ELECTRIC LIGHTWAVE, INC.
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE YEAR ENDED DECEMBER 31, 1997
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997 Commission file number 0-23393
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OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
ELECTRIC LIGHTWAVE, INC.
(Exact name of registrant as specified in its charter)
Delaware 93-1035711
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(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
8100 NE Parkway Drive
Suite 150
Vancouver, Washington 98662
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(Address, zip code of principal executive offices)
Registrant's telephone number, including area code: (360) 892-1000
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Securities registered pursuant to Section 12(b) of
the Act: None Securities registered pursuant to
Section 12(g) of the Act:
Common Stock Class A, par value $.01 per
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(Title of each class)
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 twelve 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 ninety days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of March 6, 1998 was $143,775,000. The number of shares
outstanding of each of the registrant's classes of common stock as of March 6,
1998 were:
Common Stock Class A 8,520,000
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Common Stock Class B 41,165,000
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DOCUMENTS INCORPORATED BY REFERENCE
The Proxy Statement for the registrant's 1998 Annual Meeting of Stockholders to
be held on May 21, 1998, is incorporated by reference into Part III of this Form
10-K.
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Item 1. Description of Business
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a. General development of business
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Electric Lightwave, Inc. ("The Company"), is a fully-integrated,
facilities-based competitive local exchange carrier ("CLEC") providing a broad
range of communications services in five major market clusters in the western
United States. The Company provides voice and data communications services to
retail customers, primarily large- and medium-sized communications-intensive
businesses, and wholesale customers. The Company was incorporated in 1990.
In November 1997, the Company completed an ("IPO") of 8,000,000 shares
of its Class A Common Stock at $16 per share. This IPO offering represents 16.1%
of the Company's outstanding common stock. Citizens Utilities Company
("Citizens") owns 82.8% of the outstanding common stock. The remaining 1.1% is
represented by shares issued pursuant to the Company's stock plans.
The Company currently provides services in five markets: Portland,
Oregon; Seattle, Washington; Salt Lake City, Utah; Sacramento, California; and
Phoenix, Arizona ("hub cities") and their respective surrounding areas (together
with the hub cities, "market clusters" or "clusters"). The Company's clusters
include an extensive fiber optic network. The Company currently provides
switched services, including local dial tone, utilizing five Nortel DMS 500
switches, in all of its market clusters except Phoenix, where the Company
expects to initiate local dial tone service upon installing an additional switch
in the first half of 1998. The Company serves its cluster cities with an
extensive frame relay network which is comprised of 20 state-of-the-art
switches. This network covers 29 western local access transport areas ("LATAs")
with 52 network-to-network interfaces, and provides the Company's customers with
national and international coverage through strategic relationships with other
providers. The Company has also developed an Internet backbone network providing
Internet connectivity in each of its markets which includes access on a
redundant basis to the three largest Internet service providers in the United
States.
The Company offers a portfolio of products and services in four
categories: dedicated services, local dial tone services, long distance services
and enhanced services. These products and services include: dedicated services
which include point-to-point communications and dedicated DS-1 and DS-3 lines;
local dial tone services which include voice mail and enhanced features such as
Integrated Services Digital Network ("ISDN"); long distance services which
include toll-free and prepaid services; and enhanced services which include
frame relay, high speed internet access, video conferencing and local area
network ("LAN")-to-LAN services with very high transport speeds.
b. Financial information about industry segments.
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The Company operates in a single industry segment, communications
services.
c. Narrative description of business
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The Company's focus is on MSAs in the western United States that the
Company believes have fewer CLEC competitors, a relatively high proportion of
communications-dependent businesses and the prospect of population and economic
growth above the national average. The Company builds facilities and offers
services in market clusters which exist in and around a hub city in the
selected MSA. Once a potential market is identified, the Company establishes
a network in the hub city and then expands the network to adjacent cities and
communities of interest. Clustering enables the Company to (i) optimize its
network switching capacity through the ability to place switches anywhere in
the cluster, (ii) offer services to smaller markets adjacent to its existing
networks in which the Company is less likely to face strong competition from
other CLECs, and (iii) achieve improved network reliability due to higher levels
of on-net traffic.
The Company formed strategic relationships with utility companies that
enable it to (i) utilize existing rights-of-way and fiber optic facilities, (ii)
leverage their construction expertise and local permitting experience and (iii)
have access to capital in order for the Company to extend its network
infrastructure more quickly and economically. The Company's strategic alliances
include agreements for the utilization of existing excess facilities and the
construction of long-haul networks which link the Portland, Oregon and Seattle,
Washington clusters and which will link Portland and Spokane, Washington and
Portland and Eugene, Oregon. Another agreement provides for a fiber optic
network in the Phoenix, Arizona metropolitan area.
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The Company interconnects the Company's major market clusters with
facilities-based broadband, long-haul fiber optic networks. Interconnecting its
market clusters enables the Company to carry increasing amounts of long
distance, frame relay, Internet and point-to-point traffic on its own
facilities. By carrying traffic on its own facilities, the Company is able to
improve the utilization of its network facilities and avoid leased facilities
charges and certain interconnection costs.
The Company has constructed extensive voice, frame relay, Internet
backbone and interconnecting long-haul networks, and each of the Company's
operating clusters includes an extensive fiber optic network backbone.
Approximately half of the Company's services provided to customers are currently
on-net.
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. In 1997, one customer,
IXC Communications, accounted for approximately 10% of the Company's revenues. A
portion of the Company's services provided to IXC Communications will no longer
be required when IXC Communications completes construction of its own facilities
in the first quarter of 1998. A significant reduction in the level of services
ELI performs for any of these customers could have a material adverse effect on
the Company's results of operations or financial condition. Most of the
Company's customers have short notice contracts.
Products and Services
Since inception, the Company's product portfolio has grown from
traditional competitive access provider ("CAP") services such as point-to-point
connectivity for inter-exchange carriers ("IXC") and businesses to a full array
of switched voice and data services that target communications-intensive
companies in both the retail and wholesale markets.
The Company provides facilities-based products and services over its
switched broadband digital network platform. This network platform enables the
Company to integrate high revenue generating products into its existing
portfolio. The product and service offerings are divided into the following four
categories: Dedicated Services, Local Dial Tone Services, Long Distance Services
and Enhanced Services. The following discussion summarizes the Company's primary
product and services offering.
Dedicated Services
The Company's dedicated point-to-point services, which include special
access and digital private line services, use high capacity digital circuits to
carry voice, video and data services. Services are offered in flexible
configurations at standardized transmission speeds.
The Company's network services are grouped together under the name
"LightLine." LightLine is a dedicated interstate and intrastate point-to-point
transmission facility (private line) which may require some specific equipment
on the customer's premises on which the connection can be terminated. This
equipment can be leased from the Company by the customer. In most cases, the
Company uses its own fiber optic networks to provide LightLine services,
although the Company may lease facilities from another carrier if it does not
have the facilities available. LightLine is labeled as four separate products
differentiated by transmission speed: DS-0, DS-1, DS-3 and OC-3.
Local Dial Tone Services
The Company's Local Dial Tone Services consist of products which
involve the switching of local calls. There are three primary customer segments
for Local Dial Tone Services: (i) small customers (less than 10 employees) with
multi-key telephone sets; (ii) medium-sized customers (10-50 employees) who use
a key system; and (iii) customers with more than 50 employees who have either
their own Private Branch Exchange ("PBX"), have a hybrid key system, or use the
ILEC's Centrex(tm) product. The Company's Local Dial Tone Services products are
as follows:
Basic Business Lines offer either two-way lines (calls that can be
placed or received) or one-way lines (outgoing calls from the customer) to small
and medium-sized businesses with certain types of customer premise equipment.
Features such as call forwarding, three-way conferencing/call transfer,
directory number hunting, caller/number ID and speed dialing can also be
included.
PBX/Key System Trunk Interface is offered to medium and large
businesses that have their own PBX or key system that require special interface
equipment. The Company offers both trunk-side and line-side interfaces.
Trunk-side connections are used when all calls are directed to an attendant and
can accommodate features such as three-way calling/call transfer, call
forwarding and hunting. Line-side connections are used when calls are directed
to each station line.
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Virtual Private Exchange ("VPX") is an alternative to the customer's
PBX, key system or Incumbent Local Exchange Carrier ("ILEC") provided Centrex
for medium and large businesses that require the advanced functionality of a
PBX or key system, such as call park, call pick-up and last number redial. The
Company's switch provides approximately 28 features for a flat monthly rate with
optional features available for an additional charge. Direct inward dialing
is an inherent feature of VPX. The Company also offers the Nortel electronic
business sets which are designed to work with VPX, allowing customers to use
features with the touch of a button. VPX can be purchased separately or with
the electronic business set, and voice mail can be added for an additional
monthly charge.
Foreign Exchange Service ("FEX") provides customers local dial tone
service from an exchange (central office) other than the exchange from which
they would normally be served. Therefore, the customer would obtain access to
the local calling area (free calling area) of the foreign exchange office.
Customers who experience significant long distance calling between locations
within the same LATA are typical users of FEX lines in order to pay one flat
rate per month for these calls, rather than usage-based long distance fees.
Voice Mail offers customers the option of using the Company's voice
mail product versus buying their own system. Voice mail is either offered for a
flat additional fee per month or bundled with other products, such as Enhanced
Business Services ("EBS"). EBS is a package for small business users, usually
with less than 10 lines.
CustomLink (Multi-service Fractional T-1) is a package of services
built around local dial tone services. It is the bundling of local lines/trunks
with DS-0s used for other services, all delivered on the same T-1. Since the
Company in many cases is already taking a T-1 to the customer's premises to
deliver dial tone, the customer is offered the opportunity to utilize the empty
DS-0s on the T-1 for access.
Customer Premise Equipment ("CPE") which is provided through a
partnership with various equipment vendors, makes available to the Company's
customers Nortel telephone sets, "2500"-type sets and electronic business sets.
Integrated Service Digital Network: Primary Rate Interface ("ISDN PRI")
provides customers with a high-speed, flexible digital access connection to the
Company's network for voice, video and data applications. Applications include
Internet access, telecommuting, video conferencing and remote access to local
area networks ("LAN") or mainframes. The Company offers ISDN PRI in all of its
service areas.
Long Distance Service
The Company's Long Distance Service is comprised of both retail and
wholesale, switched and dedicated, 1+, toll-free and pre-paid services.
Retail Switched 1+ and toll-free service is offered to business
customers, whereby the customer chooses the Company as its long
distance/toll-free carrier and calls are routed to/from the Company through the
public switched network.
Customers can call intrastate, interstate, or internationally.
Retail Dedicated 1+ and toll-free service is offered to high volume
business customers, whereby the customer establishes a point-to-point circuit
(i.e. DS-1 or DS-3) from their switch/PBX to the Company's switch. Outbound long
distance and toll-free calls are routed directly to/from the Company via this
dedicated path. Customers can call intrastate, interstate, or internationally.
Wholesale Termination encompasses an array of 1+ and toll-free services
providing carriers with LATA-wide termination services, enabling lower cost
access to, or diversity from, the ILEC's facilities. This product aggregates the
termination traffic of many carriers at the Company's switch and terminates it
at a lower cost than each of the carriers could obtain individually.
Prepaid Debit Cards and Travel Cards, are product offerings allowing
travelers the ability to make long distance calls from any phone, anywhere
through accessing a toll-free number and the pre-paid switch. The service can
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either be pre- or post-paid and sold through either retail or wholesale
channels. Callers can utilize the calling card from anywhere in the United
States, Canada, or 18 other countries worldwide and can make calls anywhere in
the world.
Enhanced Services
The Company offers a wide range of switched and dedicated data
connectivity and internetworking products. These products are marketed through
both retail and wholesale channels.
Dedicated Internet Services provides access to Internet service
providers and large businesses. The Company offers Internet access through frame
relay, dedicated DS-1, dedicated DS-3 and shared Ethernet.
Frame Relay is a data communications alternative to traditional
point-to-point networks for wide area network ("WAN") connectivity. The service
provides multi-point, wide-area connectivity using frame relay packet technology
that reduces the connection costs of distributed data networks. The service
offers a choice of interface speeds with multiple virtual circuits possible at
each site. The Company offers worldwide connectivity to its network through its
frame relay partners.
LAN/WAN Services are turn-key data networking solutions that connect
two or more customer locations at very high speeds, typically, 10Mbps to
100Mbps. Included in the transparent LAN service is point-to-point connectivity,
installed CPE and the monitoring of the customer's network to insure
connectivity. Through this service, the Company provides native LAN protocols
like Ethernet, Token Ring or Fiber Distributed Data Interface ("FDDI") in a
variety of configurations.
Video conferencing is a service whereby the Company operates video
conferencing rooms in five cities in the western United States: Vancouver,
Seattle, Salt Lake City, Portland and Sacramento. The Company can connect two or
more of its rooms together and can tie in two other non-Company video
conferencing rooms at the same time.
The Company expects to offer Asynchronous Transfer Mode ("ATM") during
1998. It is a service that formats, switches, and multiplexes various types of
information, including voice, video and data at speeds ranging from T-1 (1.544
megabits per second ("Mbps")) to OC-3 (155 Mbps). ATM provides Quality of
Services ("QoS") parameters based on the type of information being carried in a
statistically multiplexed architecture to reduce network costs. The Company's
ATM service will provide interworking between frame relay, transparent LAN and
native ATM locations.
Regulatory Environment
The Company's services are subject to federal and state regulation,
which is subject to continuing judicial scrutiny. In general, the Company's
interstate communications services are regulated by the Federal Communications
Commission ("FCC"). The Company's intrastate services are regulated by the
public utilities commission of each state in which the Company operates.
Nationally, the recent trend has been for federal and state legislators and
regulators to permit and encourage additional competition in the local
communications industry.
Federal Regulation
The FCC exercises regulatory jurisdiction over all facilities of, and
services offered by, communications common carriers to the extent those
facilities are used to provide, originate or terminate interstate
communications. The FCC has established different levels of regulation for
"dominant" carriers and "nondominant" carriers. For domestic interstate
communications services, only the ILECs are classified as dominant carriers, and
all other carriers are classified as nondominant carriers. Additionally, to the
extent a Regional Bell Operating Company ("RBOC") is engaged in out-of-region
long distance services it is also classified as nondominant as to those
services. Non-RBOC ILEC-affiliated long distance services are classified as
nondominant regardless of whether conducted inside or outside the ILEC service
area. The FCC regulates many of the rates, charges and services of dominant
carriers to a greater degree than those of nondominant carriers.
As a nondominant carrier, the Company may install and operate
facilities for domestic interstate communications without prior FCC
authorization. The Company is presently required to tariff certain of its
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domestic interstate tariff services. The FCC has promulgated rules to eliminate
tariffing of interstate long distance services. Those rules have been stayed
during the pendency of judicial review. If and when these rules are allowed to
go into effect, the Company will no longer be required to file FCC tariffs for
its interstate long distance services. Additionally, under a recent FCC order,
CLECs, including the Company, are no longer required to file tariffs for
interstate exchange access services. As a provider of international long
distance services, the Company obtained FCC operating authority and maintains an
international tariff. The Company is also required to submit certain periodic
reports to the FCC and to pay regulatory fees.
Telecommunications Act of 1996
In February 1996, the Telecommunications Act of 1996 ("1996 Act")
became law. The national public policy framework for communications was changed
dramatically by the 1996 Act. A central focus of this sweeping policy reform was
to open local communications markets to workable competition.
The 1996 Act preempts state and local laws to the extent that they
prevent competitive entry into the provision of any communications service.
Under the 1996 Act, however, states retain authority to impose on carriers,
including the Company, requirements necessary to preserve universal
communications service, protect public safety and welfare, ensure quality of
service and protect consumers. States are also responsible for mediating and
arbitrating interconnection agreements between CLECs and ILECs if voluntary
negotiations fail.
In order to create an environment in which local competition is a
practical possibility, the 1996 Act imposes a number of access and
interconnection requirements on all local communications providers. All local
carriers, including the Company, must interconnect with other carriers, permit
resale of their services, provide local telephone number portability and dialing
parity, provide access to poles, ducts, conduits, and rights-of-way, and
complete calls originated by competing carriers under reciprocal compensation or
mutual termination arrangements.
Full implementation of the provisions of the 1996 Act will require
further federal and state rule makings, industry negotiations, and possible
legal enforcement actions and remedies.
RBOCs have been barred from participating in the market for interLATA
services (which is primarily long distance traffic) in their service territories
since the break up of the Bell System in 1984. The 1996 ACT provides a mechanism
for an RBOC to enter interLATA markets which would increase the level of
competition faced by the Company's retail long distance services. However, the
provisions of the Act that allows for the RBOCs to enter the long distance
market are still under scrutiny.
Before an RBOC can enter an interLATA market it must first meet
specific criteria set out by section 271 of the Act. These criteria are commonly
referred to as the "14 point check list". The checklist is meant to ensure that
the RBOCs have opened up their local markets to competition before they compete
in the long distance markets in their regions. To date, no RBOC has satisfied
the FCC that it has met the criteria. In frustration, one RBOC, SBC
Communications (which was later joined by US West in the lawsuit), took the
checklist provisions to Court on constitutional grounds and won a victory of
sorts. A US District judge in the Northern District of Texas at Wichita Falls
ruled that the Section 271 language constituted a "bill of attainder" by
unfairly singling out, presupposing guilt, and then punishing the RBOCs. This
decision was immediately appealed to the Court of Appeals for the Fifth Circuit
Court, and the RBOCs continue to pursue checklist approval, however it is
unclear how or when the RBOCs will actually be competing in in-region interLATA
markets.
Interconnection
On August 8, 1996, the FCC issued an order containing rules providing
guidance to the ILECs, CLECs, long distance companies and state public utility
commissions ("PUCs") on several provisions of the 1996 Act. The rules include,
among other things, FCC guidance on: (i) discounts for end-to-end resale of ILEC
local exchange services; (ii) availability of unbundled local loops and other
unbundled ILEC network elements; (iii) the use of Total Element Long Run
Incremental Costs in the pricing of these unbundled network elements; (iv)
average default proxy prices for unbundled local loops in each state; (v) mutual
compensation proxy rates for termination of ILEC/CLEC local calls; and (vi) the
ability of CLECs and other interconnecters to opt into portions of
interconnection agreements negotiated by the ILECs with other parties on the
basis of the ability to "pick and choose" among the provisions of an existing
agreement.
Various parties, including ILECs and state PUCs, filed appeals of the
FCC's August 8, 1996 interconnection order, many of which were consolidated and
transferred to the U.S. Court of Appeals for the Eighth Circuit. On July 18,
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1997, the Eight Circuit rendered its decision, which held that, in general, the
FCC does not have jurisdiction over prices for interconnection, resale, leased
unbundled network elements and traffic termination. The Eighth Circuit also
overturned the FCC's "pick and choose" rules as well as certain other FCC rules
implementing the 1996 Act's local competition provisions. In addition, the
Eighth Circuit decision substantially limits the FCC's authority to enforce the
local competition provisions of the 1996 Act. The FCC and other parties
petitioned for Supreme Court review of the decision, and the Supreme Court has
granted certiorari.
In the short term the Company believes that the Eighth Circuit decision
will not have a material adverse effect on it, because the Company already has
interconnection agreements in place, or expects to have such agreements in
place, under the provisions of the FCC's order and the 1996 Act which were not
invalidated by the Court. The decision does not delay the implementation of the
1996 Act by the parties and by the state PUCs, but rather eliminates the
guidance on pricing and pick and choose as well as other issues that the FCC
sought to provide to the parties and the state PUCs.
In the long term, the Eighth Circuit's decision makes it more likely
that the rules governing local competition will vary from state to state. Most
states have already begun to establish rules for local competition that are
consistent with the FCC rules overturned by the Eighth Circuit. If a patchwork
of state regulations were to develop, it could increase the Company's costs of
regulatory compliance and could make competitive entry in some markets more
difficult and expensive than in others
Universal Service
The 1996 Act requires the FCC to establish explicit mechanisms for
subsidizing service to rural areas, low-income customers, schools and libraries,
and rural health care providers. On May 8, 1997, the FCC adopted an Order in its
universal service proceeding to implement this mandate. All communications
carriers, including the Company and other CLECs, are required under that Order
to contribute to a federal universal service fund. The availability of such
support will assist such entities in obtaining advanced communications and
information services. Most states are expected to implement state-specific
universal service funds to supplement the federal programs. All carriers,
including the Company, will be required to contribute to those state and federal
funds. At this time, the Company is unable to quantify the total amount of these
payments it will be required to make or the effect these required payments will
have on its financial condition, statements of operations or cash flows.
Access Charge/Price Cap
In a combined Report and Order and Notice of Proposed Rulemaking
released on December 24, 1996, the FCC made changes and proposed further changes
in the interstate access charge structure. In the Report and Order, the FCC
removed restrictions on the ILECs' ability to lower access prices and proposed
the relaxation of the regulation of new switched access services in those
markets where there are other providers of access services. If any such
increased pricing flexibility is allowed but is not effectively monitored by
federal regulators, it could have a material adverse effect on the Company's
revenues from interstate access services. On May 16, 1997, the FCC released an
order revising its access charge rate structure. The new rules substantially
increase the costs that ILECs subject to the FCC's price cap rules (price cap
local exchange carriers), recover through monthly, non-traffic sensitive access
charges and substantially decrease the costs that price cap LECs recover through
traffic sensitive access charges. In the May 16 order, the FCC also announced
its plan to bring interstate access rate levels more in line with cost. The plan
will include rules to be established sometime this year that grant price cap
LECs increased pricing flexibility upon demonstrations of increased competition
(or potential competition) in relevant markets. The manner in which the FCC
implements this approach to lowering access charge levels may have a material
adverse effect on the Company's ability to compete in providing interstate
access services. Under the FCC's rules, which are the subject of a petition for
reconsideration, the Company will no longer be required to pay a portion of ILEC
access charges (the terminating interconnection charge) by connecting directly
to ILEC end offices. Additionally, the Company may be able to differentiate its
access prices from those of competing ILECs by eliminating certain other rate
elements. Several parties have appealed the May 16 order. Those appeals have
been consolidated and transferred to the United States Court of Appeals for the
Eighth Circuit where they are currently pending.
As part of the overall plan to lower interstate access rates, the FCC
also released an order on May 21, 1997, in which the FCC revised its price cap
rules. In the order, the FCC increased the so-called X-Factor (the percentage by
which price cap LECs must lower their interstate access charges every year, net
of inflation and exogenous cost increases) and made it uniform for all price cap
LECs. The results of these rule changes will be both a one-time overall
reduction in price cap ILEC interstate access charges and an increase in the
rate at which those charges will be reduced in the future. Several parties have
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appealed the May 21 order. Those appeals have been consolidated and transferred
to the United States Court of Appeals for the Tenth Circuit where they are
currently pending.
State Regulation
Most state public utilities commissions require communications
providers such as the Company to obtain operating authority prior to initiating
intrastate services. Most states also require the filing of tariffs or price
lists and/or customer-specific contracts. In the states in which the Company
currently operates, the Company is not subject to rate-of-return or price
regulation. The Company is subject, however, to state-specific quality of
service, universal service, periodic reporting and other regulatory
requirements, although the extent of such requirements is generally less than
that applicable to ILECs. The Company currently has intrastate operating
authority in the states of Arizona, California, Idaho, Minnesota, Nevada,
Oregon, Utah, and Washington.
Local Government Authorizations
The Company generally is required to obtain street opening and
construction permits from city and county authorities prior to installing or
expanding its fiber optic network facilities. In most states in which the
Company currently operates as a CLEC, it must first obtain a franchise or
license from each incorporated city and town, and sometimes from each county, in
which it wishes to utilize public rights of way. The franchise or license
establishes the overall terms, conditions and fees for use of the rights of way
in the particular jurisdiction. In California, the Company and other holders of
certification from the California Public Utilities Commission are not required
to obtain municipal franchises nor pay franchise fees.
The 1996 Act now provides that while local governments may continue to
manage the public rights of way, they may not impose conditions on companies
like the Company which constitute barriers to entry in the communications
market. Further, the 1996 Act requires that municipal right-of-way
authorizations be granted on a nondiscriminatory basis and that any fees be
reasonable.
Competition
ILEC Competition
In each of its markets, the Company faces significant competition from
the ILEC, which currently dominates the local exchange market and is a de facto
monopoly provider of local switched voice services. The Company's primary ILEC
competitors are U S WEST, PacBell and GTE. ILECs have long-standing
relationships with their customers, have financial and technical resources
substantially greater than those of the Company and benefit from federal and
state laws and regulations that, the Company believes, in some instances favor
the ILECs over CLECs. Under certain circumstances, FCC and state regulatory
authorities may provide ILECs with increased flexibility to reprice their
services as competition develops and as ILECs allow competitors to interconnect
to their networks. In addition, some new entrants in the local market may price
certain services to particular customers or for particular routes below the
prices charged by the Company for services to those customers or for those
routes, just as the Company may itself underprice those new entrants for other
services, customers or routes. If the ILECs and other competitors lower their
rates and can sustain significantly lower prices over time, this may adversely
affect revenues of the Company if it is required by market pressure to price at
or below the ILECs' prices. If regulatory decisions permit the ILECs to charge
competitive access providers ("CAPs")/CLECs substantial fees for interconnection
to the ILECs' networks or afford ILECs other regulatory relief, such decisions
could also have a material adverse effect on the Company.
Under the 1996 Act, ILECs formerly subject to anti-trust decree
restrictions on interLATA (interexchange) long distance services are no longer
permanently barred from entry into these businesses, subject to certain
requirements in the 1996 Act and rules and policies to be implemented by the FCC
and the states. The FCC may authorize an RBOC to provide interLATA services in a
state when the RBOC enters into a state utility commission-approved agreement
with one or more facilities-based competitors which provide business and
residential local exchange service and such agreement satisfies 14 specified
interconnection requirements. In evaluating an RBOC application for interLATA
entry, the FCC must consult with the U.S. Department of Justice. Alternatively,
if no such facilities-based competitors request such interconnection, the RBOC
may obtain authority from the FCC to provide interLATA services if the RBOC
obtains state utility commission approval of a statement of generally available
terms and conditions of interconnection that satisfies the requirements. If and
when an RBOC obtains authority to provide interLATA services, it will be able to
offer customers local and long distance telephone services. This will permit the
RBOC to offer a full range of services to potential customers in a new region
7
<PAGE>
and thus eliminate an existing competitive advantage of the Company. Given the
resources and experience the RBOCs currently possess in the local exchange
market, the ability to provide both local and long distance services could make
the RBOCs very strong competitors.
The 1996 Act imposes interconnection obligations on ILECs, and
generally requires that interconnection charges be cost-based and
nondiscriminatory. To the extent the Company interconnects with and uses an
ILEC's network to service the Company's customers, the Company is dependent upon
the technology and capabilities of the ILEC to meet certain communications needs
of the Company's customers and to maintain its service standards. The Company
will become increasingly dependent on interconnection with ILECs as switched
services become a greater percentage of the Company's business. However, there
can be no assurance that the Company will be able to obtain the services it
requires at rates, and on terms and conditions, that permit the Company to offer
switched services at rates that are both profitable and competitive. However,
historically, the Company has been able to build new networks and expand
existing networks in a more timely and economical manner than most CAP or CLEC
competitors through strategic arrangements such as leasing fiber optic cable
from others that already possess rights-of-way and have facilities in place.
CLEC Competition
The Company's facility-based operational CLEC competitors in the
markets in which the Company operates include: MCI Metro, Inc.; MFS
Telecommunications, Inc.; Teleport Communications Group, Inc.; Brooks Fiber;
NEXTLINK Communications, Inc.; and GST Telecommunications, Inc. Based on
management's experience, the initial market entrant with an operational fiber
optic CLEC network generally enjoys a competitive advantage over other CLECs
that later enter the market. In each of the clusters in which the Company
operates, at least one other CLEC, and in some cases several other CLECs, offer
many of the same local communications services provided by the Company,
generally at similar prices.
Competition From Others
Potential and actual new market entrants in the local communications
services business include RBOCs entering new geographic markets, inter-exchange
carriers ("IXCs"), cable television companies, electric utilities, international
carriers, satellite carriers, teleports, microwave carriers, wireless telephone
system operators and private networks built by large end users, many of which
may have financial, personnel and other resources substantially greater than
those of the Company. In addition, the current trend of business combinations
and alliances in the communications industry, including mergers between RBOCs,
may increase competition for the Company. With the passage of the 1996 Act and
the entry of RBOCs into the long distance market, the Company believes that IXCs
may be motivated to construct their own local facilities or otherwise acquire
the right to use local facilities and/or resell the local services of the
Company's competitors.
Dedicated Services
Competition for dedicated services is based on price, quality, network
reliability, customer service, service features and responsiveness to the
customer's needs. The Company's fiber optic networks will provide both diverse
access routing and redundant electronics, design features not widely deployed
within the ILEC's networks.
High-Speed Data Service
The Company's competitors for high-speed data services include major
IXCs, CAPs, other CLECs, and various providers of niche services (e.g., Internet
access providers, router management services and systems integrators). The
interconnectivity of the Company's markets may create additional competitive
advantages over other data service providers that must obtain local access from
the ILEC or another CLEC in each market or that cannot obtain intercity
transport rates on as favorable terms as the Company.
Internet Services
The market for Internet access and related services in the United
States is extremely competitive, with no substantial barriers to entry. The
Company expects that competition will intensify as existing services and network
providers and new entrants compete for customers. The Company's current and
future competitors include communications companies, including the RBOCs, IXCs,
CLECs and CATVs, and other Internet access providers. Many of these competitors
have greater market presence and greater financial, technical, marketing and
human resources, more extensive infrastructure and stronger customer and
strategic relationships than the Company.
8
<PAGE>
Operations/Information Technology
The Company has implemented an integrated network management and
maintenance system designed to monitor and test the Company's networks 24 hours
a day, seven days a week and is developing a fully integrated superior customer
care system from three leading vendors which will automate the entire order
management process (i.e., order placement, design, provisioning and billing
preparation) for both wholesale and retail customers. The order placement,
design and provisioning components of the order management system have been
installed and are operational. The current billing management system is capable
of producing a single bill detailing all of the products and services provided
to both wholesale and retail customers. The Company is installing a new billing
system, which will allow the Company to bill for incremental services and unique
product bundles in a more rapid and cost-efficient manner. The Company
anticipates certain enhancements to the billing system may be necessary.
Impact of Year 2000 Issue
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather that the Year 2000. This could result in a system failure
or miscalculation causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
Based upon an assessment, conducted in conjunction with and information
systems consulting firm, it has been determined that a limited number of the
Company's software programs need to be modified so that dates beyond December
31, 1999, are properly recognized. The Company presently believes that with
modifications to existing software and conversions to new software, the Year
2000 Issue can be mitigated and the anticipated conversion cost to be
insignificant. However, if such modifications and conversions are not made in a
timely fashion, the Year 2000 Issue could have a material impact on the
operations of the Company.
The Company has developed a plan to mitigate the Year 2000 Issue. The
plan includes formal communications with all of its significant suppliers to
determine the extent to which the Company is vulnerable to those third parties'
failure to remediate their own Year 2000 Issue. However, there can be no
guarantee that the systems of suppliers or other companies on which the
Company's systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Company's
systems, would not have material adverse effect on the Company. The Company has
determined that is has limited exposure to contingencies related to the Year
2000 Issue for the services marketed.
The Company is and will continue to use both internal and external
resources to reprogram or replace and test software for the Year 2000
compliance. The Company plans to complete its Year 2000 modifications and
conversions, related to its business operations no later than June 30, 1999. The
total cost of the Year 2000 modifications and conversions has not been estimated
and is anticipated to be insignificant.
Employees
As of December 31, 1997 the Company employed 573 persons. None of the
Company's employees are represented by a union, and the Company considers its
employee relations to be excellent.
d. Financial information about foreign and domestic operations and export sales
----------------------------------------------------------------------------
The Company does not have any foreign operations or export sales.
Item 2. Description of Property
-----------------------
The Company manages its operations through its corporate headquarters,
located at 8100 NE Parkway Drive, Suite 150, Vancouver, Washington. Its
telephone number at that address is (360) 892-1000. In addition, the Company has
local offices in Portland, Seattle, Sacramento, Phoenix and Salt Lake City.
Currently, all of the Company's office space is leased and a warehouse facility
is maintained in Portland, Oregon. The Company also leases network hub and
network equipment installation sites in various locations throughout the
metropolitan areas in which it provides products and services. The office,
9
<PAGE>
warehouse and other facilities leases expire on various dates through July 2014.
Additional facilities will be needed as the Company expands its markets. The
Company owns a 6.6-acre parcel of land in Vancouver, Washington, on which it is
constructing its new corporate headquarters building, anticipated to be
completed April 1998.
In June 1995 the Company entered into agreements to lease certain
equipment to be constructed for the Company (the "Lease"). The lessor has agreed
to commit up to a maximum of $110 million of the cost of purchasing and
installing the equipment. Rental obligations for the equipment commenced in June
1995, and, with renewal options, will expire on April 30, 2002. The Company may,
at its option, purchase the equipment either at or before the end of the Lease
at a price approximating the amounts expended by the lessor to acquire and
install the leased equipment. If the Company does not purchase the equipment by
April 30, 2002, it will be sold to a third party and the Company will guarantee
that the sales price to be received by the lessor will equal the acquisition and
installation costs, subject generally to a maximum payment under the guarantee
of 80% of such costs. Payments under the lease depend on then current interest
rates, and assuming continuation of current interest rates and full utilization
of the lease facility, payments would amount to approximately $6.5 million
annually through April 30, 2002 and, assuming exercise of the purchase option,
approximately $110 million in 2002. Citizens has guaranteed all obligations of
the Company under the Lease and the Company will pay Citizens a guarantee fee at
the rate of 3.25% per annum based on the amount of the lessor's investment in
the leased assets.
The Company entered into a 5 year operating lease for approximately
43,000 square foot of space at 8100 NE Parkway Drive, Vancouver, Washington
which begins April 1998. The office space will be used for certain
administrative functions.
Item 3. Legal Proceedings
-----------------
On June 30, 1997, the Company filed an antitrust action against U S
WEST, Communications, Inc. (U S West), in the U.S. District Court for the
Western District of Washington. The Company alleged that U S WEST violated
federal and state antitrust laws as well as various federal and state laws and
commission orders by failing to provide to the Company adequate interconnection
services and facilities to enable the Company to provide quality services to its
customers. The Company is seeking an unspecified amount of damages to be
determined at trial, as well as an injunction to prohibit U S West from
discriminating against the Company and its customers. U S WEST has filed an
answer denying all liability and it seeks to recover its costs and attorney's
fees. U S WEST filed a motion to stay the case pending arbitration of the
antitrust claims. On December 29, 1997, the trial court entered an order
requiring the antitrust claims arising under the now-expired Interim
Interconnection Agreements to be arbitrated. The court also invalidated the
limitations on the Company's remedies that were contained in the old Interim
Agreements so that the arbitrator may award treble damages and attorney's fees
if the Company prevails on its antitrust claims. All damage claims arising after
the termination of the old Interim Agreements are not stayed and will continue
to be prosecuted in the federal court. U S WEST also filed an appeal to the
Ninth Circuit Court of Appeals from that portion of the trial court's order
dated December 29, 1997, denying arbitration of the Company's antitrust claims
arising after the termination of the Interim Interconnection Agreements.
Item 4. Submission of Matters to Vote of Security Holders
-------------------------------------------------
Not applicable.
10
<PAGE>
PART II
-------
Executive Officers
- ------------------
The executive officers of the Company and their respective ages and
positions are set forth below.
<TABLE>
<CAPTION>
Name Age Title
- ---- --- -----
<S> <C> <C>
Leonard Tow 69 Chairman of the Board
Daryl A. Ferguson 59 Vice Chairman of the Board and Chief Executive Officer
David B. Sharkey 48 President, Chief Operating Officer and Director
Robert J. DeSantis 42 Chief Financial Officer, Vice President and Treasurer
James Berthot 54 Vice President - Marketing and Product Development
Todd Hanson 36 Vice President - Engineering
Randall Lis 38 Vice President - Staff Operations
Michael J. Miller 41 Vice President - Planning
Kerry Rea 39 Vice President and Controller
John Wolff 51 Vice President - New City Development
</TABLE>
Leonard Tow has been a director and Chairman of the Board of the
Company since August 1994. Mr. Tow has been a Director of Citizens since April
1989. In June 1990, he was elected Chairman of the Board and Chief Executive
Officer of Citizens. He was Chief Financial Officer of Citizens from October
1991 through November 1997. He has also been a Director and Chief Executive
Officer of Century Communications Corp. since its incorporation in 1973,
and Chairman of its Board of Directors since October 1989. He is a Director of
Hungarian Telephone and Cable Corporation.
Daryl A. Ferguson has been a director of the Company since September
1995 and Vice Chairman of the Board and Chief Executive Officer of the Company
since October 1997. Mr. Ferguson has been President and Chief Operating Officer
of Citizens since June 1990. He is currently also a Director of Centennial
Cellular Corp.
David B. Sharkey joined the Company as President and Chief Executive
Officer in August 1994, has been a director since September 1995, and Chief
Operating Officer since October 1997. Prior to joining the Company, he was Vice
President and General Manager of Mobile Media, Inc., a wireless company
headquartered in New Jersey, from August 1989 through July 1994.
Robert J. DeSantis, Chief Financial Officer, Vice President and
Treasurer of the Company since August 1994, has been Vice President and
Treasurer of Citizens since October 1991 and Chief Financial Officer since
November 1997.
James Berthot joined the Company as Vice President of Marketing and
Product Development in July 1995. Prior to joining the Company, from January
1990 to July 1995, Mr. Berthot was Director of Marketing and Public Relations
for Century Telephone Enterprises, Inc.'s Telephone Group.
Todd Hanson joined the Company as Vice President of Engineering in
June 1995. Prior to joining the Company, from 1993 to 1995, Mr. Hanson served
as Vice President of Network Engineering for MFS Telecom. Mr. Hanson was
Senior Director of Project Management and Access Engineering at AT&T Canada in
1992 and 1993.
Randall Lis joined the Company as Vice President-Operations in February
1995 and has served as Vice President-Staff Operations since April 1996. Prior
to joining the Company, from 1993 to 1995, Mr. Lis was General Manager of the
Mid-Atlantic Region of Nextel Communications. From 1985 through 1993, Mr. Lis
held several positions with Metromedia and Metromedia Paging, in which he served
as Business Manager, General Manager and Senior Director of Operations.
Michael J. Miller joined the Company as Director of Accounting in March
1994, was promoted to Vice President of Finance in October 1995 and became Vice
President-Planning in September 1997. Prior to joining the Company, from
February 1988 to December 1993, Mr. Miller was Manager of Financial Planning and
Analysis for NERCO, Inc.
11
<PAGE>
Kerry D. Rea joined the Company as Vice President and Controller in
October 1997. Prior to joining the Company, Mr. Rea served as a Controller for
Mattel, Inc. from March 1997 to October 1997, and its predecessor Tyco Toys,
Inc. from November 1989 to March 1997.
John Wolff joined the Company as Vice President-Sales in October 1994
and became Vice President-New City Development in January 1998. Mr. Wolff was
with Mobil Media from 1992 until 1994, at which time he joined the Company.
PART II
-------
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
------------------------------------------------------------------------
PRICE RANGE OF COMMON STOCK
The Company began trading publicly on November 25, 1997, and is traded
on the Nasdaq National Market under the symbol ELIX. The high and low prices per
share as taken from the daily quotations published in the "Wall Street Journal"
from that date through December 31, 1997 were $16 1/8 and $13 1/8, respectively.
As of March 6, 1998, the approximate number of record security holders of the
Company's Common Stock Class A was 40. This information was obtained from the
Company's transfer agent.
DIVIDENDS
The Company has no current intention to pay dividends on its common
stock.
INFORMATION ABOUT RECENT SALES OF UNREGISTERED SECURITIES AND THE USE OF
PROCEEDS FROM SALES OF REGISTERED SECURITIES IN AN INITIAL PUBLIC OFFERING
On November 21, 1997, the Company's Registration Statement on Form S-1,
file number 333-35227, registering $207,000,000 aggregate amount of the
Company's Class A Common Stock, par value $.01 per share, became effective under
the Securities Act of 1933. On November 24, 1997, the offering date, the company
sold 8,000,000 shares of the Company's Class A Common Stock for gross proceeds
of $128,000,000. The Offering was terminated before the sale of all securities
registered. The U.S. managing underwriters were Lehman Brothers Inc., Merrill
Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. Incorporated,
and Deutsche Morgan Grenfell, Inc. The International managing underwriters were
Lehman Brothers International (Europe), Merrill Lynch International, Morgan
Stanley & Co. International Limited and Morgan Grenfell & Co. Limited. From
November 21, 1997, the effective date, until December 31, 1997, the Company
incurred underwriting discounts and commissions and other expense in connection
with the issuance and distribution of the Class A Common Stock of $9,446,000.
The actual net offering proceeds of the offering after the deduction of expenses
were $118,554,000. On November 25, 1997, the Company drew down $120,000,000 from
its bank credit facility and utilized it to pay outstanding indebtedness to
Citizens. Subsequently, $80,000,000 of the net offering proceeds was used for
the repayment of indebtedness incurred under the Credit Facility, $32,023,000
was used for operating and capital expenditures, and $6,531,000 of the
offering proceeds remains in cash at December 31, 1997 to be used for ongoing
operating and capital expenditures. On December 30, 1997, the Company drew down
an additional $20,000,000 from the Credit Facility.
12
<PAGE>
<TABLE>
<CAPTION>
Item 6. Selected Financial and Operating Data
- ----------------------------------------------------------------------------------------------------------------
($ in thousands, except per 1997 vs 1996 Years ended December 31,
<S> <C> <C> <C> <C> <C> <C>
share % Incr(Decr) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------
Statements of Operations Data
Revenues 95% $ 61,084 $ 31,309 $ 15,660 $ 8,152 $ 3,705
Loss from operations (16%) $ (34,095) $ (29,383) $ (19,950) $ (9,541) $ (2,884)
Net loss (16%) $ (33,945) $ (29,383) $ (20,322) $ (10,414) $ (3,937)
Net loss per share (1) N/A $ (.80) $ - $ - $ - $ -
- ----------------------------------------------------------------------------------------------------------------
Balance Sheet Data As at December 31,
1997 1996 1995 1994 1993
--------------------------------------------------------------------------------
Total assets 84% $ 359,962 $ 195,656 $ 128,901 $ 110,691 $ 47,840
Long-term obligations (2) (55%) $ 70,511 $ 155,395 $ 64,941 $ 41,674 $ 31,091
Shareholders' equity 2,197% $ 213,314 $ 9,286 $ 38,699 $ 55,991 $ 9,150
- ----------------------------------------------------------------------------------------------------------------
Operating Data Years ended December 31,
1997 1996 1995 1994 1993
--------------------------------------------------------------------------------
EBITDA without operating lease (3) 9% $ (17,692) $ (19,468) $ (12,038) $ (7,065) $ (1,317)
Revenue per employee 37% $ 107 $ 78 $ 70 $ 64 $ 49
As at December 31,
--------------------------------------------------------------------------------
Property, plant & equipment 67% $ 316,109 $ 189,334 $ 127,297 $ 108,549 $ 45,309
- under operating lease (4) 53% $ 87,426 $ 57,279 $ 36,858 $ - $ -
--------------------------------------------------------------------------------
- Total 64% $ 403,535 $ 246,613 $ 164,155 $ 108,549 $ 45,309
--------------------------------------------------------------------------------
Route miles (5) 75% 2,494 1,428 780 601 131
Fiber miles (5) 44% 140,812 97,665 52,013 37,504 9,796
Buildings connected 39% 610 438 282 191 104
Access line equivalents 291% 34,328 8,779 N/A N/A N/A
Switches installed:
Voice -% 5 5 2 2 1
Frame relay 33% 20 15 5 2 -
Internet 113% 17 8 - - -
ATM N/A 8 - - - -
Employees 43% 573 402 225 127 75
Customers 53% 1,165 763 402 221 -
- ----------------------------------------------------------------------------------------------------------------
Information presented above should be read in conjunction with the Company's Financial Statements and
accompanying Notes.
(1) Net loss per share for years prior to 1997 is not presented because it is not meaningful (see Note 2 of Notes
to Financial Statements).
(2) Long-term obligations include amounts due to Citizens in the years ended 1993 - 1996, capital lease
obligations and long-term debt.
(3) EBITDA consists of Earnings Before Interest, Income Taxes, Depreciation and Amortization and excludes the
effects of the operating lease and construction agency agreement as described in Note 11 of Notes to Financial
Statements. EBITDA is a measure commonly used in the communications industry to analyze companies on the basis
of operating performance. It is not a measure of financial performance under generally accepted accounting
principles and should not be considered as an alternative to net income as a measure of performance nor as
an alternative to cash flow as a measure of liquidity.
(4) Facilities under an operating lease agreement under which the Company has the option to purchase the facilities
at the end of the lease term (see Note 11 of Notes to Financial Statements).
(5) Route miles and fiber miles also include those to which the Company has exclusive use pursuant to license and
lease arrangements.
</TABLE>
13
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This annual report on Form 10-K contains forward-looking statements
that are subject to risks and uncertainties which could cause actual results to
differ materially from those expressed or implied in the statements. These and
all forward-looking statements (including oral representations) are only
predictions or statements of current plans, which are constantly under review by
the Company. All forward-looking statements may differ from actual future
results due to, but not limited to, changes in the local and overall economy,
the nature and pace of technological changes, the number and effectiveness of
competitors in the Company's markets, success in marketing strategy, weather
conditions, changes in legal and regulatory policy, the Company's ability to
identify future markets and successfully expand existing ones and the mix of
products and services offered in the Company's target markets. Readers should
consider these important factors in evaluating any statement contained herein
and/or made by the Company or on its behalf. The following information should be
read in conjunction with the financial statements and related footnotes included
in this report.
Overview
- --------
The Company is a fully integrated, facilities-based communications
provider operating in five major metropolitan areas of the western United
States. The Company currently provides services in the following markets:
Portland, Oregon; Seattle, Washington; Salt Lake City, Utah; Sacramento,
California; and Phoenix, Arizona ("hub cities") and their respective surrounding
areas (together with the hub cities, "market clusters" or "clusters"). Among its
five current market clusters, the Company has been operating in Portland and
Seattle since 1991, Salt Lake City and Sacramento since 1994 and Phoenix since
1995. The Company began building its switched data network in 1994. The Company
installed its first local switch in the Seattle market in 1994 and began
generating revenues in early 1995 followed by Portland, Salt Lake City and
Sacramento in 1996. The Company intends to install a local switch in Phoenix in
1998. The Company placed in service its first long haul network from Phoenix to
Las Vegas in 1995 and its second long haul network from Portland to Seattle in
early 1997.
The Company's product portfolio has grown from traditional competitive
access provider services such as point-to-point connectivity for interexchange
carriers and businesses to a full array of switched voice, data and long-haul
services targeted toward communications-intensive businesses in both the retail
and wholesale markets. The Company offers an extensive portfolio of products and
services in four categories: dedicated services, local telephone, long distance
and enhanced services as follows:
- Dedicated Services - point-to-point services that include special
access, digital private line and other dedicated services both in
metropolitan and long-haul applications.
- Local Dial Tone Services - local dial tone and switched products
and services that include lines, trunks, ISDN PRI, local access
and Centrex, among other services.
- Long Distance - wholesale and retail services that include 1+,
toll-free, pre-paid, originating and terminating access services.
- Enhanced Services - switched and dedicated data connectivity
services that includes frame relay, video conferencing, LAN/WAN
and Internet transport services.
The Company categorizes its operating expenses into the following four major
groupings:
- Network Access - includes all leased network facilities and
resold product expenses.
- Sales and Marketing - includes all direct and indirect sales
channel expenses and commissions. Also includes all product
development, advertising and promotional expenses.
- Depreciation and Amortization - includes depreciation of
communications network assets including fiber optic cable, network
electronics, network switching and network data equipment.
- Other Operating - includes all general and other operating
and administrative expenses.
14
<PAGE>
(a) Liquidity and Capital Resources
-------------------------------
The capital expenditures of the Company associated with the
installation, development and expansion of its existing and new communications
networks are substantial, and a significant portion of these expenditures
generally are incurred before any revenues are realized. The Company's gross
property, plant and equipment has grown to $316 million at December 31, 1997
from $189 million at December 31, 1996. These expenditures, together with
associated initial operating expenses, have resulted in negative cash flow and
operating losses and will continue to do so until an adequate customer base and
revenue stream for these networks have been established. The Company expects to
incur net losses for the foreseeable future as it continues to install, develop
and expand its new and existing communications networks. There can be no
assurance that an adequate revenue base will be established or that the Company
will achieve or sustain profitability or generate sufficient positive cash flow
to fund its operating and capital requirements and/or service debt.
The development and expansion of the Company's new and existing
networks and services will require significant additional capital expenditures.
The Company's capital expenditures for 1997 were approximately $130 million and
for 1998 are estimated to be $275 million. In addition, the Company expects to
lease an additional $22.6 million of network facilities through an existing
operating lease agreement. The Company continues to evaluate opportunities for
revenue growth and to make substantial capital investments in connection with
the entry into new markets and the continued development of its existing
networks. These opportunities include, but are not limited to, acquisitions
and/or joint ventures which are consistent with the Company's long-range
business plans. Additionally, the Company expects to continue to build on its
existing relationships with providers and other strategic customers, suppliers
and communications carriers. Such acquisitions, investments and/or strategic
arrangements, if available, could require additional financial resources and/or
reallocation of the Company's financial resources.
On November 21, 1997, the Company entered into a $400 million, 5-year
revolving credit facility ("Credit Facility") which has been guaranteed by
Citizens, which expires on November 21, 2002 and has associated facility fees of
1/20 of 1% (0.05%) per annum. The Company has agreed to pay Citizens an annual
guarantee fee at the rate of 3.25% per annum based on the balance outstanding.
At December 31, 1997, the balance outstanding was $60 million and the weighted
average interest rate was 6.05%. No principal payment is due until the end of
the term of the Credit Facility.
On November 24, 1997, the Company sold 8,000,000 shares of Class A
Common Stock in an initial public offering (the "Offering") at a price of $16.00
per share. Gross proceeds from this offering totaled approximately $128 million
and proceeds net of underwriting discounts and commissions totaled approximately
$120.3 million. Additionally, 535,000 shares of restricted stock were issued to
directors, officers and employees under the equity incentive plan (see Note 9 to
Financial Statements), 15,000 of which were subsequently canceled. The
Company has historically been funded by capital contributions and advances from
Citizens and through lease agreements guaranteed by Citizens. Citizens owns all
of the Class B Common Stock, representing an 82.83% economic interest in the
Company. Citizens does not have any obligation to make additional equity
investments in or advances to the Company or to guarantee or otherwise provide
financial support for the Company, other than the guarantees described herein.
In 1997, 1996 and 1995, Citizens had been charging interest on the amount due to
Citizens only to the extent that the Company was allowed to capitalize interest
under Generally Accepted Accounting Principles.
The Company anticipates that the funds needed for 1998 operating and
capital expenditures will be provided from lease arrangements, the Credit
Facility and other borrowings.
During 1995, the Company entered into an operating lease agreement in
connection with the construction of certain network facilities. The construction
is ongoing and rent is paid on the facilities when completed and placed in
service. The Company will have the option to purchase the facilities at the end
of the lease term. In the event the Company chooses not to exercise this option,
the Company is obligated to arrange for the sale of the facilities to an
unrelated party and is required to pay the lessor any difference between the net
sales proceeds and the lessor's investment in the facilities. However, any
amount required to be paid to the lessor is subject generally to a maximum of
80% of the lessor's investment, giving effect to lease payments previously made.
The total amount of facilities leased through this agreement is expected to be
$110 million by April 30, 1998, of which approximately $87.4 million has been
completed and placed in service as of December 31, 1997. Citizens has guaranteed
all obligations of the Company under this operating lease. The Company has
agreed to pay to Citizens a guarantee fee at the rate of 3.25% per annum based
on the amount of the lessor's investment in the leased assets.
Citizens also provides certain administrative services to the Company
including, but not limited to, certain financial management services, informa-
tion services, legal and contract services and human resources services. The
Company entered into an Administrative Services Agreement ("Agreement") with
Citizens on December 1, 1997 for the continuation of such services and will
continue to be billed for reimbursable costs as defined in the agreement plus
an administrative charge.
15
<PAGE>
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Computer
programs that have date-sensitive software may recognize a date using "00" as
the year 1900 rather that the Year 2000. This could result in a system failure
or miscalculation causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
Based upon an assessment, conducted in conjunction with an information
systems consulting firm, it has been determined that a limited number of the
Company's software programs need to be modified so that dates beyond December
31, 1999 are properly recognized. The Company presently believes that with
modifications to existing software and conversions to new software, the Year
2000 Issue can be mitigated and the anticipated conversion cost to be
insignificant. However, if such modifications and conversions are not made in a
timely fashion, the Year 2000 Issue could have a material impact on the
operations of the Company.
The Company has developed a plan to mitigate the Year 2000 Issue. The
plan includes formal communications with all of its significant suppliers to
determine the extent to which the Company is vulnerable to those third parties'
failure to remediate their own Year 2000 Issue. However, there can be no
guarantee that the systems of suppliers or other companies on which the
Company's systems rely will be timely converted, or that a failure to convert by
another company, or a conversion that is incompatible with the Company's
systems, would not have material adverse effect on the Company. The Company has
determined that it has limited exposure to contingencies related to the Year
2000 Issue for the services marketed.
The Company is and will continue to use both internal and external
resources to reprogram or replace and test software for the Year 2000
compliance. The Company plans to complete its Year 2000 modifications and
conversions, related to its business operations no later than June 30, 1999. The
total cost of the Year 2000 modifications and conversions has not been estimated
and is anticipated to be insignificant.
Employees
As of December 31, 1997, the Company employed 573 persons. None of the
Company's employees are represented by a union, and the Company considers its
employee relations to be excellent.
(b) Results of Operations
---------------------
REVENUES
--------
Revenues increased approximately $29.8 million, or 95%, in 1997 and $15.6
million or 100% in 1996. The increase in revenue growth over 1996 and 1995 is
due to the build out of the five market clusters in which the Company has a
presence. In 1995, the Company was in the process of branching off the major hub
and cluster into the surrounding areas. By 1996, the Company added 156 buildings
(55% increase over 1995) and 361 customers (90% increase over 1995). The
increased revenue in 1997 is due to the continued growth within each of the five
clusters with the addition of 172 buildings (39% increase over 1996) and the
addition of 402 customers (53% increase over 1996).
<TABLE>
<CAPTION>
1997 1996 1995
--------------------- ------------------------ -----------
Increase Over Increase Over
Amount Prior Year Amount Prior Year Amount
------ ------------- -------- ------------- --------
($ in thousands)
<S> <C> <C> <C> <C> <C>
Dedicated services $ 33,522 79% $ 18,741 54% $ 12,141
Local dial tone services 10,565 317% 2,533 275% 676
Long-distance services 8,140 75% 4,661 194% 1,587
Enhanced services 8,857 65% 5,374 328% 1,256
-------- ----- -------- ----- --------
$ 61,084 95% $ 31,309 100% $ 15,660
======== ===== ======== ===== ========
</TABLE>
16
<PAGE>
Revenues from dedicated services increased $14.8 million in 1997, or 79%, over
1996 primarily due to the Company's improved sales of additional products to
existing customers and increase in route miles of 75% over 1996. Approximately
$6.8 million of the increase is associated with a short-term contract with a
significant customer which expires in early 1998. Dedicated services revenue
increased $6.6 million, or 54%, in 1996 over 1995 primarily due to the increase
of long-haul transport of DS-3 and DS-1 sales.
Revenues from local dial tone services increased $8.0 million in 1997, or 317%,
over 1996 due primarily to three local switch implementations for new and
existing customers in the last half of 1996. The successful implementation of
the ISDN PRI product generated $2.3 million of increased revenue in 1997. Local
dial tone services revenue increased $1.9 million, or 275%, in 1996 over 1995
due primarily to local switch implementations occurring during 1996.
Revenues from long distance services increased $3.5 million, or 75%, over 1996
due to a $1.7 million, or 423%, increase in Advantage Long distance, the
Company's long distance service, and $1.1 million increase in prepaid debit
card services introduced in late 1996. The increases were partially offset by a
$1.9 million decrease in wholesale long distance services. Long distance
services revenue increased $3.1 million, or 194%, in 1996 over 1995 primarily
due to a short-term contract for wholesale long distance services which has
since expired.
Revenues from enhanced services in 1997 increased $3.5 million, or 65%,over 1996
primarily due to a $2.1 million increase in Internet access services revenue and
a $1.6 million increase in frame relay, partially offset by a decrease in other
products. The Internet access service and frame relay revenue increases were
primarily due to a 75% increase in Internet switches installed. Enhanced
services revenue increased $4.1 million in 1996, or 328%, over 1995 primarily
due to increases in Internet access service and frame relay services related to
the initial installation of Internet and 10 additional frame relay switches.
OPERATING EXPENSES
------------------
Operating expenses increased $34.5 million, or 57%, in 1997 and $25.1, or 70%,
in 1996. The increase in expenses was due to the Company's rapid network and
customer growth as reflected in revenues, offset in part by economies of scale
from infrastructure and network development.
<TABLE>
<CAPTION>
1997 1996 1995
----------------------------- ------------------------------ ------------
Increase Over Increase Over
Amount Prior Year Amount Prior Year Amount
----------- ------------- ----------- ------------- ------------
($ in thousands)
<S> <C> <C> <C> <C> <C>
Network access $ 29,546 43% $ 20,620 179% $ 7,387
Sales & marketing 13,905 54% 9,056 35% 6,722
Depreciation & amortization 11,167 55% 7,192 2% 7,064
Other operating 40,561 70% 23,824 65% 14,437
----------- --------- ---------- ------- ----------
$ 95,179 57% $ 60,692 70% $ 35,610
=========== ========= ========== ======= ==========
</TABLE>
Network access expenses increased $8.9 million in 1997, or 43%, over 1996 due
primarily to the Company's expansion of its frame relay product, development of
a fully redundant leased Internet access backbone network with related Internet
access costs, and other product and customer growth. Network access expenses
increased $13.2 million, or 179%, in 1996 as compared to 1995 due primarily to
increased utilization of third party facilities and services associated with the
expansion of the Company's customer base.
17
<PAGE>
Sales and marketing expenses increased $4.8 million, or 54%, in 1997 and $2.3
million, or 35%, in 1996. The increase in 1997 was due primarily to the
Company's expanded focus on direct retail sales which targets large-to-medium
size communications intensive businesses in order to maximize vertical selling
opportunities. The increase in 1996 was due primarily to costs associated with
an introduction of local switched services in Portland, Salt Lake City and
Sacramento, expanded local services in the Seattle market, the expanded frame
relay product, and newly introduced Internet access and ISDN products.
Depreciation and amortization expense increased $4.0 million, or 55%,in 1997 due
primarily to higher plant in service balances for newly completed communications
network facilities and electronics. Depreciation and amortization in 1996
increased $.1 million, or 2%, primarily due to network construction completed in
December 1995.
Other operating expenses increased $16.7 million, or 70%, in 1997 as compared to
a $9.4 million increase, or 65%, in 1996. The increases were due primarily to
increases in general and administrative salaries, payroll taxes and employee
benefits to support the expanded delivery of services, new product development,
and an expanded customer service organization. The number of employees increased
43% in 1997 and 79% in 1996 as compared to the previous year. Rental and lease
expenses increased 77% over 1996 and 110% over 1995 related to certain leases
and expanded service coverage. An increase in the provision of uncollectible
accounts of $2.9 million in 1996 over 1995 contributed to the increase in other
operating expenses.
INTEREST AND OTHER EXPENSES
---------------------------
Increase Over Increase Over
Amount Prior Year Amount Prior Year Amount
------ ------------- ------ ------------- ------
($ in thousands)
Interest expense, net $ 1,166 N/A $ -- N/A $ 372
======= ===== ======= ===== =====
Interest (net of capitalized interest) expense increased $1.2 million in 1997
due primarily to the capital lease for the Company's long-haul route between
Portland and Seattle, which commenced in February 1997, and interest and
guarantee fees associated with the Company's borrowings against its credit
facility which was consummated in November 1997. Interest expense decreased $.4
million in 1996 as compared to 1995 due to the repayment in 1995 of previously
outstanding debt.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
The following documents are filed as part of this Report:
1. Financial Statements:
See Index on page F.
2. Supplementary Data:
Quarterly Financial Data is included in the Financial
Statements (see 1. above).
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
None
18
<PAGE>
PART III
--------
The Company intends to file with the Commission a definitive proxy statement for
the 1998 Annual Meeting of Stockholders pursuant to Regulation 14A not later
than 120 days after December 31, 1997. The information called for by this Part
III is incorporated by reference to that proxy statement.
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
---------------------------------------------------------------
(a) The exhibits listed below are filed as part of this Report:
Exhibit
No. Description
- ------- -----------
3.1 Amended and Restated Certificate of Incorporation.
3.2 By-laws of the Company.
10.1 License Agreement between the Company and the United States of
America Department of Energy acting by and through the Bonneville
Power Administration dated March 29, 1996.
10.2 License Agreement between the Company and the United States of
America Department of Energy acting by and through the Bonneville
Power Administration dated November 11, 1996.
10.3 License Agreement between the Company and the United States of
America Department of Energy acting by and through the Bonneville
Power Administration dated July 18, 1997.
10.4 Optical Fiber License Agreement between the Company and Salt
River Project Agricultural Improvement and Power District dated
September 11, 1996.
10.5 Participation Agreement between the Company, Shawmut Bank
Connecticut, National Association, the Certificate Purchasers
named therein, the Lenders named therein, BA Leasing & Capital
Corporation and Citizens Utilities Company dated as of April 28,
1995, and the related operating documents.
10.6 Agreement for Lease of Dark Fiber between the Company and
Citizens Utilities Company dated March 24, 1995.
10.7 Administrative Services Agreement between the Company and
Citizens Utilities Company dated as of December 1, 1997.
10.8 Tax Sharing Agreement between the Company and Citizens Utilities
Company dated as of December 1, 1997.
10.9 Indemnification Agreement between the Company and Citizens
Utilities Company dated as of December 1, 1997.
10.10 Registration Rights Agreement between the Company and Citizens
Utilities Company dated as of December 1, 1997.
10.11 Customers and Service Agreement between the Company and Citizens
Utilities Company dated as of December 1, 1997.
10.12 Guaranty Fee Agreement between the Company and Citizens
Utilities Company dated as of December 1, 1997.
10.13 Equity Incentive Plan of Electric Lightwave, Inc.
10.14 Pre-Construction IRU Agreement between the Company and FTV
Communications, LLC dated October 16, 1997.
10.15 Bank Credit Agreement dated November 21, 1997.
24.1 Powers of Attorney.
27.1 Financial Data Schedule.
Exhibit 10.13 is a management contract or compensatory plan or arrangement.
Exhibit Nos. 3.1, 3.2, 10.1, 10.2, 10.3, 10.4, 10.5, 10.6 and 10.13 are
incorporated by reference to the same exhibit designations in the Company's
Registration Statement on Form S-1, File No. 333-35227. Exhibit No. 10.14 is
incorporated by reference to Exhibit No. 10.27 in the Company's Registration
Statement on Form S-1, File No.333-35227. Exhibit Nos. 10.7, 10.8, 10.9, 10.10,
10.11, 10.12 and 10.15 are incorporated by reference to the Company's Current
Report on Form 8-K filed on February 19, 1998.
(b) A report form 8-K was filed February 19, 1998 providing Exhibits Nos.10.7,
10.8, 10.9, 10.10, 10.11, 10.12 and 10.15.
19
<PAGE>
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ELECTRIC LIGHTWAVE, INC.
------------------------
(Registrant)
By: /s/ Daryl A. Ferguson
________________________________________
Daryl A. Ferguson
Vice Chairman of the Board, Chief Executive Officer, Member,
Executive Committee and Director
March 11, 1998
20
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 11th day of March 1998.
Signature Title
--------- ------
/S/ Robert J. DeSantis Chief Financial Officer, Vice President
___________________________ and Treasurer
(Robert J. DeSantis)
/s/ Kerry D. Rea Vice President and Controller
_______________________________
(Kerry D. Rea)
________________________________ Director
(Stanley Harfenist) *
________________________________ Director
(Robert A. Stanger) *
________________________________ Director
(Maggie Wilderotter) *
________________________________ President, Chief Operating Officer, Member,
(David B. Sharkey) * Executive Committee and Director
________________________________ Chairman of the Board, Member, Executive
(Leonard Tow)* Committee and Director
*By:/s/ Robert J. DeSantis
______________________
(Robert J. DeSantis)
Attorney-in-Fact
21
<PAGE>
ELECTRIC LIGHTWAVE, INC
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Page
Independent Auditors' Report..........................................................................................F-1
Balance Sheets at December 31, 1997 and 1996 .........................................................................F-2
Statements of Operations for the Years Ended December 31, 1997, 1996 and 1995 ........................................F-3
Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 ........................................F-4
Statements of Changes in Stockholders' Equity for the Years Ended
December 31, 1997, 1996 and 1995...................................................................................F-5
Notes to Financial Statements.........................................................................................F-6
</TABLE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Electric Lightwave, Inc.
We have audited the balance sheets of Electric Lightwave, Inc. as of
December 31, 1997 and 1996 and the related statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1997. These financial statements are the responsi-
bility of the Company's management. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Electric Lightwave,
Inc. as of December 31, 1997 and 1996, and the results of its operations and its
cash flows for each of the years in the three-year period ended December 31,
1997, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
New York, New York
March 10, 1998
F-1
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Balance Sheets
(All amounts in thousands)
<TABLE>
December 31,
<S> <C>
-----------
1997 1996
---------------------
ASSETS
Current assets:
Cash $ 26,531 $ 611
Trade receivables, net 12,569 4,610
Other receivables 7,688 8,329
Other current assets 844 224
---------------------
Total current assets 47,632 13,774
---------------------
Property, plant and equipment 316,109 189,334
Less accumulated depreciation and amortization (25,791) (17,337)
---------------------
Property, plant and equipment, net 290,318 171,997
---------------------
Other assets 22,012 9,885
---------------------
Total assets $ 359,962 $ 195,656
=====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 50,237 $ 18,892
Taxes other than income taxes 3,136 2,329
Due to Citizens Utilities Company 944 -
Other current liabilities 3,102 2,493
---------------------
Total current liabilities 57,419 23,714
---------------------
Deferred credits and other 1,800 1,435
Deferred income taxes payable 16,918 5,826
Capital lease obligation 10,511 -
Long-term debt 60,000 -
Due to Citizens Utilities Company - 155,395
Shareholders' equity 213,314 9,286
---------------------
Total liabilities and $ 359,962 $ 195,656
shareholders' equity =====================
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-2
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Operations
(All amounts in thousands, except share data)
<TABLE>
<S> <C>
For the years ended December 31,
------------------------------------
1997 1996 1995
------------------------------------
Revenues $ 61,084 $ 31,309 $ 15,660
------------------------------------
Operating expenses:
Network access expenses 29,546 20,620 7,387
Sales and marketing expenses 13,905 9,056 6,722
Depreciation and amortization 11,167 7,192 7,064
Other operating expenses 40,561 23,824 14,437
------------------------------------
Total operating expenses 95,179 60,692 35,610
------------------------------------
Loss from operations (34,095) (29,383) (19,950)
Interest expense, net 1,166 - 372
------------------------------------
Net loss before income tax benefit (35,261) (29,383) (20,322)
Income tax benefit (1,316) - -
------------------------------------
Net loss $ (33,945) $ (29,383) $ (20,322)
====================================
Weighted average shares outstanding 42,352
Net loss per share
Basic $ (0.80)
Diluted $ (0.80)
</TABLE>
EPS for years prior to 1997 are not presented because the amounts are not
meaningful.
The accompanying Notes are an integral part of these Financial Statements.
F-3
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Cash Flows
(All amounts in thousands)
<TABLE>
<S> <C>
For the years ended December 31,
------------------------------------
1997 1996 1995
------------------------------------
Cash flows from operating activities: $ (33,945) $ (29,383) $ (20,322)
Net loss
Adjustments to reconcile net loss
to net cash used for operating
activities:
Depreciation and amortization 11,167 7,192 7,064
Amortization of restricted stock 219 - -
Changes in operating assets
and liabilities:
Receivables (7,318) (9,797) (1,698)
Accounts payable and other
accrued liabilities 5,359 (2,802) 10,444
Taxes other than income taxes 807 765 967
Other 6,522 2,035 1,975
------------------------------------
Net cash used for
operating activities (17,189) (31,990) (1,570)
------------------------------------
Cash flows used for investing activities:
Capital expenditures (103,984) (56,072) (16,129)
------------------------------------
Cash flows from financing activities:
Debt borrowings 60,000 - (9,111)
Citizens fundings (repayments) (31,461) 88,530 26,862
Issuance of common stock 118,554 - -
------------------------------------
Net cash provided by
financing activities 147,093 88,530 17,751
------------------------------------
Net increase in cash 25,920 468 52
Cash at beginning of period 611 143 91
------------------------------------
Cash at end of period $ 26,531 $ 611 $ 143
====================================
Supplemental cash flow information:
Cash paid for interest $ 937 $ - $ 630
Other non-cash transactions
with Citizens:
Capital contributions by Citizens $ 119,200 $ - $ 3,000
Deferred income taxes $ (12,408) $ (3,198) $ (1,160)
Capitalized interest $ 4,076 $ 2,868 $ 2,619
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-4
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Shareholders' Equity
(All amounts in thousands, except share data)
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
Class A Common Stock, Class B Common Stock,
Preferred Stock $.01 per share $.01 per share Additional
--------------------------------------------------------------- Paid-in- Shareholders'
Shares Amount Shares Amount Shares Amount Capital Deficit Equity
-------------------------------------------------------------------------------------------------------
Balance January 1, 1995 99 $ - - $ - 411,650 $ 4 $ 76,251 $ (20,264) $ 55,991
Acquisition of minority
interest - - - - - - 3,000 - 3,000
Net loss - - - - - - - (20,322) (20,322)
-------------------------------------------------------------------------------------------------------
Balance December 31, 1995 99 - - - 411,650 4 79,251 (40,586) 38,669
Conversion of preferred
stock to common stock (99) - - - 40,753,350 408 (408) - -
Net loss - - - - - - - (29,383) (29,383)
-------------------------------------------------------------------------------------------------------
Balance December 31, 1996 - - - - 41,165,000 412 78,843 (69,969) 9,286
Conversion of due to Citizens
to additional paid in capital - - - - - - 119,200 - 119,200
Issuance of common stock - - 8,000,000 80 - - 118,474 - 118,554
Issuance of restricted stock - - 535,000 5 - - 8,555 - 8,560
Unamortized restricted stock - - - - - - (8,101) - (8,101)
Cancellation of
restricted stock - - (15,000) - - - (240) - (240)
Net loss - - - - - - - (33,945) (33,945)
----------------------------------------------------------------------------------------------------
Balance December 31, 1997 - $ - 8,520,000 $ 85 41,165,000 $ 412 $ 316,731 $(103,914) $ 213,314
====================================================================================================
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-5
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Notes to Financial Statements
(1) Organization and Description of Business
Electric Lightwave, Inc. ("the Company"), is a fully-integrated,
facilities-based competitive local exchange carrier ("CLEC") providing
a broad range of communications services in five major market clusters
in the western United States. The Company provides state-of-the-art
voice and data communications services to retail customers, primarily
large- and medium-sized communications-intensive businesses, and
wholesale customers. The Company was incorporated in 1990 and is a
subsidiary of Citizens Utilities Company ("Citizens").
The Company currently provides services in five markets: Portland,
Oregon; Seattle, Washington; Salt Lake City, Utah; Sacramento,
California; and Phoenix, Arizona ("hub cities") and their respective
surrounding areas.
The capital expenditures of the Company associated with the
installation, development and expansion of its existing and new
communications networks are substantial, and a significant portion of
these expenditures generally are incurred before any revenues are
realized. These expenditures, together with associated initial
operating expenses, have resulted in negative cash flow and operating
losses and will continue to do so until an adequate customer base and
revenue stream for these networks have been established. The Company
expects to incur losses for the foreseeable future as it continues to
install, develop and expand its new and existing communications
networks. There can be no assurance that an adequate revenue base will
be established or that the Company will achieve or sustain
profitability or generate sufficient positive cash flow to fund its
operating and capital requirements and/or service debt.
(2) Summary of Significant Accounting Policies
(a) Basis of Presentation and Use of Estimates
The financial statements have been prepared in accordance with
Generally Accepted Accounting Principles ("GAAP"). The
preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions which
affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues
and expenses during the reporting periods. Actual results
could differ from those estimates. Certain items have been
reclassified to conform to the current year presentation.
(b) Revenue Recognition
Revenues from communications services are recognized when the
services are provided. Revenues from long-term leases of fiber
optic cable is recognized on a straight line basis over the
terms of the related leases.
F-6
<PAGE>
(c) Trade and Other Receivables
The Company's trade customers are primarily large- and
medium-sized communications-intensive businesses and
communications service providers that require state-of-the-art
communications and data services. Trade accounts receivable is
shown net of an allowance for doubtful accounts in amounts of
approximately $3,569,000 and $1,166,000 at December 31, 1997
and 1996, respectively. At December 31, 1997, the Company's
trade receivables are concentrated in and around the five
cities referred to in Note 1. The Company has substantial
business relationships with a few large customers, including
the major long distance carriers. In 1997, one customer,
pursuant to a short term contract expiring in early 1998,
accounted for approximately 10% of the Company's revenues.
Other receivables at December 31, 1997 and 1996 included
approximately $7,029,000 and $6,700,000, respectively, of
reimbursement due to the Company under a construction agency
agreement (see Note 10).
(d) Property, Plant and Equipment
Property, plant and equipment are stated at cost and include
certain costs which are capitalized during the installation
and expansion of communications networks including interest
costs related to construction of approximately $4,693,000,
$2,868,000 and $2,619,000 for the years ended December 31,
1997, 1996 and 1995, respectively. Depreciation is computed
using the straight line method over the estimated useful lives
of the assets. Leasehold improvements are amortized using the
straight line method over the shorter of the estimated useful
lives of the assets or the remaining terms of the leases. A
capital lease included in communications networks is being
amortized using the straight line method over the life of the
capital lease. The estimated useful lives of owned assets are
as follows:
Communications networks 25 years
Electronics and related equipment 7 - 8 years
Office equipment and other 5 - 7 years
The Company's communications networks are subject to
technological risks and rapid market changes due to new
products and services and changing customer demand. These
changes may result in future adjustments to the estimated
useful lives of these assets.
(e) Other Assets
Other assets include third party direct costs incurred in
connection with negotiating and securing initial rights-of-way
and developing network design for new market clusters or
locations, which costs are deferred until service is ready to
commence. Such costs are then amortized over a 5 year period
utilizing the straight line method. Also included in other
assets at December 31, 1997 and 1996 is goodwill of $4,504,000
and $4,680,000, respectively (see Note 7). Goodwill is being
amortized utilizing the straight line method over a 25 year
period. At December 31, 1997, a $12,555,000 deposit related
to an indefeasible right to use contract was included in
other assets (see Note 10).
F-7
<PAGE>
(f) Income Taxes
The Company is included in the consolidated federal income tax
return of Citizens. The Company utilizes the asset and
liability method of accounting for income taxes. Under the
asset and liability method, deferred income taxes are recorded
for the tax effect of temporary differences between the
financial statements and the tax bases of assets and
liabilities using tax rates expected to be in effect when the
temporary differences are expected to turn around. Citizens'
policy has been to record tax provisions, assets and
liabilities at the subsidiary level on a stand alone basis.
Citizens will reimburse the Company for net operating losses
generated after the IPO date but only to the extent that such
losses could be utilized by the Company on a stand alone
basis.
(g) Impairment
In accordance with Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of," the
Company reviews for the impairment of long-lived assets and
certain identifiable intangibles to be held and used by the
Company whenever events or changes in circumstances indicate
that the carrying amount of the asset may not be recoverable.
The Company assesses the recoverability of an asset by
determining whether the amortization of the asset balance over
its remaining life can be recovered through projections of
undiscounted future cash flows of the related asset. The
amount of asset impairment, if any, is measured based on
projected discounted future cash flows using a discount rate
reflecting the Company's average cost of funds.
(h) Employee Stock Plans
Prior to the Initial Public Offering ("IPO"), the Company
participated in the Management Equity Incentive Plan
("Citizens' MEIP") and Equity Incentive Plan ("Citizens EIP")
of Citizens, which may grant awards of Citizens Common Stock
to eligible officers, management employees and non-management
exempt employees of Citizens and its subsidiaries in the form
of incentive stock options, non-qualified stock options, stock
appreciation rights, restricted stock or other stock-based
awards. The Company also had participated in the Employee
Stock Purchase Plan ("Citizens' ESPP") of Citizens in which
employees of Citizens and its subsidiaries may subscribe to
purchase shares of Citizens' common stock at 85% of the lower
of the average market price on the first or last day of the
purchase period.
In October 1997, the Board of Directors adopted the 1997
Equity Incentive Plan ("EIP") which authorizes, among other
things, the grant of incentive stock options, non-qualified
stock options, stock appreciation rights, restricted stock or
other stock-based awards.
Prior to January 1, 1996, the Company accounted for the
Citizens' employee stock option plans in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees", and related
interpretations. As such, compensation expense is recorded on
the date of grant only if the current market price of the
underlying stock exceeded the exercise price. On January 1,
1996, the Company adopted SFAS 123, "Accounting for
Stock-Based Compensation" which permits entities to recognize
as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS
123 also allows entities to continue to apply the provisions
of APB Opinion No. 25 and provide pro forma net income and pro
forma earnings per share disclosures for employee stock option
grants made in 1995 and future years as if the fair-value
based method defined in SFAS 123 had been applied. The Company
has elected to continue to apply the provisions of APB Opinion
No. 25 and provide the pro forma disclosure provisions of SFAS
123 (see Note 9).
F-8
<PAGE>
(i) Net Loss Per Share
The Company follows the provisions of SFAS No. 128, "Earnings
Per Share" which requires dual presentation of basic and
diluted earnings per share ("EPS") on the face of the income
statement. Basic EPS is based on the weighted average number
of common shares outstanding. Diluted EPS reflects the
potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted
into common stock. EPS for years prior to 1997 are not
presented because the amounts are not meaningful.
Weighted average shares outstanding have been adjusted for the
effects of application of Securities and Exchange Commission
Staff Accounting Bulletin ("SAB") No. 83. Pursuant to SAB No.
83, all stock issued within one year of an IPO at less than
the offering price and all options granted within one year of
the Company's IPO which have an exercise price less than the
Offering price are treated as outstanding for all periods
presented (using the treasury stock method at the assumed IPO
price) even though the effect is to reduce the net loss per
share. The application of SAB No. 83 had the effect of
increasing outstanding shares by 520,000 for 1997.
(3) Property, Plant and Equipment
The components of property, plant and equipment at December 31, 1997
and 1996 are as follows:
<TABLE>
<S> <C> <C>
($ in thousands) 1997 1996
---------------- ------------- -----------
Communications networks $ 152,578 $ 112,394
Electronics and related equipment 22,003 20,417
Office equipment and leasehold improvements 17,315 12,804
Construction work in progress 121,426 37,433
Inventory 2,787 6,286
------------- -------------
Property, plant and equipment 316,109 189,334
Accumulated depreciation and amortization (25,791) (17,337)
-------------- -------------
Property, plant and equipment, net $ 290,318 $ 171,997
============= =============
</TABLE>
Communications networks include a capital lease at December 31, 1997
in the amount of $11,320,000.
Inventory consists primarily of new and reusable parts to maintain and
build fiber optic networks.
The Company has leased fiber optic cable included in its communications
networks to an unrelated long distance carrier for 10 years beginning
in 1995 and to Citizens for 10 years beginning in 1996. The lease
agreement with the long distance carrier provided for $1,500,000 in
cash at inception, which amount is being amortized utilizing the
straight line method over the lease period, and $144,000 per month over
the 10 year lease period. The lease agreement with Citizens calls for
monthly rentals of $30,000 over the 10 year lease period (see Note 10).
F-9
<PAGE>
(4) Accounts Payable and Accrued Liabilities
The components of accounts payable and accrued liabilities at
December 31, 1997 and 1996 are as follows:
<TABLE>
<S> <C> <C> <C>
($ in thousands) 1997 1996
----------------- ---------- ----------
Accounts payable - trade $ 5,407 $ 3,118
Accrued services purchased for resale 5,609 1,106
Accrued construction work in progress 25,986 3,097
Accrued compensation 3,530 -
Other accrued liabilities 9,705 11,571
---------- ----------
Accounts payable and accrued liabilities $ 50,237 $ 18,892
========== ==========
</TABLE>
(5) Long-term Debt
In November 1997 the Company arranged for a $400 million, 5-year
revolving bank credit facility ("Credit Facility"), guaranteed by
Citizens, which expires in November 2002 and which has associated
facility fees of 1/20 of 1% (0.05) per annum. The Company has agreed to
pay Citizens an annual guarantee fee of 3.25% per annum on the balance
outstanding under the Credit Facility. At December 31, 1997, the
balance outstanding is $60 million and the weighted average interest
rate is 6.05%. No principal payment is due until the expiration date of
the Credit Facility.
(6) Income Taxes
The components of deferred income taxes at December 31, 1997 and 1996
are as follows:
<TABLE>
<S> <C> <C> <C>
($ in thousands) 1997 1996
----------------- --------- ---------
Benefit of operating loss carryforwards $ 3,171 $ 24,348
Less valuation allowance - (24,348)
--------- ---------
Net deferred tax asset $ 3,171 $ -
--------- ----------
Deferred income tax liability,
primarily property, plant and equipment $ 20,089 $ 5,826
--------- ----------
Net deferred income tax liability $ 16,918 $ 5,826
========= ==========
</TABLE>
The Company is included in the consolidated federal income tax return
of Citizens. The net deferred tax asset for the benefit of the
operating loss carryforwards represent amounts due from Citizens for
the utilization by Citizens of the Company's operating losses incurred
after the IPO date which are included in the consolidated federal
income tax return. These amounts will be reimbursed to the Company only
when such losses can be utilized by the Company on a stand alone basis.
The benefit reflected in Citizens' consolidated federal income tax
return for the cumulative net operating loss as of the IPO date will
not be reimbursed to the Company; accordingly, $35,374,000 has been
eliminated along with the corresponding amount of valuation allowance
as of the IPO date.
F-10
<PAGE>
The following is a reconciliation of the provision for income taxes at
federal statutory rates to the effective rates:
<TABLE>
<S> <C> <C> <C>
1997 1996
------ ------
Tax provision at federal statutory rate 35.0% 35.0%
Pre IPO operating loss not benefited (31.3%) (35.0%)
------- -------
3.7% 0.0%
======= =======
</TABLE>
The provision for income tax expense consisted of deferred federal tax
expense of approximately $11,092,000, $3,198,000 and $1,160,000 and
current tax benefits of $12,408,000, $3,198,000 and $1,160,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.
(7) Capital Stock
During 1995, Citizens purchased 58,750 shares of common stock from the
minority shareholder of the Company. This purchase has been recorded in
the Company's accounts as goodwill and additional paid-in capital.
During 1996, all of the then outstanding preferred stock was converted
into 7,475,527 shares of common stock. On June 14, 1996 there was a
reverse stock split of common stock in the amount of 100 for 7,600,536.
The split reduced the shares of common stock outstanding from 7,600,536
to 100 shares, and the number of authorized shares was reduced to 500
shares of preferred and 500 shares of common.
On November 11, 1997, the Company amended its Certificate of
Incorporation to change its authorized capital stock to 180,000,000
shares, including 110,000,000 shares of Class A Common Stock $.01 par
value per share, 60,000,000 shares of Class B Common Stock $.01 par
value per share, and 10,000,000 shares of preferred stock $.01 par
value per share. At that time, the outstanding common stock was
converted to Class B Common Stock and the Company declared a stock
split of 411,650 to one. The stock split increased the number of shares
of Class B Common Stock outstanding to 41,165,000.
On November 24, 1997, the Company completed its IPO of 8,000,000 shares
of Class A Common Stock at a price of $16.00 per share. Gross proceeds
from this offering totaled approximately $128,000,000 and proceeds net
of underwriting discounts and commissions totaled approximately
$120,320,000. Additionally, 535,000 of restricted shares of Class A
Common Stock were issued to directors, officers and employees under the
Equity Incentive Plan (See Note 9). Subsequently, 15,000 of the
restricted shares were returned and canceled.
At December 31, 1997, there were 8,520,000 shares of Class A Common
Stock and 41,165,000 shares of Class B Common Stock outstanding. There
were no preferred shares outstanding. Citizens owns all of the Class B
Common Stock, representing approximately 82.83% of the economic
interest in the Company.
Each share of Class A Common Stock entitles the holder to one vote and
each share of Class B Common Stock entitles the holder to 10 votes on
each matter to be voted upon by the holders of the Common Stock. As a
result, Citizens has 97.97% of the voting control of the Company. With
the exception of voting rights, the rights and privileges of Class A
and Class B Common Stock are identical. Class B Common Stock is
convertible into Class A Common Stock on a one-for-one basis. The Class
A Common Stock has no exchange rights. The financial statements give
retroactive effect to the aforementioned stock splits.
F-11
<PAGE>
(8) Related Party Transactions
Transactions with Citizens
The Company has been a subsidiary of Citizens since 1990. In connection
with this ownership interest, prior to the IPO, Citizens had advanced
funds to the Company to finance operations, construction and capital
expenditures. Interest was not charged on Citizens advances for
operations and capital expenditures, except for intercompany advances
used to fund construction-in-progress. Interest on such intercompany
advances was recorded as an increase in the amount due to Citizens and
capitalized as part of property, plant and equipment. Subsequent to the
construction period, the advances became non-interest bearing.
Citizens also provides certain administrative services to the Company
including, but not limited to, certain financial management services,
information services, legal and contract services and human resources
services. The Company entered into an Administrative Services Agreement
("Agreement") with Citizens on December 1, 1997 for the continuation
of such services and will continue to be billed for reimbursable costs
as defined in the agreement plus an administrative charge.
In 1996, Citizens entered into a lease for fiber optic cable from the
Company for 10 years which calls for rentals of $30,000 per month. Also
during 1996, Citizens and the Company combined their purchasing power
of long-haul services in arrangements with a long distance carrier in
order to receive a lower unit cost. The Company reimbursed Citizens
$5,116,000 and $7,600,000 in 1997 and 1996, respectively, representing
the cost of the Company's usage of these long-haul services plus a 5%
administrative fee. This arrangement with Citizens was replaced
effective May 1, 1997 with a 24-month agreement which eliminated the 5%
administrative fee.
A summary of the activity in the amount due to Citizens at December 31,
1997, 1996 and 1995 is as follows:
See Note 6 for information regarding the Company's tax sharing
agreement with Citizens and Note 9 for information regarding
participation in Citizens' stock plans.
<TABLE>
<S> <C> <C> <C> <C>
($ in thousands) 1997 1996 1995
---------------- ---------- ---------- ----------
Balance beginning of period $ 155,395 $ 64,941 $ 35,109
Capital contribution (119,200) - -
Cash advances from Citizens, net (31,461) 88,530 26,862
Guarantee fees 548 - -
Deferred income taxes (see Note 6) (12,408) (3,198) (1,160)
Interest 4,076 2,868 2,619
Administrative services and other items 3,994 2,254 1,511
---------- ---------- ----------
Balance end of period $ 944 $ 155,395 $ 64,941
========== ========== ==========
</TABLE>
(9) Stock Plans
Citizens Plans
Prior to the IPO, Company employees participated in three Citizens
stock based compensation plans which are described below. The Company
applies APB Opinion No. 25 and related interpretations in accounting
for the Citizens employee stock plans. Accordingly, no compensation
cost was recognized in the financial statements for options issued
pursuant to the Citizens MEIP, Citizens EIP or Citizens ESPP.
F-12
<PAGE>
In October 1997, the Board of Directors adopted the 1997 Equity
Incentive Plan ("EIP"), which authorizes, among other things, the grant
of incentive stock options, nonqualified stock options, stock
appreciation rights or combinations thereof and restricted stock. The
exercise price for such awards shall be determined by the Compensation
Committee of the Board of Directors at the date of grant. The exercise
period for option awards is generally 10 years from the date of grant.
The Company has reserved 4,170,000 shares for issuance under the terms
of the plan.
The Company applies APB Opinion No. 25 and related interpretations in
accounting for the Company's employee stock plan. Accordingly, no
compensation cost has been recognized in the financial statements for
options issued pursuant to EIP. Compensation expense recognized for
restricted stock issued pursuant to the EIP was $219,000 in 1997.
Had the Company determined compensation cost based on the fair value at
the grant date under SFAS 123, the Company's pro forma net loss would
have been as follows:
<TABLE>
<S> <C> <C> <C> <C> <C>
($ in thousands, except per share) 1997 1996 1995
-----------------------------------------------------------------------
Net loss As reported $ (33,945) $ (29,383) $ (20,322)
Pro forma $ (34,392) $ (29,528) $ (20,352)
Basic net loss As reported $ (.80)
per share Pro forma $ (.81)
Diluted net loss As reported $ (.80)
per share Pro forma $ (.81)
</TABLE>
The following information reflects the Citizens MEIP, Citizens EIP and
Citizens ESPP for Company employees and excludes full time employees
and officers of Citizens.
Under the Citizens MEIP and Citizens EIP, the exercise price of stock
options shall be equal to or greater than the fair market value of the
underlying Citizens common stock on the date of grant. Stock options
are generally not exercisable on the date of grant but vest over a
period of time. A summary of Citizens shares subject to option for
Company employees is as follows:
<TABLE>
<S> <C> <C> <C>
Shares Weighted
Subject to Average Option
Option Price Per Share
Citizens MEIP:
Balance at January 1, 1995 107,374 $12.09
Options granted 29,307 10.36
Options canceled or lapsed (20,768) 12.05
--------
Balance at December 31, 1995 115,913 11.66
Options granted 114,614 10.86
Options exercised - -
Options canceled or lapsed (6,223) 11.29
--------
Balance at December 31, 224,304 $11.26
1996 and 1997 ========
Citizens EIP:
Balance January 1, 1997 - $ -
-
Options granted 321,382 8.79
--------
Balance at December 31, 1997 321,382 $ 8.79
========
</TABLE>
F-13
<PAGE>
The following table summarizes information about Citizens shares
subject to option for Company employees under the Citizens MEIP and
Citizens EIP at December 31, 1997.
<TABLE>
<S> <C>
Options Outstanding Options Exercisable
-----------------------------------------------------------------------------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Number Range of Exercise Life in Number Exercise
Outstanding Exercise Prices Price Years Exercisable Price
------------------------------------------------------------------------------------------
Citizens MEIP 224,304 $9.66 - $14.67 $11.26 7.4 86,157 $10.23
Citizens EIP 321,382 $8.79 $ 8.79 9.9 - -
</TABLE>
The weighted-average fair value of options granted during 1997, 1996
and 1995 were $4.23, $4.61 and $5.09, respectively. For purposes of the
pro forma calculation under SFAS 123, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions
used for grants at December 31, 1997, 1996 and 1995:
<TABLE>
<S> <C> <C> <C>
Citizens EIP Citizens MEIP
1997 1996 1995
------------ ----------------
Dividend yield - - -
Expected volatility 32% 20% 20%
Risk-free interest rate 6.13% 5.62% 6.61%
Expected life 7 years 7 years 7 years
</TABLE>
The Citizens ESPP allows eligible employees of Citizens and its
subsidiaries to subscribe to purchase shares of Citizens Common Stock
at 85% of the lower of the average market price on the first or last
day of the purchase period. An employee may elect to have up to 20% of
annual base pay withheld in equal installments throughout the
designated payroll-deduction period for the purchase of shares. The
value of an employee's subscription may not exceed $25,000 in any one
calendar year.
The weighted-average fair value of purchase rights granted in 1997,
1996 and 1995 was $3.07, $3.46 and $3.59, respectively. For purposes of
the pro forma calculation under SFAS 123, compensation cost is
recognized for the fair value of the employees' purchase rights, which
was estimated using the Black-Scholes Model with the following
assumptions for subscription periods beginning in 1997, 1996 and 1995:
<TABLE>
<S> <C> <C> <C> <C>
1997 1996 1995
------------------------------------------------------------
Dividend yield - - -
Expected volatility 32% 20% 20%
Risk-free interest rate 5.44% 5.28% 5.53%
Expected life 6 months 6 months 6 months
</TABLE>
F-14
<PAGE>
Company Plans
Concurrent with the IPO, the Company granted stock options in the
amount of 2,326,000 shares of Class A Common Stock at the Offering
price of $16 per share to certain directors, officers and employees of
the Company and Citizens. The Company also granted 535,000 restricted
shares of Class A Common Stock at the date of the IPO to certain
directors, officers and employees. Subsequently, 15,000 restricted
shares were returned and canceled. None of the restricted stock awards
may be sold, assigned, pledged or otherwise transferred, voluntarily or
involuntarily, by the employee until the restrictions lapse. The
restrictions lapse over one through three-year periods, however, the
restrictions on one-third of the stock will not lapse until
$100,000,000 of annual revenue is achieved, the restrictions on the
second one-third of the stock will not lapse until $121,000,000 of
annual revenues is achieved, and the restrictions on the last one-third
of the stock will not lapse until $155,000,000 of annual revenues is
achieved. At December 31, 1997, the Company had not reached the
$100,000,000 revenue requirement.
The weighted-average fair value of options granted during 1997 under
the EIP were $5.13. For purposes of the pro forma calculation under
SFAS 123, the fair value of each option grant is estimated on the date
of grant using the Black-Scholes option-pricing model with the
following weighted average assumptions used for grants in 1997:
<TABLE>
<S> <C> <C>
1997
-----------------------------------------------------
Dividend yield -
Expected volatility 13%
Risk-free interest rate 5.87%
Expected life 7 yrs
</TABLE>
(10) Commitments and Contingencies
In 1995, the Company entered into a $110 million construction agency
agreement and an operating lease agreement in connection with the
construction of certain communications networks and fiber cable links.
The Company serves as agent for the construction of these projects and
upon completion of each project has agreed to lease the facilities for
a three year term, with one year renewals available through April 30,
2002. At December 31, 1997 and 1996, the Company was leasing assets
with an original cost of approximately $87,426,000 and $57,300,000
respectively, under this agreement. The Company has the option to
purchase the facilities at the end of the lease terms for the amount of
the lessor's average investment in the facilities, which is expected to
be $110,000,000. In the event the Company chooses not to exercise this
option, the Company is obligated to arrange for the sale of the
facilities to an unrelated party and is required to pay the lessor any
difference between the net sales proceeds and the lessor's investment
in the facilities. However, any amount required to be paid to the
lessor is subject generally to a maximum of 80% of the lessor's
investment, giving effect to lease payments previously made. The
performance of these lease obligations is guaranteed by Citizens. The
Company has agreed to pay to Citizens a guarantee fee at the rate of
3.25% per annum based on the amount of the lessor's investment in the
leased assets.
The Company conducts certain of its operations in leased premises and
also leases certain equipment. Obligations, renewals and maintenance
costs vary by lease.
F-15
<PAGE>
The Company has entered into an operating lease contract and a capital
lease contract with a third party in order to develop long-haul routes
between Portland, Oregon and Seattle, Washington and between Portland,
Oregon, and Spokane, Washington and between Portland, Oregon and
Eugene, Oregon. The operating lease agreement provides for rental
payments based on a percentage of the Company's monthly leased traffic
over such routes and is expected to become operational in the second
quarter of 1998. The capital lease agreement provides for a monthly
minimum lease payment of $105,000 plus a percentage of leased traffic
over such route in excess of certain minimums and became operational in
February 1997. Both agreements have terms of 15 years.
The Company has entered into an operating lease contract to develop a
local network in Phoenix, Arizona. The operating lease provides for
rental payments based on a percentage of the network's operating income
for a period of 15 years.
In October 1997, the Company entered into a 20 year indefeasible right
to use contract for 24 optical fibers with an unrelated third party for
approximately $50,200,000. The third party intends to construct a fiber
optic communications system linking Portland, Boise, Salt Lake City,
Las Vegas and Los Angeles. The network is scheduled to be completed by
February 28, 1999 and will have approximately 1,620 route miles. The
Company has paid approximately $12,555,000 as a deposit which is
included in Other Assets.
In November 1997, the Company entered into a 30 year indefeasible and
exclusive right to use agreement for optical fibers with an unrelated
third party. The Company has exclusive rights to approximately 76 miles
of these fibers at an annual cost of approximately $577,000 per year.
The third party will construct certain sections of a fiber optic
communications system in the San Francisco Bay Area. The network is
scheduled to be completed before December 31, 1998.
On December 31, 1997, the Company entered into an agreement with a
third party under which it will develop a 672 mile long-haul route from
Oregon into southern California. The Company will construct, at its own
expense, an optical fiber communications system. In exchange for the
construction of the system and annual fees payable to the third party
(estimated to be $1,500,000) when the system is completed, the Company
will receive an indefeasible right of way to use the system through
2018.
On January 8, 1998, the Company entered into an operating lease
contract with a third party in order to develop a long-haul route
between Portland and Malin, Oregon. The operating lease agreement
provides for rental payments based on a percentage of the Company's
monthly leased traffic over such route and is expected to become
operational in the first quarter of 1999. The lease agreement provides
for an annual minimum lease payment based on a percentage of leased
traffic over such route in excess of certain minimums. The lease term
is 20 years, beginning when the lines become operational.
F-16
<PAGE>
Future minimum rental commitments for all long-term noncancelable
leases as of December 31, 1997 are:
<TABLE>
<S> <C> <C>
Lease Type
----------------------------
Year Capital Operating
---- ------------ ------------
($ in thousands)
1998 $ 1,260 $ 7,874
1999 1,260 7,741
2000 1,260 7,636
2001 1,260 6,515
2002 1,260 3,383
Thereafter 10,941 3,036
------------ ------------
Total 17,241 $ 36,185
============
Less amounts representing interest (6,278)
-------------
Present value of net minimum 10,963
lease payments
Less current installments of (452)
obligations under capital leases -------------
$ 10,511
=============
</TABLE>
Total rental expense included in the Company's results of operations
for the years ended December 31, 1997, 1996 and 1995 was $9,196,000,
$5,193,000 and $2,475,000 respectively.
The Company is also a party to contracts with several unrelated long
distance carriers. The contracts provide for fees based on leased
traffic subject to minimum monthly fees which aggregate $14,660,000 for
1998, $19,060,000 for 1999 and $1,887,000 for 2000.
The Company's budgeted capital expenditures for 1998 are $275,000,000
and certain commitments have been entered into in connection therewith.
The Company is involved in various claims and legal actions arising in
the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on the Company's results of operations, financial position or
liquidity.
F-17
<PAGE>
<TABLE>
<CAPTION>
Schedule II
Electric Lightwave, Inc.
Valuation and Qualifying Accounts
($ in thousands)
Balance at Charged to Charge to Balance
Beginning Cost Other at End
Accounts of Period and Expense Accounts Deductions of Period
- -------- ---------- ----------- --------- ---------- ---------
1995:
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts $ (36) $ (111) $ - $ (72) $ (75)
Deferred income taxes valuation
allowance (7,045) - (7,063) - (14,108)
1996:
Allowance for doubtful accounts (75) (3,010) - (1,919) (1,166)
Deferred income taxes valuation
allowance (14,108) - (10,240) - (24,348)
1997:
Allowance for doubtful accounts (1,166) (1,801) (1,529) (927) (3,569)
Deferred income taxes valuation
allowance $(24,348) $ - $(11,026) $(35,374) $ -
</TABLE>
<PAGE>
The Board of Directors
Electric Lightwave, Inc.:
We have audited and reported separately herein on the financial statements of
Electric Lightwave, Inc. as of December 31, 1997 and 1996 and the related
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1997.
Our audits were made for the purpose of forming an opinion on the basic
financial statements of Electric Lightwave, Inc. taken as a whole. The
supplementary information included in Schedule II is presented for purposes of
additional analysis and is not a required part of the basic financial
statements. Such information has been subjected to the auditing procedures
applied in the audit of the basic financial statements and, in our opinion, is
fairly stated in all material respects in relation to the basic financial
statements taken as a whole.
KPMG Peat Marwick LLP
March 11, 1998
Exhibit 24.1
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
ELECTRIC LIGHTWAVE, INC. constitutes and appoints Robert J. DeSantis and Kerry
Rea, jointly and severally, for him in any and all capacities to sign on Form
10-K for the fiscal year 1997 for ELECTRIC LIGHTWAVE, INC., and any and all
amendments to said Form 10-K, and to file the same, with the Securities and
Exchange Commission, hereby ratifying and conforming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
/s/ Leonard Tow
-------------------
Leonard Tow
February 24, 1998
<PAGE>
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
ELECTRIC LIGHTWAVE, INC. constitutes and appoints Robert J. DeSantis and Kerry
Rea, jointly and severally, for him in any and all capacities to sign on Form
10-K for the fiscal year 1997 for ELECTRIC LIGHTWAVE, INC., and any and all
amendments to said Form 10-K, and to file the same, with the Securities and
Exchange Commission, hereby ratifying and conforming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
/s/ Robert A. Stanger
---------------------
Robert A. Stanger
February 24, 1998
<PAGE>
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
ELECTRIC LIGHTWAVE, INC. constitutes and appoints Robert J. DeSantis and Kerry
Rea, jointly and severally, for him in any and all capacities to sign on Form
10-K for the fiscal year 1997 for ELECTRIC LIGHTWAVE, INC., and any and all
amendments to said Form 10-K, and to file the same, with the Securities and
Exchange Commission, hereby ratifying and conforming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
/s/ Stanley Harfenist
---------------------
Stanley Harfenist
February 24, 1998
<PAGE>
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
ELECTRIC LIGHTWAVE, INC. constitutes and appoints Robert J. DeSantis and Kerry
Rea, jointly and severally, for him in any and all capacities to sign on Form
10-K for the fiscal year 1997 for ELECTRIC LIGHTWAVE, INC., and any and all
amendments to said Form 10-K, and to file the same, with the Securities and
Exchange Commission, hereby ratifying and conforming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
/s/ David B. Sharkey
--------------------
David B. Sharkey
February 24, 1998
<PAGE>
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned director of
ELECTRIC LIGHTWAVE, INC. constitutes and appoints Robert J. DeSantis and Kerry
Rea, jointly and severally, for him in any and all capacities to sign on Form
10-K for the fiscal year 1997 for ELECTRIC LIGHTWAVE, INC., and any and all
amendments to said Form 10-K, and to file the same, with the Securities and
Exchange Commission, hereby ratifying and conforming all that each of said
attorneys-in-fact, or his substitute or substitutes may do or cause to be done
by virtue hereof.
/s/ Maggie Wilderotter
----------------------
Maggie Wilderotter
February 24, 1998
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
Electric Lightwave, Inc.'s Consolidated Financial Statements for the
year ended December 31, 1997 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<CIK> 0001044827
<NAME> Electric Lightwave, Inc.
<MULTIPLIER> 1,000
<CURRENCY> US Dollars
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1997
<PERIOD-START> Jan-1-1997
<PERIOD-END> Dec-31-1997
<EXCHANGE-RATE> 1
<CASH> 26,531
<SECURITIES> 0
<RECEIVABLES> 23,826
<ALLOWANCES> 3,569
<INVENTORY> 0
<CURRENT-ASSETS> 47,632
<PP&E> 316,109
<DEPRECIATION> (25,791)
<TOTAL-ASSETS> 359,962
<CURRENT-LIABILITIES> 57,419
<BONDS> 0
0
0
<COMMON> 497
<OTHER-SE> 213,314
<TOTAL-LIABILITY-AND-EQUITY> 359,962
<SALES> 61,084
<TOTAL-REVENUES> 61,084
<CGS> 29,546
<TOTAL-COSTS> 95,179
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,166
<INCOME-PRETAX> (35,261)
<INCOME-TAX> (1,316)
<INCOME-CONTINUING> (33,945)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (33,945)
<EPS-PRIMARY> (.80)
<EPS-DILUTED> (.80)
</TABLE>
