<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 1-15343
WILLIAMS COMMUNICATIONS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
73-1462856
DELAWARE (IRS Employer
(State of Incorporation) Identification Number)
</TABLE>
<TABLE>
<S> <C>
ONE WILLIAMS CENTER
TULSA, OKLAHOMA 74172
(Address of principal executive officer) (Zip Code)
</TABLE>
Registrant's Telephone Number: (918) 573-2000
NO CHANGE
(Former name, former address and former fiscal year, if changed since last
report)
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 [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
<TABLE>
<S> <C>
CLASS OUTSTANDING AT OCTOBER 29, 1999
Class A Common Stock, $0.01 par value 68,164,496 Shares
Class B Common Stock, $0.01 par value 395,434,965 Shares
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
WILLIAMS COMMUNICATIONS GROUP, INC.
INDEX
PART I. CONDENSED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ITEM 1. CONDENSED FINANCIAL STATEMENTS
Condensed Consolidated Statements of
Operations -- Three and Nine Months Ended September
30, 1999 and 1998..................................... 2
Condensed Consolidated Balance Sheets -- September 30,
1999 and December 31, 1998............................ 3
Condensed Consolidated Statements of Cash Flows -- Nine
Months Ended September 30, 1999 and 1998.............. 4
Notes to Condensed Consolidated Financial Statements... 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.................... 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK............................................ 27
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........ 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................. 29
</TABLE>
Certain matters discussed in this report, excluding historical information,
include forward-looking statements. Although Williams Communications Group, Inc.
believes such forward-looking statements are based on reasonable assumptions, no
assurance can be given that every objective will be achieved. Such statements
are made in reliance on the safe harbor protections provided under the Private
Securities Litigation Reform Act of 1995. Additional information about issues
that could lead to material changes in performance is contained in Williams
Communications Group, Inc.'s Form S-1.
1
<PAGE> 3
WILLIAMS COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
1999 1998 1999 1998
-------- -------- ---------- ----------
(IN THOUSANDS, EXCEPT PER-SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Revenues (Note 3).............................. $498,340 $423,120 $1,499,479 $1,224,846
Operating expenses:
Cost of sales................................ 391,338 308,552 1,157,080 895,790
Selling, general and administrative.......... 137,732 120,717 402,584 327,713
Provision for doubtful accounts.............. 5,318 2,756 17,128 5,452
Depreciation and amortization................ 34,226 21,359 96,338 62,118
Other (Note 4)............................... 444 29,628 27,357 30,661
-------- -------- ---------- ----------
Total operating expenses............. 569,058 483,012 1,700,487 1,321,734
-------- -------- ---------- ----------
Loss from operations (Note 3).................. (70,718) (59,892) (201,008) (96,888)
Interest accrued............................... (29,601) (4,966) (58,634) (11,216)
Interest capitalized........................... 6,953 4,948 15,751 9,504
Equity losses (Note 3)......................... (9,465) (5,290) (28,147) (8,029)
Investing income (loss)........................ (33) 266 4,729 1,533
Minority interest in (income) loss of
subsidiaries................................. 7,936 1,142 19,208 (3,762)
Other income (loss), net....................... 165 83 (593) 39
-------- -------- ---------- ----------
Loss before income taxes....................... (94,763) (63,709) (248,694) (108,819)
(Provision) benefit for income taxes (Note
5)........................................... 8,850 1,792 (36,984) 2,975
-------- -------- ---------- ----------
Net loss....................................... $(85,913) $(61,917) $ (285,678) $ (105,844)
======== ======== ========== ==========
Basic and diluted loss per share (Note 6):
Net loss..................................... $ (.22) $ (.16) $ (.72) $ (.27)
Weighted average shares outstanding.......... 395,435 395,435 395,435 395,435
</TABLE>
See accompanying notes.
2
<PAGE> 4
WILLIAMS COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Dollars in thousands, except share amounts)
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 118,949 $ 42,004
Receivables less allowance of $36,881 ($23,576 in 1998)... 657,682 491,871
Due from affiliates....................................... -- 3,881
Costs and estimated earnings in excess of billings........ 165,184 185,922
Inventories............................................... 115,493 67,699
Deferred income taxes (Note 5)............................ 93,220 23,829
Other (Note 4)............................................ 27,233 26,198
---------- ----------
Total current assets........................................ 1,177,761 841,404
Investments................................................. 563,181 265,217
Property, plant and equipment, net of accumulated
depreciation of $237,607 ($183,869 in 1998)............... 1,386,666 712,404
Goodwill and other intangibles, net of accumulated
amortization of $94,573 ($81,882 in 1998)................. 359,092 430,557
Other assets and deferred charges........................... 173,912 88,964
---------- ----------
Total assets...................................... $3,660,612 $2,338,546
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Accounts payable.......................................... $ 231,009 $ 269,736
Due to affiliates......................................... 44,689 38,372
Deferred revenue.......................................... 135,904 67,228
Accrued liabilities....................................... 153,988 131,448
Billings in excess of costs and estimated earnings........ 48,569 49,434
Long-term debt due within one year (Note 8):
Affiliates............................................. 8,340 138
Third parties.......................................... 289 690
---------- ----------
Total current liabilities................................... 622,788 557,046
Long-term debt (Note 8):
Affiliates................................................ 788,660 620,710
Third parties............................................. 1,126,290 3,020
Deferred income taxes (Note 5).............................. 144,765 29,417
Other liabilities........................................... 30,522 10,595
Minority interest in subsidiaries........................... 131,730 110,076
Stockholder's equity:
Class A common stock, $0.01 par value, 1 billion shares
authorized, no shares issued in 1999 or 1998 (Note
2)..................................................... -- --
Class B common stock, $0.01 par value, 500 million shares
authorized, 395.4 million shares issued in 1999 and
1998 (Note 2).......................................... 3,954 3,954
Capital in excess of par value............................ 1,391,935 1,295,918
Accumulated deficit....................................... (602,838) (316,896)
Accumulated other comprehensive income (Note 9)........... 22,806 24,706
---------- ----------
Total stockholder's equity........................ 815,857 1,007,682
---------- ----------
Total liabilities and stockholder's equity........ $3,660,612 $2,338,546
========== ==========
</TABLE>
See accompanying notes.
3
<PAGE> 5
WILLIAMS COMMUNICATIONS GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
1999 1998
----------- ---------
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (285,678) $(105,844)
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation.............................................. 72,934 41,857
Amortization of goodwill and other intangibles............ 23,404 20,261
Provision (benefit) for deferred income taxes............. 35,805 (4,468)
Provision for loss on property............................ 26,792 --
Provision for loss on investment.......................... -- 23,150
Provision for doubtful accounts........................... 17,128 5,452
Equity losses............................................. 28,147 8,029
Minority interest in income (loss) of subsidiaries........ (19,208) 3,762
Cash provided (used) by changes in:
Receivables sold........................................ (33,767) 3,648
Receivables............................................. (160,269) (97,486)
Costs and estimated earnings in excess of billings...... 20,738 (11,832)
Inventories............................................. (47,056) 4,890
Other current assets.................................... (860) (8,257)
Accounts payable........................................ 47,081 39,337
Deferred revenue........................................ 68,676 24,971
Accrued liabilities..................................... 1,094 (5,994)
Billings in excess of costs and estimated earnings...... (865) (39,717)
Due to/from affiliates.................................. 7,970 129,105
Other................................................... 26,713 (17,558)
----------- ---------
Net cash provided by (used) in operating activities......... (171,221) 13,306
FINANCING ACTIVITIES
Proceeds from long-term debt................................ 2,377,901 --
Payments on long-term debt.................................. (1,246,049) (126,158)
Debt issuance costs......................................... (21,963) --
Capital contributions from parent........................... 91,290 148,633
Contribution to subsidiary from minority interest
shareholders.............................................. 35,523 --
Changes due to/from affiliates.............................. 169,490 517,533
----------- ---------
Net cash provided by financing activities................... 1,406,192 540,008
INVESTING ACTIVITIES
Property, plant and equipment:
Capital expenditures...................................... (952,477) (358,269)
Proceeds from sales and dark fiber transactions........... 52,048 1,374
Purchase of investments..................................... (307,049) (184,773)
Acquisitions of businesses, net of cash acquired............ -- 12,604
Proceeds from sale of business.............................. 49,452 --
Other....................................................... -- 8,920
----------- ---------
Net cash used in investing activities....................... (1,158,026) (520,144)
----------- ---------
Increase in cash and cash equivalents....................... 76,945 33,170
Cash and cash equivalents at beginning of period............ 42,004 11,290
----------- ---------
Cash and cash equivalents at end of period.................. $ 118,949 $ 44,460
=========== =========
</TABLE>
See accompanying notes.
4
<PAGE> 6
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
The accompanying interim consolidated financial statements of Williams
Communications Group, Inc. ("WCG") do not include all notes in annual financial
statements and therefore should be read in conjunction with WCG's Form S-1. The
accompanying financial statements have not been audited by independent auditors
but include all normal recurring adjustments, which, in the opinion of WCG's
management, are necessary to present fairly its financial position at September
30, 1999, results of operations for the three and nine months ended September
30, 1999 and 1998, and cash flows of the nine months ended September 30, 1999
and 1998.
2. BASIS OF PRESENTATION
In April 1999, WCG filed a registration statement with the Securities and
Exchange Commission for an initial equity offering along with a registration
statement for high yield public debt. The registration statements were declared
effective in September 1999. Proceeds from the offerings were received in
October 1999 and consisted of approximately $1.94 billion from the debt offering
and approximately $1.48 billion from the equity offering. In connection with the
equity offering, WCG converted its existing 1,000 shares of common stock
outstanding to 395,434,965 shares of newly created Class B common stock. The
equity offering sold 68,104,451 Class A common shares. Because the closings and
receipt of cash from both offerings occurred in October 1999, as of September
30, 1999, WCG's equity ownership was represented by 395,434,965 shares, all of
which were owned by The Williams Companies, Inc. ("Williams"). Included in the
equity offering proceeds were amounts from concurrent investors as follows: SBC
Communications of $438.5 million for a 4.36% ownership in WCG, $200 million from
Intel for a 2.0% ownership in WCG and $100 million from Telefonos de Mexico for
a 1.0% ownership in WCG. The remaining equity proceeds received represent a
7.34% ownership. Williams retained an 85.3% ownership. The proceeds from the
offerings are to be used to develop and light the WCG network and repay portions
of debt. In addition, the proceeds will be used to fund operating losses, for
working capital and for other general corporate purposes.
WCG is organized into three operating segments as follows: (1) Network,
which includes fiber optic construction, transmission and management services,
(2) Solutions, which includes distribution and integration of communications
equipment for voice and data networks and (3) Strategic Investments, which
includes Vyvx services (video, advertising distribution, and other multimedia
transmission services via terrestrial and satellite links for the broadcast
industry), audio and video conferencing services and closed circuit video
broadcasting services for businesses (see Note 4 below) and investments in
domestic and foreign communications companies.
Effective January 1, 1999, the segments previously known as Applications
and Strategic Investments were combined as they are now collectively managed and
reported under the name of Strategic Investments.
Certain prior year amounts have been reclassified to conform with the 1999
presentation.
3. SEGMENT DISCLOSURES
WCG adopted Statement of Financial Accounting Standards ("SFAS") No. 131,
"Disclosures about Segments of an Enterprise and Related Information," during
the fourth quarter of 1998. SFAS No. 131 establishes standards for reporting
information about operating segments and related disclosures about products and
services, geographic areas and major customers.
WCG evaluates performance based upon segment profit or loss from operations
which includes revenues from external and internal customers, equity earnings or
losses, operating costs and expenses, and depreciation and amortization and
excludes allocated charges from parent. Intercompany sales are generally
accounted for as if the sales were to unaffiliated third parties, that is, at
current market prices.
5
<PAGE> 7
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents certain financial information concerning WCG's
reportable segments.
<TABLE>
<CAPTION>
STRATEGIC
NETWORK SOLUTIONS INVESTMENTS ELIMINATIONS TOTAL
-------- --------- ----------- ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1999
Revenues:
External customers:
Dark fiber............................ $ 9,354 $ -- $ -- $ -- $ 9,354
Capacity and other.................... 62,510 -- 63,930 -- 126,440
New systems sales and upgrades........ -- 214,688 -- -- 214,688
Maintenance and customer service
orders.............................. -- 138,505 -- -- 138,505
Other................................. -- 4,624 -- -- 4,624
-------- --------- ----------- ------------ --------
Total external customers................. 71,864 357,817 63,930 -- 493,611
Affiliates............................... 3,542 1,187 -- -- 4,729
Intercompany............................. 10,628 -- 47 (10,675) --
-------- --------- ----------- ------------ --------
Total segment revenues........... $ 86,034 $ 359,004 $ 63,977 $ (10,675) $498,340
======== ========= =========== ============ ========
Cost of sales:
Dark fiber............................... $ 2,464 $ -- $ -- $ -- $ 2,464
Capacity and other....................... 85,371 -- 42,123 -- 127,494
New systems sales and upgrades........... -- 160,442 -- -- 160,442
Maintenance and customer service
orders................................ -- 70,114 -- -- 70,114
Indirect operating and maintenance....... -- 30,824 -- -- 30,824
Intercompany............................. -- 2,478 8,197 (10,675) --
-------- --------- ----------- ------------ --------
Total cost of sales.............. $ 87,835 $ 263,858 $ 50,320 $ (10,675) $391,338
======== ========= =========== ============ ========
Segment loss:
Loss from operations..................... $(43,834) $ (13,091) $ (13,793) $ -- $(70,718)
Equity earnings (losses)................. 127 -- (9,592) -- (9,465)
Add back-allocated charges from
Williams.............................. 964 2,141 241 -- 3,346
-------- --------- ----------- ------------ --------
Total segment loss............... $(42,743) $ (10,950) $ (23,144) $ -- $(76,837)
======== ========= =========== ============ ========
Depreciation and amortization.............. $ 13,933 $ 12,051 $ 8,242 $ -- $ 34,226
</TABLE>
6
<PAGE> 8
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
STRATEGIC
NETWORK SOLUTIONS INVESTMENTS ELIMINATIONS TOTAL
-------- --------- ----------- ------------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 1998
Revenues:
External customers:
Capacity and other............... $ 19,339 $ -- $ 57,251 $ -- $ 76,590
New systems sales and upgrades... -- 209,906 -- -- 209,906
Maintenance and customer service
orders......................... -- 133,202 -- -- 133,202
Other............................ -- 912 -- 912
-------- -------- -------- -------- --------
Total external customers............ 19,339 344,020 57,251 -- 420,610
Affiliates.......................... 1,637 873 -- -- 2,510
Intercompany........................ 12,510 -- 130 (12,640) --
-------- -------- -------- -------- --------
Total segment revenues................ $ 33,486 $344,893 $ 57,381 $(12,640) $423,120
======== ======== ======== ======== ========
Cost of sales:
Capacity and other............... $ 30,597 $ -- $ 34,850 $ -- $ 65,447
New systems sales and upgrades... -- 135,529 -- -- 135,529
Maintenance and customer service
orders......................... -- 72,740 -- -- 72,740
Indirect operating and
maintenance.................... -- 34,836 -- -- 34,836
Intercompany..................... 65 2,403 10,172 (12,640) --
-------- -------- -------- -------- --------
Total cost of sales................... $ 30,662 $245,508 $ 45,022 $(12,640) $308,552
======== ======== ======== ======== ========
Segment loss:
Loss from operations................ $(11,389) $ (3,424) $(45,079) $ -- $(59,892)
Equity losses....................... -- -- (5,290) -- (5,290)
Add back-allocated charges from
Williams......................... 398 2,236 588 -- 3,222
-------- -------- -------- -------- --------
Total segment loss.................... $(10,991) $ (1,188) $(49,781) $ -- $(61,960)
======== ======== ======== ======== ========
Depreciation and amortization......... $ 3,257 $ 9,540 $ 8,562 $ -- $ 21,359
</TABLE>
7
<PAGE> 9
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
STRATEGIC
NETWORK SOLUTIONS INVESTMENTS ELIMINATIONS TOTAL
-------- ---------- ----------- ------------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1999
Revenues:
External customers:
Dark fiber......................... $ 81,281 $ -- $ -- $ -- $ 81,281
Capacity and other................. 159,365 -- 197,135 -- 356,500
New systems sales and upgrades..... -- 618,506 -- -- 618,506
Maintenance and customer service
orders........................... -- 409,936 -- -- 409,936
Other.............................. -- 19,772 -- -- 19,772
-------- ---------- --------- -------- ----------
Total external customers.............. 240,646 1,048,214 197,135 -- 1,485,995
Affiliates............................ 10,202 3,282 -- -- 13,484
Intercompany.......................... 32,575 -- 311 (32,886) --
-------- ---------- --------- -------- ----------
Total segment revenues.................. $283,423 $1,051,496 $ 197,446 $(32,886) $1,499,479
======== ========== ========= ======== ==========
Costs of sales:
Dark fiber............................ $ 56,653 $ -- $ -- $ -- $ 56,653
Capacity and other.................... 217,040 -- 125,666 -- 342,706
New systems sales and upgrades........ -- 454,681 -- -- 454,681
Maintenance and customer service
orders............................. -- 213,619 -- -- 213,619
Indirect operating and maintenance.... -- 89,421 -- -- 89,421
Intercompany.......................... -- 7,834 25,052 (32,886) --
-------- ---------- --------- -------- ----------
Total cost of sales..................... $273,693 $ 765,555 $ 150,718 $(32,886) $1,157,080
======== ========== ========= ======== ==========
Segment loss:
Loss from operations.................. $(89,210) $ (34,038) $ (77,760) $ -- $ (201,008)
Equity earnings (losses).............. 127 -- (28,274) -- (28,147)
Add back-allocated charges from
Williams........................... 2,828 6,278 865 -- 9,971
-------- ---------- --------- -------- ----------
Total segment loss...................... $(86,255) $ (27,760) $(105,169) $ -- $ (219,184)
======== ========== ========= ======== ==========
Depreciation and amortization........... $ 27,414 $ 34,737 $ 34,187 $ -- $ 96,338
</TABLE>
8
<PAGE> 10
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
STRATEGIC
NETWORK SOLUTIONS INVESTMENTS ELIMINATIONS TOTAL
-------- ---------- ----------- ------------ ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
NINE MONTHS ENDED SEPTEMBER 30, 1998
Revenues:
External customers:
Capacity and other................ $ 42,621 $ -- $159,589 $ -- $ 202,210
New systems sales and upgrades.... -- 589,703 -- -- 589,703
Maintenance and customer service
orders.......................... -- 422,535 -- -- 422,535
Other............................. -- 2,238 -- -- 2,238
-------- ---------- -------- -------- ----------
Total external customers............. 42,621 1,014,476 159,589 -- 1,216,686
Affiliates........................... 5,647 2,513 -- -- 8,160
Intercompany......................... 37,260 -- 404 (37,664) --
-------- ---------- -------- -------- ----------
Total segment revenues................. $ 85,528 $1,016,989 $159,993 $(37,664) $1,224,846
======== ========== ======== ======== ==========
Cost of sales:
Capacity and other................ $ 71,426 $ -- $ 98,674 $ -- $ 170,100
New systems sales and upgrades.... -- 402,264 -- -- 402,264
Maintenance and customer service
orders.......................... -- 234,733 -- -- 234,733
Indirect operating and
maintenance..................... -- 88,693 -- -- 88,693
Intercompany...................... 204 6,853 30,607 (37,664) --
-------- ---------- -------- -------- ----------
Total cost of sales.................... $ 71,630 $ 732,543 $129,281 $(37,664) $ 895,790
======== ========== ======== ======== ==========
Segment loss:
Loss from operations................. $(26,536) $ 9,223 $(79,575) $ -- $ (96,888)
Equity losses........................ -- -- (8,029) -- (8,029)
Add back-allocated charges from
Williams.......................... 1,184 7,402 1,509 -- 10,095
-------- ---------- -------- -------- ----------
Total segment loss..................... $(25,352) $ 16,625 $(86,095) $ -- $ (94,822)
======== ========== ======== ======== ==========
Depreciation and amortization.......... $ 8,392 $ 28,242 $ 25,484 $ -- $ 62,118
</TABLE>
<TABLE>
<CAPTION>
TOTAL ASSETS
----------------------------
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Network..................................................... $1,565,100 $ 727,119
Solutions................................................... 1,054,131 967,948
Strategic Investments....................................... 1,041,381 643,479
---------- ----------
Total............................................. $3,660,612 $2,338,546
========== ==========
</TABLE>
4. ASSET SALES AND WRITE-OFFS
During the second quarter of 1999, management determined that the
businesses within Strategic Investments that provided audio and video
conferencing services and closed-circuit video broadcasting services for
businesses were held for sale. On June 30, 1999, WCG signed an agreement, which
closed effective July 31, 1999, with Genesys, S.A. to sell its business which
provides audio and video conferencing services. In addition, on July 31, 1999,
WCG signed and closed an agreement with Cyberstar L.P. to sell its business
which provides closed-circuit video broadcasting services for businesses. The
proceeds from these transactions
9
<PAGE> 11
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
total approximately $50 million. In the second quarter of 1999, WCG recognized a
pre-tax loss of $26.7 million consisting of a $22.8 million impairment of the
assets to fair value based on the expected net sales proceeds and exit costs of
$3.9 million consisting of $2.8 million of contractual obligations and $1.1
million of employee-related costs related to the sales of the businesses. These
transactions resulted in an income tax provision of approximately $7.9 million,
which reflects the impact of goodwill not deductible for tax purposes. Loss from
operations related to the assets for the three months ended September 30, 1999
and 1998 were $.9 million and $4.9 million, respectively and loss from
operations for the nine months ended September 30, 1999 and 1998 were $10.2
million and $14.8 million, respectively.
Included in the third quarter of 1998 in other operating expenses as part
of Strategic Investments' segment loss is a $23.2 million loss related to
abandoning an investment in a venture involved in the technology and
transmission of business information for news and educational purposes. The loss
occurred as a result of WCG's re-evaluation and decision to exit the venture as
WCG decided against making further investments in the venture. WCG abandoned its
entire ownership interest in the venture in 1998. The loss primarily consists of
$17.0 million from writing off the entire carrying amount of the investment and
$5.0 million from the recognition of contractual obligations that will continue
after the abandonment. WCG's share of losses from the venture accounted for
under the equity method were $1.0 million and $3.7 million for the three and
nine months ended September 30, 1998, respectively.
5. PROVISION (BENEFIT) FOR INCOME TAXES
WCG's operations are included in Williams' consolidated federal income tax
return. WCG has a tax sharing agreement with Williams under which the amount of
federal income taxes allocated to WCG is generally determined as though WCG were
filing a separate federal consolidated income tax return. Under the terms of the
tax sharing agreement, any loss or other similar tax attribute realized for
periods prior to the initial public offering will be allocated solely to
Williams. WCG will be responsible for any taxes resulting to Williams if the
loss or similar tax attribute is reduced by audit or otherwise.
The provision (benefit) for income taxes for the three and nine months
ended September 30, 1999 and 1998 includes:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------
1999 1998 1999 1998
------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Current:
Federal.................................... $ -- $ -- $ -- $ --
State...................................... 175 50 185 89
Foreign.................................... (1,797) 818 994 1,404
------- ------- ------- -------
(1,622) 868 1,179 1,493
Deferred:
Federal.................................... (2,685) (1,970) 29,633 (3,283)
State...................................... (4,543) (690) 6,172 (1,185)
------- ------- ------- -------
(7,228) (2,660) 35,805 (4,468)
------- ------- ------- -------
Total provision (benefit).......... $(8,850) $(1,792) $36,984 $(2,975)
======= ======= ======= =======
</TABLE>
The tax benefit for the three and nine months ended September 30, 1998 is
significantly less than applying the federal statutory rate to the pre-tax loss
primarily due to tax losses allocated solely to Williams under the tax sharing
agreement.
10
<PAGE> 12
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax benefit for the three months ended September 30, 1999 is
significantly less than applying the federal statutory rate to the pre-tax loss
primarily due to tax losses allocated solely to Williams under the tax sharing
agreement and the impact of net foreign losses not deductible for tax purposes.
The tax provision of the nine months ended September 30, 1999 is
significantly more than the benefit expected from applying the federal statutory
rate to the pre-tax loss primarily due to tax losses allocated solely to
Williams under the tax sharing agreement, state income taxes and the impact of
net foreign losses and goodwill not deductible for tax purposes. The goodwill
related to assets impaired during the second quarter 1999 (see Note 4).
6. LOSS PER SHARE
Basic loss per share was computed using the 395,434,965 shares that were
outstanding at September 30, 1999 for all periods presented as the 1,000 shares
previously outstanding were converted to Class B common stock in September 1999
(see Note 2). Diluted loss per share was the same as the basic calculation as
any stock options outstanding at September 30, 1999 would be antidilutive.
Pro-forma loss per share would have been $0.19 and $0.13 for the three
months ended September 30, 1999 and 1998, respectively, and $0.62 and $0.23 for
the nine months ended September 30, 1999 and 1998. Pro-forma loss per share was
computed giving effect to 463,539,416 shares of common stock outstanding after
completion of the equity offering in October 1999 (see Note 2). Diluted loss per
share was the same as the basic calculation as any stock options outstanding at
September 30, 1999 would be antidilutive.
7. RECENT ACCOUNTING STANDARDS
In June 1999, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 43, "Real Estate Sales, an interpretation of FASB Statement
No. 66." The interpretation is effective for sales of real estate with property
improvements or integral equipment entered into after June 30, 1999. Under this
interpretation, dark fiber is considered integral equipment and accordingly
title must transfer to a lessee in order for a lease transaction to be accounted
for as a sales-type lease. After June 30, 1999, the effective date of FASB
Interpretation No. 43, sales-type lease accounting is no longer appropriate for
dark fiber leases and therefore these transactions will be accounted for as
operating leases unless title to the fibers under lease transfers to the lessee
or the agreement was entered into prior to June 30, 1999.
8. LONG-TERM DEBT
Affiliates
Long-term debt due to affiliates as of September 30, 1999 and December 31,
1998 consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Williams note............................................... $788,110 $614,343
Other....................................................... 8,890 6,505
-------- --------
797,000 620,848
Current maturities.......................................... 8,340 138
-------- --------
Long-term debt.............................................. $788,660 $620,710
======== ========
</TABLE>
11
<PAGE> 13
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Williams note
WCG has historically received capital contributions and interest-bearing
advances from Williams in order to fund operations. On September 8, 1999,
previous non-capital borrowings from Williams were converted into a seven-year
note payable bearing interest at an annual rate based upon WCG's credit rating.
At September 30, 1999, the outstanding borrowings from Williams were $788
million and the interest rate was LIBOR plus 2.25%, or 7.63%. Of the total
borrowings from Williams, $6.25 million has been classified as current at
September 30, 1999 as quarterly principal payments begin July 1, 2000, with no
less than $25 million payable in any fiscal year. After the completion of the
offerings in October 1999, WCG subsequently re-characterized $200 million of
Williams capital contributions to the Williams note resulting in approximately
$1 billion in borrowings from Williams.
Third parties
Long-term debt (excluding amounts due to affiliates) as of September 30,
1999 and December 31, 1998 consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Short-term loan facility.................................... $ 625,000 $ --
Long-term credit facility, variable rate payable through
2006...................................................... 500,000 --
Other....................................................... 1,579 3,710
---------- ------
1,126,579 3,710
Current maturities.......................................... 289 690
---------- ------
Long-term debt.............................................. $1,126,290 $3,020
========== ======
</TABLE>
Short-term loan facility
In September 1999, WCG entered into a $750 million short-term loan facility
with its underwriters. As of September 30, 1999, WCG had borrowed $625 million
all of which was repaid in October 1999 upon the completion of WCG's debt and
equity offerings. The interest rate on this facility was the same as the long-
term credit facility described below.
Long-term credit facility
In September 1999, Williams Communications, Inc. ("WCI"), the wholly owned
operating subsidiary of WCG, entered into a $1.05 billion credit facility with
various banks. The credit facility consists of a $525 million seven-year senior
multi-draw amortizing term loan facility and a $525 million six-year senior
reducing revolving credit facility. WCG (through WCI) may borrow under the term
loan facility during a one-year period beginning on the commencement date of the
credit facility and may borrow under the revolving credit facility throughout
its six-year term. The loans bear interest based on WCG's credit ratings. The
current rate of interest is LIBOR plus 2.25%, or 7.63%. As of September 30,
1999, WCG had borrowed $500 million all of which was repaid in October 1999 upon
completion of the debt and equity offerings.
Term loans must be repaid beginning in the fourth year of the term loan
facility: 15% of the term loans must be repaid during the fourth year, 25%
during the fifth year, 30% during the sixth year and 30% during the seventh
year. The commitments under the revolving credit facility will be permanently
reduced by 20% in the fourth year, by 30% in the fifth year, and by 50% in the
sixth year. WCG must repay amounts borrowed under the revolving credit facility
to the extent these amounts are in excess of the remaining commitments. In
addition, WCG is required to ratably prepay the term loans or reduce its
revolving loans commitments in
12
<PAGE> 14
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
certain circumstances, as defined, based on excess cash flows or proceeds
received from asset sales that are not otherwise reinvested back into WCG's core
business operations.
At any time within two years of the effective date of the long-term credit
facility, WCG may request one or more additional credit facilities from the
long-term credit facility lenders. These facilities would be in the aggregate
amount of not less than $100 million or more than $500 million. The terms and
conditions of any additional facilities have not been agreed to and would have
to be negotiated.
Senior redeemable notes
Subsequent to September 30, 1999 and in conjunction with the equity
offering (see Note 2), WCG issued $2.0 billion in senior redeemable notes. WCG
issued $1.5 billion in 10.875% and $500 million in 10.7% fixed rate senior
redeemable notes due 2009 and 2007, respectively. Interest on the notes is
payable in cash semiannually in arrears on October 1 and April 1, commencing on
April 1, 2000. WCG may prepay the notes at varying redemption premiums or
make-whole prices, as defined.
Proceeds from the completion of WCG's debt and equity offerings were used
to pay off the $625 million outstanding under the short-term loan facility and
the $500 million outstanding under the long-term credit facility. As a result,
these borrowings are classified as noncurrent obligations for financial
reporting purposes.
9. COMPREHENSIVE LOSS
Comprehensive loss for the three and nine months ended September 30, 1999
and 1998 is as follows:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
--------- -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net loss.................................................. $ (85,913) $(61,917) $(285,678) $(105,844)
Other comprehensive income (loss):
Unrealized gain (loss) on securities.................. (102,505) (15,943) 23,169 10,834
Foreign currency translation adjustments.............. 7,808 (1,118) (13,761) (2,781)
--------- -------- --------- ---------
Other comprehensive income (loss) before taxes.......... (94,697) (17,061) 9,408 8,053
Income tax benefit (provision) on other comprehensive
income (loss)......................................... 39,874 6,202 (11,308) (4,214)
--------- -------- --------- ---------
Comprehensive loss........................................ $(140,736) $(72,776) $(287,578) $(102,005)
========= ======== ========= =========
</TABLE>
The unrealized loss on securities for the three months ended September 30,
1999 was due primarily to the decline in the stock price of WCG's investment in
Concentric Network Corporation.
10. CONTINGENCIES
WCG is subject to various types of litigation in connection with its
business and operations. However, with the possible exception of the Shrier and
Oxford lawsuits described below, WCG does not believe that any of the pending
litigation is material to WCG's business and operations.
Shrier v. Williams was filed on August 4, 1999, in the U.S. District Court
for the Northern District of Oklahoma. Oxford v. Williams was filed on September
3, 1999, in a state court in Jefferson County, Texas. The Oxford complaint was
amended to add an additional plaintiff on September 24, 1999. On October 1,
1999, the case was removed to the U.S. District Court for the Eastern District
of Texas, Beaumont Division. In each lawsuit, the plaintiff seeks to bring a
nationwide class action on behalf of all landowners on whose property the
plaintiffs have alleged WCG installed fiber optic cable without the permission
of the landowner. The plaintiffs are seeking a declaratory ruling that WCG is
trespassing, damages resulting from the alleged
13
<PAGE> 15
WILLIAMS COMMUNICATIONS GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
trespass, damages based on WCG's profits from use of the property and damages
from alleged fraud. Relief requested by the plaintiff includes injunction
against further trespass, actual and punitive damages and attorneys' fees.
WCG believes that installation of the cable containing the single fiber
network that crosses over or near the named plaintiffs' land does not infringe
on the plaintiffs' property rights. WCG also does not believe that the plaintiff
has sufficient basis for certification of a class action. The proposed
composition of the class in the Oxford lawsuit appears to include only
landowners who would also be included in the class proposed in the Shrier suit.
Other communications carriers have been successfully challenged with
respect to their rights to use railroad rights of way, which are also challenged
by the plaintiffs, in Shrier and Oxford. Approximately 15% of the WCG network is
installed on railroad rights of way. In many areas, the railroad granting WCG
the license holds full ownership of the land, in which case its license should
be sufficient to give WCG valid rights to cross the property. In some states
where the railroad is not the property owner but has an easement over the
property the law is unsettled as to whether a landowner's approval is required.
WCG generally did not obtain landowner approval where the rights of way are
located on railroad easements. In most states, WCG has eminent domain rights
which WCG believes would limit the liability for any trespass damages. It is
likely that WCG will be subject to other purported class action suits
challenging the use of railroad or pipeline rights of way, but WCG cannot
quantify the impact of such claims at this time. Thus, WCG cannot be certain
that the plaintiffs' purported class action or other purported class actions, if
successful, will not have a material adverse effect.
WCG is a party to various other claims, legal actions and complaints
arising in the ordinary course of business. In the opinion of management, the
ultimate resolution of all claims, legal actions and complaints after
consideration of amounts accrued, insurance coverage, or other indemnification
arrangements will not have a materially adverse effect upon WCG's future
financial position, results of operations or cash flows.
14
<PAGE> 16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
Included in the tables below are financial data related to EBITDA. EBITDA
represents earnings before interest, income taxes, depreciation and amortization
and other non-recurring or non-cash items, such as equity earnings or losses and
minority interest. Excluded from the computation of the third quarter 1999
EBITDA are charges of $2.6 million in selling, general and administrative
expenses, related to the impact of converting Williams options and shares to WCG
options and shares in conjunction with the initial public offering of WCG
shares. Excluded from the computation of the nine months ended September 30,
1999 EBITDA are charges of $2.6 million discussed above and $26.7 million in
other expense related to the sale of WCG's audio and video conferencing and
closed circuit broadcasting services businesses. Excluded from the computation
of the three and nine months ended September 30, 1998 EBITDA are charges of
$23.2 million in other expense related to exiting a venture in the strategic
investments unit involved in the transmission of business information for news
and educational purposes. EBITDA is used by management and certain investors as
an indicator of a company's historical ability to service existing debt.
Management believes that an increase in EBITDA is an indicator of improved
ability to service existing debt, to sustain potential future increases in debt
and to satisfy capital requirements. However, EBITDA is not intended to
represent cash flows for the period, nor has it been presented as an alternative
to either operating income, as determined by generally accepted accounting
principles, nor as an indicator of operating performance or cash flows from
operating, investing and financing activities, as determined by generally
accepted accounting principles, and is thus susceptible to varying calculations.
EBITDA as presented may not be comparable to other similarly titled measures of
other companies. Under the terms of WCG's long-term credit facility, the
discretionary use of funds reflected by EBITDA is limited in order to conserve
funds for capital expenditures and debt service.
The table below summarizes WCG's consolidated results for the three months
and the nine months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
1999 1998 1999 1998
-------- -------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Network............................... $ 86,034 $ 33,486 $ 283,423 $ 85,528
Solutions............................. 359,004 344,893 1,051,496 1,016,989
Strategic Investments................. 63,977 57,381 197,446 159,993
Eliminations.......................... (10,675) (12,640) (32,886) (37,664)
-------- -------- ---------- ----------
Total revenues................ 498,340 423,120 1,499,479 1,224,846
Operating costs:
Cost of sales......................... 391,338 308,552 1,157,080 895,790
Selling, general and administrative... 137,732 120,717 402,584 327,713
Provision for doubtful accounts....... 5,318 2,756 17,128 5,452
Depreciation and amortization......... 34,226 21,359 96,338 62,118
Other................................. 444 29,628 27,357 30,661
-------- -------- ---------- ----------
Total operating expenses...... 569,058 483,012 1,700,487 1,321,734
-------- -------- ---------- ----------
Loss from operations.................... $(70,718) $(59,892) $ (201,008) $ (96,888)
======== ======== ========== ==========
EBITDA.................................. $(33,892) $(15,383) $ (75,416) $ (11,620)
======== ======== ========== ==========
</TABLE>
THIRD QUARTER 1999 VS. THIRD QUARTER 1998
Consolidated Results
WCG experienced a net loss of $85.9 million for the quarter ended September
30, 1999 compared to a net loss of $61.9 million for the same period in 1998, an
increase of $24.0 million from the prior period. The increase in net loss
included an increase in losses from operations of $10.8 million, an increase in
equity losses
15
<PAGE> 17
of $4.2 million, an increase in net interest expense of $22.6 million and a $.3
million increase in investing losses, somewhat offset by a change in minority
interest results of $6.8 million. Net loss was decreased by a $7.1 million
increase in the tax benefit recorded pursuant to a tax sharing agreement with
Williams (see Note 5 -- Notes to Condensed Consolidated Financial Statements).
WCG's network unit accounted for $32.4 million of the increase in losses
from operations and WCG's solutions unit accounted for $9.7 million of the
increase in losses from operations, partially offset by WCG's strategic
investments unit which accounted for a $31.3 million decrease in losses from
operations. The decrease in losses at the strategic investment unit is primarily
due to the third quarter 1998 write-down of $23.2 million related to the
abandonment of a venture involved in the technology and transmission of business
information.
WCG's network unit
The table below summarizes WCG's network unit's results for the three
months and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Dark fiber....................................... $ 9,354 $ -- $ 81,281 $ --
Leased capacity and other........................ 62,510 19,339 159,365 42,621
Intercompany..................................... 10,628 12,510 32,575 37,260
Affiliates....................................... 3,542 1,637 10,202 5,647
-------- -------- -------- --------
Total revenues........................... 86,034 33,486 283,423 85,528
Operating costs:
Cost of sales.................................... 87,835 30,662 273,693 71,630
Selling, general and administrative.............. 27,550 10,955 70,934 31,796
Provision for doubtful accounts.................. 558 1 598 43
Depreciation and amortization.................... 13,933 3,257 27,414 8,392
Other............................................ (8) -- (6) 203
-------- -------- -------- --------
Total operating expenses................. 129,868 44,875 372,633 112,064
-------- -------- -------- --------
Loss from operations............................... $(43,834) $(11,389) $(89,210) $(26,536)
======== ======== ======== ========
</TABLE>
WCG's network unit's revenues increased $52.5 million, or 157%, to $86.0
million for the quarter ended September 30, 1999 from $33.5 million for the same
period in 1998. The increase was primarily due to a $35.8 million increase in
revenues from services provided to network customers, $9.4 million of revenues
from dark fiber leases for transactions entered into prior to June 30, 1999 and
accordingly accounted for as sales-type leases and a $6.6 million increase in
revenues from consulting and outsourcing services.
WCG's network unit's gross margin decreased to a $1.8 million loss for the
quarter ended September 30, 1999 from a $2.8 million profit for the same period
in 1998 while gross margin decreased to a 2% loss for the quarter ended
September 30, 1999 from a 8% profit for the same period in 1998. Cost of sales
increased $57.1 million, or 186%, to $87.8 million for the quarter ended
September 30, 1999 from $30.7 million for the same period in 1998 due primarily
to $23.0 million of higher off-net capacity costs incurred prior to the
completion of the network currently under construction, $16.0 million of higher
operating and maintenance expenses, $6.5 million higher local access connection
costs, $6.0 million higher costs associated with consulting and outsourcing
services and $2.5 million related to construction cost associated with dark
fiber leases.
WCG's network unit's selling, general and administrative expenses increased
$16.6 million, or 151%, to $27.6 million for the quarter ended September 30,
1999 from $11.0 million for the same period in 1998 due
16
<PAGE> 18
primarily to an increase in the number of employees and the expansion of the
infrastructure to support the network currently under construction including
$3.7 million of start-up costs associated with the development of voice services
in 1999.
WCG's network unit's depreciation and amortization increased $10.6 million,
or 328%, to $13.9 million for the quarter ended September 30, 1999 from $3.3
million for the same period in 1998 due primarily to completion of various
segments of its network.
WCG's solutions unit
The table below summarizes WCG's solutions unit's results for the three
months and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -----------------------
1999 1998 1999 1998
-------- -------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
New systems and upgrades...................... $214,688 $209,906 $ 618,506 $ 589,703
Maintenance and customer service orders....... 138,505 133,202 409,936 422,535
Other......................................... 4,624 912 19,772 2,238
Affiliates.................................... 1,187 873 3,282 2,513
-------- -------- ---------- ----------
Total revenues........................ 359,004 344,893 1,051,496 1,016,989
Operating costs:
Cost of sales................................. 263,858 245,508 765,555 732,543
Selling, general and administrative........... 91,287 85,405 269,104 237,723
Provision for doubtful accounts............... 4,595 2,280 15,710 3,816
Depreciation and amortization................. 12,051 9,540 34,737 28,242
Other......................................... 304 5,584 428 5,442
-------- -------- ---------- ----------
Total operating expenses.............. 372,095 348,317 1,085,534 1,007,766
-------- -------- ---------- ----------
Income (loss) from operations................... $(13,091) $ (3,424) $ (34,038) $ 9,223
======== ======== ========== ==========
</TABLE>
WCG's solutions unit's revenues increased $14.1 million, or 4%, to $359.0
for the quarter ended September 30, 1999 from $344.9 million for the same period
in 1998. The increased revenues were attributable to increases of $5.3 million
in maintenance and customer service orders, $4.8 million in new systems and
upgrades and $2.7 million in professional services. The increase in professional
services is primarily attributable to the October 1998 acquisition of Computer
Network Group, Inc.
WCG's solutions unit's gross profit decreased to $95.1 million for the
quarter ended September 30, 1999 from $99.4 million for the same period in 1998,
while gross margin decreased to 27% for the quarter ended September 30, 1999
from 29% for the same period in 1998. Cost of sales increased $18.4 million, or
7%, to $263.9 million for the quarter ended September 30, 1999 from $245.5
million for the same period in 1998. The increase in cost is due primarily to
higher costs associated with new systems and upgrades offset by reduced costs
for maintenance and customer service orders. The decline in gross margin is a
result of increased competitive pressures in the voice equipment business.
WCG's solutions unit's selling, general and administrative expenses
increased $5.9 million, or 7%, to $91.3 million for the quarter ended September
30, 1999 from $85.4 million for the same period in 1998. The increase in
selling, general and administrative expense was primarily due to $5.4 million in
higher information technology and other business integration costs associated
with the implementation of new systems, a $1.7 million increase in business
consulting services in support of sales efforts and a $1.6 million charge for
the conversion and vesting of employee stock options from Williams to WCG stock
options at the time of the WCG initial equity offering. These increases were
partially offset by a $2.2 million reduction of marketing costs.
17
<PAGE> 19
WCG's solutions unit's provisions for doubtful accounts increased $2.3
million, or 102%, to $4.6 million for the quarter ended September 30, 1999 from
$2.3 million for the same period in 1998. The increase in provisions reflects
adjustments to reserves based on unresolved billing and collection issues.
WCG's solutions unit's depreciation and amortization increased $2.6
million, or 26%, to $12.1 million for the quarter ended September 30, 1999 from
$9.5 million for the same period in 1998. The increase is attributable to $1.4
million of depreciation on systems implemented in 1999 and $.7 million of
amortization relating to the acquisition of Computer Network Group, Inc in
October 1998.
WCG's solutions unit's other operating expense decreased $5.3 million, or
95%, to $.3 million for the quarter ended September 30, 1999 from $5.6 million
for the same period in 1998, primarily due to a third quarter 1998 non-cash
charge of $5.6 million related to the abandonment of capitalized software costs
in favor of new systems.
WCG's strategic investments unit
The table below summarizes WCG's strategic investments unit's results for
the three months and nine months ended September 30, 1999 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Vyvx Services.................................... $ 39,458 $ 41,123 $119,426 $120,812
PowerTel......................................... 13,361 4,590 32,684 4,590
Other............................................ 11,111 11,538 45,025 34,187
Intercompany..................................... 47 130 311 404
-------- -------- -------- --------
Total revenues........................... 63,977 57,381 197,446 159,993
Operating costs:
Cost of sales.................................... 50,320 45,022 150,718 129,281
Selling, general and administrative.............. 18,895 24,357 62,546 58,194
Provision for doubtful accounts.................. 165 475 820 1,593
Depreciation and amortization.................... 8,242 8,562 34,187 25,484
Other............................................ 148 24,044 26,935 25,016
-------- -------- -------- --------
Total operating expenses................. 77,770 102,460 275,206 239,568
-------- -------- -------- --------
Income (loss) from operations...................... $(13,793) $(45,079) $(77,760) $(79,575)
======== ======== ======== ========
ATL and other equity losses........................ $ (9,592) $ (5,290) $(28,274) $ (8,029)
======== ======== ======== ========
</TABLE>
WCG's strategic investments unit's revenues increased $6.6 million, or 11%,
to $64.0 million for the quarter ended September 30, 1999 from $57.4 million for
the same period in 1998 primarily due to the August 14, 1998 acquisition of
PowerTel which had $8.8 million of increased revenues and the October 23, 1998
acquisition of Intersys which had $6.1 million of increased revenues and a $7.4
million decrease of revenues related to the July 31, 1999 sale of audio and
video conferencing services and closed-circuit video broadcasting services
businesses.
WCG's strategic investments unit's gross profit increased to $13.7 million
for the quarter ended September 30, 1999 from $12.4 million for the same period
in 1998 while gross margin decreased to 21% for the quarter ended September 30,
1999 from 22% for the same period in 1998. Cost of sales increased $5.3 million,
or 12%, to $50.3 million for the quarter ended September 30, 1999 from $45.0
million for the same period in 1998 primarily due to a $6.4 million increase
related to the PowerTel acquisition, a $5.1 million increase related to the
Intersys acquisition and a $2.2 million increase in other various investment
companies offset by decreases of $5.2 million related to the July 31, 1999 sale
of audio and video conferencing services
18
<PAGE> 20
and closed-circuit video broadcasting services businesses and $4.3 million
related to the video transmission business.
WCG's strategic investments unit's selling, general and administrative
expenses decreased $5.5 million, or 22%, to $18.9 million for the quarter ended
September 30, 1999 from $24.4 million for the same period in 1998 primarily due
to a $3.1 million charge in the third quarter of 1998 related to exiting the
learning content business and a decrease of expenses of $4.5 million related to
the July 31, 1999 sales of audio and video conferencing services and
closed-circuit video broadcasting services businesses, offset by an increase of
$3.6 million related to the PowerTel acquisition.
WCG's strategic investments unit's other operating expense for the quarter
ended September 30, 1998 includes a $23.2 million charge related to exiting a
venture involved in the transmission of business information for news and
educational purposes.
WCG's strategic investments unit's equity losses increased $4.3 million, or
81%, to $9.6 million for the quarter ended September 30, 1999 from $5.3 million
for the same period in 1998 primarily due to start-up losses related to ATL's
construction of a digital cellular network in Brazil.
Consolidated non-operating costs
WCG's net interest expense for the quarter ended September 30, 1999
increased $22.6 million from the same period in 1998 as interest expense
incurred to finance operations and capital expenditures exceeded amounts
capitalized for the quarter by $22.6 million. The change in minority interest
increased $6.8 million for the quarter ended September 30, 1999 compared to the
same period in 1998 of which $3.0 million is attributable to the solutions unit
and $3.8 million is attributable to PowerTel.
For the quarter ended September 30, 1999, WCG recorded a tax benefit of
$8.9 million compared to a tax benefit of $1.8 million for the same period in
1998. The increase in the tax benefit is primarily due to changes in estimates
related to deferred tax liabilities pursuant to a tax sharing agreement with
Williams (see Note 5 - Notes to Condensed Consolidated Financial Statements).
NINE MONTHS ENDED SEPTEMBER 30, 1999 VS. NINE MONTHS ENDED SEPTEMBER 30, 1998
Consolidated Results
WCG experienced a net loss of $285.7 million for the nine months ended
September 30, 1999 compared to a net loss of $105.8 million for the same period
in 1998, an increase of $179.9 million from the prior period. The increase in
net loss included an increase in losses from operations of $104.1 million, an
increase in equity losses of $18.3 million, an increase in net interest expense
of $42.8 million and an increase in other expense of $.7 million, offset by a
change in minority interest results of $23.0 million and other interest income
of $3.2 million. Net loss was also increased by $40.0 million pursuant to a tax
sharing agreement with Williams (see Note 5 - Notes to Condensed Consolidated
Financial Statements).
WCG's network unit accounted for $62.7 million of the increase in losses
from operations and WCG's solutions unit accounted for $43.3 million of the
increase in losses from operations, partially offset by WCG's strategic
investments unit which accounted for a $1.8 million decrease in losses from
operations.
WCG's network unit
WCG's network unit's revenues increased $197.9 million, or 231%, to $283.4
million for the nine months ended September 30, 1999 from $85.5 million for the
same period in 1998. The increase is primarily due to a $103.8 million increase
in revenues from services provided to network customers, $81.3 million of
revenues from dark fiber leases for transactions entered into prior to June 30,
1999 and accordingly accounted for as sales-type leases and a $12.9 million
increase in revenues from consulting and outsourcing services.
WCG's network unit's gross profit decreased to $9.7 million for the nine
months ended September 30, 1999 from $13.9 million for the same period in 1998
while gross margin decreased to 3% for the nine months
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ended September 30, 1999 from 16% for the same period in 1998. Cost of sales
increased $202.1 million, or 282%, to $273.7 million for the nine months ended
September 30, 1999 from $71.6 million for the same period in 1998 due primarily
to $70.1 million of higher off-net capacity costs incurred prior to the
completion of the network currently under construction, $56.7 million related to
construction cost associated with dark fiber leases, $32.0 million of higher
operating and maintenance expenses, $15.4 million higher local access connection
costs and $12.3 million higher costs associated with consulting and outsourcing
services.
WCG's network unit's selling, general and administrative expenses increased
$39.1 million, or 123%, to $70.9 million for the nine months ended September 30,
1999 from $31.8 million for the same period in 1998 due primarily to an increase
in the number of employees, the expansion of the infrastructure to support the
network currently under construction including $12.5 million of start-up costs
associated with the development of voice services in 1999.
WCG's network unit's depreciation and amortization increased $19.0 million,
or 227%, to $27.4 million for the nine months ended September 30, 1999 from $8.4
million for the same period in 1998 due primarily to completion of various
segments of its network.
WCG's solutions unit
WCG's solutions unit's revenues increased $34.5 million, or 3%, to $1,051.5
million for the nine months ended September 30, 1999 from $1,017.0 million for
the same period in 1998. The increased revenues were attributable to increases
of $28.8 million in new systems and upgrades due to higher demand for voice
equipment, $7.9 million in professional services, $6.1 million from the sale of
equipment residuals and $3.5 million in other revenues offset by a decrease of
$12.6 million in maintenance and customer service orders revenues. The increase
in professional services revenue is primarily attributable to the October 1998
acquisition of Computer Network Group, Inc.
WCG's solutions unit's gross profit increased to $285.9 million for the
nine months ended September 30, 1999 from $284.4 million for the same period in
1998, while gross margin decreased to 27% for the nine months ended September
30, 1999 from 28% for the same period in 1998. Cost of sales increased $33.1
million, or 5%, to $765.6 for the nine months ended September 30, 1999 from
$732.5 million for the same period in 1998. The increase in cost of sales is
consistent with the increased revenues. The slight decline in gross margin is a
result of increased competitive pressures in the voice equipment business.
WCG's solutions unit's selling, general and administrative expenses
increased $31.4 million, or 13%, to $269.1 million for the nine months ended
September 30, 1999 from $237.7 million for the same period in 1998. The increase
in selling, general and administrative expense is primarily due to $16.5 million
in higher technological and infrastructure support costs associated with the
implementation of new systems and processes of which $12.9 million is directly
related to increased information technology and business integration costs, $6.6
million of higher salaries and wages costs, a $3.4 million increase in business
consulting services in support of sales efforts, $3.1 million related to a
Williams-wide stock performance incentive and a $1.6 million charge for the
conversion and vesting of employee stock options from Williams to WCG stock
options at the time of the WCG initial equity offering.
WCG's solutions unit's provisions for doubtful accounts increased $11.9
million, or 312%, to $15.7 million for the nine months ended September 30, 1999
from $3.8 million for the same period in 1998. The increase in provisions
reflects adjustments to reserves based on unresolved billing and collection
issues.
WCG's solutions unit's depreciation and amortization increased $6.5
million, or 23%, to $34.7 million for the nine months ended September 30, 1999
from $28.2 million for the same period in 1998. The increase is primarily due to
$2.6 million of depreciation on systems implemented in 1999 and $2.2 million of
amortization relating to the acquisition of Computer Network Group, Inc. in
October 1998.
WCG's solutions unit's other operating expense decreased $5.0 million, or
92%, to $.4 million for the nine months ended September 30, 1999 from $5.4
million for the same period in 1998, primarily due to a third quarter 1998
non-cash charge of $5.6 million related to the abandonment of capitalized
software costs in favor of new systems.
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WCG's strategic investments unit
WCG's strategic investments unit's revenues increased $37.4 million, or
23%, to $197.4 million for the nine months ended September 30, 1999 from $160.0
million for the same period in 1998 primarily due to the August 14, 1998
acquisition of PowerTel which had $28.1 million of increased revenues and the
October 23, 1998 acquisition of Intersys which had $13.6 million of increased
revenues and a $5.0 million decrease of revenues related to the July 31, 1999
sale of audio and video conferencing services and closed-circuit video
broadcasting services businesses.
WCG's strategic investments unit's gross profit increased to $46.7 million
for the nine months ended September 30, 1999 from $30.7 million for the same
period in 1998 while gross margin increased to 24% for the nine months ended
September 30, 1999 from 19% for the same period in 1998. Cost of sales increased
$21.4 million, or 17%, to $150.7 million for the nine months ended September 30,
1999 from $129.3 million for the same period in 1998 primarily due to a $23.1
million increase related to the PowerTel acquisition, an $11.5 million increase
related to the Intersys acquisition, and other various increases of $6.2
million. These increases are offset by a $15.0 million decrease of costs related
to the video transmission business and a $4.4 million decrease related to the
July 31, 1999 sale of audio and video conferencing services and closed-circuit
video broadcasting services businesses.
WCG's strategic investments unit's selling, general and administrative
expenses increased $4.3 million, or 7%, to $62.5 million for the nine months
ended September 30, 1999 from $58.2 million for the same period in 1998
primarily due to a $13.0 million increase related to the PowerTel acquisition
and a $2.7 million increase related to the Intersys acquisition. These increases
are offset by a $5.2 million decrease related to the video transmission
business, a $5.0 million decrease related to the July 31, 1999 sale of audio and
video conferencing services and closed-circuit video broadcasting services
businesses and various other decreases of approximately $1.2 million.
WCG's strategic investments unit's depreciation and amortization increased
$8.7 million, or 34%, to $34.2 million for the nine months ended September 30,
1999 from $25.5 million for the same period in 1998 primarily due to $3.9
million related to the acquisition of PowerTel and a $5.7 million increase
related to a stadium seat touch-screen display business offset by a $1.7 million
decrease related to the sale of audio and video conferencing services and
closed-circuit video broadcasting services businesses.
WCG's strategic investment unit's other operating expense for the nine
months ended September 30, 1999 includes a $26.7 million charge related to the
sale of audio and video conferencing and closed-circuit video broadcasting
services businesses. Other operating expense for the same period in 1998
includes $23.2 million of charges related to exiting a venture involved in the
transmission of business information for news and educational purposes.
WCG's strategic investments unit's equity losses increased $20.2 million,
or 252%, to $28.3 million for the nine months ended September 30, 1999 from $8.0
million for the same period in 1998 primarily due to start-up losses related to
ATL's construction of a digital cellular network in Brazil.
Consolidated non-operating costs
WCG's net interest expense for the nine months ended September 30, 1999
increased $42.8 million from the same period in 1998 as interest expense
incurred to finance operations and capital expenditures exceeded interest
amounts capitalized. The change in minority interest increased $23.0 million for
the nine months ended September 30, 1999 compared to the same period in 1998 of
which $13.2 million is attributable to the solutions unit and $9.8 million is
attributable to PowerTel.
For the nine months ended September 30, 1999, WCG recorded a tax provision
of $37.0 million compared to a tax benefit of $3.0 million for the same period
in 1998. The increase in the tax provision is primarily due to an increase in
deferred taxes pursuant to a tax sharing agreement with Williams. The
depreciation currently being incurred results in a significant deferred tax
expense in 1999 with no current benefit for the net operating losses generated,
as a result of the tax sharing agreement entered into with Williams (see Note
5 -- Notes to Condensed Consolidated Financial Statements).
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LIQUIDITY AND CAPITAL RESOURCES
Cash sources
WCG's operations do not currently provide net positive cash flow.
Accordingly, prior to the completion of its equity and high yield offerings, WCG
funded capital expenditures, acquisitions and other cash needs through a
combination of borrowings and capital contributions from Williams as well as
external borrowings when required. As a result of the recently completed
offerings and entering into a long-term credit facility, which are discussed
below, WCG plans on financing future cash outlays through internally generated
and external funds without relying on cash advances, credit support or
contributions from Williams.
During 1998, WCG entered into an asset defeasance program. The asset
defeasance program provides cash which WCG may use, as agent for a trust, to buy
and install fiber optic cable and equipment in order to construct portions of
the network that WCG will lease upon completion. WCG has the right to acquire
the assets from the lessor upon expiration of the lease. The lessor is a trust
formed for the purpose of obtaining funding for network construction. The
maximum amount available under this asset defeasance program is $750 million. As
of September 30, 1999, approximately $547 million had been spent under this
program for the network and there was an additional $203 million available.
Obligations under the lease are partially guaranteed by Williams.
In September 1999, WCG (through WCI) entered into a $1.05 billion credit
facility to replace an interim credit facility. As of September 30, 1999, the
long-term credit facility was guaranteed by Williams. Williams is expected to be
released from the guarantee in the fourth quarter of 1999. At September 30,
1999, WCG had $500 million outstanding under this facility all of which was
repaid in October 1999. WCG also entered into a $750 million short-term loan
facility in September 1999 to provide funds to repay a portion of the borrowings
on the interim credit facility and to finance capital expenditures for its
business units through the completion of the offerings. Borrowings under this
short-term loan facility totaled $625 million at September 30, 1999, all of
which were repaid in October upon the completion of the offerings.
WCG's offerings were declared effective in September 1999 and trading on
the high yield public debt began on September 30, 1999 and trading on the equity
securities began on October 1, 1999. Proceeds from the offerings were received
in October 1999 and consisted of approximately $1.94 billion from the high yield
offering and approximately $1.47 billion from the equity offering. Included in
the equity offering proceeds were amounts from concurrent investors as follows:
SBC Communications of $438.5 million for a 4.36% ownership in WCG, $200 million
from Intel for a 2.00% ownership in WCG and $100 million from Telefonos de
Mexico for a 1.00% ownership in WCG. The remaining equity proceeds received
represented a 7.34% ownership. Williams retained an 85.3% ownership. The
proceeds from the equity and high yield offerings are to be used to develop and
light the network currently under construction, repay portions of debt, fund
operating losses and for working capital and general corporate purposes.
After the completion of the offerings in October, WCG subsequently
re-characterized $200 million from paid-in capital to amounts due to Williams
resulting in approximately $1.0 billion in borrowings from Williams. WCG will
pay a floating interest rate on borrowings from Williams equal to LIBOR plus a
margin based on its credit rating.
Cash uses
Network capital expenditures -- WCG's primary anticipated cash need is
funding capital expenditures for its network unit for construction costs
including the purchase and deployment of fiber optic cable, equipment costs and
other costs including capitalized interest. WCG's network's construction
contracts typically cover all or a portion of a cable construction project.
While WCG's network may use the same contractors on different projects, it has
no long-term construction agreements. WCG's network has long-term equipment
purchase contracts with Nortel and Ascend Communications Inc. WCG spent
approximately $1.6 billion under its network capital plan through September 30,
1999. WCG estimates that during the period from October 1, 1999 through December
31, 2000, it will spend a total of approximately $2.3 billion on its network.
This amount includes expenditures made under the asset defeasance program, as
agent for the trust, and expenditures made for dark fiber.
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Other business units and corporate level capital expenditures -- WCG
expects to spend approximately $184 million in other business units and
corporate level expenditures from October 1, 1999 through December 31, 2000
including $77 million for the construction of PowerTel's network, approximately
$49 million for corporate level leasehold improvements and equipment,
approximately $37 million for systems upgrades and equipment for the solutions
business unit, approximately $14 million for equipment for Vyvx and
approximately $7 million for other items.
Payments for wireless capacity -- At September 30, 1999, WCG had payments
of approximately $255 million, payable over four years, remaining on its $400
million commitment under an agreement with Winstar. The payments required during
the period from October 1, 1999 through December 31, 2000 will be approximately
$175 million.
Debt service payments -- WCG estimates that during the period from October
1, 1999 through December 31, 2000 it will pay approximately $370 million in
interest expense, based on a weighted average rate of interest of 10.8% on the
notes and average LIBOR over this period of 5.75%. WCG also estimates that it
will repay approximately $25 million in principal under its approximately $1.0
billion Williams note, after re-characterization of paid-in capital amounts,
during this period.
Lease payments under asset defeasance program -- WCG expects that during
the period from October 1, 1999 through December 31, 2000 it will pay
approximately $55 million in lease payments under the asset defeasance program.
Other -- Proceeds from the offerings will also be used to fund net
operating deficits, for working capital and for other general corporate
purposes.
WCG believes that the net proceeds from the offerings, the concurrent
investments, the amount funded by Williams, borrowings under bank facilities,
the funds available under the asset defeasance program, proceeds from grants of
dark fiber rights and cash on hand will be sufficient to satisfy anticipated
cash requirements at least through the end of 2000.
WCG's debt agreements contain restrictive covenants and require it to meet
certain financial ratios and tests. These agreements will restrict WCG's ability
to borrow additional money, pay dividends or other distributions to
stockholders, make investments, create liens on assets and sell assets.
YEAR 2000 READINESS DISCLOSURE
WCG's State of Readiness
Beginning on January 1, 2000, many installed computer systems and software
products must either accept four digit entries to distinguish the year 2000 and
all subsequent years from the year 1900 or be modified to recognize the change
of the century even if there are only two digits being used.
WCG, with Williams, established a plan in 1997 to address Year 2000 issues
relating to the areas of its business that could be impacted by the date and
time change from 1999 to 2000. WCG is reviewing its products and services as
well as its internal systems in order to identify and modify the products,
services and systems that are date-and time-sensitive. These areas include:
- traditional informational technology
- non-traditional informational technology
- external interfaces with customers and vendors
WCG's traditional information technology, or IT, includes software,
applications, data and related computer hardware equipment, such as mainframe
and personal or midrange computers. WCG's non-traditional technology, or Non-IT,
includes all computer hardware, network hardware, plant equipment and other
embedded items that contain date-sensitive code. Examples of Non-IT include
elevator control systems, card key access systems and telecommunications
equipment.
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Also in 1997, Williams established a Year 2000 committee to oversee
management and execution of the plan. The Year 2000 issue is being addressed in
the following phases:
- awareness
- inventory and assessment
- renovation and replacement
- testing and validation
The initial phase, awareness, is a continuing process intended to heighten
awareness of Year 2000 issues both within WCG and among its customers.
WCG has completed the inventory and assessment phase. During this phase,
WCG inventoried and classified all systems with possible Year 2000 implications
into the following categories:
- highest, compliance is business critical
- high, compliance necessary within a short period of time following
January 1, 2000
- medium, compliance necessary within 30 days from January 1, 2000
- low, compliance desirable but not required
- unnecessary
WCG designated the first three categories above as critical and as its
major focus. Critical systems are systems that directly support customer systems
and applications for WCG's products and services customer base. Examples of
critical systems include solutions unit's "SIMS" database, which holds the
solutions unit's customer records, and network unit's provisioning and ordering
fulfillment system.
WCG split the inventory and assessment phase into two categories, IT and
Non-IT. WCG hired an external contractor as a consultant to provide support
services for the IT assessment. Third-party software information was compared
with the contractor's master product compliance database to determine Year 2000
compliance status. Vendors were contacted for software not found in this master
database. The systems identified in the assessment phase included all date- and
time-sensitive hardware and embedded items. The Non-IT assessment was developed
to ensure that all computer hardware, network hardware and plant equipment
continues to operate without interruption up to and beyond the rollover to the
year 2000. The systems identified in the assessment included both manned sites
and unmanned network sites as well as other Non-IT systems.
For the testing and validation phases, a Year 2000 test lab capable of
testing almost any software is in place and operational. All critical IT and
Non-IT systems have been fully tested or otherwise validated as compliant. An
example of another way a system is validated as compliant is when a business
process is determined not to be date- and time-sensitive. Some non-critical
systems that will not have a material impact on WCG business may not be
compliant until after January 1, 2000.
WCG has initiated a formal communications process with customers, vendors,
service providers and other companies to determine the extent to which these
companies are addressing Year 2000 compliance. In connection with this process,
as of September 30, 1999 WCG has sent approximately 9000 letters and
questionnaires to third parties who have conducted business with WCG during the
last three years. While the response rate has been 37% overall, the response
rate is higher from critical business partners. For example, there is a 72%
response rate from IT business partners, a 78% response rate from Non-IT
partners and a 44% response rate from lessors. Virtually all of these companies
have indicated that they are already compliant or will be compliant on a timely
basis. WCG has identified the most critical business partners and are currently
in the process of determining the amount of risk to which WCG may be exposed.
Where necessary, WCG will be working with key business partners to reduce the
risk of a break in service or supply and with non-compliant companies to
mitigate any material adverse effect on business.
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WCG has utilized both internal resources and external contractors to
complete the Year 2000 compliance project. WCG has a core group of 13 people who
are responsible for coordinating, organizing, managing, communicating, and
monitoring the project and another estimated 80 staff members are responsible
for completing the project. Depending on which phase the project is in and what
area is being focused on at any given point in time, there can be an additional
50 to 250 employees working on completion of the project. The estimated cost of
external contractors is approximately $3.5 million.
Costs of Year 2000 Compliance
WCG expects to incur total costs of $11.5 million to address the Year 2000
issue. Of this total, approximately $500,000 is expected to be incurred for new
software and hardware purchases and will be capitalized with the remaining
amounts expensed. Through September 30, 1999, approximately $9.9 million has
been expensed and $350,000 has been capitalized. The $11.5 million in total
costs has been or is expected to be spent as follows:
- First quarter 1998. Prior to and during the first quarter of 1998, WCG
conducted the project awareness and inventory and assessment phases of
the project and incurred costs totaling $200,000.
- Second quarter 1998. WCG spent $700,000 on renovation and replacement and
the completion of the inventory and assessment phase.
- Third and fourth quarter 1998. WCG focused on the renovations and
replacement, and testing and validation phases in which a cost of
approximately $2.5 million was incurred.
- First quarter 1999. Renovations and replacement and testing and
validation continued, and contingency planning began. WCG spent
approximately $2 million during the first quarter of 1999.
- Second quarter 1999. Primary focus shifted to testing and validation and
contingency planning and final testing, with approximately $3 million
spent.
- Third quarter 1999. Focused primarily on contingency planning and final
testing and spent approximately $1.8 million.
- Fourth quarter 1999. WCG will focus primarily on contingency planning and
estimates that it will spend approximately $800,000.
- First and second quarters 2000. WCG will be managing and reporting Year
2000 issues and estimates an additional $450,000 will be spent over this
period.
Of the approximately $1.3 million of future costs necessary to complete the
project on schedule, approximately $1.1 million will be expensed and the
remainder capitalized. This estimate does not include WCG's potential share of
Year 2000 costs that may be incurred by partnerships and joint ventures in which
WCG participates but is not the operator. The costs of previously planned system
replacements are not considered to be Year 2000 costs and are therefore excluded
from the amounts discussed above.
Risks Associated with Year 2000 Issues
WCG's estimates of costs associated with the project and of the completion
dates are based on best estimates, derived by utilizing numerous assumptions of
future events, including the continued availability of resources, third-party
Year 2000 compliance modifications plans and other factors. WCG expects the
necessary modifications will be made on a timely basis and does not believe that
the cost of these modifications will have a material adverse effect on its
business, financial conditions and operating results. However, in part due to
the unavailability and high cost of trained personnel, the difficulty locating
all relevant computer code, reliance on third-party suppliers and vendors and
the ability to implement interfaces between the new systems and the systems
being replaced, there is a possibility of service interruptions due to
non-compliance. For example, power failures along the network would cause both
customer and internal service interruptions. WCG cannot guarantee that these
estimates or completion dates will be achieved, and actual results could differ
materially from these estimates.
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WCG has attempted to minimize risks for the Year 2000 rollover by taking
actions, which include the following:
- following a comprehensive project methodology
- ongoing coordination with the legal and audit departments
- completing an audit of the software, hardware and firmware in use at its
facilities
- determining the business criticality of the items identified and
formulating appropriate action plans
- maintaining centralized storage of project documentation and
communication with critical files kept and logged as vital records
- contacting vendors, suppliers and business partners regarding their Year
2000 compliance efforts
- issuing consistent and approved responses to external requests regarding
Year 2000 status
- conducting ongoing management reporting and awareness and training
programs for employees
- contacting customers and notifying them of plans and changes (potential
or tangible) relating to its business
- taking appropriate legal actions where required based on contractual
agreements, warranties and representations (including Year 2000 wording
in contracts, warranties, and purchase orders)
- preventing the purchase or construction of any system, tools or processes
that are not Year 2000 compliant or upgradeable before January 1, 2000
Although all critical systems over which WCG has control are planned to be
compliant and tested before the Year 2000, WCG has identified two areas of
concern. First is the possibility of service interruptions to WCG and/or its
customers due to non-compliance by third parties. Second is the delay in system
replacements scheduled for completion during 1999. WCG is closely monitoring the
status of these systems to reduce the chance of delays in completion. WCG
believes the most reasonably likely worst possible scenario would be a systems
failure beyond its control to remedy, which could materially prevent it from
operating its business. WCG believes that such a failure would likely lead to
lost revenues, increased operations costs, loss of customers or other business
interruptions of a material nature, in addition to potential claims including
mismanagement, misrepresentation or breach of contract.
Contingency Plans
WCG began initial contingency planning during 1998 and significant focus on
that phase of the project is taking place in 1999. Guidelines for that process
were issued in January 1999 in the form of a formal business continuity plan. An
external contractor has worked within each business unit to review existing
business continuity plans and to modify these plans to include Year 2000
contingency plans for the critical business processes, critical business
partners, suppliers and system replacements that may experience significant
delays.
WCG's Year 2000 contingency plan methodology is as follows:
- assess each business process for business risk and potential need for
contingency plans
- create business process contingency plans as needed based on the risk
analysis
- test the completed plans, evaluate the test results and revise plans
accordingly
- store completed plans both on-site and off-site
- maintain plan copies at the appropriate Year 2000 offices
- review and modify contingency plans as part of an ongoing change
management process
All defined business contingency plans have been completed and implemented
where appropriate. However, due to the general uncertainty inherent in the Year
2000 issue and the inability to anticipate all
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potential risks, WCG cannot ensure its ability to timely and cost effectively
resolve all post-year 2000 problems associated with the Year 2000 issue that may
affect operations and business or expose it to third party liability.
In addition to the Year 2000 committee which serves all of the business
units, WCG's solutions unit has established a Year 2000 team to assist in making
its customer base Year 2000 compliant. The team consists of marketing, legal,
operations and other shared services personnel who assess, test and validate the
telecommunications products for the solutions unit's customer base. Monetary
support for the team and the solutions unit's Year 2000 project is provided for
out of each department's budget.
WCG's solutions unit team's purpose is to educate and inform customers and
employees about Year 2000 related issues and proactively seek to implement
upgrades to bring customers into compliance. The majority of the upgrades and
new products needed to support the customer migration are available from the
manufacturers. WCG's solutions unit has launched extensive efforts including
direct and mass mailings to inform its customer base of the need to take action
to assess and if necessary, upgrade, their products to be Year 2000 compliant.
Although WCG's solutions unit believes it has sufficient resources to
provide timely support to its customers that require product migrations or
upgrades, WCG's solutions unit is continually reviewing and updating its
contingency plan to address both potential spikes in the demand for customer
support and potential problems with its suppliers. Based on customer demand,
WCG's solutions unit is reviewing its work projects to address customer service.
To ensure timely delivery from its suppliers, WCG's solutions unit is
proactively monitoring and seeking assurances from its key suppliers. However,
since the effort to provide Year 2000 compliant products and essential services
to its customers is heavily dependent on its major suppliers, interruptions or
disruptions in this supply could have an adverse material impact on WCG's
solutions unit.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
At September 30, 1999, WCG primarily had interest rate exposure related to
its existing note with Williams, $788 million outstanding, its short-term loan
facility, $625 million outstanding, and the long-term credit facility, $500
million outstanding. Subsequent to September 30, 1999, $200 million of Williams
capital contributions were re-characterized to the Williams note, and the
short-term loan facility and the long-term credit facility were repaid with the
proceeds of the WCG debt and equity offerings. Quarterly principal payments on
the note with Williams begin in July 1, 2000 with no less than $25 million
payable in any fiscal year. The debt offerings included the issuance of $1.5
billion in 10.875 percent and $500 million in 10.7 percent fixed rate senior
redeemable notes due 2009 and 2007, respectively. As a result of these
transactions, WCG has interest rate exposure related to changes in short-term
LIBOR rates related to the approximate $1 billion balance of the Williams note
which bears interest at an annual rate based on WCG's credit rating of LIBOR
plus 2.25 percent, or 7.63 percent, at September 30, 1999. WCG also has interest
rate risk related to the $2 billion in fixed rate senior redeemable notes
related to future decreases in interest rates on obligations with comparable
terms below the interest rate on the notes.
None of the arrangements described above require WCG to manage or hedge the
risks related to interest rate movements and WCG does not currently mitigate the
risk through the use of interest rate swaps or other derivative instruments.
However, WCG may choose to manage the risk associated with interest rate
movements through an appropriate balance of fixed and variable rate obligations.
To maintain an effective balance of fixed and variable obligations, WCG may
elect to enter into specific interest rate swaps or other derivative instruments
as deemed necessary.
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FOREIGN CURRENCY RISK
At September 30, 1999, WCG has a preferred stock investment in a Brazilian
telecommunications venture totaling $318 million. Estimating cash flows from
this investment is not practical given that the cash flows from or liquidation
of this investment is uncertain. The Brazilian economy has experienced
significant volatility in 1999 resulting in an approximate 37 percent reduction
in the Brazilian Real against the U.S. dollar. However, management believes the
fair value of this investment approximates the carrying value. An additional 20
percent reduction in the value of the Brazilian Real against the U.S. dollar
could result in up to a $64 million reduction in the fair value of this
investment. This analysis assumes a direct correlation in the fluctuation of the
Brazilian Real against the value of this investment. The ultimate duration and
severity of the conditions in Brazil remains uncertain, as does the long-term
impact on WCG's interests in the venture. Management presently does not utilize
derivative or other financial instruments to hedge the risk associated with the
movement in foreign currencies. However, management continually monitors
fluctuations in these currencies and will consider the use of derivative
financial instruments or employment of other investment alternatives if cash
flows or investment returns so warrant.
28
<PAGE> 30
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The effective date of WCG's first registration statements relating to WCG's
initial public offering of its Class A Common Stock and Senior Redeemable Notes,
filed on Form S-1 under the Securities Act of 1933 (Nos. 333-76007 and
333-76877, respectively), was September 30, 1999. The Class A Common Stock
commenced trading on October 1, 1999 and proceeds were received on October 6,
1999. The Senior Redeemable Notes commenced trading on September 30, 1999 and
proceeds were received on October 6, 1999. As no proceeds were received prior to
September 30, 1999, no disclosure is required for the amount of proceeds
received and how those proceeds were spent.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits were filed as part of this report:
27.1 Financial Data Schedule -- Nine Months Ended September 30, 1999
(EDGAR version only)
27.2 Financial Data Schedule -- Nine Months Ended September 30, 1998
(EDGAR version only)
(b) During the third quarter 1999, WCG did not file a Form 8-K.
29
<PAGE> 31
SIGNATURE
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.
WILLIAMS COMMUNICATIONS GROUP, INC.
--------------------------------------
(Registrant)
/s/ SCOTT E. SCHUBERT
--------------------------------------
Scott E. Schubert
Senior Vice President and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
November 11, 1999
30
<PAGE> 32
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<S> <C>
27.1 Financial Data Schedule -- Nine Months Ended September 30, 1999
27.2 Financial Data Schedule -- Nine Months Ended September 30, 1998
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 118,949
<SECURITIES> 0
<RECEIVABLES> 694,563
<ALLOWANCES> 36,881
<INVENTORY> 115,493
<CURRENT-ASSETS> 1,177,761
<PP&E> 1,624,273
<DEPRECIATION> 237,607
<TOTAL-ASSETS> 3,660,612
<CURRENT-LIABILITIES> 622,788
<BONDS> 1,914,950
0
0
<COMMON> 3,954
<OTHER-SE> 1,391,935
<TOTAL-LIABILITY-AND-EQUITY> 3,660,612
<SALES> 0
<TOTAL-REVENUES> 1,499,479
<CGS> 0
<TOTAL-COSTS> 1,683,359
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 17,128
<INTEREST-EXPENSE> 58,634
<INCOME-PRETAX> (248,694)
<INCOME-TAX> 36,984
<INCOME-CONTINUING> (285,678)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (285,678)
<EPS-BASIC> (0.72)
<EPS-DILUTED> (0.72)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 0
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 1,224,846
<CGS> 0
<TOTAL-COSTS> 1,316,282
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 5,452
<INTEREST-EXPENSE> 11,216
<INCOME-PRETAX> (108,819)
<INCOME-TAX> (2,975)
<INCOME-CONTINUING> (105,844)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (105,844)
<EPS-BASIC> (0.27)
<EPS-DILUTED> (0.27)
</TABLE>
