UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 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 November 12, 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
September 30, 1999 (unaudited)...............................3
Consolidated Statements of Operations (unaudited) for the
Three Months and Nine Months Ended September 30, 1998
and 1999.....................................................5
Consolidated Statement of Stockholder's Equity (unaudited)
for the Nine Months Ended September 30, 1999 ................6
Consolidated Statements of Cash Flows (unaudited) for the
Nine Months Ended September 30, 1998 and 1999 ...............7
Notes to Consolidated Financial Statements, December 31,
1998 and September 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 September 30, 1999 (unaudited)
December 31, September 30,
1998 1999
------------------ ----------------
Assets (in thousands)
Current assets:
Cash and cash equivalents $ 114,380 40,899
Short-term investments available for sale 41,000 19,383
Receivables:
Network services, including amounts due from ICG
(note 6) - 7,912
Leasing services, due from ICG (note 6) 7,753 56,447
Due from ICG (note 6) 137,762 145,736
----------------- ----------------
145,515 210,095
----------------- ----------------
Inventory - 70
Prepaid expenses and deposits 20 714
----------------- ----------------
Total current assets 300,915 271,161
----------------- ----------------
Property and equipment (note 6) 301,969 682,722
Less accumulated depreciation (4,064) (44,807)
----------------- ----------------
Net property and equipment 297,905 637,915
----------------- ----------------
Restricted cash - 1,020
Investments in restricted and exchangeable preferred stock
(note 4) - 11,000
Investments, accounted for under the equity method (note 4) 10,179 44,465
Deferred financing and lease administration costs, net of
accumulated amortization of $1.5 million and $3.2 million at
December 31, 1998 and September 30, 1999, respectively 16,727 21,305
Other assets - 769
Net non-current assets of discontinued operations (note 3) 54,023 -
----------------- ----------------
Total assets (note 8) $ 679,749 987,635
================= ================
(Continued)
3
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets (unaudited), Continued
December 31, September 30,
1998 1999
------------------- -----------------
Liabilities and Stockholder's Equity (in thousands)
Current liabilities:
Accounts payable, including amounts due to ICG (note 6) $ 28,840 28,244
Accrued liabilities 1,309 26,410
Deferred gain on sale (note 3) - 8,624
Current portion of capital lease obligations - 2,373
Net current liabilities of discontinued operations (note 3) 22,328 -
------------------- -----------------
Total current liabilities 52,477 65,651
------------------- -----------------
Capital lease obligations, less current portion - 6,237
Long-term debt, net of discount (note 5) 594,617 752,373
Other long-term liabilities (note 6) - 2,500
------------------- -----------------
Total liabilities 647,094 826,761
------------------- -----------------
Stockholder's equity:
Common stock, $.01 par value, 1,000 shares authorized; 10 shares
issued and outstanding at December 31, 1998 and September 30, 1999 - -
Additional paid-in capital 207,798 150,621
Retained (deficit) earnings (175,024) 10,253
Accumulated other comprehensive loss (119) -
------------------- -----------------
Total stockholder's equity 32,655 160,874
------------------- -----------------
Commitments and contingencies (notes 5 and 7)
Total liabilities and stockholder's equity $ 679,749 987,635
=================== =================
See accompanying notes to consolidated financial statements.
4
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (unaudited)
Three Months and Nine Months Ended September 30, 1998 and 1999
Three months ended Nine months ended
September 30, September 30,
------------------------------------- ----------------------------------
1998 1999 1998 1999
------------------- ----------------- ------------------ ---------------
(in thousands)
Revenue from network and leasing services, including
services provided to ICG (notes 6 and 8) $ 3,104 32,844 3,556 67,488
Cost of services and expenses:
Cost of services - 1,116 - 2,550
Selling, general and administrative expenses,
including amounts allocated from ICG (note 6) 1,255 588 2,760 1,424
Depreciation (note 8) 537 14,925 686 35,868
------------------- ----------------- ------------------ ---------------
Total cost of services and expenses 1,792 16,629 3,446 39,842
------------------- ----------------- ------------------ ---------------
Operating income 1,312 16,215 110 27,646
Other (expense) income:
Interest expense (note 8) (14,560) (18,492) (30,796) (51,629)
Interest income, including amounts earned from
ICG (note 6) 7,996 5,215 16,406 20,497
Other income, including realized gain on
marketable trading securities, net of
unrealized gains and losses - 1 - 440
------------------- ----------------- ------------------ ---------------
(6,564) (13,276) (14,390) (30,692)
------------------- ----------------- ------------------ ---------------
(Loss) income from continuing operations before
share of net earnings (losses) (5,252) 2,939 (14,280) (3,046)
Share of net earnings (losses) of equity investees 187 (3,441) 187 (4,706)
------------------- ----------------- ------------------ ---------------
Loss from continuing operations (5,065) (502) (14,093) (7,752)
------------------- ----------------- ------------------ ---------------
Loss from discontinued operations (note 3) (14,062) - (42,436) -
------------------- ----------------- ------------------ ---------------
Extraordinary gain on sales of operations of NETCOM,
net of income taxes of $6.4 million
(note 3) - - - 193,029
------------------- ----------------- ------------------ ---------------
Net (loss) income $ (19,127) (502) (56,529) 185,277
=================== ================= ================== ===============
Other comprehensive loss - foreign currency
translation adjustment (118) - (194) -
------------------- ----------------- ------------------ ---------------
Comprehensive (loss) income $ (19,245) (502) (56,723) 185,277
=================== ================= ================== ===============
See accompanying notes to consolidated financial statements.
5
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholder's Equity (unaudited)
Nine Months Ended September 30, 1999
Accumulated
Common stock Additional Retained 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) - - (61,076) - - (61,076)
Net income - - - 185,277 - 185,277
======== =========== ============== ============== ================ ===============
Balances at September 30, 1999 - $ - 150,621 10,253 - 160,874
======== =========== ============== ============== ================ ===============
See accompanying notes to consolidated financial statements.
6
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited)
Nine Months Ended September 30, 1998 and 1999
Nine months ended September 30,
------------------------------------
1998 1999
--------------- ----------------
(in thousands)
Cash flows from operating activities:
Net (loss) income $ (56,529) 185,277
Loss from discontinued operations 42,436 -
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 - (17,376)
Share of net (earnings) losses of equity investees (187) 4,706
Depreciation 686 35,868
Interest expense deferred and included in long-term debt 29,759 44,866
Amortization of deferred financing costs included in interest expense 1,037 1,438
Amortization of deferred lease administration costs included in
selling, general and administrative expenses - 878
Change in operating assets and liabilities:
Receivables (95,935) (71,473)
Inventory - 136
Prepaid expenses and deposits - (815)
Accounts payable and accrued liabilities 36,784 (8,725)
--------------- ----------------
Net cash used by operating activities (41,949) (18,249)
--------------- ----------------
Cash flows from investing activities:
Acquisition of property, equipment and other assets (123,757) (379,713)
Investment in equity investees (9,000) (35,093)
Investment in restricted preferred stock - (11,000)
Proceeds from sales of operations of NETCOM, net of cash included in sale - 252,881
(Purchase) sale of short-term investments available for sale (41,000) 21,617
Proceeds from sale of marketable trading securities, net of realized gain - 30,000
--------------- ----------------
Net cash used by investing activities (173,757) (121,308)
--------------- ----------------
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 80,000
Deferred financing and lease administration costs (17,589) (6,264)
Principal payments on capital lease obligations - (2,365)
Principal payments on long-term debt - (188)
--------------- ----------------
Net cash provided by financing activities 533,458 71,183
--------------- ----------------
Net increase (decrease) in cash and cash equivalents 317,752 (68,374)
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 $ 317,729 40,899
=============== ================
(Continued)
7
ICG SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (unaudited), Continued
Nine months ended September 30,
------------------------------------
1998 1999
--------------- ----------------
(in thousands)
Supplemental disclosure of cash flows information of continuing operations:
Cash paid for interest $ - 5,325
=============== ================
Cash paid for taxes $ - 1,140
=============== ================
Supplemental disclosure of non-cash investing and financing activities of
continuing operations:
Acquisition of corporate headquarters assets through the issuance of
long-term debt $ - 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 September 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"), in a transaction 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 nine months ended
September 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 nine months ended September 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
agreement, the Company deferred approximately $26.0
10
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(3) Discontinued Operations (continued)
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 nine months ended September 30, 1999, the
Company applied $6.9 million and $17.4 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
On March 30, 1999, the Company purchased, for approximately $10.0
million in cash, 454,545 shares of restricted Series D-1 Preferred
Stock of NorthPoint Communications Holdings, Inc., a Delaware
corporation and competitive local exchange carrier ("CLEC") based in
San Francisco, California ("NorthPoint") which was converted into
555,555 shares of Class B common stock of NorthPoint (the "NorthPoint
Class B Shares") on May 5, 1999. The NorthPoint Class B shares have no
voting rights and are ultimately convertible on or after March 23,
2000 on a one-for-one basis into a voting class of common stock of
NorthPoint. The Company has accounted for its investment in NorthPoint
under the cost method of accounting.
On August 11, 1999, the Company purchased 1,250,000 shares of Series C
Preferred Stock (the "ThinkLink Preferred Stock") of International
ThinkLink Corporation ("ThinkLink"), or approximately 8% of the
outstanding shares, for $1.0 million in cash. The ThinkLink Preferred
Stock accrues dividends at an annual rate of 8% and is exchangeable
into common stock of ThinkLink at any time. The ThinkLink Preferred
Stock will automatically convert to common stock upon the completion
of the initial public offering of the common stock of ThinkLink or
upon election to convert by the holders of a majority of the ThinkLink
Preferred Stock. The conversion rate from the ThinkLink Preferred
Stock to common stock of ThinkLink is initially one-for-one; however,
such conversion rate is subject to adjustment. The Company has
accounted for its investment in ThinkLink under the cost method of
accounting. Dividends on the ThinkLink Preferred Stock will be
included in income when paid. ThinkLink is an Internet and enhanced
services provider.
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, September 30,
1998 1999
--------------------- ---------------------
(in thousands)
Senior Facility with adjustable rate of interest due on
scheduled maturity dates, secured by assets of ICG
Equipment and NetAhead (a) $ - 79,812
9 7/8% Senior discount notes, net of discount 266,918 286,898
10% Senior discount notes, net of discount 327,699 352,586
Mortgage loan payable with adjustable rate of interest
(14.77% at September 30, 1999) due in full on January
31, 2013, secured bycorporate headquarters - 33,077
===================== =====================
$ 594,617 752,373
===================== =====================
(a) 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. At September 30,
1999, the $75.0 million term loan bears annual interest at LIBOR
plus 3.5%, or 8.88%. Quarterly repayments commenced 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. At September
30, 1999, the Company had $74.8 million outstanding under the
$75.0 million term loan.
On August 12, 1999, the Company borrowed $5.0 million on the
$100.0 million term loan. The $100.0 million term loan 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. At September 30, 1999, the $100.0 million term loan bears
annual interest at LIBOR plus 3.125%, or 8.51%. 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.
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.
12
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(5) Long-term Debt (continued)
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 of operations and the results of operations of
ICG. On September 30, 1999, certain defined terms in the credit
agreement for the Senior Facility were amended to ensure that ICG
Services and ICG would remain in compliance with the financial
covenants of 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 (the "Restricted Subsidiaries") on
behalf of the Company. Allocated expenses generally include a portion
of salaries and related benefits of legal, accounting and finance,
information systems support and other ICG employees, certain overhead
costs and reimbursement for invoices of the Company paid by ICG.
Conversely, any cash collected by ICG on behalf of the Company or its
subsidiaries or invoices paid by the Company on behalf of ICG or its
Restricted Subsidiaries are in turn reimbursed to the Company by ICG.
As the Company and its subsidiaries and ICG and its Restricted
Subsidiaries jointly enter into service offerings and other
transactions, joint costs incurred are generally allocated to each of
the Company and ICG according to the relative capital invested and
efforts expended by each party. Management believes that all
transactions between the Company, including its subsidiaries, and ICG,
including its Restricted Subsidiaries, contain fair and reasonable
terms. All such transactions are approved by the boards of directors
of the Company and of ICG and are settled in cash on a quarterly
basis.
ICG charged approximately $2.5 million and $5.7 million for the three
months and nine months ended September 30, 1998, respectively, and
approximately $2.0 million and $37.6 million for the three months and
nine months ended September 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 $1.1 million and $1.7 million is included in
the Company's selling, general and administrative expenses for the
three months and nine months ended September 30, 1998, respectively,
and approximately $0.2 million and $0.7 million is included in
selling, general and administrative expenses for the three months and
nine months ended September 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 $116.1
million and $145.4 million for the three months and nine months ended
September 30, 1998, respectively, and approximately $147.4 million and
$417.0 million for the three months and nine months ended September
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 statements of operations and was approximately $1.6
million for the three months and nine months ended September 30, 1998
and $3.9 million and $13.9 million for the three months and nine
months ended September 30, 1999, respectively. Interest has been
accrued on outstanding balances of intercompany transfers and direct
and indirect costs between ICG Services and ICG and its Restricted
Subsidiaries at 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
$30.9 million and $45.7 million during the three months and nine
months ended September 30, 1998, respectively, and approximately $45.5
million and $329.5 million during the three months and nine months
ended September 30, 1999, respectively. Additionally, ICG Equipment
entered into separate agreements to lease $30.9 million and $45.7
million during the three months and nine months ended September 30,
1998, respectively, and $18.4 million and $164.4 million, during the
three months and nine months ended September 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
$1.4 million for the three months and nine months ended September 30,
1998 and approximately $26.7 million and $53.4 million for the three
months and nine months ended September 30, 1999, respectively, in
revenue under its operating leases with ICG Telecom. The purchase
prices and lease payments for all leases are subject to adjustment,
based on the results of an independent appraisal which may be
requested at the option of ICG 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 certain transactions completed during
fiscal 1998 and 1999 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 $61.1
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% (12.25% at
September 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 places assets
in service upon the commencement of the respective lease term. ICG
Equipment recognized approximately $1.7 million and $2.2 million for
the three months and nine months ended September 30, 1998,
respectively, and approximately $4.4 million and $9.7 million for the
three months and nine months ended September 30, 1999, respectively,
of service fee revenue under this agreement. The amount of assets
purchased by ICG Equipment and intended for future lease to ICG
Telecom, but not yet placed into service, was approximately $155.0
million at September 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 nine months ended September
30, 1998, NETCOM incurred approximately $0.5 million and $1.6 million,
respectively, for installation and recurring local access charges from
ICG Telecom, which are included in loss from discontinued operations
in the accompanying consolidated financial statements. For the three
months and nine months ended September 30, 1999, NETCOM and NetAhead
together incurred approximately $1.2 million and $4.0 million,
respectively, for installation and recurring local access charges from
ICG Telecom, which is 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 nine months ended
September 30, 1999. 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 nine
14
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(6) Related Party Transactions (continued)
months ended September 30, 1999, NetAhead recognized approximately
$0.3 million and $0.6 million, respectively, 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 $0.7 million for the three months and nine months ended September
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 building, land and improvements (the "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 nine months ended September 30, 1999, the Company earned
leasing revenue from the Restricted Subsidiary of ICG of approximately
$1.3 million and $3.6 million, respectively, under the operating
lease, which is included in revenue and due from ICG in the Company's
consolidated financial statements. The Company received $2.5 million
from the subsidiary as security deposit on the operating lease, which
is included in other long-term liabilities 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 $87.8 million
at September 30, 1999.
NETCOM, now NetAhead, is a party to certain litigation which has
arisen in the ordinary course of business. In the opinion of
management, the ultimate resolution of these matters will not have a
material adverse effect on the Company's financial condition, results
of operations or cash flows.
(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. The operations of Network
Services are not considered to be significant for purposes of business
segment reporting and, accordingly, are included with the remaining
corporate subsidiaries of the Company which primarily hold securities.
Set forth below are revenue, EBITDA (which represents the measure of
operating performance used by management to evaluate operating
results), depreciation, 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.
15
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Business Units (continued)
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
1998 1999 1998 1999
--------------- --------------- -------------- ---------------
(in thousands)
Revenue:
Leasing Services $ 3,104 32,334 3,556 66,725
All other - 510 - 763
=============== =============== ============== ===============
Total revenue $ 3,104 32,844 3,556 67,488
=============== =============== ============== ===============
EBITDA (a):
Leasing Services $ 3,034 32,094 3,213 66,146
All other (1,185) (954) (2,417) (2,632)
=============== =============== ============== ===============
Total EBITDA $ 1,849 31,140 796 63,514
=============== =============== ============== ===============
Depreciation (b):
Leasing Services $ 537 12,835 686 30,613
All other - 2,090 - 5,255
=============== =============== ============== ===============
Total depreciation $ 537 14,925 686 35,868
=============== =============== ============== ===============
Interest expense (b):
Leasing Services $ - 1,297 - 2,331
All other 14,560 17,195 30,796 49,298
=============== =============== ============== ===============
Total interest expense $ 14,560 18,492 30,796 51,629
=============== =============== ============== ===============
Capital expenditures of continuing operations (c):
Leasing Services $ 71,521 77,542 123,757 366,274
All other - 11,372 - 19,629
=============== =============== ============== ===============
Total capital expenditures of continuing
operations $ 71,521 88,914 123,757 385,903
=============== =============== ============== ===============
December 31, September 30,
1998 1999
-------------------- ------------------
(in thousands)
Total assets:
Leasing Services $ 292,300 672,785
All other (d) 195,664 169,114
Net current assets of discontinued operations (e) - -
Net non-current assets of discontinued operations 54,023 -
Due from ICG 137,762 145,736
-------------------- ------------------
Total assets $ 679,749 987,635
==================== ==================
(a) EBITDA consists of loss from continuing operations before
interest, income taxes, depreciation, other expense, net, and
share of net earnings (losses) of equity investees, or simply,
operating income plus depreciation. EBITDA is presented as the
Company's measure of operating performance because it is a
measure commonly used in the telecommunications industry. EBITDA
16
ICG SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
(8) Business Units (continued)
is presented to enhance an understanding of the Company's
operating results and is not intended to represent cash flows
from operating activities 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 includes 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
nine months ended September 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 nine months ended September 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 Communications, Inc. ("ICG").
The Company's Leasing Services and Network Services operations are currently
conducted through its two operating subsidiaries, ICG Equipment, Inc. ("ICG
Equipment") and ICG NetAhead, Inc. ("NetAhead") (formerly NETCOM On-Line
Communication Services, Inc. ("NETCOM")).
On January 21, 1998, ICG acquired NETCOM, a Delaware corporation and
provider of Internet connectivity and Web site hosting services located in San
Jose, California, in a transaction accounted for as a pooling of interests. As
consideration for the acquisition, ICG issued approximately 10.2 million shares
of common stock of ICG ("ICG Common Stock"), valued at approximately $284.9
million on the date of the merger. Upon the formation of ICG Services, ICG
contributed its investment in NETCOM to ICG Services and NETCOM became a wholly
owned subsidiary of, and predecessor entity to, ICG Services. Accordingly, the
historical consolidated financial statements of the Company prior to January 23,
1998 consist solely of the accounts of NETCOM.
In January 1998, the Company formed ICG Equipment, a Colorado corporation,
for the principal purpose of providing financing of telecommunications equipment
and services to ICG Telecom Group, Inc., an 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 nine months ended September
30, 1999, ICG Equipment entered into a series of agreements whereby ICG
Equipment purchased telecommunications equipment and fiber optic capacity from
and for ICG Telecom and leased 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 September 30, 1999, ICG
Equipment had approximately $476.5 million of telecommunications equipment,
software, network capacity and related services under lease to ICG Telecom and
approximately $155.0 million of such assets intended for future lease to ICG
Telecom, but not yet placed into service.
18
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"), 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 nine
months ended September 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 227
points of presence ("POPs") serving more than 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 nine months ended September 30, 1999, the Company applied $6.9
million and $17.4 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 NetAhead to provide modem access at ICG's 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 NetAhead, allows
NetAhead to act as an aggregator of ISP traffic. In offering RAS, NetAhead
provides 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 will begin providing such services offerings to other ISPs and
telecommunications providers in the near term. In June 1999, ICG entered into a
five-year agreement with Qwest Communications Corporation ("Qwest"), whereby
Qwest has agreed to purchase 100,000 RAS ports from ICG. ICG has installed
60,000 of Qwest's RAS ports as of September 30, 1999, with the remaining 40,000
19
RAS ports to be installed prior to June 29, 2000. In August 1999, ICG signed a
long-term contract with a large national ISP to provide 100,000 RAS ports to the
ISP for a minimum five-year term. As of September 30, 1999, ICG had 100,000 of
the RAS ports installed, including 83,000 ports previously providing local
access services which were upgraded to accommodate RAS. In September 1999, ICG
signed a three-year agreement with NetZero, Inc., a leading provider of free
Internet access ("NetZero"), to deliver Internet RAS. Throughout the term of the
agreement, ICG will install up to 100,000 RAS ports for NetZero. Service
delivery is expected to begin in early 2000. Additionally, the Company signed an
agreement in October 1999 with Microsoft Network, L.L.C. ("MSN") to provide
Internet RAS to MSN for a three-year period. Under this agreement, MSN will
purchase the use of a minimum of 150,000 RAS ports. The Company and ICG expect
to install approximately 100,000 of these RAS ports by April 30, 2000 and the
remaining 50,000 by October 2000. In August 1998, ICG Telecom began offering
enhanced telephony services via IP technology. ICG Telecom currently offers this
service in 230 major cities in the United States, 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. Additionally, ICG and NetAhead are
together 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
provides expanded bandwidth for small to medium-sized business customers as an
alternative to purchasing additional circuits. Data traffic, including Internet
traffic, from IAS service offerings is carried over NetAhead's network. In March
1999, ICGentered 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 is required to purchase a minimum of 49,000 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.
Additionally, NetAhead intends to provide other enhanced network services as
demand warrants.
The Company has and will continue to enter into agreements with ICG Telecom
to provide network services at negotiated rates. 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 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.
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.
20
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 income and
EBITDA as a percentage of the Company's revenue.
Three months ended Nine months ended
September 30, September 30,
------------------------------------ -------------------------------------
1998 1999 1998 1999
---------------- ---------------- ---------------- ----------------
$ % $ % $ % $ %
--------- ----- --------- ----- --------- ----- --------- -----
(unaudited)
(in thousands)
Statement of Operations Data:
Revenue 3,104 100 32,844 100 3,556 100 67,488 100
Cost of services and expenses:
Cost of services - - 1,116 3 - - 2,550 4
Selling, general and administrative expenses 1,255 41 588 2 2,760 78 1,424 2
Depreciation 537 17 14,925 46 686 19 35,868 53
---------- ------ ---------- ------- ----------- ------- ----------- -------
Total cost of services and expenses 1,792 58 16,629 51 3,446 97 39,842 59
Operating income 1,312 42 16,215 49 110 3 27,646 41
Other Data:
Net cash used by operating activities (48,358) (25,584) (41,949) (18,249)
Net cash used by investing activities (105,521) (104,793) (173,757) (121,308)
Net cash (used) provided by financing activities (384) 73,602 533,458 71,183
EBITDA (1) 1,849 59 31,140 796 22 63,514
Capital expenditures of continuing operations (2) 71,521 88,914 123,757 385,903
Capital expenditures of discontinued operations (2) 5,021 - 20,218 -
(1) EBITDA consists of loss from continuing operations before interest,
income taxes, depreciation, other expense, net and share of net earnings
(losses) of equity investees, or simply, operating income plus
depreciation. EBITDA is provided because it is a measure commonly used
in the telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended to
represent cash flows from operating activities 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 September 30, 1999 Compared to Three Months Ended September
30, 1998
Revenue. The Company recorded revenue of approximately $3.1 million and
$32.8 million for the three months ended September 30, 1998 and 1999,
respectively. The increase in revenue relates primarily to the expansion of ICG
Equipment's operations since June 30, 1998. Revenue recorded on operating leases
of property and equipment to ICG Telecom was $1.4 million and $26.7 million for
the three months ended September 30, 1998 and 1999, respectively. Additionally,
the Company charges lease service fees to ICG Telecom for the cost of carrying
assets not yet placed into service. For the three months ended September 30,
1998 and 1999, revenue earned on lease service fees was $1.7 million and $4.4
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 September 30, 1999, the Company recorded revenue on the
operating lease for the corporate headquarters of $1.3 million. For the three
months ended September 30, 1999, NetAhead generated revenue of approximately
$0.4 million for RAS custom programming and IP network services provided to ICG
and other customers. Revenue earned of $11.2 million for the three months ended
September 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 $18.1 million incurred under the same agreement. This
21
$6.9 million operating deficit has been equally offset by the recognition of
$6.9 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 new services to MindSpring and
obtains and generates revenue from new customers.
Cost of services. Cost of services of $1.1 million for the three months
ended September 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 $1.3 million and $0.6
million for the three months ended September 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 $1.1 million and $0.2 million,
representing approximately 85% and 33% of total SG&A expenses for the three
months ended September 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 Septmeber 30,
1998 include increased professional fees due to the start-up and organization of
the Company in 1998. SG&A expenses are expected to increase in absolute dollars
as the volume of ICG Equipment's operations increases and as NetAhead obtains
new customers.
Depreciation. Depreciation increased $14.4 million, from $0.5 million
for the three months ended September 30, 1998 to $14.9 million for the three
months ended September 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 since June 30,
1998. 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 $3.9 million, from $14.6
million for the three months ended September 30, 1998 to $18.5 million for the
three months ended September 30, 1999, which includes $15.9 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, the 9 7/8% Senior
Discount Notes due 2008 (the "9 7/8% Notes") issued in April 1998 and the senior
secured financing facility (the "Senior Facility") completed in August 1999. The
Company's interest expense has and will continue to increase as the principal
amounts of the 10% Notes and the 9 7/8% Notes increase until the 10% Notes and
the 9 7/8% Notes begin to pay interest in cash in 2003.
Interest income. Interest income decreased $2.8 million, from $8.0
million for the three months ended September 30, 1998 to $5.2 million for the
three months ended September 30, 1999 and primarily represents net interest
income from ICG of approximately $1.6 million and $3.9 million during the three
months ended September 30, 1998 and 1999, respectively, for invoices paid by the
Company on behalf of ICG and its other operating subsidiaries and repaid on a
quarterly basis. The decrease in interest income is attributable to the decrease
in cash, cash equivalents and short-term investments as the Company invests
available cash balances in telecommunications equipment and other assets.
Other income, including realized gain on marketable trading securities,
net of unrealized gains and losses. Other income, including realized gain on
marketable trading securities, net of unrealized gains and losses for the three
months ended September 30, 1999, represents miscellaneous other income.
Share of net earnings (losses) of equity investees. The Company's share
of net earnings (losses) of equity investees decreased $3.6 million, from net
earnings of $0.2 million for the three months ended September 30, 1998 to net
losses of $3.4 million for the three months ended September 30, 1999. The
Company's share of net losses of equity investees for the three months ended
September 30, 1999 consists of the Company's share of net losses of ICG Ohio
LINX, Inc. ("ICG Ohio LINX") of $0.7 million and the Company's share of net
losses of ICG ChoiceCom L.P. ("ChoiceCom") of $2.7 million. For the three months
ended September 30, 1998, share of net earnings (losses) of equity investees
22
consists of the Company's share of net income of ICG Ohio LINX. 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 $4.6 million, or 90%, from $5.1 million for the three months ended
September 30, 1998 to $0.5 million for the three months ended September 30, 1999
primarily 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 September 30, 1998, loss from discontinued operations was $14.1 million,
or 74% 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.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September 30,
1998
Revenue. The Company recorded revenue of approximately $3.6 million and
$67.5 million for the nine months ended September 30, 1998 and 1999,
respectively. The increase in revenue relates primarily to the expansion of ICG
Equipment's operations since June 30, 1998. Revenue recorded on operating leases
of property and equipment to ICG Telecom was $1.4 million and $53.4 million for
the nine months ended September 30, 1998 and 1999, respectively. Additionally,
the Company charges lease service fees to ICG Telecom for the cost of carrying
assets not yet placed into service. For the nine months ended September 30, 1998
and 1999, revenue earned on lease service fees was $2.2 million and $9.7
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
nine months ended September 30, 1999, the Company recorded revenue on the
operating lease for the corporate headquarters of $3.6 million. For the nine
months ended September 30, 1999, NetAhead generated revenue of approximately
$0.8 million for RAS custom programming and IP network services provided to ICG
and other customers. Revenue earned of $28.6 million for the nine months ended
September 30, 1999 under the Company's network capacity agreement with
MindSpring has been offset by operating costs and selling, general and
administrative expenses of $46.0 million incurred under the same agreement. This
$17.4 million operating deficit has been equally offset by the recognition of
$17.4 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 $2.6 million for the nine months
ended September 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 $2.8 million and $1.4 million for the nine months ended September
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 $1.7
million and $0.7 million, representing approximately 60% and 50% of total SG&A
expenses for the nine months ended September 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 nine
months ended September 30, 1998 include increased professional fees due to the
start-up and organization of the Company in 1998.
Depreciation. Depreciation increased $35.2 million, from $0.7 million
for the nine months ended September 30, 1998 to $35.9 million for the nine
months ended September 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 since June 30,
1998.
Interest expense. Interest expense increased $20.8 million, from $30.8
million for the nine months ended September 30, 1998 to $51.6 million for the
nine months ended September 30, 1999, which includes $46.3 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. The Company's interest
23
expense has and 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 $4.1 million, from $16.4
million for the nine months ended September 30, 1998 to $20.5 million for the
nine months ended September 30, 1999 and primarily represents net interest
income from ICG of approximately $1.6 million and $13.9 million during the nine
months ended September 30, 1998 and 1999, respectively, for invoices paid by the
Company on behalf of ICG and its other operating subsidiaries and repaid on a
quarterly basis. The Company also earned interest on invested cash balances 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.
Other income including realized gain on marketable trading securities,
net of unrealized gains and losses. Other income, including realized gain on
marketable trading securities, net of unrealized gains and losses of $0.4
million for the nine months ended September 30, 1999 primarily includes 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 earnings (losses) of equity investees. The Company's share
of net earnings (losses) of equity investees decreased $4.9 million, from net
earnings of $0.2 million for the nine months ended September 30, 1998 to net
losses of $4.7 million for the nine months ended September 30, 1999. The
Company's share of net losses of equity investees for the nine months ended
September 30, 1999 consists of the Company's share of net income of ICG Ohio
LINX of $1.6 million, offset by the Company's share of net losses of ChoiceCom
of $6.3 million. For the nine months ended September 30, 1998, share of the net
earnings (losses) of equity investees consists of the Company's share of net
income of ICG Ohio LINX.
Loss from continuing operations. Loss from continuing operations
improved $6.3 million, or 45%, from $14.1 million for the nine months ended
September 30, 1998 to $7.8 million for the nine months ended September 30, 1999
primarily due to increases in revenue, offset by increases in depreciation and
interest expense, as noted above.
Loss from discontinued operations and net loss. For the nine months
ended September 30, 1998, loss from discontinued operations was $42.4 million,
or 75% 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 nine months ended September 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 nine months ended September 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 the
issuance of the 10% Notes and the 9 7/8% Notes in February and April 1998,
respectively, the Senior Facility completed in August 1999 and the sales of the
operations of NETCOM. As of September 30, 1999, the Company had current assets
of $271.2 million, including $60.3 million of cash, cash equivalents and
short-term investments, which exceeded current liabilities of $65.7 million,
providing working capital of $205.5 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
24
Company's business. The Company's short term investment objectives are safety,
liquidity and yield, in that order.
Net Cash Used By Operating Activities
The Company's operating activities used $41.9 million and $18.2 million
for the nine months ended September 30, 1998 and 1999, respectively. Net cash
used by operating activities is primarily due to losses from continuing
operations, in addition to changes in working capital items and non-cash
expenses, such as recognition of deferred gain, 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 customers other than MindSpring, any of which
may not occur.
Net Cash Used By Investing Activities
The Company's investing activities used $173.8 million and $121.3
million for the nine months ended September 30, 1998 and 1999, respectively. Net
cash used by investing activities for the nine months ended September 30, 1998
includes the acquisition of property, equipment and other assets, the purchase
of short-term investments available for sale and the purchase of the Company's
investment in ICG Ohio LINX. Net cash used by investing activities for the nine
months ended September 30, 1999 includes the acquisition of property, equipment
and other assets of $379.7 million, the purchase of the 49% equity interest in
ChoiceCom of $35.1 million and the purchase of long-term investments of $11.0
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 trading
securities of $51.6 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,
potentially, for acquisitions. The Company acquired assets under capital leases
of $6.2 million during the nine months ended September 30, 1999.
Net Cash Provided By Financing Activities
The Company's financing activities provided $533.5 million and $71.2
million for the nine months ended September 30, 1998 and 1999, respectively. Net
cash provided by financing activities for the nine months ended September 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 nine months ended September 30, 1999,
the Company's financing activities consist of the net proceeds from the Senior
Facility, 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. At September 30, 1999, the $75.0 million term loan bears annual
interest at LIBOR plus 3.5%, or 8.88%. Quarterly repayments commenced 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. At September 30, 1999, the Company had $74.8 million outstanding under the
$75.0 million term loan. On August 12, 1999, the Company borrowed $5.0 million
on the $100.0 million term loan. The $100.0 million term loan 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. At September 30, 1999, the $100.0 million term loan
bears annual interest at LIBOR plus 3.125%, or 8.51%. Quarterly repayments
25
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. 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.
As of September 30, 1999, the Company had an aggregate accreted value
of approximately $719.3 million outstanding under the 10% Notes, the 9 7/8%
Notes and the Senior Facility. 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 September 30, 1999, the Company had $8.6
million of capital lease obligations and $33.1 million of other indebtedness
outstanding. With respect to fixed rate senior indebtedness outstanding on
September 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, including
assets acquired under capital leases, were $123.8 million and $385.9 million for
the nine months ended September 30, 1998 and 1999, respectively. The Company
anticipates that the expansion of the Company's businesses as currently planned
will require capital expenditures of approximately $145.0 million for the
remainder of 1999. In the event that ICG's and the Company's efforts to acquire
new customers and deploy new services are more successful than planned, the
Company may require to expend capital resources earlier than expected to
accommodate customer demands. To facilitate the expansion of its services and
networks, the Company has entered into equipment purchase agreements with
various vendors under which the Company will purchase equipment and other
assets, including a full range of switching systems, fiber optic cable, network
electronics, software and services. If the Company fails to meet the minimum
purchase level in any given year, the vendor may discontinue certain discounts,
allowances and incentives otherwise provided to the Company. Actual capital
expenditures will depend on numerous factors, including certain factors beyond
the Company's control. These factors include the nature of future expansion and
acquisition opportunities, economic conditions, competition, and the
availability of equity, debt and lease financing.
Management believes that the Company's cash on hand and amounts
expected to be available through cash flows from operations, the Senior
Facility, vendor financing arrangements and credit facilities will provide
sufficient funds necessary for the Company to expand ICG Equipment's and
NetAhead's businesses as currently planned and to fund its operations through
2000. Changes in the Company's business plan may require additional sources of
cash which may be obtained through public and private debt or equity financings,
capital leases and other financing arrangements. To date, the Company has been
able to secure sufficient amounts of financing to meet its capital and operating
needs. There can be no assurance that additional financing will be available to
the Company or, if available, that it can be obtained on terms acceptable to the
Company. The failure to obtain sufficient amounts of financing could result in
the delay or abandonment of some or all of the Company's development and
expansion plans, which could have a material adverse effect on the Company's
business.
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
26
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 was focused upon ensuring, to the extent reasonably possible,
the continued, normal operation of its business and supporting systems.
Accordingly, ICG developed a four-phase plan which it applied 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 was 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;
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 applied 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.
27
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.
o Phase II - Remediation
During this phase, ICG developed and executed a remediation plan
for each component based upon the priorities set in Phase I.
Remediation included component upgrade, reprogramming,
replacement, receipt of vendor and supplier certification or other
actions which were deemed necessary or appropriate.
o Phase III - Testing
During this phase, ICG performed testing sufficient to confirm
that the component met the desired state of Year 2000 readiness.
This phase consisted 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 implemented each act of remediation
developed and tested for each component, as well as the
implementation of adequate controls to ensure that future upgrades
and changes to ICG's computer systems, for operational reasons
other than Year 2000 compliance, would not alter ICG's Year 2000
state of readiness.
ICG has completed all of the phases within its Year 2000 compliance plan
for each of its functional system categories.
Costs
ICG expenses all incremental costs to ICG associated with Year 2000
compliance issues as incurred. Through September 30, 1999, such costs incurred
were approximately $2.0 million, consisting of approximately $0.6 million of
replacement hardware and software and approximately $1.4 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 September 30, 1999. ICG expects total incremental costs of Year
2000 compliance efforts subsequent to September 30, 1999 to be approximately
$0.6 million for consulting fees and other miscellaneous costs. All such costs
incurred and expected to be incurred are included in ICG's fiscal 1999 budget.
Budgeted expenses for Year 2000 compliance costs represent approximately 4% of
ICG's total budgeted expenses for information technology for fiscal 1999. ICG
intends to use cash on hand for Year 2000 compliance costs, as necessary.
28
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 did 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.
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 are 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 implemented will be adequate
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 September 30, 1999, the Company had approximately $60.3
million in cash, cash equivalents and short-term investments available for sale,
at a weighted average fixed interest rate of 3.19% for the three months ended
September 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 September 30, 1999 of approximately $0.1 million and, accordingly,
would not cause a material impact on the Company's financial position, results
of operations or cash flows.
At September 30, 1999, the Company's indebtedness included $639.5
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 September
30, 1999, the Company had $79.8 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 nine months ended September 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 restricted Series D-1 Preferred Stock of
NorthPoint which was converted into 555,555 shares of Class B common stock of
NorthPoint (the "NorthPoint Class B Shares") on May 5, 1999. The NorthPoint
Class B Shares have no voting rights and are ultimately convertible on or after
March 23, 2000 on a one-for-one basis into a voting class of common stock of
NorthPoint. Accordingly, the Company will be subject to the effects of
fluctuations in the fair value of the common stock of NorthPoint until such time
when the Company is permitted to liquidate its investment in NorthPoint.
30
On August 11, 1999, the Company purchased 1,250,000 shares of Series C
Preferred Stock (the "ThinkLink Preferred Stock") of International ThinkLink
Corporation ("ThinkLink"), or approximately 8% of the outstanding shares, for
$1.0 million in cash. The ThinkLink Preferred Stock is exchangeable into common
stock of ThinkLink at any time and will automatically convert to common stock
upon the completion of the initial public offering of the common stock of
ThinkLink or upon election to convert by the holders of a majority of the
ThinkLink Preferred Stock. The conversion rate from the ThinkLink Preferred
Stock to common stock of ThinkLink is initially one-for-one; however, such
conversion rate is subject to adjustment. The Company will be subject to the
effects of fluctuations in the fair value of the common stock of ThinkLink until
such time when the Company may liquidate its investment in ThinkLink.
Although changes in the fair market value of the common stock of
NorthPoint and ThinkLink may affect the fair market value of the Company's
investments in NorthPoint and ThinkLink 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 September 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: Amendment No. 1 to the Credit Agreement, dated as of
September 30, 1999, among ICG Equipment, Inc. and ICG
NetAhead, Inc., as Borrowers, ICG Services, Inc., as
Parent, certain Initial Lender Parties thereto, Morgan
Stanley Senior Funding, Inc., as Sole Book-Runner and
Lead Arranger, Royal Bank of Canada, as Collateral
Agent and as Administrative Agent for such Lender
Parties, and Bank of America, N.A. and Barclays Bank
Plc, as Co-Documentation Agents.
(27) Financial Data Schedule.
27.1: Financial Data Schedule of ICG Services, Inc. for the
Nine Months Ended September 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: Amendment No. 1 to the Credit Agreement, dated as of September 30,
1999, among ICG Equipment, Inc. and ICG NetAhead, Inc., as Borrowers,
ICG Services, Inc., as Parent, certain Initial Lender Parties thereto,
Morgan Stanley Senior Funding, Inc., as Sole Book-Runner and Lead
Arranger, Royal Bank of Canada, as Collateral Agent and as
Administrative Agent for such Lender Parties, and Bank of America, N.A.
and Barclays Bank Plc, as Co-Documentation Agents.
27.1: Financial Data Schedule of ICG Services, Inc. for the Nine Months Ended
September 30, 1999.
EXHIBIT 10.1
Amendment No. 1 to the Credit Agreement, dated as of September 30, 1999, among
ICG Equipment, Inc. and ICG NetAhead, Inc., as Borrowers, ICG Services, Inc., as
Parent, certain Initial Lender Parties thereto, Morgan Stanley Senior Funding,
Inc., as Sole Book-Runner and Lead Arranger, Royal Bank of Canada, as Collateral
Agent and as Administrative Agent for such Lender Parties, and Bank of America,
N.A. and Barclays Bank Plc, as Co-Documentation Agents.
EXHIBIT 27.1
Financial Data Schedule of ICG Services, Inc. for the Nine Months Ended
September 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 November 12, 1999.
ICG SERVICES, INC.
Date: November 12, 1999 By: /s/ Harry R. Herbst
-----------------------------------------
Harry R. Herbst, Executive Vice President
and Chief Financial Officer (Principal
Financial Officer)
Date: November 12, 1999 By: /s/ John V. Colgan
-----------------------------------------
John V. Colgan, Senior Vice President of
Finance and Controller (Principal
Accounting Officer)