<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ___________
Commission File Number 0-30218
TIME WARNER TELECOM INC.
------------------------
(Exact name of Registrant as specified in its charter)
State of Delaware 84-1500624
------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
10475 Park Meadows Drive
Littleton, Colorado 80124
---------------------------------------- ----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (303) 566-1000
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 [_]
The number of shares outstanding of Time Warner Telecom Inc.'s common stock as
of October 31, 2000 was:
Time Warner Telecom Inc. Class A common stock -- 105,713,898 shares
Time Warner Telecom Inc. Class B common stock -- 72,226,500 shares
<PAGE>
TIME WARNER TELECOM INC.
INDEX TO FORM 10-Q
------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I. Financial Information
---------------------
Item 1. Financial Statements:
---------------------
Consolidated and Condensed Balance Sheets at September 30,
2000 and December 31, 1999 1
Consolidated Statements of Operations for the three and nine
months ended September 30, 2000 and 1999 2
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2000 and 1999 3
Consolidated Statement of Changes in Stockholders' Equity
for the nine months ended September 30, 2000 4
Notes to Consolidated and Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Part II. Other Information
-----------------
Item 1. Legal Proceedings 27
Item 6. Exhibits and Reports on Form 8-K 28
</TABLE>
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED AND CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------------- -------------------
(unaudited)
(amounts in thousands, except share amounts)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents.......................................................... $ 74,091 90,586
Marketable debt securities......................................................... 28,578 173,985
Receivables, less allowances of $18,479 and $7,857 ................................ 81,821 52,652
Prepaid expenses................................................................... 2,247 2,938
------------ ------------
Total current assets.......................................................... 186,737 320,161
------------ ------------
Property, plant and equipment........................................................... 1,082,016 868,770
Less accumulated depreciation...................................................... (257,881) (191,664)
------------ ------------
824,135 677,106
------------ ------------
Intangible and other assets, net of accumulated amortization (notes 1 and 2)............ 93,663 45,745
------------ ------------
Total assets.................................................................. $ 1,104,535 1,043,012
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................... $ 46,407 64,678
Deferred revenue................................................................... 35,719 37,913
Other current liabilities.......................................................... 127,356 86,752
------------ ------------
Total current liabilities.................................................... 209,482 189,343
------------ ------------
Long-term debt and capital lease obligations (note 3)................................... 403,311 403,627
Deferred income taxes................................................................... 21,231 27,126
Stockholders' equity (note 1):
Preferred stock, $0.01 par value, 20,000,000 shares authorized, no
shares issued and outstanding.................................................. - -
Class A common stock, $0.01 par value, 277,300,000 shares authorized,
33,428,172 and 23,543,422 shares issued and outstanding in 2000
and 1999, respectively........................................................... 334 235
Class B common stock, $0.01 par value, 162,500,000 shares authorized,
72,226,500 and 81,214,285 shares issued and outstanding in 2000
and 1999, respectively........................................................... 722 812
Additional paid-in capital......................................................... 590,924 559,950
Accumulated other comprehensive income, net of taxes............................... 12,030 -
Accumulated deficit................................................................ (133,499) (138,081)
------------ ------------
Total stockholders' equity.................................................... 470,511 422,916
------------ ------------
Total liabilities and stockholders' equity.................................... $ 1,104,535 1,043,012
=========== =============
</TABLE>
See accompanying notes.
1
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- -----------------------------------
2000 1999 2000 1999
---------------- ---------------- ---------------- ----------------
(amounts in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Revenue:
Dedicated transport services...................... $ 71,129 40,666 183,759 105,727
Switched services................................. 50,027 30,649 169,308 71,558
---------------- ---------------- ---------------- ----------------
Total revenue................................ 121,156 71,315 353,067 177,285
---------------- ---------------- ---------------- ----------------
Costs and expenses (a):
Operating......................................... 48,299 30,488 130,846 81,949
Selling, general and administrative............... 44,475 30,097 122,663 80,501
Depreciation and amortization..................... 23,994 19,291 68,793 50,272
---------------- ---------------- ---------------- ----------------
Total costs and expenses..................... 116,768 79,876 322,302 212,722
---------------- ---------------- ---------------- ----------------
Operating income (loss)................................. 4,388 (8,561) 30,765 (35,437)
Interest expense (a).................................... (10,043) (9,983) (30,657) (35,139)
Interest income......................................... 2,220 3,840 9,016 12,828
Equity in income of unconsolidated affiliate (note 2)... -- -- -- 285
---------------- ---------------- ---------------- ----------------
Income (loss) before income taxes....................... (3,435) (14,704) 9,124 (57,463)
Income tax expense (benefit)............................ (1,110) (5,589) 4,542 29,473
---------------- ---------------- ---------------- ----------------
Net income (loss)....................................... $ (2,325) (9,115) 4,582 (86,936)
================ ================ ================ ================
Basic and diluted earnings (loss) per share $ (0.02) (0.09) 0.04 (0.94)
================ ================ ================ ================
Weighted average shares outstanding:
Basic 105,531 104,480 105,262 92,957
================ ================ ================ ================
Diluted 105,531 104,480 108,427 92,957
================ ================ ================ ================
(a) Includes expenses resulting from transactions with
affiliates (note 4):
Operating.................................. $ 290 749 755 1,764
================ ================ ================ ================
Selling, general and administrative........ $ 399 312 1,100 1,259
================ ================ ================ ================
Depreciation and amortization.............. $ 3,231 2,626 9,594 7,842
================ ================ ================ ================
Interest expense........................... $ -- -- -- 5,078
================ ================ ================ ================
</TABLE>
See accompanying notes
2
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
---------------------------------
2000 1999
------------ -------------
(amounts in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)........................................................................... $ 4,582 (86,936)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization............................................................ 68,793 50,272
Amortization of deferred debt issue costs................................................ 1,661 937
Equity in income of unconsolidated affiliate............................................. - (285)
Deferred income tax expense.............................................................. 4,542 29,473
Changes in operating assets and liabilities, net of the effect of acquisitions:
Receivables and prepaid expenses...................................................... (28,478) (8,641)
Accounts payable, deferred revenue and other current liabilities...................... 20,138 1,986
------------ -------------
Net cash provided by (used in) operating activities................................ 71,238 (13,194)
------------ -------------
Cash flows from investing activities:
Capital expenditures........................................................................ (213,246) (138,305)
Cash paid for acquisitions, net of cash acquired............................................ (10,000) (2,567)
Purchases of marketable securities.......................................................... (93,919) (116,557)
Proceeds from maturities of marketable securities........................................... 239,326 132,625
Other investing activities.................................................................. (9,978) -
------------ -------------
Net cash used in investing activities............................................... (87,817) (124,804)
------------ -------------
Cash flows from financing activities:
Net proceeds from issuance of common stock upon exercise of stock options................... 10,370 889
Net proceeds from issuance of common stock in connection with the employee
stock purchase plan.................................................................... 2,089 -
Payment of capital lease obligations........................................................ (315) (133)
Deferred debt issue costs................................................................... (12,060) -
Net proceeds from initial public offering................................................... - 270,182
Repayment of loans to Former Parent Companies............................................... - (180,018)
Repayment of acquired debt.................................................................. - (15,668)
------------ -------------
Net cash provided by financing activities........................................... 84 75,252
------------ -------------
Decrease in cash and cash equivalents............................................... (16,495) (62,746)
Cash and cash equivalents at beginning of period.................................... 90,586 105,140
------------ -------------
Cash and cash equivalents at end of period.......................................... $ 74,091 42,394
============ =============
Supplemental disclosures of cash flow information:
Cash paid for interest $ 38,407 46,825
============ =============
Tax benefit related to exercise of non-qualified stock options....................... $ 18,524 -
============ =============
Cash paid for income taxes........................................................... $ 419 168
============ =============
</TABLE>
See accompanying notes.
3
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
Nine Months Ended September 30, 2000
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Accumulated
-------------------------------------- other
Class A Class B Additional comprehensive Total
------------------ ------------------ paid-in income, Accumulated stockholders'
Shares Amount Shares Amount Capital net of taxes deficit equity
-------- -------- -------- -------- ------------ ----------------- ------------- ----------------
(amounts in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1,
2000.................. 23,543 $ 235 81,214 $ 812 559,950 - (138,081) 422,916
Shares issued for cash
in connection with
the exercise of stock
options............... 844 8 - - 28,886 - - 28,894
Shares issued for cash
in connection with
the employee stock
purchase plan......... 54 1 - - 2,088 - - 2,089
Conversion of shares
by related party
(note 1).............. 8,987 90 (8,987) (90) - - - -
Change in unrealized
holding gain for
available-for-sale
security, net of
taxes................. - - - - - 12,030 - 12,030
Net income.............. - - - - - - 4,582 4,582
-------- -------- -------- -------- ------------ ----------------- ------------- ----------------
Balance at September
30, 2000.............. 33,428 $ 334 72,227 $ 722 590,924 12,030 (133,499) 470,511
======== ======== ======== ======== ============ ================= ============= ================
</TABLE>
See accompanying notes.
4
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS
September 30, 2000
(unaudited)
1. Organization and Summary of Significant Accounting Policies
Description of Business and Capital Structure
Time Warner Telecom Inc. (the "Company"), a Delaware corporation, is a
leading fiber facilities-based provider of integrated communications
services and solutions to medium and large business customers in selected
metropolitan markets across the United States. The Company offers local
businesses "last-mile" broadband connections for data, high-speed Internet
access, local voice, and long distance services.
Time Warner Cable, as defined below, began the Company's business in
1993 by providing telephony services through cable systems owned by Time
Warner Entertainment Company, L.P. ("TWE"), Time Warner
Entertainment-Advance/Newhouse Partnership ("TWE-A/N"), and Time Warner
Inc. ("Time Warner"), collectively referred to as the "Former Parent
Companies." "Time Warner Cable" refers to the cable systems owned by TWE,
TWE-A/N, and Time Warner.
TWE and TWE-A/N are owned as follows:
(1) TWE is a partnership of subsidiaries of Time Warner and AT&T
Corp. ("AT&T"), as successor by merger to Media One Group, Inc.
("MediaOne"); and
(2) TWE-A/N is a partnership of TWE, Time Warner and Advance/Newhouse
Partnership ("Advance").
On July 14, 1998, Time Warner Telecom LLC ("TWT LLC") succeeded to the
ownership of the Company's business. At that time, Time Warner, MediaOne
and Advance (collectively referred to as the "Class B Stockholders") formed
TWT LLC to acquire the assets and liabilities of the Company's business
from the Former Parent Companies and to conduct the offering on July 21,
1998 of $400 million principal amount 9 3/4% Senior Notes due July 2008
(the "Senior Notes"). In the transaction, referred to as the
"Reorganization," the Class B Stockholders (either directly or through
subsidiaries) became the owners of all the limited liability company
interests in TWT LLC. The Reorganization has been reflected as of July 1,
1998 for accounting purposes.
On May 10, 1999, in preparation for the Company's initial public
offering, TWT LLC was reconstituted as a Delaware corporation (the
"Reconstitution") under the name Time Warner Telecom Inc. by merging into a
newly formed Delaware corporation. The Company accounted for the
Reorganization and the Reconstitution at each of the Class B Stockholders'
historical cost basis and, except as noted below, the Reorganization and
Reconstitution had no effect on the Company's total stockholders' equity,
which has been presented on a consistent basis. In connection with the
Reconstitution, the Company's capitalization was authorized to include two
classes of common stock, Class A common stock and Class B common stock. As
part of the merger, the outstanding Class A limited liability company
interests were converted into Class A common stock and the Class B
Stockholders exchanged their Class B limited liability company interests in
TWT LLC for Class B common stock of the newly formed corporation, Time
Warner Telecom Inc. Prior to the Reconstitution, the only outstanding Class
A interests were those held by the former shareholders of Internet Connect,
Inc, which the Company acquired in April 1999 (see note 2). Following the
Reconstitution, the Class B Stockholders held all of the Company's Class B
common stock. Accordingly, the accompanying financial statements have been
adjusted to retroactively reflect the authorization and issuance of the
shares of Class A common stock and Class B common stock for all periods
presented.
5
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A common
stock at a price of $14 per share (the "IPO"). The IPO generated $270.2
million in proceeds for the Company, net of underwriting discounts and
expenses. The net proceeds were used primarily to repay indebtedness to the
Former Parent Companies (see note 4). The proceeds of the IPO remaining
after repayment of that indebtedness were used to repay assumed debt from
acquisitions and to fund capital expenditures.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. Holders of
Class A common stock have one vote per share and holders of Class B common
stock have ten votes per share. Each share of Class B common stock is
convertible, at the option of the holder, into one share of Class A common
stock. Holders of Class A common stock and Class B common stock generally
vote together as a single class. However, some matters require the approval
of 100% of the holders of the Class B common stock voting separately as a
class, and some matters require the approval of a majority of the holders
of the Class A common stock, voting separately as a class. Upon completion
of the IPO, the Class B Stockholders owned all of the 81,250,000 shares of
outstanding Class B common stock. Subsequent to the IPO, 9,023,500 shares
of Class B common stock have been converted into Class A common stock. As
of September 30, 2000, the Class B Stockholders had approximately 95.6% of
the combined voting power of the outstanding common stock.
The Company also is authorized to issue shares of Preferred Stock. The
Company's Board of Directors has the authority to establish the voting
powers, the preferences, and special rights for the Preferred Stock. No
such voting powers, preferences, or special rights have been established
and no shares of Preferred Stock have been issued as of September 30, 2000.
MediaOne completed an underwritten offering on May 1, 2000 of
9,000,000 shares of Class A common stock of the Company, 8,987,785 of which
were converted from shares of Class B common stock. As a result of this
transaction, MediaOne was no longer entitled to appoint three members of
the Company's Board of Directors and the three directors designated by
MediaOne have resigned. After the transaction, MediaOne held 6,289,842
shares of Class B common stock, representing 6.0% of the Company's total
outstanding common stock and 8.3% of the total voting power, and the Class
B Stockholders as a group had approximately 95.6% of the combined voting
power of the outstanding common stock as of May 2, 2000. The Company did
not receive any proceeds nor did its total shares outstanding change as a
result of this transaction.
On June 15, 2000, MediaOne merged with AT&T. As a result of the
merger, the Class B common stock previously beneficially owned by a
MediaOne subsidiary is beneficially owned by AT&T, since that subsidiary
has become a wholly-owned subsidiary of AT&T. However, the transaction does
not affect the rights of that subsidiary as a Class B Stockholder.
On January 10, 2000, Time Warner announced an agreement to merge with
America Online, Inc. ("AOL") in a stock-for-stock transaction that would
create a new company called AOL Time Warner Inc. As a result of the merger,
both AOL and Time Warner will become wholly owned subsidiaries of AOL Time
Warner. If the merger is completed, the Class B common stock beneficially
owned by Time Warner will be beneficially owned by AOL Time Warner and its
subsidiaries. However, the transaction will not affect the rights of Time
Warner subsidiaries as Class B Stockholders. The merger was approved by the
Time Warner stockholders, but is also subject to customary closing
conditions, including regulatory clearance. There is no assurance that the
clearance will be obtained or that the merger will be consummated.
Basis of Presentation
Until July 14, 1998, the historical financial statements of the
Company reflected the "carved out" historical financial position, results
of operations, cash flows, and changes in stockholders' equity of the
commercial telecommunications operations of the Former Parent Companies, as
if they
6
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
had been operating as a separate company. Although these financial
statements are presented as if the Company had operated as a corporation,
the Company operated as a partnership for tax purposes and continued to
operate in a partnership structure through May 10, 1999. The consolidated
statements of operations have been adjusted to retroactively reflect an
allocation of certain expenses pursuant to the final terms of agreements
related to the Reorganization, primarily relating to office rent, overhead
charges for various administrative functions performed by Time Warner
Cable, and certain facility maintenance and pole rental costs. These
allocations were required to reflect all costs of doing business and have
been based on various methods which management believes result in
reasonable allocation of these costs.
The accompanying interim consolidated and condensed financial
statements are unaudited, but in the opinion of management, reflect all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the results for such periods. The results of operations for
any interim period are not necessarily indicative of results for the full
year. The accompanying financial statements should be read in conjunction
with the audited consolidated financial statements and notes thereto for
the year ended December 31, 1999.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenue
and expenses during the reporting period. Actual results could differ from
those estimates.
Basis of Consolidation
The consolidated financial statements include the accounts of the
Company and all entities in which the Company has a controlling voting
interest ("subsidiaries"). Significant intercompany accounts and
transactions have been eliminated. Significant accounts and transactions
with Time Warner Cable are disclosed as related party transactions.
Investments
Marketable equity securities held by the Company are classified as
available-for-sale. Accordingly, these securities are included in other
assets at fair value. Unrealized holding gains and losses on securities
classified as available-for-sale are carried net of taxes as a component of
accumulated other comprehensive income in stockholders' equity. Other
investments in which ownership interest is less than 20% and are not
considered marketable securities are generally carried at the lower of cost
or net realizable value. Realized gains and losses are determined on a
specific identification basis.
At September 30, 2000, the fair value of the Company's
available-for-sale security was $23.1 million. The unrealized holding gain
on this marketable equity security is reported as accumulated other
comprehensive income, net of taxes, in the accompanying consolidated
financial statements. As of September 30, 2000, the unrealized holding gain
on this security was $12.0 million, net of taxes. There were no sales of
marketable securities for the nine months ended September 30, 2000 and
1999, respectively.
Investments in entities in which the Company has significant
influence, but less than a controlling voting interest, are accounted for
using the equity method. During the first quarter of 1999, the Company's
investment in unconsolidated affiliate consisted solely of a 50% investment
in MetroComm AxS, L.P. ("MetroComm L.P."), a joint venture providing
commercial telecommunications services in the central Ohio area. Under the
equity method, only the Company's investment in and amounts due to and from
the equity investee were included in the consolidated balance sheets, and
only the Company's share of the investee's income (losses) was included in
the consolidated statements of operations. During the second quarter of
1999, the remaining 50% of
7
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
MetroComm L.P. was acquired (see note 2) and, accordingly, is accounted for
on a consolidated basis as of May 31, 1999.
Revenue
The Company's revenue has been derived primarily from business
telephony services, including dedicated transport, local switched, long
distance, data and high-speed Internet access services. The Company's
customers are principally telecommunications-intensive business end-users,
long distance carriers, Internet service providers ("ISPs"), wireless
communications companies, and governmental entities.
Revenue for dedicated transport services is generally billed in
advance on a fixed rate basis and recognized over the period the services
are provided. Revenue for switched services, data and Internet services,
and long distance are generally billed on a transactional basis determined
by customer usage with some fixed rate elements. The transactional elements
of switched services are billed in arrears and estimates are used to
recognize revenue in the period earned. The fixed rate elements are billed
in advance and recognized over the period provided.
Reciprocal compensation revenue is an element of switched services
revenue, which represents compensation from local exchange carriers
("LECs") for local exchange traffic terminated on the Company's facilities
originated by other LECs. Reciprocal compensation is based on contracts
between the Company and LECs. The Company recognizes reciprocal
compensation revenue as it is earned, except in such cases where the
revenue is under dispute. Under several of its contracts, the LECs have
disputed the payment of reciprocal compensation for traffic terminating to
ISP customers contending that such traffic was not local. As a result, the
Company initiated the dispute resolution process under the applicable
contracts to collect these amounts and filed complaints with various public
utility commissions ("PUCs") contending that the ISP traffic is local.
Various of these state PUCs have ruled in favor of the Company, but all of
these favorable decisions have subsequently been appealed by the LECs.
While the Company believes that these disputes will ultimately be resolved
in its favor, the Company only recognizes revenue on a portion of the cash
received and defers recognition of a portion of this revenue pending
outcome of the dispute. In addition, the payment of reciprocal compensation
under certain of the Company's interconnection agreements is, by the terms
of those agreements, subject to adjustment or repayment depending on
prospective federal or state generic rulings with respect to reciprocal
compensation for ISP traffic. Switched services revenue for the nine months
ended September 30, 2000 includes the recognition of $27.3 million of
non-recurring reciprocal compensation. A significant portion of the
non-recurring reciprocal compensation revenue recognized during the nine
months ended September 30, 2000 was a result of the resolution of certain
cases involving reciprocal compensation disputes. As of September 30, 2000,
the Company had deferred recognition of $25.4 million in reciprocal
compensation revenue for payments received associated with pending disputes
and agreements that are subject to future reciprocal compensation
adjustments. The Company pays reciprocal compensation expense to the other
LECs for local exchange traffic it terminates on the LEC's facilities.
These costs are recognized as incurred and are reported as a component of
operating expenses in the accompanying consolidated statements of
operations.
Significant Customers
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. For the nine months
ended September 30, 2000 and 1999, the Company's top 10 customers accounted
for 46% and 45%, respectively, of the Company's consolidated revenue. MCI
WorldCom, Inc. ("MCI") accounted for more than 10% of the Company's total
revenue, or $36.4 million, during the nine months ended September 30, 2000,
but accounted for less than 10% of the Company's total revenue during the
nine months ended September 30, 1999. AT&T accounted for more than 10% of
the Company's total revenue or $23.5 million, during the nine months ended
September 30, 1999, but accounted for less than 10% of the
8
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
Company's total revenue during the nine months ended September 30, 2000.
However, a substantial portion of this revenue results from traffic that is
directed to the Company by the Company's customers who have selected AT&T
or MCI as their long distance provider.
Segment Reporting
The Company operates in 22 service areas and the Company's management
makes decisions on resource allocation and assesses performance based on
total revenue, EBITDA, and capital spending of these operating locations.
Each of the service areas offers the same products and services, has
similar customers and networks, is regulated by the same type of
authorities, and is managed directly by the Company's executives, allowing
the 22 service areas to be aggregated, resulting in one reportable line of
business.
Earnings (Loss) Per Common Share and Potential Common Share
Basic earnings (loss) per share for all periods presented herein was
computed by dividing the net income (loss) by the weighted average shares
outstanding for the period.
The diluted loss per common share for the three and nine months ended
September 30, 1999 and the three months ended September 30, 2000 was
computed by dividing the net loss attributable to common shares by the
weighted average outstanding common shares for the period. Potential common
shares were not included in the computation of weighted average shares
outstanding because their inclusion would be anti-dilutive.
The diluted earnings per share for the nine months ended September 30,
2000 was computed by dividing the net income by the weighted average number
of common shares and dilutive potential common shares outstanding during
the period.
Set forth below is a reconciliation of the basic and diluted earnings
(loss) per share for each period:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
2000 1999 2000 1999
----------- ----------- ----------- ------------
(amounts in thousands, except per share amounts)
<S> <C> <C> <C> <C>
Net income (loss) for basic and
diluted earnings (loss) per share $(2,325) (9,115) 4,582 (86,936)
=========== =========== =========== ============
Weighted-average number of
shares - basic 105,531 104,480 105,262 92,957
Dilutive effect of stock options - - 3,165 -
----------- ----------- ----------- ------------
Weighted-average number of
shares - diluted 105,531 104,480 108,427 92,957
=========== =========== =========== ============
Earnings (loss) per share:
Basic (0.02) (0.09) 0.04 (0.94)
=========== =========== =========== ============
Diluted (0.02) (0.09) 0.04 (0.94)
=========== =========== =========== ============
</TABLE>
Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued
Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, which is required to be adopted in years beginning
after June 15, 2000. Because the Company has historically not made use of
derivatives, management does not anticipate that the adoption of the new
statement will have a significant effect on earnings or the financial
position of the Company.
9
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
2. Acquisitions
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Internet Connect, Inc., an Internet service
provider, for consideration consisting of $3.8 million of Class A limited
liability interests in TWT LLC, the Company's predecessor, approximately
$3.5 million in net cash, and the assumption of $1.9 million in
liabilities. At the time of the IPO, these Class A limited liability
interests were converted into 307,550 shares of Class A common stock of the
Company. The Class A common stock of the Company into which the limited
liability interests were converted are being held in escrow to be released
to the former Internet Connect, Inc. shareholders over a period of three
years, beginning in April 2000. Through the acquisition of this subsidiary,
the Company plans to manage current and future data networks and provide
new Internet products. The transaction was accounted for under the purchase
method of accounting and generated $6.9 million in goodwill, which is being
amortized on a straight-line basis over a ten-year period. Amortization
expense aggregated $521,000 and $289,000 for the nine months ended
September 30, 2000 and 1999, respectively.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm, Inc. ("MetroComm") through the
issuance of 2,190,308 shares of Class A common stock of the Company valued
at $24.1 million, and the assumption of $20.1 million in liabilities.
Through the acquisition of MetroComm, the Company acquired the 50% interest
of MetroComm L.P. not already owned by the Company. After the acquisition,
the Company's Columbus, Ohio assets were transferred to MetroComm L.P. and
all operations in Columbus, Ohio are now reported under the new entity. The
transaction was accounted for under the purchase method of accounting and
generated $18.8 million in goodwill, which is being amortized on a
straight-line basis over a ten-year period. Amortization expense aggregated
$1,412,000 and $627,000 for the nine months ended September 30, 2000 and
1999, respectively.
Since both acquisitions are accounted for as purchases, the results of
operations of Internet Connect, Inc. and MetroComm are consolidated with
the Company's results of operations from their respective acquisition
dates.
On September 11, 2000, the Company executed a definitive purchase
agreement to acquire substantially all of the assets of GST
Telecommunications, Inc ("GST") out of bankruptcy. GST is a facilities-
based integrated communications provider offering voice, data, and Internet
services primarily to business customers throughout the western United
States. The asset purchase agreement provides for the purchase of
substantially all of the GST assets for cash consideration of $640 million,
plus the assumption of certain liabilities and fees, for a total purchase
price of $690 million, subject to certain purchase price adjustments. The
bankruptcy court approved the transaction, but the closing is still subject
to regulatory approvals and certain other closing conditions. There is no
assurance that all necessary regulatory approvals will be obtained or that
all closing conditions will be satisfied. The GST asset acquisition, if
completed, is expected to accelerate the Company's build-out strategy by
adding to the Company's network 15 additional markets in the western United
States, 4,210 route miles, 227,674 fiber miles, and service to 345 on-net
buildings. In addition, the Company will acquire GST's network operations
center in Vancouver, Washington, SS7 networks, voice and data switches, and
substantially all other assets excluding certain customers and certain
assets in Hawaii. The acquisition is expected to close by the end of 2000
or the first quarter of 2001.
3. Long-Term Debt
The Senior Notes are unsecured, unsubordinated obligations of the
Company. Interest on the Senior Notes is payable semi-annually on
January 15 and July 15, and began on January 15,
10
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
1999. Interest expense, including amortization of debt discount, relating
to the Senior Notes totaled approximately $30.1 million for both the nine
months ended September 30, 2000 and 1999. At September 30, 2000, the fair
market value for the $400 million of Senior Notes was $360 million, based
on market prices.
The Senior Notes are governed by an Indenture that contains certain
restrictive covenants. These restrictions affect, and in many respects
significantly limit or prohibit, among other things, the ability of the
Company to incur indebtedness, make prepayments of certain indebtedness,
pay dividends, make investments, engage in transactions with shareholders
and affiliates, issue capital stock of subsidiaries, create liens, sell
assets, and engage in mergers and consolidations.
On April 10, 2000, the Company executed a $475 million Senior Secured
Revolving Credit Facility (the "Revolver"). The Revolver has a final
maturity of December 31, 2007, with annual reductions in the principal
amount available under the Revolver commencing on December 31, 2004, and
borrowings will be at the Eurodollar rate plus a margin of up to 2.0%,
depending on financial metrics. The Company is required to pay commitment
fees on a quarterly basis ranging from 0.875% to 0.500% per annum on the
undrawn available commitment. Commitment fee expense was $1,997,000 for the
nine months ended September 30, 2000 and has been classified as a component
of interest expense in the accompanying consolidated statements of
operations. It is anticipated that the Revolver will primarily be used for
the build-out of the Company's network and working capital needs. At
September 30, 2000, the undrawn available commitment under the Revolver was
$475 million.
Under a commitment letter with The Chase Manhattan Bank ("Chase") and
Morgan Stanley Senior Funding ("Morgan Stanley") dated September 11, 2000,
the Company expects to replace its existing $475 million senior secured
revolving credit facility with a new $1 billion amended and restated
facility. Chase and Morgan Stanley's commitments to provide the amended and
restated facility are subject to various conditions.
The amended and restated facility will provide up to $525 million of
senior secured term loan financing, a substantial portion of which the
Company expects to use for the purchase of the GST assets, and a $475
million senior secured revolving credit facility. As with the Company's
existing credit facility, borrowings under the amended and restated
facility will be secured by the Company's interest in all of its
subsidiaries and substantially all of the assets of the Company's
subsidiaries, including the assets to be acquired from GST, except for
certain assets with respect to which the grant of a security interest is
prohibited by governing agreements. As with the Company's existing credit
facility, the amended and restated facility will require the Company to
prepay outstanding loans when its cash flow exceeds certain levels and with
the proceeds received from a number of specified events or transactions,
including certain asset sales and insurance recoveries for assets not
replaced. In addition, obligations under the amended and restated facility
will be subject to various covenants that limit the Company's ability to:
. borrow and incur liens on its property;
. pay dividends or make other distributions; and
. make capital expenditures.
As with the Company's existing credit facility, the amended and
restated facility will also contain financial covenants, including a
consolidated leverage ratio, a consolidated interest coverage ratio, a
consolidated debt service coverage ratio, and a consolidated debt default,
including cross default provisions. Under the cross default provisions, the
Company is deemed to be in default under the amended and restated facility
if the Company has defaulted under any of the other material outstanding
obligations, such as the 9 3/4% Senior Notes.
11
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
The Company also entered into a commitment letter with Chase, Morgan
Stanley, and Lehman Commercial Paper Inc. for a $700 million senior
unsecured bridge loan facility. The Company expects to borrow the entire
$700 million on the closing date of the GST asset acquisition. The
commitments of the bridge lenders to provide the bridge facility are
subject to various conditions.
Any notes issued under the proposed bridge facility will be repayable
one year from the date of the issuance under the bridge facility and will
bear interest quarterly at the London Interbank Offered Rate plus a
specified margin that increases over time. The specified margin may be
increased if the Company's credit rating deteriorates. The Company will
have the ability to repay the bridge facility at any time prior to the
maturity date upon 10 days' written notice. In addition, the bridge notes
must be repaid with the proceeds of any debt or equity financings, as well
as certain other events, that occur prior to the maturity date. The Company
also expects to pay customary commitment and other fees in connection with
the bridge facility.
In the event that the Company is not able to repay the bridge notes
within one year, it will be obligated to issue new notes in exchange for
the bridge notes. Any such exchange notes would have the same principal
amount as the bridge notes and mature 10 years from the date of issuance.
In addition, the Company would be required to pay customary fees under the
bridge notes upon issuance of any exchange notes. Interest on the exchange
notes would be payable quarterly at a specified interest rate.
4. Related Party Transactions
In the normal course of business, the Company engages in various
transactions with the Former Parent Companies, generally on negotiated
terms among the affected units that, in management's opinion, result in
reasonable allocations.
The Company benefits from its strategic relationship with Time Warner
Cable both through access to local right-of-way and construction
cost-sharing. The Company's networks have been constructed primarily
through the use of fiber capacity licensed from Time Warner Cable. Under
this licensing arrangement, the Company paid Time Warner Cable $1.4 million
and $13.7 million for the nine months ended September 30, 2000 and 1999,
respectively. These costs have been capitalized by the Company. The
amortization expense of these costs and fiber previously capitalized in the
amount of $9.6 million and $7.8 million for the nine months ended September
30, 2000 and 1999, respectively, has been classified as a component of
depreciation and amortization expense in the accompanying consolidated
statements of operations. In addition, under this licensing arrangement,
the Company reimburses Time Warner Cable for facility maintenance and pole
rental costs, which aggregated $755,000 and $1.8 million for the nine
months ended September 30, 2000 and 1999, respectively.
The Company's operations, which in certain cases are co-located with
Time Warner Cable's divisions, are allocated a charge for various overhead
expenses for services provided by these divisions. Prior to the
Reorganization, the allocations were based on direct labor, total expenses,
or headcount relative to each operating unit. The Company is also allocated
rent based on the square footage of space occupied by the Company at Time
Warner Cable's facilities. After the Reorganization, these costs are based
on contracts with Time Warner Cable. The charges aggregated $1.1 million
and $1.3 million for the nine months ended September 30, 2000 and 1999,
respectively.
During the period from July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with subordinated loans from
the Former Parent Companies. These loans remained outstanding, accruing
interest, through May 14, 1999. The loans from the Former Parent Companies
were subordinated in right of payment to the Senior Notes, except for a
provision allowing repayment prior to maturity with the net proceeds of any
offering of common stock or equivalent interest of the Company. These loans
bore interest (payable in kind) at Chase's prime
12
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
rate, which was 7.75% from January 1, 1999 through the payoff of the loan
in May 1999. Interest expense relating to these loans totaled approximately
$5.1 million for the nine months ended September 30, 1999. On May 14, 1999,
approximately $180 million of the proceeds from the IPO were used to repay
the subordinated loans payable to the Former Parent Companies in full,
including accrued interest.
5. Commitments and Contingencies
Pending legal proceedings are substantially limited to litigation
incidental to the business of the Company. In the opinion of management,
the ultimate resolution of these matters will not have a material adverse
effect on the Company's financial statements.
13
<PAGE>
TIME WARNER TELECOM INC.
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Cautions Concerning Forward Looking Statements
The following discussion and analysis provides information concerning the
results of operations and financial condition of Time Warner Telecom Inc. (the
"Company") and should be read in conjunction with the accompanying financial
statements and notes thereto. Additionally, the following discussion and
analysis should be read in conjunction with Management's Discussion and Analysis
of Financial Condition and Results of Operations and the consolidated financial
statements included in Part II of Time Warner Telecom Inc.'s Annual Report on
Form 10-K for the year ended December 31, 1999.
The Securities and Exchange Commission encourages companies to disclose
forward-looking information so that investors can better understand a company's
future prospects and make informed investment decisions. Certain information
included in this report contains "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995, including statements
anticipating future growth in revenue, EBITDA, and cash flow. Words such as
"anticipate," "estimate," "expects," "projects," "intends," "plans," "believes,"
"target," and words and terms of similar substance used in connection with any
discussion of future operating or financial performance identify such
forward-looking statements. Those forward-looking statements are management's
present expectation of future events. As with any projection or forecast, they
are inherently susceptible to changes in circumstances, and the Company is under
no obligation to (and expressly disclaims any such obligation to) update or
alter its forward-looking statements despite such changes. Important factors
that could cause actual results to differ materially from these expectations are
set forth under "Risk Factors" in the Company's Registration Statement on Form
S-1 (Registration No. 333-33166) and under "Additional Risks and Other
Uncertainties" in Item 7 of the Company's Annual Report on Form 10-K for the
year ended December 31, 1999.
Overview
The Company is a leading fiber facilities-based integrated communications
provider offering local businesses "last-mile" broadband connections for data,
high-speed Internet access, local voice, and long distance services. The Company
serves customers in 22 metropolitan markets in the United States. The markets
include: Austin, Dallas, Houston, and San Antonio, Texas; Charlotte,
Fayetteville, Greensboro, and Raleigh, North Carolina; Albany, Binghamton, New
York City, and Rochester, New York; Northern New Jersey; Cincinnati and
Columbus, Ohio; Memphis, Tennessee; Orlando and Tampa, Florida; Indianapolis,
Indiana; Milwaukee, Wisconsin; San Diego, California and Honolulu, Hawaii. In
addition, the Company plans to activate two networks (Los Angeles/Orange County,
California and Dayton, Ohio) later this year. The Company plans to begin
offering service in Denver, Colorado; Atlanta, Georgia; Chicago, Illinois;
Minneapolis, Minnesota and Columbia, South Carolina in 2001.
The Company began its business in 1993 by providing telephony services
through cable systems owned by Time Warner Entertainment Company, L.P. ("TWE"),
Time Warner Entertainment-Advance/Newhouse Partnership ("TWE-A/N"), and Time
Warner Inc. ("Time Warner"), collectively referred to as the "Former Parent
Companies." The Company's original business was to provide certain telephony
services together with cable television. In January 1997, the Company put in
place a new management team that implemented a business strategy focused
exclusively on serving business customers, rapidly providing switched services
in the Company's service areas, and expanding the range of business telephony
services offered by the Company.
TWE and TWE-A/N are owned as follows:
(1) TWE is a partnership of subsidiaries of Time Warner and AT&T Corp.
("AT&T"), as successor by merger to MediaOne Group, Inc. ("MediaOne");
and
(2) TWE-A/N is a partnership of TWE, Time Warner, and Advance/Newhouse
Partnership ("Advance").
14
<PAGE>
TIME WARNER TELECOM INC.
On July 14, 1998, Time Warner Telecom LLC ("TWT LLC") succeeded to the
ownership of the Company's business. At that time, Time Warner, MediaOne, and
Advance (collectively referred to as the "Class B Stockholders") formed TWT LLC
to acquire the assets and liabilities of the Company's business from the Former
Parent Companies and to conduct the offering on July 21, 1998 of $400 million
principal amount 9 3/4% Senior Notes due July 2008 (the "Senior Notes"). In the
transaction, referred to as the "Reorganization," the Class B Stockholders
(either directly or through subsidiaries) became the owners of all the limited
liability company interests in TWT LLC.
On May 10, 1999, in preparation for the Company's initial public offering,
TWT LLC was reconstituted as a Delaware corporation (the "Reconstitution") under
the name Time Warner Telecom Inc. by merging into a newly formed Delaware
corporation. As part of the merger, the outstanding Class A limited company
interests were converted into Class A common stock and the Class B Stockholders
exchanged their Class B limited liability company interests in TWT LLC for Class
B common stock of the newly formed corporation, Time Warner Telecom Inc. Prior
to the Reconstitution, the only outstanding Class A interests were those held by
former shareholders of Internet Connect, Inc., which the Company acquired in
April 1999. The Company accounted for the Reorganization and the Reconstitution
at each of the Class B Stockholders' historical cost basis and, except as noted
below, the Reorganization and the Reconstitution had no effect on the Company's
total stockholders' equity, which has been presented on a consistent basis.
The primary change to the Company's operating structure since the
Reconstitution is that the management of the Company became accountable to the
Board of Directors, instead of to the management committee of TWT LLC. In
addition, all future net operating loss carryforwards from the date of the
Reconstitution can be utilized against future earnings of the Company as a
result of the change in the Company's operating and legal structure from a
limited liability company to a corporation. Prior to the Reconstitution, all net
operating losses were allocated to and utilized primarily by the Class B
Stockholders. The Company has not been, and will not be compensated for net
operating losses utilized by the Class B Stockholders. As a result of the
Reconstitution, which occurred during the second quarter of 1999, the Company
recorded a non-recurring charge to earnings for a net deferred tax liability of
approximately $39.4 million.
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A common
stock at a price of $14 per share (the "IPO"). The IPO generated approximately
$270.2 million in proceeds for the Company, net of underwriting discounts and
expenses. A portion of the proceeds of the IPO was used to repay $180 million of
loans from the Former Parent Companies that were generated from the financing
requirements of the Company from July 1, 1997 through July 14, 1998, which had
remained outstanding, accruing interest, through May 14, 1999.
As a result of the IPO, the Company has two classes of common stock
outstanding, Class A common stock and Class B common stock. In general, holders
of Class A common stock have one vote per share and holders of Class B common
stock have ten votes per share. Each share of Class B common stock is
convertible, at the option of the holder, into one share of Class A common
stock. Holders of Class A common stock and Class B common stock generally vote
together as a single class. However, some matters require the approval of 100%
of the holders of the Class B common stock voting separately as a class, and
some matters require the approval of a majority of the holders of the Class A
common stock, voting separately as a class. Upon completion of the IPO, the
Class B Stockholders owned all of the 81,250,000 shares of outstanding Class B
common stock. Subsequent to the IPO, 9,023,500 shares of Class B common stock
have been converted into Class A common stock. As of September 30, 2000, the
Class B Stockholders had approximately 95.6% of the combined voting power of the
outstanding common stock.
MediaOne completed an underwritten offering on May 1, 2000 of 9,000,000
shares of Class A common stock of the Company, 8,987,785 of which were converted
from shares of Class B common stock. As a result of this transaction, MediaOne
was no longer entitled to appoint three members of the Company's Board of
Directors and the three directors designated by MediaOne have resigned. After
the transaction, MediaOne held 6,289,842 shares of Class B common stock,
representing 6.0% of the Company's total outstanding common stock and 8.3% of
the total voting power, and the Class B Stockholders as a group had
approximately 95.6% of the combined voting power of the outstanding common stock
as of May 2, 2000.
15
<PAGE>
TIME WARNER TELECOM INC.
The Company did not receive any proceeds nor did its total shares outstanding
change as a result of this transaction.
On June 15, 2000, MediaOne merged with AT&T. As a result of the merger, the
Class B common stock previously beneficially owned by a MediaOne subsidiary is
beneficially owned by AT&T, since that subsidiary has become a wholly-owned
subsidiary of AT&T. However, the transaction does not affect the rights of that
subsidiary as a Class B Stockholder.
On January 10, 2000, Time Warner announced an agreement to merge with
America Online, Inc. ("AOL") in a stock-for-stock transaction that would create
a new company called AOL Time Warner Inc. As a result of the mergers, both AOL
and Time Warner will become wholly owned subsidiaries of AOL Time Warner. If the
merger is completed, the Class B common stock beneficially owned by Time Warner
will be beneficially owned by AOL Time Warner and its subsidiaries. However, the
transaction will not affect the rights of Time Warner subsidiaries as Class B
Stockholders. The merger was approved by the Time Warner stockholders, but is
also subject to customary closing conditions, including regulatory clearance.
There is no assurance that the clearance will be obtained or that the merger
will be consummated.
Acquisitions
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Internet Connect, Inc., an Internet service
provider, for consideration consisting of $3.8 million of Class A limited
liability interests in TWT LLC, the Company's predecessor, approximately $3.5
million in net cash, and the assumption of $1.9 million in liabilities. At the
time of the IPO, these Class A limited liability interests were converted into
307,550 shares of Class A common stock of the Company. The Class A common stock
of the Company into which the limited liability interests were converted are
being held in escrow to be released to the former Internet Connect, Inc.
shareholders over a period of three years, beginning in April 2000. Through the
acquisition of this subsidiary, the Company plans to manage current and future
data networks and provide new Internet products.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm, Inc. ("MetroComm") through the issuance
of 2,190,308 shares of Class A common stock of the Company valued at $24.1
million, and the assumption of $20.1 million in liabilities. Through the
acquisition of MetroComm, the Company acquired the 50% interest of MetroComm
AxS, L.P., a competitive local exchange carrier in Columbus, Ohio, not already
owned by the Company.
On September 11, 2000, the Company executed a definitive purchase agreement
to acquire substantially all of the assets of GST Telecommunications, Inc
("GST") out of bankruptcy. GST is a facilities-based integrated communications
provider offering voice, data, and Internet services primarily to business
customers throughout the western United States. The asset purchase agreement
provides for the purchase of substantially all of the GST assets for cash
consideration of $640 million, plus the assumption of certain liabilities and
fees, for a total purchase price of $690 million, subject to certain purchase
price adjustments. The bankruptcy court approved the transaction, but the
closing is still subject to regulatory approvals and certain other closing
conditions. Although there is no assurance that all necessary regulatory
approvals will be obtained or that all closing conditions will be satisfied, the
acquisition is expected to close by the end of 2000 or the first quarter of
2001. Any delay in the closing of the GST acquisition could result in the loss
of customers and the related revenue, as well as key personnel at GST. The GST
asset acquisition, if completed, is expected to accelerate the Company's build-
out strategy by adding to the Company's network 15 additional markets in the
western United States, 4,210 route miles, 227,674 fiber miles, and service to
345 on-net buildings. In addition, the Company will acquire GST's network
operations center in Vancouver, Washington, SS7 networks, voice and data
switches, and substantially all other assets excluding certain customers and
certain assets in Hawaii. If this acquisition is consummated, the Company will
experience significant increases in expenses for depreciation and for interest
on borrowings to complete this acquisition.
16
<PAGE>
TIME WARNER TELECOM INC.
Although the acquisition of the GST assets increases the Company's
geographic presence, expands its products and services, and enlarges the
capacity of its networks, this transaction is considerably larger than the
transactions the Company has completed in the past.
The completion of this transaction will likely involve some or all of the
following operating risks to the Company:
. the difficulty of assimilating the acquired operations and personnel;
. the potential disruption of the Company's ongoing business;
. the possible inability of management to maintain uniform standards,
controls, procedures, and policies;
. the possible difficulty of managing the Company's growth and
information systems;
. the risks of entering markets in which the Company has little or no
experience; and
. the potential impairment of relationships with employees or customers.
The Company has entered into the asset purchase agreement with GST with the
expectation that the asset purchase will result in certain benefits, including
expansion of the markets the Company serves and increasing the Company's
operational efficiencies. Achieving the benefits of the asset purchase will
depend upon the successful integration of the acquired businesses into the
Company's existing operations. There is no assurance that the Company will be
successful in integrating the acquired GST assets into its current businesses.
The integration risks associated with the acquisition include but are not
limited to:
. the diversion of the Company's management's attention as integrating
the GST operations and assets will require a substantial amount of our
management's attention;
. difficulties associated in assimilating GST's technology, including
billing and customer information systems; and
. any significant loss of key GST operational personnel could lead to
interruptions in our billing, accounting, and engineering
capabilities.
There is no assurance that the Company will be able to successfully
overcome the risks associated with integrating the assets it will acquire from
GST. There is a risk that the costs of integration could have a material adverse
effect on the Company's operating results.
17
<PAGE>
TIME WARNER TELECOM INC.
Results of Operations
The following table sets forth certain consolidated statements of
operations data of the Company, in thousands of dollars and expressed as a
percentage of total revenue, for each of the periods presented. This table
should be read together with the Company's financial statements, including the
notes thereto, appearing elsewhere in this report:
<TABLE>
<CAPTION>
Three Months Ended September 30,
----------------------------------------------
2000 1999
------------------ -----------------------
(amounts in thousands, except per share amounts)
<S> <C> <C>
Statements of Operations Data:
Revenue:
Dedicated transport services $ 71,129 59 % 40,666 57 %
Switched services (1) 50,027 41 30,649 43
-------- ----- -------- -----
121,156 100 71,315 100
-------- ----- -------- -----
Costs and expenses (2):
Operating 48,299 40 30,488 43
Selling, general and administrative 44,475 36 30,097 42
Depreciation and amortization 23,994 20 19,291 27
-------- ----- -------- -----
Total costs and expenses 116,768 96 79,876 112
-------- ----- -------- -----
Operating income (loss) 4,388 4 (8,561) (12)
Interest expense (2) (10,043) (8) (9,983) (14)
Interest income 2,220 1 3,840 5
Equity in income of unconsolidated affiliate - - - -
-------- ----- -------- -----
Net income (loss) before income taxes (3,435) (3) (14,704) (21)
Income tax expense (benefit) (4) (1,110) (1) (5,589) (8)
-------- ----- -------- -----
Net income (loss) $ (2,325) (2)% (9,115) (13)%
========= ====== ======== ======
Basic and diluted earnings (loss) per share $ (0.02) (0.09)
Earnings (loss) per share before income taxes (4):
Basic $ (0.03) (0.14)
Diluted $ (0.03) (0.14)
Weighted average shares outstanding:
Basic 105,531 104,480
Diluted 105,531 104,480
EBITDA (1) (3) $ 28,382 23 % 10,730 15 %
Net cash provided by (used in) operating activities 16,597 (467)
Net cash provided by (used in) investing activities (43,711) (140,480)
Net cash provided by (used in) financing activities (3,952) 2,192
Nine Months Ended September 30,
---------------------------------------------
2000 1999
-------------------- -----------------------
(amounts in thousands, except per share amounts)
Statements of Operations Data:
Revenue:
Dedicated transport services 183,759 52 % 105,727 60 %
Switched services (1) 169,308 48 71,558 40
-------- ----- -------- ----
353,067 100 177,285 100
-------- ----- -------- ----
Costs and expenses (2):
Operating 130,846 37 81,949 46
Selling, general and administrative 122,663 35 80,501 46
Depreciation and amortization 68,793 19 50,272 28
-------- ----- -------- ----
Total costs and expenses 322,302 91 212,722 120
-------- ----- -------- ----
Operating income (loss) 30,765 9 (35,437) (20)
Interest expense (2) (30,657) (9) (35,139) (20)
Interest income 9,016 2 12,828 8
Equity in income of unconsolidated affiliate - - 285 -
-------- ----- -------- ----
Net income (loss) before income taxes 9,124 2 (57,463) (32)
Income tax expense (benefit) (4) 4,542 1 29,473 17
-------- ----- -------- ----
Net income (loss) 4,582 1 % (86,936) 49 %
======== ===== ======== ====
Basic and diluted earnings (loss) per share 0.04 (0.94)
Earnings (loss) per share before income taxes (4):
Basic 0.09 (0.62)
Diluted 0.08 (0.62)
Weighted average shares outstanding:
Basic 105,262 92,957
Diluted 108,427 92,957
EBITDA (1) (3) 99,558 28 % 14,835 8 %
Net cash provided by (used in) operating activities 71,238 (13,194)
Net cash used in investing activities (87,817) (124,804)
Net cash provided by (used in) financing activities 84 75,252
</TABLE>
(1) Includes the recognition of $3.9 million and $23.4 million of non-recurring
reciprocal compensation in the first and second quarter of 2000,
respectively.
(2) Includes expenses resulting from transactions with affiliates of $3.9
million and $3.6 million for the three months ended September 30, 2000 and
1999, respectively, and $11.4 million and $15.9 million for the nine months
ended September 30, 2000 and 1999, respectively.
18
<PAGE>
TIME WARNER TELECOM INC.
(3) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income (loss), cash flow, and other measures of
financial performance and liquidity reported in accordance with generally
accepted accounting principles. Rather, EBITDA is a measure of operating
performance and liquidity that investors may consider in addition to these
measures. Management believes that EBITDA is a standard measure of
operating performance and liquidity that is commonly reported and widely
used by analysts, investors, and other interested parties in the
telecommunications industry because it eliminates many differences in
financial, capitalization, and tax structures, as well as non-operating
one-time charges to earnings. EBITDA is used internally by the Company's
management to assess ongoing operations and is a component of a covenant of
the Senior Notes that limits the Company's ability to incur certain
additional future indebtedness. However, EBITDA as used in this report may
not be comparable to similarly titled measures reported by other companies
due to differences in accounting policies.
(4) A one-time charge to earnings of $39.4 million was recorded in the second
quarter of 1999 to reflect the deferred tax liability associated with the
change from a limited liability company to a corporation. Income tax
expense for the nine months ended September 30, 1999 reflects the $39.4
million charge, net of a $9.9 million income tax benefit.
General
The Company operates in metropolitan areas that have high concentrations of
medium- and large-sized businesses. These businesses tend to be
telecommunications-intensive and seek the greater reliability provided by an
advanced network such as the Company's. Historically the Company has focused its
sales and marketing efforts on such businesses, as they are potentially high
volume users of the Company's services. To drive revenue growth in these
markets, the Company has expanded its direct sales force to focus on these
business customers while it develops managed service offerings to meet their
voice, data, and Internet needs. The Company's revenue has been derived
primarily from business telephony services, including dedicated transport, local
switched, long distance, data and high-speed Internet access services. A
significant portion of the Company's revenue growth is in switched services
provided through the 24 digital Lucent Technologies Inc. 5ESS switches that the
Company has deployed, and through the rapid growth in demand for switching data
traffic. Also, through the acquisition of Internet Connect, Inc. in 1999, the
Company has deployed a national Internet backbone and has experienced growth in
data and high-speed Internet services. The Company believes that data services
are becoming increasingly more important to the Company's target customer base.
In particular, the Company believes that the demand for high-speed, high quality
local area network and wide area network connectivity will continue to grow over
the near term.
The Company continues to expand its footprint within its existing markets
by expanding its network into new buildings and geographically by turning up two
new markets since this time last year: Northern New Jersey and Dallas, Texas.
The Company is also interconnecting existing service areas within regional
clusters with owned or licensed fiber optic facilities. The goal is to rapidly
deploy new services and technologies when technically proven and when customer
demand is evident. As new technologies arise that enable the switching of voice
calls over an Internet protocol and local area network infrastructure, the
Company will evaluate how to best integrate this soft switch technology into its
infrastructure. There is no assurance that the Company will bring any or all of
these products to market successfully or profitably.
Reciprocal compensation revenue is an element of switched services revenue,
which represents compensation from local exchange carriers ("LECs") for local
exchange traffic terminated on the Company's facilities originated by other
LECs. Reciprocal compensation is based on contracts between the Company and
LECs. The Company recognizes reciprocal compensation revenue as it is earned,
except in such cases where the revenue is under dispute. Under several of its
contracts, the LECs have disputed the payment of reciprocal compensation for
traffic terminating to Internet service provider ("ISP") customers contending
that such traffic was not local. As a result, the Company initiated the dispute
resolution process under the applicable contracts to collect these amounts and
filed complaints with various public utility commissions ("PUCs")
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TIME WARNER TELECOM INC.
contending that the ISP traffic is local. Various of these state PUCs have ruled
in favor of the Company, but all of these favorable decisions have subsequently
been appealed by the LECs. While the Company believes that these disputes will
ultimately be resolved in its favor, the Company only recognizes revenue on a
portion of the cash received and defers recognition of a portion of this revenue
pending outcome of the dispute. In addition, the payment of reciprocal
compensation under certain of the Company's interconnection agreements is, by
the terms of those agreements, subject to adjustment or repayment depending on
prospective federal or state generic rulings with respect to reciprocal
compensation for ISP traffic. Switched services revenue for the nine months
ended September 30, 2000 includes the recognition of $27.3 million of
non-recurring reciprocal compensation. A significant portion of the
non-recurring reciprocal compensation revenue recognized during the nine months
ended September 30, 2000 was a result of certain cases involving reciprocal
compensation disputes that were resolved as described in Part II, Item 1. As of
September 30, 2000, the Company had deferred recognition of $25.4 million in
reciprocal compensation revenue for payments received associated with pending
disputes and agreements that are subject to future reciprocal compensation
adjustments. The Company pays reciprocal compensation expense to the other LECs
for local exchange traffic it terminates on the LEC's facilities. These costs
are recognized as incurred.
A portion of the Company's revenue is comprised of services that are rate
sensitive. Switched access -- the connection between a long distance carrier's
point of presence and an end-user's premises provided through the switching
facilities of a LEC -- is billed on a per minute of use basis. Historically, the
Federal Communications Commission ("FCC") has regulated the access rates imposed
by the incumbent local exchange carriers ("ILECs"), while the integrated
communications provider ("ICP") access rates have been less regulated. During
the second quarter of 2000, the FCC adopted a proposal that substantially
reduces the ILEC per-minute access charges while allowing for an increase in the
flat monthly charge paid by local residential service subscribers. While the FCC
decision does not specifically apply to the switched access rates charged by
ICPs, it places significant downward market pressure on ICP access rates. For
the nine months ended September 30, 2000 and 1999, switched access revenue
represented 10% and 11% of total revenue, respectively. Management believes that
increased volume in services and markets served will partially offset the impact
of rate reduction. However, the degree and timing of the reductions in the
Company's access revenue cannot be predicted.
Reciprocal compensation is another component of switched services that is
rate sensitive. Rates are established by interconnection agreements between the
parties based on regulatory and judicial ruling in each of the states. Several
significant agreements expired in 1999 and 2000 and have been renegotiated. In
most of the states, regulatory bodies have established lower traffic termination
rates than the rates provided under the Company's expired agreements; and as a
result, the rates under the new agreements, while reasonable in light of the
regulatory environment, are lower than the rates under the expired agreements.
As discussed below, reciprocal compensation represented 6% and 7% of revenue,
excluding the effects of the recognition of $27.3 million of non-recurring
reciprocal compensation during the nine months ended September 30, 2000,
respectively. Although the renegotiated interconnection agreements have resulted
in lower prospective rates, management believes that the growth in Internet and
related markets will partially mitigate the impact of the rate reduction. The
outcome of regulatory and judicial rulings on reciprocal compensation for ISP
traffic may also negatively impact the Company's revenue from reciprocal
compensation since the rates under most interconnection agreements are subject
to change based on such rulings. The Company cannot predict the outcome of these
rulings. In addition, legislation has been introduced in Congress which would
prohibit payment of reciprocal compensation for Internet-bound traffic.
Accordingly, there is no assurance that the Company will be able to compensate
for the reduction in reciprocal compensation with increased volume of
terminating local traffic.
The Company benefits from its strategic relationship with Time Warner Cable
both through access to local right-of-way and construction cost-sharing. The
Company's networks have been constructed primarily through the use of fiber
capacity licensed from Time Warner Cable. As of September 30, 2000, the Company
operated networks in 22 metropolitan areas that spanned 9,457 route miles,
contained 363,644 fiber miles, and offered service to 7,228 on-net and off-net
buildings.
The Company plans to continue expanding its revenue base by fully utilizing
available network capacity in its existing markets, by adding networks in new
markets, and by continuing to develop and selectively tailor new services in
competitively-priced packages to meet the needs of its medium and large-sized
business customers. The Company intends to expand its product offerings on a
continuous basis to
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TIME WARNER TELECOM INC.
achieve a diverse revenue base. As part of that process, the Company is
targeting the expansion of data and Internet products that can be offered on the
Company's existing network.
Operating expenses consist of costs directly related to the operation and
maintenance of the networks and the ordering and provisioning of the Company's
services. This includes the salaries and related expenses of operations and
engineering personnel, as well as costs incurred from the incumbent local
exchange carriers, other competitors, and long distance providers for facility
leases and interconnection. These costs have increased over time as the Company
has increased its operations and revenue. The Company expects these costs to
continue to increase as the Company's revenue growth continues, but generally at
a slower rate than revenue growth. The fact that a significant portion of the
Company's traffic rides on its own fiber infrastructure enhances the Company's
ability to control its costs.
Selling, general, and administrative expenses consist of salaries and
related costs for employees other than those involved in operations and
engineering. These expenses include costs related to sales and marketing,
information technology, billing, regulatory, and legal costs. These costs have
increased over time as the Company has increased its operations and revenue. The
Company expects these costs to continue to increase as the Company's revenue
growth continues, but generally at a slower rate than revenue growth.
In the normal course of business, the Company engages in various
transactions with Time Warner Cable, generally on negotiated terms among the
affected units that, in management's view, result in reasonable allocations. In
connection with the Reorganization, the Company entered into several contracts
with Time Warner Cable with respect to certain of these transactions. The
Company's selling, general, and administrative expenses include charges
allocated from Time Warner Cable for office rent and overhead charges for
various administrative functions they perform for the Company. These charges are
required to reflect all costs of doing business and are based on various
methods, which management believes result in reasonable allocations of the costs
that are necessary to present the Company's operations as if they are operated
on a stand alone basis. In addition, the Company licenses the right to use the
majority of its fiber optic cable facilities from Time Warner Cable through
prepaid right-to-use agreements and reimburses Time Warner Cable for facility
maintenance and pole rental costs. The maintenance and pole rental costs are
included in the Company's operating expenses.
Three Months Ended September 30, 2000 Compared to Three Months Ended September
30, 1999
Revenue. Revenue increased $49.8 million, or 70%, to $121.2 million for the
three months ended September 30, 2000, from $71.3 million for the comparable
period in 1999. Exclusive of the effects of acquisitions, revenue increased
$48.4 million, or 72% to $115.8 million, from $67.4 million for the comparable
period in 1999. Revenue from the provision of dedicated transport services
increased $30.5 million, or 75%, to $71.1 million for the three months ended
September 30, 2000, from $40.7 million for the comparable period in 1999.
Switched service revenue increased $19.4 million, or 63%, to $50.0 million for
the three months ended September 30, 2000, from $30.6 million for the comparable
period in 1999. Exclusive of the effects of acquisitions, dedicated transport
service and switched service revenue increased 74% and 69%, respectively. The
increase in revenue from dedicated transport services primarily reflects a 27%
increase in average dedicated transport customers and a broader array of
products and services offered in existing markets. The increase in switched
service revenue reflects a 63% increase in average switched service customers,
increased revenue from switched access services and reciprocal compensation, and
a broader array of products and services offered in existing markets. Reciprocal
compensation represented 6% and 7% of total revenue for the three months ended
September 30, 2000 and 1999, respectively. At September 30, 2000 the Company
offered dedicated transport services in 22 metropolitan areas, all of which also
offered switched services. At September 30, 1999, the Company offered dedicated
transport services in 19 consolidated metropolitan areas, 16 of which also
offered switched services.
Operating Expenses. Operating expenses increased $17.8 million, or 58%, to
$48.3 million for the three months ended September 30, 2000, from $30.5 million
for the comparable period in 1999. Exclusive of the effects of acquisitions,
these expenses increased 56%. The increase in operating expenses was primarily
attributable to the Company's expansion of its business, principally switched
services, the ongoing development of existing markets resulting in higher local
exchange carrier charges for circuit leases and
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TIME WARNER TELECOM INC.
interconnection, and higher headcount for technical personnel. As a percentage
of revenue, operating expenses decreased to 40% for the three months ended
September 30, 2000 from 43% for the comparable period in 1999.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses increased $14.4 million, or 48%, to $44.5 million for
the three months ended September 30, 2000, from $30.1 million for the comparable
period in 1999. Exclusive of the effects of acquisitions, these expenses
increased 49%. The increase in selling, general, and administrative expenses was
primarily attributable to an increase in employee headcount and higher direct
sales costs associated with the increase in revenue, higher property tax
expense, and an increase in the provision for doubtful accounts related to the
increase in revenue. As a percentage of revenue, selling, general, and
administrative expenses decreased to 36% for the three months ended September
30, 2000 from 42% for the comparable period in 1999.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $4.7 million, or 24%, to $24.0 million for the three months
ended September 30, 2000, from $19.3 million for the comparable period in 1999.
Exclusive of the effects of acquisitions, this expense increased 26%. The
increase in depreciation and amortization expense was primarily attributable to
increased capital expenditures and increased goodwill generated from
acquisitions.
EBITDA. EBITDA for the three months ended September 30, 2000 increased
$17.7 million to $28.4 million, from $10.7 million in 1999. The increase was
$18.4 million, exclusive of the effects of acquisitions. This improvement was
primarily the result of economies of scale as more revenue was generated in
existing markets, increased utilization of networks and facilities, and a more
skilled and productive workforce.
Interest Expense. During the period July 1, 1997 through July 14, 1998, all
of the Company's financing requirements were funded with subordinated loans
payable from the Former Parent Companies. These loans remained outstanding,
accruing interest, through May 14, 1999. On July 21, 1998, the Company issued
$400 million in Senior Notes in a public offering. On May 14, 1999, the
subordinated loans of approximately $180 million, including accrued interest,
were repaid in full to the Former Parent Companies from the IPO proceeds.
Interest expense relating to the Senior Notes was $10.0 million for the three
months ended September 30, 2000 and 1999, respectively.
Net Income. Earnings changed $6.8 million to a loss of $2.3 million for the
three months ended September 30, 2000, from a net loss of $9.1 million for the
comparable period in 1999. The earnings change is primarily due to the
improvement in EBITDA, partially offset by an increase in net interest expense,
and a decrease in income tax benefit.
Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30,
1999
Revenue. Revenue increased $175.8 million, or 99%, to $353.1 million for
the nine months ended September 30, 2000, from $177.3 million for the comparable
period in 1999. Exclusive of the effects of acquisitions and the effects of the
recognition of $27.3 million of non-recurring reciprocal compensation during the
nine months ended September 30, 2000, revenue increased $139.3 million, or 81%
to $311.3 million, from $172.0 million for the comparable period in 1999.
Revenue from the provision of dedicated transport services increased $78.0
million, or 74%, to $183.8 million for the nine months ended September 30, 2000,
from $105.7 million for the comparable period in 1999. Switched service revenue
increased $97.8 million, or 137%, to $169.3 million for the nine months ended
September 30, 2000, from $71.6 million for the comparable period in 1999.
Exclusive of the effects of acquisitions and the effects of the recognition of
$27.3 million of non-recurring reciprocal compensation for the nine months ended
September 30, 2000, dedicated transport service and switched service revenue
increased 68% and 100%, respectively. The increase in revenue from dedicated
transport services primarily reflects a 30% increase in average dedicated
transport customers and a broader array of products and services offered in
existing markets. The increase in switched service revenue reflects a 73%
increase in average switched service customers, increased revenue from switched
access services and reciprocal compensation, and a broader array of products and
services offered in existing markets. Reciprocal compensation represented 6% and
7% of total revenue for the nine months ended September 30, 2000 and 1999,
respectively, excluding the effects of the recognition of $27.3 million of
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TIME WARNER TELECOM INC.
non-recurring reciprocal compensation during the nine months ended September 30,
2000. At September 30, 2000 the Company offered dedicated transport services in
22 metropolitan areas, all of which also offered switched services. At September
30, 1999, the Company offered dedicated transport services in 19 consolidated
metropolitan areas, 16 of which also offered switched services.
Operating Expenses. Operating expenses increased $48.9 million, or 60%, to
$130.8 million for the nine months ended September 30, 2000, from $81.9 million
for the comparable period in 1999. Exclusive of the effects of acquisitions,
these expenses increased 52%. The increase in operating expenses was primarily
attributable to the Company's expansion of its business, principally switched
services, the ongoing development of existing markets resulting in higher local
exchange carrier charges for circuit leases and interconnection, and higher
headcount for technical personnel. As a percentage of revenue, operating
expenses decreased to 37% for the nine months ended September 30, 2000 from 46%
for the comparable period in 1999.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses increased $42.2 million, or 52%, to $122.7 million for
the nine months ended September 30, 2000, from $80.5 million for the comparable
period in 1999. Exclusive of the effects of acquisitions, these expenses
increased 51%. The increase in selling, general, and administrative expenses was
primarily attributable to an increase in employee headcount and higher direct
sales costs associated with the increase in revenue, higher property tax
expense, and an increase in the provision for doubtful accounts related to the
increase in revenue. Included in selling, general, and administrative expenses
is approximately $1.0 million in costs related to a Form S-1 filing with the
Securities and Exchange Commission to facilitate the sale of shares by a Class B
Stockholder. The Company was required to bear these costs under the terms of the
Stockholders' Agreement with the Class B Stockholders. As a percentage of
revenue, selling, general, and administrative expenses decreased to 35% for the
nine months ended September 30, 2000 from 46% for the comparable period in 1999.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $18.5 million, or 37%, to $68.8 million for the nine months
ended September 30, 2000, from $50.3 million for the comparable period in 1999.
Exclusive of the effects of acquisitions, this expense increased 35%. The
increase in depreciation and amortization expense was primarily attributable to
increased capital expenditures and increased goodwill generated from
acquisitions.
EBITDA. EBITDA for the nine months ended September 30, 2000 increased $84.7
million to $99.6 million, from $14.8 million in 1999. The increase was $58.1
million, exclusive of the effects of acquisitions and the effects of the
recognition of $27.3 million of non-recurring reciprocal compensation for the
nine months ended September 30, 2000. This improvement was primarily the result
of economies of scale as more revenue was generated in existing markets,
increased utilization of networks and facilities, and a more skilled and
productive workforce.
Interest Expense. During the period July 1, 1997 through July 14, 1998, all
of the Company's financing requirements were funded with subordinated loans
payable from the Former Parent Companies. These loans remained outstanding,
accruing interest, through May 14, 1999. On July 21, 1998, the Company issued
$400 million in Senior Notes in a public offering. On May 14, 1999, the
subordinated loans of approximately $180 million, including accrued interest,
were repaid in full to the Former Parent Companies from the IPO proceeds.
Interest expense relating to the Senior Notes was $30.1 million for the nine
months ended September 30, 2000 and interest expense relating to the Senior
Notes and subordinated loans payable aggregated $35.1 million for the nine
months ended September 30, 1999. The decrease of $5.0 million is primarily due
to the lower weighted average debt balance during the nine months ended
September 30, 2000.
Net Income. Earnings changed $91.5 million to $4.6 million for the nine
months ended September 30, 2000, from a net loss of $86.9 million for the
comparable period in 1999. The earnings change is primarily due to the
improvement in EBITDA, a decrease in interest expense and a decrease in income
tax expense.
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TIME WARNER TELECOM INC.
Liquidity and Capital Resources
Operations. The Company's cash provided by operating activities was $71.2
million for the nine months ended September 30, 2000, as compared to cash used
in operating activities of $13.2 million for the comparable period in 1999. This
increase in cash provided by operating activities of $84.4 million principally
resulted from an increase in EBITDA of $84.7 million. As the Company continues
its expansion plan to enter into new markets, the expenditures incurred,
together with initial operating expenses, will generally result in negative
EBITDA and operating losses from a network until an adequate customer base and
revenue stream for the network have been established. Accordingly, the Company
expects that the network constructed in each new market will generally produce
negative EBITDA for at least two and a half years after operations commence in
each market. Although overall the Company expects to continue to have positive
EBITDA for the near future as it develops and expands its business, there can be
no assurance that the Company will sustain sufficient positive EBITDA to meet
its working capital requirements and to service its indebtedness.
Investing. Cash used in investing activities was $87.8 million for the nine
months ended September 30, 2000, as compared to cash used by investing
activities of $124.8 million for the comparable period in 1999. During both the
nine months ended September 30, 2000 and 1999, proceeds from the maturities of
marketable securities were primarily used to fund capital expenditures. During
the nine months ended September 30, 2000, capital expenditures were also funded
through cash flows from operating activities.
During the nine months ended September 30, 2000, capital expenditures were
$213.2 million, an increase of $74.9 million from the comparable period in 1999.
The largest commitment of capital was related to the installation of transport
and switch related electronics to support the increase in sales activity and the
addition of 585 route miles of fiber since December 31, 1999. Based on historic
capital requirements for network construction in relation to sales volumes and
network expansion plans, the Company anticipates it will commit approximately
$350 million in 2000 to fund its capital expenditures. This target spending
includes requirements for current operating markets and the Company's expansion
plans.
The facilities-based telecommunications business is a capital-intensive
business. The Company's operations have required and will continue to require
substantial capital investment for:
. the purchase and installation of switches, electronics, fiber, and
other technologies in existing networks and in additional networks to
be constructed in new service areas;
. the acquisition and expansion of networks currently owned and operated
by other companies, including the GST networks; and
. the evolution of the network to support new products, services, and
technologies.
The Company's expected capital expenditures for general corporate and
working capital purposes include:
. expenditures with respect to the Company's management information
system and corporate service support infrastructure; and
. operating and administrative expenses with respect to new networks and
debt service.
The Company plans to make substantial capital investments in connection
with plans to construct and develop new networks, as well as for technology
upgrades. Expansion of the Company's networks will include the geographic
expansion of the Company's existing operations, and the Company will consider
the development of new markets. In addition, the Company may acquire existing
networks in the future.
The Company regularly evaluates potential acquisitions and joint ventures
that would extend the Company's geographic markets, expand the Company's
products and services and/or enlarge the capacity of its networks. In the event
the Company enters into a definitive agreement with respect to any acquisition
or
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TIME WARNER TELECOM INC.
joint venture, it may require additional financing or it may elect to use a
portion of the proceeds from the sale of the Senior Notes not theretofore
expended for other purposes, including but not limited to, capital expenditures
and working capital requirements. If the Company enters into a definitive
agreement with respect to any material transaction, it could result in the
Company increasing its leverage or issuing additional common stock or both.
There can be no assurance, however, that the Company will enter into any
transaction or, if it does, on what terms.
While the Company intends to continue to leverage its relationship with
Time Warner Cable in pursuing expansion opportunities, to the extent the Company
seeks to expand into service areas where Time Warner Cable does not conduct
cable operations, the Company may incur significant additional costs in excess
of those historically incurred by the Company when expanding into existing Time
Warner Cable service areas. In addition, Time Warner Cable is not obligated to
construct or provide additional fiber optic capacity in excess of what is
already licensed to the Company under certain operating agreements. Accordingly,
if the Company is unable to lease additional capacity at the same rates as are
currently provided for under certain operating agreements, the Company may be
required to obtain additional capacity on more expensive terms.
The development and expansion of the Company's existing and future networks
and services and the acquisition of the GST assets will require significant
capital investment. The Company expects that its future cash requirements will
principally be for funding growth and capital expenditure, the purchase of
network assets, and to finance the cost of the GST acquisition. In light of
these future cash requirements, the Company has obtained commitments from
various financial institutions to obtain approximately $1.2 billion of new
financing in the form of term loan borrowings and a bridge loan facility. Under
a commitment letter with The Chase Manhattan Bank ("Chase") and Morgan Stanley
Senior Funding ("Morgan Stanley") dated September 11, 2000, the Company expects
to replace its existing $475 million senior secured revolving credit facility
with a new $1 billion amended and restated facility. Chase and Morgan Stanley's
commitments to provide the amended and restated facility are subject to various
conditions. The amended and restated facility will provide up to $525 million of
senior secured term loan financing, a substantial portion of which the Company
expects to use for the purchase of the GST assets, and a $475 million senior
secured revolving credit facility. As with the Company's existing credit
facility, borrowings under the amended and restated facility will be secured by
the Company's interest in all of its subsidiaries and substantially all of the
assets of the Company's subsidiaries, including the assets to be acquired from
GST, except for certain assets with respect to which the grant of a security
interest is prohibited by governing agreements. As with the Company's existing
credit facility, the amended and restated facility will require the Company to
prepay outstanding loans when its cash flow exceeds certain levels and with the
proceeds received from a number of specified events or transactions, including
certain asset sales and insurance recoveries for assets not replaced. In
addition, obligations under the amended and restated facility will be subject to
various covenants that limit the Company's ability to:
. borrow and incur liens on its property;
. pay dividends or make other distributions; and
. make capital expenditures.
As with the Company's existing credit facility, the amended and restated
facility will also contain financial covenants, including a consolidated
leverage ratio, a consolidated interest coverage ratio, a consolidated debt
service coverage ratio, and a consolidated debt default, including cross default
provisions. Under the cross default provisions, the Company is deemed to be in
default under the amended and restated facility if the Company has defaulted
under any of the other material outstanding obligations, such as the 9 3/4%
Senior Notes.
The Company also entered into a commitment letter with Chase, Morgan
Stanley, and Lehman Commercial Paper Inc. for a $700 million senior unsecured
bridge loan facility. The Company expects to borrow the entire $700 million on
the closing date of the GST asset acquisition. The commitments of the bridge
lenders to provide the bridge facility are subject to various conditions.
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TIME WARNER TELECOM INC.
Any notes issued under the proposed bridge facility will be repayable one
year from the date of the issuance under the bridge facility and will bear
interest quarterly at the London Interbank Offered Rate plus a specified margin
that increases over time. The specified margin may be increased if the Company's
credit rating deteriorates. The Company will have the ability to repay the
bridge facility at any time prior to the maturity date upon 10 days' written
notice. In addition, the bridge notes must be repaid with the proceeds of any
debt or equity financings, as well as certain other events, that occur prior to
the maturity date. The Company also expects to pay customary commitment and
other fees in connection with the bridge facility.
In the event that the Company is not able to repay the bridge notes within
one year, it will be obligated to issue new notes in exchange for the bridge
notes. Any such exchange notes would have the same principal amount as the
bridge notes and mature 10 years from the date of issuance. In addition, the
Company would be required to pay customary fees under the bridge notes upon
issuance of any exchange notes. Interest on the exchange notes would be payable
quarterly at a specified interest rate.
The Company expects that its cash, cash equivalents, and marketable debt
securities at September 30, 2000, borrowings under its existing and proposed
revolving credit facilities, the above-described proposed bridge facility, and
internally generated funds will provide sufficient funds for the Company to meet
its expected capital and liquidity needs, to expand its business as currently
planned and pay interest on outstanding indebtedness. If the Company's plans or
assumptions change or prove to be inaccurate, or if the foregoing sources of
funds prove to be insufficient to fund the Company's growth and operations or
become unavailable, or if the Company consummates other acquisitions or joint
ventures, the Company may be required to seek additional capital sooner than
currently anticipated. The Company's revenue and costs are dependent upon
factors that are not within the Company's control, for example, regulatory
changes, changes in technology, and increased competition. Due to the
uncertainty of these and other factors, actual revenue and costs may vary from
expected amounts, possibly to a material degree, and these variations could
affect the level of the Company's future capital expenditures and expansion
plans. Sources of additional financing, if needed or deemed appropriate, may
include public or private debt or equity financings by the Company or its
subsidiaries or other financing arrangements.
Financing. Net cash provided by financing activities for the nine months
ended September 30, 2000 was $84,000 and was primarily due to the net proceeds
from both the issuance of common stock upon exercise of stock options and the
issuance of common stock in connection with the employee stock purchase plan,
partially offset by deferred debt issue costs related to the Revolver.
During the period from July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with subordinated loans from the
Former Parent Companies. These loans remained outstanding, accruing interest,
through May 14, 1999. The loans from the Former Parent Companies were
subordinated in right of payment to the Senior Notes, except for a provision
allowing repayment prior to maturity with the net proceeds of any offering of
common stock or equivalent interest of the Company. The $400 million principal
amount in Senior Notes that the Company issued in July 1998 are unsecured,
unsubordinated obligations of the Company. Interest on the Senior Notes is
payable semiannually on January 15 and July 15, and began on January 15, 1999.
Aggregate annual interest payments on the Senior Notes through 2008 are expected
to be approximately $39 million. The Senior Notes are required to be repaid on
July 15, 2008. On May 14, 1999, approximately $180 million of the proceeds from
the IPO were used to repay the subordinated loans payable to the Former Parent
Companies in full, including accrued interest. The proceeds of the IPO remaining
after repayment of the subordinated loans payable, combined with the proceeds
from the Senior Notes, have been used to continue funding the Company's
continued growth, which includes expansion of the Company's networks, and for
general corporate purposes. The Former Parent Companies are not under any
obligation to make any additional equity investments or loans to the Company.
The Senior Notes are governed by an Indenture that contains certain
restrictive covenants. These restrictions affect, and in many respects
significantly limit or prohibit, among other things, the ability of the Company
to incur indebtedness, make prepayments of certain indebtedness, pay dividends,
make investments, engage in transactions with shareholders and affiliates, issue
capital stock of subsidiaries, create liens, sell assets and engage in mergers
and consolidations.
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TIME WARNER TELECOM INC.
Part II
Other Information
Item 1. Legal Proceedings
Southwestern Bell Telephone Company v. Public Utility Commission of Texas et al.
The Company filed a complaint with the Texas Public Utility Commission
("PUC") in October 1997 as a result of Southwestern Bell Telephone's ("SWBT")
refusal to pay the Company reciprocal compensation under the Interconnection
Agreement between the parties for calls terminated to the Company's Internet
service provider ("ISP") customers in Texas based on SWBT's contention that such
traffic was not "local". The PUC ruled that calls to ISPs are local and required
SWBT to compensate the Company for those calls under the Interconnection
Agreement. SWBT then sought to enjoin and stay the PUC's order in Federal
District Court for the Western District of Texas and sought a declaration that
calls to ISPs are not local. On April 16, 1998, the District Court denied all
relief sought by SWBT, and SWBT appealed that decision to the Fifth Circuit
Court of Appeals. Following the PUC's order, SWBT began to make reciprocal
compensation payments for ISP traffic under the Interconnection Agreement.
On March 30, 2000, the Fifth Circuit Court of Appeals affirmed the decision
of the PUC that modem calls within a local calling area to Internet service
providers are "local" calls within the meaning of the Interconnection Agreement
between the parties and therefore subject to reciprocal compensation under that
agreement. The Fifth Circuit also denied Southwestern Bell's petition for
rehearing and the time period for Southwestern Bell to file a petition for
certiori seeking review of the decision by the Supreme Court has expired.
Therefore, the Company will be entitled to retain the amounts received from SWBT
between April 1997 and September 1999 in respect of ISP traffic except for the
amounts to be refunded pursuant to the arbitration award described below.
Southwestern Bell v. Time Warner Telecom
On December 17, 1999, SWBT filed a Demand for Commercial Arbitration under
the Interconnection Agreement between the Company and SWBT that expired in
September 1999. SWBT alleged that the Company breached the Agreement by refusing
to amend the Agreement to replace the reciprocal compensation rates stated in
the contract with lower rates established by the PUC in a consolidated
arbitration with AT&T, MCI and MFS Communications ("Mega Arb rates"). The case
was heard by an arbitration panel of the American Arbitration Association on May
31, 2000. On June 30, 2000, the panel ordered the Company to refund to SWBT the
difference between the contract rates and the Mega Arb rates for reciprocal
compensation only for a 16-day period out of the 16-month period for which SWBT
claimed it was entitled to a rate adjustment. The Company estimates this amount
to be less than $2 million. SWBT was ordered to refund to the Company an amount
equal to the same rate differential applied to minutes of use terminated to
SWBT, which the Company estimates to be less than $100,000. The panel's
arbitration award is in final satisfaction of the claims raised in the
arbitration and is not subject to appeal.
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TIME WARNER TELECOM INC.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
The exhibits listed on the accompanying Exhibit Index are filed or
incorporated by reference as part of this report and the Exhibit Index
is incorporated herein by reference.
(b) Reports on Form 8-K
(i) 8-K dated September 11, 2000 reporting the execution of an
Asset Purchase Agreement to acquire substantially all of the
assets of GST Telecommunications, Inc. ("GST").
(ii) 8-K/A dated November 8, 2000 amending the Form 8-K dated
September 11, 2000 and filed September 18, 2000 reporting
the Asset Purchase Agreement to acquire substantially all of
the assets of GST and commitment letters with The Chase
Manhattan Bank ("Chase") and Morgan Stanley Senior Funding
("Morgan Stanley") to amend and restate the Company's
existing revolving credit agreement and with Morgan Stanley,
Lehman Commercial Paper and Chase for a $700 million bridge
loan facility, together with financial statements of GST and
pro forma financial statements of the Company giving effect
to the acquisition of substantially all of the assets of
GST.
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TIME WARNER TELECOM INC.
EXHIBIT INDEX
Exhibit
Number Description of Exhibit
------ ----------------------
2.1 -- Reorganization Agreement among Time Warner Companies, Inc.,
MediaOne Group, Inc., Advance/Newhouse Partnership, Time Warner
Entertainment Company, L.P., and Time Warner
Entertainment-Advance/Newhouse Partnership (filed as Exhibit 2.1 to
Time Warner Telecom ("TWT") LLC's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1998. *
2.2 -- Merger Agreement among the Company, TWT LLC, and TWT Inc. (filed as
Exhibit 2.2 to the Company's Registration Statement on Form S-1
(Registration No. 333-49439)). *
2.3 -- Asset Purchase Agreement dated as of September 11, 2000 among Time
Warner Telecom Inc., GST Telecommunications, Inc., GST USA, Inc.
and the other parties identified on Exhibit A thereto (filed as
Exhibit 2.1 to the Company's Report on Form 8-K dated September 18,
2000 and dated September 11, 2000). *
3.1 -- Restated Certificate of Incorporation of the Company (filed as
Exhibit 2.2 to Company's Registration Statement on Form S-1
(Registration No. 333-49439)). *
3.2 -- Restated By-Laws of the Company (filed as Exhibit 3.2 to Company's
Registration Statement on Form S-1 (Registration No. 333-49439)). *
4.1 -- Stockholders' Agreement, among the Company, Time Warner Companies,
Inc., American Television and Communications Corporation, Warner
Communications Inc., TW/TAE Inc., FibrCOM Holdings, L.P., Paragon
Communications, MediaOne Group, Inc., Multimedia Communications,
Inc. and Advance/Newhouse Partnership (filed as Exhibit 4.1 to
Company's Registration Statement on Form S-1 (Registration No.
333-49439)). *
4.2 -- Indenture, between TWT LLC, TWT Inc. and The Chase Manhattan Bank,
as Trustee (filed as Exhibit 4.1 to TWT LLC's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998). *
10.1 -- Credit Agreement among Time Warner Telecom Inc., Time Warner
Telecom Holdings Inc., the several lenders from time to time
parties hereto, The Chase Manhattan Bank, as Administrative Agent,
Bank of America, N.A., as Syndication Agent and ABN Amro Bank N.V.,
as Documentation Agent (filed as Exhibit 10.1 to Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2000). *
10.2 -- Time Warner Telecom Inc. 2000 Employee Stock Plan (filed as Exhibit
4.3 to the Company's Registration Statement on Form S-8,
Registration No. 333-48084). *
10.3 -- Time Warner Telecom Inc. Independent Director Compensation Plan
(filed as Exhibit 4.3 to the Company's Registration Statement on
Form S-8, Registration No. 333-48098). *
27 -- Financial Data Schedule
* Incorporated by reference.
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Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TIME WARNER TELECOM INC.
Date: November 14, 2000 By: /s/ Jill R. Stuart
------------------------------------------
Jill R. Stuart
Vice President, Accounting and Finance and
Chief Accounting Officer
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