<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
Quarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act
of 1934 for the quarterly period ended MARCH 31, 1996
COMMISSION FILE NUMBER: 1-11052
INTELCOM GROUP INC.
(Exact name of Registrant as Specified in its Charter)
CANADA N/A
(Jurisdiction of Incorporation) (I.R.S. Employer Identification Number)
JAMES D. GRENFELL, CHIEF FINANCIAL OFFICER
INTELCOM GROUP INC. C/O INTELCOM GROUP (U.S.A.), INC.
#11 - 1155 NORTH SERVICE ROAD WEST 9605 EAST MAROON CIRCLE
OAKVILLE, ONTARIO, CANADA L6M 3E3 P.O. BOX 6742
(Registrant's Principal Executive Offices) ENGLEWOOD, COLORADO 80155-6742
(905) 469-0686 (303) 572-5960
(Registrant's telephone number, (Agent for Service)
including area code)
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 Registrant's outstanding common shares as of May 9, 1996 was
26,329,721.
1
<PAGE>
INTELCOM GROUP INC.
Part I - Financial Information
------------------------------
<TABLE>
<CAPTION>
<S> <C> <C>
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets as of September 30, 1995 and March 31, 1996........ 3
Consolidated Statements of Operations for the Three Months and Six Months
Ended March 31, 1995 and 1996 ............................................... 5
Consolidated Statement of Shareholders' Equity for the Year ended
September 30, 1995 and Six Months Ended March 31, 1996 ...................... 6
Consolidated Statements of Cash Flows for the Six Months
Ended March 31, 1995 and 1996 ............................................... 7
Notes to Consolidated Financial Statements .................................... 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ....................................................... 13
Part II - Other Information
---------------------------
Part II - Other Information ................................................... 26
Signatures .................................................................... 27
</TABLE>
<PAGE>
INTELCOM GROUP INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except shares)
<TABLE>
<CAPTION>
September 30, March 31,
1995 1996
------------- ---------
(unaudited)
ASSETS
------
<S> <C> <C>
Current assets:
Cash and cash equivalents (note 1) $269,416 139,485
Short-term investments at cost, approximating market value (note 1) - 19,552
Receivables:
Trade, net of allowance of $2,217 and $2,859 at September 30, 1995
and March 31, 1996, respectively 23,483 29,221
Revenue earned, but unbilled (note 2) 7,046 2,358
Joint venture and affiliate 732 730
Other 1,430 1,517
Inventory 2,165 2,368
Prepaid expenses and deposits 3,424 2,136
Notes receivable 1,761 1,650
-------- --------
Total current assets 309,457 199,017
Property and equipment 228,609 307,382
Less accumulated depreciation (note 2) (26,605) (31,440)
-------- --------
202,004 275,942
Investments 5,209 9,169
Long - term notes receivable 7,599 9,683
Restricted cash (note 8) - 13,333
Other assets, net of accumulated amortization:
Transmission and other licenses 10,792 8,910
Goodwill 29,199 30,487
Other 19,293 20,026
-------- --------
59,284 59,423
-------- --------
$583,553 566,567
======== ========
</TABLE>
(continued)
3
<PAGE>
INTELCOM GROUP INC.
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(in thousands, except shares)
<TABLE>
<CAPTION>
September 30, March 31,
1995 1996
------------- ----------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable $ 14,712 13,459
Accrued liabilities 18,346 23,423
Line-of-credit payable 3,692 -
Current portion of long-term debt (note 4) 14,454 1,185
Current portion of capital lease obligations 9,164 8,014
--------- -------
Total current liabilities 60,368 46,081
Long-term debt, net of discount, less current portion (note 4) 379,100 393,704
Capital lease obligations, less current portion 26,435 65,392
Deferred income taxes (note 2) 5,702 847
Share of losses of joint venture in excess of investment 1,037 1,847
--------- -------
Total liabilities 472,642 507,871
Minority interests 4,040 3,612
Redeemable preferred stock of subsidiary
($30,000,000 liquidation value) (note 5) 14,986 19,571
Shareholders' equity (note 5):
Convertible Series B Preferred Stock, no par value, 2,000,000
shares authorized; 990,000 shares issued
and outstanding at September 30, 1995 9,350 -
Common shares, no par value, 100,000,000
shares authorized; 24,990,839 and 26,301,926
shares issued and outstanding at September 30, 1995
and March 31, 1996, respectively 190,753 205,284
Additional paid-in capital 26,492 26,520
Foreign currency translation adjustment (330) (330)
Accumulated deficit (note 2) (134,380) (195,961)
--------- -------
Total shareholders' equity 91,885 35,513
--------- -------
Commitments and contingencies (note 8)
$ 583,553 566,567
========= =======
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
INTELCOM GROUP INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
March 31, March 31,
1995 1996 1995 1996
------------------- -------------------
<S> <C> <C> <C> <C>
Revenue:
Telecom services (note 2) $ 7,039 17,635 12,833 31,148
Network services 13,496 13,973 28,789 29,691
Satellite services 5,387 4,336 8,934 10,504
-------- -------- ------- -------
Total revenue 25,922 35,944 50,556 71,343
Cost of services 16,768 25,150 33,253 49,824
Selling, general and administrative expenses 16,003 19,175 27,485 40,239
Depreciation and amortization (note 2) 3,776 7,442 7,107 12,361
-------- -------- ------- -------
36,547 51,767 67,845 102,424
Operating loss (10,625) (15,823) (17,289) (31,081)
Other income (expense):
Interest expense (3,626) (14,217) (6,197) (29,432)
Interest income 820 2,725 1,203 6,475
Share of losses of joint venture (230) (582) (356) (810)
Other, net (411) (1,554) (902) (2,577)
-------- -------- ------- -------
Loss before minority interest, income taxes and
cumulative effect of change in accounting (14,072) (29,451) (23,541) (57,425)
Minority interest in share of losses,
accretion and preferred dividends (note 7) 539 (1,970) 511 (4,158)
-------- -------- ------- -------
Loss before income taxes and cumulative effect
of change in accounting (13,533) (31,421) (23,030) (61,583)
Income tax benefit (expense) (note 2) 25 4,482 (11) 4,482
-------- -------- ------- -------
Loss before cumulative effect of change in accounting (13,508) (26,939) (23,041) (57,101)
Cumulative effect of change in accounting for
revenue from long-term telecom services contracts - - - (3,453)
-------- -------- ------- -------
Net loss (13,508) (26,939) (23,041) (60,554)
Preferred stock dividend (note 6) - - - (1,027)
Net loss attributable to
common shareholders $ (13,508) (26,939) (23,041) (61,581)
======== ======== ======= =======
Loss per common share:
Loss before cummulative effect of
change in accounting $ (0.57) (1.04) (1.01) (2.24)
Cumulative effect of change in accounting - - - (0.14)
Preferred stock dividend - - - (0.04)
-------- -------- ------- -------
Loss per common share $ (0.57) (1.04) (1.01) (2.42)
======== ======== ======= =======
Weighted average number of shares outstanding 23,577 25,803 22,746 25,471
======== ======== ======= =======
Pro forma amounts before cumulative effects of
change in accounting assuming the new method of
accounting for revenue from long-term telecom services
contracts is applied retroactively:
Net loss $ (13,878) (26,939) (23,681) (57,101)
======== ======== ======= =======
Net loss attributable to common shareholders $ (13,878) (26,939) (23,681) (58,128)
======== ======== ======= =======
Loss per common share $ (0.59) (1.04) (1.04) (2.28)
======== ======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
INTELCOM GROUP INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
Preferred Shares Common Shares
Shares Amount Shares Amount
------- ---------- ------- --------
(unaudited)
<S> <C> <C> <C> <C>
BALANCES AT SEPTEMBER 30, 1994 - $ - 17,047 $ 95,606
Shares issued for cash:
Public offering and private placements 1,600 16,000 6,312 84,498
Public offering and private placement costs - (850) - (6,162)
Exercise of options and warrants - - 338 1,471
Shares issued as repayment of debt and related accrued interest - - 614 8,402
Shares issued in connection with business combinations - - 130 1,737
Shares issued upon conversion of subordinated notes - - 69 1,080
Conversion of preferred shares (200) (2,000) 302 2,000
Shares issued as contribution to 401(k) plan - - 38 490
Warrants issued in connection with offerings - - - -
Redemption of preferred shares (410) (3,800) - -
Dividend on preferred shares - - - -
Change in foreign currency translation adjustment - - - -
Compensation expense related to issuance of
stock options - - - -
Shares issued in exchange for investments and other assets - - 123 1,398
Shares issued as payment of trade payables - - 18 233
Net loss - - - -
------- ---------- ------- --------
BALANCES AT SEPTEMBER 30, 1995 990 $ 9,350 24,991 $190,753
Shares issued for cash - options and warrants - - 103 766
Shares issued as contribution to 401(k) plan - - 54 576
Shares issued upon conversion of subordinated notes - - 520 8,120
Conversion of preferred shares (400) (3,780) 496 3,780
Redemption of preferred shares (590) (5,570) - -
Dividend on preferred shares - - - -
Shares issued as repayment of debt and related accrued interest - - 78 589
Shares issued in connection with business combinations - - 60 700
Compensation expense related to issuance of
stock options - - - -
Net loss - - - -
------- ---------- ------- --------
BALANCES AT MARCH 31, 1996 - $ - 26,302 $205,284
======= ========== ======= ========
Foreign
Additional Currency Total
Paid-in Translation Accumulated Shareholder
Capital Adjustment Deficit Equity
---------- ----------- ----------- -----------
(unaudited)
<S> <C> <C> <C> <C>
BALANCES AT SEPTEMBER 30, 1994 2,200 (292) (57,732) 39,782
Shares issued for cash:
Public offering and private placements - - - 100,498
Public offering and private placement costs - - - (7,012)
Exercise of options and warrants - - - 1,471
Shares issued as repayment of debt and related accrued interest - - - 8,402
Shares issued in connection with business combinations - - - 1,737
Shares issued upon conversion of subordinated notes - - - 1,080
Conversion of preferred shares - - - -
Shares issued as contribution to 401(k) plan - - - 490
Warrants issued in connection with offerings 24,134 - - 24,134
Redemption of preferred shares - - - (3,800)
Dividend on preferred shares - - (467) (467)
Change in foreign currency translation adjustment - (38) - (38)
Compensation expense related to issuance of
stock options 158 - - 158
Shares issued in exchange for investments and other assets - - - 1,398
Shares issued as payment of trade payables - - - 233
Net loss - - (76,181) (76,181)
------- ---------- ------- --------
BALANCES AT SEPTEMBER 30, 1995 26,492 (330) (134,380) 91,885
Shares issued for cash - options and warrants - - - 766
Shares issued as contribution to 401(k) plan - - - 576
Shares issued upon conversion of subordinated notes - - - 8,120
Conversion of preferred shares - - - -
Redemption of preferred shares - - - (5,570)
Dividend on preferred shares - - (1,027) (1,027)
Shares issued as repayment of debt and related accrued interest - - - 589
Shares issued in connection with business combinations - - - 700
Compensation expense related to issuance of
stock options 28 - - 28
Net loss - - (60,554) (60,554)
------- ---------- ------- --------
BALANCES AT MARCH 31, 1996 26,520 (330) (195,961) 35,513
======= ========== ======= ========
</TABLE>
See accompanying notes to consolidated financial statements
6
<PAGE>
INTELCOM GROUP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended
March 31,
1995 1996
--------- ---------
(unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $(23,041) (60,554)
Adjustments to reconcile net loss to net cash used by operating activities:
Cumulative effect of change in accounting - 3,453
Share of losses of joint venture 356 810
Minority interest in share of losses, accretion and preferred dividends (511) 4,158
Depreciation and amortization 7,107 12,361
Compensation expense related to issuance of stock options 79 28
Interest expense deferred and included in long-term debt 2,432 23,915
Amortization of deferred financing costs included in interest expense 360 689
Deferred debt issuance costs (118) -
Contribution to 401(k) plan through issuance of common shares 348 576
Deferred income tax benefit - (4,482)
Loss on sale of certain satellite assets - 891
Increase in operating assets, excluding the effects of business
acquisitions, dispositions and non-cash transactions:
Accounts receivable (1,831) (5,717)
Inventory (24) (362)
Prepaid expenses and deposits (5,076) (1,065)
Increase (decrease) in operating liabilities, excluding the effects
of business acquistions, dispositions and non-cash transactions:
Accounts payable and accrued liabilities (268) 3,676
--------- ---------
Net cash used by operating activities (20,187) (21,623)
--------- ---------
Cash flows from investing activities:
Notes receivable (4,955) 261
Advances to affiliates (292) (373)
Advances to joint venture (3,629) (1,951)
Payments for business acquisitions, net of cash acquired (8,229) (2,680)
Long-term investment (2,000) (3,960)
Investment in short-term investments - (19,552)
Restricted cash - (13,333)
Acquisition of property, equipment and other assets, net (18,536) (54,917)
Proceeds from the sale of certain satellite assets - 21,593
--------- ---------
Net cash used by investing activities (37,641) (74,912)
--------- ---------
Cash flows from financing activities:
Issuance of common shares for cash:
Public offering, net of costs 74,314 -
Exercise of options and warrants 691 766
Redemption of preferred shares - (5,570)
Dividend on preferred shares - (1,027)
Principal payments on capital lease obligations (2,504) (9,561)
Proceeds from issuance of short-term debt - 17,500
Principal payments on short-term debt - (21,192)
Principal payments on long-term debt (11,836) (14,312)
--------- ---------
Net cash provided (used) by financing activities 60,665 (33,396)
--------- ---------
Net increase (decrease) in cash equivalents 2,837 (129,931)
Cash and cash equivalents, beginning of period 6,025 269,416
--------- ---------
Cash and cash equivalents, end of period $ 8,862 139,485
========= =========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 3,405 4,828
========= =========
Supplemental schedule of non-cash financing and investing activities:
Common shares issued in connection with business combinations,
repayment of debt or conversion of liabilities to equity $ 12,097 9,409
========= =========
Assets acquired under capital leases and through the issuance of debt $ 31,351 47,368
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996 and 1995
(unaudited)
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
IntelCom Group Inc. ("IntelCom" or the "Company") is incorporated as a
Canadian federal corporation. IntelCom's primary business activity is
telecommunications services provided through its wholly owned U.S. subsidiary,
IntelCom Group (U.S.A.), Inc. ("ICG"). IntelCom and its subsidiaries are
referred to herein as the Company.
(a) Reference to Annual Report
These financial statements should be read in conjunction with the Annual
Report on Form 10-K/A for the year ended September 30, 1995, as certain
information and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to the rules and regulations of the United States
Securities and Exchange Commission. The interim financial statements reflect all
adjustments which are, in the opinion of management, necessary for a fair
presentation of financial position, results of operations and cash flows as of
and for the interim periods presented. Such adjustments are of a normal
recurring nature. Operating results for the six months ended March 31, 1996, are
not necessarily indicative of the results that may be expected for the year
ending September 30, 1996.
(b) Cash equivalents and short-term investments
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The Company invests
primarily in high grade short-term investments which consist of money market
instruments, commercial paper, certificates of deposit, government obligations
and corporate bonds. The Company's investment objectives are safety, liquidity
and yield, in that order.
Presently, the Company carries all cash equivalents and short-term
investments at cost, which approximates fair value. Gains and losses are
included in investment income in the period they are realized. The cost of all
securities sold is based on the specific identification method.
(c) Reclassifications
Certain 1995 amounts have been reclassified for comparative purposes.
2. CHANGE IN ACCOUNTING:
Effective January 1, 1996, the Company changed its method of accounting
for long-term telecom services contracts. Under the new method, the Company will
recognize revenue as services are provided and will continue to charge direct
selling expenses to operations as incurred. The Company had previously
recognized the noncancelable portion of the contract, which is a minimum of one
year on a three-year or longer contract, at the inception of the contract and
upon activation of service to the customer to the extent of direct installation
and selling expenses incurred in obtaining customers during the period in which
such revenue was recognized. Revenue recognized in excess of normal monthly
billings during the year was limited to an amount which did not exceed such
installation and selling expense. The remaining revenue from the contract had
been recognized ratably over the remaining noncancelable portion of the
contract. The Company believes the new method is preferable because it provides
a better matching of revenue and related operating expenses and is more
consistent with accounting practices within the telecommunications industry.
As required by generally accepted accounting principles, the Company has
restated its results for the three months ended December 31, 1995, to reflect
the effects of the change in accounting, as if such change had been adopted as
of October 1, 1995, and has presented the pro forma effects on prior periods
assuming the change had been applied retroactively. The Company's results for
the six months ended March 31, 1996, reflect a charge of $3,453,000 relating to
the cumulative effect of this change in accounting as of October 1, 1995. The
effect of this change in accounting in fiscal year 1996 was to decrease loss
before cumulative effect of change in accounting by approximately $196,000
($0.01 per common share) in the first quarter and to increase loss before
cumulative effect of change in accounting by approximately $174,000 ($0.01 per
common share) in the second quarter, for a net decrease in loss before
cumulative effect of change in accounting of approximately $22,000 (less than
$0.01 per common share) for the six months ended March 31, 1996.
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
In addition, the Company has shortened the estimated depreciable lives
for substantially all of its fixed assets. These estimates were changed to
better reflect the estimated periods during which these assets will remain in
service and result in useful lives which are more consistent with industry
practice. The changes in estimates of depreciable lives are being made on a
prospective basis, beginning January 1, 1996. The effect of this change was to
increase depreciation expense and net loss attributable to common shareholders
for the six months ended March 31, 1996, by $2.3 million ($0.92 per common
share). The deferred tax liability has been adjusted for the effect of this
change in estimated depreciable lives, which resulted in an income tax benefit
of $4.5 million for the three months ended March 31, 1996.
3. BUSINESS COMBINATIONS:
On January 3, 1996, the Company purchased the 49% minority interest of
Fiber Optic Technologies, Inc. ("FOTI"), making FOTI a wholly owned subsidiary.
Consideration for the purchase was $1,980,000 in cash and 66,236 common shares
of the Company valued at $770,000, for total consideration of $2,750,000.
In February 1996, the Company entered into an agreement with Linkatel
California, L.P. ("Linkatel") and its other partners, Linkatel Communications,
Inc., and The Copley Press, Inc., publisher of The San Diego Union Tribune,
under which the Company acquired a 60% interest in Linkatel for an aggregate
purchase price of $10.0 million in cash and became the general partner of
Linkatel. At March 31, 1996, the Company had invested $4.0 million in cash. The
remaining $6.0 million was paid in April 1996, at which time the partnership was
renamed ICG Telecom of San Diego, L.P. ("ICG Telecom of San Diego").
In March 1996, the Company acquired a 90% equity interest in Maritime
Cellular Tele-Network, Inc. ("MCN"), a Florida-based provider of cellular and
satellite communications for commercial ships, private vessels, off-shore
platforms and land-based mobile units, for $0.7 million in cash and $0.4 million
of assumed debt, for total consideration of $1.1 million.
4. LONG-TERM DEBT:
<TABLE>
<CAPTION>
September 30, March 31,
1995 1996
------------- ----------
(in thousands)
<S> <C> <C>
Senior discount notes, net of discount $299,934 321,255
Convertible subordinated notes (a) 74,434 68,534
Credit facility (paid subsequent to September 30, 1995) 13,515 -
Note payable with interest at 11%, due monthly
through fiscal 1999, secured by equipment 3,493 3,172
Mortgage payable with interest at 8.5%, due
monthly through 2009, secured by building 1,242 1,218
Notes payable to sellers of FOTI (paid subsequent to
September 30, 1995) 600 -
Notes payable to sellers of PrivaCom 99 99
Other 237 611
------------- ----------
393,554 394,889
Less current portion (14,454) (1,185)
------------- ----------
$379,100 393,704
============= ==========
</TABLE>
(a) During the six months ended March 31, 1996, $7.0 million of the convertible
subordinated notes and $1.1 million of the interest on such notes was converted
into 520,512 common shares of the Company.
9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. PRIVATE PLACEMENT:
On April 30, 1996, ICG completed a private placement (the "Private
Placement") of 12 1/2% Senior Discount Notes (the "12 1/2% Notes") and of
14 1/4% Exchangeable Preferred Stock (the "Preferred Stock") for gross proceeds
of $300.0 million and $150.0 million, respectively. Net proceeds from the
Private Placement after costs of approximately $17.0 million were approximately
$433.0 million.
The 12 1/2% Notes are unsecured senior obligations of ICG
(guaranteed by the Company) that mature on May 1, 2006, at a maturity value of
$550.3 million. Interest will accrue at 12 1/2% per annum beginning May 1, 2001,
and is payable each May 1 and November 1 commencing November 1, 2001.
The Preferred Stock consists of 150,000 shares that bear a cumulative
dividend at the rate of 14 1/4% per annum. The dividend is payable quarterly in
arrears each February 1, May 1, August 1 and November 1 commencing August
1,1996. Through May 1, 2001, the dividend is payable at the option of ICG in
cash or additional shares of Preferred Stock. ICG may exchange the Preferred
Stock into 14 1/4% Senior Subordinated Exchange Debentures at any time after the
exchange is permitted by certain indenture restrictions. The Preferred Stock is
subject to mandatory redemption on May 1, 2007.
Approximately $35.3 million of the proceeds from the Private Placement
were used to redeem the 12% Redeemable Preferred Stock of ICG (the "Redeemable
Preferred Stock") issued in August 1995 ($30.0 million), pay accrued preferred
dividend ($2.6 million) and to repurchase 916,666 warrants of the Company ($2.7
million) issued in connection with the Redeemable Preferred Stock. The Company
recognized a charge of approximately $12.3 million for the excess of the
redemption of the Redeemable Preferred Stock over the carrying amount at April
30, 1996, and recognized a charge of approximately $11.5 million for the payment
with respect to consents to amendments to the 13 1/2% Notes Indenture to permit
the Private Placement, which together will be reflected in the Company's results
of operations for the three months ended June 30, 1996. See further discussion
of the use of proceeds in "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
6. SHAREHOLDERS' EQUITY:
Preferred Stock
During the first six months of fiscal 1996, the Company repurchased
$5,570,000 of Series B Preferred Stock and $3,780,000 of the Series B Preferred
Stock was converted to common shares. The excess of the repurchase and
conversion price over the stated value of the preferred shares purchased of
$1,027,000 has been recorded as a preferred stock dividend in the accompanying
consolidated financial statements.
7. MINORITY INTEREST IN SHARE OF LOSSES, ACCRETION AND PREFERRED
DIVIDENDS:
Included in minority interest in share of losses, accretion and
preferred dividends for the six months ended March 31, 1996, is approximately
$4,586,000 associated with the ICG Preferred Stock, including accretion of
warrants issued in connection with the Preferred Stock, accretion of issuance
costs, and a 12% preferred dividend accrual. These costs are offset by the
minority interest share of losses in subsidiaries of approximately $428,000.
8. COMMITMENTS AND CONTINGENCIES:
(a) Sale of Teleports
In December 1995, the Company received approximately $21,100,000 from
the purchaser of four of its teleports in partial payment for the assets and
entered into a management agreement with the purchaser whereby the purchaser
took over the teleport operations. Upon FCC approval of the transaction the
Company completed the sale in March 1996 and received an additional $400,000 due
to certain closing adjustments. Total proceeds received was $21,500,000 and the
Company recognized a loss of approximately $800,000. Revenue associated with
these assets was approximately $2.1 million and $4.5 million for the three and
six months ended March 31, 1995, respectively, and $2.5 million for the three
months ended December 31, 1995. The Company has reported results of operations
from these assets through December 31, 1995.
(b) Network Construction
In November 1995, the Company signed an agreement with City Public
Service of San Antonio ("CPS") to license excess fiber optic facilities on a new
300-mile fiber network being built by the municipally owned electric and gas
utility
10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
to provide for its communications needs in the greater metropolitan area.
Pursuant to this agreement the Company has provided a $12.0 million irrevocable
letter of credit to finance the Company's portion of the construction costs. The
letter of credit is secured by cash collateral of $13.3 million.
In February 1996, the Company entered into a 20-year agreement with
WorldCom, Inc. ("WorldCom") under which the Company will pay approximately $8.8
million for the right to use fiber along a 330-mile fiber optic network in Ohio.
The network is being constructed by WorldCom in conjunction with the Company. An
aggregate of approximately $2.6 million has been paid by the Company through
March 31, 1996, with the balance due upon the completion of specified segments
of the network.
In March 1996, the Company and Southern California Edison Company
("SCE") jointly filed a 25-year agreement with the California Public Utilities
Commission ("CPUC") under which the Company will license 1,258 miles of fiber
optic cable in Southern California. The agreement also allows the Company to
utilize SCE's facilities to install up to 500 additional miles of fiber optic
cable. Under the terms of this agreement, SCE will be entitled to receive an
annual fee for ten years, certain fixed quarterly payments, including a
quarterly payment equal to a percentage of certain network revenue, and certain
other installation and fiber connection fees. The aggregate fixed payments
remaining under this 25-year agreement totaled approximately $146.0 million at
March 31, 1996. The agreement has been accounted for as a capital lease in the
accompanying consolidated balance sheets at March 31, 1996.
In March 1996, the Company entered into a long-term agreement with a
subsidiary of The Southern Company ("Southern") and Alabama Power Company
("Alabama Power") for the right to use 22 miles of existing fiber and 122 miles
of additional Alabama Power rights of way and facilities to reach the three
major business centers in Birmingham. Southern will, in conjunction with the
Company, construct the network and provide maintenance services with respect to
the fiber installed. Southern also will provide consulting services to the
Company relating to the buildout of the network and potential enhancements to
the Company's products and services. Under the agreement, the Company also is
required to pay Southern a quarterly fee based on specified percentages of the
Company's revenue for services provided through this network.
In addition to the above agreements, the Company has entered into
commitments to purchase assets with an aggregate purchase price of approximately
$12.0 million at March 31, 1996.
(c) Litigation
In July 1994, FOTI was notified that it had been debarred and that, as a
result, the federal government would not solicit, award to, or permit contracts
or subcontracts with FOTI for federal government work through March 1997.
Federal government contract work by FOTI accounted for revenue of approximately
$1.8 million, $1.5 million and $0.2 million for the fiscal years ended September
30, 1993, 1994 and 1995, respectively. Therefore, the revenue that has been lost
during the debarment is not material. The debarment proceeding was conducted by
the Department of the Army ("Army") and related to work performed by FOTI as a
subcontractor on a $38,000 government project which was completed in 1992 (prior
to the Company's acquisition of its majority equity interest in FOTI). Employees
of FOTI allegedly falsified test results when conducting final testing of the
FOTI work on the project. Although FOTI had been debarred, it continued to bid
and accept work on federal government contracts. Certain of these actions may
not have complied with the terms of the suspension and debarment or with
applicable federal regulations. The Company's senior management did not learn of
FOTI's suspension, debarment or post-debarment conduct until late March 1995. On
May 5, 1995, FOTI filed a request with the Army for reconsideration of the
debarment order. On July 21, 1995, the Inspector General informed the Company
that it had been accepted to the Department of Defense's Voluntary Disclosure
Program. The Company expects that the debarment and voluntary disclosure will be
resolved with less than $200,000 in fines, penalties and costs, one-half of
which will be paid by the former minority shareholders of FOTI, resulting in a
net cost to the Company of less than $100,000.
Four putative class action complaints have been filed in the U.S.
District Court for the District for Colorado by shareholders of the Company
naming the Company, William W. Becker, Larry L. Becker, John R. Evans and
William J. Maxwell as defendants. The complaints allege that the defendants
violated the Securities Exchange Act of 1934, as amended (the "Exchange Act"),
with respect to the content and timing of its disclosures concerning the
suspension and debarment of FOTI. The complaints seek damages for all persons
who purchased common shares of the Company between May 16, 1994
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
and May 16, 1995. The Company has filed an answer, discovery has commenced and
plaintiffs have recently filed a motion for class certification. After
consultation with legal counsel, the Company believes that it has meritorious
defenses and intends to vigorously defend these lawsuits.
The Company is a party to certain other litigation which has arisen in
the ordinary course of business. In the opinion of management and legal counsel,
the ultimate resolution of these matters will not have a significant effect on
the financial condition of the Company.
9. SUMMARIZED FINANCIAL INFORMATION OF SUBSIDIARY
The separate complete financial statements of ICG have not been included
herein because such disclosure is not considered to be material to the holders
of the Senior Notes issued by ICG in August 1995. However, summarized
consolidated financial information for ICG and subsidiaries as of September 30,
1995 and March 31, 1996 and for the six months ended March 31, 1995 and 1996 is
as follows (in thousands):
Summarized Consolidated Balance Sheet Information
<TABLE>
<CAPTION>
September 30, 1995 March 31, 1996
------------------ --------------
<S> <C> <C>
Current assets $309,208 198,865
Property and equipment, net 201,983 275,942
Other noncurrent assets, net 66,737 86,736
Current liabilities 60,036 45,894
Long-term debt, less current portion 304,666 325,170
Due to shareholder 238,282 108,233
Other noncurrent liabilities 37,214 71,698
Preferred stock 14,986 19,572
Shareholders' deficit (77,256) (9,024)
Summarized Consolidated Statement of Operations Information
Six Months Ended March 31,
1995 1996
-------- --------
Total revenue $50,556 71,343
Total operating costs and expenses 67,437 101,709
Operating loss (16,881) (30,366)
Net loss attributable to common
shareholders (19,576) (56,786)
</TABLE>
12
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion includes certain forward-looking statements
which are affected by important factors including, but not limited to,
dependence on increased traffic on the Company's facilities, increased Satellite
Services revenue from the cruise ship and U.S. Navy telephone services business
and actions of competitors and regulatory authorities, that could cause actual
results to differ materially from the forward-looking statements.
COMPANY OVERVIEW
The Company provides Telecom Services, Network Services and Satellite
Services. Telecom Services consist of the Company's CLEC (competitive local
exchange company) operations. Network Services consist of information technology
services, network design and installation and support of network systems.
Satellite Services consist of domestic and international satellite transmission
services. The Company commenced the design and construction of its first fiber
optic network in Denver in 1990, which became operational to a limited extent in
May 1991. The Company's rapid growth since 1990 is the result of the initial
installation, acquisition and subsequent expansion of its networks, the
acquisition and growth of its network systems integration business and growth in
satellite services. During 1992 and 1993, the Company continued to build out its
Denver network. The Company began construction of its fiber optic network in
Phoenix during 1993 and expanded this network throughout 1994. During 1994, the
Company commenced construction of networks in Akron, Boulder, Colorado Springs,
Columbus and Nashville. The Company also acquired operating networks serving
Charlotte, Cleveland, Dayton, Louisville, Melbourne, Florida, Sacramento and 17
cities with populations in excess of 100,000 in the Los Angeles and San
Francisco metropolitan areas. In addition, in 1995 the Company commenced
development of fiber optic networks in Birmingham and Greensboro/Winston-Salem.
The Company intends to sell its networks in Melbourne and Phoenix. Since
initiation of competitive access services, the Company has experienced declining
access rates and increasing price competition which have been more than offset
by increasing network usage. The Company expects to continue to experience
declining access rates for the foreseeable future.
The Company first began providing Satellite Services in 1990 when it
acquired its Denver teleport facility, which has since been sold. Growth in
Satellite Services revenue has resulted principally from increased transmissions
of video programming, the acquisitions of satellite teleports in the Los
Angeles, Atlanta and New York metropolitan areas in 1994 (three of which have
been sold), the acquisition of Nova-Net Communications, Inc. in 1994 and the
acquisition of a 64% interest in Maritime Telecommunication Network, Inc.
("MTN") in January 1995. The Company acquired a 51% interest in FOTI, which
accounts for most of the Company's Network Services, in May 1992 and the
remaining 49% in January 1996. As a result of the significant lag time between
commencement of network development and generation of appreciable related
Telecom Services revenue, the majority of the Company's revenue historically has
been derived from Network Services. However, the Company's Network Services
revenue (as well as Satellite Services revenue) will continue to represent a
diminishing percentage of the Company's consolidated revenue as the Company
continues to emphasize its Telecom Services.
In the third and fourth quarters of fiscal 1994 and throughout fiscal
1995, the Company launched its switched services strategy by acquiring 13 high
capacity digital switches. The Company has installed switches in Birmingham,
Charlotte, Cleveland, Columbus, Denver, Irvine, Los Angeles, Louisville,
Melbourne, Nashville, Oakland, Phoenix and Sacramento. The Company financed the
acquisition of 12 of the switches pursuant to capital leases totaling $24.5
million. The Company began generating switched services revenue in the fourth
quarter of fiscal 1994 and expects revenue from switched services to continue to
increase. The Company's switched minutes of use have increased from 10 million
minutes in the first quarter of fiscal 1995 to 362 million in the second quarter
of fiscal 1996.
In November 1995, the Company entered into a long-term agreement with
CPS to license half of the capacity on a 300-mile fiber optic network (60 of
which currently exist) in greater San Antonio. It is anticipated that the
network will be able to service 120 buildings when completed in approximately
two years. During construction, the Company will be able to provide services to
completed segments of the network.
13
<PAGE>
The Company recently invested $10.0 million to acquire a 60% interest
in, and became the general partner of, ICG Telecom of San Diego, a partnership
whose other partners are Linkatel Communications, Inc. and The Copley Press
Inc., the publisher of The San Diego Union Tribune. ICG Telecom of San Diego
operates a 50-mile fiber optic network and is constructing an additional 110
miles of fiber in metropolitan San Diego. In February 1996, the Company entered
into a long-term agreement with WorldCom under which the Company will pay
approximately $8.8 million for the right to use fiber along a 330-mile fiber
optic network in Ohio. The network, which is being constructed by WorldCom in
conjunction with the Company, will provide a direct fiber link between the
Company's existing networks in Akron, Cleveland, Columbus and Dayton and its new
network under development in Cincinnati.
In March 1996, the Company and SCE jointly filed an agreement with the
CPUC under which the Company will license 1,258 miles of fiber optic cable in
Southern California. The agreement allows the Company to utilize SCE's
facilities to install up to 500 additional miles of fiber optic cable. The
Company has identified over 1,300 buildings which will be targeted by the
Company for connection to the network. Also in March 1996, the Company entered
into a national contract with AT&T Corp. ("AT&T") under which the Company will
provide special and switched access services to AT&T on a non-exclusive basis.
The Company and AT&T initially have identified 12 MSAs (metropolitan statistical
areas) in which the Company will provide services to AT&T and are in discussions
with respect to seven additional MSAs in which the Company may provide services.
Under the agreement, the Company will work with AT&T to provide special and
switched access services in the Company's other markets and new markets which
the Company may enter. In March 1996, the Company entered into a long-term
license agreement with a subsidiary of Southern, an affilate of Alabama Power,
for the right to use 22 miles of existing fiber and 122 miles of additional
Alabama Power rights of way and facilities to reach the three major business
centers in Birmingham.
The Company expects to continue to experience negative operating margins
from the provision of switched services while its networks are in the
development and construction phases, during which the Company relies on local
exchange carrier ("LEC") networks to carry a significant portion of its
customers' traffic. The Company expects to realize improved operating margins
for switched services on a given network when (i) sales efforts result in
increased volumes of traffic carried on the Company's own network instead of LEC
facilities, and (ii) higher margin enhanced services are provided to customers
on the network. In addition, the Company believes that the unbundling of LEC
services and the implementation of local telephone number portability, which are
mandated by the Federal Telecommunications Act of 1996, will reduce the
Company's costs of providing switched services and facilitate the marketing of
such services. However, the Company's switched services strategy has not yet
been profitable and may not become profitable due to, among other factors, lack
of customer demand, competition from other CLECs and pricing pressure from the
LECs. In addition, in order to fully implement its switched services strategy,
the Company must make significant capital expenditures to provide additional
switching capacity, network infrastructure and electronic components. The
Company has limited experience providing switched services and there can be no
assurance that the Company will be able to successfully implement its switched
services strategy.
The continued development, construction and expansion of the Company's
business requires significant capital, a large portion of which is expended
before any revenue is generated. The Company has experienced, and expects to
continue to experience, negative cash flow and significant losses while it
implements its switched services strategy, expands its operations and
establishes a sufficient revenue-generating customer base. There can be no
assurance that the Company will be able to establish such a customer base. When
constructing and relying principally on its own facilities, the Company has
experienced a period of up to 18 months from initial design of a network to
revenue generation for that network. However, based upon its experience with
using leased LEC facilities to provide initial customer service and the
Company's new agreements to use utilities' existing fiber, the Company
anticipates accelerating initial revenue generation to within six to nine months
after commencing network design.
The Company estimates that a new network will generate positive EBITDA
(before corporate allocations) within 6 to 12 months after initial revenue
generation. There can be no assurance that this estimate will be realized in any
particular market. EBITDA consists of operating loss plus depreciation and
amortization. EBITDA is provided because it is a measure commonly used in the
telecommunications industry. It is presented to enhance an understanding of the
Company's operating results and is not intended to represent cash flow or
results of operations in accordance with generally accepted accounting
principles for the periods indicated. When describing a particular business
operation, certain corporate expenses not attributable to the business operation
(e.g., corporate overhead and related expenses) are not directly allocated to
the specific business operation, and therefore EBITDA for a particular business
operation is referred to as "EBITDA (before corporate allocations)." The Company
allocated corporate overhead and related expenses of approximately $25.3 million
to its Telecom Services in fiscal 1995 compared to $8.5 million in fiscal 1994,
and $16.0 million for the six months ended March 31, 1996 compared to $9.6
million for the six months ended March 31, 1995.
14
<PAGE>
The Company has expanded the number of Telecom Services markets it
serves from six markets at the end of fiscal 1993 to 37 markets at March 31,
1996. The Company's Los Angeles and San Francisco metropolitan area networks,
acquired in April 1994 and serving 17 cities with populations in excess of
100,000, accounted for approximately 38% and 44% of the Company's Telecom
Services revenue for fiscal 1995 and the six months ended March 31, 1996,
respectively. The Company's Denver network accounted for approximately 30% and
22% of the Company's Telecom Services revenue for fiscal 1995 and the six months
ended March 31, 1996, respectively. The Company's Denver network generated
initial revenue in the fourth quarter of fiscal 1991 and generated positive
EBITDA (before corporate allocations) in the fourth quarter of fiscal 1992. The
Company's networks in Cleveland and Colorado Springs generated positive EBITDA
(before corporate allocations) in fiscal 1994. The Boulder network, which the
Company began to construct in 1994, generated positive EBITDA (before corporate
allocations) in the first fiscal quarter of 1995. The Phoenix network, which the
Company intends to sell, generated initial revenue in the first quarter of
fiscal 1994 and has not generated positive EBITDA. The Company's Louisville and
Melbourne networks, acquired in April and July of 1994, respectively, the
Nashville network, which the Company began to construct in 1994, and the
Company's Akron and Columbus networks, which became operational in fiscal 1995,
have not generated positive EBITDA. The Company intends to sell its Melbourne
network. The Company has commenced operation of a fiber optic network in
Birmingham and is developing fiber optic networks in Greensboro and Winston-
Salem. The Los Angeles metropolitan area network generated positive EBITDA
(before corporate allocations) prior to its acquisition in fiscal 1994. The
network reported negative EBITDA for fiscal 1995 and for the first two quarters
of fiscal 1996 as a result of expenses associated with the introduction of
switched services. The San Francisco metropolitan area network first generated
positive EBITDA (before corporate allocations) in the fourth quarter of fiscal
1993, which was prior to its acquisition by the Company. The Charlotte network
generated positive EBITDA (before corporate allocations) in fiscal 1994. The
Charlotte network reported negative EBITDA in the second and third quarters of
fiscal 1995 as a result of expenses incurred in connection with the introduction
of switched services. The Charlotte network again generated positive EBITDA
(before corporate allocations) in the fourth quarter of fiscal 1995 and the
first two quarters of fiscal 1996. The Company's network in Dayton generated
positive EBITDA (before corporate allocations) in the first quarter of fiscal
1995.
The Board of Directors of IntelCom has adopted a plan under which
IntelCom will become a subsidiary of a new publicly traded United States
corporation. Substantially all of the Company's operations (which are conducted
by ICG's subsidiaries) are located in the United States. In addition, the
Company views the United States as its primary source for raising capital in the
future and the Company believes that the United States incorporation will
facilitate access to such markets and increase its flexibility to meet its
future financing needs. Also, certain aspects of the Company's operations are
regulated by the FCC, which imposes restrictions on the interests a foreign
company may hold in telecommunications businesses in the United States.
15
<PAGE>
RESULTS OF OPERATIONS
The following table provides a breakdown of revenue and cost of services
for Telecom Services, Network Services, Satellite Services and certain other
financial data for the Company for the periods indicated. The table also shows
certain revenue, expenses, operating loss and EBITDA as a percentage of the
Company's total revenue.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
March 31, March 31,
----------------------------------------- ---------------------------------
1995 1996 1995 1996
------------------- ------------------ ---------------- --------------
$ % $ % $ % $ %
--------- --------- --------- ------ --------- ----- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue:
Telecom services (1) 7,039 27 17,635 49 12,833 25 31,148 44
Network services 13,496 52 13,973 39 28,789 57 29,691 42
Satellite services 5,387 21 4,336 12 8,934 18 10,504 15
--------- -------- --------- ------ --------- ----- -------- ----
Total revenue 25,922 100 35,944 100 50,556 100 71,343 100
Cost of services:
Telecom services 3,380 12,173 5,715 21,619
Network services 10,902 11,058 23,199 23,056
Satellite services 2,486 1,919 4,339 5,149
--------- -------- --------- ------ --------- ----- -------- ----
Total cost of services 16,768 65 25,150 70 33,253 66 49,824 70
Selling, general and administrative 16,003 62 19,175 53 27,485 54 40,239 56
Depreciation and amortization 3,776 15 7,442 21 7,107 14 12,361 17
--------- -------- --------- ------ --------- ----- -------- ----
Operating loss (10,625) (41) (15,823) (44) (17,289) (34) (31,081) (43)
EBITDA (2) (6,849) (26) (8,381) (23) (10,182) (20) (18,720) (26)
Supplemental Pro Forma Data (1):
Telecom services revenue 6,669 26 17,635 49 12,193 24 31,148 44
Total revenue 25,552 100 35,944 100 49,916 100 71,343 100
Operating loss (10,995) (43) (15,823) (44) (17,929) (36) (31,081) (43)
EBITDA (7,219) (28) (8,381) (23) (10,822) (22) (18,720) (26)
</TABLE>
<TABLE>
<CAPTION>
STATISTICAL DATA: March 31, June 30, September 30, December 31, March 31,
Telecom networks: 1995 1995 1995 1995 1996
--------- --------- ------------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Cities served 32 32 32 32 37
Buildings connected:
On-net 251 273 280 304 327
Off-net 777 978 1,095 1,235 1,401
--------- --------- ------------- ------------ ---------
Total buildings connected 1,028 1,251 1,375 1,539 1,728
Customer circuits in service (VGE's) 287,167 389,928 430,535 488,403 510,755
Switches operational 6 12 13 13 13
Switched minutes of use
(millions) (3) 32 97 144 235 362
Fiber route miles: (4)
Operational 466 579 627 637 780
Under construction - - - - 1,921
Fiber strand miles: (5)
Operational 21,811 25,264 27,150 28,779 36,310
Under construction - - - - 52,351
Wireless miles (6) 606 606 568 545 582
Satellite Services:
Teleports 5 5 5 5 1
Teleport antennas 58 59 59 59 7
VSAT's 694 687 626 633 658
Maritime installations 17 24 27 31 33
Maritime minutes of use
(thousands) (3) 251 479 694 747 1,337
</TABLE>
(Accompanying footnotes are on the following page)
16
<PAGE>
(1) Effective January 1, 1996, the Company changed its method of
accounting for long-term telecom services contracts to recognize
revenue as services are provided. See "--Accounting Matters--
Accounting Changes." As required by generally accepted accounting
principles, the Company has restated its results for the three
months ended December 31, 1995 to reflect the effects of the
change in accounting as if such change had been adopted as of
October 1, 1995, and is presenting the pro forma effects on prior
periods assuming the change had been applied retroactively.
(2) EBITDA consists of operating loss plus depreciation and
amortization. EBITDA is provided because it is a measure commonly
used in the telecommunications industry. It is presented to
enhance an understanding of the Company's operating results and is
not intended to represent cash flow or results of operations in
accordance with generally accepted accounting principles for the
periods indicated.
(3) Amounts presented are for three-month periods.
(4) Fiber route miles refers to the number of miles of fiber optic
cable, including leased fiber. As of March 31, 1996, the Company
had 780 fiber route miles, of which 178 fiber route miles were
leased. Fiber route miles under construction represents fiber
under construction and fiber which is expected to be
operational within six months.
(5) Fiber strand miles refers to the number of fiber route miles,
including leased fiber, along a telecommunications path multiplied
by the number of fiber strands along that path. As of March 31,
1996, the Company had 36,310 fiber strand miles, of which 1,847
fiber strand miles were leased. Fiber strand miles under
construction represents fiber under construction and fiber which
is expected to be operational within six months.
(6) Wireless miles represents the total distance of the digital
microwave paths between Company transmitters which are used in the
Company's networks.
THREE MONTHS ENDED MARCH 31, 1996, COMPARED TO THREE MONTHS ENDED MARCH 31, 1995
The following information reflects the results of operations for the three
months ended March 31, 1996, compared to the pro forma results of operations for
the three months ended March 31, 1995, assuming the change in accounting for
long-term telecom services contracts described in "--Accounting Matters--
Accounting Changes" had been applied retroactively.
Revenue. Revenue for the three months ended March 31, 1996, increased
$10.4 million, or 40.7%, from the three months ended March 31, 1995. The
increase in total revenue reflects continued growth in Telecom Services and
Network Services, offset slightly by the decline in Satellite Services revenue
resulting from the sale of four of the Company's teleports. Telecom Services
revenue increased 164.4% to $17.6 million due to an increase in network usage
for both special and switched access services, offset in part by a decline in
average access rates. The number of operational switches increased from six as
of March 31, 1995, to 13 as of March 31, 1996. Switched minutes of use increased
from 32 million during the quarter ended March 31, 1995, to 362 million for the
quarter ended March 31, 1996. Network usage as reflected in VGEs increased 77.9%
from 287,167 VGEs on March 31, 1995, to 510,755 VGEs on March 31, 1996. On March
31, 1995, the Company had 251 on-net buildings connected to its networks
compared to 327 on-net buildings connected on March 31, 1996. Network Services
revenue increased 3.5% to $14.0 million primarily due to additional projects
from existing customers and increased business networking requirements.
Consistent with expectations, Network Services revenue decreased by 11.1%
compared to the first quarter of fiscal year 1996, while the Company continued
to reposition its systems and operations to better manage its bottom line
growth. Satellite Services revenue decreased 19.5% to $4.3 million for the three
months ended March 31, 1996. The decrease resulted from the sale of four of the
Company's teleports. The decrease is partially offset by an increase in maritime
services revenue from MTN. Satellite Services revenue for the three months ended
March 31, 1995, on a pro forma basis to reflect the recent sale of the
teleports, was $3.3 million.
Cost of Services. Total cost of services for the three months ended
March 31, 1996 increased $8.4 million, or 50.0%, from the three months ended
March 31, 1995. Telecom cost of services increased from $3.4 million, or 50.7%,
of Telecom Services revenue for the three months ended March 31, 1995, to $12.2
million, or 69.0%, of Telecom Services revenue for the three months ended March
31, 1996. Telecom cost of services consists of payments to LECs for the use of
network facilities to support off-net and switched services, right of way fees
and other costs. The increase in absolute dollars is attributable to the
increase in switched services and the expansion in off-net special access
service offerings. The increase in the cost of services as a percentage of total
revenue is due primarily to the increase in revenue from switched services which
currently generate lower margins than special access revenue. The Company
expects that its Telecom Services ratio of cost of services to revenue will
improve as the Company carries a greater proportion of traffic
17
<PAGE>
on its own facilities, can use segments of LEC networks on an unbundled basis
and provides a sufficient volume of higher margin enhanced services, including
local dial tone. The expectation described in the foregoing forward-looking
statement is dependent upon, among other things, the Company carrying a greater
proportion of traffic on its own facilities, providing a sufficient volume of
higher margin enhanced services and obtaining the right to use unbundled LEC
facilities on satisfactory terms, any or all of which may not occur. Network
cost of services increased 1.4% to $11.1 million, however, cost of service
decreased as a percentage of Network Services revenue from 80.8% for the three
months ended March 31, 1995, to 79.1 % for the three months ended March 31,
1996, due to an improved job bidding process and a more selective job acceptance
process, whereby more acceptable gross margins were obtained. Network cost of
services includes the cost of equipment sold, direct hourly labor and other
direct project costs. Satellite cost of services decreased to $1.9 million for
the three months ended March 31, 1996, from $2.5 million for the three months
ended March 31, 1995. Satellite cost of services as a percentage of revenue also
declined from 46.1 % at March 31, 1995, to 44.3% at March 31, 1996. The decrease
is attributable to the sale of four of the Company's teleports partially offset
by the increase in maritime services revenue at MTN. Satellite cost of services
consists of MTN transponder costs, VSAT network costs and costs of VSAT
equipment sold and, for the three months ended March 31, 1995, also includes
satellite transponder lease costs. Revenue from teleport operations historically
have yielded lower gross margins than revenue from the cruise ship and U.S. Navy
telephone services business of MTN. Gross margins for Satellite Services should
improve as a result of the sale of the teleports. The expectation described in
the foregoing forward-looking statement is dependent upon, among other things,
increased Satellite Services revenue from the cruise ship and U.S. Navy services
business, a lack of increased competition in this market, the renewal of the
Company's experimental license in February 1997 and a lack of new technology
which could potentially render the Company's leased satellite facilities
obsolete.
Selling, General and Administrative ("SG&A ") Expense. SG&A expense for the
three months ended March 31, 1996, increased $3.2 million, or 19.8%, compared to
the three months ended March 31, 1995. This increase was principally due to the
continued rapid expansion of the Company's Telecom Services networks and related
significant additions to the Company's engineering, operations, management
information systems, marketing and sales staff dedicated to the expansion of the
networks and implementation of the Company's switched services strategy. The
increase in SG&A expense was net of a decrease in SG&A of approximately $0.3
million for the Satellite Services division due to the sale of four of the
Company's teleports. SG&A expense as a percentage of total revenue declined to
53.3% for the three months ended March 31, 1996, from 62.6% for the comparable
period in 1995. There is typically a period of higher administrative and
marketing expense prior to the generation of appreciable revenue from newly
acquired or developed networks. The Company expects SG&A expense for Telecom
Services to increase over the near term as a result of hiring new staff to
facilitate the marketing and development of local dial tone services. SG&A
expense for Network Services increased due to expansion into new markets and
increased engineering, marketing and sales staff to support increased growth in
network systems builds.
Depreciation and Amortization. Depreciation and amortization increased
$3.7 million, or 97.1%, for the three months ended March 31, 1996, compared to
the three months ended March 31, 1995. Depreciation of fixed assets increased
by $2.3 million as a result of the shortening of estimated depreciable lives
discussed in "--Accounting Matters" and also increased as a result of the
increased investment in depreciable fixed assets as a result of the continued
expansion of competitive access networks. The increase in depreciation expense
was offset slightly by the decrease in depreciable assets resulting from the
sale of four of the Company's teleports. The Company reports high levels of
depreciation relative to revenues during the early years of operation of a new
network because the full cost of a network is depreciated using the straight
line method despite the low rate of capacity utilization in the early stages of
network operation.
Interest Expense. Interest expense increased by $10.6 million from $3.6
million for the three months ended March 31, 1995, to $14.2 million for the
three months ended March 31, 1996. The $14.2 million of interest expense
included $12.1 million of non-cash interest. This increase was attributable to
an increase in long-term debt, primarily the Senior Discount Notes issued in the
fourth quarter of fiscal 1995, and an increase in capitalized lease obligations
to finance Telecom Services and Satellite Services equipment.
Interest Income. Interest income increased $1.9 million, from $0.8 million
for the three months ended March 31, 1995, to $2.7 million for the three months
ended March 31, 1996. The increase is attributable to the increase in cash from
the proceeds of the issuance of Senior Discount Notes in August 1995.
Share of Losses in Joint Venture. Share of losses in joint venture
increased $0.4 million, or 153.0% from the three months ended March 31, 1995, to
$0.6 million for the three months ended March 31, 1996. This increase is due to
increased losses of the Phoenix network joint venture in which the Company holds
a 50% equity interest. The losses of the joint venture increased due to
continued expansion and implementation of switched services at low margins.
Other, Net. Other, net increased $1.1 million or 278.1% for the three
months ended March 31, 1996 from $0.4 million for the three months ended March
31, 1995. The majority of the increase is due to a $0.9 million loss on the sale
of four of the Company's teleports and certain other satellite assets and a $0.5
million write-off of certain assets.
Minority Interest in Share of Losses, Accretion and Preferred Dividends.
Minority interest in share of losses, accretion and preferred dividends
increased $2.5 million, from the benefit of $0.5 million for the three months
ended March 31, 1995 to an expense of approximately $2.0 million for the three
months ended March 31, 1996. The increase is due to the accretion of warrants
and issue costs associated with the issuance of the 12% Redeemable Preferred
Stock of ICG (the "Redeemable Preferred Stock") in August of 1995 and accrual of
the preferred stock dividend which, together, accounted for $2.3 million.
Income Tax Benefit. Income tax benefit for the three months ended March
31, 1996, was $4.5 million compared to a $25,000 income tax benefit for the
three months ended March 31, 1995. The income tax benefit for the three months
ended March 31, 1996 is due to an adjustment to the deferred tax liability as a
result of the change in estimated depreciable lives.
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SIX MONTHS ENDED MARCH 31, 1996, COMPARED TO SIX MONTHS ENDED MARCH 31, 1995
The following information reflects the results of operations for the six
months ended March 31, 1996, compared to the pro forma results of operations for
the six months ended March 31, 1995, assuming the change in accounting for long-
term telecom services contracts described in "--Accounting Matters--Accounting
Changes" had been applied retroactively.
Revenue. Revenue for the six months ended March 31, 1996 increased $21.4
million, or 42.9%, from the six months ended March 31, 1995. The increase in
total revenue reflects continued growth in Telecom Services, Network Services
and Satellite Services operations. Telecom Services revenue increased 155.4% to
$31.1 million due to an increase in network usage for both special and switched
access services, offset in part by a decline in average access rates. The
number of operational switches increased from six as of March 31, 1995, to 13 as
of March 31, 1996. Switched minutes of use increased from 42 million during the
six months ended March 31, 1995, to 597 million for the six months ended March
31, 1996. Network usage as reflected in VGEs increased 77.9% from 287,167 VGEs
on March 31, 1995 to 510,755 VGEs on March 31, 1996. On March 31, 1995, the
Company had 251 on-net buildings connected to its networks compared to 327 on-
net buildings connected on March 31, 1996. Network Services revenue increased
3.1% to $29.7 million primarily due to additional projects from existing
customers and increased business networking requirements. Satellite Services
revenue increased 17.6% to $10.5 million for the six months ended March 31,
1996. The increase resulted principally from the acquisition of MTN in January
1995 and the increased volume of uplink hours for the three months ended
December 31, 1995, offset by the decrease resulting from the sale of four of the
Company's teleports.
Cost of Services. Total cost of services for the six months ended March 31,
1996, increased $16.6 million, or 49.8%, from the six months ended March 31,
1995. Telecom cost of services increased from $5.7 million, or 46.9%, of
Telecom Services revenue for the six months ended March 31, 1995, to $21.6
million, or 69.4%, of Telecom Services revenue for the six months ended March
31, 1996. Telecom cost of services consists of payments to LECs for the use of
network facilities to support off-net and switched services, right of way fees
and other costs. The increase in absolute dollars is attributable to the
increase in switched services and the expansion in off-net special access
service offerings. The increase in the cost of services as a percentage of
total revenue is due primarily to the increase in switched services revenues,
which currently generate lower margins than special access services. The Company
expects that the Telecom Services ratio of cost of services to revenue will
improve. The expectation described in the foregoing forward-looking statement is
dependent upon, among other things, the Company carrying a greater proportion of
traffic on its facilities, providing a sufficient volume of higher margin
enhanced services, including local dial tone and obtaining the right to use
unbundled LEC facilities on satisfactory terms, any or all of which may not
occur. Network cost of services decreased 0.6% to $23.1 million and also
decreased as a percentage of Network Services revenue from 80.6% for the six
months ended March 31, 1995, to 77.7% for the six months ended March 31, 1996,
due to an improved job bidding process and a more selective job acceptance
process, whereby more acceptable gross margins have been obtained. Network cost
of services includes the cost of equipment sold, direct hourly labor and other
direct project costs. Satellite cost of services increased to $5.1 million for
the six months ended March 31, 1996, from $4.3 million for the six months ended
March 31, 1995. Satellite cost of services as a percentage of revenue remained
relatively constant at 49.0% at March 31, 1996, compared to 48.6% at March 31,
1995. The increase in absolute dollars was attributable to an increased volume
of Satellite Services business primarily due to the increase in maritime
services revenue. Satellite cost of services consists of satellite transponder
lease costs (for the prior period and for the three months ended December 31,
1995), MTN transponder costs, VSAT network costs and costs of VSAT equipment
sold. Revenue from teleport operations historically have yielded lower gross
margins than revenue from the cruise ship and U.S. Navy telephone services
business of MTN. Gross margins for Satellite Services should improve as a result
of the sale of the teleports. The expectation described in the foregoing
forward-looking statement is dependent upon, among other things, increased
Satellite Services revenue from the cruise ship and U.S. Navy telephone services
business, a lack of increased competition in this market, the renewal of the
Company's experimental license in February 1997 and a lack of new technology
which potentially could render the Company's leased satellite facilities
obsolete.
Selling, General and Administrative Expense. SG&A expense for the six
months ended March 31, 1996, increased $12.8 million, or 46.4%, compared to the
six months ended March 31, 1995. This increase was principally due to the
continued rapid expansion of the Company's Telecom Services networks and related
significant additions to the Company's engineering, operations, management
information systems, marketing and sales staff dedicated to the expansion of the
networks and implementation of the Company's switched services strategy. SG&A
expense as a percentage of total revenue was 56.4% for the six months ended
March 31, 1996, compared to 55.1% for the comparable period in 1995. There is
typically a period of higher administrative and marketing expense prior to the
generation of appreciable revenue from newly acquired or developed networks.
SG&A expense for Network Services increased due to expansion into new markets
and increased engineering, marketing and sales staff to support increased growth
in
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network systems installation contracts. Satellite Services SG&A expense
increased primarily due to the acquisition of MTN.
Depreciation and Amortization. Depreciation and amortization increased
$5.3 million, or 73.9%, for the six months ended March 31, 1996, compared to the
six months ended March 31, 1995. Depreciation of fixed assets increased by $2.3
million as a result of the shortening of estimated depreciable lives discussed
in "--Accounting Matters", and also increased as a result of the increase in
depreciable fixed assets as a result of the continued expansion of competitive
access networks. The increase in depreciation expense was offset slightly by
the decrease in depreciable assets resulting from the sale of four of the
Company's teleports. The Company reports high levels of depreciation relative
to revenues during the early years of operation of a new network because the
full cost of a network is depreciated using the straight line method despite the
low rate of capacity utilization in the early stages of network operation.
Interest Expense. Interest expense increased by $23.2 million, from $6.2
million for the six months ended March 31, 1995, to $29.4 million for the six
months ended March 31, 1996. The $29.4 million of interest expense included
$24.6 million of non-cash interest. This increase was attributable to an
increase in long-term debt, primarily the Senior Discount Notes issued in the
fourth quarter of fiscal 1995, and an increase in capitalized lease obligations
to finance Telecom Services and Satellite Services equipment and the expansion
of the Company's competitive access networks.
Interest Income. Interest income increased $5.3 million, from $1.2 million
for the six months ended March 31, 1995, to $6.5 million for the three months
ended March 31, 1996. The increase is attributable to the increase in cash from
the proceeds of the issuance of Senior Discount Notes in August 1995.
Share of Losses in Joint Venture. Share of losses in joint venture
increased $0.5 million, or 127.5% from the six months ended March 31, 1995, to
$0.8 million for the six months ended March 31, 1996. This increase is due to
increased losses of the Phoenix network joint venture in which the Company holds
a 50% equity interest. The losses of the joint venture increased due to
continued expansion and implementation of switched services.
Other, Net. Other, net increased $1.7 million or 185.7% for the six months
ended March 31, 1996, from $0.9 million for the six months ended March 31, 1995.
The majority of the increase is due to a $0.9 million loss on the sale of four
of the Company's teleports and certain other satellite assets and a $0.5 million
write-off of certain assets.
Minority Interest in Share of Losses, Accretion and Preferred Dividends.
Minority interest in share of losses, accretion and preferred dividends
increased $4.7 million from a benefit of $0.5 million for the six months ended
March 31, 1995, to an expense of approximately $4.2 million for the six months
ended March 31, 1996. The increase is due to the accretion of warrants and issue
costs associated with the issuance of the Redeemable Preferred Stock and accrual
of the preferred stock dividend which, together, accounted for $4.6 million.
Income Tax Benefit. Income tax benefit for the six months ended March 31,
1996 was $4.5 million compared to an $11,000 income tax expense for the six
months ended March 31, 1995. The income tax benefit is due to an adjustment to
the deferred tax liability as a result of the change in estimated depreciable
lives.
Cumulative Effect of Change in Accounting for Revenue from Long-Term
Telecom Services Contracts. The increase in cumulative effect of change in
accounting for revenue from long-term telecom services contracts is due to the
change in accounting as described in "--Accounting Matters--Accounting Changes."
Preferred Stock Dividends. The $1.0 million preferred stock dividend for
the six months ended March 31, 1996 represents the excess redemption price over
the stated value of Convertible Series B Preferred Stock (the "Series B
Preferred Stock"). There was no Series B Preferred Stock outstanding during the
six months ended March 31, 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations have required significant capital expenditures for
development, construction, expansion and acquisitions. Significant amounts of
capital are required to be invested before revenue is generated, which results
in initial negative cash flow.
Cash Used By Operating Activities
The Company's operating activities used $2.8 million, $10.2 million and
$56.2 million in fiscal 1993, 1994 and 1995, respectively, and $20.2 million and
$21.6 million for the six months ended March 31, 1995 and 1996, respectively.
Cash used by operations is primarily due to net losses, which are partially
offset by non-cash expenses, such as depreciation and deferred interest expense,
and changes in working capital items.
The Company expects to continue to generate negative cash flow from
operating activities while it emphasizes development, construction and expansion
of its Telecom Services business. Consequently, it does not anticipate that
cash provided by operations will be sufficient to fund future expansion of
existing networks or the construction and acquisition of new networks in the
near term.
Cash Used By Investing Activities
Cash used by investing activities was $13.4 million, $51.5 million and
$71.3 million in fiscal 1993, 1994 and 1995, respectively, and $37.6 million and
$74.9 million (net of $21.6 million received in connection with the sale of
certain satellite equipment including four teleports) for the six months ended
March 31, 1995 and 1996, respectively. Cash used by investing activities
includes cash expended for the acquisition of property, equipment and other
assets of $12.2 million, $43.2 million and $49.8 million for fiscal years 1993,
1994 and 1995, respectively, and $18.5 million and $54.9 million for the six
months ended March 31, 1995 and 1996, respectively. The Company will continue
to use cash for the remainder of fiscal 1996 for the construction of new
networks and the expansion of existing networks. The Company acquired assets
under capital leases and through the issuance of debt or warrants of $8.4
million, $11.7 million and $38.7 million in fiscal years 1993, 1994 and 1995,
respectively, and $31.4 million and $47.4 million for the six months ended March
31, 1995 and 1996, respectively. The majority of assets acquired under capital
leases and through the issuance of debt during the six months ended March 31,
1995, was for the purchase and installation of 12 of the Company's 13 high
capacity digital switches to provide switched services in Birmingham, Charlotte,
Cleveland, Columbus, Denver, Irvine, Los Angeles, Louisville, Melbourne,
Nashville, Oakland, Phoenix and Sacramento. Assets
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purchased during the six months ended March 31, 1996, under capital leases
primarily consisted of the fiber optic networks included in the SCE agreement.
In January 1994, the Company committed to provide $10.0 million in
financing to its Telecom joint venture in Phoenix, of which $6.9 million and
$8.8 million had been provided through September 30, 1995, and March 31, 1996,
respectively. The acquisition in January 1995 of a 64% interest in MTN, $4.4
million convertible promissory notes of MTN and consulting and non-compete
agreements valued at an aggregate of $250,000, required cash payments of $9.0
million, the surrender and cancellation of a $0.6 million note and the issuance
of approximately $5.1 million in IntelCom common shares and funding of $2.7
million in MTN working capital requirements. The Company has also agreed that
if MTN has not completed an initial public offering of its common stock by
January 3, 1998, the Company will, at the option of the minority shareholders,
buy the minority shares of MTN at the then fair market value.
The Company owns approximately 70.0% of the issued and outstanding common
stock of Zycom Corporation (Alberta, Canada), Zycom Corporation (Texas) and
Zycom Network Services, Inc. (collectively, "Zycom"). In March 1995, the
Company acquired a 56.0% equity interest in Zycom for approximately $3.2
million, consisting of $0.6 million in cash, the conversion of a $2.0 million
note receivable to equity of Zycom and the assumption of $0.6 million in debt.
In July 1995, the Company purchased an additional 2.0% of Zycom common stock
held by Zycom's former president and chief executive officer for approximately
$0.2 million. In March 1996, the Company acquired an additional approximate
12.0% equity interest in Zycom by converting a $3.2 million receivable due from
Zycom.
In March 1996, the Company sold four teleports and related assets for
approximately $21.5 million in cash of which $21.1 million had been received
from the purchaser as of December 31, 1995.
In November 1995, the Company entered into a long-term agreement with CPS,
a municipally owned electric and gas utility, to license half of the capacity on
a 300-mile fiber optic network (60 of which currently exist) in greater San
Antonio. Pursuant to this agreement the Company has provided a $12.0 million
irrevocable letter of credit to finance the Company's portion of the
construction costs. The letter of credit is secured by cash collateral of $13.3
million.
On January 3, 1996, the Company acquired the remaining 49% minority
interest in FOTI, resulting in FOTI becoming a wholly owned subsidiary.
Consideration for the acquisition was $2.0 million in cash and 66,236 IntelCom
common shares valued at $0.8 million for total consideration of $2.8 million.
In February 1996, the Company invested $4.0 million and in April 1996
invested $6.0 million to acquire a 60% interest in, and become the general
partner of, ICG Telecom of San Diego.
In February 1996, the Company entered into a long-term agreement with
WorldCom under which the Company will pay approximately $8.8 million for the
right to use fiber along a 330-mile fiber optic network in Ohio. An aggregate
of approximately $2.6 million has been paid by the Company through March 31,
1996.
In March 1996, the Company and SCE jointly filed an agreement with the CPUC
under which the Company will license 1,258 miles of fiber optic cable in
Southern California. An aggregate of approximately $3.4 million has been paid
by the Company through March 31, 1996.
Cash Provided (Used) By Financing Activities
Financing activities provided $30.4 million, $52.1 million, $390.9 million
and $60.7 million in each of fiscal 1993, 1994 and 1995, and the six months
ended March 31, 1995, respectively, and used $33.4 million in the six months
ended March 31, 1996. The significant change in cash provided in the first two
quarters of fiscal 1995 to cash used in the first two quarters of fiscal 1996 is
due to the completion of a public equity offering during the first quarter of
fiscal 1995. The funds to finance the Company's past business acquisitions,
capital expenditures, working capital requirements and operating losses were
from public and private offerings of IntelCom common shares, units (the "Units")
consisting of 13 1/2% Senior Discount Notes due 2005 (the "13 1/2% Notes") and
warrants (the "Unit Warrants") to purchase IntelCom common shares (the "Unit
Offering"), 12% Redeemable Preferred Stock of ICG (the "Redeemable Preferred
Stock"), 8% Convertible Subordinated Notes and 7% Convertible Subordinated Notes
(together the "Convertible Subordinated Notes") and Convertible Preferred Shares
of IntelCom, capital lease financings and various working capital sources,
including credit facilities. Such funds were obtained from the following
sources:
(i) In the fourth quarter of fiscal 1995, the Company completed the Unit
Offering consisting of the 13 1/2% Notes and the Unit Warrants, and sold the
Redeemable Preferred Stock of ICG and the Redeemable Warrants (as defined below)
to improve its operating and financial flexibility over the near term. The
Company believes its liquidity improved
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because the 13 1/2% Notes do not require the payment of cash interest until 2001
and do not require payment of principal until maturity in 2005. The foregoing
consisted of:
(a) Unit Offering: In August 1995, IntelCom and ICG issued and sold Units
comprised of the 13 1/2% Notes and the Unit Warrants for net proceeds of
approximately $286.4 million. The 13 1/2% Notes are unsecured senior
obligations of ICG (guaranteed by IntelCom) that mature on September 15,
2005. Interest is payable each March 15 and September 15 commencing March 15,
2001. ICG completed an offer to exchange the 13 1/2% Notes for 13 1/2% Notes
registered under the Securities Act of 1933, in January 1996.
(b) Preferred Stock Placement: Simultaneously with the closing of the Unit
Offering, ICG issued the Redeemable Preferred Stock to Princes Gate
Investors, L.P., an affiliate of Morgan Stanley & Co. Incorporated ("Morgan
Stanley"), and related investors (collectively, "PGI"), together with 916,666
redeemable warrants (the "Redeemable Warrants") and warrants to purchase
2,353,334 IntelCom common shares (the"PGI Warrants") (the "Preferred Stock
Placement"). The Redeemable Preferred Stock accrues dividends quarterly at an
annual rate of 12% per annum. On April 30, 1996, the Redeemable Preferred
Stock and the Redeemable Warrants were redeemed with a portion of the
proceeds from the private placement offering described below.
(ii) As an interim financing arrangement, in July 1995, IntelCom, ICG and
certain subsidiaries of ICG entered into a Note Purchase Agreement with Morgan
Stanley Group Inc. ("Morgan Stanley Group") and PGI for up to $35.0 million of
Senior Secured Notes and issued warrants to Morgan Stanley Group to purchase
800,000 IntelCom common shares and warrants to PGI to purchase 600,000 IntelCom
common shares. Proceeds from the Unit Offering and the Preferred Stock
Placement were used to repay principal and interest (approximately $6.0 million)
on all Senior Secured Notes purchased by Morgan Stanley Group. In connection
with such repayment, warrants to purchase 280,000 IntelCom common shares issued
to Morgan Stanley Group were returned to IntelCom and canceled.
(iii) Public Offering of IntelCom Common Shares: On October 24, 1994,
IntelCom and an unaffiliated shareholder completed the sale of 6,900,000
IntelCom common shares at a price of $14.00 per share in a public offering, of
which 5,716,853 IntelCom common shares were sold by IntelCom for net proceeds of
approximately $74.3 million. The Company used $6.9 million of such proceeds to
repay a note issued in April 1994 in connection with its purchase of the telecom
network assets of Mtel Digital Services, Inc. in Los Angeles.
(iv) Convertible Subordinated Long-Term Debt Financing: IntelCom issued
and sold $18.0 million principal amount of 8% Convertible Subordinated Notes in
September 1993. As of March 31, 1996, $8.0 million of the 8% Convertible
Subordinated Notes and $1.2 million of the interest on such notes had been
converted to 589,742 IntelCom common shares. An additional $47.8 million
principal amount of 7% Convertible Subordinated Notes were issued and sold in
October 1993. Interest on these notes is payable in cash or in kind, at the
option of IntelCom. IntelCom has paid the first five installments of interest
by issuing additional interest notes (the "Interest Notes").
(v) Private Equity Financing: IntelCom raised $13.2 million in 1993
through private placements of IntelCom common shares. In settlement of certain
short-term obligations to vendors, IntelCom issued $0.3 million in IntelCom
common shares in 1993. In February 1994, William W. Becker, a Director of
IntelCom, purchased 600,000 IntelCom common shares for $3.8 million pursuant to
an outstanding warrant obtained in February 1992. In May and June 1995,
IntelCom raised $4.0 million in a private placement of 595,000 IntelCom common
shares and $16.0 million ($15.2 million net proceeds) in private placements of
Convertible Preferred Shares. A portion of the proceeds from the Unit Offering
and the Preferred Stock Placement has been used to repurchase $10.0 million of
the Convertible Preferred Shares and the remaining $6.0 million of the
Convertible Preferred Shares have been converted to 783,657 IntelCom common
shares.
(vi) Lease Financing: The Company used lease financing of $24.5 million
for the acquisition of 12 digital switches. A capital lease agreement with AT&T
Capital Corporation provides $18.2 million for the acquisition of 9 digital
switches from Lucent Technologies, Inc. (formerly AT&T Network Systems). After
six and one-half years, the Company may purchase these switches for 30% of the
original price. At March 31, 1996, the interest rate on the leases was
approximately 7.6%. Additional capital lease obligations (including a lease
obligation for three other switches) totalled $6.3 million, bearing interest at
rates ranging from 11.8% to 13.0% as of March 31, 1996.
In March 1996, the Company entered into a 25-year agreement with SCE under
which the Company will license 1,258 miles of fiber optic cable in Southern
California. The agreement also allows the Company to utilize SCE's facilities
to install up to 500 additional miles of fiber optic cable. Under the terms of
the agreement the Company will pay SCE an annual fee for ten years, certain
fixed quarterly payments, including a quarterly payment equal to a
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percentage of network revenue, and certain other installation and fiber
connection fees. The aggregate fixed payments remaining under this 25-year
agreement (consisting of the annual fee and fixed quarterly payments) totaled
approxi- mately $146.0 million at March 31, 1996.
(vii) Working Capital Sources: FOTI and its subsidiaries had a $4.0
million working capital line of credit (the "FOTI Line of Credit") with Norwest
Business Credit, Inc., which was guaranteed by IntelCom. The FOTI Line of
Credit bore interest at the prime rate plus 5.0% per annum, which was 13.75% at
September 30, 1995, and was due on demand. At September 30, 1995, the
outstanding borrowings under the FOTI Line of Credit totaled approximately $3.7
million. In December 1995, the Company refinanced the FOTI Line of Credit as
part of a short-term facility with Norwest Bank Colorado, N.A. ("Norwest") (see
(viii) below). FOTI also has a $4.5 million working capital line of credit, of
which $1.0 million was outstanding as of March 31, 1996, with a supplier that
provides goods and services that are used on network system integration
installations.
(viii) Short-Term Credit Facility: In December 1995, ICG obtained a short-
term credit facility with Norwest to refinance certain of the Company's debt.
The credit facility provided for $17.5 million in short-term financing with
interest at 2.5% above the Money Market Account yield (3.3% at December 31,
1995, for a rate of 5.8%). The Company paid off this debt and accrued interest
in March 1996.
On April 30, 1996, ICG completed a private placement (the "Private
Placement") of 12 1/2% Senior Discount Notes and 150,000 shares of 14 1/4%
Exchangeable Preferred Stock (the "Preferred Stock") for aggregate net proceeds
of approximately $433.0 million. The net proceeds of the Private Placement,
along with the balance of the net proceeds of the Unit Offering, will improve
the Company's operating and financial flexibility over the near term. The
Company believes its liquidity improved because (a) the Senior Discount Notes do
not require the payment of cash interest until 2001 and (b) ICG has the option
to pay dividends on the Preferred Stock in additional shares of Preferred Stock
through May 1, 2001 and the Preferred Stock is not mandatorily redeemable until
2007. Approximately $35.3 million of the proceeds from the Private Placement
were used to redeem the Redeemable Preferred Stock issued in August 1995 ($30.0
million), pay accrued preferred dividends ($2.3 million) and to repurchase
916,666 IntelCom warrants ($2.7 million) issued in connection with the
Redeemable Preferred Stock. The Company recognized a charge of approximately
$13.1 million for the excess of the redemption price of the Redeemable Preferred
Stock over the carrying amount at April 30, 1996, and recognized a charge of
approximately $11.5 milion for the payment with respect to consents to
amendments to the 13 1/2% Notes Indenture to permit the Private Placement, which
together which will be reflected in the Company's results for the three months
ended June 30, 1996.
The Senior Discount Notes are unsecured senior obligations of ICG
(guaranteed by IntelCom) that mature on May 1, 2006. Interest will accrue at 12
1/2% per annum beginning May 1, 2001, and is payable each May 1 and November 1,
commencing November 1, 2001. Dividends on the Preferred Stock are cumulative at
a rate of 14 1/4% per annum and are payable quarterly each February 1, May 1,
August 1 and November 1, commencing August 1, 1996. The Preferred Stock has a
liquidation preference of $1,000 per share, plus accrued and unpaid dividends,
and is mandatorily redeemable in 2007. The Preferred Stock is exchangeable, at
the option of ICG, into 14 1/4% senior subordinated exchange debentures of ICG
due 2007, at any time after the exchange is permitted under certain indenture
restrictions.
Capital Expenditures
The Company expects to continue to generate negative cash flow from
operating activities while it emphasizes development, construction and expansion
of its business and until the Company establishes a sufficient revenue-
generating customer base. The Company's capital expenditures were $20.7
million, $54.9 million and $88.5 million in fiscal 1993, 1994 and 1995,
respectively, and $49.9 million and $102.3 million (including assets acquired
under capital leases and through the issuance of debt) for the six months ended
March 31, 1995 and 1996, respectively. The Company anticipates that the
expansion of existing networks, construction of new networks and further
development of the Company's products and services will require capital
expenditures of up to $165.0 million for fiscal 1996, $300.0 million for fiscal
1997 and continued significant capital expenditures thereafter. Actual capital
expenditures will depend on numerous factors beyond the Company's control or
ability to predict. These factors include the nature of future expansion and
acquisition opportunities, economic conditions, competition, regulatory
developments and the availability of capital.
General
In view of the anticipated negative cash flow from operating activities,
the continuing development of the Company's products and services, the expansion
of existing networks and the construction, leasing and licensing of new
networks, the Company will require additional amounts of cash in the future from
outside sources. Management believes that the Company's funds on hand, the
funds from the Private Placement, the funds remaining from the Unit Offering
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and amounts expected to be available through vendor financing arrangements will
provide sufficient funds necessary for the Company to expand its telecom
services business as currently planned and to fund its operating deficits for
approximately 21 months. Additional sources of cash may include public and
private equity and debt financings by IntelCom, ICG or ICG's subsidiaries, sales
of non-strategic assets, capital leases and other financing arrangements. The
Company will require additional amounts of equity capital in the near term. In
the past, the Company has been able to secure sufficient amounts of financing to
meet its capital expenditure needs. There can be no assurance that additional
financing will be available to the Company or, if available, that it can be
obtained on terms acceptable to the Company.
ACCOUNTING MATTERS
Accounting Changes
Effective January 1, 1996, the Company changed its method of accounting for
long-term telecom services contracts. Under the new method, the Company will
recognize revenue as services are provided and will continue to charge direct
selling expenses to operations as incurred. The Company had previously
recognized revenue in an amount equal to the noncancelable portion of the
contract, which is a minimum of one year on a three-year or longer contract, at
the inception of the contract and upon activation of service to the customer to
the extent of direct installation and selling expense incurred in obtaining
customers during the period in which such revenue was recognized. Revenue
recognized in excess of normal monthly billings during the year was limited to
an amount which did not exceed such installation and selling expense. The
remaining revenue from the contract had been recognized ratably over the
remaining noncancelable portion of the contract. The Company believes the new
method is preferable because it provides a better matching of revenue and
related operating expenses and is more consistent with accounting practices
within the telecommunications industry.
As required by generally accepted accounting principles, the Company has
restated its results for the three months ended December 31, 1995, to reflect
the effects of the change in accounting as if such change had been adopted as of
October 1, 1995. The Company's results for the six months ended March 31, 1996
include a charge of $3.5 million ($0.14 per common share) relating to the
cumulative effect of this change in accounting as of October 1, 1995. The effect
of this change in accounting in fiscal year 1996 was to decrease loss before
cumulative effect of change in accounting by approximately $196,000 ($0.01 per
common share) in the first quarter and to increase loss before cumulative effect
of change in accounting of approximately $174,000 ($0.01 per common share) in
the second quarter, for a net decrease in loss before cumulative effect of
change in accounting of approximately $22,000 (less than $0.01 per common share)
for the six months ended March 31, 1996. If the new revenue recognition method
had been applied retroactively, Telecom Services revenue would have decreased by
$2.0 million, $0.5 million, and $0.7 million for fiscal 1993, 1994, and 1995,
respectively, and $0.6 million for the six months ended March 31, 1995.
In addition, the Company has shortened the estimated depreciable lives for
substantially all of its fixed assets. These estimates were changed to better
reflect the estimated periods during which these assets will remain in service
and result in useful lives which are more consistent with industry practice. The
changes in estimates of depreciable lives are being made on a prospective basis,
beginning January 1, 1996. The effect of this change in estimate was to increase
depreciation expense and net loss attributable to common shareholders for the
three months ended March 31, 1996, by $2.3 million ($0.92 per common share).
This change in estimate is expected to increase depreciation expense during
fiscal year 1996 by approximately $7.0 million. The change would have had an
estimated annual effect of approximately $9.0 million had the change been in
effect for the entire year. Deferred tax liability has been adjusted for the
effect of this change in estimated depreciable lives, which resulted in an
income tax benefit of $4.5 million.
New Accounting Standards
Statement of Financial Accounting Standards No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of
(SFAS 121), was issued in March 1995 by the Financial Accounting Standards
Board. It requires that long-lived assets and certain identifiable intangibles
held and used by an entity be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. SFAS 121 is required to be adopted for fiscal years beginning
after December 15, 1995 and will be adopted by the Company as of October 1,
1996. Adopting this statement is not expected to have a significant effect on
the consolidated financial statements of the Company.
Statement of Financial Accounting Standards No. 123, Accounting for Stock-
Based Compensation (SFAS 123), was issued by the Financial Accounting Standards
Board in October 1995. SFAS 123 establishes financial accounting and reporting
standards for stock-based employee compensation plans as well as transactions in
which an entity issues its equity instruments to acquire goods or services from
non-employees. This statement defines a fair value based method of accounting
for employee stock options or similar equity instruments, and encourages all
entities to adopt this method of accounting for all employee stock compensation
plans. However, it also allows an entity to continue to measure compensation
cost for those plans using the intrinsic value based method of accounting
prescribed by Accounting
24
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Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Entities electing to remain with the accounting method prescribed in Opinion 25
must make pro forma disclosures of net income and, if presented, earnings per
share, as if the fair value based method of accounting defined by SFAS 123 had
been applied. SFAS 123 is applicable to fiscal years beginning after December
15, 1995. The Company currently accounts for its equity instruments using the
accounting method prescribed by Opinion 25. The Company does not currently
expect to adopt the accounting method prescribed by SFAS 123; however, the
Company will include the pro forma disclosures required by SFAS 123 when
required.
25
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PART II
- -------
OTHER INFORMATION
- -----------------
Item 1. See Note 8 (c) in Notes to the Consolidated Financial Statements for
the six months ended March 31, 1996.
Item 2. NOT APPLICABLE
Item 3. NOT APPLICABLE
Item 4. NOT APPLICABLE
Item 5. NOT APPLICABLE
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
(10) Non-Qualified Stock Option Agreement between IntelCom Group Inc.
and J. Shelby Bryan dated as of November 13, 1995.
(27) Financial Data Schedule
(b) Reports on Form 8-K - none
26
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTELCOM GROUP INC.
Date: May 14, 1996 By:/s/ JAMES D. GRENFELL
------------------------------------------
James D. Grenfell, Chief Financial Officer
Date: May 14, 1996 By:/s/ RICHARD BAMBACH
-------------------------------------
Richard Bambach, Corporate Controller
27
