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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
AND EXCHANGE ACT OF 1934
For the transition period from ___ to ___
COMMISSION FILE NUMBER 0-27555
ILLUMINET HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
Delaware 36-4042177
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
4501 Intelco Loop, Lacey, Washington 98503
(Address of principal executive office) (Zip code)
</TABLE>
(360) 493-6000
(Registrant's telephone number, including area code)
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 past 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 past 90 days. Yes [X] No [ ]
At May 1, 2000, 29,946,359 shares of Common Stock, $0.01 par value per share,
were outstanding.
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ILLUMINET HOLDINGS, INC.
FORM 10-Q
INDEX
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Page
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PART I: FINANCIAL INFORMATION
ITEM 1: Financial Statements
Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999 1
Consolidated Statements of Income for the three months ended March 31, 2000 and 1999 2
Consolidated Statements of Cash Flows for the three months ended March 31, 2000 and 1999 3
Notes to Consolidated Financial Statements - March 31, 2000 4
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 8
ITEM 3: Quantitative and Qualitative Disclosures about Market Risk 13
PART II: OTHER INFORMATION
ITEM 1: Legal Proceedings 14
ITEM 2: Changes in Securities and Use of Proceeds 14
ITEM 3: Defaults Upon Senior Securities 14
ITEM 4: Submission of Matters to a Vote of Security Holders 14
ITEM 5: Other Information 14
ITEM 6: Exhibits and Reports on Form 8-K 14
SIGNATURES 15
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PART I
ITEM 1: FINANCIAL STATEMENTS
ILLUMINET HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
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MARCH 31, DECEMBER 31,
2000 1999
------------ ------------
(UNAUDITED)
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ASSETS
Current assets:
Cash and cash equivalents .......................................... $ 26,581 $ 22,903
Available-for-sale securities ...................................... 80,816 79,738
Accounts receivable, less allowance for doubtful
accounts of $1,352 ($1,944 in 1999) ............................. 31,663 30,916
Deferred income taxes .............................................. 1,485 1,485
Prepaid expenses and other ......................................... 1,924 1,458
------------ ------------
Total current assets ....................................... 142,469 136,500
Property and equipment, net .......................................... 44,234 45,129
Computer software product costs, less accumulated
amortization of $2,486 ($2,345 in 1999) ............................ 373 513
Other assets ......................................................... 1,388 1,515
------------ ------------
Total assets ............................................... $ 188,464 $ 183,657
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued expenses ........................ $ 5,552 $ 9,099
Due to customers ................................................... 15,849 16,133
Income taxes payable ............................................... 4,308 1,723
Current portion of obligations under capital
leases .......................................................... 2,478 2,428
Current portion of long-term debt .................................. 955 1,430
------------ ------------
Total current liabilities .................................. 29,142 30,813
------------ ------------
Deferred income taxes ................................................ 4,853 4,853
Obligations under capital leases, less current portion ............... 4,358 4,997
Long-term debt, less current portion ................................. 5,829 6,028
Stockholders' equity:
Preferred Stock, par value $.01 per share,
authorized 100,000 shares, 4,416 shares designated as Series A,
none outstanding and 7,000 shares designated as Series B,
none outstanding ................................................... -- --
Common Stock, par value $.01 per share,
authorized 150,000,000 shares, issued and outstanding
4,485,000 ....................................................... 45 45
Class A Common Stock, par value $.01 per share,
authorized 7,200,000 shares, issued and outstanding
6,344,134 ....................................................... 63 63
Additional paid-in capital ......................................... 103,859 103,865
Deferred stock-based compensation .................................. (3,536) (3,828)
Retained earnings .................................................. 43,851 36,821
------------ ------------
Total stockholders' equity ................................. 144,282 136,966
------------ ------------
Total liabilities and stockholders'
equity ..................................................... $ 188,464 $ 183,657
============ ============
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ILLUMINET HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
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THREE MONTHS ENDED
MARCH 31,
-------------------------------
2000 1999
------------ ------------
(UNAUDITED)
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Revenues:
Network services ........................... $ 27,657 $ 19,833
Clearinghouse services ..................... 1,315 1,539
Network usage software applications ........ 270 231
------------ ------------
Total revenues ..................... 29,242 21,603
Expenses:
Carrier costs .............................. 5,950 6,519
Operating .................................. 7,033 5,743
Selling, general and administrative ........ 3,499 2,894
Depreciation and amortization .............. 2,986 2,498
------------ ------------
Total expenses ..................... 19,468 17,654
------------ ------------
Operating income ............................. 9,774 3,949
Interest income .............................. 1,791 206
Interest expense ............................. (227) (396)
------------ ------------
Income before income taxes ................... 11,338 3,759
Income tax provision ......................... 4,308 1,428
------------ ------------
Net income ................................... $ 7,030 $ 2,331
============ ============
Earnings per share -- basic .................. $ 0.24 $ 0.10
============ ============
Earnings per share -- diluted ................ $ 0.22 $ 0.09
============ ============
Weighted-average common shares -- basic ...... 29,861,536 21,463,972
============ ============
Weighted-average common shares -- diluted .... 31,692,546 26,097,456
============ ============
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ILLUMINET HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
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<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2000 1999
------------ ------------
(UNAUDITED)
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Operating activities:
Net income ......................................... $ 7,030 $ 2,331
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization ...................... 2,986 2,498
Stock-based compensation expense ................... 286 85
Deferred income taxes .............................. -- 1,429
Change in:
Accounts receivable ............................. (747) (1,313)
Trade accounts payable .......................... (3,547) (1,315)
Due to customers ................................ (284) 1,380
Income taxes payable ............................ 2,585 (909)
Other ........................................... (341) (139)
------------ ------------
Net cash provided by operating activities .......... 7,968 4,047
------------ ------------
Investing activities:
Purchases of investments ......................... (1,078) --
Capital purchases ................................ (1,949) (2,088)
------------ ------------
Net cash used in investing activities .............. (3,027) (2,088)
Financing activities:
Proceeds from issuance of Class A Common Stock ..... -- 10
Principal payments on notes payable and
capital leases .................................. (1,263) (414)
------------ ------------
Net cash used in financing activities .............. (1,263) (404)
------------ ------------
Net increase in cash and cash equivalents ............ 3,678 1,555
Cash and cash equivalents at:
Beginning of period ................................ 22,903 11,967
------------ ------------
End of period ...................................... $ 26,581 $ 13,522
============ ============
Supplemental cash flow disclosure:
Income taxes paid .................................. $ 1,723 $ 909
============ ============
Interest paid ...................................... $ 283 $ 361
============ ============
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3
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ILLUMINET HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Illuminet Holdings, Inc. and its wholly-owned subsidiary Illuminet, Inc.
(collectively referred to as "Illuminet") are engaged in the business of
developing, managing and marketing a Signaling System 7 ("SS7") network and
related products and services based on SS7 technology to the entire
telecommunications marketplace. SS7 is a telecommunications industry-standard
system of protocols and procedures that is used to control telephone
communications and provide routing information in association with vertical
calling features, such as calling card validation, advanced intelligent network
services, local number portability, wireless services, toll-free number database
access, and caller identification. Additionally, Illuminet provides advanced
database services, billing-and-collection services, calling card services, and
network usage software applications to a range of telephone companies as well as
interexchange carriers, operator service providers and other telecommunications
companies and providers of telecommunications services.
Illuminet has its corporate headquarters and a portion of its operations
located in Lacey, Washington; a network control center and related operations
located in Overland Park, Kansas; and additional SS7 Signal Transfer Points
located in Rock Hill, South Carolina; Mattoon, Illinois; Las Vegas, Nevada;
Akron, Pennsylvania, and Waynesboro, Virginia.
Illuminet Holdings, Inc. (formerly USTN Holdings, Inc. through May 1997)
and Illuminet, Inc. (formerly USTN Services, Inc. through May 1997) were
incorporated in the State of Delaware on August 2, 1995.
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of Illuminet as of March 31, 2000
and for the three months ended March 31, 2000 and 1999 presented in this Form
10-Q are unaudited, and in the opinion of management, reflect all adjustments
(consisting only of normal recurring adjustments) necessary for the fair
presentation of Illuminet's financial position, results of its operations and
its cash flows for each period presented. Certain information and footnote
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 Securities and Exchange Commission.
Illuminet believes that the disclosures made are adequate to make the
information presented not misleading. The results of the interim periods are not
necessarily indicative of future results. These consolidated financial
statements and notes thereto should be read in conjunction with Illuminet's
Annual Report on Form 10-K, filed with the Securities and Exchange Commission on
March 14, 2000.
The consolidated financial statements include the financial statements
of Illuminet Holdings, Inc. and its subsidiary. All significant intercompany
balances and transactions have been eliminated in consolidation.
CASH EQUIVALENTS
Illuminet considers all highly liquid investments of operating cash,
defined as funds generated from ongoing business operations, with original
maturities of three months or less at purchase to be cash equivalents. Cash
equivalents consist of money market funds and commercial paper that are stated
at cost, which approximates fair value. At December 31, 1999, such investments
included $19.8 million invested in a money market fund consisting of direct
obligations of the U.S. Treasury and repurchase agreements collateralized by
such obligations of the U.S. Treasury. At December 31, 1999, investments in a
fund collateralized by commercial paper investments totaled $3.1 million.
AVAILABLE-FOR-SALE SECURITIES
Investments classified as available-for-sale securities are reported at
fair value with unrealized gains and losses excluded from earnings and recorded
net of deferred taxes directly to stockholders' equity as accumulated other
comprehensive income. There were not any gross unrealized holding gains or
losses at March 31, 2000 or December 31, 1999.
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ACCOUNTS RECEIVABLE
One of Illuminet's services involves providing a clearinghouse function
for toll collected by telephone companies on behalf of other telecommunications
service providers. Accounts receivable from these companies are
uncollateralized; however, uncollected amounts may be offset against amounts
otherwise due to service providers.
Concentration of credit risk with respect to trade receivables is
limited due to the diversity of the customer base and geographic dispersion, and
is evidenced by a history of minimal customer account write-offs.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided
using the straight-line method over the estimated useful lives of the assets.
Estimated useful lives for property and equipment are as follows:
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Corporate headquarters building.................... 31.5 years
Network assets..................................... 5 to 10 years
Office equipment and systems....................... 5 to 20 years
Furniture and fixtures............................. 5 to 15 years
Computer equipment and software.................... 3 to 5 years
Leasehold improvements............................. 5 years
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Property and equipment and liabilities under capital leases are recorded
at the lower of the present value of the minimum lease payments or the fair
value of the asset. Interest rates on capitalized leases are imputed based on
the lower of Illuminet's incremental borrowing rate at the inception of each
lease or the lessor's implicit rate of return. Depreciation on the leased assets
are included in depreciation expense, and is provided using the straight-line
method over the estimated useful lives of the assets.
CAPITALIZED SOFTWARE
Computer software product costs represent capitalized costs incurred for
development of software products after the technological feasibility of the
product is established. Costs incurred prior to that date are expensed. The
annual amortization is determined on a product-by-product basis as the greater
of the amount computed using (a) the ratio that current gross revenues for a
product bear to the total of current and anticipated future gross revenues for
that product, or (b) the straight-line method over the remaining estimated
economic life of the product. Amortization starts when the product is available
for general release to customers.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets consist of intangible assets and certain capital
assets. The carrying value of these assets is regularly reviewed to verify that
they are valued properly. If changes in facts and circumstances suggest that the
value has been impaired, an assessment is made of future cash flows and the
carrying value of the related assets will be reduced appropriately to their fair
value based on current market values. When market values are not available, the
fair value will be determined based on other valuation techniques such as
estimated discounted future cash flows.
REVENUE RECOGNITION
Illuminet recognizes revenue as the related services are performed.
Network services revenues are comprised of network connectivity revenues and
intelligent network service revenues. Network connectivity revenues are derived
from establishing and maintaining connection to Illuminet's SS7 network and
trunk signaling services. Revenues from network connectivity consist primarily
of monthly recurring fees, and trunk signaling services revenues are charged
monthly based on the number of switches to which a customer signals. Network
connectivity revenues are recognized once the installation services have been
completed. Intelligent network services, which include calling card validation,
local number portability, wireless services, toll-free database access, and
caller identification are derived primarily from database administration and
database query services and are charged on a per-use or per-query basis.
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Clearinghouse services revenues are derived primarily from serving as a
distribution and collection point for billing information and payment collection
for services provided by one carrier to customers billed by another.
Clearinghouse revenues are earned based on the number of messages processed.
Network usage software applications revenues are comprised of sales of
software and software maintenance services. Revenues on sales of software are
recognized when an arrangement exists, the price is fixed and determinable, the
related amounts are collectible, and the software has been delivered and all
customer acceptance requirements, if any, have been met. Revenues on software
maintenance are recognized on a monthly basis over the term of the maintenance
arrangement.
STOCK-BASED COMPENSATION
Illuminet has elected to apply the disclosure-only provisions of the
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("Statement 123").
Accordingly, Illuminet accounts for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"). Compensation expense for
stock options is measured as the excess, if any, of the fair value of Common
Stock and Class A Common Stock at the measurement date over the stock option
exercise price. Statement 123 requires companies that continue to follow APB 25
to provide pro forma disclosure of the impact of applying the fair value method
of Statement 123.
INCOME TAXES
Illuminet provides for income taxes under the liability method, whereby
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
EARNINGS PER SHARE
The computation of earnings per share-basic is based on net income and
the weighted-average number of outstanding common shares, including Class A
Common Stock. The computation of earnings per share-diluted includes the
dilutive effect of outstanding preferred stock, convertible debentures
calculated using the as if converted method, and Common Stock options and Class
A Common Stock options calculated using the treasury stock method. Effective
with Illuminet's initial public offering on October 7, 1999, all existing common
stock outstanding immediately prior to the initial public offering was renamed
to Class A Common Stock. Each share of Class A Common Stock automatically
converted into four shares of Common Stock on April 5, 2000. All share and per
share amounts have been restated to reflect the conversion of the Class A Common
Stock into Common Stock at the beginning of each period presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain reclassifications to the 1999 financial statements have been
made to conform to the 2000 presentation.
SEGMENT INFORMATION
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 131, "Disclosure About Segments
of an Enterprise and Related Information" ("Statement 131"), effective for
financial statements for fiscal years beginning after December 15, 1997.
Statement 131 establishes standards for the reporting by public business
enterprises of financial and descriptive information about reportable operating
segments in annual financial statements and interim financial reports issued to
shareholders. Illuminet primarily provides services to companies in the
telecommunications industry that are located throughout the United States and
considers all of its operations as one segment because expenses support multiple
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products and services. Revenues are reported separately for network services,
clearinghouse services and network usage software applications. No segment
information is provided to the chief operating decision maker for expenses,
operating income, total assets, depreciation, or capital purchases.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes standards for the recognition, measurement, and reporting of
derivatives and hedging activities and is effective for Illuminet's year ending
December 31, 2001. Illuminet anticipates that the adoption of this new
accounting standard will not have a material impact on Illuminet's consolidated
financial statements, but continues to evaluate that impact.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin Number 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". This summarized certain areas of the staff's views in applying
generally accepted accounting principles as it applies to revenue recognition.
Illuminet believes that its revenue recognition principles comply with SAB 101.
Illuminet will continue to evaluate interpretations of SAB 101.
NOTE 2. EARNINGS PER SHARE
The following table sets forth the computation of earnings per
share-basic and diluted (in thousands, except share and per share amounts) and
includes the effect of Class A Common Stock on an as if converted basis. On
April 5, 2000, 6,344,134 shares of Class A Common Stock were automatically
converted into 25,376,536 shares of Common Stock.
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THREE MONTHS ENDED
MARCH 31,
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2000 1999
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Numerator:
Numerator for earnings per
share-basic -- net income ....................... $ 7,030 $ 2,331
Effect of dilutive securities - Debenture
interest, net of tax ............................ -- 99
------------ ------------
Numerator for earnings per
share-diluted -- net
income after assumed
conversions ..................................... $ 7,030 $ 2,430
============ ============
Denominator:
Denominator for earnings per
share-basic -- weighted-average shares .......... 29,861,536 21,463,972
Weighted-average effect of dilutive securities:
Stock options ................................... 1,831,010 715,224
Debentures ...................................... -- 3,098,384
Series A Stock .................................. -- 819,876
------------ ------------
Dilutive potential common
shares .......................................... 1,831,010 4,633,484
------------ ------------
Denominator for earnings per
share-diluted - adjusted
weighted-average shares
and assumed conversions ......................... 31,692,546 26,097,456
============ ============
Earnings per share-- basic ........................... $ 0.24 $ 0.10
============ ============
Earnings per share-- diluted ......................... $ 0.22 $ 0.09
============ ============
</TABLE>
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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of our consolidated financial condition and
results of operations should be read in conjunction with the Financial
Statements and the related Notes thereto included in this Form 10-Q. This
discussion contains, in addition to historical information, forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from the results discussed in the forward-looking statements. Factors
that could cause or contribute to such differences include, but are not limited
to, those discussed below under "Forward Looking Statements". We disclaim any
obligation to update information contained in any forward-looking statement.
OVERVIEW
We operate the largest unaffiliated SS7 network in the United States and
are a leading provider of complementary intelligent network and SS7 services to
telecommunications carriers. Connection to our network gives carriers access to
the system of signaling networks of nearly the entire U.S. public-switched
telecommunications infrastructure through a single source.
SS7 is the industry standard used by almost every switched telephone
network operator in the United States and Canada to identify available network
routes and designate the circuits to be used for each individual telephone call.
SS7 networks also provide access to intelligent network services, such as caller
identification, calling card validation and other specialized database access
functions, all of which are performed in the seconds it takes to complete a
call. SS7 networks are specialized packet-switched data networks that provide
these control functions and services in parallel with separate voice networks.
Our network is composed of specialized SS7 switches, sophisticated
computers and databases strategically located across the country. These elements
interconnect our customers and all of the largest U.S. telecommunications
carriers through leased lines. As of March 31, 2000, our network served more
than 700 network customers, including incumbent local exchange carriers,
competitive local exchange carriers, long distance companies, wireless
telecommunications providers and Internet service providers.
Our products and services can be grouped into three general categories:
- network services, which includes SS7 connectivity, switching and
the transport of messages used to route calls and query
databases, and intelligent network services, such as database
access, including local number portability and support for
roaming between carriers;
- clearinghouse services that facilitate payments among
telecommunications carriers; and
- network usage software applications.
Our SS7 network connectivity, switching and transport services provide
telecommunications carriers access to the signaling networks of nearly the
entire U.S. public-switched telecommunications infrastructure through a single
source. Once connected, customers use our network to route and complete voice
and data transmissions and access related and complementary services and
applications available from us or from third-party vendors. Once a customer is
connected to our network, we continue to provide support services to maintain
and upgrade its connection on a 24 hour a day, seven day a week basis.
Intelligent network services encompass a number of database query
functions, including caller identification, toll-free calling, calling card
validation, local number portability and seamless wireless roaming. Each of
these services uses our SS7 network to access databases, some maintained by us
and others maintained by third parties.
Our clearinghouse services include serving as a distribution and
collection point for billing information and payment collection for services
provided by one carrier to customers billed by another. For example, we receive
a monthly report from a long distance carrier detailing the long distance calls
made by the customers of another carrier. We prepare statements to each billing
carrier of its customers' usage, which the billing carrier then uses to bill its
customers. The billing carrier remits the payments received from its customers
to us. We aggregate these payments and remit them to the long distance carrier,
net of our servicing fee.
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Network usage software applications are commercial applications derived
primarily from software we developed to create billing data for the use of our
network and services. This software is licensed to carriers and allows them to
create billing data to bill another carrier for use of their signaling network
or their underlying public-switched telecommunications network.
REVENUES
Our revenues primarily come from the sale of network services, including
SS7 connectivity, switching and transport and the provision of intelligent
network services. To a much lesser extent, we derive revenues from our
clearinghouse services and network usage software applications.
Customers generally are charged for connectivity to our SS7 network on a
monthly "per link" basis. If we provision the network facilities that provide
their connection to our network, they pay us for establishing the initial
connections that link them to our network and pay a separate monthly fee to
maintain those links. We generally price these connectivity links on a cost-plus
basis based on our facility lease costs. In addition, customers are charged for
network switching (the transmission of signaling traffic throughout the network)
based on the number of switches to which they signal.
Our intelligent network services are delivered through our network and a
substantial majority of our customers purchase both SS7 network connectivity and
intelligent network services. Our intelligent network services fall into two
general categories: database administration and database query services. In
addition to paying monthly fees for SS7 connectivity, our customers pay a
per-use or per-query fee for database services. For example, we price local
number portability service order administration on a per-ported number basis,
and obtain volume-based revenue for accessing the local number portability
database on a per-query basis.
Clearinghouse services are provided on a per message billed basis. Our
revenues vary based on the number of messages provided to us by
telecommunications companies and other message providers for aggregation and
distribution by us to the carrier who will bill to and collect from its
customers. Clearinghouse services are relatively mature and are experiencing
competitive pricing pressures.
Revenues from network usage software applications are derived from
licenses of our software products and continuing software maintenance fees.
These products have a long sales cycle, with each individual license normally
contributing significant revenue to the product line. New sales opportunities
for these products in their current form are limited, as many of the customers
in the top tier market, consisting primarily of regional Bell operating
companies, have already licensed our product. Therefore, revenues may change
significantly from period to period, depending on the mix of license and
maintenance fees in any given period.
The table below indicates the portion of our revenues attributable to
network services, clearinghouse services and network usage software applications
for the three months ended March 31, 2000 and 1999, together with the percentage
change in revenues.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------------------
2000 1999 % CHANGE
---------- ---------- ----------
($ IN THOUSANDS)
<S> <C> <C> <C>
Network services ........ $ 27,657 $ 19,833 39%
Clearinghouse services .. 1,315 1,539 (15)
Network usage software
applications .......... 270 231 17
---------- ----------
$ 29,242 $ 21,603 35%
========== ==========
</TABLE>
EXPENSES
Our costs and expenses, which we do not attribute directly to individual
product lines, consist generally of the following:
- Carrier costs, which include recurring payments to
telecommunications carriers for leased lines and signal transfer
point ports. These lines and ports provide connections (1)
between our customers and our network, (2) among our own network
locations and (3) between our network and nearly all other SS7
networks in the United States. Cost of links and ports to our
customers is variable, relating directly to the number of links
and ports we provide to our customers. Cost of links and ports
among our own network locations and to other SS7 networks is
primarily fixed. We generally lease lines and ports under
tariffs with volume discounts;
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- Operating expenses, which include the cost of providing network
services, clearinghouse services and network usage software
applications. Such costs primarily include personnel costs and
hardware and software maintenance costs to monitor and maintain
our network on a 24 hour a day, seven day a week basis, maintain
and operate our databases, process our clearinghouse messages,
and develop and maintain our network usage software
applications;
- Selling, general and administrative, which consist primarily of
executive, sales and marketing and administrative personnel and
professional services expense; and
- Depreciation and amortization, which relate primarily to our
installed network equipment, our computer hardware and software,
our corporate facilities and our network usage software
applications.
The table below indicates our expenses for the three months ended March
31, 2000 and 1999, together with the percentage change in expenses.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2000 1999 % CHANGE
---------- ---------- --------
($ IN THOUSANDS)
<S> <C> <C> <C>
Carrier costs ........... $ 5,950 $ 6,519 (9)%
Operating ............... 7,033 5,743 22
Selling, general and
administrative ....... 3,499 2,894 21
Depreciation and
amortization ......... 2,986 2,498 20
---------- ----------
$ 19,468 $ 17,654 10%
========== ==========
</TABLE>
RESULTS OF OPERATIONS
The table below indicates the results of our operations expressed as a
percentage of total revenues. The historical results are not necessarily
indicative of results to be expected for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
2000 1999
---------- ----------
<S> <C> <C>
Revenues:
Network services ........................ 95% 92%
Clearinghouse services .................. 4 7
Network usage software applications ..... 1 1
---------- ----------
Total revenues ....................... 100 100
Expenses:
Carrier costs ........................... 20 30
Operating ............................... 24 27
Selling, general and administrative ..... 12 13
Depreciation and amortization ........... 10 12
---------- ----------
Total expenses ....................... 66 82
---------- ----------
Operating income .......................... 34 18
Interest income ........................... 6 1
Interest expense .......................... (1) (2)
---------- ----------
Income before income taxes ................ 39 17
Income tax provision ...................... 15 6
---------- ----------
Net income ................................ 24% 11%
========== ==========
</TABLE>
THREE MONTHS ENDED MARCH 31, 2000 COMPARED TO THE THREE MONTHS ENDED MARCH 31,
1999
REVENUES
Network services. Network services revenues, comprised of revenues from
network connectivity, which includes message switching and transport, and
intelligent network services, increased by $7.9 million, or 39%, to $27.7
million for the three months ended March 31, 2000 ("2000") from $19.8 million
for the three months ended March 31, 1999 ("1999"). These increases were due to
increased customer connections and signaling across our network, substantial
growth in queries processed in the line information, caller identification or
calling name delivery and toll-free databases, and the continued nationwide
rollout of local number portability.
10
<PAGE> 13
Network connectivity revenues increased by $3.7 million, or 34%, to
$14.4 million in 2000 from $10.7 million in 1999. Intelligent network services
revenues increased by $4.2 million, or 45%, to $13.3 million in 2000 from $9.1
million in 1999. These increases reflect the overall growth in our customer base
and higher caller information services volume as we obtained access to
additional caller information maintained in third-party databases. The remainder
of these increases was due to continued growth in local number portability,
which is expected to slow for the year ending December 31, 2000, due to
competitive pricing pressures for database access.
Clearinghouse services. Clearinghouse services revenues decreased by
$0.2 million, or 15%, to $1.3 million in 2000 from $1.5 million in 1999 due to a
continued decline in the number of messages processed. Although the
clearinghouse industry continues to experience some residual negative impact
from slamming and cramming activity, we expect this to stabilize.
Network usage software applications. Network usage software applications
revenues were comparable in 2000 and 1999. Revenues in both periods were
comprised of maintenance fees.
EXPENSES
Carrier costs. Carrier costs decreased by $0.5 million, or 9%, to $6.0
million in 2000 from $6.5 million in 1999. Carrier costs decreased as network
capacity has been leveraged to support increasing revenues, and network growth
has allowed for the realization of volume discounts.
Operating. Operating expenses increased by $1.3 million, or 22%, to $7.0
million in 2000 from $5.7 million in 1999. These increases resulted mainly from
higher personnel expenses related to an expansion of the customer support,
operations and engineering functions, increased maintenance costs for new
network and systems hardware and software, and database access costs related to
toll-free calling revenues.
Selling, general and administrative. Selling, general and administrative
expenses increased by $0.6 million, or 21%, to $3.5 million in 2000 from $2.9
million in 1999. These increases were primarily due to increased incentive
compensation expenses and costs associated with being a public company,
including annual report publication and increased professional services
expenses.
Depreciation and amortization. Depreciation and amortization expenses
increased by $0.5 million, or 20%, to $3.0 million in 2000 from $2.5 million in
1999. These increases reflect the significant investment made in the last two
years for network monitoring and data collection hardware and software, database
applications, and signal transfer point switches.
Interest income. Interest income increased by $1.6 million to $1.8
million in 2000 from $0.2 million in 1999. The increase reflects increased
interest income generated by the investment of $78.3 million of net proceeds
from our mid-October 1999 initial public offering and earnings from higher cash
balances generated from operations beginning in mid-1999.
Interest expense. Interest expense decreased by $0.2 million, or 43%, to
$0.2 million in 2000 from $0.4 million in 1999. The decrease reflects savings
from the conversion of the redeemable subordinated debentures in October 1999,
partially offset by increased interest expense from capital leases completed in
mid-1999.
Income taxes. Income tax expense increased by $2.9 million, or 202%, to
$4.3 million in 2000 from $1.4 million in 1999, due to increased income, an
effective tax rate of 38.0% in both years.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have relied on a combination of cash generated from
operations, commercial borrowings, vendor financing and the issuance of equity
securities to fund our operations and capital needs. Currently, our operating
activities generate positive cash flows. We anticipate continued high levels of
investment in our infrastructure over the next several years to manage increased
network volumes, to enhance customer support systems and to continue to improve
network and service reliability. Additionally, we anticipate continued
investments in the development and acquisition of new services and products
related to our network, database and clearinghouse services in order to address
changing markets and customer needs.
Our working capital (current assets in excess of current liabilities)
was $113.3 million at March 31, 2000. Our cash and cash equivalent balances
included $7.4 million required as working capital to service our clearinghouse
services customers. Clearinghouse funds are received and disbursed on a monthly
basis. The growth in working capital of $7.6 million from $105.7 million at
11
<PAGE> 14
December 31, 1999, reflects increased cash balances for clearinghouse
customers as well as increases in available-for-sale securities and accounts
receivable, decreases in accounts payable and due to customers, offset by an
increase in income taxes payable.
Our property and equipment acquisitions were $1.9 million in the quarter
ended March 31, 2000, and $12.8 million for the year ended December 31, 1999.
Expenditures for property and equipment were primarily for network equipment to
expand capacity and enhance reliability, including network monitoring equipment
and local number portability service-related assets. We anticipate capital
expenditures of approximately $23.1 million for the remainder of 2000. These
investments will support new product introductions such as OSS mediation where
we have chosen a platform, are in the process of developing the offering, and
expect to launch service in August.
At March 31, 2000, we had a secured line of credit expiring August 15,
2001 with Rural Telephone Finance Cooperative ("RTFC") that permits us, subject
to certain conditions, to borrow up to $7.3 million, not to exceed 80% of
accounts receivable. There were no borrowings against this line of credit at
that date. Additionally, at March 31, 2000, we had $3.8 million of unused loan
facilities established or committed with RTFC, expiring in the years 2000 and
2001. Long-term secured notes payable to RTFC were $6.8 million at March 31,
2000, with various maturity dates ranging from August 2000 to March 2015.
We believe that our existing cash balances, funds generated from our
operations, and borrowings available under our existing credit agreements will
be sufficient to meet our anticipated capital expenditure and working capital
needs for the foreseeable future. However, acquisitions of complementary
businesses or technologies may require significant capital beyond our current
expectations, which would require us to issue additional equity securities
and/or incur additional long-term debt.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes standards for the recognition, measurement, and reporting of
derivatives and hedging activities and is effective for Illuminet's year ending
December 31, 2001. Illuminet anticipates that the adoption of this new
accounting standard will not have a material impact on Illuminet's consolidated
financial statements, but continues to evaluate that impact. In December 1999,
the Securities and Exchange Commission issued Staff Accounting Bulletin Number
101 ("SAB 101"), "Revenue Recognition in Financial Statements". This summarized
certain areas of the staff's views in applying generally accepted accounting
principles as it applies to revenue recognition. Illuminet believes that its
revenue recognition principles comply with SAB 101. Illuminet will continue to
evaluate interpretations of SAB 101.
FORWARD LOOKING STATEMENTS
Certain information included in this document may be deemed to be
"forward looking statements" within the meaning of Section 27A of the Securities
Act and Section 21E of the Securities Exchange Act. All statements of historical
facts, that address activities, events or developments that Illuminet intends,
expects, projects, believes or anticipates will or may occur in the future are
forward looking statements. Such statements are characterized by terminology
such as "believe," "anticipate," "should," "intend," "plan," "will," "expects,"
"estimates," "projects," "positioned," "strategy," and similar expressions.
These statements are based on assumptions and assessments made by Illuminet's
management in light of its experience and perception of historical trends,
current conditions, expected future developments and other factors it believes
to be appropriate. These forward looking statements are subject to a number of
risks and uncertainties, including but not limited to our ability to provide
reliable services, ability of third-party communications infrastructure
suppliers to maintain operational integrity of our connections and to continue
to provide and expand service to us, our ability to efficiently and cost
effectively acquire and integrate complementary businesses and technologies,
continued acceptance of our SS7 network and the telecommunications market's
continuing use of SS7 technology, and our ability to attract and retain
employees with requisite skills to execute our growth plans. All written and
oral forward looking statements made in connection with this Form 10-Q which are
attributable to Illuminet or persons acting on its behalf are expressly
qualified in their entirety by "Risk Factors" and other cautionary statements
and disclosures regarding Illuminet's business included herein and in our Annual
Report on Form 10-K, filed with the Securities and Exchange Commission on March
14, 2000.
12
<PAGE> 15
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our market risks relate primarily to changes in interest rates. We are
exposed to this risk in two specific ways. First, we have debt outstanding. Our
secured notes payable to RTFC, which were $6.8 million at March 31, 2000 and
$7.5 million at December 31, 1999, had a variable interest rate, which exposed
our income statement and cash flows to changes in interest rates. The rate of
these secured notes is based on the lender's cost of funds. We also have a
variable rate revolving line of credit for up to $7.3 million that has not been
used. The interest rate on this line of credit is based on the prevailing bank
prime rate plus a margin of one and one-half percent per year. The lender may,
at its discretion, fix a lower rate from time to time. If market interest rates
were to increase immediately and uniformly by 10% from levels at December 31,
1999, our net income and cash flows would decrease by an immaterial amount.
The second component of interest rate risk involves the short-term
investment of excess cash. Such risk affects fair values, earnings and cash
flows. Excess cash is primarily invested in overnight repurchase agreements
backed by U.S. government securities. These are considered to be cash
equivalents and are shown that way on our balance sheet. We had securities
available-for-sale of $80.8 million at March 31, 2000 and $79.7 million at
December 31, 1999, which represent the investment of our initial public offering
net proceeds. Available-for-sale securities are primarily comprised of
commercial paper, and provided earnings of $1.0 million in 1999, or
approximately $4.0 million on an annualized basis.
13
<PAGE> 16
PART II
ITEM 1: LEGAL PROCEEDINGS
We are a party to various legal proceedings arising in the ordinary
course of business. We do not believe that those claims, individually or
combined, will have a material adverse effect on our business, financial
condition or operating results.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
(a)None.
(b) None.
(c) None.
(d) We expect to use the net offering proceeds from our October 1999
initial public offering, Registration Statement No. 333-85779, effective
October 7, 1999, to fund potential acquisitions, to develop new and
improved services, to maintain and expand our network and for general
corporate purposes. To date, none of the net proceeds from the initial
public offering has been disbursed.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the first
quarter of 2000.
ITEM 5: OTHER INFORMATION
None.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS REQUIRED TO BE FILED BY ITEM 601 OF REGULATION S-K
Exhibit 27 - Financial Data Schedule
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the three months ended March
31, 2000.
14
<PAGE> 17
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.
ILLUMINET HOLDINGS, INC.
Date: May 10, 2000 By: /s/Daniel E. Weiss
--------------------------------------------
Daniel E. Weiss,
Chief Financial Officer, Secretary
(Principal Financial and Accounting Officer)
15
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 26,581
<SECURITIES> 80,816
<RECEIVABLES> 33,015
<ALLOWANCES> (1,944)
<INVENTORY> 0
<CURRENT-ASSETS> 142,469
<PP&E> 99,254
<DEPRECIATION> (55,020)
<TOTAL-ASSETS> 188,464
<CURRENT-LIABILITIES> 29,142
<BONDS> 10,187
0
0
<COMMON> 108
<OTHER-SE> 144,174
<TOTAL-LIABILITY-AND-EQUITY> 188,464
<SALES> 0
<TOTAL-REVENUES> 29,242
<CGS> 0
<TOTAL-COSTS> 19,468
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 227
<INCOME-PRETAX> 11,338
<INCOME-TAX> 4,308
<INCOME-CONTINUING> 7,030
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,030
<EPS-BASIC> 0.24
<EPS-DILUTED> 0.22
</TABLE>
