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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, 1998
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 199
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number 0-23393
ELECTRIC LIGHTWAVE, INC.
(Exact name of registrant as specified in its charter)
Delaware 93-1035711
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4400 NE 77th Avenue
Vancouver, Washington 98662
(Address, zip code of principal executive offices)
Registrant's telephone number, including area code: (360) 816-3000
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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 share
(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
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. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 25, 1999 was $70,114,000. The number of shares
outstanding of each of the registrant's classes of common stock as of February
25, 1999 were:
Common Stock Class A: 8,642,763
Common Stock Class B: 41,165,000
DOCUMENTS INCORPORATED BY REFERENCE
The Proxy Statement for the registrant's 1999 Annual Meeting of Stockholders to
be held on May 20, 1999, is incorporated by reference into Part III of this Form
10-K.
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ITEM 1. DESCRIPTION OF BUSINESS
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. Further discussion
regarding forward-looking statements, including the factors which may cause
actual results to differ from such statements, is located in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", in this report.
a. General development of business
Electric Lightwave, Inc. (the Company or ELI) is a facilities-based Integrated
Communications Provider (ICP) providing a broad range of communications
services. The Company provides the full range of its products and services,
including switched local and long distance voice service as well as enhanced
data communications services and dedicated point-to-point services, in the
western United States. Enhanced data services are also offered in selected
cities throughout the country. The Company markets to retail customers, who are
primarily large- and medium-sized communications-intensive businesses, and to
wholesale customers, who are primarily other communications providers.
The Company initially operated as a Competitive Access Provider (CAP) in
selected western United States cities, providing point-to-point connectivity for
inter-exchange carriers (IXCs) and businesses. With the passage of the
Telecommunications Act of 1996, the increase in customer demand for enhanced
broadband data services and the development of competitive public data and voice
networks, the Company has substantially expanded the breadth of its product
offering and its geographic reach.
During 1998 the Company expanded the number of its Metropolitan Area Networks
(MANs), where it provides the full range of its services on its own fiber optic
network, from 5 to 7. The Company also added 2 voice switches, 3 frame relay
switches, 6 Asynchronous Transfer Mode (ATM) switches and 7 Internet routers to
its facilities during the year. The Company's ATM network backbone began
operation in 1998, and is used to transfer voice, video images and data.
Management believes the ATM network will position the Company to offer one
network for all data, voice and video transmission needs. The Company's local
and long-haul installed fiber optic network was expanded by 24% to 3,091 route
miles during the year, and construction has started on over 2,900 route miles of
additional fiber with completion scheduled for the second half of 1999. In the
second half of 1998, the Company began the expansion of its enhanced data
services to cities outside of its MAN network, with additional cities scheduled
for addition in 1999.
The Company was incorporated in 1990 and is approximately 83% owned by Citizens
Utilities Company (Citizens). The Company completed the Initial Public Offering
(IPO) of its common stock in November 1997. On May 18, 1998, Citizens announced
it planned to separate its telecommunications businesses and its public services
businesses into two stand-alone, publicly traded companies. Citizens'
telecommunications businesses include the Company as well as other
telecommunications businesses and investments. These telecommunications
businesses and investments would be transferred to a new, as yet un-named
corporation. Citizens has advised the Company that it expects to then distribute
the stock of the Company's new parent to Citizens shareholders. The goal of the
separation is to enable Citizens telecommunications and public services
businesses to independently pursue their own strategies, and to operate and
compete more effectively.
The separation requires numerous federal and state regulatory approvals before
it can take effect. The approval process is ongoing. Citizens expects that the
separation will be completed in the second half of 1999.
The two post-separation businesses (Citizens and the Company's new parent) will
have, among other things, a different capital structure, net asset value,
operating revenues and net income than Citizens does now. The Company's
relationship with Citizens is governed by agreements entered into with Citizens
in connection with the Company's IPO, including an Administrative Services
Agreement, a Tax Sharing Agreement, an Indemnification Agreement, a Customers
and Service Agreement and a Registration Rights Agreement. Citizens is also
currently guaranteeing the Company's $400 million bank Credit Facility and $110
million construction agency and operating lease agreements. The Company cannot
provide assurance, at this time, about the effects of the separation on these
agreements and guarantees, or on the Company's new parent's ability to guarantee
future borrowings of the Company. However, the agreements are assignable to the
Company's new parent, and Citizens has indicated its intention to do so.
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b. Financial information about industry segments
The Company operates in a single industry segment, communications services.
Operations are managed and financial performance is evaluated based on the
delivery of multiple services to customers over a single fiber-optic network. As
a result, there are many shared expenses generated by the various revenue
streams and geographic locations. Management believes that any allocation of the
expenses incurred on a single network to multiple revenue streams would be
impractical and arbitrary. Management does not currently make such allocations
internally.
c. Narrative description of business
In the last five years, the Company has made substantial investments in fiber,
switching and transmission equipment and other assets to build its
communications network, and it has added staff and systems to support an
expanded product portfolio, a larger customer base and planned network growth.
While the Company expects additional network growth in 1999, especially with the
completion of its Western route long-haul facilities, the primary focus of
Company operations in the next year is targeted at increased use of the
installed asset base. A substantial portion of the Company's growth is planned
to come from increased penetration of existing on-net buildings, a focus on
sales to customers that are connected to the network and an increase in market
share in MAN cities.
The Company currently provides the full range of its services in 7 primary MANs:
Seattle and Spokane, Washington; Portland, Oregon; Salt Lake City, Utah;
Sacramento, California; Boise, Idaho; and Phoenix, Arizona and their respective
surrounding areas. The MANs include an extensive network of approximately 1,819
route miles of fiber optic cable. Switched service, including local dial tone,
is provided from 7 Nortel DMS 500 switches in the primary MAN cities. The
Company also has transmission equipment co-located with switches of the
Incumbent Local Exchange Carrier (ILEC) at 45 locations. The Company's MANs are
focused on metropolitan areas in the western United States that the Company
believes have fewer Competitive Local Exchange Carriers (CLECs), a relatively
high proportion of communications-dependent businesses and the prospect of
population and economic growth above the national average.
The Company provides enhanced broadband data services in its MAN cities as well
as other cities across the U.S. In addition to San Francisco, Los Angeles and
Las Vegas in the West, the Company has also begun offering enhanced broadband
service in Chicago and New York City, with additional cities to be added in
1999, including Atlanta, Cleveland, Dallas, Denver, Philadelphia, San Diego and
Washington, D.C. The Company's broadband network consists of 23 frame relay
switches and 14 ATM switches and includes 58 network-to-network interfaces.
National and international coverage is provided through strategic relationships
with other communications providers. The Company has also developed an Internet
backbone network with 24 routers providing Internet connectivity in each of its
markets, including over 90 "peering arrangements" with other Internet backbone
service providers. A peering arrangement is an agreement where Internet backbone
service providers agree to allow each other direct access to Internet data
contained on their networks.
The Company owns or leases broadband long-haul fiber optic network connections
between its MAN cities. By carrying traffic on its own facilities, the Company
is able to improve the utilization of its network facilities and minimize
network access and certain interconnection costs. Currently, it operates
long-haul networks with a total route mileage of 1,272 miles, including routes
between Phoenix and Las Vegas; Portland and Seattle; Portland and Spokane; and
Portland and Eugene, Oregon. During 1998 the Company began construction of what
it believes will be the largest ringed Synchronous Optical Network (SONET) in
the western United States. The approximately 2,900 mile self-healing ring is
expected to be completed in the second half of 1999 and will connect Portland,
Sacramento, San Francisco, Los Angeles, Las Vegas, Salt Lake City and Boise. The
network will include Dense Wave Division Multiplexing (DWDM) equipment and will
support voice and data traffic at speeds up to OC-192.
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DWDM is a technique for transmitting 16 or more different light-wave frequencies
on a single fiber to increase transmission capacity. In addition, the Company is
completing a link between Seattle and Spokane that will create a second SONET
ring connecting those cities with Portland.
In the development of its long-haul facilities, the Company has 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. In addition to the long-haul agreements, another agreement
provides for a fiber optic network in the Phoenix, Arizona metropolitan area.
The Company continues to evaluate potential acquisitions that are consistent
with its long-range business plans to generate revenue growth through the
expansion of its network and customer base.
Significant Customer
U S WEST Communications (US West) accounted for approximately 20% of the
Company's revenues in 1998. The revenues from US West are primarily the result
of interconnection agreements that provide for reciprocal compensation relating
to the transport and termination of traffic between US West and the Company.
Further discussion regarding reciprocal compensation issues is located in Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations", in this report. No other customer accounted for more than 10% of
1998 revenue.
PRODUCTS AND SERVICES
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:
Network Services, Local Telephone Services, Long Distance Services and Data
Services. The revenues for each of these four product categories over the last
three years are presented in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations", in this report. The following
discussion summarizes the components of the Company's product and services
categories:
Network Services
The Network Services product consists of point-to-point dedicated services that
provide a private transmission channel for our customer's exclusive use between
two or more locations. This product line is offered in both local MAN and
long-haul applications.
Local MAN services are provided over the SONET networks that the Company has
built in each of its MAN cities. Dedicated point-to-point and multiplexed
services are provided from DS-0 to OC-48 transmission levels over protected
routes to our on-net locations. Additionally, an extensive use of ILEC
collocations allows the Company to extend the reach of its products to more than
just on-net locations.
Long-haul services are provided over owned or leased broadband long-haul fiber.
As an added value, ELI provides an end-to-end solution by providing local loop
connectivity in MAN markets to deliver end-to-end solutions. Longhaul services
are offered from DS-0 to OC-48 transmission speeds.
Local Telephone Services
The Company's Local Telephone Services product line consists of the delivery of
local dial tone and related products to various business customer segments.
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Business lines are offered in the form of Basic, Enhanced and Virtual Private
Exchange. Basic Business lines provide an incoming, outgoing, or 2-way call path
to the Company's Central Office and the public switched telephone network.
Calling features are available to provide additional user functions. Enhanced
Business Service is a product bundle of the business line, calling features and
voice messaging, designed to meet small business needs.
Virtual Private Exchange (VPX) is an alternative to the customer's PBX, key
system or ILEC-provided Centrex for medium and large businesses that require
more advanced services, such as call park, call pick-up and last number redial.
The Company provides approximately 28 features for a flat monthly rate with
optional features available. The Company also offers customer premise telephone
sets designed for easier use of VPX features and voice messaging.
The Company offers a selection of trunk products to medium and large businesses
with their own PBX or key system equipment. Trunk products are provided as
incoming, outgoing, or 2-way call paths to the ELI Central Office and the public
switched telephone network.
Integrated Service Digital Network Primary Rate Interface (ISDN PRI) provides
customers with a high-speed, flexible digital access connection to the public
switched telephone network for voice, video and data applications. ISDN PRI
products are provided in Data Only, Data and Voice, and Dialable Wideband
Service configurations, according to the customer's need. For Voice and Data
applications, calling features and Direct Inward Dialing functions are provided.
Local Number Portability (LNP) is provided in Salt Lake City, Sacramento,
Portland, Phoenix, and Seattle for line, trunk and ISDN PRI products. LNP
provides the Company's customers with a seamless transition from their current
provider to ELI by allowing customers to migrate all of their telephone numbers
from their current dial tone provider to ELI when ELI becomes their new service
provider.
Foreign Exchange Service (FEX) is provided for line, trunk and ISDN PRI products
to provide customers local telephone service from an exchange (central office)
other than the exchange from which they would normally be served. 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 Messaging and Voice Menuing products offer customers alternatives to
providing their own hardware for managing incoming messages and the routing of
incoming calls. These services are offered either associated with line, trunk or
ISDN PRI services, or on a stand-alone basis.
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 use the unused DS-0s on the T-1
for other services.
Long Distance Services
The Company's Long Distance Services are comprised of retail and wholesale,
switched and dedicated, 1+, toll-free and prepaid 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.
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Travel Cards allow customers the ability to make long distance calls from any
phone, anywhere through accessing a toll-free number and the prepaid switch,
which is then billed to the customer's long distance account.
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 Services provide a platform to make long distance phone calls to over
200 countries worldwide. The primary application of prepaid calling cards that
the Company offers is the remote memory card. With remote memory, the value of
the prepaid card does not reside in the card itself, but in a remote database
accessible via a toll-free number.
Data Services
The Company offers a wide range of switched and dedicated data connectivity and
inter-networking products. These products are marketed through both retail and
wholesale channels.
Dedicated Internet Services provides access to Internet Service Providers (ISPs)
and large businesses. The Company offers Internet access through frame relay,
dedicated DS-1, dedicated DS-3 and dedicated 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 data networking solutions that connect two or more customer
locations at very high speeds, typically, 10 megabits per second (Mbps) to 100
Mbps. Included in the transparent LAN service are point-to-point connectivity,
installed customer premise equipment 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 in a variety of configurations.
Video Conferencing is a service whereby the Company operates video conferencing
rooms in eight cities in the western United States: Vancouver, Seattle, Salt
Lake City, Portland, Sacramento, Phoenix, Boise and Spokane. 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.
Asynchronous Transfer Mode (ATM) is a service that formats, switches and
multiplexes various types of information, including voice, video and data at
speeds ranging from T-1 to OC-3. ATM provides Quality of Services parameters
based on the type of information being carried in a statistically multiplexed
architecture to reduce network costs. The Company's ATM service provides
interworking between frame relay, transparent LAN and native ATM locations.
Remote Systems Virtual Portal (RSVP) is a complete, outsourced dial-up access to
the Internet product. With the introduction of RSVP to the market, existing ISPs
will be able to outsource their local access to the Internet to the Company.
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REGULATORY ENVIRONMENT
The Company's services are subject to federal, state and local regulation, which
in turn receives 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. Local governments may require the Company to obtain licenses or
franchises regulating the use of public rights-of-way necessary to install and
operate its networks.
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 its domestic interstate long distance services
and its international termination services. The FCC has promulgated rules to
eliminate tariffing of interstate domestic 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. The Company has opted,
under a recent FCC forbearance order, to no longer 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 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 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.
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 in-region interLATA markets. Full RBOC entry into interLATA
markets would increase the level of competition faced by the Company's long
distance services. However, no RBOC has yet successfully met the conditions for
interLATA entry.
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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. One RBOC, SBC Communications (which was later
joined by US West) filed a lawsuit challenging the checklist provisions on
constitutional grounds. A U.S. 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 against, and then
punishing the RBOCs. The FCC and the Department of Justice appealed this
decision to the Court of Appeals for the Fifth Circuit which ruled against the
RBOCs. The U.S. Supreme Court recently declined further review, thus effectively
ending the RBOCs' bill of attainder challenge. 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, and the impact, if any, that it
would have on the Company.
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.
On January 25, 1999, the U.S. Supreme Court upheld the bulk of the FCC's local
competition rules, which had been overturned by a lower court primarily on
jurisdictional grounds. The Supreme Court, however, vacated the portion of the
FCC rules that defined the minimum list of unbundled network elements ILECs must
make available to competitors. The FCC must now revisit its list of required
unbundled network elements to determine which elements are necessary to
competing carriers and without which competitors' ability to provide services
would be impaired.
The Company believes that there will be no material adverse effects on its
operations whether or not the FCC ultimately changes this list of network
elements. The Company currently is not reliant on unbundled elements in its
provision of services.
The Company believes it may benefit from several aspects of the Supreme Court's
decision. The Supreme Court held that the FCC does have jurisdiction to
establish certain pricing guidelines for interconnection services to be followed
by the states. Among the FCC's interconnection guidelines reinvigorated by the
Supreme Court's ruling is the requirement that the price for unbundled loops be
deaveraged geographically. To the extent this deaveraging is implemented and
results in lower prices in urban areas, the Company in the future may be able to
take advantage of more economically favorable unbundled loop rates in its urban
service areas. Additionally, the Supreme Court upheld the FCC's interpretation
of the "pick and choose" language of the Federal Act, which should afford the
Company the ability to adopt favorable provisions from multiple existing
interconnection agreements as it negotiates or renegotiates its interconnection
arrangements with ILECs.
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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 to provide local telephone
services in the states of Arizona, California, Idaho, Minnesota, Nevada, Oregon,
Utah, and Washington. Additionally, the Company has authority to provide
intrastate resold long distance and prepaid services in 48 states, and has
applications pending in the remaining two states.
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 or 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 ELI,
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 facilities-based markets, the Company faces significant
competition from the ILECs, which currently dominate the local exchange market
and are a de facto monopoly provider of local switched voice services. The
Company's primary ILEC competitors are US 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 under-price 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 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.
As discussed above, under the heading "Regulatory Environment -
Telecommunications Act of 1996", 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 the 14 point checklist. 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 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.
-8-
<PAGE>
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, the Company cannot
provide assurance that it 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, among others: AT&T Local Services, GST
Telecommunications, MCI WorldCom and NEXTLINK Communications. In each of the
markets 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, 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.
Network Services
Competition for network 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 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.
-9-
<PAGE>
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.
OPERATIONS/INFORMATION TECHNOLOGY
The Company has a number of system automation projects currently in progress.
The most significant of which is the development of a fully integrated customer
care system which combines the software from three vendors and will automate the
order management process. This new system, once completed, will automate the
order placement, circuit design, provisioning and billing systems. The
integrated billing system is currently in the final stages of development and is
anticipated to be completed during 1999. The Company anticipates that once the
integrated system installation is complete, that additional functionality can be
added through system enhancements as necessary.
EMPLOYEES
As of December 31, 1998 the Company employed 1,090 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. See the
Financial Statements for financial information regarding domestic operations.
ITEM 2. DESCRIPTION OF PROPERTY
The Company manages its operations through its corporate headquarters, located
at 4400 NE 77th Avenue, Vancouver, Washington, in an approximately 98,000 square
foot office building which it owns. This building is fully utilized by the
Company, and an additional 93,000 square feet of administrative office space has
been leased in Vancouver. In addition, the Company has leased local office space
in various markets throughout the United States, and also maintains a warehouse
facility 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 services. The office, warehouse and other facilities
leases expire on various dates through October 2008. The Company believes that
its properties are adequate and suitable for their intended purposes, and that
additional facilities will be added as needed as the Company continues expansion
into new markets.
-10-
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
On June 30, 1997, the Company filed an antitrust action against US West, in the
U.S. District Court for the Western District of Washington alleging violation of
federal and state antitrust laws as well as various federal and state laws and
commission orders for US West's failure to provide 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, as well as
an injunction to prohibit US West from discriminating against the Company and
its customers. US West filed an answer denying all liability and is seeking an
award of its costs and attorney's fees. The trial court granted US West's motion
to stay the case pending arbitration of the Company's claims arising under the
now-expired Interim Interconnection Agreements. All damage claims arising after
the termination of the old Interim Agreements were not stayed and will continue
to be prosecuted in the federal court. The trial court also invalidated the
limitations on the Company's remedies that were contained in the old Interim
Agreements so that the arbitrators may award treble damages and attorney's fees
if the Company prevails. Arbitration is pending. However, US West filed an
appeal of the trial court's order denying arbitration of the Company's antitrust
claims arising after the termination of the Interim Interconnection Agreements.
The appeal is pending before the Ninth Circuit Court of Appeals.
Additionally, the Company is currently party to routine litigation incidental to
its business, none of which, individually or in the aggregate, is expected to
have a material adverse effect on the Company. The Company is a party to various
proceedings before the public utilities commissions of the states in which it
provides or proposes to provide telecommunications services. These proceedings
typically relate to licensure of the Company, regulation of provisions of the
1996 Act and regulatory arbitration proceedings relating to certain of the
Company's interconnection agreements.
ITEM 4. SUBMISSION OF MATTERS TO a VOTE OF SECURITY HOLDERS
Not applicable.
-11-
<PAGE>
<TABLE>
Executive Officers
<CAPTION>
The executive officers of the Company and their respective ages and positions
are set forth below.
<S> <C> <C>
Name Age Title
- ---- --- -----
Leonard Tow 70 Chairman of the Board
Daryl A. Ferguson 60 Vice Chairman of the Board and Chief Executive Officer
David B. Sharkey 49 President, Chief Operating Officer and Director
Robert J. DeSantis 43 Chief Financial Officer, Vice President and Treasurer
James M. Berthot 55 Vice President - Marketing and Product Development
Jerry L. Cady 41 Vice President - Operations
Todd T. Hanson 37 Vice President - Network Planning and Engineering
Randall J. Lis 39 Vice President - Staff Operations
Michael J. Miller 42 Vice President - Finance and Planning
James S. Parker 42 Vice President - Wholesale
Kerry D. Rea 40 Vice President and Controller
John P. Wolff 52 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 also 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 Hungarian Telephone
and Cable Corporation.
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 Metromedia Paging, 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 October 1991, has been Vice President and Treasurer of Citizens
since October 1991 and Chief Financial Officer, Vice President and Treasurer of
Citizens since November 1997.
James M. Berthot joined the Company as Vice President - 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.
Jerry L. Cady joined the Company as Vice President - Operations in April 1998.
Prior to joining the Company, from 1992 through 1998, Mr. Cady served as Vice
President of Operations and Engineering for Midcom Communications.
Todd T. Hanson joined the Company as Vice President - Network Planning and
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.
-12-
<PAGE>
Randall J. 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 - Finance in October 1995 and became Vice
President - Finance and 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.
James S. Parker joined the Company as Vice President - Wholesale in August 1998.
Prior to joining the Company, Mr. Parker spent 16 years with MCI in both sales
and marketing management positions.
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 P. 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.
-13-
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock
The Company's Class A Common Stock began trading publicly on November 24, 1997,
and is traded on The NASDAQ National Market under the ticker symbol ELIX. The
following table sets forth the high and low sales prices per share of Class A
Common Stock as reported by The NASDAQ National Market for the periods
indicated:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
1997 High Low 1998 High Low
------------------------- ----------- ---------- ----------------------- ----------- -----------
First Quarter N/A N/A First Quarter 23.13 12.38
Second Quarter N/A N/A Second Quarter 20.25 11.00
Third Quarter N/A N/A Third Quarter 14.31 7.00
Fourth Quarter 16.13 13.13 Fourth Quarter 10.69 3.50
</TABLE>
As of February 25, 1999, the approximate number of record security holders of
the Company's Class A Common Stock was 60. This information was obtained from
the Company's transfer agent.
Dividends
The Company to date has paid no cash dividends, and does not anticipate paying
any cash dividends on its common stock in the foreseeable future.
Recent Sales Of Unregistered Securities
None.
-14-
<PAGE>
<TABLE>
ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
($ in thousands, except per share and
non-dollar denominated operating data) 1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------
Statements of Operations Data (years ended December 31)
<S> <C> <C> <C> <C> <C>
Revenues $ 100,880 $ 61,084 $ 31,309 $ 15,660 $ 8,152
Loss from operations (73,783) (34,095) (29,383) (19,950) (9,541)
Net loss before cumulative effect (1) (67,200) (33,945) (29,383) (20,322) (10,414)
Net loss (70,017) (33,945) (29,383) (20,322) (10,414)
Net loss per share before cumulative effect (1 and 2) (1.35) (0.80) -- -- --
Net loss per share (2) (1.41) (0.80) -- -- --
- -------------------------------------------------------------------------------------------------------------------------
Balance Sheet Data (as at December 31)
Total assets $ 532,309 $ 359,962 $ 195,656 $ 128,901 $ 110,691
Long-term obligations (3) 302,256 70,511 155,395 64,941 41,674
Shareholders' equity 148,493 213,314 9,286 38,699 55,991
- -------------------------------------------------------------------------------------------------------------------------
Operating Data
EBITDA without operating lease (4) $ (50,567) $ (17,692) $ (19,468) $ (12,038) $ (7,065)
Property, plant & equipment 528,582 328,664 189,334 127,297 108,549
- under operating lease (5) 108,541 87,426 57,279 36,858 --
------------------------------------------------------------------------
- Total $ 637,123 $ 416,090 $ 246,613 $ 164,155 $ 108,549
========================================================================
Route miles (6) 3,091 2,494 1,428 780 601
Fiber miles (6) 181,368 140,812 97,665 52,013 37,504
Buildings connected 766 610 438 282 191
Access line equivalents 74,924 34,328 8,779 N/A N/A
Switches and routers installed:
Voice 7 5 5 2 2
Frame relay 23 20 15 5 2
Internet 24 17 8 -- --
ATM 14 8 -- -- --
Employees 1,090 573 402 225 127
Customers 1,644 1,165 763 402 221
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
Information presented above should be read in conjunction with the Company's
Financial Statements and accompanying Notes.
(1) The Company adopted SOP 98-5, "Reporting on the Costs of Start-Up
Activities", effective January 1, 1998 (see Note 4 of Notes to
Financial Statements).
(2) 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).
(3) Long-term obligations include amounts due to Citizens in the years
ended 1994 - 1996, capital lease obligations and long-term debt.
(4) 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 12 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. The Company's
EBITDA loss may not be comparable to similarly calculated measures of
other Companies.
(5) 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 12 of Notes to Financial Statements).
(6) Route miles and fiber miles also include those to which the Company has
exclusive use pursuant to license and lease arrangements.
-15-
<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. Forward-looking statements (including oral representations)
are statements about future performance or results, and include any
statements using the words "believe", "expect", "anticipate" or similar
words. All forward-looking statements 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
overall strategy, changes in legal and regulatory policy, relations
with ILECs and their ability to provide delivery of services including
interoffice trunking, implementation of back office service delivery
systems, 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 Company has no obligation to
update or revise forward-looking statements to reflect the occurrence
of future events or circumstances.
- --------------------------------------------------------------------------------
The following information should be read in conjunction with the financial
statements and related footnotes included in this report.
(a) Liquidity and Capital Resources
During 1998, the Company used the remaining proceeds ($6.5 million) from its IPO
and proceeds of $224 million from a bank Credit Facility to fund operating
losses and capital expenditures. The bank Ccredit Facility is a $400 million,
5-year revolving Credit Facility which has been guaranteed by Citizens. The
Credit Facility 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, 1998, the balance outstanding was $284 million and the weighted
average interest rate was 5.61%. Interest rates are based on the Eurodollar rate
at the time the funds are drawn and reset periodically thereafter. No principal
payment is due until the end of the term of the Credit Facility.
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 total capital additions
during 1998 were $200 million. These expenditures, together with associated
operating expenses, have resulted in operating losses and negative cash flows
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. The Company cannot assure that it
will establish an adequate revenue base or that it 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 existing and new networks and
services will require significant additional capital. The Company's capital
additions for 1999 are estimated to be $261 million, of which $216 million are
estimated to be cash expenditures and approximately $45 million are estimated to
be non-cash capital lease additions. The Company continues to evaluate
opportunities for revenue growth and to make substantial capital investments in
connection with continued development of its existing networks, completion of
its long-haul construction and the entry into new markets. These opportunities
include, but are not limited to, acquisitions and/or joint ventures that are
consistent with the Company's long-range business plans of generating revenue
growth through the expansion of its network and customer base. Additionally, the
Company expects to continue to build on its existing relationships with
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.
-16-
<PAGE>
The Company anticipates that the $116 million of remaining funds available for
draw on the Credit Facility will not be adequate to fund operating losses,
working capital deficiencies and capital expenditures for 1999. The Company is
in the process of arranging financing sufficient to fund its operating losses,
working capital deficiencies and capital expenditures through at least 1999. To
the extent such financing is not arranged prior to the utilization of the
un-drawn Credit Facility, Citizens has committed to provide the necessary bridge
financing, at then market terms and conditions, until third party financing is
completed.
The Company has the following commitments in the forms of service agreements,
capital leases and a construction agency agreement. These agreements and costs
associated with them are summarized as follows:
In June 1998, the Company entered into a private line services agreement with a
third party, which allows the Company to utilize the third party's national
fiber optic network for a period of nine years. The Company is obligated for a
minimum commitment of $122 million over the life of the agreement in a
take-or-pay arrangement, including $12 million in 1999. In addition, the Company
is 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 $21 million, $7 million and $3 million for 1999, 2000 and
2001, respectively.
The Company has entered into certain long-term capital leases to obtain dark
fiber to more quickly expand its network. Total future minimum cash payment
commitments under these leases amounted to $41 million as of December 31, 1998,
including $2 million in 1999. For certain contracts, rental payments are based
on a percentage of the Company's leased traffic, and are exclusive, subject to
certain minimums. The Company intends to maintain exclusive use of the fiber
optic cable related to the long-haul routes where provided by certain contracts.
If exclusivity is not retained on these routes, Management does not expect
non-exclusivity to have a material impact on the Company's financial position,
results of operations or cash flows.
During 1995, the Company entered into a $110 million construction agency
agreement and an operating lease agreement in connection with the construction
of certain network facilities. The Company will have the option to purchase the
facilities at the end of the lease term. Payments under the lease depend on
current interest rates, and assuming continuation of current interest rates,
payments would approximate $6.1 million annually through April 30, 2002 and,
assuming exercise of the purchase option, approximately $110 million in 2002. In
the event the Company chooses not to exercise the purchase 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% (approximately $88
million) of the lessor's investment. 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.
Until its IPO in November 1997, the Company had been funded primarily 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
approximately 83% economic interest in the Company. Citizens has indicated that
it intends to assist the Company in arranging financing, as discussed in the
Company's Form 8-K dated October 14, 1998, although the Company cannot assure
that Citizens will be able to do so. In 1997 and 1996, 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.
-17-
<PAGE>
YEAR 2000
The Year 2000 (Y2K) issue stems from the fact that many computer programs
worldwide use two digits, rather than four, to define the applicable year. For
instance, many computers on January 1, 2000 may assume that 01-01-00 is the
first day of the year 1900 rather than 2000. Massive system failures may occur
globally if this issue is not properly addressed. The Company has developed a
Y2K Initiative (the Initiative) to mitigate the impact of the Y2K issue for its
internal systems and the systems that it relies on indirectly from third
parties.
The Company's State of Readiness
Under the Initiative, the Company has formed a cross functional Y2K project team
that reports to the Company's Chief Information Officer (CIO). The CIO has full
authority to establish methodologies, approve expenditures, and marshal
additional resources as necessary. A full-time consultant project manager, who
answers regularly to the CIO, manages the initiative and oversees the project
team. The CIO is responsible for researching, planning, executing, implementing
and completing the Initiative for the Company.
The three functional categories evaluated in the Initiative include:
o Communications Network, which processes voice and data information relating
to the Company's communications operations, including Transmission equipment,
o Information Technology (IT) which consists of all internal hardware and
software used to support the Company's financial and administrative
operations, and
o Facilities consisting of all systems necessary to run an office including
security system, fire suppression, generators, HVAC, and components with
embedded technology at the Company's headquarters and leased facilities.
For each of the three functional categories the Company is in the process of
applying the following three-phase approach to identify and address the
potential impact of Y2K compliance issues.
Phase I - Inventory and Assessment
Inventory and assessment involves each Y2K team member identifying all relevant
systems, providers and information sources within their functional areas. A risk
analysis rank is assigned to each item identified ranging from 1 to 3, with 1
representing items considered mission-critical.
Phase I was completed December 31, 1998 for all functional categories except
Transmission, part of the Communications Network category, and Facilities which
are substantially complete. Transmission and Facilities are expected to be
completed by March 31, 1999.
Phase II - Remediation
Remediation is the process of making changes to hardware, software or services
in order to become Y2K compliant. During the inventory and assessment phase each
system or provider is evaluated for remediation. Each system requiring
remediation under the Company's direct control will be replaced or upgraded as
needed. Under situations where the service provider has already performed
remediation, the Company will accept the service provider's statement of Y2K
compliance that remediation has been performed.
Phase II is underway and should be completed during the first quarter of 1999
for all categories except Transmission and Facilities which are expected to be
completed by June 30, 1999.
Phase III - Testing, Contingency Planning and Certification
All mission-critical systems, including both internal and external, identified
during the inventory stage will be tested by the Company sufficient to confirm
whether the system will continue to operate properly in Y2K and beyond. Proper
contingency planning for all mission-critical items will allow the Company to
mitigate the risk associated with potential Y2K failures. Y2K certification is
achieved when all phases have been successfully completed and approved by the
project manager.
Phase III is underway and should be completed by June 30, 1999 for all
categories except Transmission, which is anticipated to be completed August 31,
1999.
-18-
<PAGE>
The Costs to Address the Company's Y2K Issues
As of December 31, 1998, the Company had incurred $.2 million related to the Y2K
issue. The Company currently anticipates that total costs of Y2K remediation
will be approximately $1.1 million consisting of $.7 million in costs related to
the consultant Y2K project manager and internal salaries and $.4 million in
costs for replacement/upgrade of certain equipment. Such cost estimates are
based upon presently available information and management cannot provide
assurance that the costs associated with the Y2K issue will not be greater than
anticipated.
The Risks of the Company's Y2K Issues
Within its Communications Network, the Company is dependent on the provisioning
and switching capabilities of the ILECs in those markets in which the Company
provides services. The Company has not received certification from those ILECs
and other key suppliers indicating that they are Y2K compliant, but has been
notified that the ILECs have initiated programs to mitigate their Y2K issues.
However, the Company cannot assure that the systems of ILECs or other companies
on which the Company's systems rely will become Y2K compliant before the earlier
of when the systems will first be impacted or the year 2000. At worst case,
failure of the ILECs to remediate Y2K compliance issues could result in a
disruption of the Company's operations and have a material adverse impact on the
Company's financial condition.
Within IT, the Company is dependent on the development of software by internal
and external experts, and the availability of critical resources with the
requisite skill sets. At worst case, delays in supplier shipment and/or
installation of compliant software or hardware could result in a disruption of
the Company's operations and the Company's ability to bill or collect revenues.
This worst case scenario could have a material adverse impact on the Company's
financial condition.
Within Facilities, the Company is dependent upon utility suppliers to provide
compliant service and building system compliance in leased and owned buildings.
Although the Company's Y2K compliant backup power systems will be in place, at
worst case an extended power outage could result in a disruption of the
Company's operations. The Company is dependent on property managers to
thoroughly review and replace/upgrade when necessary in leased locations. At
worst case, failure of the property managers to remediate Y2K compliance issues
could result in a disruption of the Company's operations. This worst case
scenario could have a material adverse impact on the Company's financial
condition.
Management believes that these worst case scenarios are unlikely, and that its
efforts to mitigate Y2K issues through remediation, testing and contingency
planning will be successful.
The Company's Contingency Plans
As a part of Phase III the Company is preparing contingency plans for all
mission-critical systems. The Company is not anticipating any material problems
attributed to the Y2K issue, however, a Y2K Rapid Response Team will be formed
during the first quarter of 1999 to quickly respond in the event of potential
Y2K failures. The team will include experts from each of the key operational
functions.
-19-
<PAGE>
Reciprocal Compensation
The Company has interconnection agreements with US West, the ILEC in the
majority of the states in which the Company provides local telephone services.
These agreements govern reciprocal compensation relating to the transport and
termination of traffic between the Company and US West. Reciprocal compensation
revenues are recognized by the Company as earned, based on the terms of the
interconnection agreements. Total net reciprocal compensation revenues
recognized by the Company for the years ended December 31, 1998, 1997 and 1996
were $18.6 million, $1.4 million and $0, respectively. Total net trade accounts
receivable relating to reciprocal compensation at December 31, 1998 and 1997
totaled $10.4 million and $1.4 million, respectively.
The Company filed complaints with the PUCs in Washington and Utah requesting
that US West pay the Company for reciprocal compensation charges relating to the
termination of calls to ISPs, as required by the interconnection agreements. The
state PUCs ruled in the Company's favor and accordingly, US West began paying
the Company for reciprocal compensation in Washington in 1998 and in Utah in the
first quarter of 1999. The Company has similar complaints pending with the PUCs
in Oregon and Arizona. Although neither the Oregon nor Arizona PUCs has issued a
final ruling, the Oregon PUC has ruled in other recent cases that calls
terminated to ISPs should be categorized as local traffic, and should therefore
be subject to reciprocal compensation.
The Company recognized $1.1 million of reciprocal compensation revenue in the
first quarter of 1998 as a result of the reversal of an allowance established in
1997. Additionally, revenues of $2.2 million were recognized in the fourth
quarter of 1998 as a result of the reversal of an allowance that had been
established during previous quarters in 1998.
On February 25, 1999, the FCC issued a Declaratory Ruling and Notice of Proposed
Rulemaking that categorized calls terminated to ISPs as "largely" interstate in
nature, which could have the effect of precluding these calls from reciprocal
compensation charges. However, the ruling stated that ILECs are bound by the
existing interconnection agreements and the state decisions that have defined
them. Although it cannot provide assurance, the Company believes that the
reciprocal compensation revenues that it has recognized will not be subject to
reversal, as the states in which the Company recognizes virtually all of its
reciprocal compensation revenues have already ruled that calls to ISPs are
subject to reciprocal compensation.
Most of the Company's interconnection agreements expire in the second half of
1999. Management believes that these agreements will be replaced by agreements
offering the Company some form of compensation regarding termination of calls to
ISPs. The Company cannot assure, however, that the level of reciprocal
compensation revenues will remain consistent with current levels.
-20-
<PAGE>
Results of Operations
Revenues
Revenues increased approximately $39.8 million, or 65%, in 1998 over 1997, due
to the continued expansion of the Company's network and customer base. In 1998,
the Company added Boise, Idaho and Spokane, Washington, as new MANs, providing
local and long distance switched services, as well as enhanced broadband
services. Also, during 1998, the Company initiated a national data expansion,
under which the Company intends to begin selling enhanced broadband services to
cities across the United States. The Company began selling these services in Los
Angeles and San Francisco, California; Las Vegas, Nevada; Chicago, Illinois; and
New York City, New York. During 1998, access line equivalents increased 40,596,
or 118%, and customers increased 479, or 41%, over December 31, 1997. The 95%
increase in revenue in 1997 over 1996 was due to the continued growth within
each of the five MANs existing at that time with the addition of 172 buildings,
a 39% increase over 1996, and the addition of 402 customers, a 53% increase over
1996.
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------- --------------------------------- -------------
($ in thousands) Amount % Increase Amount % Increase Amount
- ---------------- ----------- ------------ ----------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Network services $ 36,589 9% $ 33,522 79% $ 18,741
Local telephone services 38,169 261% 10,565 317% 2,533
Long distance services 12,309 51% 8,140 75% 4,661
Data services 13,813 56% 8,857 65% 5,374
----------- ------------ ----------- ---------- ---------
$100,880 65% $ 61,084 95% $ 31,309
=========== ============ =========== ========== =========
</TABLE>
Network Services
Network services revenues increased $3.1 million, or 9%, in 1998 over 1997
primarily due to increased revenues of $3.8 million in existing markets and $2.2
million in markets entered into subsequent to 1997. The existing market increase
resulted from additional circuits sold to new and existing customers. These
increases were partially offset by decreases in revenues of $3.0 million from a
significant customer, primarily due to the expiration of its short-term contract
in the first quarter of 1998. Revenues from network services increased $14.8
million, or 79%, in 1997 over 1996 primarily due to the Company's improved sales
of additional products to existing customers and an increase in route miles of
75% over 1996. Approximately, $6.8 million of the increase was associated with a
short-term contract with the significant customer mentioned above that expired
in early 1998.
Local Telephone Services
Local telephone services revenues increased $27.6 million, or 261%, in 1998 over
1997 primarily due to increased reciprocal compensation revenues of $17.2
million from $1.4 million in 1997. During 1998, access line equivalents
increased 40,596, or 118%, over December 31, 1997, also contributing to
increased local dial tone services revenues. In addition, increased sales of the
ISDN product also generated increased revenue over 1997 of $7.1 million, or
301%. Revenues from local telephone services increased $8.0 million, or 317%, in
1997 over 1996 primarily due to local switch implementations in Portland,
Sacramento and Salt Lake City in the last half of 1996. The implementation of
the ISDN product generated $2.3 million of increased revenue in 1997 over 1996.
Long Distance Services
Long distance services revenues increased $4.2 million, or 51%, in 1998 over
1997 primarily due to a $4.8 million, or 424%, increase in prepaid services
revenue. The increase in prepaid services revenue is due to an increase in
minutes processed over 1997, resulting from the addition of new customers.
Further, retail long distance revenues increased $1.0 million, or 51%, over
1997, due to an increase in long distance minutes processed as a result of the
Company bundling sales of long distance with other products. The increase in
retail long distance revenues was partially offset by a decrease in wholesale
long distance revenues of $1.6 million, or 33%, from 1997 primarily due to the
elimination of a large customer with credit problems.
-21-
<PAGE>
Revenues from long distance services increased $3.5 million, or 75%, in 1997
over 1996 due to a $1.7 million, or 423%, increase in retail long distance
revenues, and a $1.1 million increase in prepaid services introduced in late
1996. The increases were partially offset by a $1.9 million decrease in
wholesale long distance services from 1996.
Data Services
Data services revenues increased $5.0 million, or 56%, in 1998 over 1997
primarily due to a $4.5 million increase in sales of Internet, frame relay and
LAN/WAN services in new and existing markets. To a lesser extent, new product
offerings in 1998, such as ATM and RSVP also contributed to the increase.
Revenues from data services in 1997 increased $3.5 million, or 65%, in 1997 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 in 1997 were primarily due to a 75% increase in Internet switches
installed in 1997.
Operating Expenses
Operating expenses increased $79.5 million, or 84%, in 1998 over 1997 and $34.5
million, or 57%, in 1997 over 1996. The increase in expenses was due to the
Company's network and customer growth as reflected in revenues, as well as
additional costs incurred to develop an infrastructure to support the Company's
national data expansion and new market development.
<TABLE>
<CAPTION>
1998 1997 1996
------------------------------- ------------------------------- -------------
($ in thousands) Amount % Increase Amount % Increase Amount
- ---------------- ----------- ------------ ----------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Network access $ 50,957 72% $ 29,546 43% $ 20,620
Operating expenses 28,149 80% 15,615 107% 7,548
Selling, general and administrative 78,555 102% 38,851 53% 25,332
Depreciation and amortization 17,002 52% 11,167 55% 7,192
----------- ------------ ----------- ---------- -----------
$174,663 84% $ 95,179 57% $ 60,692
=========== ============ =========== ========== ===========
</TABLE>
Network Access
Network access expenses include resold product expenses. The primary components
are usage based charges for carrying and terminating traffic on another
carrier's network.
Network access expenses increased $21.4 million, or 72%, in 1998 over 1997
primarily due to the Company's revenue growth. Network access expenses were
higher, as a percentage of revenues, than 1997 as a result of increased expenses
related to the Company's national data expansion effort which utilizes leased
circuits outside the Company's West Coast SONET ring and owned network
facilities. In addition, the significant growth in the Company's prepaid
services has increased usage-based charges on the Company's leased long distance
circuits, which typically have a lower gross margin.
Network access expenses increased $8.9 million, or 43%, in 1997 over 1996
primarily due 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.
Operating Expenses
Operating expenses include costs relating to providing facilities based network
and enhanced communications services other than network access costs.
Operating expenses increased $12.5 million, or 80%, in 1998 over 1997 and $8.1
million, or 107%, in 1997 over 1996, primarily due to increases in salaries and
related expenses to support the expanded delivery of services and an expanded
customer service organization. Operating employee head count increased by 229
employees to 508 employees at December 31, 1998, or 82% over 1997 primarily due
to the Company's effort to increase customer service and technical resources
available in each market. In addition, operations maintenance costs have risen
-22-
<PAGE>
$3.3 million and $.4 million over 1997 and 1996, respectively, due to the
expansion of the Company's network and number of customers on-net. Operating
lease payments related to the Company's construction agency agreement and
operating lease agreement increased $1.0 million, or 18%, and $1.8 million, or
51%, over 1997 and 1996 respectively. The increase is due to increased
utilization of the lease facility.
Selling, General and Administrative
Selling, general and administrative expenses include all direct and indirect
sales channel expenses and commissions, as well as all general and
administrative expenses.
Selling, general and administrative expenses increased $39.7 million, or 102%,
in 1998 over 1997 primarily due to increases in salaries and related expenses to
support the infrastructure needed for the delivery of services in existing and
new markets such as Boise, Idaho; Los Angeles and San Francisco, California; Las
Vegas, Nevada and Spokane, Washington, as well as the Company's national data
expansion. The Company increased its sales force by 96 employees, to 163
employees, a 143% increase over 1997. In addition, the Company has expanded
advertising, direct marketing, and public relations efforts in key markets to
increase name recognition and product awareness in 1998.
Selling, general and administrative expenses increased $13.5 million, or 53%, in
1997 over 1996 primarily due to increases in salaries and related expenses to
support the infrastructure needed for the delivery of services in the Company's
original MAN networks including Seattle, Washington; Portland, Oregon;
Sacramento, California; Salt Lake City, Utah; and Phoenix, Arizona.
Depreciation and Amortization
Depreciation and amortization expenses include depreciation of communications
network assets including fiber optic cable, network electronics, network
switching and network data equipment.
Depreciation and amortization expense increased $5.8 million, or 52%, in 1998
over 1997 and $4.0 million, or 55%, in 1997 over 1996. The increases were
primarily due to higher plant in service balances for newly completed
communications network facilities and electronics.
Interest Expense and Interest Income
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------- --------------------------- ----------
<S> <C> <C> <C> <C> <C>
($ in thousands) Amount % Increase Amount % Increase Amount
- ---------------- -------- ----------- -------- ----------- --------
Interest expense, net $ 7,526 545% $ 1,166 N/A $ --
Interest income and other $ 272 N/A $ -- N/A $ --
</TABLE>
Interest expense increased $6.4 million, or 545%, in 1998 over 1997, and $1.2
million in 1997 over 1996 due to interest and guarantee fees associated with the
Company's borrowings against its bank Credit Facility and guarantee fees
associated with the Company's construction agency agreement and operating lease
agreement. Interest expense is net of capitalized interest of $10.4 million and
$4.7 million for 1998 and 1997, respectively.
Interest income and other increased over 1997 primarily due to interest earned
on cash balances.
-23-
<PAGE>
Income Tax Benefit
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- ------------------------- --------
($ in thousands) Amount % Increase Amount % Increase Amount
- ---------------- -------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
Income tax benefit $ 14,414 995% $1,316 N/A $ --
</TABLE>
Income tax benefit (including $.6 million netted against cumulative effect of
change in accounting principle) increased $13.1 million, or 995%, in 1998 over
1997, primarily due to the recognition of the tax benefit of operating losses
net of related valuation allowances. Income tax benefit increased $1.3 million
in 1997 over 1996 due to the elimination on the IPO date, November 24, 1997, of
Citizens' policy that it would not reimburse the Company for the tax benefits
that were contributed to the consolidated tax return of Citizens for operating
losses.
Cumulative Effect of Change in Accounting Principle
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ----------------------- --------
<S> <C> <C> <C> <C> <C>
($ in thousands) Amount % Increase Amount % Increase Amount
- ------------------- -------- ----------- --------- ----------- --------
Cumulative Effect of Change in
Accounting Principle $ 3,394 N/A $ -- N/A $ --
</TABLE>
Cumulative effect of change in accounting principle represented a write-off of
the unamortized portion of deferred start-up costs due to the Company adopting
AICPA Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities" in 1998.
-24-
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to minimal market risks. Sensitivity of results of
operations to these risks is managed by maintaining a conservative investment
portfolio, which is comprised solely of money market funds, and entering into
long-term debt obligations with appropriate price and term characteristics. The
Company does not hold or issue derivative, derivative commodity instruments or
other financial instruments for trading purposes. Financial instruments held for
other than trading purposes do not impose a material market risk.
The Company is exposed to interest rate risk, as additional financing is
periodically needed due to the large operating losses and capital expenditures
associated with establishing and expanding the Company's communications
networks. The interest rate that the Company will be able to obtain on debt
financing will depend on market conditions at that time, and may differ from the
rates the Company has secured on its current debt. Additionally, the Company is
exposed to interest rate risk on amounts borrowed against its Credit Facility as
of December 31, 1998. Advances against the Credit Facility periodically renew,
at which point the borrowings are subject to the then current market interest
rates, which may differ from the rates the Company is currently paying on its
borrowings.
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 Note 14 to the Financial
Statements (see 1. above).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
-25-
<PAGE>
PART III
The Company intends to file with the Commission a definitive proxy statement for
the 1999 Annual Meeting of Stockholders pursuant to Regulation 14A not later
than 120 days after December 31, 1998. The information called for by this Part
III, including the information required by Item 405 of Regulation S-K under the
caption "Section 16(a) Beneficial Ownership Reporting Compliance," 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:
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
3.1 Amended and Restated Certificate of Incorporation.
3.2 Amended 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.
10.14.1 Amendment Number One to the Pre-Construction IRU agreement between the Company and FTV Communications,
LLC dated November 14, 1997.
10.15 Bank Credit Agreement dated November 21, 1997.
10.16* License Agreement between the Company and the United States of America Department of Energy
acting by and through the Bonneville Power Administration dated March 20, 1998.
10.17* License Agreement between the Company and the United States of America Department of Energy
acting by and through the Bonneville Power Administration dated January 8, 1998.
10.18* Optical Fiber Installation and IRU Agreement between the Company and Pacific Gas and Electric Company
dated December 31, 1997.
10.18.1* First Amendment to Optical Fiber Installation and IRU Agreement between the Company and Pacific Gas and
Electric Company dated March 9, 1998.
10.19* Initial Optical Fiber Design and Installation Agreement between the Company and FOCAS, Inc. dated as of May 7, 1998.
10.20* Post-Completion Agreement between the Company and FOCAS, Inc. dated as of May 7, 1998.
10.21* Private Line Services Agreement between the Company and Qwest Communications Corporation dated as of June 1, 1998.
10.22 Electric Lightwave, Inc. Employee Stock Purchase Plan.
23.1 Auditors' Consent.
24.1 Powers of Attorney.
27.1 Financial Data Schedule.
27.2 Restated Financial Data Schedules for the years ended December 31, 1997 and 1996.
-26-
<PAGE>
Exhibits 10.13 and 10.22 are management contracts or compensatory plans or
arrangements.
Exhibits 3.1, 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 10.14 is
incorporated by reference to Exhibit No. 10.17 in the Company's Registration Statement on Form S-1 (File No.
333-35227). Exhibits 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 (File No. 0-23393). Exhibits 10.14.1, 10.16,
10.17, 10.18 and 10.18.1 are incorporated by reference to the same exhibit designations in the Company's Form
10-Q for the three months ended March 31, 1998 (File No. 0-23393). Exhibits 3.2, 10.19, 10.20 and 10.21 are
incorporated by reference to the same exhibit designations in the Company's Form 10-Q for the six months ended
June 30, 1998 (File No. 0-23393). Exhibit 10.22 is incorporated by reference to the Company's Proxy Statement on
Schedule 14A filed on April 28, 1998.
</TABLE>
* Material has been omitted pursuant to a previous request for confidential
treatment that was granted by the Commission.
b. Reports on Form 8-K
The Company filed the following reports on Form 8-K in the last quarter of 1998:
+ October 14, 1998, under Item 5, "Other Events", to make available a
press release dated October 14, 1998 affirming the Company's future
outlook.
+ October 29, 1998, under Item 5, "Other Events", to make available a
press release dated October 29, 1998, regarding the Company's 1998
third quarter financial results.
-27-
<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 4, 1999
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 4th day of March 1999.
<TABLE>
<CAPTION>
Signature Title
<S> <C> <C>
/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)
/s/ Guenther E. Greiner * Director
----------------------------------
(Guenther E. Greiner)
/s/ Stanley Harfenist * Director
----------------------------------
(Stanley Harfenist)
/s/ Robert A. Stanger * Director
----------------------------------
(Robert A. Stanger)
/s/ Maggie Wilderotter * Director
----------------------------------
(Maggie Wilderotter)
/s/ David B. Sharkey * President, Chief Operating Officer, Member,
---------------------------------- Executive Committee and Director
(David B. Sharkey)
/s/ Leonard Tow * Chairman of the Board, Member, Executive Committe
---------------------------------- and Director
(Leonard Tow)
</TABLE>
*By: /s/ Robert J. DeSantis
---------------------------
(Robert J. DeSantis)
Attorney-in-Fact
-28-
<PAGE>
ELECTRIC LIGHTWAVE, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Independent Auditors' Report..........................................................................................F-1
Balance Sheets at December 31, 1998 and 1997 .........................................................................F-2
Statements of Operations for the Years Ended December 31, 1998, 1997 and 1996 ........................................F-3
Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 ........................................F-4
Statements of Changes in Shareholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996...................................................................................F-5
Notes to Financial Statements.........................................................................................F-6
</TABLE>
F
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Electric Lightwave, Inc.
We have audited the accompanying balance sheets of Electric Lightwave, Inc. as
of December 31, 1998 and 1997, and the related statements of operations,
shareholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1998. These financial statements are the
responsibility 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, 1998 and 1997, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 1998, in
conformity with generally accepted accounting principles.
As discussed in Note 4 to the financial statements, the Company changed its
method of accounting for start-up costs in 1998 to adopt the provisions of the
American Institute of Certified Public Accountants Statement of Position 98-5
"Reporting on the Costs of Start-Up Activities".
KPMG LLP
New York, New York
March 1, 1999
F-1
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Balance Sheets
(Amounts in thousands)
<TABLE>
<CAPTION>
December 31,
----------------------------------
1998 1997
------------------- --------------
<S> <C> <C>
ASSETS
Current assets:
Cash ........................................... $ 13,120 $ 26,531
Trade receivables, net ......................... 20,320 12,569
Other receivables .............................. 2,671 7,688
Other current assets ........................... 1,953 844
--------- ---------
Total current assets ....................... 38,064 47,632
--------- ---------
Property, plant and equipment ...................... 528,582 328,664
Less accumulated depreciation and amortization ..... (40,912) (25,791)
--------- ---------
Property, plant and equipment, net ............. 487,670 302,873
--------- ---------
Other assets ....................................... 6,575 9,457
--------- ---------
Total assets ............................... $ 532,309 $ 359,962
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities ....... $ 61,760 $ 50,237
Other accrued taxes ............................ 5,577 3,136
Due to Citizens Utilities Company .............. 5,254 944
Other current liabilities ...................... 5,375 3,102
--------- ---------
Total current liabilities .................. 77,966 57,419
Deferred credits and other ......................... 1,834 1,800
Deferred income taxes payable ...................... 1,760 16,918
Capital lease obligations .......................... 18,256 10,511
Long-term debt ..................................... 284,000 60,000
--------- ---------
Total liabilities .......................... 383,816 146,648
Shareholders' equity ............................... 148,493 213,314
--------- ---------
Total liabilities and shareholders' equity . $ 532,309 $ 359,962
========= =========
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-2
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Operations
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the years ended December 31,
-------------------------------------------
1998 1997 1996
-------------------------------------------
<S> <C> <C> <C>
Revenues ..................................................................... $ 100,880 $ 61,084 $ 31,309
--------- --------- ---------
Operating expenses:
Network access expenses .................................................. 50,957 29,546 20,620
Operating expenses ....................................................... 28,149 15,615 7,548
Selling, general and administrative expenses ............................. 78,555 38,851 25,332
Depreciation and amortization ............................................ 17,002 11,167 7,192
--------- --------- ---------
Total operating expenses ............................................. 174,663 95,179 60,692
--------- --------- ---------
Loss from operations ..................................................... (73,783) (34,095) (29,383)
Interest expense, net of capitalized portion ................................. 7,526 1,166 --
Interest income and other .................................................... 272 -- --
--------- --------- ---------
Net loss before income taxes and cumulative effect of
change in accounting principle ......................................... (81,037) (35,261) (29,383)
Income tax benefit ........................................................... (13,837) (1,316) --
--------- --------- ---------
Net loss before cumulative effect of
change in accounting principle ......................................... (67,200) (33,945) (29,383)
Cumulative effect of change in accounting
principle (net of $577 income tax benefit) ............................... 2,817 -- --
---------- --------- ----------
Net loss ............................................................... $ (70,017) $ (33,945) $ (29,383)
========= ========= =========
Net loss before cumulative effect of change in accounting principle per share:
Basic ................................................................ $ (1.35) $ (.80) *
Diluted .............................................................. $ (1.35) $ (.80) *
Net loss per share:
Basic ................................................................ $ (1.41) $ (.80) *
Diluted .............................................................. $ (1.41) $ (.80) *
Weighted average shares outstanding .......................................... 49,709 42,352
* EPS for 1996 is not presented because the amounts are not meaningful.
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-3
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Cash Flows
(Amounts in thousands)
<TABLE>
<CAPTION>
For the years ended December 31,
------------------------------------------
1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss .............................................. $ (70,017) $ (33,945) $ (29,383)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization ..................... 17,002 11,167 7,192
Deferred income taxes ............................. (14,414) -- --
Cumulative effect of change in accounting principle 3,394 -- --
Non-cash compensation expense ..................... 4,697 219 --
Loss on disposal of property, plant and equipment . 386 -- --
Changes in operating assets and liabilities:
Receivables ....................................... (2,734) (7,318) (9,797)
Accounts payable and other accrued liabilities .... 21,427 5,359 (2,802)
Other accrued taxes ............................... 2,441 807 765
Due to Citizens Utilities Company ................. 4,310 -- --
Other ............................................. (3,268) 6,522 2,035
--------- -------- ---------
Net cash used for operating activities ....... (36,776) (17,189) (31,990)
--------- -------- ---------
Cash flows used for investing activities:
Capital expenditures .................................. (200,791) (103,984) (56,072)
--------- -------- ---------
Cash flows from financing activities:
Debt borrowings ....................................... 224,000 60,000 --
Reduction of capital lease obligations ................ (343) -- --
Citizens fundings (repayments) ........................ -- (31,461) 88,530
Issuance of common stock, net of issuance costs ....... 499 118,554 --
--------- -------- ---------
Net cash provided by financing activities .... 224,156 147,093 88,530
--------- -------- ---------
Net increase (decrease) in cash ........................... (13,411) 25,920 468
Cash at beginning of period ............................... 26,531 611 143
--------- -------- ---------
Cash at end of period ..................................... $ 13,120 $ 26,531 $ 611
========= ======== =========
Supplemental cash flow information:
Cash paid for interest, net of capitalized portion .... $ 6,074 $ 937 $ --
Non-cash increase in capital lease asset and liability 7,987 -- --
Other non-cash transactions with Citizens:
Capital contributions by Citizens ................. -- 119,200 --
Deferred income taxes ............................. -- (12,408) (3,198)
Capitalized interest .............................. -- 4,076 2,868
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-4
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Shareholders' Equity
(Amounts in thousands, except share data)
<TABLE>
<CAPTION>
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
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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
Issuance of common stock -- -- 121,816 1 -- -- 529 -- 530
Amortization of restricted
stock -- -- -- -- -- -- 4,666 -- 4,666
Net loss -- -- -- -- -- -- -- (70,017) (70,017)
------------------------------------------------------------------------------------------------
Balance, December 31, 1998 -- $-- 8,641,816 $ 86 41,165,000 $ 412 $321,926 $(173,931) $ 148,493
================================================================================================
</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 or ELI) is a facilities-based
Integrated Communications Provider (ICP) providing a broad range of
communications services. The Company provides the full range of its
products and services, including switched local and long distance voice
services as well as enhanced data communications services and dedicated
point-to-point services, in the western United States. Enhanced
broadband data services are also offered in selected cities throughout
the country. The Company markets to retail customers, who are primarily
large- and medium-sized communications-intensive businesses, and to
wholesale customers who are primarily other communications providers.
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 flows 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.
The Company was incorporated in 1990 and is an 83% owned subsidiary of
Citizens Utilities Company (Citizens). On May 18, 1998, Citizens
announced its intent to separate its telecommunications businesses and
public service businesses into two stand-alone, publicly traded
companies, subject to regulatory approval. Citizens telecommunications
businesses include the Company as well as other telecommunications
businesses and investments. These telecommunications businesses and
investments would be transferred to a new, as yet un-named corporation.
The Company anticipates that the remaining funds available for draw on
its Credit Facility (Note 7) will not be adequate to fund operating
losses, working capital deficiencies and capital expenditures for 1999.
The Company is in the process of arranging financing sufficient to fund
its operating losses, working capital deficiencies and capital
expenditures through at least 1999. To the extent that such financing
is not arranged prior to the utilization of the un-drawn Credit
Facility, Citizens has committed to provide the necessary bridge
financing, at then market terms and conditions, until third party
financing is completed.
(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 accounted for as operating leases are 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 $3,809,000 and $3,569,000 at December 31, 1998
and 1997, respectively. See Note 13 for discussion of
significant customers. Other receivables at December 31, 1997
included approximately $7,029,000 of reimbursement due to the
Company under a construction agency agreement (see Note 12).
(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 the Company's communications networks. Costs
capitalized during the network development stage include
expenses associated with engineering, construction, overhead
and interest. Interest costs related to construction of
approximately $10,444,000, $4,693,000 and $2,868,000 were
capitalized for the years ended December 31, 1998, 1997 and
1996, 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. Capital leases included in
communications networks are being amortized using the
straight-line method over the lives of the capital leases. The
estimated useful lives of owned assets are as follows:
Building 40 years
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 At December 31, 1997, other assets included third
party direct costs incurred in connection with negotiating and
securing initial rights-of-way and the development of network
design for new market clusters or locations, which costs were
deferred until service was ready to commence. Such costs were
being amortized over a 5-year period utilizing the
straight-line method. On January 1, 1998, these costs were
expensed as a cumulative effect of a change in accounting
principle in accordance with American Institute of Certified
Public Accountants Statement of Position (SOP) 98-5,
"Reporting on the Costs of Start-Up Activities". Start-up
costs are now expensed as incurred (see Note 4). Also included
in other assets at December 31, 1998 and 1997 is goodwill of
$4,267,000 and $4,504,000, respectively, resulting from the
acquisition of the minority interests in the Company by
Citizens, which is being amortized utilizing the straight-line
method over a 25-year period.
(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 Initial Public Offering (IPO) date but
only to the extent that such losses could be utilized by the
Company on a stand-alone basis.
F-7
<PAGE>
(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.
(h) Employee Stock Plans
Prior to its 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. In May 1998, shareholders approved
the Company's Employee Stock Purchase Plan (ESPP).
Prior to January 1, 1996, the Company accounted for the 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
disclosures required by SFAS 123 (see Note 11).
(i) Net Loss Per Share
The Company follows the provisions of SFAS 128, "Earnings Per
Share" which requires presentation of both basic and diluted
earnings per share (EPS) on the face of the income statement.
Basic EPS is computed using the weighted average number of
common shares outstanding during the period. 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 at the beginning of the period.
EPS for 1996 is not presented because the amounts are not
meaningful. Certain common stock equivalents arising from
stock options outstanding during the years ended December 31,
1998 and 1997 have been omitted from diluted EPS as the effect
would be anti-dilutive.
F-8
<PAGE>
Weighted average shares outstanding have been adjusted for the
effects of application of Securities and Exchange Commission
Staff Accounting Bulletin (SAB) No. 98. Pursuant to SAB 98,
all stock issued for nominal consideration should be treated
as outstanding for all periods presented even though the
effect is to reduce the net loss per share. The application of
SAB 98 had the effect of increasing outstanding shares by
520,000 for the years ended December 31, 1998 and 1997.
(3) Reciprocal Compensation
The Company has interconnection agreements with US West, the ILEC in
the majority of the states in which the Company provides local
telephone services. These agreements govern reciprocal compensation
relating to the transport and termination of traffic between the
Company and US West. Reciprocal compensation revenues are recognized by
the Company as earned, based on the terms of the interconnection
agreements. Total net reciprocal compensation revenues recognized by
the Company for the years ended December 31, 1998, 1997 and 1996 were
$18.6 million, $1.4 million and $0, respectively. Total net trade
accounts receivable relating to reciprocal compensation at December 31,
1998 and 1997 totaled $10.4 million and $1.4 million, respectively.
The Company filed complaints with the PUCs in Washington and Utah
requesting that US West pay the Company for reciprocal compensation
charges relating to the termination of calls to ISPs, as required by
the interconnection agreements. The state PUCs ruled in the Company's
favor and accordingly, US West began paying the Company for reciprocal
compensation in Washington in 1998 and in Utah in the first quarter of
1999. The Company has similar complaints pending with the PUCs in
Oregon and Arizona. Although neither the Oregon nor Arizona PUCs has
issued a final ruling, the Oregon PUC has ruled in other recent cases
that calls terminated to ISPs should be categorized as local traffic,
and should therefore be subject to reciprocal compensation.
The Company recognized $1.1 million of reciprocal compensation revenue
in the first quarter of 1998 as a result of the reversal of an
allowance established in 1997. Additionally, revenues of $2.2 million
were recognized in the fourth quarter of 1998 as a result of the
reversal of an allowance that had been established during previous
quarters in 1998.
On February 25, 1999, the FCC issued a Declaratory Ruling and Notice of
Proposed Rulemaking that categorized calls terminated to ISPs as
"largely" interstate in nature, which could have the effect of
precluding these calls from reciprocal compensation charges. However,
the ruling stated that ILECs are bound by the existing interconnection
agreements and the state decisions that have defined them. Most of the
Company's interconnection agreements expire in the second half of 1999.
(4) Change in Accounting Principles and New Accounting Pronouncements
On April 3, 1998, the Accounting Standards Executive Committee of the
AICPA released SOP 98-5, "Reporting on the Costs of Start-Up
Activities". The SOP requires that at the beginning of the fiscal year
of adoption, the unamortized portion of deferred start-up costs be
written off and reported as a change in accounting principle. Future
costs of start-up activities should then be expensed as incurred. The
Company adopted SOP 98-5, effective January 1, 1998. Certain 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 had been capitalized by the Company in previous
years, and were being amortized over five years. The net book value of
these deferred amounts was $3,394,000 which has been reported as a
cumulative effect of a change in accounting principle in the statement
of operations for the year ended December 31, 1998, net of income tax
benefit of $577,000. These deferred amounts were reported as other
assets at December 31, 1997.
F-9
<PAGE>
On January 1, 1998, the Company early adopted SOP 98-1, "Accounting for
the Costs of Computer Software Developed or Obtained for Internal Use".
The adoption of the SOP did not have a material impact on the Company's
financial position and results of operations. The SOP requires that
certain costs related to the development or purchase of internal-use
software be capitalized and amortized over the estimated useful life of
the software and costs related to the preliminary project stage and the
post-implementation/operations stage of an internal-use computer
software development project be expensed as incurred. Capital software
costs included in construction work in progress reflect costs for
internally developed or purchased software. These costs are capitalized
and amortized on the straight-line method over the estimated useful
life of the software.
In 1998, the Company adopted the provisions of SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information".
SFAS 131 establishes standards for the way that public business
enterprises report information about operating segments in annual
financial statements and requires that those enterprises report
selected information about operating segments in interim financial
reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas and
major customers. This Statement supersedes SFAS 14, "Financial
Reporting for Segments of a Business Enterprise", but retains the
requirement to report information about major customers. See Note 13
for segment disclosures.
(5) Property, Plant and Equipment
The components of property, plant and equipment at December 31 are as
follows:
<TABLE>
<CAPTION>
($ in thousands) 1998 1997
---------------- ----------- -----------
<S> <C> <C>
Communications networks $ 264,647 $ 152,578
Electronics and related equipment 40,836 22,003
Facility and leasehold improvements 21,280 3,161
Office equipment and furniture 24,775 14,154
Construction work in progress 176,256 133,981
Materials and supplies 788 2,787
----------- -------------
Property, plant and equipment 528,582 328,664
Accumulated depreciation and amortization (40,912) (25,791)
----------- -------------
Property, plant and equipment, net $ 487,670 $ 302,873
=========== =============
</TABLE>
Communications networks include capital leases at December 31, 1998 and
1997 of $18,489,000 and $11,320,000, respectively.
Materials and supplies 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 $30,000 over the 10-year lease period (see Note 10).
F-10
<PAGE>
(6) Accounts Payable and Accrued Liabilities
The components of accounts payable and accrued liabilities at December
31 are as follows:
($ in thousands) 1998 1997
---------------- -------- --------
Accounts payable - trade $ 3,431 $ 5,407
Accrued services purchased for resale 9,411 5,609
Accrued construction work in progress 18,500 25,986
Accrued compensation 4,258 3,530
Cash overdraft 25,515 9,475
Other accrued liabilities 645 230
-------- --------
Accounts payable and accrued liabilities $ 61,760 $ 50,237
======== ========
(7) Long-term Debt
In November 1997 the Company entered into 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 (see Note 10). The
balances outstanding as of December 31, 1998 and 1997 were $284 million
and $60 million, respectively. The weighted average interest rate at
December 31, 1998 and 1997 was 5.61% and 6.05%, respectively. Interest
rates are based on the Eurodollar rate at the time the funds are drawn
and reset periodically thereafter. No principal payment is due until
the expiration date of the Credit Facility.
(8) Income Taxes
The components of deferred income taxes at December 31 are as follows:
($ in thousands) 1998 1997
---------------- ---------- ----------
Benefit of operating loss carryforwards $ 44,181 $ 3,171
Less valuation allowance (15,137) --
---------- ----------
Net deferred tax asset 29,044 3,171
Deferred income tax liability, primarily
property, plant and equipment 30,804 20,089
---------- ----------
Net deferred income tax liability $ 1,760 $ 16,918
========= ==========
The Company is included in the consolidated federal income tax return
of Citizens. In accordance with the tax sharing agreement with
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 of benefit
was eliminated along with the corresponding amount of valuation
allowance as of the IPO date. In addition, the benefit recorded prior
to the IPO, which carried a 100% valuation allowance, was trued up in
1998, resulting in a reduction of the deferred tax payable of $744,000
and a corresponding increase in the amount due to Citizens.
F-11
<PAGE>
The following is a reconciliation of the provision for income taxes at
federal statutory rates to the effective rates:
1998 1997 1996
------- ------- -------
Tax provision at federal statutory rate 35.0% 35.0% 35.0%
Pre IPO operating loss not benefited -- (31.3%) (35.0%)
Valuation allowance (17.9%) -- --
------- ------- -------
Effective tax rate 17.1% 3.7% 0.0%
======= ======= =======
The provision for income taxes consisted of deferred federal tax
expense (benefit) of approximately ($13,837,000), $11,092,000 and
$3,198,000 and current tax benefits of $0, $12,408,000 and $3,198,000
for the years ended December 31, 1998, 1997 and 1996, respectively. In
addition, a $577,000 deferred tax benefit was recorded in 1998 related
to the cumulative effect of an accounting change.
(9) Capital Stock
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 11). Subsequently, in 1997, 15,000 of
the restricted shares were returned and canceled.
During 1998, the Company issued 119,345 shares of Class A Common Stock
under its Employee Stock Purchase Plan (Note 11). Additionally, 2,471
shares of Class A Common Stock were issued to directors of the Company
for services provided. The Company recognized $31,000 of non-cash
compensation expense related to the director issued shares.
At December 31, 1998, there were 8,641,816 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 82.65% 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 97.94% 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-12
<PAGE>
(10) Related Party Transactions
Transactions with Citizens
Citizens 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.
The Company has transactions in the normal course of business with
Citizen's Communications segment (Citizens Communications). Citizens
Communications is an ILEC in certain markets in which the Company
provides services. In order to provide services in those markets, the
Company purchases access from Citizens Communications. ELI is charged
the full-tariff rate for those services. The Company paid Citizens
$4,790,000, $5,116,000 and $7,600,000 in 1998, 1997 and 1996,
respectively, representing usage based charges for the services
provided. Prior to the IPO in November 1997, Citizens and the Company
combined their purchasing power with several long distance carriers in
order to receive a lower unit cost. The amounts paid to Citizens in
1997 include the cost of the Company's usage from these long-distance
carriers, including a 5% administrative fee.
Citizens Communications purchases certain services and products from
ELI at prevailing market rates. Related party revenue recognized by the
Company was approximately $2,882,000, $3,447,000 and $1,653,000 in
1998, 1997 and 1996, respectively. Outstanding trade accounts
receivables from Citizens were $557,000 and $1,035,000 for 1998 and
1997, respectively.
A summary of the activity in the amount due to Citizens at December 31
is as follows:
<TABLE>
<CAPTION>
($ in thousands) 1998 1997 1996
---------------- --------- --------- ---------
<S> <C> <C> <C>
Balance beginning of period ...... $ 944 $ 155,395 $ 64,941
Capital contribution ............ -- (119,200) --
Cash advances from Citizens, net . -- (31,461) 88,530
Guarantee fees ................... 8,614 548 --
Deferred income taxes ............ 744 (12,408) (3,198)
Interest ......................... -- 4,076 2,868
Administrative services:
Services provided by Citizens 4,827 3,994 2,254
ELI expenses paid by Citizens 6,141 -- --
Payments to Citizens ............. (16,016) -- --
--------- --------- ---------
Balance end of period ............ $ 5,254 $ 944 $ 155,395
========= ========= =========
</TABLE>
See Note 8 for information regarding the Company's tax sharing
agreement with Citizens and Note 11 for information regarding
participation in Citizens' stock plans.
F-13
<PAGE>
(11) STOCK PLANS
Prior to the IPO, Company employees participated in three Citizens
stock based compensation plans, the Citizens MEIP, Citizens EIP and the
Citizens ESPP (Note 2). At December 31, 1998, the Company had two stock
based compensation plans, the EIP and ESPP (Note 2). The Company
applies APB Opinion No. 25 and related interpretations in accounting
for the employee stock plans. Accordingly, no compensation cost has
been recognized in the financial statements for options issued pursuant
to the stock plans mentioned above. Had the Company determined
compensation cost based on the fair value at the grant date for these
stock plans, the Company's pro forma loss and loss per share would have
been as follows:
<TABLE>
<CAPTION>
($ in thousands except per share) 1998 1997 1996
--------- ---------- ---------
<S> <C> <C> <C>
Net loss As reported: $(70,017) $ (33,945) $ (29,383)
Pro forma: (75,783) (34,392) (29,528)
Net loss per share As Reported:
Basic $ (1.41) $ (.80) N/A
Diluted (1.41) (.80) N/A
Pro Forma:
Basic (1.52) (.81) N/A
Diluted (1.52) (.81) N/A
</TABLE>
The full impact of calculating compensation cost for stock options is
not reflected in the pro forma amounts above because pro forma
compensation cost only includes costs associated with the vested
portion of options granted pursuant to the stock plans on or after
January 1, 1995.
In August 1998, the Compensation Committee of ELI's Board of Directors
approved a stock option exchange program for the EIP, pursuant to which
employees of the Company holding outstanding options with an exercise
price in excess of $15.50 had the right to exchange all or half of
their options for a lesser number of new options with an exercise price
of $8.75. A calculation was prepared using the Black Scholes Option
Pricing Model to determine the exchange rate for each eligible grant.
The repriced options maintain the same vesting and expiration terms.
This stock option exchange program had no impact on reported earnings
and resulted in a net reduction in shares subject to option of 546,000.
In November 1998, the Compensation Committee of Citizens' Board of
Directors approved a stock option exchange program pursuant to which
current employees of Citizens and its subsidiaries holding outstanding
options, under the Citizens MEIP and Citizens EIP plans, with an
exercise price in excess of $10.00 had the right to exchange their
options for a lesser number of new options with an exercise price of
$7.75. The exchanged options maintain the same vesting and expiration
terms.
Both the Company and Citizens repriced these employee stock options in
an effort to retain employees at a time when a significant percentage
of employee stock options had exercise prices that were above fair
market value. No compensation costs have been recognized in the
financial statements as the exercise price of the option was equal to
the market value of the stock at the date of repricing.
F-14
<PAGE>
Company Plans
Employee Stock Purchase Plan
The ESPP was approved by shareholders on May 21, 1998. Under the ESPP,
eligible employees of the Company have the right to subscribe to
purchase shares of Class A Common Stock at the lesser of 85% of the
average of the high and low market prices on the first day of the
purchase period or on the 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. An employee may not
participate in the ESPP if such employee owns stock possessing 5% or
more of the total combined voting power or value of all classes of
capital stock. As of December 31, 1998, there were 200,000 shares of
Class A Common Stock reserved for issuance under the ESPP. These shares
may be adjusted for any future stock dividends or stock splits. The
ESPP will terminate when all shares reserved have been subscribed for
and purchased, unless terminated earlier or extended by the Board of
Directors. The ESPP is administered by the Compensation Committee of
the Board of Directors. As of December 31, 1998, the number of
employees enrolled and participating in the ESPP was 468 and the total
number of shares purchased under the ESPP in 1998 was 119,345. For
purposes of the pro forma calculation, compensation cost is recognized
for the fair value of the employees' purchase rights, which was
estimated using the Black-Scholes option-pricing model with the
following assumptions for subscription periods beginning in 1998:
1998
----------------
Dividend yield --
Expected volatility 71%
Risk-free interest rate 4.92%
Expected life 6 months
The weighted average fair value of those purchase rights granted in
1998 was $3.82.
Equity Incentive Plan
In October 1997, the Board of Directors approved the EIP. Under the
EIP, awards of Class A Common Stock may be granted to eligible
directors, officers, management employees, non-management employees and
consultants of the Company in the form of incentive stock options,
non-qualified stock options, SARs, restricted stock or other
stock-based awards. The EIP is administered by the Compensation
Committee of the Board of Directors. The exercise price for such awards
shall not be less than 85% or more than 110% of the average of the high
and low stock prices on the date of grant. The exercise period for such
awards is generally 10 years from the date of grant. The Company has
reserved 4,170,600 shares for issuance under the terms of this plan.
The following is a summary of share activity subject to option under
the EIP:
<TABLE>
<CAPTION>
Weighted
Shares Average Option
Subject to Option Price Per Share
-------------------- ---------------
<S> <C> <C>
Balance at January 1, 1997 -- $ --
Options granted 2,326,000 16.00
-----------
Balance at December 31, 1997 2,326,000 16.00
Options granted 1,654,000 10.77
Options cancelled or lapsed (1,649,000) 16.21
-----------
Balance at December 31, 1998 2,331,000 $ 12.14
===========
</TABLE>
F-15
<PAGE>
As a result of the stock option exchange program approved by the
Compensation Committee of the Board of Directors, a total of 2,212,000
options were eligible for exchange, of which 1,426,000 options were
cancelled in exchange for 880,000 new options.
The following table summarizes information about shares subject to
options under the EIP at December 31, 1998.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------------- --------------------------------
Weighted Average
Number Range of Weighted Average Remaining Number Weighted Average
Outstanding Exercise Prices Exercise Price Life in Years Exercisable Exercise Price
----------- --------------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
1,261,000 $ 8 - 9 $ 9 9 268,000 $ 9
32,000 9 - 16 13 9 27,000 13
963,000 16 - 17 16 9 320,000 16
75,000 17 - 20 19 9 -- --
--------- -------
2,331,000 8 - 20 12 9 615,000 13
========= =======
</TABLE>
For purposes of the pro forma calculation, compensation cost is
recognized for the fair value of the employees' purchase rights, which
was estimated using the Black-Scholes option-pricing model with the
following assumptions for subscription periods beginning in 1998 and
1997:
1998 1997
--------- --------
Dividend yield -- --
Expected volatility 71% 13%
Risk-Free interest rate 5.44% 5.87%
Expected life 6 years 7 years
The weighted average fair value of those options granted in 1998 and
1997 was $6.94 and $5.13, respectively.
In conjunction with the IPO, the Company granted 535,000 restricted
stock awards to key employees in the form of Class A Common Stock.
Subsequently in 1997, 15,000 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. For 395,000 shares, the restrictions lapse over one
through three-year periods, including one-third of the shares when the
Company achieves $100,000,000 of annual revenues, one-third of the
shares when the Company achieves $125,000,000 of annual revenues, and
one-third of the shares when the Company achieves $155,000,000 of
annual revenues. For the remaining 125,000 shares, the restrictions
will lapse in January 2001 if certain performance targets are met. At
December 31, 1998, 520,000 shares of this stock were outstanding, of
which 131,667 shares were no longer restricted. Compensation expense of
$4,666,000 and $219,000 for the years ended 1998 and 1997,
respectively, has been recorded in connection with these grants.
Citizens Plans
The following information reflects the Citizens MEIP, Citizens EIP and
Citizens ESPP for Company employees and excludes full time employees
and officers of Citizens.
F-16
<PAGE>
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>
<CAPTION>
Shares Weighted
Subject to Average Option
Option Price Per Share
-------------- -------------------
Citizens MEIP:
--------------
<S> <C> <C>
Balance at January 1, 1996 119,000 $ 11.32
Options granted 118,000 10.54
Options cancelled or lapsed (6,000) 10.96
---------
Balance at December 31, 1996 and 1997 231,000 10.93
Options granted 70,000 7.75
Options cancelled, forfeited or lapsed (125,000) 10.77
---------
Balance at December 31, 1998 176,000 9.75
=========
</TABLE>
As a result of the stock option exchange program approved by the
Compensation Committee of the Board of Directors of Citizens, a total
of 115,000 options were eligible for exchange, of which 115,000 options
were cancelled in exchange for 71,000 new options with an exercise
price of $7.75.
<TABLE>
<CAPTION>
Shares Weighted
Subject to Average Option
Option Price Per Share
-------------- -------------------
Citizens EIP:
-------------
<S> <C> <C>
Balance at January 1, 1997 -- $ --
Options granted 331,000 8.53
Balance at December 31, 1997 331,000 8.53
Options cancelled, forfeited or lapsed (29,000) 8.53
Balance at December 31, 1998 302,000 8.53
</TABLE>
The following table summarizes information about Citizens shares
subject to option for Company employees under the Citizens MEIP and
Citizens EIP at December 31, 1998.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------------- --------------------------------
Weighted
Range of Weighted Average Weighted
Number Exercise Average Remaining Number Average
Outstanding Prices Exercise Price Life in Years Exercisable Exercise Price
----------- ---------------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
Citizens MEIP 176,000 $7.75-14.24 $ 9.75 6.4 107,000 $ 10.11
Citizens EIP 302,000 8.53 8.53 8.7 101,000 8.53
</TABLE>
The weighted average fair value of options granted during 1998, 1997
and 1996 was $2.18, $4.23 and $4.61, respectively. For purposes of the
pro forma calculation, 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, 1998, 1997 and 1996:
F-17
<PAGE>
Citizens EIP Citizens MEIP
1997 1998 1996
------------ ------ --------
Dividend yield -- -- --
Expected volatility 32% 26% 20%
Risk-Free interest rate 6.13% 4.49% 5.61%
Expected life 7 years 4 years 7 years
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 annual installments throughout the
designated payroll-deduction period for the purchase of the shares. The
value of an employee's subscription may not exceed $25,000 in any one
calendar year.
Company employees did not participate in the Citizens ESPP in 1998,
since the Company's ESPP was established. The weighted average
fair-value of purchase rights granted in 1997 and 1996 was $3.07 and
$3.46, 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 and 1996:
1997 1996
--------- ---------
Dividend yield -- --
Expected volatility 32% 20%
Risk-Free interest rate 5.44% 5.28%
Expected life 6 months 6 months
(12) Commitments and Contingency
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 served as agent for the construction of these projects and
upon completion of each project leased the facilities for a three year
term, with one year renewals available through April 30, 2002. At
December 31, 1998 and 1997, the Company was leasing assets with an
original cost of approximately $108,541,000 and $87,426,000
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. Payments under the
lease depend on current interest rates, and assuming continuation of
current interest rates, payments would approximate $6.1 million
annually through April 30, 2002 and, assuming exercise of the purchase
option, approximately $110 million in 2002. 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% (approximately $88 million) of the lessor's investment.
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.
The Company conducts certain of its operations in leased premises and
also leases certain equipment. Obligations, renewals and maintenance
costs vary by lease.
F-18
<PAGE>
The Company has entered into various capital and operating leases for
fiber optic cable to interconnect its MAN networks with long-haul fiber
optic routes. The terms of the various agreements covering the routes
described above range from 20 to 25 years, with varying optional
renewal periods. For certain contracts, rental payments are based on a
percentage of the Company's leased traffic, and are exclusive, subject
to certain minimums. For other contracts, certain minimum payments are
required, which are reflected in the commitment table below.
The Company has also entered into certain operating and capital leases
in order to develop MANs, including an operating lease to develop a
local network in Phoenix and a capital lease to develop a local network
in San Francisco. The operating lease in Phoenix provides for rental
payments based on a percentage of the network's operating income for a
period of 15 years. The capital lease in San Francisco is a 30-year
indefeasible and exclusive right to use agreement for optical fibers in
the San Francisco Bay Area. The Company is required to make quarterly
minimum payments under the agreement, which are reflected in the
commitment table below. The Phoenix operating lease network is
currently operational, and the San Francisco capital lease network is
expected to become operational in the second half of 1999.
Future minimum rental commitments for all long-term non-cancelable
leases as of December 31, 1998 are:
<TABLE>
<CAPTION>
Lease Type
-------------------------
Year Capital Operating
---- ------------- -----------
($ in thousands)
<S> <C> <C>
1999 $ 1,693 $ 12,383
2000 1,838 12,367
2001 1,838 11,826
2002 1,838 7,714
2003 1,838 4,153
Thereafter 31,766 7,095
------------- -----------
Total 40,811 $ 55,538
===========
Less amounts representing interest (22,204)
-------------
Present value of net minimum lease
payments 18,607
Less current installments of obligations
under capital leases (351)
-------------
$ 18,256
=============
</TABLE>
Total operating lease rental expense included in the Company's results
of operations for the years ended December 31, 1998, 1997 and 1996 was
$12,511,000, $9,196,000 and $5,193,000, respectively.
In June 1998, the Company entered into a private line services
agreement with a third party, which allows the Company to utilize the
third party's national fiber optic network for a period of nine years.
The Company has a total minimum commitment of $122 million over the
term of the agreement, including $11.6 million in 1999. A portion of
the network was operational as of December 31, 1998, with construction
on the remainder of the network scheduled for completion in 1999.
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 $21,300,000,
$7,200,000 and $3,200,000 for 1999, 2000 and 2001, respectively.
The Company's capital additions for 1999 are estimated to be
$261,000,000. Certain commitments have been entered into in connection
with this budget.
F-19
<PAGE>
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.
(13) Segment Disclosures
The Company operates in a single industry segment, communications
services. The Company's operations involve developing an integrated
advanced fiber network to provide the full range of the Company's
products and services in the western United States as well as enhanced
broadband data services in selected cities nationwide. While the
Company's chief operating decision maker monitors the revenue streams
of the various products and geographic locations, operations are
managed and financial performance is evaluated based on the delivery of
multiple services to customers over a single fiber-optic network. This
practice allows the Company to leverage its network costs to maximize
profitability. As a result, there are many shared expenses generated by
the various revenue streams and management believes that any allocation
of the expenses incurred on a single network to multiple revenue
streams or geographic locations would be impractical and arbitrary, and
management does not currently make such allocations internally.
Products and Services
The Company groups its products and services into the following
categories:
Network Services - point-to-point dedicated services that provide a
private transmission channel for our customers' exclusive use between
two or more locations, both in metropolitan and long haul applications.
Local Telephone Services - local dial tone and switched products and
services that provide incoming and outgoing calls over the public
switched network with added functionality. This category includes
reciprocal compensation revenues.
Long Distance Services - retail and wholesale services that include 1+,
toll-free, pre-paid, originating and terminating access services.
Data Services - switched and dedicated data connectivity services that
include frame relay, video conferencing, LAN/WAN and Internet transport
services.
The revenues generated by these products and services at December 31
were:
<TABLE>
<CAPTION>
($ in thousands) 1998 1997 1996
--------------- ---------- ---------- ----------
<S> <C> <C> <C>
Network services $ 36,589 $ 33,522 $ 18,741
Local telephone services 38,169 10,565 2,533
Long distance services 12,309 8,140 4,661
Data services 13,813 8,857 5,374
---------- ---------- -----------
$ 100,880 $ 61,084 $ 31,309
========== ========== ===========
</TABLE>
The Company does not currently provide services outside the United
States.
F-20
<PAGE>
Major Customers
For the years ended December 31, 1998 and 1997, two separate customers
have accounted for 10% or more of the Company's total revenue. No
customers accounted for 10% or more of the Company's total revenue for
the year ended December 31, 1996. At December 31, 1998, Customer A
accounted for 20% of the Company's total revenue. At December 31, 1997,
customer B accounted for 10% of the Company's total revenue.
(14) Quarterly Financial Information (Unaudited)
Selected unaudited financial information for each of the quarters in
1998 is as follows:
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------
March 31, June 30, September 30, December 31,
---------- ---------- --------------- -------------
($ in thousands, except per share amounts)
------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 20,057 $ 21,443 $ 25,664 $ 33,716
Network access expenses 9,212 9,860 12,317 19,568
Net loss before cumulative effect of change in
accounting principle (11,955) (14,758) (18,405) (22,082)
Net loss (14,772) (14,758) (18,405) (22,082)
Net loss per share before cumulative effect
of change in accounting principle $ (.24) $ (.30) $ (.37) $ (.44)
Net loss per share (.30) (.30) (.37) (.44)
</TABLE>
Quarterly information for 1997 is not supplied, as the Company was not
publicly traded for any full quarters in 1997.
F-21
<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, 1998 and 1997 and the related
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1998.
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 LLP
March 1, 1999
<PAGE>
Schedule II
Electric Lightwave, Inc.
Valuation and Qualifying Accounts
($ in thousands)
<TABLE>
<CAPTION>
Balance at Charged to Charge to Balance
Beginning Cost Other at End
Accounts of Period And Expense Accounts Deductions of Period
- -------- --------- ----------- --------- ---------- ----------
1996:
<S> <C> <C> <C> <C> <C>
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 --
1998
Allowance for doubtful accounts (3,569) (2,524) (188) 2,472 (3,809)
Deferred income taxes valuation
allowance ................. $ -- $(15,137) $ -- $ -- $(15,137)
</TABLE>
Exhibit 23.1
The Board of Directors
Electric Lightwave, Inc.
We consent to the incorporation by reference in the Registration Statement Form
S-8 (no. 333-61009) of Electric Lightwave, Inc. our report dated March 1, 1999,
relating to the balance sheets of Electric Lightwave, Inc. as of December 31,
1998 and 1997, and the related statements of operations, shareholders' equity,
and cash flows for the years in the three-year period ended December 31, 1998,
which report appears in the December 31, 1998 annual report on Form 10-K of
Electric Lightwave, Inc.
New York, New York
March 1, 1999
Exhibit 24.1
POWER OF ATTORNEY
For Executing Form 10-K for 1998
KNOW ALL BY THESE PRESENTS, that theundersigned 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 1998 for Electric Lightwave, Inc., and any ad 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.
Dated February 23, 1999
/s/ Guenther E. Greiner
-----------------------------
Guenther E. Greiner
/s/ Stanley Harfenist
-----------------------------
Stanley Harfenist
/s/ Robert A. Stanger
-----------------------------
Robert A. Stanger
/s/ Maggie Wilderotter
-----------------------------
Maggie Wilderotter
/s/ David B. Sharkey
-----------------------------
David B. Sharkey
/s/ Leonard Tow
-----------------------------
Leonard Tow
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
Electric Lightwave, Inc.'s Financial Statements for the period ended
December 31, 1998 and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> US Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Dec-31-1998
<EXCHANGE-RATE> 1
<CASH> 13,120
<SECURITIES> 0
<RECEIVABLES> 24,129
<ALLOWANCES> 3,809
<INVENTORY> 0
<CURRENT-ASSETS> 38,064
<PP&E> 528,582
<DEPRECIATION> 40,912
<TOTAL-ASSETS> 532,309
<CURRENT-LIABILITIES> 77,966
<BONDS> 302,256
0
0
<COMMON> 498
<OTHER-SE> 147,995
<TOTAL-LIABILITY-AND-EQUITY> 532,309
<SALES> 0
<TOTAL-REVENUES> 100,880
<CGS> 0
<TOTAL-COSTS> 50,957
<OTHER-EXPENSES> 28,149
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,526
<INCOME-PRETAX> (81,037)
<INCOME-TAX> (13,837)
<INCOME-CONTINUING> (67,200)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 2,817
<NET-INCOME> (70,017)
<EPS-PRIMARY> (1.41)
<EPS-DILUTED> (1.41)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
Electric Lightwave, Inc.'s Financial Statements for the years ended
December 31, 1997 and 1996 and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> US Dollars
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> Dec-31-1997 Dec-31-1996
<PERIOD-START> Jan-01-1997 Jan-01-1996
<PERIOD-END> Dec-31-1997 Dec-31-1996
<EXCHANGE-RATE> 1 1
<CASH> 26,531 611
<SECURITIES> 0 0
<RECEIVABLES> 16,138 5,766
<ALLOWANCES> 3,569 1,166
<INVENTORY> 0 0
<CURRENT-ASSETS> 47,632 13,774
<PP&E> 328,664 189,334
<DEPRECIATION> 25,791 17,337
<TOTAL-ASSETS> 359,962 195,656
<CURRENT-LIABILITIES> 57,419 23,714
<BONDS> 70,511 0
0 0
0 0
<COMMON> 497 412
<OTHER-SE> 212,817 8,874
<TOTAL-LIABILITY-AND-EQUITY> 359,962 195,656
<SALES> 0 0
<TOTAL-REVENUES> 61,084 31,309
<CGS> 0 0
<TOTAL-COSTS> 29,546 20,620
<OTHER-EXPENSES> 15,615 7,548
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 1,166 0
<INCOME-PRETAX> (35,261) (29,383)
<INCOME-TAX> (1,316) 0
<INCOME-CONTINUING> (33,945) (29,383)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (33,945) (29,383)
<EPS-PRIMARY> (.80) 0<F1>
<EPS-DILUTED> (.80) 0<F1>
<FN>
EPS for 1996 is not presented because the amounts are not meaningful.
</FN>
</TABLE>
