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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One) | |
[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarter Ended June 30, 1999 | |
OR
|
|
[ ] |
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to |
Commission File Number: 0-20135
INTERMEDIA
COMMUNICATIONS INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization) |
59-2913586
(I.R.S. Employer Identification Number) |
|
3625 Queen Palm Drive
Tampa, Florida 33619 (Address of principal executive offices) (813) 829-0011 Telephone Number |
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 August 6, 1999,
there were 50,765,151 shares of the
Registrant's Common Stock outstanding.
INTERMEDIA COMMUNICATIONS INC.
INDEX
Page
No. |
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|
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PART I. FINANCIAL INFORMATION
|
|||
ITEM 1. | Financial Statements (Unaudited): | ||
Condensed Consolidated Statements of Operations
Three and six months
ended June 30, 1999 and 1998 |
3
|
||
Condensed Consolidated Balance SheetsJune 30,
1999
and December 31, 1998 |
4
|
||
Condensed Consolidated Statements of Cash Flows
Six months
ended June 30, 1999 and 1998 |
5
|
||
Notes to Condensed Consolidated Financial Statements | 6
|
||
ITEM 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 11
|
|
ITEM 3. | Quantitative and Qualitative Disclosures about Market Risk | 24
|
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PART II. OTHER INFORMATION
|
|||
ITEM 1. | Legal Proceedings | 24
|
|
ITEM 2. | Changes in Securities | 24
|
|
ITEM 3. | Defaults Upon Senior Securities | 24
|
|
ITEM 4. | Submission of Matters to a Vote of Security Holders | 24
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ITEM 5. | Other Information | 25
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ITEM 6. | Exhibits and Reports on Form 8-K | 25
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SIGNATURES | 26
|
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INTERMEDIA COMMUNICATIONS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share
information)
Three Months Ended
|
Six Months Ended
|
|||||||
|
|
|||||||
|
June
30, 1999
|
June
30, 1998
|
June
30, 1999
|
June
30, 1998
|
||||
|
|
|
|
|||||
Revenues: | ||||||||
Local network services | $ 55,475
|
$ 38,193
|
$ 108,457
|
$ 71,869
|
||||
Enhanced data services | 66,675
|
42,668
|
126,768
|
79,205
|
||||
Interexchange services | 64,329
|
82,747
|
131,942
|
127,498
|
||||
Integration services | 31,410
|
26,622
|
55,444
|
48,443
|
||||
|
|
|
|
|||||
217,889
|
190,230
|
422,611
|
327,015
|
|||||
Expenses: |
||||||||
Network operations | 93,996
|
88,015
|
187,904
|
159,557
|
||||
Facilities administration and maintenance | 23,171
|
18,536
|
45,807
|
33,568
|
||||
Cost of goods sold | 19,501
|
17,218
|
35,305
|
30,909
|
||||
Selling, general and administrative | 71,102
|
56,402
|
128,416
|
102,747
|
||||
Depreciation and amortization | 74,130
|
50,215
|
145,741
|
90,991
|
||||
Charge-off of purchased in-process R&D | -
|
-
|
|
-
|
63,000
|
|||
Business restructuring, integration and other charges | 3,439
|
50,081
|
8,838
|
50,081
|
||||
|
|
|
|
|||||
|
285,339
|
280,467
|
552,011
|
530,853
|
||||
|
|
|
|
|||||
Loss from operations |
(67,450)
|
|
(90,237)
|
|
(129,400)
|
|
(203,838)
|
|
|
||||||||
Other income (expense): |
||||||||
Interest expense | (69,224)
|
(47,858)
|
(131,402)
|
(97,159)
|
||||
Other income | 13,749
|
6,040
|
20,307
|
16,770
|
||||
|
|
|
|
|||||
Net loss | (122,925)
|
|
(132,055)
|
|
(240,495)
|
|
(284,227)
|
|
Preferred stock dividends and accretions | (22,965)
|
|
(18,876)
|
|
(45,448)
|
|
(37,471)
|
|
|
|
|
|
|||||
Net loss attributable to common stockholders | $ (145,890)
|
|
$ (150,931)
|
|
$ (285,943)
|
|
$ (321,698)
|
|
|
|
|
|
|||||
|
||||||||
Basic and diluted loss per common share: | ||||||||
Net loss per common share | $ (2.92)
|
|
$ (3.49)
|
|
$ (5.76)
|
|
(8.17)
|
|
|
|
|
|
|||||
|
||||||||
Weighted average number of shares outstanding - basic and diluted | 50,009,473
|
43,300,889
|
|
49,682,966
|
39,373,704
|
|||
|
|
|
|
See accompanying notes.
3
INTERMEDIA COMMUNICATIONS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share
information)
June 30, 1999
|
December 31, 1998
|
||
Assets
|
|||
Current assets: | |||
Cash and cash equivalents | $ 467,866
|
|
$
387,615
|
Restricted investments | 8,553
|
7,930
|
|
Accounts receivable, less allowance for | |||
doubtful accounts of $23,426 in 1999 and $22,229 in 1998 | 222,404
|
178,519
|
|
Prepaid expenses and other current assets | 34,963
|
27,272
|
|
|
|
||
Total current assets | 733,786
|
|
601,336
|
Telecommunications equipment, net | 1,505,745
|
|
1,371,583
|
Intangible assets, net | 984,753
|
|
1,022,556
|
Other assets | 66,940
|
53,544
|
|
|
|
||
Total assets | $ 3,291,224
|
|
$3,049,019
|
|
|
||
Liabilities, Redeemable Preferred Stock and Stockholders'
Equity (Deficit)
|
|||
Current liabilities: | |||
Accounts payable | $ 79,230
|
|
$
102,905
|
Other accrued expenses | 73,369
|
82,088
|
|
Current portion of long-term debt and capital lease obligations | 30,982
|
21,880
|
|
|
|
||
Total current liabilities | 183,581
|
|
206,873
|
Long-term debt and capital lease obligations | 2,853,274
|
2,350,506
|
|
Series B redeemable exchangeable preferred stock and accrued dividends, $1.00 | |||
par value; 600,000 shares authorized; 397,890 and 381,900 issued and outstanding | |||
in 1999 and 1998, respectively | 398,384
|
371,678
|
|
Series D junior convertible preferred stock and accrued dividends, $1.00 par | |||
value; 69,000 shares authorized; 54,129 issued and outstanding in 1999 and 1998 | 133,973
|
133,686
|
|
Series E junior convertible preferred stock and accrued dividends, $1.00 par value; | |||
87,500 shares authorized; 64,892 shares issued and outstanding in 1999 and 1998 | 160,445
|
160,086
|
|
Series F junior convertible preferred stock and accrued dividends, $1.00 par | |||
value; 92,000 shares authorized; 80,000 shares issued and outstanding in 1999 | |||
and 1998 | 196,380
|
196,838
|
|
Stockholders' equity (deficit): | |||
Preferred stock, $1.00 par value; 1,111,500 authorized in 1999 and 1998, | |||
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 shares authorized in 1999 | |||
and 1998; 50,159,287 and 48,648,993 shares issued and outstanding | |||
in 1999 and 1998, respectively | 502
|
|
486
|
Additional paid-in capital | 609,068
|
|
587,413
|
Accumulated deficit | (1,239,522)
|
|
(953,579)
|
Deferred compensation | (4,861)
|
|
(4,968)
|
|
|
||
Total stockholders' deficit | (634,813)
|
(370,648)
|
|
|
|
||
Total liabilities, redeemable preferred stock and stockholders' deficit | $ 3,291,224
|
$3,049,019
|
|
|
|
See accompanying notes.
4
See accompanying notes.
5
INTERMEDIA COMMUNICATIONS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 of Intermedia Communications Inc. ("Intermedia" or the " Company") for the year ended December 31, 1998.
Operating results for the three and six month periods ended June 30, 1999 are not necessarily an indication of the results that may be expected for the year ending December 31, 1999.
Note 2. Business Restructuring and Integration Program
As more fully described in the Company's 1998 Annual Report on Form 10-K, during the second quarter of 1998, management committed to and commenced implementation of a 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 anticipated completion date of the Program is December 31, 1999. The ultimate effect of the Program is currently estimated by management to result in approximately $10.7 million of savings in operating costs per quarter. The Company will realize these savings as various Program activities are completed.
The following table sets forth the significant components and activity in the restructuring program reserve since the inception of the Program (in millions):
Activity |
Employee
Termination Benefits (vii) |
Contract
Terminations |
Asset
Impairments |
Other
Business Integration Costs |
Total
|
|||||
|
|
|
|
|
|
|||||
Network integration(i) | $
|
$ 0.9
|
$
|
$
|
$ 0.9
|
|||||
Sales force consolidation and branding(ii) | 0.4
|
|
|
|
0.4
|
|||||
Consolidation of financial functions(iii) | 0.9
|
|
|
|
0.9
|
|||||
Information systems integration(iv) | 0.7
|
|
|
|
0.7
|
|||||
Campus consolidation(v) |
|
2.3
|
|
|
2.3
|
|||||
Exiting non-core businesses(vi) | 0.6
|
11.5
|
13.4
|
1.6
|
27.1
|
|||||
|
|
|
|
|
||||||
Total provisions recorded during the quarter ended
June 30, 1998 |
2.6
|
14.7
|
13.4
|
1.6
|
32.3
|
|||||
Payments and other
adjustments during year ended
December 31, 1998 |
1.4
|
11.7
|
13.3
|
0.4
|
26.8
|
|||||
|
|
|
|
|
||||||
Balance in accrual at December 31, 1998 | 1.2
|
3.0
|
0.1
|
1.2
|
5.5
|
|||||
Payments and other adjustments during six months
ended June 30, 1999 |
0.5
|
|
|
|
0.5
|
|||||
|
|
|
|
|
||||||
Balance in accrual at June 30, 1999 | $ 0.7
|
$ 3.0
|
$ 0.1
|
$ 1.2
|
$ 5.0
|
|||||
|
|
|
|
|
6
INTERMEDIA COMMUNICATIONS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
(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.
(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. The only costs included in this category in the table above relate to the termination of certain employees as described in (vii) below.
(v) This activity relates to the consolidation of office space. Contract termination costs represent the estimated costs of lease terminations for property exited as part of the Program.
(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, Inc. (WorldCom) ($10.1 million) and lease termination payments. On September 30, 1998, the Company amended its agreement with WorldCom to provide the Company with an option for an earlier termination date and lower monthly minimum usage amounts. On October 27, 1998, the Company exercised its option and, in connection therewith, paid $3.3 million to WorldCom. As a result, restructuring charges were reduced by $10.1 million during the third quarter of 1998. The option payment of $3.3 million was recorded in October 1998 as a deferred charge and is being amortized into operations over the remaining period of the contract. Asset impairments relate to $9.2 million of accounts receivable balances from four customers that were reserved as a result of the Company's exit of the wholesale long-distance business. However, no determination to write off these assets has been made to date. In addition, this category also includes $2.8 million related to equipment write-downs. The impaired assets consist of terminal servers with an estimated fair value of $0.4 million as of June 30, 1998. The fair value estimate was based on the Company's review of the historical operations and cash flows of the related Internet business that such assets support. The impairment loss of $2.8 million was recognized in connection with the Company's decision to outsource these services and to dispose of these assets. The estimated remaining life of the assets of six months correlated to the time required to migrate the business to the third party provider. The revenue generated from operations that the Company has exited amounted to $4.7 million and $17.0 million for the three and six months ended June 30, 1998, respectively. No revenue was generated in 1999 from operations exited by the Company.
(vii) The total number of employees affected by the restructuring program was approximately 280. The terminated employees were notified that their termination was involuntary and of their associated benefit arrangements, prior to the date of the June 30, 1998 financial statements.
As provided for in the Program, the Company also expensed other business restructuring and integration costs that were incurred since the inception of the Program. These costs represent incremental, redundant, or convergence costs that resulted directly from implementation of the Program, but are required to be expensed as incurred.
7
INTERMEDIA COMMUNICATIONS INC.
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The following table summarizes total Program costs and sets forth the components of the other business restructuring and integration costs that were expensed as incurred during the three and six months ended June 30, 1999 and 1998 (in millions):
Three Months Ended |
Six Months Ended |
|||
June 30, |
June 30, |
|||
1999 |
1998 |
1999 |
1998 |
|
Business restructuring charges |
|
|
|
|
Employee termination benefits (A) |
$ -- |
$ 2.6 |
$ -- |
$ 2.6 |
Contract terminations (A) |
-- |
14.7 |
-- |
14.7 |
Other charges |
|
|
|
|
Asset impairments (A) |
-- |
13.4 |
-- |
13.4 |
Legal costs (A) |
-- |
1.6 |
-- |
1.6 |
|
|
|
|
|
Total provision recorded |
-- |
32.3 |
-- |
32.3 |
Integration costs |
|
|
|
|
Network integration (B) |
1.8 |
12.4 |
4.6 |
12.4 |
Department and employee
|
0.2 |
0.8 |
0.7 |
0.8 |
Functional re-engineering (D) |
1.0 |
0.8 |
2.4 |
0.8 |
Other (E) |
0.4 |
3.8 |
1.1 |
3.8 |
|
|
|
|
|
Total integration costs |
3.4 |
17.8 |
8.8 |
17.8 |
|
|
|
|
|
|
$ 3.4 |
$ 50.1 |
$ 8.8 |
$ 50.1 |
|
|
|
|
(A) See prior table for
components of cost.
(B) Consists primarily of redundant
network expense and amortization of a canceled contract for switched
services, with some employee
severance costs.
(C) Consists of branding, employee
severance, training, relocation expenses, and contract termination
costs.
(D) Consists primarily of
consultant costs and employee severance costs.
(E) Consists primarily of
professional fees and employee severance costs.
Note 3. Long-Term Debt
On February 24, 1999, the Company sold $300 million principal amount of 9.5% Senior Notes due 2009 (the "9.5% Senior Notes") and $364 million principal amount at maturity of 12.25% Senior Subordinated Discount Notes due 2009 (the "12.25% Senior Subordinated Discount Notes") in a private placement transaction. Net proceeds to the Company amounted to approximately $488.5 million from both issuances.
Cash interest on the 9.5% Senior Notes is payable semi-annually in arrears on March 1 and September 1 of each year, commencing September 1, 1999. The proceeds of the offering of the 9.5% Senior Notes cannot be used for working capital purposes and can only be used to fund up to 80% of the cost of acquiring or constructing telecommunications related assets. The 9.5% Senior Notes are redeemable at the option of the Company at any time at various prices as set forth in the indenture governing the 9.5% Senior Notes. The 9.5% Senior Notes rank on par with all of the other outstanding senior indebtedness of the Company.
The 12.25% Senior Subordinated Discount Notes will accrete in value through March 1, 2004 at a fixed annual rate of 12.25%, compounded every six months. After March 1, 2004, the 12.25% Senior Subordinated Discount Notes will accrue interest at an annual rate of 12.25%, payable in cash every six months on March 1 and September 1, commencing September 1, 2004. The proceeds from the offering of the 12.25% Senior Subordinated Discount Notes will be used for general corporate purposes, including the funding of working capital and operating losses, and the funding of a portion of the costs of acquiring or constructing telecommunications related assets. The 12.25% Senior Subordinated Discount Notes will be redeemable at the option of the Company at any time at various prices as set forth in the indenture governing the 12.25% Senior Subordinated Discount Notes.
8
INTERMEDIA COMMUNICATIONS INC.
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
Note 4. Earnings Per Share
The following table sets forth the computation of basic and diluted loss per share of common stock (dollars in thousands, except share and per share amounts):
Three Months Ended
|
|
Six Months Ended
June 30, |
||||
|
|
|||||
1999 |
1998 |
1999 |
1998 |
|||
|
|
|
|
|||
Numerator: |
|
|
|
|
||
Net loss |
$ (122,925) |
$ (132,055) |
$ (240,495) |
$ (284,227) |
||
Preferred stock dividends and accretions |
(22,965) |
(18,876) |
(45,448) |
(37,471) |
||
|
|
|
|
|||
Numerator for basic loss per share - loss
|
(145,890) |
(150,931) |
(285,943) |
(321,698) |
||
Effect of dilutive securities |
- |
- |
- |
- |
||
|
|
|
|
|||
Numerator for diluted loss per share - income
|
$ (145,890) |
$ (150,931) |
$ (285,943) |
$ (321,698) |
||
Denominator: |
|
|
|
|
||
Denominator for basic loss per share - |
|
|
|
|
||
weighted-average shares |
50,009,473 |
43,300,889 |
49,682,966 |
39,373,704 |
||
Effect of dilutive securities |
- |
- |
- |
- |
||
|
|
|
|
|||
Denominator
for diluted loss per share -
|
50,009,473 |
43,300,889 |
49,682,966 |
39,373,704 |
||
|
|
|
|
|||
Basic loss per share of common stock |
$ (2.92) |
$ (3.49) |
$ (5.76) |
$ (8.17) |
||
|
|
|
|
|||
|
|
|
|
|||
Diluted loss per share of common stock |
$ (2.92) |
$ (3.49) |
$ (5.76) |
$ (8.17) |
||
|
|
|
|
Unexercised options to purchase 7,859,598 and 6,327,258 shares of common stock as of June 30, 1999 and 1998, respectively, and outstanding convertible preferred stock, convertible into 17,076,495 and 15,483,745 shares of common stock as of June 30, 1999 and 1998, respectively, were not included in the computations of diluted loss per share because assumed exercise/conversion would be anti-dilutive.
Note 5. Contingencies
The Company is not a party to any 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, North Carolina, Tennessee, and in numerous other states across the country. 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 and 1998, the Company recognized revenue from these ILECs of approximately $46.0 million for these services. During the first half of 1999, the Company recognized approximately $37.1 million in revenue for these services.
9
INTERMEDIA COMMUNICATIONS INC.
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
The Company accounts for reciprocal compensation with the ILECs, including the activity associated with the disputed ISP traffic, as local network services, fully subject to mutual compensation, pursuant to the terms of the Company's interconnection agreements. Accordingly, revenue is recognized in the period that the traffic is terminated. A number of ILECs have refused to pay these reciprocal compensation amounts in whole or in part, however, citing a variety of legal theories. The circumstances surrounding the disputes, including the status of cases that have arisen by reason of similar disputes referred to below, are considered by management periodically in determining whether reserves against unpaid balances are warranted. As of June 30, 1999, 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. As of December 31, 1998, 31 state commissions had issued final orders finding that ILECs must pay mutual compensation to competitive carriers for local calls to ISPs located on competitive carriers' networks, and no state commission had ruled to the contrary. A February 25, 1999 decision by the FCC generated some uncertainties about mutual compensation. The FCC's order declared that ISP-bound traffic is predominantly "interstate" traffic that is subject to federal jurisdiction. Subsequent to the FCC's February 25 order, 12 states have reaffirmed prior determinations that ILECs are required to compensate CLECs for terminating ISP-bound traffic, and 4 additional states have, for the first time, issued affirmative decisions that such payments are required. An exception to this pattern has occurred in three states that have either re-opened the mutual compensation issue for further proceedings on the merits, deferred a decision pending completion of further FCC proceedings or, in one case, rendered a decision adverse to mutual compensation on grounds uniquely applicable to one agreement and those parties to the agreement.
Most current interconnection agreements - including Intermedia's agreements with BellSouth - provide that compensation is owed for the termination of "local" traffic, and the FCC's order established that, for purposes of determining jurisdiction, dial-up calls to ISPs are not local. As a result, many ILECs asked state commissions to overturn their earlier decisions calling for payment of compensation for this traffic. However, while the FCC's order did find that most ISP-bound traffic is jurisdictionally interstate, the FCC went on to clarify that this jurisdictional determination does not preclude parties from including ISP-bound traffic within the scope of the reciprocal compensation provisions included in their interconnection agreements. Management is pursuing this matter vigorously and believes the ILECs will ultimately pay all amounts in full.
Note 6. Subsequent Event
On August 4, 1999, the Company's web hosting subsidiary, Digex, Incorporated ("Digex") sold 11.5 million shares of Class A common stock in an initial public offering. The shares sold represent approximately 18.7% of the aggregate number of shares of Class A common stock and Class B common stock outstanding. The Company retains a 97.8% voting interest in Digex. The gross proceeds from the offering were $195.5 million. The proceeds, net of commissions and other costs, will be used to purchase telecommunications related assets. The Company may take other actions in the future which would further decrease its ownership interest.
10
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 related notes and with the Management's Discussion and Analysis of Financial Condition and Results of Operations and audited consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998, filed with the Commission.
Overview
Intermedia has experienced substantial revenue growth since its inception in 1986. 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 substantially increased its customer base.
Intermedia's customers include a broad range of business and government end users and, to a lesser extent, Internet service providers ("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. 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 and internationally. Through its 793 network to network interfaces ("NNIs") and 173 data switches, Intermedia has established one of the most densely deployed frame relay switching networks in the nation. The Company's nationwide interexchange network carries both its data traffic and its voice network traffic.
The Company is also party to various agreements with companies within the telecommunications industry. These agreements are part of the Company's ICP strategy and allow the Company to economically expand its product offerings into new markets. On April 27, 1999, the Company announced that it has entered into strategic alliances with two DSL (digital subscriber line) companies, NorthPoint Communications and Rhythms NetConnection Inc. These agreements will allow the Company to purchase DSL transport to provide additional telecommunications services such as high speed internet access, local and long distance services, and frame relay to Intermedia's small and medium sized customers. Intermedia has implemented DSL technology using its own network facilities for its shared-tenant services (Comactiv) buildings to provide greater bandwidth for data, voice, and internet access. The NorthPoint and Rhythms alliances will enable the Company to increase its existing market coverage for its DSL services. On August 4, 1999, the Company announced that it has entered into an agreement to provide frame relay services to Bell Atlantic's out-of-region customers. The Company believes this arrangement will offer customers a single point of contact for sales and customer care and will enable the Company to benefit from Bell Atlantic's customer relationships and distribution abilities and thereby sell additional frame relay services.
In the second quarter of 1999, the Company expanded its Unified Voice (UV.net) service, which provides integrated local, long distance and high-speed Internet access, to 23 cities. While the Company has offered bundled services in the past, UV.net is now offered on a more economical basis in order to successfully market to small and medium-sized businesses. During the remainder of 1999, the Company expects continued demand created by customers in need of Year 2000 upgrades, which is a catalyst for new systems purchases, as well as a positive revenue impact from the strategic partnership data agreements.
Plan of Operation
For the remainder of 1999, the Company believes its revenue growth will be generated primarily from its enhanced data, including Internet, local exchange and integration services. Based on the Company's analysis of Federal Communications Commission market data and its knowledge of the industry, the Company estimates that the market for enhanced data, local exchange, and interexchange services will exceed $100.0 billion in 1999 within its service territory.
In order to develop its business more rapidly and efficiently utilizing 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 (a network architecture which efficiently combines multiple data and voice protocols over a single network fabric). 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 revenue with lower incremental costs. 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 Intermedia's 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 this operating leverage inherent in 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:
Three Months Ended
June 30 |
Six Months Ended
June 30 |
|||
|
|
|||
1999
|
1998
|
1999
|
1998
|
|
|
|
|
|
|
Revenues: | ||||
Local network services |
25.5%
|
20.1%
|
25.7%
|
22.0%
|
Enhanced data services |
30.6
|
22.4
|
30.0
|
24.2
|
Interexchange services |
29.5
|
43.5
|
31.2
|
39.0
|
Integration services |
14.4
|
14.0
|
13.1
|
14.8
|
|
|
|
|
|
100.0
|
100.0
|
100.0
|
100.0
|
|
Expenses: | |
|
|
|
Network operations |
43.1
|
46.3
|
44.5
|
48.8
|
Facilities administration and maintenance |
10.6
|
9.7
|
10.8
|
10.3
|
Cost of goods sold |
9.0
|
9.1
|
8.4
|
9.5
|
Selling, general and administrative |
32.6
|
29.6
|
30.4
|
31.4
|
Depreciation and amortization |
39.1
|
26.4
|
34.5
|
27.8
|
Charge-off of purchased in-process R&D |
|
|
|
19.3
|
Business restructuring, integration and other charges |
1.6
|
26.3
|
2.0
|
15.3
|
|
|
|
|
|
Loss from operations |
(31.0)
|
(47.4)
|
(30.6)
|
(62.3)
|
Other income (expense): | |
|
|
|
Interest expense |
(31.8)
|
(25.2)
|
(31.0)
|
(29.7)
|
Other income |
6.3
|
3.2
|
4.7
|
5.1
|
|
|
|
|
|
Net loss |
(56.4)
|
(69.4)
|
(56.9)
|
(86.9)
|
Preferred stock dividends and accretions |
(10.6)
|
(9.9)
|
(10.8)
|
(11.5)
|
|
|
|
|
|
Net loss attributable to common stockholders |
(67.0)%
|
(79.3)%
|
( 67.7)%
|
(98.4)%
|
|
|
|
|
12
The following table sets forth other statistical data derived from the Company's operating records:
June 30, 1999
|
June 30, 1998
|
|||
Transport, Local and Long Distance Services: (1) | ||||
Buildings connected (2) | 4,374 |
4,309 |
||
Voice switches in operation | 25 |
21 |
||
Access line equivalents | 407,675 |
280,144 |
||
Access line equivalents per local switch (3) | 14,315 |
6,180 |
||
Enhanced Data Services: (1) | ||||
Data switches in operation | 173 |
153 |
||
Nodes in service (4) | 42,741 |
27,123 |
||
NNI connections | 793 |
553 |
||
Employees | 4,252 |
3,597 |
1) | Amounts reflected in the table are based upon information contained in the Company's operating records. | |
2) | Includes buildings connected to Intermedia's network via facilities leased by Intermedia in addition to those connected to Intermedia's network via facilities constructed by or otherwise owned by Intermedia. | |
3) | Calculated
by dividing the number of on-switch access line equivalents by the
number of switches
providing local service. |
|
4) | Amount represents an individual point of origination and termination of data served by the Company's enhanced network. |
Quarter Ended June 30, 1999 Compared to Quarter Ended June 30, 1998:
Revenue
Total revenue increased 14.5% to $217.9 million for the second quarter of 1999 compared to $190.2 million for the same period in 1998. The Company has 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. The Company's core strategic revenue categories continue to grow, and the Company plans to maintain its emphasis on sales of key services such as enhanced data, including Internet, local exchange and integration services. The Company expects enhanced data, including Internet, local exchange and integration services to be the core components of its growth in revenue.
Local network services revenue increased 45.2% to $55.5 million for the second quarter of 1999 compared to $38.2 million for the same period in 1998. This increase was principally due to the Company's continued rollout of local exchange services into additional markets. The number of access line equivalents increased by 127,531 from July 1, 1998 through the end of the second quarter of 1999. The additional access line equivalents were primarily on-switch, contributing to improved gross margins and allowing the Company to cross-sell additional services to its customers. The Company has also continued its efforts to reduce its base of local customers who utilize resale lines, which have historically yielded low margins for Intermedia. In addition, the Company was certified as a competitive local exchange carrier ("CLEC") in 38 states and the District of Columbia as of the end of the second quarter of 1999.
Enhanced data services revenue increased 56.3% to $66.7 million for the second quarter of 1999 compared to $42.7 million for the same period in 1998. This increase was principally a result of the expansion of the Company's frame relay and ATM network as well as strong growth in Internet and web related services. As a result of the Company's integration of acquired businesses, the Company has consolidated a portion of its data traffic over fewer frame relay switches for efficiency. Intermedia's data network expanded by 240 NNI connections, 15,618 new frame relay nodes, and 20 data switches since July 1, 1998. In addition, the Company experienced an increase in sales of frame relay services as a result of the Company's agreements with US West and Ameritech. The Company also experienced increased sales in Internet and web hosting services due to an increase in sales of additional services to the existing customer base and an increase of 737 web hosting servers on line since July 1, 1998.
Interexchange services revenue decreased 22.3% to $64.3 million for the second quarter of 1999 compared to $82.7 million for the same period in 1998. This decrease resulted from the Company's decision during the second quarter of 1998 to exit the low margin wholesale long distance business as well as per minute pricing declines, consistent with industry trends.
Integration services revenue increased 18% to $31.4 million for the second quarter of 1999 compared to $26.6 million for the same period in 1998. This increase was principally due to an increased demand for the installation and sale of telecommunications equipment as compared to the second quarter of 1998 resulting from Year 2000 upgrades and the successful expansion of the Company's sales force on the West Coast.
Operating Expenses
Total operating expenses increased 1.7% to $285.3 million for the second quarters of 1999 and 1998. Total operating expenses decreased to 131.0% of revenue for the second quarter of 1999 compared to 147.4% of revenue for the same period in 1998. This decrease in operating expenses as a percentage of revenue resulted principally from the decrease in business restructuring and integration expenses to $3.4 million for the second quarter of 1999 compared to $50.1 million for the same period in 1998. This decrease was offset by increases, as a percentage of revenue, in selling, general and administrative expenses due to required additions for support personnel as well as increases in depreciation charges as a result of the Company's telecommunications equipment additions.
Network expenses increased 6.8% to $94.0 million for the second quarter of 1999 compared to $88.0 million for the same period in 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. These increases are partially offset by reduced network expenses, as a percentage of revenue, resulting from the Company's integrated business strategy. In addition, the Company has focused its selling efforts on on-switch access lines, which have better gross margins and improved provisioning time.
Facilities administration and maintenance expenses increased 25% to $23.2 million for the second quarter of 1999 compared to $18.5 million for the same period in 1998. The increase resulted from support costs related to the expansion of the Company's owned and leased network capacity, increased maintenance expenses due to network expansion and increased payroll expenses related to additional engineering and operations staff necessary to support and service the expanding network. These increases were partially offset by administrative cost efficiencies and synergies that were realized from implementation of the restructuring and integration program including integration of the Company's acquired businesses. Facilities administration and maintenance expenses were also positively impacted by the Company's exit of the wholesale long distance business in 1998.
Cost of goods sold increased 13.3% to $19.5 million for the second quarter of 1999 compared to $17.2 million for the same period in 1998. This increase was principally due to the increase in demand for telecommunications equipment resulting from Year 2000 upgrades and the successful expansion of the Company's sales force on the West Coast.
Selling, general and administrative expenses increased 26.1% to $71.1 million for the second quarter of 1999 compared to $56.4 million for the same period in 1998. The Company's core growth strategy required increases in sales and marketing efforts and other support costs. The increase was also due to a substantial increase in the number of employees required to support the Company's web hosting business. The Company's sales and marketing related expenses increased approximately $8.7 million, customer operations and circuit design and provisioning increased approximately $5.1 million, and other general administrative costs to support the administrative departments, management information systems and corporate development increased approximately $0.9 million.
Depreciation and amortization expenses increased 37% to $68.8 million for the second quarter of 1999 compared to $50.2 million for the same period in 1998. This increase was principally due to depreciation and amortization of telecommunications equipment placed in service since July 1, 1998 as a result of ongoing network expansion. Depreciation and amortization expense is expected to increase in future periods based on the Company's plans to continue expanding its network and facilities, including its web hosting facilities on the East and West Coasts.
Business restructuring and integration expense of approximately $3.4 million was recorded by the Company during the second quarter of 1999 compared to $50.1 million during the same period in 1998. During the second quarter of 1998, such costs include a one-time charge of $18.7 million comprised primarily of network integration, back office accounting integration and information systems integration costs and costs associated with positions eliminated as a result of the Program. Additional costs of $3.4 million and $31.4 million during the second quarter of 1999 and 1998, respectively, represent incremental, redundant, or convergence costs that result directly from implementation of the Program but which are required to be expensed as incurred. Such costs were substantially in line with the amounts expected by management. Additional incremental, redundant and convergence costs within this category of Program costs will be expensed as they are incurred each quarter over the Program implementation period. Management currently expects to incur up to approximately $9.8 million of these costs over the remainder of the Program. The Company expects future cash outlays for the Program of up to approximately $14.8 million during the remainder of 1999.
Interest Expense
Interest expense increased 44.6% to $69.2 million for the second quarter of 1999 compared to $47.9 million for the same period in 1998. This increase primarily resulted from interest expense on approximately $300.0 million principal amount of 9.5% Senior Notes and $364.0 million principal amount at maturity of 12.25% Senior Subordinated Discount Notes issued in February 1999. In addition, the increase partially resulted from increased interest expense on $500.0 million principal amount of 8.6% Senior Notes due 2008 (the "8.6% Senior Notes") issued in May 1998. Interest cost capitalized in connection with the Company's construction of telecommunications equipment amounted to approximately $2.7 million for the three months ended June 30, 1999.
Other Income
Other income increased 127.6% to $13.7 million for the second quarter of 1999 compared to $6.0 million for the same period in 1998. This increase was primarily the result of interest earned on the comparatively higher level of average cash balances in the second quarter of 1999 as compared to the second quarter of 1998. In addition, customer finance charges increased in the second quarter of 1999 compared to the same period in 1998.
Net Loss
Net loss decreased 6.9% to $(122.9) million for the second quarter of 1999 compared to $(132.1) million for the same period in 1998. Factors contributing to the decrease in the Company's net loss are described above.
Preferred Stock Dividends and Accretions
Preferred stock dividends and accretions increased 21.7% to $23.0 million for the second quarter of 1999 compared to $18.9 million for the same period in 1998. The increase was due to dividend payments on the Series F preferred stock issued in August 1998.
EBITDA Before Certain Charges
EBITDA before certain charges, as defined below, remained constant at $10.1 million for the second quarters of 1999 and 1998. Gross margin, inclusive of network expenses, facilities administration and maintenance and cost of good sold, increased to $81.2 million for the second quarter of 1999 compared to $66.5 million for the same period in 1998 as a result of the Company's continued 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," improving customer provisioning time, rolling out new products and services, and increasing its mix of higher margin products. Fully offsetting the favorable increase in gross margin was a $14.7 million increase in selling, general and administrative expenses. The Company has made significant strides in restructuring its back-office and administrative functions and has substantially integrated its information systems and resources. In addition, the business restructuring and integration program has yielded benefits by eliminating redundant costs associated with rationalizing and integrating the acquired businesses. However, the Company's core growth strategy and accelerated growth in its web hosting business required increases in sales and marketing efforts and other support costs which contributed to the overall increase in selling, general and administrative expenses.
EBITDA before certain charges consists of earnings (net loss) before interest expense, interest and other income, income taxes, depreciation, amortization, charges for in-process research and development ("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.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998:
Revenue
Total revenue increased 29.2% to $422.6 million for the six months ended June 30, 1999 compared to $327.0 million for the same period in 1998. This increase was partially due to the acquisitions of the affiliated entities known as the Long Distance Savers group of companies (collectively, "LDS") on March 31, 1998 and National Telecommunications of Florida, Inc. and NTC, Inc. (collectively, "National") on April 30, 1998. The operating results of LDS and National are included in the Company's consolidated financial statements commencing April 1, 1998. 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. The Company's core strategic revenue categories continue to grow, and the Company plans to maintain its emphasis on sales of key services such as enhanced data, including Internet, local exchange and integration services. The Company expects enhanced data, including Internet, local exchange and integration services to be the core components of its growth in revenue.
Local network services revenue increased 50.9% to $108.5 million for the six months ended June 30, 1999 compared to $71.9 million for the same period in 1998. This increase was partially due to the acquisition of National on April 30, 1998, and the continued rollout of local exchange services into additional markets. The number of access line equivalents increased by 127,531 from July 1, 1998 through the end of the second quarter of 1999. The additional access line equivalents were primarily on-switch, contributing to improved gross margins and allowing the Company to cross-sell additional services to its customers. The Company has also continued its efforts to reduce its base of local customers who utilize resale lines, which have historically yielded low margins for Intermedia. In addition, the Company was certified as a competitive local exchange carrier ("CLEC") in 38 states and the District of Columbia as of the end of the second quarter of 1999.
Enhanced data services revenue increased 60.1% to $126.8 million for the six months ended June 30, 1999 compared to $79.2 million for the same period in 1998. This increase was principally a result of the expansion of the Company's frame relay and ATM network as well as strong growth in Internet and web related services. As a result of the Company's integration of acquired businesses, the Company has consolidated a portion of its data traffic over fewer frame relay switches for efficiency. Intermedia's data network expanded by 240 NNI connections, 15,618 new frame relay nodes, and 20 data switches since July 1, 1998. In addition, the Company experienced an increase in sales of frame relay services as a result of the Company's agreements with US West and Ameritech. The Company also experienced increased sales in Internet and web hosting services due to an increase in sales of additional services to the existing customer base and an increase of 737 web hosting servers on line since July 1, 1998.
16
Interexchange services revenue increased 3.5% to $131.9 million for the six months ended June 30, 1999 compared to $127.5 million for the same period in 1998. The increase resulted from the acquisitions of LDS and National on March 31, 1998 and April 30, 1998, respectively. This increase was partially offset by the Company's decision during the second quarter of 1998 to exit the low margin wholesale long distance business as well as per minute pricing declines, consistent with industry trends.
Integration services revenue increased 14.5% to $55.4 million for the six months ended June 30, 1999 compared to $48.4 million for the same period in 1998. This increase was principally due to an increased demand for the installation and sale of telecommunications equipment as compared to the second quarter of 1998 resulting from Year 2000 upgrades and the successful expansion of the Company's sales force on the West Coast.
Operating Expenses
Total operating expenses increased 4.0% to $552.0 million for the six months ended June 30, 1999 compared to $530.9 million for the same period in 1998. Total operating expense decreased to 130.6% of revenue for the six months ended June 30, 1999 compared to 162.3% of revenue for the same period in 1998. The 1998 operating expenses include a $63.0 million charge for in-process research and development in connection with the acquisition of Shared Technologies Fairchild Inc. ("Shared"). In addition, business restructuring and integration expenses (discussed below) decreased to $8.8 million for the six months ended June 30, 1999 compared to $50.1 million for the same period in 1998. These decreases were offset by increases in other operating expenses including increased support costs relating to the significant expansion of the Company's owned and leased networks and the increase in personnel to sustain and support the Company's growth, primarily related to its web hosting business.
Network expenses increased 17.8% to $187.9 million for the six months ended June 30, 1999 compared to $159.6 million for the same period in 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. These increases are partially offset by reduced network expenses, as a percentage of revenue, resulting from the Company's integrated business strategy. The Company has also benefited from several network agreements, including the Company's network agreement with Williams. The Williams agreement, executed in March 1998, positively impacted network expenses by eliminating certain backbone network costs that were previously accounted for as an operating lease. Finally, the Company has focused its selling efforts on on-switch access lines, which have better gross margins and improved provisioning time.
Facilities administration and maintenance expenses increased 36.5% to $45.8 million for the six months ended June 30, 1999 compared to $33.6 million for the same period in 1998. The increase resulted from support costs related to the expansion of the Company's owned and leased network capacity, increased maintenance expenses due to network expansion and increased payroll expenses related to additional engineering and operations staff necessary to support and service the expanding network. These increases were partially offset by administrative cost efficiencies and synergies that were realized from implementation of the restructuring and integration program including integration of the Company's acquired businesses. Facilities administration and maintenance expenses were also positively impacted by the Company's exit of the wholesale long distance business in 1998.
Cost of goods sold increased 14.2% to $35.3 million for the six months ended June 30, 1999 compared to $30.9 million for the same period in 1998. This increase was principally due to the increase in demand for telecommunications equipment resulting from Year 2000 upgrades and the successful expansion of the Company's sales force on the West Coast.
Selling, general and administrative expenses increased 25.0% to $128.4 million for the six months ended June 30, 1999 compared to $102.7 million for the same period in 1998. The Company's core growth strategy required increases in sales and marketing efforts and other support costs. The increase was also due to a substantial increase in the number of employees required to support the Company's web hosting business. The Company's sales and marketing related expenses increased approximately $12.5 million, customer operations and circuit design and provisioning increased approximately $6.3 million, and other general administrative costs to support the administrative departments, management information systems and corporate development increased approximately $6.9 million.
17
Depreciation and amortization expenses increased 60.2% to $145.7 million for the six months ended June 30, 1999 compared to $91.0 million for the same period in 1998. This increase was principally due to depreciation and amortization of telecommunications equipment placed in service since July 1, 1998 as a result of ongoing network expansion (including the irrevocable right of use acquired from Williams). Depreciation and amortization expense is expected to increase in future periods based on the Company's plans to continue expanding its network and facilities, including its web hosting facilities on the East and West Coasts.
The charge for in-process R&D of $63.0 million in the first quarter 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 in-process R &D 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 and cash flows, an analysis of project accomplishments and completion costs and, 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.
Remaining development efforts for these in-process R & D projects include various phases of design, development, and testing. Anticipated completion dates for the in-process R&D projects will occur during the next six months, after which time the Company expects to begin generating economic benefits from the technologies. Expenditures to complete these projects are expected to total approximately $1.4 million in 1999.
This estimate is 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 in-process 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.
Business restructuring and integration expense of approximately $8.8 million was recorded by the Company during the six months ended June 30, 1999 compared to $50.1 million during the same period in 1998. During the six months ended June 30, 1998, such charges include a one-time charge of $18.7 million comprised primarily of network integration, back office accounting integration and information systems integration costs and costs associated with positions scheduled to be eliminated as a result of the Program. Additional costs of $3.4 million and $31.4 million during the six months ended June 30, 1999 and 1998, respectively, represent incremental, redundant, or convergence costs that result directly from implementation of the Program but which are required to be expensed as incurred. Such costs were substantially in line with the amounts expected by management. Additional incremental, redundant and convergence costs within this category of Program costs will be expensed as they are incurred each quarter over the Program implementation period. Management currently expects to incur up to approximately $9.8 million of these costs over the remainder of the Program. The Company expects future cash outlays of up to approximately $14.8 million during the remainder of 1999.
Interest Expense
Interest expense increased 35.2% to $131.4 million for the six months ended June 30, 1999 compared to $97.2 million for the same period in 1998. This increase primarily resulted from interest expense on approximately $300.0 million principal amount at maturity of 9.5% Senior Notes and $364.0 million principal amount of 12.25% Senior Subordinated Discount Notes issued in February 1999. In addition, the increase partially resulted from increased interest expense on $500.0 million principal amount of 8.6% Senior Notes issued in May 1998. Interest cost capitalized in connection with the Company's construction of telecommunications equipment amounted to approximately $5.3 million for the six months ended June 30, 1999.
18
Other Income
Other income increased 21.1% to $20.3 million for the six months ended June 30, 1999 compared to $16.8 million for the same period in 1998. This increase was the result of interest earned on the comparatively higher level of average cash balances for the six months ended June 30, 1999 as compared to the same period in 1998. In addition, customer finance charges increased during the six months ended June 30, 1999 compared to the same period in 1998.
Net Loss
Net loss decreased 15.4% to $(240.5) million for the six months ended June 30,1999 compared to $(284.2) million for the same period in 1998. Factors contributing to the decrease in the Company's net loss are described above.
Preferred Stock Dividends and Accretions
Preferred stock dividends and accretions increased 21.3% to $45.4 million for the six months ended June 30, 1999 compared to $37.5 million for the same period in 1998. The increase was due to dividend payments on the Series F preferred stock issued in August 1998.
EBITDA Before Certain Charges
EBITDA before certain charges, as defined below, increased $25.0 million to $25.2 million for the six months ended June 30, 1999 compared to $0.2 million for the same period in 1998. The integration of recent acquisitions contributed to improved EBITDA before certain charges as a result of consolidating sales forces and introducing the Company's products into additional markets. Gross margin, inclusive of network expenses, facilities administration and maintenance expenses and cost of goods sold, increased to $153.6 million for the six months ended June 30, 1999 compared to $102.9 million for the same period in 1998 as a result of the Company's continued 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," improving customer provisioning time, rolling out new products and services, and increasing its mix of higher margin products. Partially offsetting the favorable increase in gross margin was a $25.7 million increase in selling, general and administrative expenses. The Company has made significant strides in restructuring back-office and administrative functions and has integrated its information systems and resources. In addition, the business restructuring and integration program has yielded benefits by eliminating redundant costs associated with rationalizing and integrating the acquired business. However, the Company's core growth strategy and accelerated growth in its web hosting business required increases in sales and marketing efforts and other support costs which contributed to the overall increase in selling, general and administrative expenses.
EBITDA before certain charges consists of earnings (net loss) before 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.
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 $271.8 million and $198.8 million for the six months ended June 30, 1999 and 1998, 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, and (iv) continued expansion of data centers related to the development of the Company's web services.
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 years. The Company expects to continue to experience negative cash flow after investing activities for the next several years due to the continuous expansion and the development of the Company's networks and web hosting facilities. 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.
As more fully disclosed in Note 3 to the Condensed Consolidated Financial Statements, the Company sold $300 million principal amount of 9.5% Senior Notes and $364 million principal amount at maturity of 12.25% Senior Subordinated Discount Notes in a private placement transaction on February 24, 1999. Net proceeds to the Company amounted to approximately $488.5 million from both issuances. The proceeds of the offering of the 9.5% Senior Notes cannot be used for working capital purposes and can only be used to fund up to 80% of the cost of acquiring or constructing telecommunications related assets. The proceeds from the offering of the 12.25% Senior Subordinated Discount Notes will be used for general corporate purposes, including the funding of working capital and operating losses, and the funding of a portion of the cost of acquiring or constructing telecommunications related assets.
The Company believes its business plan to be funded into the first half of 2000. Depending on market conditions, the Company may decide 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 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 such transaction 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.
Project and State of Readiness
The Company has developed a five-phase plan that is designed to assess the impact of the Year 2000 issue on its information technology ( "IT") and non-information technology ("Non-IT") and remediate as necessary the non-compliant components. This table represents management's best estimates with respect to the mission-critical and non-mission-critical systems as outlined below. The percentages indicate management's best estimate of completion as of June 30, 1999.
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Phase Completion |
IT |
Completion |
Non-IT |
Completion |
|
I. |
Preliminary Activity |
100% |
12/31/97 |
100% |
12/31/97 |
II. |
Problem Determination |
100% |
9/30/98 |
100% |
5/31/99 |
III. |
Plan Complete & Resources Committed |
100% |
6/30/99 |
100% |
6/30/99 |
IV. |
Operational Sustainability |
75% |
9/30/99 |
75% |
9/30/99 |
V. |
Fully Compliant |
75% |
9/30/99 |
75% |
11/30/99 |
Due to the fact that it is not always necessary to complete one phase prior to beginning the next, some projects within a given phase have been started, while there may be outstanding tasks associated with prior phases. Priority is always placed on mission critical systems.
Phase I Preliminary Activity
This is a phase of awareness and education. The outcome of this phase was Intermedia's understanding of the criticality, risks, size and scope of its Year 2000 problem.
Phase II Problem Determination
In this phase the Company performed an inventory and assessment to determine which portions of its hardware and software would have to be replaced or modified in order for its networks, office equipment and information management systems to function properly after December 31, 1999. Such determinations were based in part on representations made by hardware and software vendors as to the Year 2000 compliance of systems utilized by the Company. However, there can be no assurances that any vendor representations received by the Company were accurate or complete. The Company also conducted a risk assessment to identify those systems whose failure would be expected to result in the greatest risk to the Company's business. As of June 30, 1999, Phase II of the plan was 100% complete with respect to both IT and Non-IT. However, much of the network equipment is located outside of the Company's headquarters, and there can be no assurance that all mission critical equipment has been inventoried and assessed.
Phase III Plan Complete & Resources Committed
During Phase III, the Company designed a plan to make the necessary modifications to and/or replace the impacted software and hardware and committed approximately $27 million towards the execution of such a plan. While the Company believes it has completed its plan for achieving Year 2000 compliance, the discovery of additional IT or Non-IT systems requiring remediation could adversely impact the current plan and the resources required to implement the plan.
Phase IV Operational Sustainability
The Company is actively engaged in Phase IV, 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. Although the Company intends to conduct tests to ensure the equipment is Year 2000 compliant, it will focus primarily on those systems whose failure would pose the greatest risks to the Company's operations. There can be no assurance that the Company has identified all mission-critical IT or Non-IT systems. The Company will likely not test all of its equipment and will rely upon vendor representations, if received, where tests are not conducted. There can be no assurance that any vendor representation will be accurate or complete. As of June 30, 1999, Phase IV of the plan was 75 % complete for IT and Non-IT. The Company expects to complete Phase IV by September 30, 1999.
Phase V Fully Compliant
The Company plans to be fully compliant on mission-critical components no later than November 30, 1999, which is prior to any anticipated impact on its operating systems. Though the majority of the work will be completed by the third quarter of 1999, there are elements that will not be completed (Phase V) until the fourth quarter of 1999 primarily due to limited availability of compliant software and hardware and prioritization of mission critical systems. As of June 30, 1999, the Company estimates that its remediation efforts are approximately 75% complete for IT and Non-IT.
Intermedia is actively engaged in activities associated with phase V with respect to its core information systems and those of its recently acquired subsidiaries as well as with respect to the associated hardware and network components. The Company believes that it has allocated adequate resources for this purpose and expects phase V to be successfully completed on a timely basis. However, there can be no assurance that it will successfully implement all of the necessary upgrades or replacements 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 significant 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.
Costs
The five-phase plan encompasses enterprise-wide projects which include updating or replacing certain of the Company's core business systems. The Company has tracked Year 2000 costs on an enterprise-wide basis, segregating its internal and external costs and hardware and software costs. The internal costs are comprised of employee hours and external costs are comprised of outside consultant costs.
The cost estimates presented below do not include system upgrades that would otherwise result as part of the Company's capital expenditure program associated with integrating acquired companies. The estimated 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.
A summary of historical and estimated costs for the Year 2000 project are listed below (in millions):
External |
Internal |
|
Historical through June 30, 1999 |
$ 6.5 |
$ 1.4 |
Estimated for remainder of 1999 |
4.5 |
0.9 |
Software/Hardware |
|
Historical through June 30, 1999 |
$ 9.2 |
Estimated for remainder of 1999 |
4.5 |
Risks and Contingency Plan
While the Company is working to test its own mission-critical systems for Year 2000 compliance, the Company does not control the systems of its suppliers. The Company is currently seeking assurance from its suppliers and strategic business partners regarding the Year 2000 readiness of their systems. The Company is currently reviewing data provided by the Telco Year 2000 Forum to ensure that its suppliers' and business partners' systems will accurately interact with the Company's systems into and beyond the Year 2000. The Telco Year 2000 Forum was formed by some of the largest U.S. telecommunications companies to pool and share testing resources for common network components and to perform network interoperability testing. Notwithstanding these measures there is some risk that the interaction of the Company's systems and those of its suppliers or business partners may be impacted by the Year 2000 date change. In addition, in light of the vast interconnection and interoperability of telecommunications networks worldwide, the ability of any telecommunications provider, including the Company, to provide services to its customers (e.g., to complete calls and transport data and to bill for such services) is dependent, to some extent, on the networks and systems of other carriers. To the extent the networks and systems of those carriers are adversely impacted by Year 2000 problems, the ability of the Company to service its customers may be adversely impacted as well. Any such impact could have a material adverse effect on the Company's operations.
The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially and adversely affect the Company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers and customers, the Company is unable to determine at this time whether the consequences of Year 2000 failures will have a material impact on the Company's results of operations, liquidity or financial condition. The Year 2000 Project is expected to significantly reduce the Company's level of uncertainty about the Year 2000 problem and, in particular, about the Year 2000 compliance and readiness of its material suppliers and business partners. The Company believes that, with the implementation of new business systems and completion of the Year 2000 project as scheduled, the possibility of significant interruptions of normal operations should be reduced.
In a recent Securities and Exchange Commission release regarding Year 2000 disclosure, the Securities and Exchange Commission stated that public companies must disclose the most reasonably likely worst case Year 2000 scenarios. Although it is not possible to assess the likelihood of any of the following events, each must be included in a consideration of worst case scenarios: widespread failure of electrical, gas, and similar supplies serving the Company; widespread disruption of the services provided by common communications carriers; similar disruption to the means and modes of transportation for the Company and its employees, contractors, suppliers, and customers; significant disruption to the Company's ability to gain access to, and remain working in, office buildings and other facilities; the failure of substantial numbers of the Company's critical computer hardware and software systems, including both internal business systems and systems controlling operational facilities such as electrical generation, transmission, and distribution systems; and the failure of outside entities' systems, including systems related to banking and finance.
If the Company cannot operate effectively after December 31, 1999, the Company could, among other things, face substantial claims by customers or loss of revenue due to service interruptions, inability to fulfill contractual obligations or to bill customers accurately and on a timely basis, and increased expenses associated with litigation, stabilization of operations following critical system failures, and the execution of contingency plans. The Company could also experience an inability by customers and others to pay, on a timely basis or at all, obligations owed to the Company. Under these circumstances, the adverse effects, although not quantifiable at this time, would be material.
The Company believes that its critical systems will be Year 2000 compliant before January 1, 2000. The Company formed an Executive Steering Committee (ESC), which is comprised of senior management of the Company. The first meeting of the ESC occurred during the first quarter 1999 to oversee and allocate additional resources, if required, for the final plans for year 2000 readiness.
Having identified the mission-critical systems of the Company and its key suppliers, and the associated risks of failure to ensure that those systems are Year 2000 ready, the Company is in the process of devising contingency plans which will be implemented in the event any such systems are not Year 2000 compliant in a timely manner. Business continuity plans are under development by the Company and will be ready for implementation by the fourth quarter of 1999.
The information set forth above in "Management's Discussion and Analysis of Financial Conditions and Results of Operations" includes 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 report for the year ended December 31, 1998.
23
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
No changes.
PART II. OTHER INFORMATION
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.
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Stockholders was held on May 20, 1999. At the meeting, the following actions were taken by the stockholders:
The following members were elected to the Company's Board of Directors to hold office for a term of three years. The voting on the resolution was as follows:
Nominee
|
For
|
Withhold Authority
|
George F. Knapp
|
41,770,665
|
69,300
|
Pierce J. Roberts, Jr.
|
41,763,865
|
76,100
|
The number of shares of common stock authorized for issuance under the company's Long-Term Incentive Plan was increased from 9,000,000 shares to 10,000,000 shares. The voting on the resolution was as follows:
For
|
Against
|
Abstained
|
Not
voted
|
23,857,449
|
17,910,251
|
72,265
|
---
|
The appointment of Ernst & Young, LLP as the independent auditors of the Company for the fiscal year ending December 31, 1999 was ratified. The voting on the resolution was as follows:
For
|
Against
|
Abstained
|
Not
voted
|
41,310,496
|
487,216
|
42,223
|
---
|
24
25
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: August 16, 1999
INTERMEDIA COMMUNICATIONS INC.
/s/ Jeanne M. Walters
|
 
26
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