<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
Exchange Act of 1934
For the Quarter Ended September 30, 1998
Commission File Number: 0-20135
INTERMEDIA COMMUNICATIONS INC.
(Exact name of registrant as specified in its charter)
DELAWARE 59-2913586
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
3625 Queen Palm Drive
Tampa, Florida 33619
(Address of principal executive offices)
Telephone Number (813) 829-0011
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 / /
As of November 10, 1998, there were 48,597,754 shares of the Registrant's Common
Stock outstanding.
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Page 1 of 31 pages
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INTERMEDIA COMMUNICATIONS INC.
INDEX
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE NO.
--------
<S> <C>
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED):
Condensed Consolidated Statements of Operations - Three and nine months ended
September 30, 1998 and 1997................................................. 3
Condensed Consolidated Balance Sheets - September 30, 1998 and December 31,
1997........................................................................ 4
Condensed Consolidated Statements of Cash Flows - Nine months ended September
30, 1998 and 1997 .......................................................... 5
Notes to Condensed Consolidated Financial Statements............................ 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS......................................... 13
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................................... 28
ITEM 2. CHANGES IN SECURITIES........................................................... 28
ITEM 3. DEFAULT UPON SENIOR SECURITIES.................................................. 29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................. 29
ITEM 5. OTHER INFORMATION............................................................... 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................ 29
SIGNATURES ................................................................................ 31
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INTERMEDIA COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share information)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Revenues:
Local network services ...................................... $ 43,778 $ 11,814 $ 115,648 $ 25,457
Enhanced data services ...................................... 47,585 30,843 126,790 54,831
Interexchange services ...................................... 71,552 27,637 199,049 80,877
Integration services ........................................ 29,438 952 77,882 4,152
----------- ----------- ------------ ------------
192,353 71,246 519,369 165,317
Expenses:
Network operations .......................................... 83,778 49,032 243,337 116,295
Facilities administration and maintenance ................... 14,935 9,985 48,503 21,409
Cost of goods sold .......................................... 19,014 503 49,923 2,537
Selling, general and administrative ......................... 59,482 25,004 162,231 64,983
Depreciation and amortization ............................... 53,662 16,100 142,827 34,274
Charge-off of purchased in-process R&D ...................... -- 60,000 85,000 60,000
Business restructuring, integration and other charges ....... 9,646 -- 62,198 --
----------- ----------- ------------ ------------
240,517 160,624 794,019 299,498
----------- ----------- ------------ ------------
Loss from operations ............................................ (48,164) (89,378) (274,650) (134,181)
Other income (expense):
Interest expense ............................................ (53,942) (17,689) (151,101) (39,895)
Other income ................................................ 9,310 6,736 26,078 16,691
----------- ----------- ------------ ------------
Loss before extraordinary item .................................. (92,796) (100,331) (399,673) (157,385)
Extraordinary loss on early extinguishment of debt .............. -- (43,834) -- (43,834)
----------- ----------- ------------ ------------
Net loss ........................................................ (92,796) (144,165) (399,673) (201,219)
Preferred stock dividends and accretions ........................ (30,647) (13,895) (68,118) (27,118)
----------- ----------- ------------ ------------
Net loss attributable to common stockholders .................... $ (123,443) $ (158,060) $ (467,791) $ (228,337)
=========== =========== ============ ============
Basic and diluted loss per common share before extraordinary item $ (2.62) $ (3.41) $ (11.15) $ (5.60)
Extraordinary loss .............................................. -- (1.31) -- (1.33)
----------- ----------- ------------ ------------
Net loss per common share ....................................... $ (2.62) $ (4.72) $ (11.15) $ (6.93)
=========== =========== ============ ============
Weighted average number of shares outstanding ................... 47,041,191 33,479,460 41,948,399 32,925,462
=========== =========== ============ ============
</TABLE>
See accompanying notes.
3
<PAGE> 4
INTERMEDIA COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 597,534 $ 756,923
Restricted investments 8,800 6,853
Accounts receivable, less allowance for
doubtful accounts of $23,473 in 1998 and $4,251 in 1997 145,075 58,579
Prepaid expenses and other current assets 19,864 6,122
----------- -----------
Total current assets 771,273 828,477
Telecommunications equipment 1,399,896 545,380
Less accumulated depreciation (176,930) (81,534)
----------- -----------
Telecommunications equipment, net 1,222,966 463,846
Intangible assets, net 1,024,332 138,028
Investment in Shared Technologies Fairchild Inc. -- 403,571
Other assets 57,658 41,048
----------- -----------
Total assets $ 3,076,229 $ 1,874,970
=========== ===========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 100,385 $ 53,630
Other accrued expenses 103,002 20,130
Current portion of long-term debt and capital lease obligations 10,804 7,471
----------- -----------
Total current liabilities 214,191 81,231
Long-term debt and capital lease obligations 2,284,794 1,244,872
Series B redeemable exchangeable preferred stock and accrued dividends, $1.00
par value; 600,000 shares authorized; 369,432 and 334,420 shares
issued and outstanding in 1998 and 1997, respectively 358,962 323,146
Series D junior convertible preferred stock and accrued dividends, $1.00 par
value; 69,000 shares authorized; 54,129 and 69,000 shares issued and
outstanding in 1998 and 1997, respectively 133,419 169,722
Series E junior convertible preferred stock, $1.00 par value; 87,500 shares
authorized; 64,892 and 80,000 shares issued and outstanding
in 1998 and 1997, respectively 159,785 196,008
Series F junior convertible preferred stock and accrued dividends, $1.00 par
value; 92,000 shares authorized; 80,000 shares issued and outstanding in 1998 195,583 --
Stockholders' deficit:
Preferred stock, $1.00 par value; 1,111,500 and 1,203,500 shares authorized in
1998 and 1997, respectively, no shares issued -- --
Series C preferred stock, $1.00 par value; 40,000 shares authorized, no
shares issued -- --
Common stock, $.01 par value; 150,000,000 and 50,000,000 shares authorized
in 1998 and 1997, respectively; 48,248,049 and 34,890,600 shares issued and
outstanding in 1998 and 1997, respectively 482 175
Additional paid-in capital 579,774 244,114
Accumulated deficit (843,797) (376,006)
Deferred compensation (6,964) (8,292)
----------- -----------
Total stockholders' deficit (270,505) (140,009)
----------- -----------
Total liabilities, redeemable preferred stock and stockholders' deficit $ 3,076,229 $ 1,874,970
=========== ===========
</TABLE>
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INTERMEDIA COMMUNICATIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------ ------------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $(399,673) $(201,219)
Adjustments to reconcile net loss to net cash
used in operating activities:
Extraordinary loss on early extinguishment of debt, noncash portion -- 5,869
Depreciation and amortization 146,102 35,502
Amortization of deferred compensation 1,328 1,095
Non cash items included in business restructuring,
integration and other charges 22,345 --
Accretion of interest on notes payable and capital leases 63,546 27,712
Imputed interest related to the business acquisitions 6,164 --
Charge-off of purchased in-process R&D 85,000 60,000
Provision for doubtful accounts 14,538 3,834
Changes in operating assets and liabilities:
Accounts receivable (47,821) (25,648)
Prepaid expenses and other current assets (4,045) (1,483)
Other assets (6,321) --
Accounts payable 9,101 8,777
Accrued expenses 23,292 3,685
--------- ---------
Net cash used in operating activities (86,444) (81,876)
INVESTING ACTIVITIES
Purchases of restricted investments (1,139) --
Maturities of restricted investments -- 30,805
Purchase of businesses, net of cash acquired (465,694) (150,085)
Maturities of short-term investments -- 5,550
Purchases of telecommunications equipment (338,116) (178,732)
--------- ---------
Net cash used in investing activities (804,949) (292,462)
FINANCING ACTIVITIES
Proceeds from sale of preferred stock, net of
issuance costs 193,747 454,992
Proceeds from issuance of long-term debt, net of issuance costs 537,303 362,993
Exercise of stock warrants and options 7,657 2,861
Principal payments on long-term debt and capital lease obligations (6,703) (164,953)
--------- ---------
Net cash provided by financing activities 732,004 655,893
Increase (decrease) in cash and cash equivalents (159,389) 281,555
Cash and cash equivalents at beginning of period 756,923 189,546
--------- ---------
Cash and cash equivalents at end of period $ 597,534 $ 471,101
========= =========
Supplemental disclosures of cash flow information
Assets purchased under capital lease obligations $ 435,771 $ 6,172
Common stock issued in purchase of business 225,925 --
Interest paid 47,180 11,759
Preferred stock issued as dividends on preferred stock 35,015 23,499
Common stock issued as dividends on preferred stock 19,012 --
Warrants and options issued in purchase of business -- 19,380
Accretion of preferred stock 2,206 869
</TABLE>
See accompanying notes.
5
<PAGE> 6
INTERMEDIA COMMUNICATIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE INFORMATION)
Note 1 Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) necessary to present fairly the information set forth therein
have been included. The accompanying condensed consolidated financial
statements should be read in conjunction with the consolidated financial
statements and footnotes included in the Annual Report on Form 10-K (the
"Form 10-K") of Intermedia Communications Inc. ("Intermedia" or the
"Company") for the year ended December 31, 1997.
Operating results for the three and nine month periods ended September
30, 1998 are not necessarily an indication of the results that may be
expected for the year ending December 31, 1998.
Stock Split
All share and per share information presented herein and in the
Company's Condensed Consolidated Financial Statements has been
retroactively restated to reflect a two-for-one stock split of the
Company's Common Stock, par value $.01 per share ("Common Stock"), on June
15, 1998, paid in the form of a stock dividend, to holders of record on
June 1, 1998.
Recently Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, Disclosures about Segments of
an Enterprise and Related Information ("SFAS 131"), which supersedes
Financial Accounting Standards No. 14. SFAS 131 uses a management approach
to report financial and descriptive information about a Company's
operating segments. Operating segments are revenue-producing components of
the enterprise for which separate financial information is produced
internally for the Company's management. SFAS 131 is effective for fiscal
years beginning after December 31, 1997, but is not required to be applied
to interim financial statements in the initial year of its application.
Management is currently assessing the impact of this Standard. However,
management believes the Company operates as a single segment,
telecommunication services provider.
Note 2 Business Acquisitions
On March 10, 1998, the Company completed its acquisition of Shared
Technologies Fairchild Inc. ("Shared"), a shared tenant communications
services provider. The operating results of Shared are included in the
Company's consolidated financial statements commencing on January 1, 1998.
Imputed interest of $5.1 million was recorded based on the cash
consideration paid after the effective date of the acquisition in the
first quarter of 1998 and the cost for Shared was reduced accordingly.
Aggregate consideration for the acquisition was approximately $589.8
million in cash, plus the retirement of $175.6 million in Shared's
long-term debt, and acquisition related expenses of $16.7 million. The
acquisition was accounted for by the purchase method of accounting, with
the purchase price allocated to the fair value of assets acquired and
liabilities assumed, principally goodwill.
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<PAGE> 7
The purchase price allocation was as follows (in thousands):
<TABLE>
<S> <C>
Purchase price $ 782,151
Less:
Interest expense adjustment 5,130
Estimated fair value of Shared net assets
acquired less assumed liabilities 51,245
---------
Excess of purchase price over fair
value of net assets acquired $ 725,776
==========
</TABLE>
The allocation of purchase price to goodwill and identifiable intangibles
and estimated lives are (dollars in thousands):
<TABLE>
<CAPTION>
Value Amortization
Allocated Period in Years
-------------------------------------
<S> <C> <C>
Developed technology $100,000 10
Tradename 10,000 2
In-process research & 85,000 -
development
Goodwill 530,776 20
</TABLE>
The amount allocated to in-process research and development ($85.0
million) was recorded as a one-time charge to operations in the
accompanying consolidated statements of operations because the technology
was not fully developed and had no future alternative use. The allocation
of the purchase price to other assets and liabilities is tentative pending
management's completion of the valuation of the purchased assets and
liabilities; however, management does not expect the final allocation of
the purchase price to differ significantly from the preliminary
allocations.
On March 31, 1998, the Company acquired the Long Distance Savers group
of companies (collectively, "LDS"), a regional interexchange carrier. The
operating results of LDS for the one day of ownership during the first
quarter of 1998 are considered immaterial. The operating results of LDS
are included in the Company's consolidated financial statements commencing
on April 1, 1998. Aggregate consideration for the acquisition was
approximately $15.7 million in cash, plus 5,359,748 shares of the
Company's Common Stock valued at approximately $137.2 million, the
retirement of $15.1 million of LDS's long-term debt, and acquisition
related expenses of $2.4 million. The acquisition was accounted for by the
purchase method of accounting, with the purchase price to be allocated to
the fair value of assets acquired and liabilities assumed, principally
goodwill ($143.1). This goodwill will be amortized over its estimated
useful life of 20 years. The allocation of the purchase price is tentative
pending management's completion of the valuation of the purchased assets
and liabilities. However, management does not expect the final allocation
of the purchase price to differ significantly from the preliminary
allocations.
On April 30, 1998, the Company completed the acquisition of privately
held National Telecommunications of Florida, Inc. and NTC, Inc.
(collectively, "National"), an emerging switch-based competitive local
exchange carrier and established interexchange carrier. The operating
results of National are included in the Company's consolidated financial
statements commencing on April 1, 1998. Aggregate consideration for the
acquisition was approximately $59.5 million in cash, plus 2,909,796 shares
of the Company's Common Stock, valued at approximately $88.7 million, the
retirement of $2.8 million in National's long-term debt, and $2.2 million
in acquisition related costs. The acquisition was accounted for by the
purchase method of accounting, with the purchase price allocated to the
fair value of assets acquired and liabilities assumed, principally
goodwill ($146.7). This goodwill will be amortized over its estimated
useful life of 20 years. The allocation of the purchase price is tentative
pending management's completion of the valuation of the purchased assets
and liabilities. However, management does not expect the final allocation
of the purchase price to differ significantly from the preliminary
allocations.
7
<PAGE> 8
The following unaudited pro forma results of operations present the
consolidated results of operations as if the acquisitions of DIGEX ,
Incorporated ("DIGEX"), Shared, LDS, and National had occurred at the
beginning of the respective periods. These pro forma results do not
purport to be indicative of the results that actually would have occurred
if the acquisition had been made as of that date or of results which may
occur in the future.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
(In thousands, except per share data) 1998 1997
------------ ------------
<S> <C> <C>
Revenue $567,277 $458,169
Net loss (390,676) (210,436)
Net loss attributable to common
stockholders (458,794) (241,243)
Basic and diluted net loss per common
share (11.14) (5.86)
</TABLE>
Note 3 Business Restructuring and Integration Program
During the second quarter of 1998, management committed to and
commenced implementation of the restructuring program (the "Program")
which was designed to streamline and refocus the Company's operations and
facilitate the transformation of the Company's five separate operating
companies into one Integrated Communications Provider ("ICP"). The
significant activities included in the Program include (i) consolidation,
rationalization and integration of network facilities, collocations,
network management and network facility procurement; (ii) consolidation
and integration of the sales forces of the Company and its recent
acquisitions, including the integration of the Company's products and
services and the elimination of redundant headcount and related costs;
(iii) centralization of accounting and financial functions, including the
elimination of redundant headcount and related costs (iv) development and
integration of information systems including the integration of multiple
billing systems and the introduction and deployment of automated sales
force and workflow management tools; (v) consolidation of office space and
the elimination of unnecessary legal entities; and (vi) exiting
non-strategic businesses including the elimination of headcount and
related costs.
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The following table sets forth the significant components and activity in
the restructuring program reserve for the nine months ended September 30,
1998 (in millions):
<TABLE>
<CAPTION>
Other
Employee Business
Termination Contract Asset Integration
Activity benefits(vii) Terminations Impairments Costs Total
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Network integration(i) $1.7 $1.7
Sales force consolidation $.4 .4
and branding(ii)
Consolidation of financial .9 $6.0 6.9
functions(iii)
Information systems .7 .7
integration(iv)
Campus consolidation(v) 2.3 2.3
Exiting non-core businesses(vi) .6 10.7 $13.4 .2 24.9
-----------------------------------------------------------------------
Total provisions recorded
during the quarter ended June
30, 1998 2.6 14.7 13.4 6.2 36.9
Less: Payments and adjustments .9 1.0 9.2 3.5 14.6
-----------------------------------------------------------------------
Balance in accrual at 1.7 13.7 4.2 2.7 22.3
September 30, 1998
=======================================================================
</TABLE>
(i) This activity consists primarily of the consolidation, rationalization and
integration of network facilities, collocations, network management and
network facility procurement.
(ii) This activity consists primarily of the consolidation and integration of
the sales forces of the Company and its recent acquisitions, including the
integration of the Company's products and services and the elimination of
redundant headcount and related costs.
(iii) This activity consists of the centralization of accounting and financial
functions, including the reduction of redundant headcount and related
costs. Other business integration costs relate primarily to estimated
consulting costs for assistance with the development and implementation of
the Company's restructuring program.
(iv) This activity consists of the development and integration of information
systems, including the integration of multiple billing systems, and the
introduction and deployment of automated sales force and workflow
management tools.
(v) This activity relates to the consolidation of office space and the
elimination of unnecessary legal entities. Contract termination costs
represent the estimated costs of lease terminations for property exited as
part of the Program. Other business integration costs relate to legal fees
for eliminating unnecessary legal entities.
(vi) This activity consists of the exiting of non-strategic businesses
including the elimination of redundant headcount and related costs.
Contract termination costs include the estimated cost to cancel a switched
services contract with WorldCom ($10.1 million) and lease termination
payments. Asset impairments relate to $9.2 million of accounts receivable
balances from five customers that were written-off as a result of the
Company's exit of the wholesale long-distance business. In addition, this
category also includes $2.8 million related to equipment write-downs.
(vii) The total number of employees affected by the restructuring program was
280.
As provided for in the Program, the Company also expensed other
business restructuring and integration costs that were incurred in the
third quarter. These costs represent incremental, redundant, or
convergence costs that resulted directly from implementation of the
Program, but are required to be expensed as incurred.
9
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The following table sets forth the components of the other business
restructuring and integration costs that were expensed as incurred during
the three and nine months ended September 30, 1998 (in millions):
<TABLE>
<CAPTION>
Expensed During Expensed During Nine
Quarter Months
Ended September 30, Ended September 30,
Activity 1998 1998
--------------------------------------------------------------------------------
<S> <C> <C>
Network integration(A) $8.8 $21.2
Facilities integration(B) .1 .2
Department and employee .9 1.6
realignment(C)
Functional re-engineering(D) .5 1.2
Year 2000(E) .2 .3
Other(F) (.9) .8
-----------------------------------------------
$9.6 $25.3
===============================================
</TABLE>
(A) Consists primarily of redundant network expense, with some employee
salary costs of severed employees through their severance date.
(B) Consists of rent expense for redundant facilities.
(C) Consists of branding, training and relocation expenses.
(D) Consists of consultant costs and some employee salary costs.
(E) Consists of consultant costs.
(F) Consists of losses on divested businesses, employee salary costs,
legal and accounting costs. In addition, the Company recorded an
adjustment to reflect the settlement of the switched services
contract with WorldCom.
Note 4 Long-Term Debt
In January 1998, the over-allotment option with respect to the December
1997 issuance of the Company's 8.5% Senior Notes due 2008 (the "8.5%
Senior Notes") was exercised and the Company sold an additional $50.0
million principal amount of 8.5% Senior Notes. Net proceeds to the Company
amounted to approximately $48.4 million.
On May 27, 1998, the Company sold $450 million principal amount of 8.6%
Senior Notes due 2008 (the "8.6% Senior Notes") in a private placement
transaction. Subsequent thereto, the over-allotment option with respect to
the 8.6% Senior Notes was exercised and the Company sold an additional
$50.0 million principal amount. Net proceeds to the Company, including the
over-allotment, amounted to approximately $488.0 million. Cash interest on
the 8.6% Senior Notes is payable semi-annually in arrears on June 1 and
December 1 of each year, commencing December 1, 1998. The 8.6% Senior
Notes are redeemable at the option of the Company at any time prior to
June 1, 2003, in whole or in part, at the Make-Whole Price (the greater of
the sum of the principal amount plus the present value of the principal,
premium, and interest with respect to the 8.6% Senior Notes as of June 1,
2003, and the redemption price of the 8.6% Senior Notes on June 1, 2003),
plus accrued and unpaid interest and Liquidated Damages (as defined in the
indenture setting forth the terms of the 8.6% Senior Notes), if any,
thereon to the redemption date. On or after June 1, 2003, the 8.6% Senior
Notes are subject to redemption by the Company, at rates commencing at
104.3%, declining to 100% on June 1, 2006. In addition, at the option of
the Company, up to 25% of the aggregate principal amount of the 8.6%
Senior Notes originally issued may be redeemed at any time prior to June
1, 2001 at a redemption price of 108.6% of the principal amount thereof
plus accrued and unpaid interest and Liquidation Damages, if any, thereon
to the date of redemption, with the net proceeds of one or more Qualified
Equity Offerings (as defined in the indenture setting forth the terms of
the 8.6% Senior Notes); provided, however that at least 75% in aggregate
principal remains outstanding following any such redemption and, provided
further, that such redemption occurs within 90 days of the date of the
closing of such offering.
10
<PAGE> 11
Note 5 Capital Lease Obligations
As disclosed in the Company's Annual Report on Form 10-K for the year
ended December 31, 1997, the Company is party to various capital lease
agreements for fiber optic cable, underground conduit equipment and
utility poles which extend through the year 2015.
In March 1998, the Company and Williams Communications, Inc.
("Williams") executed a Capacity Purchase Agreement which provides the
Company with the right to purchase transmission capacity on a
non-cancelable indefeasible right of use basis on the Williams fiber
network for the next 20 years. The agreement covers approximately 14,000
route miles of network facilities. The capitalized asset, consisting of
the Company's rights to use network facilities, including but not limited
to, fiber, optronics/electronics, digital encoders/decoders, telephone
lines and microwave facilities, in the amount of $417.0 million, is being
depreciated over the 20-year estimated useful life of the primary
underlying network asset, the fiber.
Future minimum payments (in thousands) under the Williams capital lease
at September 30, 1998, are as follows:
<TABLE>
<S> <C>
Three months ending December 31, 1998 $ 5,883
Twelve months ending:
1999 32,354
2000 39,707
2001 45,590
2002 51,472
2003 52,943
Thereafter 754,434
--------
982,383
Less amount representing interest (557,557)
--------
Present value of future minimum lease payments $424,826
========
</TABLE>
Certain executory costs, principally maintenance, associated with the
Williams agreement are being expensed as incurred.
Note 6 Preferred Stock
On August 18, 1998, the Company sold 8,000,000 Depositary Shares (the
"Series F Depositary Shares") (aggregate liquidation preference $200
million) each representing a one-hundredth interest in a share of the
Company's 7% Series F Junior Convertible Preferred Stock, (the "Series F
Preferred Stock"), in a private placement transaction. Net proceeds to the
Company amounted to approximately $193.8 million. Dividends on the Series
F Preferred Stock accumulate at a rate of 7% of the aggregate liquidation
preference thereof and are payable quarterly, in arrears. Dividends are
payable in cash or, at the Company's option, by issuance of shares of
Common Stock of the Company. The Series F Preferred Stock is convertible,
subject to prior redemption, at any time after November 16, 1998 at the
option of the holder thereof into Common Stock of the Company. The Series
F Preferred Stock is redeemable, at the option of the Company, in whole or
part, at any time on or after October 17, 2001, at rates commencing with
104%, declining to 100% on October 17, 2005.
During July and August 1998, the Company exchanged (a) approximately
2.029 million shares of its Common Stock for approximately 1.487 million
Depositary Shares (each representing 1/100th interest in a share of 7%
Series D Junior Convertible Preferred Stock ("the Series D Preferred
Stock")) and (b) approximately 1.423 million shares of its Common Stock
for approximately 1.511 million Depositary Shares (each representing a
1/100th interest in a share of 7% Series E Junior Convertible Preferred
Stock ("the Series E Preferred Stock")), pursuant to exchange agreements
with certain holders of such Depositary Shares. In connection with the
conversion of shares, the Company recorded additional preferred stock
dividends of approximately $11.0 million during the third quarter of 1998
representing the market value of the inducement feature of the
conversions.
11
<PAGE> 12
Note 7 Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income
("SFAS 130"). SFAS 130 requires that total comprehensive income be
disclosed with equal prominence as net income. Comprehensive Income is
defined as changes in stockholders' equity exclusive of transactions with
owners such as capital contributions and dividends. Adoption of SFAS 130,
effective January 1, 1998, had no impact on the Company as Comprehensive
Income for the Company, as defined by SFAS 130, equals net income for the
three and nine months ended September 30, 1998.
Note 8 Earnings Per Share
The following table sets forth the computation of basic and diluted loss
per share of Common Stock (dollars in thousands, except shares and per
share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------------------------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Numerator:
Net loss $ (92,796) $ (144,165) $ (399,673) $ (201,219)
Preferred stock dividends and accretions (30,647) (13,895) (68,118) (27,118)
------------ ------------ ------------ ------------
Numerator for basic loss per share - loss
attributable to common stockholders (123,443) (158,060) (467,791) (228,337)
Effect of dilutive securities -- -- -- --
------------ ------------ ------------ ------------
Numerator for diluted loss per share - income
attributable to common stockholders after
assumed conversions $ (123,433) $ (158,060) $ (467,791) $ (228,337)
Denominator:
Denominator for basic loss per share -
weighted-average shares 47,041,191 33,479,460 41,948,399 32,925,462
Effect of dilutive securities -- -- -- --
------------ ------------ ------------ ------------
Denominator for diluted loss per share-
adjusted weighted-average shares 47,041,191 33,479,460 41,948,399 32,925,462
============ ============ ============ ============
Basic loss per share of Common Stock $ (2.62) $ (4.72) $ (11.15) $ (6.93)
============ ============ ============ ============
Diluted loss per share of Common Stock $ (2.62) $ (4.72) $ (11.15) $ (6.93)
============ ============ ============ ============
</TABLE>
Unexercised options to purchase 6,484,148 and 6,640,814 shares of
Common Stock as of September 30, 1998 and 1997, respectively, and
outstanding convertible preferred stock, convertible into 17,079,495
shares of Common Stock as of September 30, 1998, were not included in the
computations of diluted loss per share because assumed conversion would be
anti-dilutive.
Note 9 Contingencies
On June 20, 1997, two purported class action complaints were filed in
the Court of Chancery of the State of Delaware in and for New Castle
County respectively by TAAM Associates, Inc. and David and Chaile
Steinberg (the "Complaints"), purported stockholders of DIGEX on behalf of
all non-affiliated common stockholders of DIGEX against Intermedia, DIGEX
and the directors of DIGEX (the "DIGEX Directors"). The Complaints allege
that the DIGEX Directors violated their fiduciary duties to the public
stockholders of DIGEX by agreeing to vote in favor of the merger between
DIGEX and a wholly owned subsidiary of Intermedia (the "Merger") and that
Intermedia knowingly aided and abetted such violation by offering to
retain DIGEX management in their present positions and consenting to stock
option grants to certain executive officers of DIGEX. The Complaints
sought a preliminary and permanent injunction enjoining the Merger but no
applications were made for such injunctions prior to consummation of the
Merger on July 11, 1997. In addition, the Complaints seek cash damages
from DIGEX Directors. In August 1997, a motion to
12
<PAGE> 13
dismiss the Complaints was filed on behalf of Intermedia, DIGEX, and the
DIGEX Directors. The action has been dormant since that time.
These cases are in the early stages and no assurance can be given as to
their ultimate outcome. Intermedia, after consultation with its counsel,
believes that there are meritorious factual and legal defenses to the
claims in the Complaints. Intermedia intends to defend vigorously the
claims in the Complaints.
The Company is not a party to any other pending legal proceedings except
for various claims and lawsuits arising in the normal course of business.
The Company does not believe that these normal course of business claims
or lawsuits will have a material effect on the Company's financial
condition, results of operations or cash flows.
The Company maintains interconnection agreements with incumbent local
exchange carriers ("ILECs") in Florida, Georgia, and North Carolina. These
contracts govern the reciprocal amounts to be billed by competitive
carriers for terminating local traffic of Internet service providers
("ISPs") in each state. During 1997, the Company recognized revenue from
these ILECS of approximately $10.0 million for these services. During the
nine months ended September 30, 1998, the Company recognized an additional
$22.4 million in revenue from these services. Payments of approximately
$2.2 million were received from the ILECs during the third quarter of
1998.
The Company accounts for reciprocal compensation with the ILECs,
including the activity associated with the disputed ISP traffic, as local
traffic pursuant to the terms of its interconnection agreements.
Accordingly, revenue is recognized in the period that the traffic is
terminated. The circumstances surrounding the disputes, including the
status of cases that have arisen by reason of similar disputes referred to
below, is considered by management periodically in determining whether
reserves against unpaid balances are warranted. As of September 30, 1998,
provisions have not been considered necessary by management.
Management believes the issue related to mutual compensation for
Internet traffic to be an industry wide matter that will ultimately be
resolved on a state-by-state basis. To date, twenty-four state commissions
have ruled on the issue and found that ILECs must pay compensation to
competitive carriers for local calls to ISPs located on competitive
carriers' networks. A number of other state commissions currently have
proceedings pending to consider this matter. Management is pursuing this
matter vigorously and believes the ILECs will ultimately pay all amounts
in full.
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto included herewith, and with
the Company's Management's Discussion and Analysis of Financial Condition and
Results of Operations and audited consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 filed with the Securities and Exchange Commission.
OVERVIEW
Intermedia has experienced continuous revenue growth since its inception in
1986. Since 1992, the Company has experienced an accelerated rate of revenue
growth. Building from its original base in Florida, Intermedia now provides
integrated telecommunications services nationally with a focus on customers who
have a substantial presence in the eastern United States. Through a combination
of internally generated growth and targeted acquisitions, the Company has
expanded its service territory and dramatically increased its customer base.
Intermedia's customers include a broad range of business and government end
users and, to a lesser extent, ISPs and other carriers. The Company delivers
local network services, including local exchange service, primarily through
Company owned local and long distance switches and over a Company owned or
leased digital transport network. Often, leasing facilities enables the Company
to more rapidly initiate service to customers, reduces the risk of network
construction or acquisition and potentially improves cash flow due to the
reduction or deferment of capital expenditures. The Company offers enhanced data
services to its customers on an extensive inter-city network that connects its
customers, either through its own network or through other carriers, to
locations throughout the country
13
<PAGE> 14
and internationally. Through its 608 network to network interfaces ("NNIs") and
164 data switches, Intermedia has established one of the most densely deployed
frame relay switching network in the nation. The Company's nationwide
interexchange network, which it is upgrading to provide asynchronous transfer
mode ("ATM") capability, carries both its data network traffic and its voice
network traffic.
At its inception, Intermedia provided special access and private line
services to interexchange carriers ("IXCs"). In 1988, Intermedia was the first
telecommunications provider in Florida to begin providing special access and
private line services to business customers. In 1991, Intermedia began offering
specialized integration services such as construction of campus local area
networks ("LANs"), and in 1992, Intermedia introduced its first enhanced data
services based on frame relay technology, providing flexible capacity and highly
reliable end-to-end data service. The Company began offering interexchange long
distance service in December 1994, Internet services in 1995, local exchange
services in 1996 and integrated voice/data services via Single-T(sm) in 1997.
The pace with which the Company has introduced new service offerings has enabled
it to achieve substantial growth, expand its base of customers and diversify its
sources of revenue. The Company believes that business and government customers
will continue to account for a substantial share of its revenue because of
Intermedia's ability to offer such customers integrated, cost-effective
telecommunications solutions. The Company believes that during the first few
years of local exchange competition, some IXCs may enter the local exchange
market by becoming resellers of the Company's local services. If the IXCs pursue
a resale strategy, the amount of revenue the Company realizes from carriers may
increase during this period, although the Company does not depend on these IXC
resale revenues to satisfy its business plan.
Network operating costs, administration and maintenance of facilities,
depreciation of network capital expenditures and sales, general and
administrative costs will continue to represent a large portion of the Company's
expenses for the next several years. In addition, the Company is experiencing
rapid growth in marketing and selling expenses consistent with the addition of
new customers and an increased level of selling and marketing activity. The
Company anticipates that as its customer base grows, incremental revenues will
be greater than incremental operating expenses.
All of the marketing and selling expenses associated with the acquisition of
new customers are expensed as they are incurred even though these customers are
expected to generate recurring revenue for the Company for several years. The
continued expansion of the Company's networks in preparation for new customers
and the marketing of services to new and existing customers is therefore
adversely impacting EBITDA before certain charges of the Company in the near
term. From 1992 through 1995, the Company achieved positive EBITDA before
certain charges and increased its revenue base substantially. As a result of
significant investments in the resources necessary to launch local exchange
services and expand enhanced data services, the Company's EBITDA before certain
charges was negative for 1996 and 1997. The Company expects EBITDA before
certain charges to be positive for the full year of 1998. EBITDA before certain
charges consists of earnings (loss) before extraordinary loss on early
extinguishment of debt, interest expense, interest and other income, income
taxes, depreciation, amortization, charges for in-process R&D, and business
integration, restructuring and other costs associated with the Program. EBITDA
before certain charges does not represent funds available for management's
discretionary use and is not intended to represent cash flow from operations.
EBITDA before certain charges should not be considered as an alternative to net
loss as an indicator of the Company's operating performance or to cash flows as
a measure of liquidity. In addition, EBITDA before certain charges is not a term
defined by generally accepted accounting principals and as a result the EBITDA
before certain charges presented herein may not be comparable to similarly
titled measures used by other companies. The Company believes that EBITDA before
certain charges is often reported and widely used by analysts, investors and
other interested parties in the telecommunications industry. Accordingly, this
information has been disclosed herein to permit a more complete comparative
analysis of the Company's operating performance relative to other companies in
the industry.
In January 1998, the over-allotment option with respect to the Company's
8.5% Senior Notes (December 23, 1997 issuance) was exercised and the Company
sold an additional $50.0 million principal amount of 8.5% Senior Notes. Net
proceeds to the Company amounted to approximately $48.4 million.
On January 29, 1998, the Company announced a definitive multi-year agreement
to become a U S West Communications' ("US West") interLATA data services
provider. Under the terms of this agreement, the Company granted US West a
license to utilize and market the Company's portfolio of enhanced data services.
On March 10, 1998, the Company completed its acquisition of Shared, a shared
tenant communications services provider. Aggregate cash consideration for the
acquisition was approximately $782.2 million, including $62.3 million
14
<PAGE> 15
of transaction expenses and fees relating to certain agreements, with the final
payment made March 10, 1998, and funded with the Company's existing cash
reserves in March 1998. The operating results of Shared are included in the
Company's consolidated financial statements commencing on January 1, 1998.
On March 31, 1998, the Company acquired LDS, a regional interexchange
carrier. Aggregate consideration for the acquisition was approximately $15.7
million in cash, plus 5,359,748 shares of the Company's Common Stock, valued at
approximately $137.2 million, the retirement of $15.1 million in LDS's long-term
debt, and acquisition related expenses of $2.4 million. The cash portion of the
acquisition was funded with the Company's existing cash reserves in March 1998.
The operating results of LDS for the one day of ownership during the first
quarter of 1998 are considered immaterial. The operating results of LDS are
included in the Company's consolidated financial statements commencing on April
1, 1998.
In March 1998, the Company and Williams executed a Capacity Purchase
Agreement which provides the Company with the right to purchase transmission
capacity on a non-cancelable indefeasible right of use basis on the Williams
fiber network for the next 20 years. The agreement covers approximately 14,000
route miles.
On April 29, 1998, the Company announced that it had committed resources to
the Program, a plan to implement the integration of acquired businesses to
maximize the synergies that will be realized and to reduce future costs. During
the second quarter of 1998, the Company developed and began implementation of
the Program which was designed to streamline and refocus the Company's
operations and transform Intermedia's five separate operating companies into one
ICP. The significant activities included in the Program include (i)
consolidation, rationalization and integration of network facilities,
collocations, network management and network facility procurement; (ii)
consolidation and integration of the sales forces of the Company and its recent
acquisitions, including the integration of the Company's products and services
and the elimination of redundant headcount and related costs; (iii)
centralization of accounting and financial functions, including the elimination
of redundant headcount and related costs (iv) development and integration of
information systems including the integration of multiple billing systems and
the introduction and deployment of automated sales force and workflow management
tools; (v) consolidation of office space and the elimination of unnecessary
legal entities; and (vi) exiting non-strategic businesses including the
elimination of headcount and related costs.
In connection with the adoption of the Program, the Company recorded a
restructuring charge during the second quarter of approximately $36.9 million.
The Company also expensed during the second and third quarter of 1998 other
business restructuring and integration costs associated with the Program in the
amounts of $15.7 and $9.6 million, respectively. Management anticipates that all
activities included in the Program will be completed by the end of 1999, and the
Company anticipates incurring additional related business integration and
restructuring costs through the end of that period, which will be excluded from
the calculation of EBITDA before certain charges.
On April 30, 1998, the Company completed the acquisition of privately held
National, an emerging switch-based competitive local exchange carrier and
established interexchange carrier. Aggregate consideration for the acquisition
was approximately $59.5 million in cash, plus 2,909,796 shares of the Company's
Common Stock, valued at approximately $88.7 million, the retirement of $2.8
million in National's long-term debt, and $2.2 million in acquisition related
costs. The cash portion of the acquisition was funded with the Company's
existing cash reserves in April 1998. The operating results of National are
included in the Company's consolidated financial statements commencing on April
1, 1998.
On May 19, 1998, the Company entered into an agreement with Ameritech
Communications International ("Ameritech") for the mutual provisioning of
national data services.
On May 27, 1998, the Company sold $450.0 million principal amount of its
8.6% Senior Notes in a private placement transaction. Subsequently, the
over-allotment option with respect to the 8.6% Senior Notes was exercised and
the Company sold an additional $50.0 million principal amount of 8.6% Senior
Notes. Net proceeds to the Company, including the proceeds from the exercise of
the over-allotment, amounted to approximately $488.0 million. Cash interest on
the 8.6% Senior Notes is payable semi-annually in arrears on June 1 and December
1 of each year, commencing December 1, 1998. The 8.6% Senior Notes are
redeemable at the option of the Company at any time prior to June 1, 2003, in
whole or in part, at the Make-Whole Price (the greater of the sum of the
principal amount plus the present value of the principal, premium, and interest
with respect to 8.6% Senior Notes as of June 1, 2003,
15
<PAGE> 16
and the redemption price of 8.6% Senior Notes on June 1, 2003), plus accrued and
unpaid interest and Liquidated Damages, if any, thereon to the redemption date.
On or after June 1, 2003, the 8.6% Senior Notes are subject to redemption by the
Company, at rates commencing at 104.3%, declining to 100% on June 1, 2006. In
addition, at the option of the Company, up to 25% of the aggregate principal
amount of the 8.6% Senior Notes originally issued may be redeemed at any time
prior to June 1, 2001 at a redemption price of 108.6% of the principal amount
thereof plus accrued and unpaid interest and Liquidation Damages, if any,
thereon to the date of redemption, with the net proceeds of one or more
Qualified Equity Offerings; provided, however that at least 75% in aggregate
principal remains outstanding following any such redemption and, provided
further, that such redemption occurs within 90 days of the date of the closing
of such offering.
On August 18, 1998, the Company sold 8,000,000 Series F Depositary Shares
(aggregate liquidation preference $200 million) each representing a 1/100th
interest in a share of the Company's Series F Preferred Stock, in a private
placement transaction. Net proceeds to the Company amounted to approximately
$193.8 million. Dividends on the Series F Preferred Stock accumulate at a rate
of 7% of the aggregate liquidation preference thereof and are payable quarterly,
in arrears. Dividends are payable in cash or, at the Company's option, by
issuance of shares of Common Stock of the Company. The Series F Preferred Stock
is convertible, subject to prior redemption, at any time after November 16, 1998
at the option of the holder thereof into Common Stock of the Company. The Series
F Preferred Stock is redeemable, at the option of the Company, in whole or part,
at any time on or after October 17, 2001, at rates commencing with 104%,
declining to 100% on October 17, 2005.
On September 21, 1998, the Company entered into a multi-year agreement,
having multiple one-year extension options, with Bell Atlantic Corporation
("Bell Atlantic"). Under the terms of this agreement, Bell Atlantic will resell
Intermedia's high-speed and low-speed frame relay services under the Bell
Atlantic brand. The operational alignment between the two companies should
result in an integrated extension of Bell Atlantic's operations and service
delivery functions, all transparent to the customer, and Bell Atlantic will be
licensed to use the Company's advanced network monitoring system. Service under
this agreement will begin when and if Bell Atlantic gains approval to offer
long-distance services in its primary east coast markets under the
Telecommunications Act of 1996.
PLAN OF OPERATION
For the remainder of 1998, the Company believes that its revenues will be
similar in amount to its revenues for the third quarter of 1998 which will
include revenue growth balanced between its enhanced data and local exchange
services. Based on the Company's analysis of FCC data and its knowledge of the
industry, the Company estimates that the market for enhanced data, local
exchange, and interexchange services was approximately $34.0 billion in 1997 in
the Company's service territory. As a result of the Company's actual and planned
expansion in 1998, including the acquisitions of Shared, LDS and National, the
Company expects to be positioned to provide these services in markets with a
total opportunity of more than $99.2 billion by the end of 1998.
In order to develop its business more rapidly and efficiently utilize its
capital resources, the Company plans to use the existing fiber optic
infrastructure of other providers in addition to using its own existing
networks. The Company believes transport provided on fiber optic systems has
become commodity-like, and its capital expenditures are better focused on
intelligent switching and other more strategic network components required to
implement a Packet/Cell Switched Network. While the Company will use significant
amounts of capital to deploy enhanced data and voice switches on a demand driven
basis in selected markets, Intermedia believes its substantial existing network
capacity should enable it to add new customers and provide additional services
that will result in increased revenues with lower incremental costs and,
correspondingly, improve its EBITDA before certain charges. For example, selling
additional services, such as local exchange services, to existing or new
customers allows the Company to utilize unused portions of the capacity inherent
in its existing fiber optic networks. This operating leverage increases the
utilization of the network with limited additional capital expenditures. The
Company's strategy to offer a full complement of telecommunications services is
designed to enable the Company to take advantage of the operating leverage of
its networks.
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, certain information
derived from the Unaudited Condensed Consolidated Statements of Operations of
the Company, expressed in percentages of revenue:
16
<PAGE> 17
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues:
Local network services 22.8% 16.6% 22.3% 15.4%
Enhanced data services 24.7 43.3 24.4 33.2
Interexchange services 37.2 38.8 38.3 48.9
Integration services 15.3 1.3 15.0 2.5
------------------------------------------------
100.0 100.0 100.0 100.0
Expenses:
Network operations 43.5 68.8 46.9 70.4
Facilities administration and maintenance 7.8 14.0 9.3 13.0
Cost of goods sold 9.9 .7 9.6 1.5
Selling, general and administrative 30.9 35.1 31.2 39.3
Depreciation and amortization 27.9 22.6 27.5 20.7
Charge off of purchased in-process R&D -- 84.2 16.4 36.3
Business restructuring and integration 5.0 -- 12.0 --
------------------------------------------------
Loss from operations (25.0) (125.4) (52.9) (81.2)
Other income (expense):
Interest expense (28.0) (24.8) (29.1) (24.1)
Other income 4.8 9.4 5.0 10.1
------------------------------------------------
Net Loss before extraordinary item (48.2) (140.8) (77.0) (95.2)
Extraordinary loss on early extinguishment
of debt -- (61.5) -- (26.5)
------------------------------------------------
Net loss (48.2) (202.3) (77.0) (121.7)
Preferred stock dividends and accretions (15.9) (19.5) (13.1) (16.4)
------------------------------------------------
Net loss attributable to common stockholders (64.1)% (221.8)% (90.1)% (138.1)%
================================================
</TABLE>
The following table sets forth other statistical data derived from the
Company's operating records:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997
------------------ ------------------
<S> <C> <C>
Local and Long Distance Services: (1)
Buildings connected (2) 4,331 2,703
Voice switches in operation 21 13
Long distance billable minutes (3) 516,897,223 111,049,341
Access line equivalents 311,898 50,740
Access line equivalents per local switch (4) 7,303 3,494
Enhanced data services: (1)
Data switches installed 164 130
Nodes in service (5) 30,266 17,286
NNI connections 608 366
Employees 3,678 1,820
</TABLE>
(1) Amounts reflected in the table are based upon information contained in the
Company's operating records.
(2) Includes both on-net direct connections with Intermedia-owned fiber optic
cable and on-net extended connections with leased circuits.
(3) Amount represents billable minutes for the three months ended September
30, 1998 and 1997, respectively.
(4) Calculated by dividing the number of on-switch access line equivalents by
the number of switches providing local service. Excludes access lines
contributed by Shared.
(5) Amount represents an individual point of origination and termination of
data served by the Company's enhanced network.
17
<PAGE> 18
Quarter Ended September 30, 1998 Compared to Quarter Ended September 30, 1997:
Revenue
Total revenue increased 170.0% to $192.4 million for the third quarter of
1998 compared to $71.2 million for the same period in 1997. This increase was
principally the result of the acquisitions of Shared, LDS, and National. The
Company has also continued its efforts to introduce new services and increase
the focus of the Company's sales force on offering a full suite of
telecommunications services to an expanding market. While the Company's core
strategic revenue categories continue to grow, the Company expects total revenue
in the fourth quarter of 1998 to approximate the third quarter level and long
term revenue growth in the aggregate to resume in 1999. The Company plans to
maintain its emphasis on sales of key services such as enhanced data and local
service. The Company also expects continued demand created by customers in need
of Year 2000 upgrades, which is a catalyst for new systems purchases, and a
positive revenue impact as a result of the network partnership agreements.
Local network services revenue increased 270.6% to $43.8 million for the
third quarter of 1998 compared to $11.8 million for the same period in 1997.
This increase was principally due to the acquisition of Shared during the first
quarter of 1998 and the acquisition of National during the second quarter of
1998, and the continued rollout of local exchange services into additional
markets. The number of access line equivalents has increased by 261,158 from
October 1, 1997 through the end of the third quarter of 1998. The Company was
certified as a CLEC in 36 states and the District of Columbia as of the end of
the third quarter of 1998.
Enhanced data services revenue increased 54.3% to $47.6 million for the
third quarter of 1998 compared to $30.8 million for the same period in 1997.
This increase was principally due to the acquisition of LDS during the first
quarter of 1998 and the expansion of the Company's enhanced data network. The
data network was expanded by 34 switches, 242 NNI connections, and 12,980 new
frame relay nodes. In addition, the Company experienced an increased amount of
sales in frame relay services and new web site installations.
Interexchange services revenue increased 158.9% to $71.6 million for the
third quarter of 1998 compared to $27.6 million for the same period in 1997.
This increase resulted principally from the acquisitions of Shared and LDS
during the first quarter of 1998, the acquisition of National during the second
quarter of 1998, strong growth in long distance switched revenue, and steady
growth in interLATA transport. Interexchange revenues were negatively impacted
during the third quarter of 1998 as a result of the Company's decision to exit
the low margin wholesale international long distance segment. Long distance
billable minutes increased to 516.9 million for the third quarter of 1998
compared to 111.0 million for the same period in 1997.
Integration services revenue increased 2,992.2% to $29.4 million for the
third quarter of 1998 compared to $1.0 million for the same period in 1997. This
increase was principally due to the acquisition of Shared during the first
quarter of 1998.
Operating Expenses
Total operating expenses increased 49.7% to $240.5 million for the third
quarter of 1998 compared to $160.6 million for the same period in 1997. The
increase resulted principally from the acquisitions of Shared and LDS during the
first quarter of 1998 and the acquisition of National during the second quarter
of 1998. The Company has recorded approximately $9.6 million in the third
quarter of 1998 for the execution of the business restructuring and integration
program, has increased support costs relating to the significant expansion of
the Company's owned and leased networks, and has continued expansion in
personnel to sustain and support the Company's growth.
Network operations expenses increased 70.9% to $83.8 million for the third
quarter of 1998 compared to $49.0 million for the same period in 1997. The
increase resulted principally from the acquisitions of Shared and LDS in the
first quarter of 1998 and the acquisition of National in the second quarter of
1998. The Company has incurred increased expenses in leased network capacity
associated with the growth of local network service, enhanced data service, and
interexchange service revenues. The Williams agreement positively impacted
network operations expenses during 1998 by eliminating certain backbone network
costs that were previously accounted for as operating leases.
18
<PAGE> 19
Facilities administration and maintenance expenses increased 49.6% to
$14.9 million for the third quarter of 1998 compared to $10.0 million for the
same period in 1997. The increase was principally due to the acquisitions of
Shared and LDS in the first quarter of 1998 and the acquisition of National in
the second quarter of 1998. The increase also resulted from support costs
relating to the expansion of the Company's owned and leased network capacity,
increases in maintenance expenses due to network expansion and increased payroll
expenses related to hiring additional engineering and operations staff to
support and service the expanding network, including the increase in volume
relating to the US West and Ameritech agreements. Facilities administration and
maintenance expenses were positively impacted by the Company's exit of the
wholesale interexchange business.
Cost of Goods Sold increased 3680.1% to $19.0 million for the third
quarter of 1998 compared to $.5 million for the same period in 1997. This
increase was principally due to the acquisition of Shared during the first
quarter of 1998.
Selling, general and administrative expenses increased 137.9% to $59.5
million for the third quarter of 1998 compared to $25.0 million for the same
period in 1997. The increase was principally due to the acquisitions of Shared
and LDS in the first quarter of 1998 and the acquisition of National in the
second quarter of 1998. The acquisitions of Shared, LDS, and National
contributed to the increase by approximately $10.3 million, $4.3 million, and
$2.4 million, respectively. The Company has experienced continued personnel
growth, represented by departmental expense increases in sales of approximately
$8.5 million, marketing of approximately $1.1 million, management information
services of approximately $1.9 million, and customer operations and circuit
design and provisioning of approximately $4.1 million. The growth in headcount
was directly related to the need to support the Company's data partnership
agreements.
Depreciation and amortization expenses increased 233.3% to $53.7 million
for the third quarter of 1998 compared to $16.1 million for the same period in
1997. This increase was principally due to additions to telecommunications
equipment placed in service since October 1, 1997, relating to ongoing network
expansion, as well as, the acquisitions Shared, LDS, and National which
contributed, based on preliminary estimates, approximately $640.8 million,
$143.1 million, and $146.7 million of goodwill and acquired intangibles,
respectively. Additional depreciation charges of approximately $5.1 million
resulted from the long-term lease of capital assets from Williams, which began
during March of 1998. Depreciation and amortization expense is expected to
increase in future periods as the Company expands the network and depreciates
and amortizes goodwill associated with the businesses acquired.
Charge for in-process Research & Development of $60.0 million for the
third quarter of 1997 represents the amount of purchased in-process research and
development ("R&D") associated with the purchase of DIGEX. This allocation
represents the estimated fair value based on risk-adjusted cash flows related to
the incomplete projects. At the date of acquisition, the development of these
projects had not yet reached technological feasibility and R&D in progress had
no alternative future uses. Accordingly, these costs were expensed as of the
acquisition date and were recorded as a one-time charge to earnings in the third
quarter of 1997.
In making its purchase price allocation, the Company relied on present
value calculations of income, an analysis of project accomplishments and
completion costs, an assessment of overall contribution, as well as project
risk. The amounts assigned to the in-process R&D were determined by identifying
significant research projects for which technological feasibility had not been
established. These included development, engineering, and testing activities
associated with specific and substantial network projects including new router
technology related to traffic management and very high speed data streams, as
well as value-added services such as multicasting and new advanced web
management capabilities.
The value assigned to purchased in-process technology was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products and services, estimating the resulting net cash
flows from the projects, and discounting the net cash flows to their present
value.
Remaining development efforts for DIGEX projects include various phases of
design, development, and testing. Anticipated completion dates for the projects
in progress are expected to occur by the end of 1998, after which the Company
expects to begin generating economic benefits from the technologies.
Expenditures to complete these projects are expected to total approximately $.5
million in the fourth quarter of 1998.
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These estimates are subject to change, given the uncertainties of the
development process, and no assurance can be given that deviations from these
estimates will not occur. Management expects to continue development of these
efforts and believes the Company has a reasonable chance of successfully
completing the R&D programs. However, there is a risk associated with the
completion of the projects, and there is no assurance that any will meet with
either technological or commercial success. Failure to complete the in-process
R&D programs would result in the loss of the expected economic return inherent
in the fair value allocation.
Business restructuring and integration expense of approximately $9.6
million was recorded by the Company during the third quarter of 1998, which
consists of costs related to businesses exited and integration and other
restructuring costs. Such costs were comprised primarily of network integration,
back office accounting integration, information systems integration costs, and
costs associated with positions scheduled to be eliminated by the second quarter
of 1999. These costs represent incremental, redundant, or convergence costs that
result directly from implementation of the Program but are required to be
expensed as incurred. Such costs were substantially in line with the amounts
expected for the third quarter by management. Additional incremental, redundant
and convergence costs within this category of Program cost will be expensed as
they are incurred each quarter over the Program implementation period.
Management currently expects these additional costs to amount to approximately
$33.2 million over the remainder of the Program.
Interest Expense
Interest expense increased 204.9% to $53.9 million for the third quarter
of 1998 compared to $17.7 million for the same period in 1997. This increase
primarily resulted from interest expense on approximately $1.2 billion of senior
notes issued from October 1, 1997 through the end of the third quarter of 1998.
In addition, the Company recorded interest expense of $10.0 million during the
third quarter of 1998 related to the capital lease with Williams. Also included
in 1998 interest expense is $18.5 million of debt discount amortization and $1.3
million of deferred loan cost amortization, both of which are non-cash items.
Interest expense capitalized in connection with the Company's construction of
telecommunications equipment amounted to approximately $1.8 million and $1.0
million for the three months ended September 30, 1998 and 1997, respectively.
Other Income
Other income increased 38.2% to $9.3 million for the third quarter of 1998
compared to $6.7 million for the same period in 1997. This increase was
primarily the result of interest earned on the cash available from the proceeds
of the issuance of securities in 1997, the exercise of the over-allotment option
with respect to the 8.5% Senior Notes in January 1998, the issuance of the 8.6%
Senior Notes in May 1998, and the issuance of the Series F Preferred Stock in
August 1998.
Extraordinary Loss
The extraordinary loss of $43.8 million recorded during the third quarter
of 1997 consisted of pre-payment penalties relating to certain indebtedness
which was repaid from the proceeds of the offering of the 11-1/4% Senior Notes
issued in July 1997 and the write-off of the unamortized deferred financing
costs associated with the indebtedness repaid.
Net Loss
Net loss decreased 35.6% to $92.8 million for the third quarter of 1998
compared to $144.2 million for the same period in 1997. The decrease resulted
principally from the acquisitions of Shared and LDS in the first quarter of 1998
and National in the second quarter of 1998. In addition, the Company has
realized improved operating margins as a result of the restructuring and
integration program, improved product strategy, and reduced network costs due to
the network partnership agreements. The Company's "on-switch" sales strategy has
also contributed to the improved overall margins.
Preferred Stock Dividends and Accretions
Preferred stock dividends and accretions increased 120.6% to $30.6 million
for the third quarter of 1998 compared to $13.9 million for the same period in
1997. The increase was due to the issuance of the two series of
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<PAGE> 21
preferred stock issued in October 1997 and August 1998 and the conversion of
approximately 15,000 shares of the Company's Series D Preferred Stock and
approximately 15,000 shares of the Company's Series E Preferred Stock into
Common Stock. The Company recorded a charge of approximately $11.0 million
during the third quarter of 1998 representing the market value of the inducement
feature of the conversions. In addition, preferred stock dividends were paid in
the form of Common Stock and preferred stock. Management does not expect to pay
cash dividends in the foreseeable future.
EBITDA Before Certain Charges
EBITDA before certain charges increased 214.1% to $15.1 million for the
third quarter of 1998 compared to $(13.3) million for the same period in 1997.
The increase was principally the result of the acquisitions of Shared and LDS in
the first quarter of 1998 and the acquisition of National in the second quarter
of 1998. These acquisitions contributed to improved EBITDA before certain
charges primarily by consolidating sales forces and introducing the Company's
products into additional markets. The Company has continued its efforts to
consolidate traffic through the Williams backbone network, as well as, through
the Company's existing networks in an efficient manner. In addition, the Company
has been successful in selling more of its access lines "on switch" and
increasing its mix of higher margin products. The business restructuring and
integration program has yielded benefits by eliminating redundant costs
associated with rationalizing and integrating the recent acquisitions. In
addition, the Company has reduced network operation expenses, facilities
administration and maintenance expenses, and selling, general and administrative
expenses as a percentage of revenue in the third quarter of 1998 as compared to
the same period in 1997.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended September 30,
1997:
Revenue
Total revenue increased 214.2% to $519.4 million for the nine months ended
September 30, 1998 compared to $165.3 million for the same period in 1997. The
increase was principally the result of the acquisitions of Shared and LDS in the
first quarter of 1998, the acquisition of National in the second quarter of
1998, the introduction of new services, and the increased focus of the Company's
sales force on offering a full suite of telecommunications services to an
expanding market. The Company expects revenue in the fourth quarter of 1998 to
approximate the third quarter level and long term revenue growth to resume in
1999. The Company plans to maintain its emphasis on sales of key services such
as enhanced data and local service. The Company also expects continued demand
created by customers in need of Year 2000 upgrades, which is a catalyst for new
systems purchases, and a positive revenue impact as a result of the network
partnership agreements. In addition, the Company is continuing its integration
of the recent acquisitions and further development of cross-selling programs.
Local network services revenue increased 354.3% to $115.6 million for the
nine months ended September 30, 1998 compared to $25.5 million for the same
period in 1997. This increase was principally due to the acquisition of Shared
during the first quarter of 1998, the acquisition of National during the second
quarter of 1998, and the increased number of local customers over the same
period in 1997. The number of access line equivalents increased by 261,158 from
October 1, 1997 through the end of the third quarter of 1998. Additionally, the
Company successfully continued its rollout of local exchange services into
additional markets. The Company was certified as a CLEC in 36 states and the
District of Columbia as of the end of the third quarter of 1998.
Enhanced data services revenue increased 131.2% to $126.8 million for the
nine months ended September 30, 1998 compared to $54.8 million for the same
period in 1997. This increase resulted principally from the inclusion of three
full quarters of enhanced data services revenues in 1998 relating to the
acquisition of DIGEX compared to one quarter during the same period in 1997. In
addition, the increase was attributable to the acquisition of LDS, effective
April 1, 1998, and the expansion of the Company's enhanced data network by 34
switches, 242 NNI connections, and 12,980 new frame relay nodes from October 1,
1997 through the end of the third quarter of 1998.
Interexchange services revenue increased 146.1% to $199.0 million for the
nine months ended September 30, 1998 compared to $80.9 million for the same
period in 1997. This increase resulted principally from the acquisitions of
Shared and LDS in the first quarter of 1998, and the acquisition of National in
the second quarter of 1998. The Company has experienced strong growth in long
distance switched revenue and steady growth in interLATA transport.
Interexchange revenues were negatively impacted during the third quarter of 1998
by the Company's
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decision to exit the low margin wholesale long distance segment. Long distance
billable minutes increased to 1,252.3 million for the first nine months of 1998
compared to 300.0 million for the same period in 1997.
Integration services revenue increased 1,775.8% to $77.9 million for the
nine months ended September 30, 1998 compared to $4.2 million for the same
period in 1997. This increase resulted primarily from the acquisition of Shared
during the first quarter 1998, as well as, the Company's continued focus on
providing a total service package to its customers.
Operating Expenses
Total operating expenses increased 165.1% to $794.0 million for the nine
months ended September 30, 1998 compared to $299.5 million for the same period
in 1997. The increase resulted principally from the acquisitions of Shared and
LDS in the first quarter of 1998 and the acquisition of National in the second
quarter of 1998. The Company has recorded a one-time charge to earnings of $85.0
million during the first quarter of 1998 for purchased in-process research and
development associated with the acquisition of Shared compared to a similar
charge relating to the acquisition of DIGEX in the prior period of $60.0
million. Additionally, the Company recorded expenses of approximately $62.2
million in connection with the execution of the Program during the first nine
months of 1998, increased support costs relating to the significant expansion of
the Company's owned and leased networks, and has continued expanding its
personnel to sustain and support the Company's growth.
Network operations expenses increased 109.2% to $243.3 million for the
nine months ended September 30, 1998 compared to $116.3 million for the same
period in 1998. The increase resulted principally from the acquisitions of
Shared and LDS in the first quarter of 1998, and the acquisition of National in
the second quarter of 1998. The Company has incurred increased expenses in
leased network capacity associated with the growth of local network service,
enhanced data service, and interexchange service revenues. The Williams
agreement positively impacted network operations expenses during 1998 by
eliminating certain backbone network costs that were previously accounted for as
operating leases.
Facilities administration and maintenance expenses increased 126.6% to
$48.5 million for the nine months ended September 30, 1998 compared to $21.4
million for the same period in 1997. The increase was principally the result of
the acquisitions of Shared and LDS in the first quarter of 1998 and the
acquisition of National in the second quarter of 1998. The increase also
resulted from support costs relating to the expansion of the Company's owned and
leased network capacity, increases in maintenance expense due to network
expansion, and increased payroll expenses related to hiring additional
engineering and operations staff to support and service the expanding network,
including the increase in volume relating to the US West and Ameritech
agreements. Facilities administration and maintenance expenses were positively
impacted by the Company's exit of the wholesale interexchange business.
Cost of Goods Sold increased 1,867.8% to $49.9 million for the nine months
ended September 30, 1998 compared to $2.5 million for the same period in 1997.
This increase was principally due to the acquisition of Shared during the first
quarter of 1998.
Selling, general and administrative expenses increased 149.7% to $162.2
million for the nine months ended September 30, 1998 compared to $65.0 million
for the same period in 1997. The increase was principally due to the
acquisitions of Shared and LDS in the first quarter of 1998, and the acquisition
of National in the second quarter of 1998. The acquisitions of Shared, LDS, and
National contributed to the increase by approximately $27.2, $9.1, and $5.2,
respectively. The Company has experienced continued personnel growth,
represented by departmental expense increases in sales of approximately $24.5
million, marketing of approximately $3.1 million, management information
services of approximately $4.7 million, and customer operations and circuit
design and provisioning of approximately $11.1 million. The growth in headcount
was directly related to the need to support the Company's data network
partnership agreements.
Depreciation and amortization expenses increased 316.7% to $142.8 million
for the nine months ended September 30, 1998 compared to $34.3 million for the
same period in 1997. This increase was principally due to additions of
telecommunications equipment placed in service since October 1, 1997, relating
to ongoing network expansion, as well as, the acquisitions Shared, LDS, and
National which contributed, based on preliminary estimates, approximately $640.8
million, $143.1 million, and $146.7 million of goodwill and acquired
intangibles, respectively. Additional depreciation charges of approximately
$15.4 million resulted from the long-term lease of capital assets
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<PAGE> 23
from Williams in March 1998. Depreciation and amortization expense is expected
to increase in future periods as the Company expands the network and depreciates
and amortizes goodwill associated with the businesses acquired.
Charge for in-process Research & Development of $85.0 million for the
first nine months of 1998 represents the amount of purchased in-process R&D
associated with the purchase of Shared. This allocation represents the estimated
fair value based on risk-adjusted cash flows related to the incomplete projects.
At the date of acquisition, the development of these projects had not yet
reached technological feasibility and R&D in progress had no alternative future
uses. Accordingly, these costs were expensed as of the acquisition date and were
recorded as a one-time charge to earnings in the first quarter of 1998.
In making its purchase price allocation, the Company relied on present
value calculations of income, an analysis of project accomplishments and
completion costs, an assessment of overall contribution, as well as project
risk. The amounts assigned to the in-process R&D were determined by identifying
significant research projects for which technological feasibility had not been
established. In-process R&D included the development and deployment of an
innovative multi-service access platform, which will enable Shared to provision
new data services.
The value assigned to purchased in-process technology was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products and services, estimating the resulting net cash
flows from the projects, and discounting the net cash flows to their present
value.
Remaining development efforts for Shared projects include various phases
of design, development, and testing. Anticipated completion dates for the
projects in progress will occur during the next two years, after which time the
Company expects to begin generating economic benefits from the technologies.
Expenditures to complete these projects are expected to total approximately $1.1
million in 1998 and $1.4 million in 1999.
These estimates are subject to change, given the uncertainties of the
development process, and no assurance can be given that deviations from these
estimates will not occur. Management expects to continue development of these
efforts and believes the Company has a reasonable chance of successfully
completing the R&D programs. However, there is a risk associated with the
completion of the projects, and there is no assurance that any will meet with
either technological or commercial success. Failure to complete the in-process
R&D programs would result in the loss of the expected return inherent in the
fair value allocation.
In connection with the purchase of DIGEX in the third quarter of 1997, the
Company allocated $60.0 million of the purchase price to in-process R&D projects
as described above under the caption "Quarter Ended September 30, 1998 Compared
to Quarter Ended September 30, 1997 - Operating Expenses."
Business restructuring and integration expense of approximately $62.2
million was recorded by the Company during the nine months ended September 30,
1998. The Company recorded a business restructuring and integration charge of
$52.6 million during the second quarter of 1998, which was comprised of
businesses exited, contract termination costs, and integration and other
restructuring costs. During the third quarter of 1998, the Company expensed
approximately $9.6 million in other business restructuring and integration
costs, which consist of businesses exited and integration and other
restructuring expenses. Such costs were comprised primarily of network
integration and information systems integration costs. These costs represent
incremental, redundant or convergence costs that result directly from
implementation of the Program, but are required to be expensed as incurred. Such
costs were substantially in line with the amounts expected for the third quarter
by management. Additional incremental, redundant and convergence costs within
this category of Program cost will be expensed as they are incurred each quarter
over the Program implementation period. Management currently expects these
additional costs to amount to approximately $33.2 million over the remainder of
the Program.
Interest Expense
Interest expense increased 278.7% to $151.1 million for the nine months
ended September 30, 1998 compared to $39.9 million for the same period in 1997.
This increase primarily resulted from interest expense on approximately $1.2
billion of senior notes issued from October 1, 1997, through the end of the
third quarter of 1998, plus the non-cash imputed interest charges of $5.1
million related to the acquisition of Shared and $1.0 million related to the
acquisition of National. In addition, the Company recorded interest expense of
$29.9 million during the nine months ended September 30, 1998, related to the
capital lease with Williams. Included in 1998 interest expense is
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<PAGE> 24
$55.5 million of debt discount amortization and $3.3 million of deferred loan
cost amortization, both of which are non-cash items. Interest expense
capitalized in connection with the Company's construction of telecommunications
equipment amounted to approximately $5.4 million and $2.5 million for the nine
months ended September 30, 1998 and 1997, respectively.
Other Income
Other income increased 56.2% to $26.1 million for the nine months ended
September 30, 1998 compared to $16.7 million for the same period in 1997. This
increase was primarily the result of interest earned on the cash available from
the proceeds of the issuance of securities in 1997 and the exercise of the
over-allotment option with respect to the 8.5% Senior Notes in January 1998, the
issuance of the 8.6% Senior Notes in May 1998, and the issuance of the Series F
Preferred Stock in August 1998.
Extraordinary Loss
The extraordinary loss of $43.8 million recorded during the third quarter
of 1997 consisted of pre-payment penalties relating to certain indebtedness
which was repaid from the proceeds of the offering of the 11-1/4% Senior Notes
issued in July of 1997 and the write-off of the unamortized deferred financing
costs associated with the indebtedness repaid.
Net Loss
Net loss increased 98.6% to $399.7 million for the nine months ended
September 30, 1998 compared to $201.2 million for the same period in 1997. The
increase was principally due to the acquisition of Shared in the first quarter
of 1998 and National in the second quarter of 1998. In addition, the increased
operating expenses resulting from the expansion of the network, increased
selling, general and administrative costs, the charge for in-process R&D,
business restructuring and integration expenses, and increased interest costs
contributed to the increase in net loss.
Preferred Stock Dividends and Accretions
Preferred stock dividends and accretions increased 151.2% to $68.1 million
for the nine months ended September 30, 1998 compared to $27.1 million for the
same period in 1997. The increase was due to the issuance of the two series of
preferred stock issued in October 1997 and August 1998 and the conversion of
approximately 15,000 shares of the Company's Series D Preferred Stock and
approximately 15,000 shares of the Company's Series E Preferred Stock into
Common Stock. The Company recorded a charge of approximately $11.0 million
during the third quarter of 1998 representing the market value of the inducement
feature of the conversions. Preferred stock dividends were paid in the form of
Common Stock and preferred stock. Management does not expect to pay cash
dividends in the foreseeable future.
EBITDA Before Certain Charges
EBITDA before certain charges increased 138.5% to $15.4 million for the
nine months ended September 30, 1998 compared to $(39.9) million for the same
period in 1997. The increase was principally the result of the acquisitions of
Shared and LDS in the first quarter of 1998 and the acquisition of National in
the second quarter of 1998. These acquisitions contributed to improved EBITDA
before certain charges primarily by consolidating sales forces and introducing
the Company's products into additional markets. The Company has continued its
efforts to consolidate traffic through the Williams backbone network, as well
as, through the Company's existing networks in an efficient manner. In addition,
the Company has been successful in selling more of its access lines "on switch"
and increasing its mix of higher margin products. The business restructuring and
integration program has yielded benefits from the elimination of redundant costs
associated with rationalizing and integrating the recent acquisitions. In
addition, the Company has reduced network operation expenses, facilities
administration and maintenance expenses, and selling, general and administrative
expenses as a percentage of revenue in the third quarter of 1998 as compared to
the same period in 1997.
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Liquidity and Capital Resources
The Company's operations have required substantial capital investment for
the purchase of telecommunications equipment and the design, construction and
development of the Company's networks. Capital expenditures for the Company were
approximately $338.1 million and $178.7 million for the nine months ended
September 30, 1998 and 1997, respectively, excluding capital leases and
telecommunications equipment acquired in connection with business acquisitions.
The Company expects that it will continue to have substantial capital
requirements in connection with the (i) expansion and improvement of the
Company's existing networks, (ii) design, construction and development of new
networks, (iii) connection of additional buildings and customers to the
Company's networks, (iv) purchase of switches necessary for local exchange
services and expansion of interexchange services and (v) continued development
of the Company's enhanced data services. During the first quarter of 1998, the
Company utilized approximately $782.2 million of its available cash to complete
the Shared acquisition and approximately $33.2 million of its available cash to
complete the LDS acquisition. In addition, the Company utilized approximately
$64.4 million of its available cash to complete the acquisition of National in
April 1998.
The Company has funded a substantial portion of these expenditures through
the public and private sale of debt and equity securities. From inception
through December 31, 1996, the Company raised approximately $212.6 million in
net proceeds from the sale of Common Stock, including Common Stock issued in
connection with certain acquisitions, and $324.6 million in net proceeds from
the sale of senior notes. During 1997 the Company raised approximately $957.7
million in net proceeds from the sale of senior notes and approximately $648.4
million in net proceeds from the sale of three series of preferred stock. During
1998, the Company raised approximately $537.3 million in net proceeds from the
sale of senior notes, including the over-allotment exercises, and approximately
$193.8 million in net proceeds from the sale of a series of preferred stock. All
of the Company's issued series of preferred stock include provisions that may
cause the securities to be redeemed upon a change of control of the Company. As
a result of these redemption provisions, the Company is required to classify the
preferred stock outside of stockholder's equity on the Company's balance sheet
at September 30, 1998. Additionally, none of the outstanding series of preferred
stock require the Company to pay cash dividends in the foreseeable future.
The substantial capital investment required to build the Company's network
has resulted in negative cash flow after consideration of investing activities
over the last five-year period. This negative cash flow after investing
activities is a result of the requirement to build a substantial portion of the
Company's network before connecting revenue-generating customers. The Company
expects to continue to produce negative cash flow after investing activities for
the next several years due to the continuous expansion and the development of
the Company's networks. Until sufficient cash flow after investing activities is
generated, the Company will be required to utilize its current and future
capital resources, including the issuance of additional debt and/or equity
securities, to meet its cash flow requirements.
In response to the new pro-competitive telecommunications environment, the
Company accelerated and expanded its capital deployment plan to allow for an
increased level of demand-driven capital spending necessary to more rapidly
exploit the market opportunity in the local exchange market. The Company expects
to commit substantial amounts of funds to expand its existing network in order
to switch traffic within the local service area in those states where it is
currently permitted to provide such services. As of September 30, 1998, the
Company was certified as a CLEC in 36 states plus the District of Columbia,
allowing the Company to provide local exchange services in those markets, and is
currently seeking CLEC certification in 12 additional states. The Company
expects to expend capital for the further development of the Company's enhanced
data service and interexchange service offerings.
A portion of the Company's expansion has occurred, and may continue to
occur, by means of acquisitions. In July 1997, the Company acquired DIGEX, a
leading nationwide business ISP. The aggregate cash consideration for the
acquisition was approximately $160.0 million and was funded with the Company's
then existing cash reserves. In March 1998, the Company acquired Shared. The
total aggregate cash consideration for Shared was approximately $782.2 million,
which was paid out in 1998 and 1997, including certain transaction expenses and
fees relating to certain agreements. This amount includes repayment of $175.6
million of Shared's outstanding bank debt (including accrued interest and
outstanding fees) in connection with the consummation of the acquisition. In
March 1998, the Company completed its acquisition of LDS for a purchase price of
approximately $170.4 million, of which approximately $137.2 million was paid in
Common Stock and approximately $33.2 million was paid in cash, including the
repayment of approximately $15.1 million of LDS debt.
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On April 30, 1998, the Company completed the acquisition of privately held
National, an emerging switch-based competitive local exchange carrier and
established interexchange carrier. Aggregate consideration for the acquisition
was approximately $59.5 million in cash, plus 2,909,796 shares of the Company's
Common Stock valued at approximately $88.7 million, the retirement of $2.8
million in National's long-term debt, and $2.2 million in acquisition related
costs.
During July and August 1998, the Company exchanged (a) approximately 2.029
million shares of its Common Stock for approximately 1.487 million Depositary
Shares (each representing a 1/100th interest in a share of Series D Preferred
Stock) and (b) approximately 1.423 million shares of its Common Stock for
approximately 1.511 million Depositary Shares (each representing a 1/100th
interest in a share of Series E Preferred Stock), pursuant to exchange
agreements with certain holders of such Depositary Shares.
On August 18, 1998, the Company sold 8,000,000 Series F Depositary Shares
(aggregate liquidation preference $200 million) each representing a 1/100th
interest in a share of the Company's Series F Preferred Stock, in a private
placement transaction. Net proceeds to the Company amounted to approximately
$193.8 million. Dividends on the Series F Preferred Stock accumulate at a rate
of 7% of the aggregate liquidation preference thereof and are payable quarterly,
in arrears. Dividends are payable in cash or, at the Company's option, by
issuance of shares of Common Stock of the Company. The Series F Preferred Stock
is convertible, subject to prior redemption, at any time after November 16, 1998
at the option of the holder thereof into Common Stock of the Company. The Series
F Preferred Stock is redeemable, at the option of the Company, in whole or part,
at any time on or after October 17, 2001, at rates commencing with 104%,
declining to 100% on October 17, 2005.
The Company expects that its EBITDA before certain charges will be positive
for 1998 and that its capital requirements (estimated at approximately $400.0
million, of which approximately $338.1 million has been expended during the
first nine months of 1998 which does not include the non-cash Williams network
capacity purchase) will be funded from available cash, cash generated from its
1998 operations, the bank credit facility discussed below and/or other offerings
of the Company's securities. The Company believes its business plan to be fully
funded through the end of 1999. Depending on market conditions, the Company may
determine to raise additional capital before such time. There can be no
assurance, however, that the Company will be successful in raising sufficient
debt or equity on terms that it will consider acceptable. Moreover, the terms of
the Company's outstanding indebtedness and preferred stock impose certain
restrictions upon the Company's ability to incur additional indebtedness or
issue additional preferred stock. The Company has entered discussions with
several banks for a bank credit facility, although there can be no assurance
that a bank facility on terms satisfactory to the Company will be established.
The Company has from time to time held, and continues to hold, preliminary
discussions with (i) potential strategic investors (i.e. investors in the same
or a related business) who have expressed an interest in making an investment in
or acquiring the Company, (ii) potential joint venture partners looking toward
formation of strategic alliances that would expand the reach of the Company's
network or services without necessarily requiring an additional investment in or
by the Company and (iii) companies that represent potential acquisition
opportunities for the Company. There can be no assurance that any agreement with
any potential strategic investor, joint venture partner or acquisition target
will be reached nor does management believe that any thereof is necessary to
successfully implement its strategic plans.
Impact of Year 2000
The Year 2000 issue is the result of computer-controlled systems using two
digits rather than four to define the applicable year. For example, computer
programs that have time-sensitive software may recognize a date ending in "00"
as the year 1900 rather than the year 2000. This could result in system failure
or miscalculations causing disruptions of operations including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
To ensure that its computer systems and applications will function properly
beyond 1999, the Company has implemented a Year 2000 program.
As the first phase of its program, the Company conducted an inventory and
assessment of its network equipment, office equipment and information management
systems. While the Company believes that its equipment inventory is complete,
much of the equipment utilized by Intermedia resides outside the Company's
headquarters and there can be
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no assurance that mission critical equipment has not been overlooked.
Based on its inventory and assessment, the Company determined that it will
be required to modify or replace portions of its software and hardware so that
its networks, office equipment and information management systems will function
properly with respect to dates in the year 2000 and thereafter. Such
determinations were based, in part, on statements made by hardware and software
vendors used by the Company as to the year 2000 compliance of the systems
utilized by the Company. Intermedia also has conducted a risk assessment to
identify those systems whose failure would be expected to result in the greatest
risk to the Company. Although the Company intends to conduct tests to ensure
that its equipment is Year 2000 compliant, such tests will be focused
principally on those systems whose failure would pose the greatest risk to the
Company. Intermedia will likely not test all of its equipment and will rely upon
vendor representations, if received by the Company, where tests are not
conducted. There can be no assurance of the accuracy or completeness of such
vendor representations.
The Company is in the process of contacting all of its significant suppliers
and large customers to determine the extent to which the Company's interface
systems are vulnerable to those third parties' failure to remediate their own
Year 2000 issues. The Company, however, has not undertaken an in-depth
evaluation of its suppliers' or customers' Year 2000 preparedness and the
ability of such third parties to adequately address their Year 2000 issues is
outside the Company's control. There can be no guarantee that the systems of
other companies on which the Company's systems rely will be timely converted or
that such conversions, if not completed or improperly implemented, would not
have a material adverse effect on the Company's systems.
The Company is actively engaged in utilizing both internal and external
resources to reprogram, or replace, and test certain components of its networks
and information processing systems for Year 2000 compliance and scheduling the
installation of other necessary hardware and software upgrades. The Company's
objective has been to complete the Year 2000 project not later than December 31,
1998, which is prior to any anticipated impact on its operating systems. Though
the majority of the work will be completed by year-end, there are elements that
will not be completed until the second quarter of 1999 primarily due to limited
availability of compliant software and hardware. The Company believes that it
has allocated adequate resources for this purpose and expects its Year 2000 date
conversion program to be successfully completed on a timely basis. However,
there can be no assurance that it will successfully implement all of the
necessary upgrades in a timely manner. The Company presently believes that with
modifications to existing software and conversions to new software and hardware,
the Year 2000 issue will not pose significant operational problems for its
systems or have any adverse impact on the Company's customers or business units.
However, if such modifications and conversions are not made, or are not
completed in a timely fashion, the Year 2000 problems could have a material
impact on the operations of the Company.
The 1998 cost of the Year 2000 project for the core Intermedia business is
estimated to be $.7 million in external personnel costs and $.9 million in
internal personnel costs, both of which are being funded from available cash.
This cost may be reduced if software and hardware are replaced with compliant
systems as a result of other currently scheduled capital projects. The remaining
expenses are not expected to have a material effect on the results of
operations. During the nine months ended September 30, 1998, the Company
incurred approximately $.7 million in external staffing costs, $.7 million in
internal staffing costs, and $.2 million in hardware and software costs.
Costs and timetables for Year 2000 projects associated with corporate
mergers and acquisitions are not included in the above estimates, and are funded
on a case-by-case basis as they occur. Total costs relating to systems
modification and testing associated with Year 2000 activities, including
hardware and software upgrades and personnel costs, relating to Intermedia
acquisitions is estimated to be $1.3 million for the fourth quarter of 1998.
Internal personnel costs associated with Year 2000 activities relating to the
Company's recent acquisitions were approximately $.1 million for the third
quarter. It is projected that internal personnel costs associated with such Year
2000 activities relating to the acquisitions will be $.1 million for fourth
quarter. Year 2000 compliance for Intermedia acquisitions will be accomplished
both by remediation of systems and by conversion to compliant Intermedia systems
as part of the Program. These cost estimates do not include the costs of system
conversions or upgrades that are included in the Program but which may also be
necessary to ensure Year 2000 compliance. Though some of these activities will
not be completed until the fourth quarter of 1999, the timing is not expected to
have any adverse impact on Intermedia customers or business units.
Approximately $.5 million was spent in the third quarter on upgrades to the
Company's hardware and software on an enterprise-wide basis. To date, $.4
million has been spent on upgrades for the
27
<PAGE> 28
acquired companies. Projected costs for the fourth quarter associated with
hardware and software upgrades for the acquisitions of Shared, DIGEX, LDS and
National Tel are $.3 million, largely in shared tenant equipment and office
infrastructure upgrades.
The Company intends to develop appropriate contingency plans should certain
mission critical systems utilized by the Company or its significant suppliers
fail as a result of Year 2000 issues. In addition, the Company is participating
in industry wide efforts to address Year 2000 issues, the goal of which is to
develop contingency plans which address not only the Company's issues but those
of the telecommunications industry as a whole.
These cost estimates do not include system upgrades that would otherwise
result as part of the Company's capital expenditure program associated with
integrating the acquired companies. The costs of the project and the date which
the Company has established to complete the Year 2000 modifications are based on
management's best estimates, which were derived utilizing numerous assumptions
of future events, including the continued availability of certain resources,
third party modification plans and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
materially from those anticipated. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes, unanticipated mergers and acquisitions, and similar
uncertainties.
Impact of Inflation
Inflation has not had a significant impact on the Company's operations over
the past 3 years.
The information set forth above in "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" include forward-looking
statements that involve numerous risks and uncertainties. Forward-looking
statements can be identified by the use of forward-looking terminology
such as "estimates," "projects," "anticipates," "expects," "intends,"
"believes," or the negative thereof or other variations thereon or
comparable terminology or by discussions of strategy that involve risks
and uncertainties. The Company's actual results could differ materially
from those anticipated in such forward-looking statements as a result of
certain factors, including those set forth in the section entitled "Risk
Factors" in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Except as described below, the Company is not a party to any pending legal
proceedings other than various claims and lawsuits arising in the normal course
of business. The Company does not believe that these normal course of business
claims or lawsuits will have a material effect on the Company's financial
condition or results of operations.
On June 20, 1997, two purported class action complaints were filed in the
Court of Chancery of the State of Delaware in and for New Castle County
respectively by TAAM Associates, Inc. and David and Chaile Steinberg, purported
stockholders of DIGEX on behalf of all non-affiliated common stockholders of
DIGEX against Intermedia, DIGEX and the DIGEX Directors. The cases have been
dormant since August 1997 when a motion to dismiss the Complaints was filed on
behalf of Intermedia, DIGEX and the DIGEX Directors. See Note 9 to the Company's
Condensed Consolidated Financial Statements included herein.
ITEM 2. Changes in Securities
On August 18, 1998, the Company sold 8,000,000 Series F Depositary Shares
(aggregate liquidation preference $200 million) each representing a
one-hundredth interest in a share of the Company's Series F Preferred Stock, in
a private placement transaction. Net proceeds to the Company amounted to
approximately $193.8 million. Dividends on the Series F Preferred Stock
accumulate at a rate of 7% of the aggregate liquidation preference thereof and
are payable quarterly, in arrears. Dividends are payable in cash or, at the
Company's option, by issuance of shares of Common Stock of the Company. The
Series F Preferred Stock is redeemable, at the option of the Company, in whole
or part, at any time on or after October 17, 2001, at rates commencing with
104%, declining to 100% on October 17, 2005.
28
<PAGE> 29
The Series F Preferred Stock is convertible, subject to prior redemption, at
the option of the holder thereof, at any time after November 16, 1998, into
Common Stock of the Company at a conversion price of $42.075 per share of Common
Stock, subject to certain adjustments.
The Series F Depositary Shares were issued and sold to the initial purchased
pursuant to an exemption from registration provided by Section 4 (2) of the
Securities Act of 1933, as amended (the "Act"). Each of the initial purchasers
represented to the Company, among other things, that (i) it is a qualified
institutional buyer ("QIB"), (ii) it is not acquiring the Series F Depositary
Shares with a view to any distribution thereof that would violate the Act or the
securities laws of any state of the Untied States or any other applicable
jurisdiction, (iii) it will be re-offering and reselling the Series F Depositary
Shares only to QIBs in reliance on the exemption from the registration
requirements of the Act provided by rule 144A and to institutional accredited
investors in a private placement exempt from the registration requirements of
the Act, and (iv) no form of general solicitation or general advertising has
been or will be used by it or any of its representatives in connection with the
offer and sale of any of the Series F Depositary Shares.
During July and August 1998, the Company exchanged approximately 2.029
million shares of Common Stock for approximately 1.487 million Depositary Shares
(each representing a 1/100th interest in a share of the Company's Series D
Preferred Stock) and approximately 1.423 million shares of Common Stock for
approximately 1.511 million Depositary Shares (each representing a 1/100th
interest in a share of the Company's Series E Preferred Stock) pursuant to
exchange agreements with certain holders of such Depositary Shares. The issuance
of the shares of Common Stock in exchange for the Depositary Shares was made in
reliance on the exemption from registration provided by Section 3 (a) (9) of the
Act for securities exchanged by an issuer with its existing security holders
exclusively. No commissions or other remuneration was paid or given for
soliciting such exchange.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
None.
ITEM 5. Other Information
None.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Number Exhibit
------ -------
<S> <C>
2.1 Agreement and Plan of Merger, dated as of June 4, 1997,
among the Company, Daylight Acquisition Corp. and DIGEX.
Exhibit 99 (c) (1) to the Company's Schedule 14D-1 filed
with the Commission on June 11, 1997, is incorporated
herein by reference.
2.2 Agreement and Plan of Merger, dated as of November 20,
1997, among the Company, Moonlight Acquisition Corp. and
Shared. Exhibit 99 (c) (1) to the Company's Schedule
14D-1 and Schedule 13D filed with the Commission on
November 26, 1997, is incorporate herein by reference.
2.3 Acquisition Agreement, dated as of December 17, 1997,
among the Company and the holders of interests in the
Long Distance Savers companies. Exhibit 2.3 to Amendment
No.1 to the Company's Registration Statement on Form S-3
filed with the commission on January 14, 1998 (No.
333-42999) is incorporated herein by reference.
</TABLE>
29
<PAGE> 30
<TABLE>
<S> <C>
2.4 Agreement and Plan of Merger, dates as of February 11,
1998, among the Company, Sumter One Acquisition, Inc.,
Sumter Two Acquisition, Inc., National
Telecommunications of Florida, Inc., NTC, Inc. and the
stockholders of National. Exhibit 2.4 to the Company's
Registration Statement on Form S-3 filed with the
Commission on February 13, 1998 (No. 333-46369) is
incorporated herein by reference.
4.1 Certificate of Designation of Voting Power, Designation
Preferences and Relative, Participating, Optional and
Other Special Rights and Qualifications, Limitations and
Restrictions of 7% Series F Junior Convertible Preferred
Stock of the Company, filed with the Secretary of State
of the State of Delaware on August 17, 1998. Exhibit 4.8
to the Company's Registration on Form S-3 filed with the
SEC on September 4, 1998 (No. 333-62931) is incorporated
herein by reference.
4.2 Registration Rights Agreement, dated as of August 18,
1998, among the Company and the initial purchasers of
the Series F Depositary Shares. Exhibit 4.7 to the
Company's Registration on Form S-3 filed with the SEC on
September 4, 1998 (No. 333-62931) is incorporated herein
by reference.
4.3 Deposit Agreement, dated as of August 18, 1998, among
the Company and the Continental Stock and Transfer &
Trust Company. Exhibit 4.9 to the Company's Registration
on Form S-3 filed with the SEC on September 4, 1998 (No.
333-62931) is incorporated herein by reference.
27.1 Financial Data Schedule (For SEC Use Only).
</TABLE>
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the third quarter of
1998:
The Company filed a Current Report on Form 8-K, dated August 4,
1998, reporting under Item 5 that it had exchanged approximately
2.029 million shares of Common Stock for approximately 1.487 million
Depositary Shares (each representing a 1/100th interest in a share
of Series D Preferred Stock) and approximately .665 million shares
of Common Stock for approximately .710 million Depositary Shares
(each representing a 1/100th interest in a share of Series E
Preferred Stock), pursuant to exchange agreements with certain
holders of Depositary Shares and (b) that it commenced a private
offering of $200 million liquidation preference of Series F
Depositary Shares.
The Company filed a Current Report on Form 8-K, dated August 21,
1998, reporting under Item 5 the consummation of a private offering
of $200 million liquidation preference of Series F Depositary
Shares.
The Company filed a Current Report on Form 8-K, dated September 3,
1998, filing under Item 7 unaudited pro forma condensed consolidated
financial statements giving effect to the Company's acquisitions of
National, LDS, Shared and DIGEX and its 1997 debt and equity
offerings.
30
<PAGE> 31
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.
Dated: November 16, 1998
INTERMEDIA COMMUNICATIONS INC.
(Registrant)
/s/ Robert M. Manning
-----------------------------------------------
Robert M. Manning
Senior Vice President and Chief Financial
Officer
/s/ Jeanne M. Walters
------------------------------------------------
Jeanne M. Walters
Vice President, Controller and Chief Accounting
Officer
31
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<PERIOD-START> JAN-01-1998
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<CURRENT-LIABILITIES> 214,191
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358,962
488,787
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