months ended June 30, Six months ended June 30,
------------------------------- -------------------------------
1998 1999 1998 1999
--------------- --------------- -------------- ---------------
(in thousands)
Revenue:
Leasing Services $ 452 19,788 452 34,391
All other - 253 - 253
=============== =============== ============== ===============
Total revenue $ 452 20,041 452 34,644
=============== =============== ============== ===============
EBITDA (a):
Leasing Services $ 349 19,558 179 34,052
All other (912) (812) (1,231) (1,678)
=============== =============== ============== ===============
Total EBITDA $ (563) 18,746 (1,052) 32,374
=============== =============== ============== ===============
Depreciation (b):
Leasing Services $ 65 11,425 65 17,778
All other 83 2,388 83 3,165
=============== =============== ============== ===============
Total depreciation $ 148 13,813 148 20,943
=============== =============== ============== ===============
Interest expense (b):
Leasing Services $ - 413 - 1,034
All other 12,288 17,086 16,236 32,103
=============== =============== ============== ===============
Total interest expense $ 12,288 17,499 16,236 33,137
=============== =============== ============== ===============
Capital expenditures of continuing operations (c):
Leasing Services $ 50,113 224,795 52,236 288,732
All other - 4,380 - 8,257
=============== =============== ============== ===============
Total capital expenditures of continuing
operations $ 50,113 229,175 52,236 296,989
=============== =============== ============== ===============
December 31, June 30,
1998 1999
-------------------- ------------------
(in thousands)
Total assets:
Leasing Services $ 292,300 637,446
All other (d) 195,664 178,952
Net current assets of discontinued operations (e) - -
Net non-current assets of discontinued operations 54,023 -
Due from ICG 137,762 113,420
-------------------- ------------------
Total assets $ 679,749 929,818
==================== ==================
16
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Business Units (continued)
(a) EBITDA consists of loss from continuing operations before
interest, income taxes, depreciation, other expense, net, and
share of net losses of equity investees, or simply, revenue less
operating costs and selling, general and administrative expenses.
EBITDA is presented as the Company's measure of operating
performance because it is a measure commonly used in the
telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and is not
intended to represent cash flows or results of operations in
accordance with generally accepted accounting principles for the
periods indicated. EBITDA is not a measurement under generally
accepted accounting principles and is not necessarily comparable
with similarly titled measures of other companies.
(b) Although not included in EBITDA (which represents the measure of
operating performance used by management to evaluate operating
results) the Company has supplementally provided depreciation and
interest expense for each of the Company's Leasing Services and
all other Company subsidiaries combined. Interest expense
excludes amounts charged by ICG Services, Inc. to ICG Equipment,
Inc. (Leasing Services) for interest on outstanding cash advances
and expense allocations.
(c) Capital expenditures include assets acquired under capital leases
and excludes corporate headquarters assets acquired through the
issuance of long-term debt.
(d) Total assets excludes the investment in ICG Equipment, Inc.
(Leasing Services) which eliminates in consolidation.
(e) At December 31, 1998, the Company had net current liabilities of
discontinued operations of $22.3 million, and accordingly, such
amount was not included within net current assets of discontinued
operations on that date.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion includes certain forward-looking statements which
are affected by important factors including, but not limited to, the Company's
lack of operating history, the successful execution of the Company's new
strategy of offering enhanced network services to Internet service providers
("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 three months and
six months ended June 30, 1998 and 1999 represent the consolidated operating
results of the Company and its subsidiaries. See the unaudited condensed
consolidated financial statements of the Company for the three months and six
months ended June 30, 1999 included elsewhere herein. The Company's consolidated
financial statements reflect the operations of NETCOM as discontinued for all
periods presented. The terms "fiscal" and "fiscal year" refer to the Company's
fiscal year ending December 31.
Company Overview
ICG Services, Inc. ("ICG Services" or the "Company") was formed on January
23, 1998 and is a wholly owned subsidiary of ICG. The Company's Leasing Services
and Network Services operations are currently conducted through its two
operating subsidiaries, ICG Equipment, Inc. ("ICG Equipment") and ICG NetAhead,
Inc. ("NetAhead") (formerly NETCOM On-Line Communication Services, Inc.
("NETCOM")).
On January 21, 1998, ICG acquired NETCOM, a Delaware corporation and
provider of Internet connectivity and Web site hosting services located in San
Jose, California, in a transaction accounted for as a pooling of interests. As
consideration for the acquisition, ICG issued approximately 10.2 million shares
of common stock of ICG ("ICG Common Stock"), valued at approximately $284.9
million on the date of the merger. Upon the formation of ICG Services, ICG
contributed its investment in NETCOM to ICG Services and NETCOM became a wholly
owned subsidiary of, and predecessor entity to, ICG Services. Accordingly, the
historical consolidated financial statements of the Company prior to January 23,
1998 consist solely of the accounts of NETCOM.
In January 1998, the Company formed ICG Equipment, a Colorado corporation,
for the principal purpose of providing financing of telecommunications equipment
and services to ICG Telecom Group, Inc., an 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. 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. Management believes that all leasing and other
arrangements between ICG Equipment and ICG Telecom contain fair and reasonable
terms and are intended to be conducted on the basis of fair market value and on
comparable terms that the Company would be able to obtain from a comparable
third party. ICG Equipment completed its first significant transaction on June
30, 1998 and, accordingly, ICG Equipment's operations prior to that date are not
significant. During the second half of 1998 and the six months ended June 30,
1999, 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. Additionally, under master lease
agreements between ICG Equipment and ICG Telecom, ICG Telecom is required to pay
ICG Equipment a monthly lease service fee based on the average monthly balance
of assets purchased by ICG Equipment and intended for future lease to ICG
Telecom, but not yet placed into service. At June 30, 1999, ICG Equipment had
approximately $437.5 million of telecommunications equipment, software, network
capacity and related services under lease to ICG Telecom and approximately
$149.1 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 Enterprises, Inc., an ISP located in
18
Atlanta, Georgia ("MindSpring"), for total proceeds of $245.0 million, and on
March 16, 1999, the Company sold all of the capital stock of NETCOM's
international operations in Canada and the United Kingdom to other unrelated
third parties for total proceeds of approximately $41.1 million. During the six
months ended June 30, 1999, the Company recorded a combined gain on the sales of
the operations of NETCOM of approximately $193.0 million, net of income taxes of
approximately $6.4 million. Offsetting the gain on the sales is approximately
$16.6 million of net losses from operations of NETCOM from November 3, 1998 (the
date on which the Company's board of directors adopted the formal plan to
dispose of the operations of NETCOM) through the dates of the sales. Since the
operations sold were acquired by ICG in a transaction accounted for as a pooling
of interests, the gain on the sales of the operations of NETCOM is classified as
an extraordinary item in the Company's consolidated statement of operations. 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 NetAhead, Inc. ("NetAhead"). NetAhead has retained
the domestic Internet backbone assets formerly owned by NETCOM which include 236
points of presence ("POPs") serving approximately 700 cities nationwide.
NetAhead is utilizing the retained network operating assets to provide wholesale
Internet access and enhanced network services to MindSpring and other ISPs, ICG
Telecom and other telecommunications providers. On February 17, 1999, NetAhead
entered into an agreement to lease to MindSpring for a one-year period the
capacity of certain network operating assets formerly owned by NETCOM and
retained by the Company. MindSpring is utilizing the Company's network capacity
to provide Internet access to the dial-up services customers formerly owned by
NETCOM. Over the term of the one-year agreement, MindSpring is required to pay
the Company a minimum of $27.0 million, although such minimum is subject to
increase dependent upon network usage. In addition, the Company is receiving 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
are offset by the periodic recognition of approximately $26.0 million of the
proceeds from the sale of certain of NETCOM's domestic operating assets and
liabilities 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 incremental revenue or costs
generated by other customers, or by other services provided to MindSpring, are
recognized in the Company's consolidated statement of operations as incurred.
During the three months and six months ended June 30, 1999, the Company applied
$3.8 million and $10.5 million, respectively, of deferred proceeds to the
network capacity agreement with MindSpring.
Additionally, NetAhead provides network capacity and enhanced data services
to ISPs, 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, NetAhead's
nationwide data network and service capabilities to carry out-of-region traffic
and enhance data services provided. One of the services currently being offered
is modemless remote access service ("RAS"). RAS, also 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, allows ICG to act as an
aggregator of ISP traffic. Currently, NetAhead 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. NetAhead also provides transport services to
deliver all Internet protocol ("IP") data packets either directly to the ISP, if
the ISP is not collocated at the telecommunications provider's local switch, or
directly to the Internet, bypassing the ISP. Additionally, through its network
operations center, NetAhead monitors the usage of each 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 June 1999, ICG entered into a five-year agreement with Qwest
Communications Corporation ("Qwest"), whereby Qwest has agreed to purchase
100,000 RAS circuits from ICG. ICG expects to install a minimum of 80,000 of
Qwest's RAS circuits by September 30, 1999, with the remaining 20,000 RAS
circuits to be installed prior to June 29, 2000. In August 1998, ICG Telecom
19
began offering enhanced telephony services via IP technology. ICG Telecom
currently offers this service in 230 major cities in the United States, which
cities account for more than 90% of the commercial long distance market. ICG
Telecom carries the IP traffic over NetAhead's nationwide data network and
terminates a large portion of the traffic via NetAhead's POPs. NetAhead charges
ICG Telecom for calls carried and terminated on NetAhead's network. ICG and
NetAhead together plan to begin offering integrated access service ("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 will provide 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 NetAhead's network. NetAhead'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, NetAhead intends to provide other enhanced
network services as demand warrants.
In March 1999, ICG entered into an agreement with NorthPoint
Communications, Inc., a data competitive local exchange carrier based in San
Francisco, California ("NorthPoint"), which designates NorthPoint as ICG's
preferred digital subscriber line ("DSL") provider through June 1, 2001. A
significant portion of ICG's DSL traffic will be routed by NorthPoint to
NetAhead's asynchronous transfer mode ("ATM") switches and transported by
NetAhead either to the ISP, via a point to point connection or via IP
technology, or directly to the Internet, as required. ICG expects to purchase a
minimum of 75,000 digital subscriber lines from NorthPoint during the term of
the agreement. NetAhead has not finalized its arrangements with ICG Telecom
regarding pricing and volume of services required by NetAhead in order for ICG
Telecom to perform under its agreement with NorthPoint and meet the needs of its
customers, although the Company believes this agreement will expand the current
operations of NetAhead.
The Company has and will continue to enter into agreements with ICG Telecom
to provide network services at negotiated rates. Management believes that all
such arrangements contain fair and reasonable terms and are intended to be
conducted on the basis of fair market value and on comparable terms that the
Company would be able to obtain from a comparable third party. The Company is
not presently able to determine the impact that the offerings of its newly
developed network services will have on revenue or EBITDA in 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 NetAhead
believe the Internet services market sector will benefit from these new
services, there is no assurance that ICG Telecom and NetAhead will be able to
successfully deploy and market 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 NetAhead's
network, demands a lower volume of network capacity services than originally
anticipated or is unable to adequately compensate NetAhead for services provided
or to be provided, NetAhead 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 and 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 NetAhead become
more significant and as it consummates acquisitions, if any.
Results of Operations
The following table provides certain statement of operations data and
certain other financial data for the Company for the periods indicated. The
table also presents revenue, cost of services and expenses, operating (loss)
income and EBITDA as a percentage of the Company's revenue.
20
Three months ended June 30, Six months ended June 30,
--------------------------------------- -------------------------------------
1998 1999 1998 1999
------------------ ------------------- ----------------- ------------------
$ % $ % $ % $ %
---------- ------- ---------- ------- ----------- ----- ----------- -------
(unaudited)
(in thousands)
Statement of Operations Data:
Revenue 452 100 20,041 100 452 100 34,644 100
Cost of services and expenses:
Cost of services - - 848 4 - 1,434 4
Selling, general and administrative expenses 1,015 224 447 2 1,504 333 836 3
Depreciation 148 33 13,813 69 148 33 20,943 60
---------- ------- ---------- ------- ----------- ----- ----------- -------
Total cost of services and expenses 1,163 257 15,108 75 1,652 366 23,213 67
Operating (loss) income (711) (157) 4,933 25 (1,200) (266) 11,431 33
Other Data:
Net cash provided by operating activities 4,647 2,715 6,409 6,335
Net cash used by investing activities (54,113) (147,136) (68,236) (16,515)
Net cash provided (used) by financing activities 242,373 153 533,842 (2,419)
EBITDA (1) (563) (124) 18,746 94 (1,052) (233) 32,374 93
Capital expenditures of continuing operations (2) 50,113 229,175 52,236 296,989
Capital expenditures of discontinued operations (2) 8,439 - 14,948 -
(1) EBITDA consists of earnings (loss) from continuing operations
before interest, income taxes, depreciation, other expense, net
and share of net losses of equity investees, or simply, operating
(loss) income plus depreciation. EBITDA is provided because it is
a measure commonly used in the telecommunications industry.
EBITDA is presented to enhance an understanding of the Company's
operating results and is not intended to represent cash flows or
results of operations in accordance with generally accepted
accounting principles ("GAAP") for the periods indicated. EBITDA
is not a measurement under GAAP and is not necessarily comparable
with similarly titled measures of other companies. Net cash flows
from operating, investing and financing activities as determined
using GAAP are also presented in Other Data.
(2) Capital expenditures includes assets acquired under capital
leases and excludes corporate headquarters assets acquired
through the issuance of long-term debt. Capital expenditures of
discontinued operations includes the capital expenditures of
NETCOM.
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
Revenue. The Company recorded revenue of approximately $0.5 million and
$20.0 million for the three months ended June 30, 1998 and 1999, respectively.
Revenue recorded on operating leases of property and equipment to ICG Telecom
was $15.6 million for the three months ended June 30, 1999. Additionally, the
Company charges lease service fees to ICG Telecom for the cost of carrying
assets not yet placed into service. For the three months ended June 30, 1998 and
1999, revenue earned on lease service fees was $0.5 million and $3.0 million,
respectively. The Company also received rental income from ICG under the
operating lease for ICG's corporate headquarters, which the Company purchased
and simultaneously leased to ICG, effective January 1, 1999. For the three
months ended June 30, 1999, the Company recorded revenue on the operating lease
for the corporate headquarters of $1.1 million. For the three months ended June
30, 1999, NetAhead generated revenue of approximately $0.3 million for RAS
custom programming and IP network services provided to ICG. Revenue earned of
$11.7 million for the three months ended June 30, 1999 under the Company's
network capacity agreement with MindSpring has been offset by cost of services
and selling, general and administrative expenses of $18.4 million incurred under
the same agreement. This $6.7 million operating deficit has been equally offset
by the recognition of $6.7 million of the deferred proceeds from the sale of
certain of the domestic operating assets and liabilities of NETCOM. The Company
anticipates that revenue will increase substantially in future periods as the
volume of ICG Equipment's operations increases and as NetAhead provides a
greater volume of services to ICG, provides new services to MindSpring and
obtains and generates revenue from new customers.
21
Cost of services. Cost of services of $0.8 million for the three months
ended June 30, 1999 consists of line costs and other direct costs of NetAhead
associated with NetAhead's and ICG Telecom's joint service offering of IP
telephony services.
Selling, general and administrative expenses. Selling, general and
administrative ("SG&A") expenses were approximately $1.0 million and $0.4
million for the three months ended June 30, 1998 and 1999, respectively. SG&A
expenses include allocations of a portion of ICG's general and administrative
expenses for certain direct and indirect costs incurred by ICG on behalf of the
Company. Such allocations were $0.6 million and $0.2 million, representing 44%
and 45% of total SG&A expenses for the three months ended June 30, 1998 and
1999, respectively. Remaining SG&A expenses include general corporate
administrative expenses, including professional and cash management fees. SG&A
expenses for the three months ended June 30, 1998 include increased professional
fees due to the start-up and organization of the Company in early 1998. SG&A
expenses are expected to increase in absolute dollars as the volume of ICG
Equipment's operations increases and as NetAhead commences new service offerings
to ICG and MindSpring and obtains new customers.
Depreciation. Depreciation increased $13.7 million, from $0.1 million for
the three months ended June 30, 1998 to $13.8 million for the three months ended
June 30, 1999. Depreciation consists primarily of depreciation of ICG
Equipment's property and equipment purchased from and for ICG Telecom and leased
to ICG Telecom under long-term operating leases, in addition to depreciation of
property and equipment of NetAhead. The increase in depreciation is primarily
due to the expansion of ICG Equipment's operations during the second half of
1998 and the six months ended June 30, 1999. The Company's depreciation expense
will continue to increase as NetAhead purchases additional property and
equipment, ICG Equipment places in service equipment that has already been
purchased and purchases additional property and equipment for lease to ICG's
other operating subsidiaries.
Interest expense. Interest expense increased $5.2 million, from $12.3
million for the three months ended June 30, 1998 to $17.5 million for the three
months ended June 30, 1999, which includes $15.4 million of non-cash interest.
Interest expense is primarily attributable to the 10% Senior Discount Notes due
2008 (the "10% Notes") issued in February 1998 and the 9 7/8% Senior Discount
Notes due 2008 (the "9 7/8% Notes") issued in April 1998. 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 in 2003.
Interest income. Interest income increased $0.7 million, from $6.3 million
for the three months ended June 30, 1998 to $7.0 million for the three months
ended June 30, 1999 and primarily represents net interest income from ICG of
approximately $4.1 million during the three months ended June 30, 1999 for
invoices paid by the Company on behalf of ICG and its other operating
subsidiaries and repaid on a quarterly basis. The Company also earned interest
on invested cash balances from the proceeds from the issuance of the 10% Notes
and the 9 7/8% Notes and the proceeds from the sales of the operations of
NETCOM. 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 net losses of equity investees. The Company's share of net losses
of equity investees for the three months ended June 30, 1999 consists of the
Company's share of net income of ICG Ohio LINX, Inc. ("ICG Ohio LINX") of $2.8
million, offset by the Company's share of net losses of ICG ChoiceCom L.P.
("ChoiceCom") of $2.8 million. The Company purchased a 20% equity interest in
ICG Ohio LINX in August 1998 and a 49% equity interest in ChoiceCom in March
1999.
Loss from continuing operations. Loss from continuing operations improved
$1.1 million, or 16%, from $6.7 million for the three months ended June 30, 1998
to $5.6 million for the three months ended June 30, 1999 due to the increase in
revenue, offset by increases in depreciation and interest expense, as noted
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 the three months ended
June 30, 1998, loss from discontinued operations was $11.8 million, or 64% of
the Company's net loss, and consists of the net loss of NETCOM. The Company sold
the operations of NETCOM in February and March 1999.
22
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Revenue. The Company recorded revenue of approximately $0.5 million and
$34.6 million for the six months ended June 30, 1998 and 1999, respectively.
Revenue recorded on operating leases of property and equipment to ICG Telecom
was $26.7 million for the six months ended June 30, 1999. Additionally, the
Company charges lease service fees to ICG Telecom for the cost of carrying
assets not yet placed into service. For the six months ended June 30, 1998 and
1999, revenue earned on lease service fees was $0.5 million and $5.3 million,
respectively. The Company also received rental income from ICG under the
operating lease for ICG's corporate headquarters, which the Company purchased
and simultaneously leased to ICG, effective January 1, 1999. For the six months
ended June 30, 1999, the Company recorded revenue on the operating lease for the
corporate headquarters of $2.3 million. For the six months ended June 30, 1999,
NetAhead generated revenue of approximately $0.3 million for RAS custom
programming and IP network services provided to ICG. Revenue earned of $17.4
million for the six months ended June 30, 1999 under the Company's network
capacity agreement with MindSpring has been offset by operating costs and
selling, general and administrative expenses of $27.9 million incurred under the
same agreement. This $10.5 million operating deficit has been equally offset by
the recognition of $10.5 million of the deferred proceeds from the sale of
certain of the domestic operating assets and liabilities of NETCOM.
Cost of services. Cost of services of $1.4 million for the six months ended
June 30, 1999 consists of line costs and other direct costs of NetAhead
associated with NetAhead's and ICG Telecom's joint service offering of IP
telephony services.
Selling, general and administrative expenses. SG&A expenses were
approximately $1.5 million and $0.8 million for the six months ended June 30,
1998 and 1999, respectively. SG&A expenses include allocations of a portion of
ICG's general and administrative expenses for certain direct and indirect costs
incurred by ICG on behalf of the Company. Such allocations were $0.6 million and
$0.5 million, representing 42% and 58% of total SG&A expenses for the six months
ended June 30, 1998 and 1999, respectively. Remaining SG&A expenses include
general corporate administrative expenses, including professional and cash
management fees. SG&A expenses for the six months ended June 30, 1998 include
increased professional fees due to the start-up and organization of the Company
in early 1998.
Depreciation. Depreciation increased $20.8 million, from $0.1 million for
the six months ended June 30, 1998 to $20.9 million for the six months ended
June 30, 1999. Depreciation consists primarily of depreciation of ICG
Equipment's property and equipment purchased from and for ICG Telecom and leased
to ICG Telecom under long-term operating leases, in addition to depreciation of
property and equipment of NetAhead.
Interest expense. Interest expense increased $16.9 million, from $16.2
million for the six months ended June 30, 1998 to $33.1 million for the six
months ended June 30, 1999, which includes $30.4 million of non-cash interest.
Interest expense is primarily attributable to the 10% Notes issued in February
1998 and the 9 7/8% Notes issued in April 1998.
Interest income. Interest income increased $6.9 million, from $8.4 million
for the six months ended June 30, 1998 to $15.3 million for the six months ended
June 30, 1999 and primarily represents net interest income from ICG of
approximately $10.0 million during the six months ended June 30, 1999 for
invoices paid by the Company on behalf of ICG and its other operating
subsidiaries and repaid on a quarterly basis. The Company also earned interest
on invested cash balances from the proceeds from the issuance of the 10% Notes
and the 9 7/8% Notes and the proceeds from the sales of the operations of
NETCOM.
Gain on marketable trading securities, net of unrealized gains and losses.
Gain on marketable trading securities, net of unrealized gains and losses of
$0.4 million for the six months ended June 30, 1999 represents the net gain on
the common stock of MindSpring which the Company received as partial
consideration for the sale of the domestic operations of NETCOM. The Company
sold its investment in MindSpring in April 1999.
Share of net losses of equity investees. The Company's share of net losses
of equity investees of $1.3 million for the six months ended June 30, 1999
consists of the Company's share of net income of ICG Ohio LINX of $2.3 million,
offset by the Company's share of net losses of ChoiceCom of $3.6 million.
23
Loss from continuing operations. Loss from continuing operations improved
$1.7 million, or 20%, from $9.0 million for the six months ended June 30, 1998
to $7.3 million for the six months ended June 30, 1999 due to increases in
revenue and interest income, offset by increases in depreciation and interest
expense, as noted above.
Loss from discontinued operations and net loss. For the six months ended
June 30, 1998, loss from discontinued operations was $28.4 million, or 76% of
the Company's net loss, and consists of the net loss of NETCOM. Since the
Company expected to report a gain on the disposition of NETCOM, the Company
deferred the net losses from operations of NETCOM from November 3, 1998 (the
date on which the Company's board of directors adopted the formal plan to
dispose of the operations of NETCOM) through the dates of the sales and,
accordingly, the Company reported no loss from discontinued operations of NETCOM
for the six months ended June 30, 1999.
Extraordinary gain on sales of operations of NETCOM. The Company reported
an extraordinary gain on the sales of the operations of NETCOM during the six
months ended June 30, 1999 of $193.0 million, net of income taxes of $6.4
million. Offsetting the gain on the sales is approximately $16.6 million of net
losses of operations of NETCOM from November 3, 1998 through the dates of the
sales and $26.0 million of deferred sales proceeds from the sale of certain of
the domestic operating assets and liabilities of NETCOM to MindSpring. The
deferred proceeds are recognized on a periodic basis over the term of the
Company's network capacity agreement with MindSpring.
Liquidity and Capital Resources
The Company's growth has been funded through the proceeds from its 1998
debt financings (the 10% Notes and the 9 7/8% Notes issued in February and April
1998, respectively) and the proceeds from the sales of the operations of NETCOM.
As of June 30, 1999, the Company had current assets of $258.8 million, including
$101.6 million of cash, cash equivalents and short-term investments, which
exceeded current liabilities of $72.1 million, providing working capital of
$186.7 million. The Company primarily 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 Provided By Operating Activities
The Company's operating activities provided $6.4 million and $6.3 million
for the six months ended June 30, 1998 and 1999, respectively. Net cash provided
by operating activities is primarily due to losses from continuing operations,
which are more than offset by changes in working capital items and non-cash
expenses, such as deferred interest expense and depreciation.
The Company does not expect to generate significant cash flows from
operating activities while the Company continues to expand its operations.
Consequently, the Company does not anticipate that cash provided by the
operations of ICG Equipment alone will be sufficient to fund operating
activities, including the operations of NetAhead, in the near term. The Company
anticipates that cash used by operating activities will improve when the Company
expands leasing operations under ICG Equipment and increases revenue from
services offered by NetAhead to ICG and to customers other than MindSpring, any
of which may not occur.
Net Cash Used By Investing Activities
The Company's investing activities used $68.2 million and $16.5 million for
the six months ended June 30, 1998 and 1999, respectively. Net cash used by
investing activities for the six months ended June 30, 1998 includes the
acquisition of property, equipment and other assets and the purchase of
short-term investments available for sale. Net cash used by investing activities
for the six months ended June 30, 1999 includes the acquisition of property,
equipment and other assets of $290.8 million, the purchase of the 49% equity
interest in ChoiceCom of $35.1 million and the purchase of long-term investments
of $10.0 million, offset by the sales of the operations of NETCOM of $252.9
million and the proceeds from the sale of short-term investments and marketable
securities of $66.5 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 expansion of NetAhead's operations and,
24
potentially, for acquisitions. The Company acquired assets under capital leases
of $6.2 million during the six months ended June 30, 1999.
Net Cash Provided (Used) By Financing Activities
The Company's financing activities provided $533.8 million and used $2.4
million for the six months ended June 30, 1998 and 1999, respectively. Net cash
provided by financing activities for the six months ended June 30, 1998 includes
net proceeds from the private placement of the 10% Notes and the 9 7/8% Notes
issued in February and April 1998, respectively, 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. For the six months ended June 30, 1999, the Company's
financing activities consist of principal payments on capital leases and
deferred financing and lease administration costs.
On August 12, 1999, ICG Equipment and NetAhead entered into a $200.0
million senior secured financing facility (the "Senior Facility") consisting of
a $75.0 million term loan, a $100.0 million term loan and a $25.0 million
revolving line of credit. As required under the terms of the loan, the Company
borrowed on August 12, 1999 the available $75.0 million on the $75.0 million
term loan. The loan bears interest at an annual interest rate of LIBOR plus 3.5%
or the base rate, as defined in the credit agreement, plus 2.5%, at the option
of the Company (10.5% on August 12, 1999). Quarterly repayments commence
September 30, 1999 and require quarterly loan balance reductions of 0.25%
through June 30, 2005 with the remaining outstanding balance to be repaid during
the final three quarters of the loan term. The $75.0 million term loan matures
on March 31, 2006. On August 12, 1999, the Company borrowed $5.0 million on the
$100.0 million term loan, which is available for borrowing through August 10,
2000 at an initial annual interest rate of LIBOR plus 3.125% or the base rate,
as defined in the credit agreement, plus 2.125%, at the Company's option
(10.125% on August 12, 1999). Quarterly repayments commence September 30, 2002
and require aggregate loan balance reductions of 25% through June 30, 2003, 35%
through June 30, 2004 and 40% through June 30, 2005. The $100.0 million term
loan matures on June 30, 2005. The $25.0 million revolving line of credit is
available through the maturity date of June 30, 2005 at an initial annual
interest rate of LIBOR plus 3.125% or the base rate, as defined in the credit
agreement, plus 2.125%, at the Company's option.
As of June 30, 1999, the Company had an aggregate accreted value of
approximately $624.2 million outstanding under the 10% Notes and the 9 7/8%
Notes. The 10% Notes require payments of interest to be made in cash commencing
August 15, 2003 and mature February 15, 2008. The 9 7/8% Notes require payments
of interest to be made in cash commencing November 1, 2003 and mature May 1,
2008. As of June 30, 1999, the Company had $9.6 million of capital lease
obligations and $33.1 million of other indebtedness outstanding. With respect to
senior indebtedness outstanding on June 30, 1999, the Company has cash interest
payment obligations of approximately $44.5 million in 2003 and $89.0 million in
2004, 2005 and each year thereafter through 2007. 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.
Other Cash Commitments and Capital Requirements
The Company's capital expenditures of continuing operations were $52.2
million and $297.0 million for the six months ended June 30, 1998 and 1999,
respectively. The Company anticipates that the expansion of the Company's
businesses will require capital expenditures of approximately $156.0 million for
the remainder of 1999. To facilitate the expansion of its services and networks,
the Company has entered into equipment purchase agreements with various vendors
under which the Company will purchase equipment and other assets, including a
full range of switching systems, fiber optic cable, network electronics,
software and services. If the Company fails to meet the minimum purchase level
in any given year, the vendor may discontinue certain discounts, allowances and
incentives otherwise provided to the Company. Actual capital expenditures will
depend on numerous factors, including certain factors beyond the Company's
control. These factors include the nature of future expansion and acquisition
25
opportunities, economic conditions, competition, and the availability of equity,
debt and lease financing.
Management believes that the Company's cash on hand and amounts expected to
be available through cash flows from operations, vendor financing arrangements
and credit facilities will provide sufficient funds necessary for the Company to
expand ICG Equipment's and NetAhead'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, capital leases and other financing arrangements. To
date, the Company has been able to secure sufficient amounts of financing to
meet its capital and operating needs. There can be no assurance that additional
financing will be available to the Company or, if available, that it can be
obtained on terms acceptable to the Company. The failure to obtain sufficient
amounts of financing could result in the delay or abandonment of some or all of
the Company's development and expansion plans, which could have a material
adverse effect on the Company's business.
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 and NetAhead's
dependence upon the continuing successful operations of ICG Telecom, 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:
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 circuit and data
switches and collocations and telecommunications products;
26
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 corporate 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 is applying 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 performed an inventory of
all components currently in use by ICG. Based upon this inventory,
ICG's business executives and technology staff jointly classified 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 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
- 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.
The Company has completed all areas of Phase I.
o Phase II - Remediation
During this phase, ICG is developing and executing 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 is performing testing sufficient to confirm
that the component meets the desired state of Year 2000 readiness.
This phase consists 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 is implementing each act of remediation
developed and tested for each component, as well as implementing
adequate controls to ensure that future upgrades and changes to ICG's
27
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 either already completed or has commenced all of the phases within
its Year 2000 compliance strategy for each of its functional system categories,
as shown by the table set forth below. Since ICG has not waited until the
completion of a phase for all functional category components together before
commencing the next phase, the information set forth below represents only a
general description of the phase status for each functional category. For
systems and products which the Company intends to abandon or replace prior to
January 1, 2000, the Company has currently terminated all Year 2000 compliance
efforts.
- ------------------------------- ----------------------------------------------------------------------------------------------
Phase
- ------------------------------- ----------------------------------------------------------------------------------------------
I II III IV
System and Level of Priority Assessment Remediation Testing Implementation
- ------------------------------- ----------------------------------------------------------------------------------------------
Networks and Products
- ------------------------------- ----------------------------------------------------------------------------------------------
High Complete Complete In progress In progress
To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete Complete In progress In progress
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 Q3 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete In progress In progress In progress
To complete Q3 1999 To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete In progress In progress
To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Building and Facilities
- ------------------------------- ----------------------------------------------------------------------------------------------
High Complete Complete In progress In progress
To complete Q3 1999 To complete Q3 1999
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Medium Complete Based on the results of Phase I,
Further remediation not considered necessary
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Low Complete Based on the results of Phase I,
Further remediation not considered necessary
- ------------------------------- ---------------------- -----------------------------------------------------------------------
Office Equipment
- ------------------------------- ----------------------------------------------------------------------------------------------
High Complete Complete Complete Complete
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Medium Complete Complete Complete Complete
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Low Complete Complete Complete Complete
- ------------------------------- ---------------------- ----------------------- ----------------------- -----------------------
Costs
ICG expenses all incremental costs to ICG associated with Year 2000
compliance issues as incurred. Through June 30, 1999, such costs incurred were
approximately $1.1 million, consisting of approximately $0.6 million of
replacement hardware and software and approximately $0.5 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 June 30, 1999. ICG expects that total future incremental costs
28
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 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's four-phase approach has demonstrated 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 is using 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.
ICG believes that a reasonably likely worst case scenario of a Year 2000
compliance failure could include the temporary failure of a minimal number of
operating systems, despite ICG's execution and satisfactory completion of its
comprehensive Year 2000 compliance plan. However, under this scenario, ICG also
believes that any such failed systems or components would be fully recovered
within a short period subsequent to failure and, accordingly, ICG does not
expect to experience any significant or long term operational disruption as a
result of the failure of any systems or components directly within ICG's
control.
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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial position and cash flows are subject to a variety of
risks in the normal course of business, which include market risks associated
with movements in interest rates and equity prices. The Company routinely
assesses these risks and has established policies and business practices to
protect against the adverse effects of these and other potential exposures. The
Company does not, in the normal course of business, use derivative financial
instruments for trading or speculative purposes.
Interest Rate Risk
The Company's exposure to market risk associated with changes in interest
rates relates primarily to the Company's investments in marketable securities
and its senior indebtedness.
The Company invests primarily in high grade short-term investments which
consist of money market instruments, commercial paper, certificates of deposit,
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 June 30, 1999, the Company had approximately $101.6 million in
cash, cash equivalents and short-term investments available for sale, at a
weighted average fixed interest rate of 4.82% for the six months ended June 30,
1999. 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
June 30, 1999 of approximately $0.2 million and, accordingly, would not cause a
material impact on the Company's financial position, results of operations or
cash flows.
At June 30, 1999, the Company's indebtedness included $624.2 million under
the 10% Notes and 9 7/8% Notes. These instruments contain fixed annual interest
rates and, accordingly, any change in market interest rates would have no impact
on the Company's financial position, results of operations or cash flows. Future
increases in interest rates could increase the cost of any new borrowings by the
Company. The Company does not hedge against future changes in market rates of
interest.
On August 12, 1999, the Company entered into the Senior Facility,
consisting of two term loans and a revolving line of credit. All components of
the Senior Facility bear variable annual rates of interest, based on changes in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate.
Consequently, additional borrowings under the Senior Facility and increases in
LIBOR, the Royal Bank of Canada prime rate and the federal funds rate will
increase the Company's indebtedness and may increase the Company's interest
expense in future periods. Additionally, under the terms of the Senior Facility,
the Company is required to hedge the interest rate risk on $100.0 million of the
Senior Facility if LIBOR exceeds 9.0% for 15 consecutive days. As of August 13,
1999, the Company had $80.0 million outstanding under the Senior Facility.
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, valued at approximately $79.76 per
share, or $30.0 million, at the time of the transaction. Through April 16, 1999,
the Company bore some risk of market price fluctuations in its investment in
MindSpring. In order to mitigate the risk associated with a decrease in the
market value of the Company's investment in MindSpring, the Company entered into
a hedging contract. In April 1999, the Company sold its investment in MindSpring
for net proceeds of approximately $30.4 million. The Company recorded a gain on
its investment in MindSpring of approximately $0.4 million in its statement of
operations for the six months ended June 30, 1999. The hedging contract was
terminated upon the sale of the common stock of MindSpring.
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
provided in the relevant documentation, 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 until March 23, 2000. Accordingly, the Company will be subject
to the effects of fluctuations in the fair value of the common stock of
NorthPoint until such time when the Company is permitted to liquidate its
30
investment in NorthPoint. Although changes in the fair market value of the
common stock of NorthPoint may affect the fair market value of the Company's
investment in NorthPoint and cause unrealized gains or losses, such gains or
losses will not be realized until the securities are sold.
31
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 7 to the Company's unaudited condensed consolidated financial
statements for the quarterly period ended June 30, 1999 contained
elsewhere in this Quarterly Report.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES AND USE OF PROCEEDS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) Exhibits.
(10) Material Contracts.
10.1: Amended and Restated Loan Agreement, dated
as of May 1, 1999, by and among TriNet
Realty Capital, Inc. and ICG 161, L.P.
10.2: Assumption and Modification Agreement, dated
as of May 1, 1999, by and among ICG
Services, Inc., ICG 161, L.P. and TriNet
Realty Capital, Inc.
10.3: Credit Agreement, dated as of August 12,
1999, among ICG Equipment, Inc. and ICG
NetAhead, Inc., as Borrowers, ICG Services,
Inc., as Parent, the Initial Lenders and the
Initial Issuing Bank, as Initial Lenders and
Initial Issuing Bank, Royal Bank of Canada,
as Administrative Agent and Collateral
Agent, Morgan Stanley Senior Funding, Inc.,
as Sole Book-Runner and Lead Arranger and
Bank of America, N.A. and Barclays Bank PLC,
as Co-Documentation Agents.
10.4: Security Agreement, dated August 12, 1999,
from ICG Equipment, Inc. and ICG NetAhead,
Inc., as Grantors to Royal Bank of Canada,
as Collateral Agent.
(27) Financial Data Schedule.
27.1: Financial Data Schedule of ICG Services,
Inc. for the Six Months Ended June 30, 1999.
(B) Reports on Form 8-K.
None.
32
INDEX TO EXHIBITS
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
INDEX TO EXHIBITS
10.1: Amended and Restated Loan Agreement, dated as of May 1, 1999, by and
among TriNet Realty Capital, Inc. and ICG 161, L.P.
10.2: Assumption and Modification Agreement, dated as of May 1, 1999, by and
among ICG Services, Inc., ICG 161, L.P. and TriNet Realty Capital, Inc.
10.3: Credit Agreement, dated as of August 12, 1999, among ICG Equipment,
Inc. and ICG NetAhead, Inc., as Borrowers, ICG Services, Inc., as
Parent, the Initial Lenders and the Initial Issuing Bank, as Initial
Lenders and Initial Issuing Bank, Royal Bank of Canada, as
Administrative Agent and Collateral Agent, Morgan Stanley Senior
Funding, Inc., as Sole Book-Runner and Lead Arranger and Bank of
America, N.A. and Barclays Bank PLC, as Co-Documentation Agents.
10.4: Security Agreement, dated August 12, 1999, from ICG Equipment, Inc. and
ICG NetAhead, Inc., as Grantors to Royal Bank of Canada, as Collateral
Agent.
27.1: Financial Data Schedule of ICG Services, Inc. for the Six Months Ended
June 30, 1999.
EXHIBIT 10.1
Amended and Restated Loan Agreement, dated as of May 1, 1999, by and among
TriNet Realty Capital, Inc. and ICG 161, L.P.
EXHIBIT 10.2
Assumption and Modification Agreement, dated as of May 1, 1999, by and among ICG
Services, Inc., ICG 161, L.P. and TriNet Realty Capital, Inc.
EXHIBIT 10.3
Credit Agreement, dated as of August 12, 1999, among ICG Equipment, Inc. and ICG
NetAhead, Inc., as Borrowers, ICG Services, Inc., as Parent, the Initial Lenders
and the Initial Issuing Bank, as Initial Lenders and Initial Issuing Bank, Royal
Bank of Canada, as Administrative Agent and Collateral Agent, Morgan Stanley
Senior Funding, Inc., as Sole Book-Runner and Lead Arranger and Bank of America,
N.A. and Barclays Bank PLC, as Co-Documentation Agents.
EXHIBIT 10.4
Security Agreement, dated August 12, 1999, from ICG Equipment, Inc. and ICG
NetAhead, Inc., as Grantors to Royal Bank of Canada, as Collateral Agent.
EXHIBIT 27.1
Financial Data Schedule of ICG Services, Inc. for the Six Months Ended
June 30, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on August 13, 1999.
ICG SERVICES, INC.
Date: August 13, 1999 By: /s/ Harry R. Herbst
---------------------------------------------
Harry R. Herbst, Executive Vice President
and Chief Financial Officer (Principal
Financial Officer)
Date: August 13, 1999 By: /s/ John V. Colgan
---------------------------------------------
John V. Colgan, Vice President of Finance
and Controller (Principal Accounting Officer)