United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 1998
Commission file number 0-25492
IPC Information Systems, Inc.
------------------------------------------------------
(Exact Name of registrant as specified in its charter)
Delaware 58-1636502
- ------------------------------- --------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
Wall Street Plaza, 88 Pine Street, New York, NY 10005
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 825-9060
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No[ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at January 31, 1999
- ---------------------------- -------------------------------
Common Stock par value $0.01 8,076,188 shares
<PAGE>
IPC INFORMATION SYSTEMS, INC.
INDEX TO FORM 10-Q
PAGE
----
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements (unaudited)
Condensed Consolidated Balance Sheets at December 31, 1998
and September 30, 1998 2
Condensed Consolidated Statements of Operations for the Three
Months Ended December 31, 1998 and 1997 3
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended December 31, 1998 and 1997 4
Notes to Condensed Consolidated Financial Statements 5 - 9
ITEM 2
Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 - 15
PART II. OTHER INFORMATION 16
SIGNATURES 17
<PAGE>
IPC INFORMATION SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
(Dollar amounts in thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1998
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,173 $ 28,084
Trade receivables, less allowance of $2,574 and $2,442, respectively 61,179 71,521
Inventories 46,739 40,046
Prepaid expenses and other current assets 17,450 15,904
--------- ---------
Total current assets 133,541 155,555
Property, plant and equipment, net 64,200 56,763
Debt issuance costs, net 10,719 10,707
Intangible assets, net 66,791 15,639
Other assets, net 1,940 2,628
--------- ---------
Total assets $ 277,191 $ 241,292
========= =========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Revolving credit borrowings $ 20,607 $ --
Current portion of notes payable 2,463 --
Accounts payable 18,546 21,965
Accrued liabilities 43,066 38,833
Customer advances and deferred revenue 37,408 38,119
Current portion of capital leases 4,905 4,462
--------- ---------
Total current liabilities 126,995 103,379
Senior unsecured notes 193,351 188,223
Notes payable, net of current portion 10,032 --
Lease obligations, net of current portion 13,353 12,490
Other liabilities 3,753 3,741
--------- ---------
Total liabilities 347,484 307,833
--------- ---------
Commitments and contingencies
Stockholders' deficit:
Preferred stock - $0.01 per share par value, authorized 10,000,000 shares,
none issued and outstanding
Common stock - $0.01 per share par value, authorized 25,000,000 shares;
8,076,188 shares issued and outstanding 81 81
Paid-in capital 4,797 4,797
Retained deficit (75,171) (71,419)
--------- ---------
Total stockholders' deficit (70,293) (66,541)
--------- ---------
Total liabilities and stockholders' deficit $ 277,191 $ 241,292
========= =========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
2
<PAGE>
IPC INFORMATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(Amounts in thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
December 31,
-----------------------
1998 1997
-------- -------
<S> <C> <C>
Revenue:
Product sales and installation $34,356 $38,441
Service 33,394 28,611
-------- --------
67,750 67,052
-------- -------
Cost of revenue:
Product sales and installation 18,783 22,185
Service 21,198 18,240
-------- -------
39,981 40,425
-------- -------
Gross profit 27,769 26,627
Research and development expenses 2,768 2,404
Selling, general and administrative expenses 21,704 16,557
-------- -------
Income from operations 3,297 7,666
Interest expense, net (6,191) (440)
Other income/(expense), net 76 (39)
-------- -------
(Loss) income before provision for income taxes (2,818) 7,187
Provision for income taxes 841 3,593
-------- -------
Net (loss) income $(3,659) $ 3,594
======== =======
Basic (loss) earnings per share $ (0.45) $ 0.17
======== =======
Basic weighted average shares outstanding 8,076 21,422
======== =======
Diluted earnings per share $ 0.17
=======
Diluted weighted average shares outstanding 21,730
=======
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
<PAGE>
IPC INFORMATION SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(Dollar amounts in thousands)
<TABLE>
<CAPTION>
Three months ended
December 31,
-------------------------
1998 1997
-------- -------
<S> <C> <C>
Cash flows from operations activities:
Net (loss) income $ (3,659) $ 3,594
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 4,186 2,418
Amortization of intangible assets 1,356 296
Non-cash interest on senior discount notes 5,128 --
Other interest amortization 396 73
Provision for doubtful accounts 163 267
Changes in operating assets and liabilities:
Trade receivables 13,352 (4,076)
Inventories (4,534) (3,094)
Prepaid expenses and other current assets (268) 2,773
Other assets 176 (152)
Accounts payable (5,906) (3,877)
Accrued liabilities and other liabilities (2,229) 4,603
Customer advances and deferred revenue (2,233) 6,020
-------- -------
Net cash provided by operating activities 5,928 8,845
-------- -------
Capital expenditures (4,597) (2,212)
Acquisitions, net of cash acquired (40,418) --
Contingent acquisition payments to Bridge Electronics, Inc -- (375)
-------- -------
Net cash (used in) investing activities (45,015) (2,587)
-------- -------
Net repayment of note payable -- (3,200)
Proceeds from revolving credit borrowings 20,607 --
Principal payments on capital leases (1,135) (978)
Debt issuance costs (333) --
Equity charges from fiscal year 1998 merger (42) --
Repayment of long-term debt -- (9)
Proceeds from the exercise of stock options -- 416
-------
-------- -------
Net cash provided by (used in) financing activities 19,097 (3,771)
-------- -------
Effect of exchange rate changes on cash 79 (297)
-------- -------
Net (decrease) increase in cash (19,911) 2,190
Cash and cash equivalents, beginning of 28,084 1,465
-------- -------
Cash and cash equivalents, end of period $ 8,173 $ 3,655
======== =======
</TABLE>
4
<PAGE>
IPC INFORMATION SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
(Dollar amounts in thousands, except per share amounts)
1. In the opinion of management, the accompanying unaudited condensed
consolidated financial statements include all necessary adjustments (consisting
of normal recurring accruals and appropriate intercompany elimination
adjustments) for a fair presentation of the financial position of IPC
Information Systems, Inc. ("IPC" or the "Company") as of December 31, 1998, and
the results of its operations and its cash flows for the three months ended
December 31, 1998 and 1997, in conformity with generally accepted accounting
principles for interim financial information applied on a consistent basis. The
results of operations for the three months ended December 31, 1998 and 1997 are
not necessarily indicative of the results to be expected for the full year.
These financial statements should be read in conjunction with IPC's Form 10-K
for the fiscal year ended September 30, 1998.
2. Components of inventories:
December 31, September 30,
1998 1998
----------- ------------
Components and manufacturing work in process $14,797 $13,639
Inventory on customer sites awaiting installation 24,993 21,516
Parts and maintenance supplies 6,949 4,891
======= =======
$46,739 $40,046
======= =======
3. Revolving credit borrowings:
In April 1998, the Company entered into a five-year $55,000 senior
secured revolving credit agreement (the "Revolving Credit Facility"), with
Morgan Stanley Senior Funding, Inc., as syndication agent, and other lending
parties, to be used for working capital and other general corporate purposes. At
December 31, 1998, $20,607 was outstanding. The weighted average interest rate
during the three months ended December 31, 1998 was 9.25%. In addition, the
Company had outstanding $8,163 of letters of credit at December 31, 1998.
4. Acquisitions:
On December 18, 1998 IPC, through its wholly owned subsidiary,
International Exchange Networks Ltd. ("IXnet"), acquired all of the outstanding
shares of Saturn Global Network Services Holdings Limited ("Saturn") from
Marshalls 106 Limited ("Marshalls") (the "Saturn Acquisition"). The purchase
price included the payment of cash in the amount of $35,666 (paid by the Company
through a combination of cash from operations and borrowings from the Revolving
Credit Facility) and the issuance by IXnet of a promissory note, guaranteed by
the Company, in the amount of $7,545, bearing interest at the UK Sterling Base
Rate, as defined, plus three percent and payable over three
5
<PAGE>
years ("Marshalls Note"). In addition, the Company assumed indebtedness of
Saturn due to Marshalls in the amount of $4,968 payable over 24 months with
interest at 9.25% (the "Saturn Note"). Under the agreement, the Marshalls Note
is subject to certain rights of offset.
Saturn, a UK Holding Company, owns telecommunication network
operating subsidiaries in the United Kingdom, USA, Hong Kong, Australia, Japan
and Singapore. It has established a business selling managed premium grade voice
and data communication services to the financial community, similar to IXnet,
but focused on Europe, Australia and the Pacific Rim; therefore, its customer
base and network facilities are geographically complementary to IXnet.
The Saturn Acquisition was accounted for using the purchase method of
accounting. Included in intangible assets, as a result of the Saturn
Acquisition, is approximately $49,000, representing goodwill.
The following unaudited pro forma statement of operations for the
three months ended December 31, 1998 and 1997, gives effect to the Saturn
Acquisition as if it had occurred on October 1, 1997, (amounts in thousands,
except per share amounts).
<TABLE>
<CAPTION>
For the three months ended
December 31,
--------------------------
1998 1997
------- -------
<S> <C> <C>
Revenue $73,699 $73,302
Operating Income $ 1,853 $ 5,958
Net (loss) income $(5,241) $ 2,094
Basic (loss) earnings per share $ (0.65) $ 0.10
Diluted earnings per share (a) -- $ 0.10
Basic weighted average number of common shares outstanding 8,076 21,422
Diluted weighted average number of common shares outstanding -- 21,730
</TABLE>
(a) Since the quarter ended December 31, 1998 resulted in a pro forma net loss,
common stock equivalents would have had an anti-dilutive effect. Therefore,
diluted earnings per share has not been calculated.
Pro forma adjustments include: (i) amortization of goodwill over 10
years; (ii) interest expense on the Saturn Note and the Marshalls Note; and
(iii) Interest expense from revolving credit borrowings for the Saturn
Acquisition. All pro forma adjustments were tax effected using the effective tax
rate for each period. The pro forma financial information presented above is not
necessarily indicative of the operating results which would have been achieved
had the Saturn Acquisition occurred at October 1, 1997 or of the results to be
achieved in the future.
On December 31, 1998, the Company purchased the assets of Reuters
Voice Systems ("RVS"), a business unit of Reuters Group PLC, for approximately
$5,700 (the "RVS Acquisition"). The purchase was financed through a combination
of cash from operations and borrowings from the Revolving Credit Facility.
The RVS Acquisition was accounted for using the purchase method of
accounting. Included in intangible assets, as a result of the RVS Acquisition,
is approximately $3,500, representing goodwill.
6
<PAGE>
5. Stock Dividend:
On May 29, 1998, the Company declared a two-for-one stock split
effected in the form of a 100% stock dividend (the "Stock Dividend"). The Stock
Dividend was distributed on June 24, 1998 to holders of record on June 10, 1998.
Unless otherwise indicated, all share and per share data, including stock option
information, is stated to reflect the Stock Dividend.
6. Earnings Per Share:
The following is a reconciliation of the numerators and denominators
for the computations of basic and diluted earnings per share (amounts in
thousands, except per share amounts).
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
-------- -------
<S> <C> <C>
Basic earnings per share computation
Numerator - Net (Loss) Income $ (3,659) $ 3,594
-------- -------
Denominator:
Weighted average common shares outstanding 8,076 21,422
-------- -------
Total shares 8,076 21,422
======== =======
Basic (loss) earnings per share (0.45) $ 0.17
======== =======
Diluted earnings per share computation
Numerator - Net Income $ 3,594
-------
Denominator:
Weighted average common shares outstanding 21,422
Common stock equivalent of stock options 308
-------
Total shares 21,370
=======
Diluted earnings per share $ 0.17
=======
</TABLE>
Since the quarter ended December 31, 1998 resulted in a net loss,
common stock equivalents would have had an anti-dilutive effect. Therefore,
diluted earnings per share has not been calculated. Approximately 300,000
options that were outstanding for the three months ended December 31,1997 were
not included in the computation of diluted earnings per share because the
assocoiated exercise prices exceeded the average market price of the Company's
common stock for the period.
7. Comprehensive Income:
Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income," requires the Company to include within its financial
statements information on comprehensive income, which is defined as all activity
impacting equity from non-owner sources. For the Company, comprehensive income
includes net income and foreign currency translation adjustments. Total
comprehensive Income, net of taxes, was a loss of $3,138 and income of $4,089
for the three months ended December 31, 1998 and 1997, respectively.
7
<PAGE>
8. Business Segments:
The Company's operations include Trading Systems, Information
Transport Systems ("I.T.S.") and network services (IXnet). Trading Systems
reports sales of turret systems to distributors and direct sales and
installations of turret systems as "Product sales and installation." It reports
revenue from turret system maintenance, including annual and multi-year service
contracts, and from moves, additions and changes to existing turret system
installations as "Service." I.T.S. reports revenue from the design, integration
and implementation of cabling infrastructure projects including Local and Wide
Area Networks, and from the sales of intelligent network products, such as hubs,
bridges and routers as "Product sales and installation." It reports revenue from
on-site maintenance of customer cable infrastructure, including annual and
multi-year contracts, and from the provision of outsourcing services for the
support, expansion and upgrading of existing customer networks as "Service."
Additionally, IXnet reports revenue derived from the IXnet network as "Service."
<TABLE>
<CAPTION>
Trading
Systems I.T.S IXnet Corporate Consolidated
---------- ------- -------- --------- ------------
<S> <C> <C> <C> <C> <C>
Three Months ended December 31, 1998
Revenue:
Product sales and installation $ 27,342 $ 7,014 $ -- $ -- $ 34,356
Service 16,650 3,992 12,752 -- 33,394
-------- ------- -------- ------- --------
Total revenue 43,992 11,006 12,752 -- 67,750
Gross profit 22,254 1,220 4,295 27,769
Research & development 2,768 -- -- 0 2,768
Selling, general & administrative 6,049 1,107 10,843 3,705 21,704
======== ======= ======== ======= ========
Income (loss) from operations $ 13,437 $ 113 $ (6,548) $(3,705) $ 3,297
======== ======= ======== ======= ========
Depreciation & amortization $ 1,139 $ 82 $ 3,781 $ 540 $ 5,542
======== ======= ======== ======= ========
EBITDA (a) $ 14,576 $ 195 $ (2,767) $(3,165) $ 8,839
======== ======= ======== ======= ========
Total assets (b) $219,830 $27,345 $ 30,016 $ -- $277,191
======== ======= ======== ======= ========
Three Months ended December 31, 1997
Revenue:
Product sales and installation $ 34,689 $ 3,752 $ -- $ -- $ 38,441
Service 14,299 6,922 7,390 -- 28,611
-------- ------- -------- ------- --------
Total revenue 48,988 10,674 7,390 -- 67,052
Gross profit 23,097 1,818 1,712 -- 26,627
Research & development 2,404 -- -- -- 2,404
Selling, general & administrative 5,894 1,429 5,306 3,928 16,557
======== ======= ======== ======= ========
Income from (loss) operations $ 14,799 $ 389 $ (3,594) $(3,928) $ 7,666
======== ======= ======== ======= ========
Depreciation & amortization $ 1,120 $ 130 $ 1,125 $ 339 $ 2,714
======== ======= ======== ======= ========
EBITDA (a) $ 15,919 $ 519 $ (2,469) $(3,589) $ 10,380
======== ======= ======== ======= ========
Total assets (b) $143,551 $15,862 $ 10,375 $ -- $169,788
======== ======= ======== ======= ========
</TABLE>
(a) Earnings before interest, taxes, depreciation and amortization ("EBITDA")
represents operating income plus depreciation and amortization.
(b) The Company's management reviews corporate assets combined with trading
system's assets.
8
<PAGE>
8. Effects of Recently Issued Accounting Standards:
In June 1998, the FASB issued SFAS No. 133, "Accounting for
Derivatives and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and hedging activities. This standard is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
The Company does not expect the adoption of SFAS No. 133 to have an impact on
its results of operations, financial position or cash flows.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1, "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 is effective for
financial statements for years beginning after December 15, 1998. The Company
does not anticipate the adoption of this standard would have a material effect
on the Company's capitalization policy.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (unaudited)
Overview
The Company is a leader in providing integrated telecommunications
equipment and services that facilitate the execution of transactions by the
financial trading community. Such transactions involve the trading of equity and
debt securities, commodities, currencies and other financial instruments. The
Company designs, manufactures, installs and services turret systems and installs
and services the cabling infrastructure and networks which provide financial
traders with desktop access to time-sensitive communications and data. The
Company's primary customers include securities and investment banking firms,
merchant and commercial banks, interdealer brokers, foreign exchange and
commodity brokers and dealers, securities and commodity exchanges, mutual and
hedge fund companies, asset managers and insurance companies. The Company uses
an integrated approach to marketing its products and services, leveraging its
established customer base throughout the financial trading community. In
addition, through IXnet, the Company operates a telecommunication network which
provides a variety of dedicated private line, managed data and switched network
services (the "IXnet Network"), which has been specifically designed to meet the
specialized telecommunications requirements of the financial trading community.
The Company's operations include Trading Systems, Information
Transport Systems ("I.T.S.") and network services ("IXnet"). Trading Systems
reports sales of turret systems to distributors and direct sales and
installations of turret systems as "Product sales and installation." It reports
revenue from turret system maintenance, including annual and multi-year service
contracts, and from moves, additions and changes to existing turret system
installations as "Service." I.T.S. reports revenue from design, integration and
implementation of cabling infrastructure projects including Local and Wide Area
Networks, and from sales of intelligent network products, such as hubs, bridges
and routers, as "Product sales and installation." It reports revenue from
on-site maintenance of customer cable infrastructure, including annual and
multi-year contracts and from the provision of outsourcing services for the
support, expansion and upgrading of existing customer networks as "Service."
Additionally, IXnet reports revenue derived from the use of its international
network as "Service."
Revenue from trading systems and I.T.S. sales and installation is
recognized upon completion of the installation, except for revenue from sales of
turret products to distributors, which is recognized
9
<PAGE>
upon shipment by IPC. Invoices representing progress payments on direct product
sales are submitted during various stages of the installation. The revenue
attributable to such advance payments is deferred until system installation is
completed. In addition, contracts for annual recurring turret and I.T.S.
services are generally billed in advance, and are recorded as revenue ratably
(on a monthly basis) over the contractual periods. Revenue from moves, additions
and changes to turret systems is recognized upon completion, which usually
occurs in the same month or the month following the order for services. Revenue
from IXnet network services are recognized in the month the service is provided.
Cost of revenue for turret systems and I.T.S. includes material and
labor associated with the installation of a project or the service performed.
Cost of revenue for IXnet network services includes charges from carriers for
bandwidth associated with such service revenue.
Due to the substantial sales price of the Company's large turret and
I.T.S. installations and the Company's recognition of revenue only upon
completion of installations, revenue and operating results could fluctuate
significantly from period to period. However, the Company's service business
generates a more consistent revenue stream than sales and installation and,
consequently, these fluctuations (as a percentage of total revenue) could be
somewhat diminished in the future as the Company's service business expands.
On May 29, 1998, the Company declared a two-for-one stock split
effected in the form of a 100% stock dividend (the "Stock Dividend"). The Stock
Dividend was distributed on June 24, 1998 to holders of record on June 10, 1998.
Unless otherwise indicated, all share and per share data, including stock option
information, is stated to reflect the Stock Dividend.
On April 30, 1998, Arizona Acquisition Corp. ("AAC") was merged into
the Company (the "Merger"). Under the terms of the Merger, each share of common
stock of the Company ("IPC Common Stock") was converted at the election of the
holder thereof into either (i) the right to receive $21.00 in cash (pre Stock
Dividend) or (ii) the right to retain one share of common stock of the surviving
corporation ("Surviving Corporation Common Stock"), subject to proration in
certain circumstances. Upon the Merger, the Company issued $247.4 million
aggregate principal amount at maturity ($180.0 million initial proceeds upon
issuance) of its ten year, 10 7/8% Senior Discount Notes due 2008 (the "Notes").
A portion of the proceeds of the Notes ($145.6 million), together with $54.7
million of capital provided by AAC (the "Equity Investment") were used to
repurchase 19,073,330 shares of IPC common stock, at a price of $10.50 per
share, from IPC shareholders who did not elect to retain Surviving Corporation
Common Stock upon the Merger. Prior to the Merger, AAC was owned by (i) Cable
Systems Holdings LLC ("CSH LLC"), whose membership interests were owned by
Citicorp Venture Capital, Ltd. and David Kirby and John O'Mara, private
investors, (ii) CSH LLC's indirect subsidiary Cable Systems International, Inc.
and (iii) the investment fund of Allegra Capital Partners III, L.P. (formerly
known as Lawrence Smith & Horey III, L.P.). The Merger was accounted for as a
leveraged recapitalization; accordingly, the historical cost basis of the
Company's assets and liabilities has not been impacted by the Merger.
Simultaneous with the Merger, the Company acquired the remaining 20% interest in
IXnet (the "IXnet Exchange") through the issuance of 457,140 shares of Surviving
Corporation Common Stock.
10
<PAGE>
Results of Operations
Comparison of the Three Months Ended December 31, 1998 ("Q1 1999") to the Three
Months Ended December 31, 1997 ("Q1 1998")
Revenue. Total revenue increased by $0.7 million or 1.0% to $67.8
million in Q1 1999 from $67.1 million in Q1 1998.
Turret installation and related service revenue decreased by $5.0
million or 10.2% to $44.0 million in Q1 1999 from $49.0 million in Q1 1998.
New turret installation projects decreased by $7.4 million to $27.3
million in Q1 1999 from $34.7 million in Q1 1998. The decrease primarily related
to one large installation project completed and cutover in Q1 1998 for $8.4
million in revenue; there where no installation projects of a comparable size in
Q1 1999.
Turret service revenue increased by $2.4 million in Q1 1999 to $16.7
million from $14.3 million in Q1 1998. Higher service revenue for the current
period is principally due to the Company's expanding customer base.
Revenue from I.T.S. sales and related service increased by $0.3
million or 3.1% to 11.0 million in Q1 1999 from $10.7 million in Q1 1998.
New I.T.S. installation projects increased by $3.2 million in Q1 1999
as compared to Q1 1998. Partially offsetting this increase was a decrease in
service related revenue of $2.9 million in Q1 1999 as compared to Q1 1998. The
increase in installation projects is due to a higher volume of projects
completed and recognized as revenue in the current period as compared to the
similar period of the prior year. The decrease in service is primarily from a
large customer service contract expiring at the end of fiscal year 1998 and not
renewed in Q1 1999. Due to this occurrence, the Company anticipates that I.T.S.
service revenue for the current fiscal year may be less than the prior year.
Revenue from network services increased by $5.4 million, or 72.3%, to
$12.8 million in Q1 1999 from $7.4 million in Q1 1998. The increase is related
to the growing customer base, the acquisition of Saturn in Q1 1999 and MXnet in
the prior fiscal year second quarter and increased customer utilization of
IXnet's international telecommunication network. The IXnet revenue run rate at
the end of Q1 1999 (annualized recurring revenue for the last month of the
period) was $58.0 million, an increase of 97% as compared with the prior year
period.
Cost of Revenue. Cost of revenue (as a percentage of revenue) of
59.0% in Q1 1999 decreased as compared to 60.3% in Q1 1998.
Product sales and installation cost of revenue (as a percentage of
product sales and installation revenue) for Q1 1999 was 54.9 % which decreased
as compared to 57.7% in Q1 1998. The decrease is primarily related to cost
efficiencies realized from the manufacturing of the Company's digital Tradenet
MX(R) product.
Service cost of revenue (as a percentage of service revenue) for Q1
1999 was 63.5% as compared to 63.8% in Q1 1998. The decrease in Q1 1999 is
primarily related to higher network service revenue from increased utilization
of the IXnet network and a greater percentage of turret
11
<PAGE>
maintenance revenue in revenue in the current quarter (turret maintenance
revenue typically has a lower cost of revenue as compared to turret moves,
additions and changes) offset in part by higher I.T.S. service revenue
attributable to I.T.S.'s reduction in service revenue.
Research and Development Expenses. Research and development expenses
were $2.8 million in Q1 1999 as compared to 2.4 million in Q1 1998. Research and
development efforts are focused on the development of the next generation of
trading systems products including integration of the Tradenet MX turret with
the IXnet Network as well as enhancement of existing features of the Tradenet MX
family to sustain the Company's leadership position in voice-based trading
system products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A") increased by $5.1 million, or 30.7%, to $21.7
million in Q1 1999 from $16.6 million in Q1 1998. Contributing to this increase
in Q1 1999, is a non-recurring charge of $0.8 million relating to a separation
agreement and release between the Company and Terry Clontz, the Company's former
President and Chief Executive Officer. SG&A expenses related to the expansion of
the IXnet Network increased $5.5 million in Q1 1999 as compared to Q1 1998.
Depreciation and amortization represented $2.7 million of IXnet's increase. The
Company intends to continue to invest in the IXnet Network. As the Company
deploys this network, the Company anticipates that SG&A expenses will continue
to increase. These expenses may be incurred prior to the realization of
anticipated revenue.
Interest Expense, net. Interest expense, net increased by $5.8
million to $6.2 million for Q1 1999 from $0.4 million for Q1 1998. The increase
is due to the accretion of interest expense associated with the issuance of
Senior Discount Notes in April 1998 and related amortization of debt issuance
costs, both of which are non-cash items, aggregating $5.4 million.
Provision for Income Taxes. The Company's effective tax rate was
29.8% for Q1 1999 compared to 50.0% for Q1 1998, Although the Company incurred a
net loss for Q1 1999, income taxes were provided due to a limitation on the
Company's ability to utilize foreign tax credits to offset taxes paid outside of
the United States and an increase in IXnet's losses for which the Company is not
able to receive certain state statutory tax benefits.
Liquidity and Capital Resources
From the Company's initial public offering in fiscal 1995 until the
Merger in April 1998, the Company has satisfied its cash requirements through
cash provided by operations, capital lease financing and certain unsecured bank
lines of credit. The Company's principal uses of cash were to fund working
capital requirements, operating losses and capital expenditures of its IXnet
subsidiary and acquisitions, principally related to the expansion of IXnet's
international telecommunications network.
Net cash provided by operating activities was $5.9 million in Q1 1999
as compared to net cash provided by operating activities of $8.8 million in Q1
1998. This decrease is primarily related to higher working capital requirements
due to business expansion.
Cash used in investing activities was $45.0 million and $2.6 million
for Q1 1999 and Q1 1998, respectively. Cash used in investing activities
resulted from the acquisitions of Saturn and RVS and expenditures for property,
plant and equipment, composed of IXnet Network costs, machinery and equipment
and leasehold improvements. The Company intends to continue to invest in the
IXnet Network.
12
<PAGE>
Cash provided by financing activities was $19.1 million in Q1 1999 as
compared to a use of cash of $3.8 million in Q1 1998. The increase is resulted
from $20.6 million in borrowings from the Revolving Credit Facility used to
finance the acquisitions of Saturn and RVS.
In April 1998, the Company entered into a five year $55.0 million
senior secured revolving credit agreement (the "Revolving Credit Facility"),
with Morgan Stanley Senior Funding, Inc., as syndication agent, and other
lending parties, to be used for working capital and other general corporate
purposes. At December 31, 1998, $20.6 million was outstanding. The weighted
average interest rate was 9.25% during the three months ended December 31, 1998.
In addition, the Company had issued and outstanding $8,163 of letters of credit
at December 31, 1998.
On December 18, 1998 IPC, through its wholly owned subsidiary,
International Exchange Networks Ltd. ("IXnet"), acquired all of the outstanding
shares of Saturn Global Network Services Holdings Limited ("Saturn") from
Marshalls 106 Limited ("Marshalls") (the "Saturn Acquisition"). The purchase
price included the payment of cash in the amount of $35,666 (paid by the Company
through a combination of cash from operations and borrowings from the Revolving
Credit Facility) and the issuance by IXnet of a promissory note, guaranteed by
the Company, in the amount of $7,545, bearing interest at the UK Sterling Base
Rate, as defined, plus three percent and payable over three years ("Marshalls
Note"). In addition, the Company assumed indebtedness of Saturn due to Marshalls
in the amount of $4,968 payable over 24 months with interest at 9.25% (the
"Saturn Note"). Under the agreement, the Marshalls Note is subject to certain
rights of offset.
Saturn, a UK Holding Company, owns telecommunication network
operating subsidiaries in the United Kingdom, USA, Hong Kong, Australia, Japan
and Singapore. It has established a business selling managed premium grade voice
and data communication services to the financial community, similar to IXnet,
but focused on Europe, Australia and the Pacific Rim; therefore, its customer
base and network facilities are geographically complementary to IXnet.
The Saturn Acquisition was accounted for using the purchase method of
accounting. Included in intangible assets, as a result of the Saturn
Acquisition, is approximately $49,000, representing goodwill.
On December 31, 1998, the Company purchased the assets of Reuters
Voice Systems ("RVS"), a business unit of Reuters Group PLC, for approximately
$5,700 (the "RVS Acquisition"). The purchase was financed through a combination
of cash from operations and borrowings from the Revolving Credit Facility.
The RVS Acquisition was accounted for using the purchase method of
accounting. Included in intangible assets, as a result of the RVS Acquisition,
is approximately $3,500, representing goodwill.
In connection with the implementation of the IXnet Network, IXnet has
entered into capital lease agreements for certain network switching equipment
totaling approximately $2.1 million in both Q1 1999 and Q1 1998.
The Company believes that cash flows from operations and existing
credit facilities will be sufficient to meet its working capital and capital
expenditure needs for the near future. The Company does not rule out seeking
additional debt or equity financing for other corporate purposes.
13
<PAGE>
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 using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including among
other things, a temporary inability to process transactions, deliver products
and services to customers, send invoices, or engage in similar normal business
activities.
The Company has assessed its Year 2000 compliance for the products
that it manufactures and the services it provides, along with those products
manufactured by others which the Company represents and sells. The Company is
taking steps to obtain Year 2000 compliance status updates from vendors that
supply products for resale and services which the Company either uses internally
or resells as part of the IXnet Network and expects to conclude on remedial
alternatives, if any, by June 30, 1999. Until such compliance updates are
complete, the Company will not be able to completely evaluate whether its
systems, products or services will need to be revised to be Year 2000 compliant.
However, at this point in time, the Company believes that its products and the
products it represents are Year 2000 compliant or can be made Year 2000
compliant or Year 2000 ready, as the case may be, with upgrades to both the
hardware and software made available by the Company and its vendors.
In addition, the Company has made available to trading systems
customers its trading system laboratory located in Westbrook, CT, to
independently verify and test such compliance with respect to current trading
systems products.
The Company is in the process of converting to an enterprise-wide
management information system which, through software updates to both the
application and operating systems scheduled to be completed by June 30, 1999, is
expected to be Year 2000 compliant.
To date, the Company has not incurred and does not expect to incur
any material expenditures in connection with identifying, evaluating or
addressing Year 2000 or readiness compliance issues, with the exception of the
conversion to an enterprise-wide management information system, which was
undertaken for operational reasons. Most of the Company's expenses in connection
with Year 2000 compliance have related to, and are expected to continue to
relate to, the operating costs associated with time spent by employees in the
evaluation process and Year 2000 compliance matters generally.
The Company is not aware of any Year 2000 compliance problems related
to its systems that would have a material adverse effect on the Company's
business, results of operations and financial condition. There can be no
assurance that the Company will not discover Year 2000 or readiness compliance
problems in its systems, products or services that will require substantial
revision. In addition, there can be no assurance that third-party software,
hardware or services incorporated into the Company's material systems, products
or services will not need to be revised or replaced, all of which could be
time-consuming and expensive. The failure of the Company to fix or replace its
internally developed software, third-party software, hardware or services on a
timely basis could result in lost revenues, increased operating costs, the loss
of customers and other business interruptions any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. Moreover, the failure to adequately address Year 2000 compliance
issues related to its products and services could result in claims of
mismanagement,
14
<PAGE>
misrepresentation or breach of contract and related litigation, which could be
costly and time-consuming to defend.
In addition, there can be no assurance that third party providers of
products and services, including telecommunications and utility companies, and
the Company's customer base, primarily in the financial services industry, will
be Year 2000 compliant. The failure of such entities to be Year 2000 compliant
could result in a systematic failure, beyond the control of the Company, such as
prolonged telecommunications or electrical failure, or the inability of
customers to make payment for services, which could have a material adverse
effect on the Company's business, results of operations and financial condition.
As discussed above, the Company is engaged in an ongoing Year 2000
compliance assessment and has not yet developed any contingency plans. The
results of the Company's enterprise-wide system conversion and responses
received from vendors and service providers will be taken into account in
determining the nature and extent of any contingency plans.
With respect to any forward-looking comments contained herein, the
Company refers readers to the cautionary statement under the Private Securities
Litigation Reform Act of 1995, contained in the Company's Report on Form 10-K
for the fiscal year ended September 30, 1998.
15
<PAGE>
Part II - Other Information
ITEM 1. Legal Proceedings - None
ITEM 2. Changes in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
ITEM 5. Other Information
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibit Number 27 Financial Data Schedule
(b) Form 8-K
Subsequent to the quarter ended December 31, 1998, however, prior to
the filing of this report, the Company filed with the Securities and Exchange
Commission ("SEC") a current report on Form 8-K dated, January 4, 1999,
reporting information under items 2 and 7 thereof and providing the following
exhibits:
2.3 Agreement for Sale/Purchase of the Issued Share Capital of Saturn
Global Network Services Holdings Limited dated August 7, 1998 (as
amended on December 18, 1998) among Marshalls 106 Limited, Marshalls
Finance Limited, International Exchange Networks, Ltd. and IPC
Information Systems, Inc.
99 Press Release issued on December 21, 1998
An amendment to this report on Form 8-K, was filed with the SEC on
February 11, 1999, reporting information under Items 2 and 7.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
IPC INFORMATION SYSTEMS, INC.
Dated: February 16, 1999 By: /s/ GERALD E. STARR
--------------------------
Gerald E. Starr
President and
Chief Executive Officer
Dated: February 16, 1999 By: /s/ BRIAN L. REACH
----------------------------
Brian L. Reach
Vice President,
Chief Financial Officer
17
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