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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from____ to____ .
Commission File Number 0-20803
BROADWING COMMUNICATIONS INC.
Incorporated under the laws of the State of Delaware
1122 Capital of Texas Highway South, Austin, Texas 78746-6426
I.R.S. Employer Identification Number 74-2644120
Telephone - Area Code 512 328-1112
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 .
All outstanding shares of the Registrant's common stock are owned by Broadwing
Inc.
The number of shares of Preferred Stock outstanding was 395,120 on April 30,
2000.
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<TABLE>
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TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
DESCRIPTION PAGE
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Item 1. Financial Statements
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)
Three Months Ended March 31, 2000 and 1999 3
Condensed Consolidated Balance Sheets (Unaudited)
March 31, 2000 and December 31, 1999 4
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended March 31, 2000 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
And Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
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PART II. OTHER INFORMATION
DESCRIPTION PAGE
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Item 1. Legal Proceedings 17
Item 2. Changes in Securities and Use of Proceeds 17
Item 3. Defaults Upon Senior Securities 17
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 5. Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signature 18
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Form 10-Q Part I Broadwing Communications Inc.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(Millions of Dollars)
(Unaudited)
<TABLE>
<CAPTION>
Company Predecessor
------- -----------
Three Months Ended
------------------
March 31, March 31,
2000 1999
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<S> <C> <C>
Revenues............................................................................ $ 213.0 $ 161.4
Costs and Expenses..................................................................
Cost of providing services and products sold...................................... 126.2 104.8
Selling, general and administrative............................................... 89.0 51.8
Depreciation and amortization..................................................... 74.7 36.3
Merger and other infrequent costs................................................. -- 0.1
------------ ------------
Total Costs and Expenses........................................................ 289.9 193.0
------------ -------------
Operating Loss...................................................................... (76.9) (31.6)
Other Income........................................................................ -- 5.9
Minority Interest Expense (Income)................................................. (0.2) 0.2
Equity Loss in Unconsolidated Entities.............................................. 2.0 2.9
Interest Expense.................................................................... 12.9 11.0
------------ -------------
Net Loss Before Income Taxes........................................................ (91.6) (39.8)
Income Tax Provision (Benefit)...................................................... (30.4) 2.4
------------- ------------
Net Loss............................................................................ (61.2) (42.2)
Other Comprehensive Income, Net of Tax:
Unrealized gain on investments.................................................... 27.3 133.2
------------ ------------
Comprehensive Income (Loss)......................................................... $ (33.9) $ 91.0
============== ============
</TABLE>
See Notes to Financial Statements.
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Form 10-Q Part I Broadwing Communications Inc.
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED BALANCE SHEETS
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
-----------
March 31, December 31,
2000 1999
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<S> <C> <C>
ASSETS
Current Assets
Cash and cash equivalents......................................................... $ -- $ 56.2
Receivables, less allowances of $39.6 and $36.0................................... 107.6 77.1
Deferred income tax benefits...................................................... 14.7 16.8
Prepaid expenses and other current assets......................................... 6.5 10.2
------------ ------------
Total current assets...................................................... 128.8 160.3
Property, plant and equipment, net.................................................. 1,724.0 1,726.4
Goodwill and other intangibles, net................................................. 2,525.1 2,561.3
Investments in other entities....................................................... 697.4 634.2
Investments in unconsolidated subsidiaries.......................................... 77.5 61.0
Deferred charges and other assets................................................... 5.3 4.0
------------ ------------
Total Assets.............................................................. $ 5,158.1 $ 5,147.2
============ ============
LIABILITIES, REDEEMABLE PREFERRED STOCK AND SHAREOWNERS' EQUITY
Current Liabilities
Short-term debt................................................................... $ 6.5 $ 5.9
Accounts payable.................................................................. 108.9 143.3
Intercompany payable to Parent Company............................................ 945.8 442.9
Current portion of unearned revenue and customer deposits......................... 53.1 53.6
Accrued expenses and other current liabilities.................................... 46.7 137.6
------------ ------------
Total current liabilities................................................. 1,161.0 783.3
Long-term debt, less current portion................................................ 212.3 597.4
Unearned revenue, less current portion.............................................. 634.7 633.5
Deferred income taxes............................................................... 242.7 178.4
Other long-term liabilities......................................................... 73.3 72.8
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Total liabilities......................................................... 2,324.0 2,265.4
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12 1/2% Junior Exchangeable Preferred Stock; $.01 par value; authorized -
3,000,000 shares of all classes of preferred stock; 395,120 shares issued and
outstanding and aggregate liquidation preference of $395.1 at
March 31, 2000 and December 31, 1999 ............................................. 411.5 418.2
Commitments and Contingencies
Shareowners' Equity
Common shares, $.01 par value, 1,000,000 shares authorized;
500,000 shares issued and outstanding.......................................... -- --
Additional paid-in capital........................................................ 2,417.5 2,424.6
Retained deficit.................................................................. (106.7) (45.5)
Accumulated other comprehensive income ........................................... 111.8 84.5
------------ ------------
Total shareowners' equity................................................. 2,422.6 2,463.6
------------ ------------
Total Liabilities, Redeemable Preferred Stock and Shareowners' Equity............... $ 5,158.1 $ 5,147.2
============ ============
</TABLE>
See Notes to Financial Statements.
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Form 10-Q Part I Broadwing Communications Inc.
<TABLE>
<CAPTION>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
Company Predecessor
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Three Months Ended
------------------
March 31, March 31,
2000 1999
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss............................................................................ $ (61.2) $ (42.2)
Adjustments to reconcile net loss to cash provided by (used in) operating
activities:
Depreciation and amortization..................................................... 74.7 36.3
Provision for doubtful accounts and service credits............................... 6.5 16.3
Deferred income taxes............................................................. (30.4) --
Equity in net loss of unconsolidated subsidiaries................................. 2.0 2.9
Other, net........................................................................ 1.9 0.2
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable............................................................... (31.4) (30.2)
Notes receivable from customers and IRU sales..................................... 1.5 91.1
Other current assets.............................................................. 3.8 (1.1)
Deferred charges and other non-current assets..................................... -- 3.6
Accounts payable ................................................................. 2.2 39.2
Current portion of unearned revenue and customer deposits......................... 0.2 --
Accrued expenses and other current liabilities.................................... (6.8) (0.1)
Other non-current liabilities..................................................... (3.1) (0.8)
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Net cash provided by (used in) operating activities............................. (40.1) 115.2
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............................................... (88.9) (108.1)
Investments in unconsolidated subsidiaries........................................ - (6.2)
Proceeds from sale of ownership interest in joint venture......................... 8.2 --
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Net cash used in investing activities........................................... (80.7) (114.3)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from loan from Parent Company............................................ 485.1 --
Proceeds from issuance of debt.................................................... 1.1 --
Principal payments on long-term debt and capital lease obligations................ (409.4) (3.4)
Payment of preferred dividends.................................................... (12.4) (4.6)
Issuance of common stock.......................................................... -- 4.0
Cash received from merged entity.................................................. 0.2 --
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Net cash provided by (used in) financing activities............................. 64.6 (4.0)
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Net decrease in cash and cash equivalents........................................... (56.2) (3.1)
Cash and cash equivalents at beginning of period.................................... 56.2 264.8
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Cash and cash equivalents at end of period.......................................... $ -- $ 261.7
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Income taxes (net of refunds)..................................................... $ -- $ 2.3
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Interest (net of amounts capitalized)............................................. $ 4.3 $ 41.0
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Non-cash Investing and Financing Activities:
Accretion on preferred stock...................................................... $ 0.5 $ --
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Fiber barter agreements.......................................................... $ 4.8 $ --
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</TABLE>
See Notes to Financial Statements.
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Form 10-Q Part I Broadwing Communications Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Broadwing
Communications Inc. and its subsidiaries (formerly known as IXC
Communications, Inc., now referred to as "Broadwing Communications" or "the
Company"), a leading provider of telecommunications transmission and switched
long-distance services with a coast-to-coast fiber optic network containing
approximately 16,000 fiber route miles at March 31, 2000. The Company
utilizes its advanced fiber-optic network to provide data and voice services
through its network, using both wholesale and retail channels. Broadband
transport services are comprised of the lease of dedicated circuits that
customers use to transmit voice and data traffic, indefeasible right-to-use
("IRU") agreements and network construction services. Switched services
represents the transmission of long-distance switched traffic to resellers
and retail business customers through the Company's switches. Data and
Internet services include providing frame relay and ATM-based data services,
Web hosting and collocation. Other revenues are comprised of network
integration and consulting services along with the sale of the related
equipment and, in 1999, revenues from the Company's now completed Vyvx
project.
The Company became a wholly owned subsidiary of Broadwing Inc. ("the Parent
Company") on November 9, 1999, pursuant to the merger with Broadwing Inc.
("the Merger"). On January 1, 2000, the Parent Company contributed the
capital stock of its network integration and consulting business, Broadwing
IT Consulting ("IT Consulting"), to the Company. Additionally, the Company
also entered an agreement with Cincinnati Bell Long Distance ("CBLD") to
service the customers of CBLD outside of the Cincinnati area. The
contribution of the IT Consulting stock resulted in $11.5 million in assets
and $12.4 million in liabilities (at historical cost) being contributed to
the Company in January 2000, representing net liabilities of $0.9 million.
During the current quarter, the Company recognized $9.0 million in revenues
and $9.8 million in expenses related to IT Consulting and $15.0 million in
both revenues and expenses related to the CBLD agreement.
The financial statements for periods ended before November 9, 1999 were prepared
using the Company's historical basis of accounting and are designated as
"Predecessor". The comparability of operating results for the Predecessor
periods and periods subsequent to the Merger are affected by the purchase
accounting adjustments discussed in Note 2 and the contribution of IT Consulting
and the agreement with CBLD discussed above.
These consolidated financial statements have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission (SEC) and, in the
opinion of management, include all adjustments necessary for a fair presentation
of the results of operations, financial position and cash flows for each period
shown. All adjustments are of a normal and recurring nature except for those
outlined in Notes 2 and 5. Certain prior year amounts have been reclassified to
conform to the current classifications with no effect on financial results.
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 SEC rules and regulations. The
December 31, 1999 condensed balance sheet was derived from audited financial
statements, but does not include all disclosures required by generally accepted
accounting principles. It is suggested that these financial statements be read
in conjunction with financial statements and notes thereto included in the
Company's 1999 Annual Report on Form 10-K.
2. MERGER WITH BROADWING INC.
On November 9, 1999, the Company was acquired by the Parent Company through the
merger of the Company and a wholly owned subsidiary of the Parent Company, with
the Company surviving as a wholly owned subsidiary of the Parent Company. The
Company has since been renamed Broadwing Communications Inc.
The aggregate purchase price of $2.2 billion consisted of (all numbers
approximate): $0.3 billion in cash for the purchase of five million shares of
Company common stock from Trustees of General Electric Pension Trust; the
issuance of 68 million shares of the Parent Company's common stock (to
stockholders of the Company) valued at $1.6 billion; 155,000 shares of 6 3/4%
convertible preferred stock issued by the Parent Company on the Company's behalf
and valued at $0.1 billion; and the issuance of 14 million options and warrants
to purchase Parent Company common stock valued at $0.2 billion.
The cost of the Merger has been preliminarily allocated to the assets acquired
and liabilities assumed according to their estimated fair values at the
acquisition date and is subject to adjustment as the assumptions relating to the
asset and liability valuations are finalized. In addition, the allocation may be
impacted by changes in pre-acquisition
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contingencies identified during the allocation period by the Company relating
to certain environmental, litigation, and other matters. As a result,
amounts preliminarily allocated to goodwill were decreased by approximately
$20.5 million during the first quarter of 2000. The amount allocated to
goodwill represents the excess of price paid over the fair value of assets
realized and liabilities assumed in the Merger. These amounts are being
amortized to expense over a 30-year period.
Included in the allocation of the cost to acquire the Company in the fourth
quarter of 1999 were restructuring costs associated with initiatives to
integrate operations of the Company with its Parent Company. The
restructuring costs recorded in 1999 included the costs of involuntary
employee separation benefits related to 263 employees of the Company. As of
March 31, 2000, 134 of the employee separations had been completed for a
total cash expenditure of $1.5 million. The restructuring plans also included
costs associated with the closure of a number of technical and customer
support facilities, the decommissioning of certain switching equipment, and
the termination of contracts with vendors. The Company expects that most of
these restructuring actions will be complete by December 31, 2000, and will
result in cash outlays of $7.5 million in 2000.
The following table illustrates activity in this reserve since December 31,
1999:
<TABLE>
<CAPTION>
Balance at Balance at
December 31, March 31,
1999 Expenditures 2000
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FOURTH QUARTER:
Employee separations.................. $ 2.0 $ (1.3) $ 0.7
Facility closure costs................ 2.1 (1.8) 0.3
Relocation............................ 0.2 -- 0.2
Other exit costs...................... 3.2 (0.1) 3.1
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Total................................. $ 7.5 $ (3.2) $ 4.3
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</TABLE>
3. INVESTMENTS IN OTHER ENTITIES
PSINET, INC.
The Company's investment in PSINet, Inc. ("PSINet") consists of 20.5 million
shares of PSINet common stock. This investment had a fair market value of
approximately $695.9 million and $631.7 million as of March 31, 2000 and
December 31, 1999, respectively. The amount in excess of the Company's basis in
the investment is reported as an unrealized gain on marketable securities, net
of tax and additional liabilities resulting from the stock price of PSINet. The
PSINet investment is classified as "available-for-sale" as defined by Statement
of Financial Accounting Standard No. 115. Accordingly, changes in the unrealized
gain amount are included in "Other Comprehensive Income" on the accompanying
Condensed Consolidated Statement of Income and Comprehensive Income.
DCI TELECOMMUNICATIONS
In November 1998, the Company entered into an agreement to acquire 4.25 million
shares of common stock of DCI Telecommunications, Inc. (DCI) as consideration
for payment of amounts due from one of the Company's customers that was also a
vendor of DCI. The agreement provided that DCI was to issue additional shares of
common stock to the Company if the market value of the shares the Company owned
did not reach $17.7 million by June 1, 1999. As of June 1, 1999, and subsequent
thereto, the market value of the shares the Company owned was less than the
$17.7 million guaranteed in the November 1998 agreement. DCI has publicly
disclosed that it does not intend to issue additional shares to the Company. The
Company is pursuing the remedies to which it is entitled under the November 1998
agreement. Due to a decline in the financial condition of DCI that is considered
permanent, the Company wrote down its investment in DCI by $16.1 million to $1.5
million in 1999. No other adjustment was deemed necessary during the first
quarter of 2000.
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4. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
MARCA-TEL
As of March 31, 2000, the Company holds an indirect investment equal to 30.0% of
Marca-Tel S.A. de C.V. (Marca-Tel) as a result of its ownership of 65.4% of
Progress International, LLC ("Progress") which, in turn, owns 45.8% of
Marca-Tel. The remaining 54.2% of Marca-Tel is owned by a Mexican individual,
Formento Radio Beep, S.A. de C.V. and Siemens S.A. de C.V. The other owner of
Progress is Westel International, Inc. ("Westel").
STORM TELECOMMUNICATIONS, LTD.
In October 1997, Storm Telecommunications, Ltd. ("Storm") was formed. Storm was
a joint venture with Telenor Global Services AS ("Telenor"), a subsidiary of the
Norwegian national telephone company, to provide telecommunication services to
carriers and resellers in Europe. The joint venture was owned 40% by Telenor,
40% by the Company and 20% by Clarion Resources Communications Corporation, an
U.S. based telecommunications company in which Telenor owned a controlling
interest. In February 2000, the Company sold its investment in Storm, plus
amounts due it relating to the joint venture, for $14.4 million. The Company's
investment in Storm had been written down to zero prior to the Merger because
the Company did not expect to realize any amounts pertaining to this investment.
The subsequent recovery of this investment resulted in an $8.2 million
adjustment to the preliminary purchase price allocation during the first quarter
of 2000.
APPLIED THEORY, INC.
The Company holds a 24.0% interest in Applied Theory that was valued at $77.5
million and $61.0 million on March 31, 2000 and December 31, 1999, respectively.
Applied Theory, Inc., a New York-based Internet service provider, was formed in
1996 to provide high quality Internet services for the New York state research
and education community. During the first three months of 2000, the Company
recognized $2.0 million in losses resulting from its equity method accounting
for the Applied Theory investment, as compared to approximately $0.3 million in
losses recognized during the first quarter of 1999.
5. RESTRUCTURING CHARGES
In the second quarter of 1999, the Company recorded a charge of approximately
$13.1 million to exit certain operations in the switched wholesale business. The
restructuring charge consisted of severance and various other costs associated
with workforce reduction, network decommissioning, and various terminations. The
workforce reduction of 94 people included employees contributing to the sales
function and employees contributing to the network operations. These
restructuring activities are expected to be substantially complete by June 30,
2000. Due to the Merger, it was determined that the combined companies would
need the switches that had been marked for decommissioning in the second
quarter's restructuring charge. Additionally, it was determined that the total
period contemplated for lease payments relating to an abandoned office would not
be required. Consequently, the second quarter restructuring charge was reduced
by $1.2 million during the third quarter related to decommissioning the switches
and $0.4 million related to a reduction in the lease pay off requirement.
In the third quarter of 1999, the Company recorded a charge of approximately
$8.3 million relating to the restructuring of the organization and to exit
certain foreign operations. The plan was developed prior to the Merger, by the
previous Chief Executive Officer, after reviewing the Company's operations. The
workforce reduction of 15 employees included management, administrative and
foreign sales personnel. The employees were notified of this program during July
and August of 1999. Generally, all of the charges are expected to be paid in
2000.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Activity in the first quarter of 2000 related to the accrued restructuring
liabilities was as follows (in millions):
<TABLE>
<CAPTION>
Balance at Balance at
December 31, March 31,
1999 Expenditures 2000
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SECOND QUARTER RESTRUCTURING:
Employee separations $ 1.2 $ -- $ 1.2
Network Decommissioning 2.3 -- 2.3
Terminate contractual obligations and
exit facilities 4.2 (1.5) 2.7
----------- ----------- -----------
Total $ 7.7 $ (1.5) $ 6.2
=========== =========== ===========
THIRD QUARTER RESTRUCTURING:
Severance $ 2.9 $ (2.1) $ 0.8
Terminate contractual obligations and exit
facilities .5 (.1) 0.4
----------- ----------- -----------
Total $ 3.4 $ (2.2) $ 1.2
=========== =========== ===========
6. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations consisted of the following at March
31, 2000 and December 31, 1999 (in millions):
<CAPTION>
March 31, December 31,
2000 1999
------------------------------------
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9% Senior Subordinated Notes............................ $ 46.0 $ 450.0
12 1/2% Senior Notes....................................... .8 .8
Capital lease obligations............................... 11.0 11.3
PSINet Forward Sale .................................... 153.2 133.9
Other debt.............................................. 7.8 7.3
--------------- -------------
Total long-term debt and capital lease obligations $ 218.8 $ 603.3
Less current portion.......................... 6.5 5.9
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Long-term debt and capital lease obligations.. $ 212.3 $ 597.4
=============== =============
</TABLE>
9% SENIOR SUBORDINATED NOTES
In 1998, the Company issued $450 million of 9% senior subordinated notes due
2008 ("the 9% Notes"). In January 2000, $404 million of these 9% Notes were
redeemed through a tender offer as a result of the change of control terms of
the bond indenture. As a result, the $4.4 million premium paid upon redemption,
net of taxes, was recorded as a component of the purchase price allocation
during the first quarter of 2000.
The 9% Notes are general unsecured obligations and are subordinate in right of
payment to all existing and future senior indebtedness and other liabilities of
the Company's subsidiaries. The indenture related to the 9% Notes requires the
Company to comply with various financial and other covenants and restricts the
Company from incurring certain additional indebtedness.
PSINET FORWARD SALE
The Company's investment in PSINet consists of 20.5 million common shares. In
June and July 1999, the Company received approximately $111.8 million
representing amounts from a financial institution in connection with two prepaid
forward sale contracts on six million shares of the PSINet common stock. This
amount is classified as long-term debt and is collateralized by six million
shares of PSINet common stock. Each forward-sale
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obligation for three million shares of PSINet stock may be settled at future
dates for a maximum amount of three million shares of PSINet stock, or at the
Company's option, the equivalent value in cash.
OTHER
Pursuant to the Company's May 10, 1999 acquisition of Coastal Telecom Limited
Company, the Company assumed $10 million in notes payable. This amount was
adjusted to $7.8 million as part of the preliminary purchase price allocation
for the Coastal acquisition. This amount remains outstanding at March 31, 2000.
Additionally, $0.8 million remains outstanding on the 12 1/2% senior notes
(original indebtedness of $285.0 million) that were primarily eliminated through
a tender offer in 1998.
The Company has acquired certain facilities and equipment using capital leases.
The gross amount of assets recorded under capital leases at March 31, 2000 and
December 31, 1999 (capital leases and associated accumulated depreciation was
revalued at the Merger date) was $12.0 million and $11.8 million, respectively.
The related accumulated depreciation was $3.0 million and $1.2 million at March
31, 2000 and December 31, 1999, respectively.
7. CONTINGENCIES
In the normal course of business, the Company is subject to various regulatory
proceedings, lawsuits, claims and other matters. Such matters are subject to
many uncertainties and outcomes are not predictable with assurance.
Certain former members of IXC's previous board of directors, as well as
Cincinnati Bell Inc. (now Broadwing Inc.), have been named as defendants in
five stockholder class action suits filed in the Delaware Court of Chancery (the
Court). These suits were filed in July 1999 and pertain to the Company's
recently completed Merger. The complaints allege, among other things, that the
defendants breached their fiduciary duties to the Company's former stockholders
by failing to maximize stockholder value in connection with entering into the
Merger agreement and sought a court order enjoining completion of the Merger. In
an October 27, 1999 ruling, the Court denied plaintiffs' request for a
preliminary injunction. The Merger has since closed and management believes that
the performance of Broadwing's share price has rendered plaintiffs' arguments
moot. While these suits currently remain outstanding and subject to further
litigation, the Company does not believe any of plaintiffs' arguments have
merit. The Company is in the process of negotiating a possible settlement.
A total of twenty-six Equal Employment Opportunity Commission ("EEOC") charges
were filed beginning in September 1999 by Broadwing Telecommunications Inc.
employees located in the Houston office (formerly Coastal Telephone, acquired by
the Company in May 1999) alleging sexual harassment, race discrimination and
retaliation. The Company is continuing its investigation of these charges and is
cooperating with the EEOC. The Company and the various complainants are
currently engaged in a voluntary mediation proceeding to attempt to resolve this
matter.
In the course of closing the Merger, the Company became aware of its possible
non-compliance with certain requirements under state and federal environmental
laws. Since the Company is committed to compliance with environmental laws,
management decided to undertake a voluntary environmental compliance audit of
Company facilities and operations and, by letter dated November 9, 1999,
disclosed potential non-compliance at Company facilities to U.S. Environmental
Protection Agency ("EPA") under the Agency's Self-Policing Policy. The Company
made similar voluntary disclosures to various state authorities. By letter dated
January 19, 2000, the EPA determined that the Company appears to have satisfied
the "prompt disclosure" requirement of the Self-Policing Policy, and established
a deadline of May 1, 2000 for the Company to complete its environmental audit of
all Company facilities and report any violations to the Agency. This deadline
has since been extended to June 15, 2000 and the Company is currently in the
process of completing the audit and implementing the steps necessary to correct
violations discovered in the course of the audit. The Company intends to
complete its environmental audit of these facilities within the time frame
established by U.S. EPA and undertake corrective actions necessary to promptly
achieve compliance.
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The Company believes that the resolution of such matters for amounts in excess
of those reflected in the consolidated financial statements would not likely
have a materially adverse effect on the Company's financial condition.
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 establishes accounting and
reporting standards requiring that a derivative instrument be recorded in the
balance sheet as either an asset or liability, measured at its fair value. SFAS
133 has been subsequently amended through the release of SFAS 137, which
provides for a deferral of the effective date of SFAS 133 to all fiscal years
beginning after June 15, 2000. As a result, implementation of SFAS 133 is not
mandatory for the Company until January 1, 2001. Management is currently
assessing the impact of SFAS 133 on the Company's results of operations, cash
flows and financial position, although it does not hold or issue derivative
financial instruments for trading purposes or enter into interest rate
transactions for speculative purposes.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements. In
SAB 101 (which will be effective for, and applicable to, the Company's operating
results in the second quarter of 2000), the SEC Staff expressed its views
regarding the appropriate recognition of revenue with regard to a variety of
circumstances, some of which are of particular relevance to the Company. The
Company is currently evaluating SAB 101 to determine its impact on the financial
statements.
11
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Form 10-Q Part I Broadwing Communications Inc.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Information included in this Quarterly Report on Form 10-Q contains certain
forward-looking statements that involve potential risks and uncertainties. The
Company's future results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed herein, and those discussed in the Form 10-K for the
year ended December 31, 1999. Readers are cautioned not to place undue reliance
on these forward-looking statements that speak only as of the date thereof.
DESCRIPTION OF BUSINESS
Broadwing Communications Inc. ("the Company") is a leading provider of
telecommunications transmission and switched long-distance services with a
coast-to-coast fiber optic network containing approximately 16,000 fiber route
miles at March 31, 2000. The Company utilizes its advanced fiber-optic network
to provide data and voice services through its network, using both wholesale and
retail channels. Broadband transport services are comprised of the lease of
dedicated circuits that customers use to transmit voice and data traffic,
indefeasible right-to-use ("IRU") agreements and network construction services.
Switched services represents the transmission of long-distance switched traffic
to resellers and retail business customers through the Company's switches. Data
and Internet services include providing frame relay and ATM-based data services,
Web hosting and collocation. Other is comprised of Network integration and
consulting services along with the sale of the related equipment and, in 1999,
revenues from the Company's now completed Vyvx partnership.
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto. Results for interim periods may not be
indicative of the results for the full years.
On November 9, 1999, the Company completed its merger ("the Merger") with
Broadwing Inc. ("the Parent Company"). The Parent Company accounted for the
Merger according to the purchase method of accounting, with the purchase price
allocation being "pushed down" to the Company's financial statements. The
purchase price has been preliminarily allocated to the assets and liabilities
assumed according to their estimated fair values and are subject to adjustment
when additional information concerning asset and liability valuations is
finalized. Property, plant and equipment was recorded at fair market value based
on preliminary appraisal results, and useful lives were assigned to the assets.
The excess of cost over the fair value assigned to the net assets acquired was
recorded as goodwill and is being amortized using the straight-line method over
30 years. Because the Merger did not take place until November 9, 1999,
comparisons of current quarter results with that of the prior year may not yield
meaningful results with respect to certain expenses that were effected by the
push down accounting adjustments.
On January 1, 2000, the Parent Company contributed the capital stock of
Broadwing IT Consulting ("IT Consulting") to the Company. Also effective January
1, 2000, the Company entered into an agreement with Cincinnati Bell Long
Distance Inc. ("CBLD") to service the customers of CBLD outside of the
Cincinnati area. Accordingly, the current year's results of operations include
those of IT Consulting and amounts related to the service agreement with CBLD.
The contribution of the IT Consulting stock resulted in $11.5 million in assets
and $12.4 million in liabilities (at historical cost) being contributed to the
Company in January 2000, representing net liabilities of $0.9 million. During
the current quarter, the Company recognized $9.0 million in revenues and $9.8
million in expense related to IT Consulting and $15.0 million in both revenues
and expenses related to the CBLD agreement.
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Results of operations are as follows:
<TABLE>
<CAPTION>
COMPANY PREDECESSOR
------------ ---------------
THREE MONTHS ENDED MARCH 31,
----------------------------
($ Millions) 2000 1999 CHANGE %
-------- -------- ------ ---
<S> <C> <C> <C> <C>
Revenues:
Broadband transport $ 91.3 $ 70.9 $ 20.4 29
Switched services 103.1 77.7 25.4 33
Data and Internet 9.6 5.2 4.4 85
Other 9.0 7.6 1.4 18
------- -------- --------
Total 213.0 161.4 51.6 32
Costs and Expenses:
Cost of providing services and products sold 126.2 104.8 21.4 20
Selling, general and administrative 89.0 51.8 37.2 72
------- -------- --------
Total 215.2 156.6 58.6 37
Earnings Before Interest, Taxes, Depreciation
and Amortization (EBITDA) (2.2) 4.8 (7.0)(146)
Depreciation and amortization 74.7 36.3 38.4 106
Merger and other infrequent costs -- 0.1 (0.1) --
------- -------- --------
Operating loss (76.9) (31.6) (45.3) 143
Other Income -- 5.9 (5.9) --
Minority Interest Expense (Income) (0.2) 0.2 (0.4)(200)
Equity Loss in Unconsolidated Entities 2.0 2.9 (0.9) (31)
Interest Expense 12.9 11.0 1.9 17
------- -------- ---------
Net Loss Before Income Taxes (91.6) (39.8) (51.8) 130
Income Tax Provision (Benefit) (30.4) 2.4 (32.8) --
-------- --------- ---------
Net Loss $ (61.2) $ (42.2) $ (19.0) 45
======== ========= =========
</TABLE>
Net operating revenues increased $51.6 million, or 32%. The increase was due to
a $26.2 million improvement in data services (which includes Broadband
transport, Data and Internet and Other), and a $25.4 million increase in
switched services. Broadband transport improvement was mainly comprised of
increases in circuit-lease revenue and IRU revenue, reflecting the amortization
of up-front payments. Data and Internet, while only a small percentage of
revenues today, grew 85%. Switched service revenue grew to $103 million, an
increase of 33%. Higher switched retail revenues, which include the traffic
associated with the May 10, 1999 acquisition of Coastal Telecom Limited Company
and other related companies under common control ("Coastal"), were partially
offset by the decrease in the switched wholesale as a result of the decision to
de-emphasize this business. Switched wholesale revenues amounted to less than
40% of total switched services revenues in the first quarter of 2000, down from
more than 50% in the prior year quarter. Other revenues increased $1.4 million
in the current year quarter, as new revenues provided by the network integration
and consulting business more than offset the loss of prior year revenue
resulting from the Vyvx project.
Cost of providing services and products sold increased $21.4 million, or 20%,
which primarily reflects access charges paid to LECs, transmission lease
payments to other carriers and employee and hardware costs in the
data-consulting arena. The increase was driven by revenue growth, and was
held to a minimum as much of the year-over-year increase in data revenue and
voice traffic was carried on the Company's network. Going forward, cost of
service expense is expected to grow with revenue, but continue to decline as
a percentage of revenue as more of the traffic is carried on the Company's
network.
Selling, general and administrative expenses for the quarter increased $37.2
million, or 72%. Advertising increased $17 million over the first quarter
of 1999 due to the national advertising campaign to launch the "Broadwing"
brand. The remainder of the increase was primarily salary-related costs as
the Company added approximately 700 employees from March 1999 to March 2000
mainly due to the inclusion of the Coastal and IT Consulting businesses, and
costs associated with the CBLD service agreement.
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An EBITDA loss of $2.2 million was $7.0 million less than in the prior year and
is the result of the items discussed above.
Depreciation and amortization of $74.7 million was approximately $38 million
higher, a 106% increase. This increase was the result of continued construction
of the fiber-optic network and higher asset balances resulting from the
revaluation of network assets and intangibles at the Merger date.
Other income declined from $5.9 million to zero due to lower interest income in
the current quarter. Since excess cash is now maintained by the Parent Company,
interest income is expected to be near zero in the future.
Equity losses in unconsolidated subsidiaries declined to $2.0 million in the
current quarter (versus $2.9 million in the prior year quarter) as two of the
three investments that contributed to the first quarter 1999 loss have since
been sold. Most recently, the Company sold its interest in the Storm joint
venture for $14.4 million, including approximately $6 million for a recovery
of amounts receivable from partners in the joint venture.
Interest expense increased 17% in the current quarter to $12.9 million due to
additional funding required to continue construction of the fiber-optic network.
Interest paid to the Parent Company has partially replaced external financing in
the current period, including the redemption of $404 million of the $450 million
senior subordinated notes.
Income tax expense declined $32.8 million from a provision of $2.4 million in
the first quarter of 1999 to a benefit of $30.4 million in the current quarter.
The prior year's tax benefits were substantially offset by a valuation allowance
required due to the uncertainty of the future utilization of such benefits. The
current year benefits will be partially utilized against the Parent Company's
current income in the post-Merger environment. Any remaining benefits will be
recognized and carried forward to future periods.
As a result of the above, the Company reported a net loss of $61.2 million,
45% higher than the $42.2 million reported in the prior year period.
SEGMENT INFORMATION
In accordance with Statement of Financial Accounting Standards No. 131,
"Disclosures About Segments of an Enterprise and Related Information," the
Company began reporting its results by operating segment in 1998. Historically,
management has segregated the operations of the Company into three operating
segments; private line, switched long distance and data/Internet. The operations
of the Company now comprise a single segment and are reported as such to the
Chief Executive Officer of the Parent Company, who functions in the role of
chief operating decision maker for the Company.
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FINANCIAL CONDITION
CAPITAL INVESTMENT, RESOURCES AND LIQUIDITY
Historically, the Company financed the expansion of its network through the
issuance of debt and equity securities, the sale of fiber- and capacity-based
IRUs, incurring bank debt and borrowing against its ownership in PSINet, Inc.
Since the merger, the Company has relied on the credit facility secured by the
Parent Company in order to support its cash deficit.
Cash used in operating activities of $40 million represented a $155 million
reduction in comparison to the $115 million cash provided in the prior year
quarter. This reduction was primarily the result of lower net income and cash
payments received for IRU agreements during the current quarter.
Cash used in investing activities decreased $33 million to $81 million in the
current quarter, due primarily to a $19 million decline in capital expenditures.
This reduction is a function of timing, as the Company is still projecting
capital expenditures of $600 million in 2000 and substantial spending thereafter
to continue expansion of the fiber-optic network. The Company's remaining joint
venture has not required funding since the beginning of the current year
versus the $6 million expended in the prior year quarter. The Company's interest
in its Storm joint venture was sold in the first quarter of 2000 for $14
million, which included approximately $6 million for a recovery of amounts
receivable from partners in the joint venture. Significant further funding of
joint ventures is not currently anticipated.
Cash provided by financing activities of approximately $65 million increased $69
million in the current quarter versus a $4.0 million use of cash in the prior
year's quarter. A tender offer on the Company's 9% Notes required $404 million
in cash that was provided by the Parent Company. Additional funding was also
provided by the Parent Company in order to offset the Company's operating loss
for the quarter. Approximately $12 million in cash was required in order to pay
dividends on the Company's 12 1/2% Junior Exchangeable Preferred Stock ("12 1/2%
Preferred"). In the prior year quarter, no cash was required to effect these
dividend payments since payments were made through the issuance of additional
shares of the 12 1/2% Preferred. However, these dividend payments were
partially offset by the elimination of nearly $5 million in dividend payments
on former preferred stock issues of the Company that were replaced by the
Parent Company in the Merger.
The Company did not maintain a cash balance at March 31, 2000. The Parent
Company has established a $2.1 billion credit facility in order to fund the
combined company, a portion of which was used to effect the aforementioned $404
million tender offer for the 9% Notes.
The Company's significant cash requirements relate to the following:
- - Network expansion and other capital expenditures
- - Lease payments
- - Working capital
- - Dividends on preferred stock, and
- - Debt service
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The Company is required to make payments under existing debt and capital lease
arrangements of $4.6 million, $4.1 million and $154.7 million for the remainder
of 2000, 2001 and 2002, respectively. The Company is also required to pay
quarterly dividends on its 12 1/2% Preferred and cash payments for these
dividends totaled $12.4 million for the current quarter. Through February 15,
2001, the Company has the option of paying dividends on the 12 1/2% Preferred
with additional shares of this preferred stock. However, its current intention
is to continue paying these dividends in cash. In January 2000, $404 million of
its $450 million in 9% Senior Subordinated Notes were redeemed through a tender
offer due to the change of control terms in the bond indenture. Costs associated
with that redemption were considered part of the acquisition accounting and were
not reported as an extraordinary charge.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Effective with the retirement of the revolving credit facility and with new debt
being assumed by the Parent Company, the Company is not currently subject to
market risk associated with changes in interest rates. The Company does not hold
or issue derivative financial instruments for trading purposes or enter into
interest rate transactions for speculative purposes.
Significantly all of the Company's revenue is derived from domestic operations,
so risk related to foreign currency exchange rates is considered minimal.
16
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Form 10-Q Part II Broadwing Communications Inc.
ITEM 1. LEGAL PROCEEDINGS
The information required by this Item is included in Note 7 of the notes to the
condensed consolidated financial statements on page 10 of this quarterly report.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Broadwing, as holder of all the outstanding common stock of the Company, has
consented in writing to the election of Richard G. Ellenberger as a director
for a one-year term ending in 2001. Broadwing's approval constitutes over 90%
of the votes entitled to be cast on the election of directors. As required by
regulations promulgated under the Securities Exchange Act of 1934, the
Company mailed an information statement to the holders of the shares of
preferred stock of the Company.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits identified in parenthesis below, on file with the Securities and
Exchange Commission are incorporated herein by reference as exhibits hereto:
(a) Exhibits.
The following are filed as Exhibit(s) to Part I of this Form 10-Q:
Exhibit
Number
- -------
27 Financial Data Schedule.
(b) Reports on Form 8-K.
None.
<PAGE>
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
BROADWING COMMUNICATIONS INC.
May 12, 2000 By: /s/ Kevin W. Mooney
---------------------
Kevin W. Mooney
Chief Financial Officer
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