FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
From the transition period from ________ to
Commission file number 333-41723
BTI Telecom Corp.
(Exact name of registrant as specified in its charter)
North Carolina 56-2047220
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
4300 Six Forks Road, Suite 500, Raleigh, North Carolina 27609
(Address of principal executive offices) (Zip Code)
(800)849-9100
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X___No____
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the last practicable date.
No Par Value Common Stock 100,000,000 shares as of November 13, 1998
<PAGE>
BTI Telecom Corp.
Form 10-Q
Index
<TABLE>
<CAPTION>
Page
Number
------
Part I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Consolidated Statements of Operations for the three
months ended and for the nine months ended September 30,
1998 and September 30, 1997 ............................................................ 3
Consolidated Balance Sheets as of September 30, 1998 and
December 31, 1997 ...................................................................... 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 1998 and September 30, 1997 ....................................... 5
Notes to Consolidated Financial Statements ............................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................................... 11
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ....................................................... 16
Signature .............................................................................. 17
Index to Exhibits ...................................................................... 18
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
BTI Telecom Corp.
Consolidated Statements of Operations
(Unaudited)
(In thousands, except share data)
Three Months Nine Months
Ended September 30, Ended September 30,
---------------------------------- ----------------------------------
1998 1997 1998 1997
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Revenue $ 51,684 $ 50,562 $ 157,490 $ 145,009
Cost of services 36,609 36,011 114,457 101,238
---------------- ---------------- ---------------- ----------------
Gross profit 15,075 14,551 43,033 43,771
Selling, general and
administrative expenses 17,244 15,138 49,348 39,209
Depreciation and amortization 3,048 1,455 7,697 4,545
---------------- ---------------- ---------------- ----------------
Income (loss) from operations (5,217) (2,042) (14,012) 17
Other income (expense)
Interest expense (6,334) (1,195) (19,085) (2,108)
Interest income 1,196 110 4,665 136
---------------- ---------------- ---------------- ----------------
Loss before income taxes (10,355) (3,127) (28,432) (1,955)
Income taxes - 2,210 - 2,210
Net loss $ (10,355) $ (5,337) $ (28,432) $ (4,165)
================ ================ ================ ================
Basic and diluted loss per share $ (0.10) $ (0.03) $ (0.28) $ (0.02)
================ ================ ================ ================
Weighted average shares outstanding 100,000 200,000 100,000 200,000
================ ================ ================ ================
</TABLE>
See accompanying notes.
3
<PAGE>
<TABLE>
<CAPTION>
BTI Telecom Corp.
Consolidated Balance Sheets
(Dollars in thousands)
September 30, 1998 December 31, 1997
(Unaudited)
----------------- -----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 18,730 $ 67,009
Restricted cash 26,380 25,016
Accounts receivable, less allowance of $4,915
and $4,825, respectively 25,486 22,710
Other current assets 3,781 2,296
----------------- -----------------
Total current assets 74,377 117,031
Equipment, furniture and fixtures:
Equipment, furniture and fixtures 93,429 53,744
Construction in progress 19,107 10,154
Less: accumulated depreciation (26,119) (19,321)
----------------- -----------------
Total equipment, furniture and fixtures 86,417 44,577
Other assets, net 14,158 11,916
Restricted cash, non-current 23,643 50,026
----------------- -----------------
Total assets $ 198,595 $ 223,550
================= =================
Liabilities and shareholder's deficit
Current liabilities:
Accounts payable and accrued expenses $ 40,640 $ 30,055
Accrued interest 1,180 7,232
Other liabilities 4,517 2,902
----------------- -----------------
Total current liabilities 46,337 40,189
Long-term debt 250,000 250,000
Other long-term liabilities 1,694 2,935
----------------- -----------------
Total liabilities 298,031 293,124
Shareholder's deficit:
Common stock, no par value, authorized 37 37
500,000,000 shares, issued and outstanding
100,000,000 in 1998 and 100,000,000 in 1997
Additional paid-in capital 773 738
Accumulated deficit (100,246) (70,349)
----------------- -----------------
Total shareholder's deficit (99,436) (69,574)
----------------- -----------------
Total liabilities & shareholder's deficit $ 198,595 $ 223,550
================= =================
</TABLE>
See accompanying notes.
4
<PAGE>
<TABLE>
<CAPTION>
BTI TELECOM CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Nine Months
Ended Sept 30,
-----------------------------
1998 1997
-------------- -------------
<S> <C> <C>
Operating Activities:
Net loss $ (28,432) $ (4,165)
Adjustments to reconcile net loss to net
cash (used in) provided by operating activities:
Depreciation and amortization 7,697 4,545
Non-cash compensation related to stock options 35 708
Changes in operating assets & liabilities:
Accounts receivable, net (2,775) (2,161)
Other assets (310) (130)
Accounts payable and accrued expenses 10,614 4,312
Accrued interest (7,491) 510
Other liabilities 1,939 3,452
-------------- -------------
Net cash (used in) provided by operating activities (18,723) 7,071
Investing Activities:
Change in restricted cash 25,019 (73,635)
Purchases of equipment, furniture and fixtures, net (49,878) (7,429)
Purchase of FiberSouth assets - (35,186)
Line access fees (753) (569)
Settlement of FiberSouth stock option repurchase obligation (2,300) -
-------------- -------------
Net cash used in investing activities (27,912) (116,819)
Financing Activities:
Net repayments of long-term debt - (18,671)
Proceeds from senior notes - 250,000
Decrease in other long-term liabilities (770) (371)
Increase in deferred financing costs and other assets (874) (9,065)
Reacquisition of common stock - (28,286)
Dividends paid - (1,586)
-------------- -------------
Net cash (used in) provided by financing activities (1,644) 192,021
-------------- -------------
(Decrease) increase in cash and cash equivalents (48,279) 82,273
Cash and cash equivalents at beginning of period 67,009 504
-------------- -------------
Cash and cash equivalents at end of period $ 18,730 $ 82,777
============== =============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 26,222 $ 1,585
============== =============
</TABLE>
See accompanying notes.
5
<PAGE>
Note 1: The Company and Significant Accounting Policies
Basis of Presentation
The consolidated financial information includes the accounts of BTI Telecom
Corp. and its wholly owned subsidiaries (the "Company" or "BTITC") after
elimination of intercompany transactions. The consolidated interim financial
statements of BTITC included herein are unaudited and have been prepared in
accordance with generally accepted accounting principles ("GAAP") for interim
financial reporting and Securities and Exchange Commission ("SEC") regulations.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with GAAP have been condensed or omitted
pursuant to such rules and regulations. In the opinion of management, the
financial statements reflect all adjustments (of a normal and recurring nature)
which are necessary to present fairly the financial position, results of
operations and cash flows for the interim periods. The results for any interim
period are not necessarily indicative of the results for any other period. These
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
Preparation of the financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Equipment, Furniture and Fixtures
During the fourth quarter of 1997, the Company commenced construction on
certain capital projects, including its longhaul fiber optic network. Interest
costs associated with the construction of capital assets are capitalized. The
total amount capitalized for the three and nine month periods ended September
30, 1998 was $0.4 million and $1.1 million, respectively. Interest costs were
not capitalized in prior periods because the amounts were not material to the
Company's results of operations, cash flows or financial position.
Costs associated with the longhaul fiber optic network are classified as
"Construction in Progress" in the accompanying consolidated balance sheets. Upon
completion of network segments, these costs will be transferred into service and
depreciated over their useful lives.
Note 2: Issuance of Senior Notes and Related Transactions
In September 1997, the Company issued ten-year notes (the "Senior Notes")
with a principal value of $250 million. The Senior Notes bear interest at the
rate of 10 1/2 % per annum and mature in 2007. Pursuant to the pledge agreement
executed in
6
<PAGE>
connection with the issuance of the Senior Notes, the Company utilized $74.1
million of the loan proceeds to purchase a portfolio of pledged securities that
are being held in escrow for the payment of the first six scheduled interest
payments due on the Notes. The pledged securities are included in the
"Restricted cash" caption of the consolidated balance sheets.
In connection with the issuance of the Senior Notes, the Company also
consummated the following transactions in September 1997:
(i) The Company, which began operations through Business Telecom, Inc. ("BTI")
in 1984, was reorganized into a new corporate structure consisting of BTITC as
the parent company and BTI as a wholly owned subsidiary and converted from an S
corporation to a C corporation subject to income tax.
(ii) BTI entered into an amended and restated revolving credit facility (the
"Credit Facility") guaranteed by the Company, which will provide up to $60.0
million of availability to be used for working capital and other uses, including
capital expenditures. BTI repaid all indebtedness outstanding under its then
existing credit agreement together with accrued interest thereon. (The Credit
Facility has been subsequently amended. See Note 3.)
(iii) BTI repurchased 50% of its outstanding common stock not held by its
Chairman and Chief Executive Officer under the terms of the Common Stock
Repurchase Agreement (See Note 6).
(iv) The Company acquired certain fiber optic assets and the related business of
FiberSouth, Inc. ("FiberSouth") for cash and assumption of debt. The acquisition
was accounted for using the historical basis of the assets acquired under the
provisions of AIN No. 39 of APB No. 16, "Business Combinations". The transaction
resulted in the acquisition of approximately $3.1 million in net assets and a
corresponding charge to equity of $32.2 million. Accordingly, the acquisition is
reflected in the Company's statement of financial position at September 30,
1997. The operations of FiberSouth, Inc. from January 1, 1997 through September
30, 1997, the effective date of the transaction, are not reflected in the
Company's statement of operations.
(v) The Company's Board of Directors approved an increase in the number of no
par value common stock authorized from 200,000 to 100,000,000. The Board of
Directors also authorized 10,000,000 shares $.01 par value preferred stock. As
of September 30, 1998, there were no shares of preferred stock outstanding.
7
<PAGE>
Note 3: Long-Term Debt
Effective June 30, 1998, the Company amended and restated its $60.0 million
revolving credit facility to provide a $30.0 million revolving credit facility
and a $30.0 million capital expenditure facility (the "Facilities"). Borrowings
under the Facilities are limited to a percentage of eligible accounts receivable
and eligible capital expenditures, respectively, as defined in the loan
agreement. The Facilities are secured by substantially all of the Company's
assets and bear interest, at the Company's option, at either the 30, 60 or 90
day LIBOR rate or the prime rate, plus an applicable margin which varies based
on the Company's financial position. The Company is also required to pay a fee
of 0.375% per year on the unused commitment. As of September 30, 1998, there
were no amounts outstanding under the Facilities. The Facilities contain various
financial covenants with which the Company must comply on a monthly and
quarterly basis. As of September 30, 1998, the Company was in compliance with
all such covenants.
Note 4: Shareholder's Equity
Stock Split - In April 1998, the Board of Directors and the sole
shareholder of the Company approved and the Company effected a 10-for-1 split of
the outstanding Common Stock of the Company in the form of a stock dividend with
no change in the par value of Common Stock authorized and outstanding, and
increased the number of common shares authorized from 100 million to 500
million. Historical share and per share data have been retroactively adjusted to
reflect these changes.
Stock Option Repurchase- In 1994, the Company entered into agreements with
certain former employees to repurchase stock options that had been granted under
the Company's 1994 Stock Plan. The measurement date for compensation relating to
the stock options did not occur until September 1997, at which time an estimate
for this liability was recorded. In addition, the Company assumed certain stock
repurchase obligations in connection with its acquisition of the fiber optic
assets of FiberSouth, Inc. ("FiberSouth") in 1997. In May 1998, the Company
satisfied these obligations to a former employee in accordance with the
repurchase agreements. As a result of this transaction, the Company recorded a
$1.5 million adjustment to equity in the second quarter of 1998 which decreased
equity by the difference between the estimated liability and the actual
settlement amount. This adjustment represents a reallocation of the original
FiberSouth purchase price.
8
<PAGE>
Common Stock Repurchase Agreement - In July 1992, the Company entered into
an agreement with one of its shareholders (the "Retiring Shareholder") to
purchase the outstanding common shares held by his estate upon his death. The
agreement was amended in June 1996. Under the amended agreement, the Company had
the option to purchase the Retiring Shareholder's shares at any time for an
amount that was negotiated between the Company and the Retiring Shareholder. In
September 1997, the Company exercised its option to purchase the Retiring
Shareholder's outstanding shares for $28.3 million.
Note 5: Income Taxes
In connection with the September 1997 Reorganization, the Company converted
from S corporation to C corporation status for federal and state income tax
purposes. As a result, the Company became fully subject to federal and state
income taxes and, as of September 30, 1997, recorded approximately $2.2 million
in deferred income tax expense. For the three and nine month periods ended
September 30, 1998 the Company generated net losses. Based upon management's
plans to expand the business through the construction and expansion of its
networks, customer base and product offerings, this trend is expected to
continue for the foreseeable future. Given these circumstances and the level of
taxable income expected to be generated from reversing temporary differences,
the Company has established a valuation allowance for the net deferred tax
assets associated with these net operating losses. As such, there was no impact
on the results from operations for net operating losses generated during the
three and nine month periods ended September 30, 1998. The Company will reduce
the valuation allowance when, based on the weight of available evidence, it is
more likely than not that some portion or all of the deferred tax assets will be
realized.
Note 6: Related Party Transaction
Effective July 15, 1998, the Company purchased a multi-media franchise
from FiberSouth for $1.5 million, subject to approval by the City of Raleigh. As
a result, the Company will have the right to offer multi-media services in
Raleigh. The Company anticipates that the transaction will be approved during
the fourth quarter of 1998.
9
<PAGE>
Note 7: New Accounting Pronouncements
As of January 1, 1998, the Company implemented Financial Accounting Standards
Board ("FASB") Statement No. 130 ("SFAS 130"), "Reporting Comprehensive Income."
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this statement had no
material impact on the Company's net income or shareholder's equity. SFAS 130
requires unrealized gains or losses on available-for-sale securities, which
prior to adoption were reported separately in shareholder's equity, to be
included in comprehensive income. For the periods presented there were no
material differences between net income and comprehensive income as defined by
SFAS 130.
The FASB has issued SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information" ("SFAS 131"), effective for financial statements for
fiscal years beginning after December 15, 1997. Interim period reporting in the
initial year of application is not required. This statement requires that public
companies report certain information about operating segments in complete sets
of financial statements of the company and in condensed financial statements of
interim periods issued to shareholders. It also requires that public companies
report certain information about their products and services, the geographic
areas in which they operate, and their major customers. In the initial year of
application, comparative information for earlier years is to be restated. The
Company is currently evaluating the additional disclosure requirements, if any,
that will result from the adoption of SFAS 131.
Note 8: Commitments and Contingencies
During 1997, the Company signed a contract for the indefeasible right to use
certain optical fibers in a communication system. Commitments to purchase
optical fibers under this contract total approximately $50.0 million, $19.8
million of which was fulfilled through September 30, 1998. The remaining
commitments extend through the end of 1999. In addition, the Company has made
certain other commitments for the purchase of equipment in connection with its
capital program.
8
<PAGE>
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
The matters discussed throughout this Form 10-Q, except for historical
facts contained herein, may be forward-looking in nature, or "forward-looking
statements." Actual results may differ materially from the forecasts or
projections presented. Forward-looking statements are identified by such words
as "expects," "anticipates," "believes," "intends," "plans" and variations of
such words and similar expressions. The Company believes that its primary risk
factors include but are not limited to: high leverage; the ability to service
debt; significant capital requirements; ability to manage growth; business
development and expansion risks; competition; and changes in laws and regulatory
policies. Any forward-looking statements in the September 30, 1998 Form 10-Q
should be evaluated in light of these important risk factors. For additional
disclosure regarding risk factors refer to the Company's Registration Statement
on Form S-4 as filed with the Securities and Exchange Commission (File No.
333-41723).
Business of the Company
The Company ("BTITC" or the "Company"), which began operations in 1984 as
Business Telecom, Inc. ("BTI"), provides integrated telecommunications services
to approximately 60,000 customers, primarily small-to-medium sized business
customers, concentrated in the southeastern United States. During 1997, BTI was
reorganized into a new corporate structure comprised of BTI Telecom Corp. as the
parent company and Business Telecom, Inc. as a wholly owned subsidiary. The
Company provides a broad array of services, including local, long distance,
Internet access, frame relay, high-speed data transmission, data network
management and paging.
Company Reorganization
In September 1997, BTI undertook a series of transactions (the
"Transactions") designed to provide the Company with increased liquidity and the
financial flexibility necessary to fund business growth and expansion. The
Transactions included the following:
1.) BTITC issued $250.0 million ten-year notes (the "Senior Notes") which bear
interest at the rate of 10 1/2 % per annum and mature in 2007.
2.) BTI entered into a five-year, senior secured reducing revolving credit
facility (the "Credit Facility"), guaranteed by the Company, which will provide
up to $60.0 million of availability to be used for working capital and other
uses, including capital expenditures. BTI repaid all indebtedness outstanding at
September 30, 1997 under its then existing credit agreement together with
accrued interest thereon.
9
<PAGE>
3.) BTI repurchased 50% of its outstanding common stock not held by
its Chairman and Chief Executive Officer under the terms of the Common Stock
Repurchase Agreement for approximately $28.3 million.
4.) BTI was merged with a wholly owned subsidiary of BTI Telecom and converted
for income tax purposes from an S corporation to a C corporation (the
"Reorganization").
5.) The Company acquired certain fiber optic assets and the related business of
FiberSouth, Inc. (the "FiberSouth" acquisition) for cash and assumption of debt.
The acquisition was accounted for using the historical basis of the assets
acquired under the provisions of AIN No. 39 of APB No. 16, "Business
Combinations". The transaction resulted in the acquisition of approximately $3.1
million in net assets and a corresponding charge to equity of $32.2 million.
6.) The Company's Board of Directors approved an increase in the number of no
par value common stock authorized from 200,000 to 100,000,000. The Board of
Directors also authorized 10,000,000 shares $.01 par value preferred stock.
Results of Operations
Revenue
Revenue for the third quarter of 1998 and on a year-to-date basis was $51.7
million and $157.5 million, respectively, representing increases of 2.2% and
8.6%, respectively, as compared to the same periods in 1997. The increase in
revenue of $1.1 million during the three months ended September 30, 1998 as
compared to the same period in 1997 is attributable to a $1.9 million increase
in integrated services revenue and a $3.8 million increase in local services
revenue partially offset by a $4.6 million decrease in wholesale services
revenue. For the three months ended September 30, 1998 and 1997, wholesale
revenue represented 32.6% and 42.3%, respectively, of total revenue. The
decrease in wholesale revenue during the third quarter of 1998 as compared to
the same period in the prior year is primarily due to strategic pricing
decisions made by the Company to ensure that it maintains acceptable wholesale
margins, in addition to competitive pricing pressures heightened by the effect
of access charge reform and the effects of mergers and acquisitions within the
telecommunications industry.
On a year-to-date basis, the $12.5 million increase in revenue as compared to
the same period in the prior year was primarily driven by increased local and
integrated services revenues. During the fourth quarter of 1997, the Company
began offering local services as a Competitive Local Exchange Carrier ("CLEC").
As of September 30, 1998, the Company had recognized $6.3 million from local
services, which represents 4.0% of total year-to-date revenue. Integrated
services revenue increased $4.5 million in the nine month period ended September
30, 1998 as compared to the same period in
10
<PAGE>
1997. This increase is attributable to continued improvement in sales
productivity as well as the impact of certain changes in access charges during
1998.
Cost of Services
Cost of services represented 70.8% and 72.7% of revenue for the three and
nine month periods ended September 30, 1998, respectively, as compared to 71.2%
and 69.8%, respectively, for the same periods in 1997. The lower cost of
services percentage for the three month period ended September 30, 1998 as
compared to the same period in the prior year was driven by the change in the
revenue mix to an increased percentage of higher margin retail traffic.
Wholesale services revenue for the three month period ended September 30, 1997
was 42.3% of total revenue compared to 32.5% for the same period in 1998. The
higher cost of services percentage for the nine month period ended September 30,
1998 as compared to the same period in the prior year is primarily the result of
changes in the Company's revenue mix. Also contributing to the higher cost of
services on a year-to-date basis are the previously discussed effects of
competitive pricing and access charge reform. In addition, local services
contributed to lower gross margin percentages as these services are initially
offered on a resale basis.
Year-to-date costs of services have also been adversely impacted by
regulatory matters, including increased costs related to the public payphone
compensation order. A Federal Communications Commission ("FCC") ruling
established, effective October 1997, a "per call compensation plan" that
provides payphone service providers with compensation for calls completed using
their payphones. During the first quarter of 1998, the Company began assessing a
surcharge to these payphone users in order to recover the amount of compensation
ordered by the FCC.
Expansion of the longhaul fiber optic network, conversion of local
customers from resale to facilities based and the continuing effect of access
charge reform is expected to reduce the Company's network costs in the future.
Management anticipates that its longhaul fiber optic network will be
substantially operational by mid-1999.
Selling, General and Administrative Expenses
Selling, general and administrative ("SG&A") expenses in the third quarter
of 1998 were $17.2 million or 33.3% of revenue as compared to $15.1 million or
29.9% of revenue in the same period in 1997. On a year-to-date basis, SG&A
expenses were $49.3 million or 31.3% of revenue in 1998 as compared $39.2
million or 27.0% of revenue in 1997. The increase in SG&A expenses during 1998
is largely attributable to the significant investments in human resources and
increased marketing and advertising efforts associated with the introduction of
the Company's CLEC services. These investments are intended to provide the
Company with the ability to continue to expand into new markets, maximize
customer retention and provide for growth in 1998 and beyond. In addition, the
Company is expending resources to facilitate the deployment of its fiber optic
network.
11
<PAGE>
Depreciation and amortization was $3.0 million and $7.7 million in the
three and nine months ending September 30, 1998, respectively, representing
increases of 109.5% and 69.4%, respectively, over the same periods in the prior
year. The increase in depreciation and amortization is primarily due to capital
expenditures related to the expansion of the Company's existing operations
centers and support infrastructure to accommodate increased traffic volume and
expanded service offerings.
Other Income (Expense)
Interest expense was $6.3 million in the three months ended September 30,
1998 as compared to $1.2 million in the same period in the prior year. On a
year-to-date basis, interest expense was $19.1 million and $2.1 million in 1998
and 1997, respectively. The increase in interest expense during 1998 is
primarily attributable to the Company's issuance in September 1997 of the Senior
Notes to finance capital expenditures and to finance the Company's introduction
of CLEC services.
Interest income increased to $1.2 million and $4.7 million in the three and
nine months ended September 30, 1998, respectively, due to the investment of a
portion of the proceeds of the Senior Note offering.
Income Taxes
In connection with the September 1997 Reorganization, the Company converted
from S corporation to C corporation status for federal and state income tax
purposes. As a result, the Company became fully subject to federal and state
income taxes and, as of September 30, 1997, recorded approximately $2.2 million
in deferred income tax expense. For the three and nine month periods ended
September 30, 1998 the Company generated net losses. Based upon management's
plans to expand the business through the construction and expansion of its
networks, customer base and product offerings, this trend is expected to
continue for the foreseeable future. Given these circumstances the Company has
established a valuation allowance for the net deferred tax assets associated
with these net operating losses. As such, there was no impact on the results
from operations for net operating losses generated during the three and nine
month periods ended September 30, 1998. The Company will reduce the valuation
allowance when, based on the weight of available evidence, it is more likely
than not that some portion or all of the deferred tax assets will be realized.
Throughout the period of time that BTI was an S Corporation, income, losses
and credits were passed through directly to shareholders and the shareholders
were provided, in the form of dividends, the funds necessary to meet tax
obligations arising from income earned by BTI. The Company will continue to
reimburse shareholders for any tax obligations arising from the income earned by
BTI while it was an S Corporation. The Company believes that any such
reimbursements will not have a material effect on the Company's financial
condition or results of operations.
12
<PAGE>
EBITDA
Earnings before interest, taxes, depreciation and amortization and other
non-cash charges (EBITDA) is a common measurement of a company's ability to
generate cash flow from operations. EBITDA is not a measure of financial
performance under generally accepted accounting principles and should not be
considered an alternative to net income as a measure of performance or to cash
flows as a measure of liquidity. The Company experienced negative EBITDA of $2.2
million, $6.3 million and $0.6 million for the three and nine month periods
ended September 30, 1998 and the three month period ending September 30, 1997,
respectively, and positive EBITDA of $4.6 million for the nine month period
ended September 30, 1997. The Company expects to generate negative EBITDA in the
remainder of 1998 as it expands its CLEC offerings and deploys its fiber optic
network. The decrease in EBITDA experienced by the Company throughout 1998 is
primarily attributable to the additional SG&A expenses associated with the
Company's introduction of CLEC services.
Liquidity and Capital Resources
Review of Cash Flow Activity
The Company has funded its operations and growth primarily from operating
cash flows and borrowings. During the first nine months of 1998 the Company used
$18.7 million for operating activities as compared to generating $7.1 million of
cash from operations during the same period in 1997. The primary driver of this
change is the net loss of $28.4 million experienced during the first nine months
of 1998, of which $19.1 million is attributable to interest expense related to
the issuance of the Senior Notes.
Cash used for investing activities during the first nine months of 1998 and
1997 amounted to $27.9 million and $116.8 million, respectively. The primary
investment in 1998 was capital expenditures. The increase in net capital
expenditures from $7.4 million in the first nine months of 1997 to $48.4 million
in the first nine months of 1998 was primarily due to the deployment of the
longhaul fiber optic network and purchases of equipment for the development of
the Company's facilities-based local service business. Cash used for investing
activities also includes the capitalization of line access fees, which represent
installation charges paid primarily to the incumbent local exchange carriers
("ILECs") for securing additional leased fiber optic facilities. In May 1998,
the Company satisfied stock and option repurchase obligations assumed in
connection with the September 1997 acquisition of the fiber optic assets of
FiberSouth and as a result of the 1994 Stock Plan. The Company settled these
obligations with a $2.3 million cash payment. The difference between the
liability estimated for the stock repurchase obligation that was recorded in
conjunction with the FiberSouth acquisition and the actual amount is reflected
as an adjustment to equity and represents a reallocation of the original
FiberSouth purchase price. Cash used in investing activities in 1997 included
$73.6 million in restricted cash used to secure the first six scheduled interest
payments due on the Senior Notes. Cash used in investing activities in 1997 also
included $35.2 million for the FiberSouth acquisition. During the nine months
ended September 30, 1998, cash used for investment activities was offset in part
by
13
<PAGE>
$25.0 million of cash from the Company's utilization of its restricted cash to
fund the March 1998 and September 1998 interest obligations on the Senior Notes.
The restricted cash balance as of September 30, 1998 includes proceeds from the
Senior Note offering placed in escrow to secure the next four scheduled interest
payments.
Cash used for financing activities was $1.6 million for the first nine months
of 1998 primarily as a result of payments made on the shareholder note payable
and certain capitalized costs associated with financing activities. The payments
on the shareholder note payable were in accordance with an agreement in
conjunction with the Company's Reorganization. During the first nine months of
1997, financing activities provided the Company with $250.0 million of gross
proceeds from the Senior Notes Offering, partially offset by $28.3 million of
cash used for the reacquisition of common stock and $18.7 million used to repay
outstanding indebtedness under the credit facility. In addition, the Company
paid dividends of $1.6 million during the nine months ended September 30, 1997.
These dividends were paid in part to provide funds for tax obligations owed by
BTI's shareholders as a result of BTI's income.
Debt
In September 1997, the Company issued $250.0 million 10 1/2% Senior Notes due
2007. The Indenture governing the Senior Notes requires the Company to comply
with certain financial covenants, including certain restrictions on the
Company's ability to pay dividends. As of September 30, 1998, the Company was in
compliance with all such covenants.
Effective June 30, 1998, the Company amended and restated its $60.0 million
revolving credit facility to provide a $30.0 million revolving credit facility
and a $30.0 million capital expenditure facility (the "Facilities"). Borrowings
under the Facilities are limited to a percentage of eligible accounts receivable
and eligible capital expenditures, respectively, as defined in the loan
agreement. Borrowings under the Facilities are secured by substantially all of
the Company's assets and bear interest, at the Company's option, at the 30, 60
or 90 day London Interbank Offered Rate ("LIBOR") or prime rate, plus an
applicable spread which varies based upon the Company's financial position. The
Company is also required to pay a fee of 0.375% per year on the unused
commitment. At September 30, 1998, no amounts were outstanding under the
Facilities. The Facilities require the Company's compliance with various
financial, administrative and affirmative covenants. As of September 30, 1998,
the Company was in compliance with all such covenants.
During the second quarter of 1998, Moody's adjusted the Company's long-term
credit rating from B2 to B3, citing concern that integrated services revenue and
operating cashflow are unlikely to grow as rapidly as Moody's had initially
expected when the Senior Notes were originally rated. Moody's indicated that the
trend in
14
<PAGE>
operating results has the effect of weakening BTI's anticipated debt protection
measurements for the intermediate term. However, Moody's indicated that the
Company's strategy to improve operating margins and cash flow through the
migration of its long distance and local traffic over more of its own switches
and network facilities continues to be a sound business plan. Moody's also
affirmed the Company's rating of B1 on the $60.0 million secured credit
facility.
In November 1998, Standard & Poor's ("S & P") lowered its corporate credit and
senior unsecured debt ratings on the Company's long-term debt from B+ to B and
lowered its rating from BB- to B+ on the $60.0 million secured credit facility.
This rating action reflects concerns similar to those cited by Moody's, and also
notes the anticipated operating margin improvements that should result through
the migration of long distance and local traffic to more of the Company's own
switches and fiber network. The revised rating also reflects a stable outlook
for the Company.
Capital Spending
Through September 30, 1998, capital expenditures were approximately $49.4
million as compared to $8.0 million in the same period in the prior year.
Capital expenditures during the first nine months of 1998 included $19.5 million
related to the longhaul fiber optic network and $24.6 million in switching and
related equipment primarily for the Company's CLEC operations. The Company
expects to require significant capital for its future capital expenditures and
working capital requirements. The Company plans to spend a total of
approximately $60 million (with respect to which it has remaining commitments
for $30 million which extend through the end of 1999) on its capital program
over the fifteen month period ending December 1999. A substantial portion of
these planned capital expenditures will be related to the longhaul fiber optic
network and purchases of switches and related equipment to facilitate the
offering of local services. The actual amount and timing of the Company's
capital requirements may differ materially from the foregoing estimate as a
result of regulatory, technological or competitive developments (including
market developments and new opportunities) in the Company's industry. Although
there can be no assurance, management believes that cash on hand, borrowings
expected to be available under the Facilities and cash flow from operations will
be sufficient to expand the Company's business as currently planned. The Company
also may require additional capital in the future (or sooner than currently
anticipated) for new business activities related to its current and planned
businesses, or in the event it decides to make additional acquisitions or enter
into joint ventures and strategic alliances. Sources of additional capital may
include cash flow from operations and public and private debt and equity
offerings, which would be subject to provisions in the Indenture requiring the
Company to maintain certain financial ratios in order to incur additional
indebtedness.
Year 2000 Issues
In 1996, the Company conducted a comprehensive high level review of its
information technology and operating systems, non-information technology
systems, the systems of major customers and suppliers, and third party network
service providers to ensure that the systems would properly recognize the Year
2000 and continue to process data. This review also included the evaluation of
internally developed software. As a result of this assessment, the Company has
undertaken a comprehensive plan to address the Year 2000 issue. The Year 2000
Plan includes the assessment of the Year 2000 problems that may affect the
Company, the development
15
<PAGE>
of remedies to address the problems discovered in the assessment phase, testing
of the remedies and the preparation of contingency plans to deal with the worst
case scenarios.
Implementation of the Plan began in 1997 and will continue through 1999.
The Company's hardware and software components are in various phases of the Year
2000 Plan. The Company anticipates that major business critical systems will be
tested and Year 2000 compliant by June 1999. Other non-critical systems are
targeted for compliance by the end of the third quarter 1999. The Company is
currently testing the systems and applications that have already been corrected
or reprogrammed.
As part of the Year 2000 Plan, the Company is seeking confirmation from
its significant hardware, software and other equipment vendors, third party
network providers, other material service providers and material customers that
they are developing and implementing plans to become Year 2000 compliant.
Confirmations received to date from the Company's vendors, service providers and
customers have indicated that they are in the process of implementing
remediation procedures to ensure that their computer systems are Year 2000
compliant by December 31, 1999.
The Company has begun to develop contingency plans to deal with potential
Year 2000 related business interruptions that may occur. The Company intends to
complete its determination of required contingency plans based upon worst case
scenarios that will be determined after it has received and analyzed responses
to substantially all of the confirmations that were sent to the Company's
vendors, service providers and customers.
Through the third quarter of 1998 the Company had spent approximately $0.5
million on Year 2000 projects and activities. The estimated total costs for Year
2000 projects and activities is $2.0 million, excluding capital expenditures. In
most cases capital expenditures will not only provide for Year 2000 compliance,
but will also otherwise enhance the Company's operations. In many cases, the
expenditures for system modifications will merely be an acceleration of
previously planned improvements. Year 2000 project costs are being funded
through operations and existing credit facilities and are not expected to have a
material effect on the Company's financial condition or results from operations.
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. However, it is not possible to
anticipate all possible future outcomes, especially when third parties are
involved. Failure by the Company or its major vendors, third party network
service providers and other material service providers and customers to
adequately address their respective Year 2000 issues in a timely manner could
have a material adverse effect on the Company's business, results of operations
and financial condition.
16
<PAGE>
New Accounting Pronouncements
As of January 1, 1998, the Company implemented Financial Accounting Standards
Board ("FASB") Statement No. 130 ("SFAS 130"), "Reporting Comprehensive Income."
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this statement had no
material impact on the Company's net income or shareholder's equity. SFAS 130
requires unrealized gains or losses on available-for-sale securities, which
prior to adoption were reported separately in shareholder's equity, to be
included in comprehensive income. For the periods presented, there were no
material differences between net income and comprehensive income as defined by
SFAS 130.
The FASB has issued Statement No. 131 ("SFAS 131"), "Disclosures about
Segments of an Enterprise and Related Information," effective for financial
statements for fiscal years beginning after December 15, 1997. Interim period
reporting in the initial year of application is not required. This statement
requires that public companies report certain information about operating
segments in complete sets of financial statements of the company and in
condensed financial statements of interim periods issued to shareholders. It
also requires that public companies report certain information about their
products and services, the geographic areas in which they operate, and their
major customers. In the initial year of application, comparative information for
earlier years is to be restated. The Company is currently evaluating the
additional disclosure requirements, if any, that will result from the adoption
of SFAS 131.
17
<PAGE>
Part II - Other Information
Item 6 - Exhibits and Reports on Form 8-K
(a) See Exhibit Index
(b) Reports on Form 8-K filed during the quarter: None
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BTI Telecom Corp.
--------------------------------------------------------
(Registrant)
Dated: November 12, 1998
By: /s/ Brian Branson
-------------------------------------------
Brian Branson
Chief Financial Officer
(Principal Financial and Accounting Officer)
19
<PAGE>
INDEX TO EXHIBITS
-----------------
Exhibit
Number Description
- ------ -----------
27 Financial Data Schedule
20
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1998
<CASH> 18,730
<SECURITIES> 0
<RECEIVABLES> 30,401
<ALLOWANCES> 4,915
<INVENTORY> 0
<CURRENT-ASSETS> 74,377
<PP&E> 112,535
<DEPRECIATION> (26,119)
<TOTAL-ASSETS> 198,595
<CURRENT-LIABILITIES> 46,337
<BONDS> 250,000
0
0
<COMMON> 37
<OTHER-SE> (99,436)
<TOTAL-LIABILITY-AND-EQUITY> 198,595
<SALES> 0
<TOTAL-REVENUES> 157,490
<CGS> 0
<TOTAL-COSTS> 171,502
<OTHER-EXPENSES> (4,665)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,085
<INCOME-PRETAX> (28,432)
<INCOME-TAX> 0
<INCOME-CONTINUING> (28,432)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (28,432)
<EPS-PRIMARY> (0.28)
<EPS-DILUTED> (0.28)
</TABLE>
