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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED:
SEPTEMBER 30, 2000
[ ] 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 0-25314
e.spire COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 52-1947746
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
12975 WORLDGATE DRIVE 20170
HERNDON, VIRGINIA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
703.639.6000
(ISSUER'S TELEPHONE NUMBER INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE TITLE OF SECURITIES
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:
The number of shares at e.spire Common Stock, Par Value $0.01 outstanding
on November 1, 2000 was 54,837,353.
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e.spire COMMUNICATIONS, INC.
FORM 10 - Q
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2000
(unaudited) and December 31, 1999 3
Unaudited Condensed Consolidated Statements of Operations -
Three and Nine Months Ended September 30, 2000 and 1999 4
Unaudited Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2000 and 1999 5
Notes to Unaudited Condensed Consolidated Interim 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 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
Index of Exhibits 22
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1 -- FINANCIAL STATEMENTS
e.spire COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
----------------- ---------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 43,557 $ 62,525
Restricted cash and investments 2,587 18,754
Trade accounts receivable, net of allowance for doubtful accounts
of $27,299 and $28,707 at September 30, 2000 and December 31,
1999, respectively 123,460 97,238
Unbilled revenue 4,311 14,032
Other current assets 6,867 9,435
----------- ------------
Total current assets 180,782 201,984
----------- ------------
Inventory, networks, equipment and furniture, gross 942,327 848,698
Less: accumulated depreciation and amortization (242,811) (166,224)
----------- ------------
699,516 682,474
Deferred financing fees, net of accumulated amortization of $17,861
and $13,246 at September 30, 2000 and December 31, 1999, respectively 40,049 44,660
Intangible assets, net of accumulated amortization of
$13,439 and $11,203 at September 30, 2000 and December 31, 1999,
respectively 5,215 7,452
Other assets 7,213 4,672
----------- ------------
Total assets $ 932,775 $ 941,242
=========== ============
LIABILITIES, REDEEMABLE STOCK, AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Notes payable - current portion $ - $ 164,000
Obligations under capital leases - current portion 11,724 9,932
Accounts payable 63,226 46,106
Accrued employee costs 11,045 5,262
Other accrued liabilities 22,280 15,995
Accrued interest 6,472 14,344
----------- ------------
Total current liabilities 114,747 255,639
----------- ------------
Long-Term Liabilities:
Notes payable, less current portion 937,097 749,406
Obligations under capital leases, less current portion 35,720 46,786
Other long-term liabilities 23,614 9,010
----------- ------------
Total liabilities 1,111,178 1,060,841
----------- ------------
Redeemable stock:
14 3/4% Redeemable Preferred Stock due 2008 101,170 87,051
12 3/4% Junior Redeemable Preferred Stock due 2009 214,293 194,545
----------- ------------
Total redeemable stock 315,463 281,596
Stockholders' deficit:
Series A Convertible Preferred Stock, $1 par value, 250,000
shares authorized, 81,177 and 0 shares, respectively, issued and
outstanding 81 -
Exchangeable Preferred Stock, $1 par value, 50,000 shares
Authorized, 50,000 and 0 shares, respectively, issued and
outstanding 50 -
Common Stock, $0.01 par value, 125,000,000 shares authorized,
53,325,841 and 51,149,825 shares, respectively, issued and
Outstanding 533 511
Additional paid-in capital 359,190 236,577
Accumulated deficit (853,720) (638,283)
----------- ------------
Total stockholders' deficit (493,866) (401,195)
----------- ------------
Total liabilities, redeemable stock and stockholders' deficit $ 932,775 $ 941,242
=========== ============
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
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e.spire COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED SEPTEMBER 30, FOR THE NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------- ---------------------------------------
2000 1999 2000 1999
------------------- ------------------- ------------------ -------------------
<S> <C> <C> <C> <C>
Revenues:
Telecommunications services $ 58,027 $ 39,125 $ 167,770 $ 112,068
Network technologies services 26,629 19,655 61,010 56,260
Internet services 7,135 6,336 21,474 18,181
------------- ------------- ------------- -------------
Total revenues 91,791 65,116 250,254 186,509
Cost of sales:
Telecommunications services, excluding
noncash stock compensation of
$462, $495, $728 and $1,488,
respectively 31,088 28,286 102,735 79,590
Network technologies services,
excluding noncash stock compensation
of $290, $177, $633 and $509,
respectively 15,238 10,170 35,117 30,051
Internet services 3,363 2,884 10,525 8,197
------------- ------------- ------------- -------------
Total cost of sales 49,689 41,340 148,377 117,838
Gross margin:
Telecommunications services 26,939 10,839 65,035 32,478
Network technologies services 11,391 9,485 25,893 26,209
Internet services 3,772 3,452 10,949 9,984
------------- ------------- ------------- -------------
Total gross margin 42,102 23,776 101,877 68,671
Operating expenses:
Selling, general and administrative,
excluding noncash stock compensation
of $2,605 $1,712, $4,938 and $5,580,
respectively 46,489 45,494 139,050 119,547
Noncash stock compensation expense 3,357 2,384 6,299 7,577
Depreciation and amortization 25,409 25,362 83,174 69,039
------------- ------------- ------------- -------------
Total operating expenses 75,255 73,240 228,523 196,163
Loss from operations (33,153) (49,464) (126,646) (127,492)
Nonoperating income/expense:
Interest and other income (1,006) (1,791) (4,241) (9,309)
Interest and other expense 32,424 24,310 93,030 70,365
------------- ------------- ------------- -------------
Net loss (64,571) (71,983) (215,435) (188,548)
Preferred stock dividends, accretion
and beneficial conversion 13,128 10,305 61,980 30,002
------------- ------------- ------------- -------------
Net loss applicable to common
stockholders $ (77,699) $ (82,288) $ (277,415) $ (218,550)
============= ============= ============= =============
Basic and diluted net loss per
common share $ (1.44) $ (1.64) $ (5.27) $ (4.41)
============= ============= ============= =============
Weighted average number of
common shares outstanding 53,782,946 50,267,001 52,602,306 49,550,227
============= ============= ============= =============
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
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e.spire COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
-----------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (215,435) $ (188,548)
Adjustments to reconcile net loss to net cash used in operating
activities
Depreciation and amortization 83,174 69,039
Interest deferral and accretion 48,691 43,373
Amortization of deferred financing fees 4,615 3,894
Noncash stock compensation 6,299 7,577
Non-monetary revenue - (17,958)
Changes in operating assets and liabilities:
Trade accounts receivable (16,501) (43,852)
Other current assets (670) 3,043
Other assets (109) (747)
Accounts payable 17,120 2,280
Other liabilities 14,724 1,043
----------- -----------
Net cash used in operating activities (58,092) (120,856)
Cash flows from investing activities:
Release of restricted cash and investments related to
network activities 1,042 2,139
Other assets - non operating (2,432) -
Payments for networks, equipment and furniture (96,184) (229,741)
----------- -----------
Net cash used in investing activities (97,574) (227,602)
Cash flows from financing activities:
Issuance of notes payable - 110,000
Payment of notes payable (25,000) (34,563)
Issuance of preferred stock and warrants 150,665 -
Costs associated with preferred stock issuance (1,952) -
Payment of dividends for preferred stock (96) (85)
Payment of lease obligation (7,821) (5,242)
Payment of deferred financing fees (4) (7,397)
Release of restricted cash and investments related to
financing activities 15,125 25,268
Exercise of warrants, options and other financing activities 5,781 6,118
----------- -----------
Net cash provided by financing activities 136,698 94,099
----------- -----------
Net decrease in cash & cash equivalents (18,968) (254,359)
Cash and cash equivalents - beginning of period 62,525 328,758
=========== ===========
Cash and cash equivalents - end of period $ 43,557 $ 74,399
=========== ===========
Supplemental disclosure of cash flow information:
Interest paid $ 47,416 $ 35,207
Assets acquired under capital lease $ 285 $ 19,902
Dividends declared on preferred stock $ 31,230 $ 27,348
Increase in intangibles $ - $ 14
Accrual of stock bonuses $ 4,000 $ 6,077
</TABLE>
See accompanying notes to unaudited condensed consolidated financial statements.
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e.spire COMMUNICATIONS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
INTERIM FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
e.spire Communications, Inc. ("e.spire" or the "Company") and its wholly-owned
subsidiaries. All material intercompany accounts and transactions have been
eliminated in consolidation.
The condensed consolidated balance sheet as of September 30, 2000, the
condensed consolidated statements of operations for the three and nine months
ended September 30, 2000 and 1999, and the condensed consolidated statements of
cash flows for the nine months ended September 30, 2000 and 1999, have been
prepared by the Company, without audit. In the opinion of management, all
adjustments, which include normal recurring adjustments necessary to present
fairly the Company's financial position, results of operations and cash flows as
of September 30, 2000, and for all periods presented, have been made. Certain
amounts in the 1999 condensed consolidated statements have been reclassified to
conform to the 2000 presentation. Operating results for the three and nine
months ended September 30, 2000, are not necessarily indicative of the operating
results for the full year.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. The Company believes that the disclosures
provided are adequate to make the information presented not misleading. These
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and the related notes included in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
1999.
NOTE 2: SIGNIFICANT ACCOUNTING POLICIES
RESTRICTED CASH AND INVESTMENTS
The Company has provided performance bonds and letters of credit in various
cities in connection with its operations, resulting in a restriction to cash
amounting to approximately $2,587,000 at September 30, 2000, and $3,629,000 at
December 31, 1999. The face amount of all bonds and letters of credit is
approximately $15,395,000 as of September 30, 2000, and $21,559,000 as of
December 31, 1999.
USE OF ESTIMATES
In conformity with generally accepted accounting principles, the
preparation of the condensed consolidated financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities. Furthermore, as required, management may make estimates
in connection with the disclosure of contingent assets and liabilities at the
dates of the consolidated financial statements and the reported amounts of
revenue and expenses during the reporting period. Actual results may differ from
those estimates.
NOTE 3: RISKS AND UNCERTAINTIES
a) LIQUIDITY AND NEGATIVE CASH FLOW
To date, the Company has funded the construction of its networks and its
operations with external financing through various preferred stock, common
stock, and debt issuances, as well as through capital lease financing. As a
result of certain of these transactions, the Company will be required to satisfy
substantially higher periodic cash debt service obligations in the future. There
can be no assurance that the Company will be able to generate sufficient cash
flow or otherwise obtain funds to cover interest, principal and redeemable
preferred stock dividend payments associated with currently outstanding and
future debt and other obligations.
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The Company has never been profitable, has never generated positive cash
flow from consolidated operations and, since its inception has incurred
significant net operating losses and negative cash flow. In accordance with the
terms of its debt facilities, the Company has also deferred payment of most of
its interest charges. During the third quarter of 2000, the Company began making
cash interest payments from operating funds on its 2007 Senior Notes and Senior
Secured Credit Facility. In addition, the Company made principal payments on the
Senior Secured Credit Facility during the third quarter of 2000. The total
amount of these payments was $25 million. The Company's continued development,
construction, expansion, and operation of local networks, as well as the further
development of additional services, including local switched voice and
high-speed data services, will require continued substantial capital
expenditures. The Company's ability to fund these expenditures is dependent upon
the Company raising substantial financing. To meet its remaining capital
requirements and to fund operations and cash flow deficiencies, the Company will
be required to sell additional equity securities, acquire additional credit
facilities, sell additional debt securities, or sell certain Company assets,
some of which may require the consent of the Company's bondholders. There can be
no assurance that the Company will be able to obtain the additional financing
necessary to satisfy its cash requirements or to successfully implement its
growth strategy. Failure to raise sufficient capital could compel the Company to
delay or abandon some or all of its plans or expenditures, which could have a
material adverse effect on its business, results of operations, and financial
condition. On September 19, 2000 we entered into purchase agreements with the
Huff Alternative Income Fund, L.P. ("Huff"), Greenwich Street Capital Partners
II, L.P., and Honeywell International Inc. Master Retirement Fund to sell up to
$124.3 million of convertible preferred stock, common stock or warrants which
are convertible or exercisable into our common stock once we obtain shareholder
approval authorizing such issuance. Of this amount, we issued $50 million of
securities in the form of exchangeable preferred stock on September 19, 2000. In
connection with such issuance we will issue an aggregate of 893,523 transaction
fee warrants to the purchasers of the exchangeable preferred stock. The
exchangeable preferred stock is exchangeable at our option into convertible
preferred stock, common stock or warrants, the exchange of which may be subject
to shareholder approval. At the time of exchange, Huff may designate which type
of security will be issued. Each warrant will be initially exercisable for one
share of Common Stock (at an initial exercise price of $.01). The warrants will
automatically expire on the tenth anniversary after the date they are issued.
We will issue an additional 1,327,775 transaction fee warrants that are
exercisable into common stock to the purchasers simultaneously with the closing
of each future sale of the securities under those purchase agreements. The
stockholders' obligation to provide such financing will be subject to certain
conditions, which include, but are not limited to, receiving shareholder
approval, the absence of any material adverse change or certain debt covenant
violations under the Senior Secured Credit Facilities ("Credit Facilities").
Management believes that the Company's current cash resources, together with
amounts expected to be available pursuant to the funding commitments described
above, will be sufficient to fund the Company's continuing negative cash flow
and required capital expenditures through the first quarter of 2001. If
required, the Company also believes that it could raise additional funds from
the sale of certain assets, which are not essential to the Company's core
operations.
The Credit Facilities contain financial covenants with which the Company
must comply, including adjusted EBITDA (Earnings before interest, taxes,
depreciation, amortization, and noncash compensation), debt to capital ratio,
and capital expenditures. On September 20, 2000, the Company finalized the First
Amended and Restated Senior Secured Credit Facilities with its syndicated bank
group. The Company and the lenders amended and restated its Credit Facilities
to, among other things, replace certain financial covenants and to amend those
in place in a manner that we believe will allow for future compliance by
e.spire. Going forward, it may be necessary for the Company to draw against
investor equity commitments in order to maintain compliance under the amendments
to the financial covenants contained in the amended Credit Facility. As part of
the agreement with the lenders, the Company paid $15 million of the facility's
principal on July 14, 2000 and paid an additional $10 million of the facility's
principal on September 20, 2000, at the final closing of the amendment. As of
September 30, 2000, the Company was in compliance with the covenants to the
First Amended and Restated Senior Secured Credit Facility.
b) RECIPROCAL COMPENSATION
The Company has recorded net revenue of approximately $13.5 million and
$42.0 million, respectively, for the three and nine months ended September 30,
2000 and approximately $13.6 million and $32.4 million for the same periods of
1999 for reciprocal compensation relating to the transport and termination of
local traffic, primarily to Internet Service Providers ("ISPs"), from customers
of Incumbent Local Exchange Carriers ("ILECs") pursuant to various
interconnection agreements. Some ILECs have not paid a substantial portion of
the amounts billed by the Company and have disputed these charges based on the
belief that such calls are not local traffic as defined by the various
agreements and are not subject to payment of transport and termination charges
under state and federal laws and public policies. However, the Company has
resolved certain of these disputes, as discussed in the following paragraphs.
The resolutions of these disputes have been, and will continue to be, based on
rulings by state public utility commissions and/or by the Federal Communications
Commission (FCC), rulings by commercial arbitrators, or negotiations between the
parties. To date, there have been favorable final rulings from over 30 state
public utility commissions that ISP traffic is subject to the payment of
reciprocal compensation under current interconnection agreements. Many of these
state commission decisions have been appealed by the ILECs. To date, six U.S.
District Court decisions and three federal circuit court of appeals decisions
have been issued upholding state commission decisions ordering the payment of
reciprocal compensation for ISP traffic.
On February 25, 1999, the FCC issued a decision that ISP-bound traffic is
jurisdictionally interstate in nature. The decision relies on the long-standing
federal policy that ISP traffic, although jurisdictionally interstate, is
treated as though it is local traffic for pricing purposes. The decision also
emphasized that, because the FCC concluded that there currently are no federal
rules governing inter-
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carrier compensation for ISP traffic, the determination as to whether such
traffic was subject to reciprocal compensation under the terms of
interconnection agreements was properly made by the state commissions and that
carriers were bound by their interconnection agreements and state commission
decisions regarding the payment of reciprocal compensation for ISP traffic.
The FCC has initiated a rulemaking proceeding regarding the adoption of
prospective federal rules for intercarrier compensation for ISP traffic. In its
notice of rulemaking, the FCC expressed its preference that compensation rates
for this traffic continue to be set by negotiations between carriers, with
disputes resolved by arbitrations conducted by state commissions, pursuant to
the Telecommunications Act of 1996.
Since the issuance of the FCC's decision on February 25, 1999, at least
twenty-three state public utility commissions ("PUCs"), have either ruled or
reaffirmed that ISP traffic is subject to reciprocal compensation under current
interconnection agreements, and two state commissions have declined to apply
reciprocal compensation for ISP traffic under current interconnection
agreements.
On March 24, 2000, the United States Court of Appeals for the District of
Columbia Circuit vacated and remanded the FCC's February 25, 1999 decision. The
court found that the FCC did not provide an adequate basis for its February 1999
decision that the reciprocal compensation provisions of the Telecommunications
Act and that the FCC rules did not apply to ISP traffic. The Company does not
believe that the Circuit Court's decision will adversely affect the state
decisions noted above with respect to reciprocal compensation. The decision
does, however, create some uncertainty, and there can be no assurance that
future FCC or state rulings will be favorable to the Company. The Company has
participated in a number of regulatory proceedings that address the obligation
of the ILECs to pay the Company reciprocal compensation for ISP-bound traffic
under the Company's interconnection agreements. These proceedings include
complaint proceedings brought by the Company against individual ILECs for
failure to pay reciprocal compensation under the terms of a current
interconnection agreement, generic state commission proceedings concerning the
obligations of ILECs to pay reciprocal compensation to CLECs and arbitration
proceedings before state commissions addressing the payment of reciprocal
compensation on a prospective basis under new interconnection agreements.
In January 2000, a commercial arbitrator awarded e.spire damages in the
amount of approximately $1.9 million, including interest, from an ILEC for the
state of Florida. This award settles reciprocal compensation from such ILEC for
the state of Florida through July 31, 1999. The Company has initiated the
process of obtaining a further award through at least August, 2000. In February
2000, a commercial arbitrator granted e.spire the right to recover $14.2 million
from BellSouth, representing reciprocal compensation and accrued interest
through December 31, 1999 for the states of Alabama, Louisiana, and South
Carolina. e.spire has subsequently collected these amounts. e.spire also
received favorable decisions from the PUCs in Georgia and Florida. BellSouth
appealed both decisions, but e.spire settled the appeals on favorable terms.
e.spire also recently settled a similar collection complaint in Kentucky.
e.spire has collected these Georgia, Florida and Kentucky settlement amounts.
Accordingly, the Company through its commercial arbitration award and these
recent settlements, has collected all reciprocal compensation billed to
BellSouth through December 31, 1999, totaling approximately $25 million. e.spire
and BellSouth have also agreed to prospective reciprocal compensation rates,
eliminating litigation over the ISP issue and setting rates through December 31,
2002. Such rates are less than historical rates and decrease annually through
2002 when the agreement expires.
The Company has outstanding trade accounts receivable related to reciprocal
compensation of approximately $40.1 million at September 30, 2000, net of
allowances. The allowances are determined based on a state-by-state analysis of
the collectibility of billed amounts. The Company believes that this receivable,
net of allowances, is collectible, and that future reciprocal compensation will
be realized, although the timing of receipts cannot be predicted at this time.
Certain of the Company's interconnection agreements with the ILECs have
expired or will soon expire. The Company believes that there is substantial risk
that the future rates for reciprocal compensation under new interconnection
agreements, some of which are currently in negotiation, will be significantly
lower than current rates. Certain ILECs have contested espire local usage
measurements and such usage disputes may become more prevalent in the future. In
addition, legislation has been introduced in Congress that would eliminate
reciprocal compensation and mandate "bill and keep" compensation for local
traffic bound for ISPs. Such legislation, if passed and signed into law, could
substantially reduce e.spire's reciprocal compensation revenues. This would not
effect accounts receivable under current interconnection agreements.
c) LAWSUITS
Ten putative shareholder class action lawsuits were filed against the
Company and three of its former officers and two of its former directors on or
after April 20, 2000. The lawsuits have since been consolidated in a single
lawsuit that purports to be a class action filed on behalf of purchasers of the
common stock of the company during the period from August 12, 1999 through March
30, 2000. Plaintiff alleges that defendants made false and misleading statements
about the Company's financial condition, revenues, expenses,
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and results of operations, in violation of federal securities laws. While the
outcome of the claims against the Company cannot be predicted with certainty,
the Company believes that Plaintiff's claims have no basis and intends to
vigorously defend the action.
In addition, the Company and its subsidiaries are currently parties to
other routine litigation incidental to their business, none of which,
individually or in the aggregate, are expected to have a material adverse effect
on the company. The company and its subsidiaries are parties to various court
appeals and regulatory arbitration proceedings relating to certain of the
company's interconnection agreements and continue to participate in regulatory
proceedings before the FCC and state regulatory agencies
d) OTHER
One of the customers of our wholly owned subsidiary, ACSI NT, recently
announced that it was experiencing liquidity problems and has filed for
protection under applicable bankruptcy laws. As of September 30, 2000, we have
receivables from this customer totaling approximately $2.0 million. The customer
sold its assets to a purchaser who agreed to assume ACSI NT's agreement with the
customer and pay ACSI NT the amount due and owing under the agreement less any
amounts the customer disputes. Currently, there are outstanding disputes. ACSI
NT intends to vigorously defend any such disputes and expects to recover a
significant portion of the debt. The outcome of such dispute is uncertain. Based
on an analysis of information currently available to us, we believe that we have
adequately reserved for our exposure to loss related to this receivable.
NOTE 4: FINANCING ACTIVITIES
To date, the Company has funded the construction of its networks and its
operations with external financings, as described in the Liquidity and Capital
Resources section of Management's Discussion and Analysis of Financial Condition
and Results of Operations.
On September 20, 2000, the Company announced that it had signed purchase
agreements with the Huff Alternative Income Fund, L.P., Greenwich Street Capital
Partners II, L.P., and Honeywell International Inc. Master Retirement Fund for a
total of $125 million in equity funding. These investors have committed to
purchases of approximately $125 million of Junior Securities, pending
shareholder approval. Of this amount $50 million of Exchangeable Preferred Stock
was issued on September 19, 2000. The Exchangeable Preferred Stock is
exchangeable at the option of the Company into Purchaser Junior Securities that
includes preferred stock, warrants or common stock (based upon the accreted
amount that includes accrued but unpaid dividends at the purchase price on the
date of the closing of such Purchaser Junior Securities), the exchange of which
may be subject to shareholder approval. At the time of exchange, Huff may
designate which type of security will be issued. An aggregate of 893,523
transaction fee warrants will be issued in connection with the issuance of the
exchangeable preferred stock. Each warrant will be initially exercisable for one
share of Common Stock (at an initial exercise price of $.01). The warrants will
automatically expire on the tenth anniversary after the date they are issued.
Dividends accrue from the date of issuance, are cumulative and are payable
quarterly in arrears, in shares of its Exchangeable Preferred Stock, at a per
annum rate of 30% of $1,000 (the "stated value"), plus the accrued but unpaid
dividends thereon. Dividends are cumulative and shall accrue whether or not the
Company has earnings or profits, whether or not there are funds legally
available for the payment of such dividends and whether or not dividends are
declared by the Company. Dividends are payable only when and if declared by the
Company; provided that all accrued but unpaid dividends on any share must be
paid by the Company upon the exchange of such share of exchangeable preferred
stock. The exchangeable preferred stock is junior to the 14.75% Redeemable
Preferred Stock and ranks pari passu to the 12.75% Redeemable Preferred Stock. A
proxy soliciting shareholder approval has been distributed and a shareholders
meeting is scheduled to be held on November 16, 2000. When approval is received,
the Company expects that these investors and other investors will purchase the
remaining $75 million in preferred stock as funding is needed by the Company.
Concurrently, the Company finalized the First Amended and Restated Senior
Secured Credit Facilities with its syndicated bank group as discussed in the
Liquidity and Capital Resources section below.
NOTE 5: NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin ("SAB") No. 101-Revenue Recognition in Financial Statements.
This SAB expresses the SEC's views in applying generally accepted accounting
principles to revenue recognition in financial statements. The Company can apply
the accounting and disclosure requirements of this SAB retrospectively, or may
report a change in accounting principle as of January 1, 2000 no later than the
quarter beginning October 1, 2000. Management is currently evaluating whether
SAB No. 101 will have an impact on the Company's revenue recognition for
installation and other up-front fees.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for
Derivative Instruments and Hedging Activities. The new standard establishes
accounting and reporting standards for derivative instruments embedded in other
contracts and for hedging activities. This statement, as amended, is effective
for all fiscal quarters of all fiscal years beginning after June 15, 2000. The
Company does not expect SFAS 133 to have a material affect on its financial
position or results of operations.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation (FIN) No. 44, Accounting for Certain Transactions Involving Stock
Compensation. FIN 44 further defines the accounting consequence of various
modifications to the terms of a previously fixed stock option or award under APB
25. FIN 44 became effective on July 1, 2000, but certain conclusions in FIN 44
cover specific events that occur after December 15, 1998 or January 12, 2000.
FIN 44 did not have a material affect on its financial position or results of
operations.
NOTE 6: SEGMENT REPORTING
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During 1998, the Company adopted SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information. The Company has identified three
reportable segments: Telecommunications, Internet services and Network
Technologies. The Telecommunications segment provides special access, local
switched voice, and data transmission over the Company's own facilities and on a
resale basis. Internet services provides Internet, high-speed data
communications and web-hosting services. The Network Technologies segment offers
fiber optic network design, project management and construction services. The
Company's reportable segments are strategic business units that offer different
products and services. They are managed separately because each business unit
requires different technology and marketing strategies.
The Company evaluates the performance of each segment based on revenues
from third parties and gross margin, which are separately disclosed on the
condensed consolidated statement of operations for Telecommunications services,
Network Technologies and Internet services. The reportable total assets for
Telecommunications services, Internet services and Network Technologies services
are approximately $738.5 million, $18.7 million and $175.6 million,
respectively, at September 30, 2000. Network Technologies services assets
primarily consist of accounts receivable, inventory, networks, equipment and
furniture that are specifically identifiable with Network Technologies.
NOTE 7: SUBSEQUENT EVENTS
In September, the Company announced that its Internet subsidiary CyberGate,
Inc. entered into an agreement to sell its dial-up customer base to EarthLink,
Inc., a leading Internet service provider (ISP). This agreement was entered into
during the third quarter of 2000, but the Company will not record this
transaction until it is consummated, which is expected to occur in the fourth
quarter of 2000. As part of this transaction, the Company expects to record a
gain which will be subject to final determination of the purchase price.
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ITEM 2 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and other sections herein,
including statements regarding the development of the Company's businesses, the
markets for the Company's services and products, the Company's anticipated
capital expenditures, and other similar statements are forward-looking
statements (as such term is defined in the Private Securities Litigation Reform
Act of 1995) which can be identified as any statement that does not relate
strictly to historical or current facts. Forward-looking statements use such
words as plans, expects, will, will likely result, are expected to, will
continue, is anticipated, estimate, project, believes, anticipates, intends,
may, should, continue, seek, could and other similar expressions. Although the
Company believes that its expectations are based on reasonable assumptions, it
can give no assurance that its expectations will be achieved. The important
factors that could cause actual results to differ materially from those in the
forward-looking statements herein (the "Cautionary Statements") include, without
limitation, the Company's degree of financial leverage, risks associated with
debt service requirements and interest rate fluctuations, the impact of
restriction under the Company's financial instruments, dependence on
availability of transmission facilities, regulation risks including the impact
of the Telecommunications Act of 1996, contingent liabilities, the impact of
competitive services and pricing, the ability of the Company to successfully
implement its strategies, as well as the other risks referenced from time to
time in the Company's filings with the SEC, including the Company's Form 10-K
for the year ended December 31, 1999. All subsequent written and oral
forward-looking statements attributable to the Company or persons acting on its
behalf are expressly qualified in their entirety by the Cautionary Statements.
The Company does not undertake any obligation to release publicly any revisions
to such forward-looking statements to reflect events or circumstances after the
date hereof or to reflect the occurrence of unanticipated events.
OVERVIEW
e.spire Communications, Inc. is a facilities-based integrated
communications provider, primarily serving the business customer. Established in
1993, e.spire provides a choice of telecommunications services. Since the
passage of the Telecommunications Act of 1996, which encourages competition in
the industry, we have continued to build and enhance our broadband networks and
introduce products and services that meet the ever-changing demands of doing
business in the networked economy.
As a competitive local exchange carrier, or CLEC, we offer a combination of
local, long distance, dedicated Internet access, and advanced data services,
including frame relay and asynchronous transfer mode also known as ATM,
delivered over our own fiber optic networks. Because we deliver our services
over our own networks and supporting switching and routing equipment, we can
offer our customers integrated solutions at competitive prices.
We own and operate fiber networks in 38 metropolitan markets, 28 of which
are supported by Class 5 voice switches, data switches, and carrier-grade
Internet routers. We also have a 194-mile long-haul network between New York and
Northern Virginia, connecting the New York, Philadelphia, Baltimore, Washington,
DC/Northern Virginia markets, and a nationwide Tier-1 Internet network that
supports our advanced, high-speed data applications. As of September 30, 2000,
in addition to the 28 voice switches, our network was comprised of 3,883 route
miles, 47 ATM switches, 55 routers, and approximately 26,000 backbone long haul
miles in a leased coast-to-coast data network.
Our customers are typically small- to medium-sized business customers whose
offices require 10 to 100 telephone lines and which can benefit from our
portfolio of e.spire XpressLink integrated products and services. e.spire
XpressLink products integrate, or bundle traditional voice services, including
local, long distance, toll-free, and custom calling, with frame relay or
high-speed dedicated Internet service. These services are typically carried to
and from the customer's office location and e.spire's local fiber network over a
single T-1 access platform. e.spire can provide a pre-packaged bundle of
services or a customized solution, whichever is best for the customer. As the
customer's business grows, it can easily add voice lines and services, such as
custom-calling features, or high-speed data lines and services. We believe that
businesses that choose to combine voice and data traffic on the e.spire network
save on their communications costs. The combination of services improves the
efficiency of T-1 access facilities and, thus, also reduces our costs of doing
business.
As part of our business plan, we are expanding our sales, marketing,
customer care, and operations support systems capabilities, and we have
completed the elimination of our low-margin resale business. We announced in
late 1998 that we would no longer resell access lines, and throughout 1999 and
2000 continued to execute this strategy. The development of our business and the
construction,
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acquisition, and expansion of our networks will require significant capital
expenditures. A substantial portion of these costs is incurred before
realization of revenues. These costs, together with the associated early
operating expenses, result in negative cash flow until an adequate customer base
is established. However, as our customer base grows, we expect incremental
revenues can be generated with decreasing incremental operating expenses, which
may provide positive contributions to cash flow. We have made specific strategic
decisions to build high capacity networks with broad market coverage, which
initially increases capital expenditures and operating losses. However, we
believe that over the long term this strategy will enhance our financial
performance by increasing the traffic flow over our network.
In addition to our core telecom, or CLEC business described above, e.spire
has two subsidiaries, ACSI Network Technologies, Inc. and Cyber Gate, Inc. They
operate separately but compliment the CLEC business.
Our subsidiary ACSI Network Technologies, Inc. provides optical fiber
infrastructure solutions and strategic network design services for organizations
deploying networks in major metropolitan cities throughout the United States.
Customers include local governments, corporations, and other communications
providers.
e.spire also provides Web hosting services through its subsidiary
CyberGate, Inc. and CyberGate's subsidiary, ValueWeb. CyberGate moved in January
2000 to new offices in Fort Lauderdale, FL, featuring a state-of-the-art data
center. The new facility accommodates additional employees and the equipment
necessary for business growth in the areas of colocation, dedicated server, and
application hosting services. The new facility is connected to e.spire's local
area network in South Florida. CyberGate previously offered dial-up Internet
access as well as web hosting services. In September 2000, e.spire entered into
an agreement to sell CyberGate's dial-up customer base to EarthLink, Inc., a
leading ISP. This was a strategic move that will enable us to focus on our
higher-margin Web hosting business.
RESULTS OF OPERATIONS
REVENUES
The Company reported an increase in total revenues of $26.7 million, or
41%, to $91.8 million for the three months ended September 30, 2000, compared
with revenues of $65.1 million for the three months ended September 30, 1999, as
discussed below. For the nine months ended September 30, 2000, total revenues
increased $63.8 million, or 34%, to $250.3 million from $186.5 million for the
same period of 1999, as discussed below.
TELECOMMUNICATIONS SERVICES
The Company reported an increase in Telecommunications services revenues of
$18.9 million, or 48%, to $58.0 million for the quarter ended September 30,
2000, compared with revenues of $39.1 million for the quarter ended September
30, 1999. For the nine months ended September 30, 2000, telecommunications
services revenues increased $55.7 million, or 50% to $167.8 million from $112.1
million for the nine months ended September 30, 1999. Included in
Telecommunications services are revenues from the dedicated access, switched
local, long distance, reciprocal compensation and data products. The increase in
revenues was primarily attributable to the Company's greater presence in its
markets, an expanded customer base and increases in offerings to our existing
customers. The revenue increase was partially due to increased reciprocal
compensation revenue as discussed below and increases in the Company's other
service offerings such as special access, on-net switched and data services.
Also, these increases in revenues were partially offset by a decrease in resale
revenue due to the Company's elimination of its switched resale portfolio.
Included in Telecommunications services revenues is reciprocal compensation
of approximately $13.5 million and $13.6 million, for the three months ended
September 30, 2000 and 1999, respectively and approximately $42.0 million and
$32.4 million for the nine months ended September 30, 2000 and 1999,
respectively. Reciprocal compensation relates to the transport and termination
of local traffic, primarily to ISPs from ILEC customers, pursuant to various
interconnection agreements. These ILECs have not paid a substantial portion of
the amount billed by the Company and have disputed these charges based on the
belief that such calls are not local traffic as defined by the various
agreements and under state and federal law and public policies. As of September
30, 2000, the Company has received payments of approximately $64.7 million for
reciprocal compensation. The continued resolution of the remaining disputes will
be based on rulings by state PUCs, the FCC, the courts and/or commercial
arbitrators. In February 1999, the FCC ruled that ISP-bound traffic is
jurisdictionally "interstate in nature." The FCC also found that the reciprocal
compensation provisions of the Telecommunications Act did not apply to ISP
traffic but delegated to state PUCs the decision of whether reciprocal
compensation must be paid under the terms of local interconnection agreements.
On March 24, 2000, the United States Court of
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Appeals for the District of Columbia Circuit vacated and remanded the FCC's
decision on the grounds that the FCC did not provide an adequate basis for its
decision that the reciprocal compensation provisions of the Telecommunications
Act did not apply to ISP traffic, and remanded further consideration. e.spire
has obtained favorable rulings from the Georgia and Florida PSCs requiring
payment of past due reciprocal compensation from BellSouth in those states.
BellSouth appealed those decisions, but e.spire settled the appeals on favorable
terms. e.spire has several pending proceedings before state PSCs and commercial
arbitrators to collect outstanding amounts from multiple ILECs. Accordingly, the
Company, through its commercial arbitration awards and these recent settlements
has collected all reciprocal compensation billed to BellSouth through December
31, 1999, totaling approximately $25 million. e.spire and BellSouth have also
agreed to prospective reciprocal compensation rates, eliminating litigation over
the ISP issue and setting new rates through December 31, 2002. Such rates are
less than historical rates and decrease annually through 2002. Although there
can be no assurance that future regulatory or arbitration rulings will be
favorable to the Company and the timing of receipts cannot be predicted at this
time, the Company believes that its outstanding receivables for reciprocal
compensation of $40.1 million at September 30, 2000, net of allowance, are
ultimately collectible.
NETWORK TECHNOLOGIES SERVICES
Network Technologies services revenues increased $6.9 million, or 35%, to
$26.6 million for the three months ended September 30, 2000, compared with
revenues of $19.7 million for the three months ended September 30, 1999. The
increase in revenues is attributable to the continued growth in the size and
number of contracts in this operation. The majority of the 2000 revenues are
related to the sale of conduit in one of the Company's markets to three major
customers.
For the nine month periods ended September 30, 2000 and 1999, Network
Technologies services revenues increased $4.7 million, or 8%, to $61.0 million
from $56.3 million, respectively. The increase in revenues is attributable to
the increase in the size and number of contracts in this operation. The Network
Technologies segment offers construction services, including the sale of
conduit, fiber and IRUs on portions of e.spire's networks to IXCs and other
customers, fiber optic network design and project management services. The
Company recognized approximately $11.9 million in revenue for the nine months
ended September 30, 1999 from agreements to exchange IRU of multiple fibers
along certain sections of e.spire's networks for dissimilar assets or for IRUs
on other companies networks with substantial cash payments. Included in the
revenue for the three and nine months ended September 30, 2000, were revenues of
approximately $21.8 million and $47.2 million, respectively, derived from
contracts with one and three major customers, respectively. As previously
discussed, under Financial Accounting Standards Board issued FASB Interpretation
(FIN) 43, the Company is required to recognize revenue for certain contracts for
the provision of dark fiber IRUs entered into subsequent to June 30, 1999 as
operating leases over the term of the contract. To the extent that contracts
entered into by the Company in the future do not transfer title to dark fiber
and related conduit, the Company's timing of recognition of revenues will
continue to be deferred.
INTERNET SERVICES
Internet services reported an increase in revenues of $0.8 million, or 13%,
to $7.1 million for the quarter ended September 30, 2000, compared with revenues
of $6.3 million for the quarter ended September 30, 1999. For the nine months
ended September 30, 2000, Internet services revenues increased $3.3 million, or
18% to $21.5 million from $18.2 million for the nine months ended September 30,
1999. Included in Internet services are revenues from Internet access and web
hosting. The increase in revenues was attributable to an increase in the web
hosting revenues, which was partially offset by a decrease in the Internet
access revenues. Revenue in the future will consist solely of web hosting
revenue as the Company entered into an agreement to sell its dial up internet
customers at the end of the third quarter of 2000.
COST OF SALES
For the quarter ended September 30, 2000, compared with the quarter ended
September 30, 1999, total cost of sales increased $8.4 million, or 20%, to $49.7
million from $41.3 million for the three months ended September 30, 1999, as
discussed below. Cost of sales increased $30.6 million, or 26%, to $148.4
million for the nine months ended September 30, 2000 from $117.8 million for the
same period of 1999, as discussed below.
TELECOMMUNICATIONS SERVICES
Cost of sales for Telecommunications services increased $2.8 million, or
10%, to $31.1 million for the quarter ended September 30, 2000, from $28.3
million for the same period of 1999. For the nine months ended September 30,
2000, telecommunications services cost of sales increased $23.1 million, or 29%,
to $102.7 million from $79.6 million for the nine months ended September 30,
1999. These increases relate to growth in the delivery of switched, data and
special access services and the addition of engineering and
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operations personnel dedicated to supporting the network infrastructure.
Included in cost of sales are costs of Telecommunications services paid to
IXCs, ILECs and others for leased telecommunications facilities, access and
services. Such costs increased approximately $1.3 million to approximately $26.6
million for the three months ended September 30, 2000, from approximately $25.3
million for the three months ended September 30, 1999. For the nine months ended
September 30, 2000, these costs increased approximately $16.3 million to $89.1
million compared with $72.8 million for the same period of 1999. These increases
were offset by a credit in the amount of $1.8 million awarded to the Company in
the third quarter of 2000 for the settlement of a rate dispute. Also, for the
third quarter of 2000, there was a decrease in costs due to the disconnection of
one major customer. In addition, network related personnel costs such as
employee salaries and benefits are also included in cost of sales. For the three
months ended September 30, 2000 and 1999, these costs increased approximately
$1.5 million, or 50%, to approximately $4.5 million from $3.0 million,
respectively. For the nine months ended September 30, 2000 and 1999, these costs
increased approximately $6.8 million, or 100%, to approximately $13.6 million
from $6.8 million, respectively. The increases were primarily due to increases
in the number of employees.
NETWORK TECHNOLOGIES SERVICES
Cost of sales for Network Technologies services increased $5.0 million, to
approximately $15.2 million for the quarter ended September 30, 2000, compared
with $10.2 million for the same period of 1999. The increase was due to the
increase in the size of and number of contracts during the quarter. For the nine
months ended September 30, 2000, the costs increased $5.0 million to
approximately $35.1 million compared with $30.1 million for the same period of
1999. Included in Network Technologies cost of sales are direct materials and
labor associated with the construction of networks and costs associated with
contracted services.
INTERNET SERVICES
Cost of sales for Internet services increased $0.5 million, or 17%, to
approximately $3.4 million for the quarter ended September 30, 2000, compared
with $2.9 million for the same period of 1999. For the nine months ended
September 30, 2000, cost of sales increased approximately $2.3 million, or 28%,
to $10.5 million from $8.2 million for the same period of 1999. These increases
were due to increased charges for domain registration associated with the
increase in the web hosting customer base. The increases were partially offset
by decreases in telco expenses due to the decrease in Internet access customers.
This decrease in telecommunications expenses is expected to continue as the
Company completed the sale of its dial-up internet customers at the end of the
third quarter of 2000.
GROSS MARGIN
For the quarter ended September 30, 2000, total gross margin increased 940
basis points to 45.9% from 36.5% for the quarter ended September 30, 1999, as
discussed below. Gross margins increased 390 basis points to 40.7% for the nine
months ended September 30, 2000 from 36.8% for the nine months ended September
30, 1999, as discussed below.
TELECOMMUNICATIONS SERVICES
Telecommunications services gross margin increased 1,870 basis points to
46.4% for the quarter ended September 30, 2000 from 27.7% for the same period
of 1999. For the nine months ended September 30, 2000, Telecommunications
services gross margins increased 980 basis points to 38.8% from 29.0% for the
same period of 1999. As discussed above, these increases were also due to a
credit in the amount of $1.8 million awarded to the Company for the settlement
of a rate dispute, as well as the decrease in network costs associated with a
major customer whose service, which carried negligible margins, was
disconnected. Furthermore, the Company continues to achieve network cost
savings through negotiations with its vendors. The Company does not expect to
see such significant increases in gross margin going forward.
NETWORK TECHNOLOGIES SERVICES
Network Technologies services gross margin decreased 550 basis points to
42.8% for the three months ended September 30, 2000 from 48.3% for the three
months ended September 30, 1999. The decrease is due to the mix of the conduit
contracts entered into during the third quarter of 2000. For the nine months
ended September 30, 2000 Network Technologies services gross margin decreased
420 basis points to 42.4% from 46.6% for the same period of 1999. The decrease
is principally due to the change in mix of revenue. During the nine months ended
September 30, 1999, the Company's revenue was principally from dark fiber sales.
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INTERNET SERVICES
Internet services gross margins decreased 160 basis points to 52.9% for the
three months ended September 30, 2000, compared with 54.5% for the same period
of 1999. For the nine months ended September 30, 2000, gross margins decreased
390 basis points to 51.0% from 54.9% for the same period of 1999. These
decreases were primarily due to the Company's announced exit from providing
dial-up internet services, which resulted in lower margins. Going forward, the
Company will focus on its web hosting business in which the Company expects to
earn higher margins.
OPERATING EXPENSES
SELLING, GENERAL AND ADMINISTRATIVE
For the quarter ended September 30, 2000, selling, general and
administrative ("SG&A") expenses increased $1.0 million, or 2%, to $46.5 million
from $45.5 million for the same period of 1999, as discussed below. SG&A
expenses increased $19.6 million, or 16%, to $139.1 million for the nine months
ended September 30, 2000 from $119.5 million for the same period of 1999, as
discussed below.
Included in SG&A expenses are personnel costs not directly associated with
operating the Company's network, such as employee salaries, benefits and
commissions. Such costs increased $1.0 million, to $17.7 million for the quarter
ended September 30, 2000 from $16.7 million for the quarter ended September 30,
1999. For the nine months ended September 30, 2000, these costs increased
approximately $7.2 million to $53.4 million compared with $46.2 million for the
same period of 1999. Also, included in SG&A expenses are operating costs such as
rent, advertising, general administrative and office expenses. These expenses
remained constant at $28.8 million for the quarter ended September 30, 2000 and
for the same period of 1999. For the nine months ended September 30, 2000, these
costs increased approximately $12.4 million to $85.7 million compared with $73.3
million for the same period of 1999.
Increases in SG&A are the result of increases in the Company's personnel
that are necessary to support and grow the Company's operations. Costs directly
related to the increase in personnel include salaries, benefits, bonuses and
commissions. Another significant portion of the SG&A increase is due to
back-office expenses such as professional services costs which have been
necessary to maintain and improve existing processes. In addition, increases in
costs for facilities and related expenses have been incurred due to an increased
number of office locations and facilities. In connection with the Company's
growth in revenue, bad debt allowances have increased. The Company continues to
monitor its SG&A costs on an ongoing basis to evaluate any costs that can be
eliminated.
NON-CASH STOCK COMPENSATION
Non-cash stock compensation expense increased $1.0 million, or 42%, to $3.4
million for the quarter ended September 30, 2000, from $2.4 million for the
quarter ended September 30, 1999. Non-cash stock compensation expenses decreased
$1.3 million, or 17%, to $6.3 million for the nine months ended September 30,
2000 from $7.6 million for the same period of 1999.
Included in non-cash compensation are accruals for the issuance of common
stock in connection with performance bonuses and costs of grants of employee
stock options. Costs associated with the accrual for performance bonuses were
approximately $2.4 million and $2.0 million for the quarters ended September 30,
2000 and 1999, respectively, and $4.0 million and $6.1 million for the nine
months ended September 30, 2000 and 1999. The cost for the compensation
associated with stock option plans was approximately $0.1 million for the
quarter ended September 30, 2000, and $0.4 million for the same period of 1999.
For the nine months ended September 30, 2000, stock option plan costs were
approximately $0.1 million compared with $1.5 million for the nine months of
1999. The decrease in costs was due to the Company's granting of stock options
at fair market value. Also included in non-cash compensation for the third
quarter of 2000 is $0.9 million related to a settlement agreement with a former
e.spire customer.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization expenses remained constant at $25.4 million
for the quarter ended September 30, 2000 and for the same period of 1999. For
the nine months ended September 30, 2000, depreciation and amortization expenses
increased $14.2 million, or 21%, to $83.2 million from $69.0 million for the
same period of 1999. The increase was due to an increase in gross property,
plant and equipment to $942.3 million at September 30, 2000 compared with gross
property, plant and equipment of $811.6 million at September 30, 1999.
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INTEREST AND OTHER INCOME
Interest and other income decreased $0.8 million, or 44%, to $1.0 million
for the quarter ended September 30, 2000, from $1.8 million for the quarter
ended September 30, 1999. Interest and other income decreased $5.1 million, or
55% to $4.2 million for the nine months ended September 30, 2000 from $9.3
million for the same period of 1999. The decrease in interest and other income
reflects a decrease in the cash and cash equivalents and restricted cash and
investments balances of $46.8 million from $92.9 million at September 30, 1999
to $46.1 million at September 30, 2000. These funds have been invested in
commercial paper, U.S. Government Securities and money market instruments.
INTEREST AND OTHER EXPENSE
Interest and other expense increased $8.1 million, or 33%, to $32.4 million
for the quarter ended September 30, 2000, from $24.3 million for the quarter
ended September 30, 1999. Interest and other expense increased $22.6 million, or
32%, to $93.0 million for the nine months ended September 30, 2000 from $70.4
million for the same period of 1999. The increase was primarily due to the
accrual of interest incurred in connection with the Credit Facilities, the
accrual of interest related to the 13% Senior Discount Notes due 2005 (the "2005
Notes"), the 12 3/4% Senior Discount Notes due 2006 (the "2006 Notes") and the
interest expense associated with the Company's capital leases.
NET LOSS & NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
As a result of the previously discussed fluctuations in revenues, cost of
sales, operating expenses, depreciation and amortization, and interest income
and expense, net loss decreased $7.4 million, or 10%, to $64.6 million for the
quarter ended September 30, 2000 from $72.0 million for the quarter ended
September 30, 1999. Net loss increased $26.9 million, or 14%, to $215.4 million
for the nine months ended September 30, 2000 from $188.5 million for the same
period of 1999. Further, net loss applicable to common stockholders decreased
$4.6 million, or 6%, to $77.7 million for the quarter ended September 30, 2000
from $82.3 million for the same period of 1999. For the nine months ended
September 30, 2000, net loss applicable to common stockholders increased $58.8
million, or 27%, to $277.4 million from $218.6 million for the same period of
1999. These increases to net loss applicable to common stockholders were also
affected by the preferred stock dividends and accretion related to the 14 3/4%
Preferred Stock and the 12 3/4% Preferred Stock and to the beneficial conversion
charge related to the convertible Preferred Stock issued in the first quarter of
2000.
The Series A Convertible Preferred Stock was issued at a conversion price
that was less than market price of the Company's Common Stock at the time of
the funding commitment. Thus, under Emerging Issues Task Force Issue 98-5,
"Accounting for Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios" the Company recognized a beneficial
conversion charge of $24.6 million in the first quarter of 2000. The full
amount of the charge was recognized in the first quarter because the Preferred
Stock was immediately convertible into Common Stock. In addition, the Company
expects to incur a beneficial change of approximately $9.4 million in the
fourth quarter of 2000 related to the exchangeable preferred stock issued in
the third quarter of 2000, subject to shareholder approval.
LIQUIDITY AND CAPITAL RESOURCES
The Company's further development and enhancement of new services, the
continued development, construction, expansion, operation and potential
acquisition of networks will require substantial capital expenditures. The
funding of these expenditures is dependent upon the Company's ability to raise
substantial financing. From the Company's inception through September 30, 2000,
the Company has raised net proceeds of approximately $1.5 billion from debt and
equity financings. The Company's cash, cash equivalents and restricted cash
decreased $35.1 million for the nine months ended September 30, 2000, due to
capital expended for the expansion of the Company's infrastructure and services
and to fund negative cash flow, including principal and interest payments offset
by approximately $150 million capital infusion during the period. The Company
expects to incur additional capital expenditures for the expansion of its
infrastructure and services and to fund negative cash flow in the future. During
fiscal year 2000, the Company will be required to make cash interest payments on
its 2007 Senior Notes and cash interest and principal payments on its Senior
Secured Credit Facility. At September 30, 2000, the Company had approximately
$43.6 million of cash and cash equivalents available for such purposes. On
September 19, 2000 we entered into purchase agreements with the Huff Alternative
Income Fund, L.P., Greenwich Street Capital Partners II, L.P., and Honeywell
International Inc. Master Retirement Fund to sell up to $124.3 million of
convertible preferred stock, common stock or warrants which are convertible or
exercisable into our common stock, once we obtain shareholder approval
authorizing such issuance. Of this amount, we issued $50 million of securities
in the form of exchangeable preferred stock on September 19, 2000.
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The Exchangeable Preferred Stock is exchangeable at the option of the company
into Purchaser Junior Securities that includes preferred stock, warrants or
common stock (based upon the accreted amount that includes accrued but unpaid
dividends at the purchase price on the date of the closing of such Purchaser
Junior Securities), the exchange of which may be subject to shareholder
approval. At the time of exchange, Huff will designate which type of security
will be issued. An aggregate of 893,523 transaction fee warrants will be issued
in connection with the issuance of the exchangeable preferred stock. We will
issue an additional 1,327,775 transaction fee warrants that are exercisable into
common stock to the purchasers simultaneously with the closing of each sale of
the securities under those purchase agreements. Each warrant will be intially
exercisable for one share of Common Stock (at an initial exercise price of
$.01). The warrants will automatically expire on the tenth anniversity after the
date they are issued. Dividends accrue from the date of issuance, are cumulative
and are payable quarterly in arrears, in additional shares of Exchangeable
Preferred Stock, at a per annum rate of 30% of $1,000 (the "stated value"), plus
the accrued but unpaid dividends thereon. Dividends are cumulative and shall
accrue whether or not the company has earnings or profits, whether or not there
are funds legally available for the payment of such dividends and whether or not
dividends are declared by the company. Dividends are payable only when and if
declared by the company; provided that all accrued but unpaid dividends on any
share must be paid by the company upon the exchange of such share of
exchangeable preferred stock. The exchangeable preferred stock is junior to the
14.75% Redeemable Preferred Stock and ranks pari passu to the 12.75% Redeemable
Preferred Stock.
The stockholders' obligation to provide future financings under the
September 19, 2000 will be subject to certain conditions which include, but are
not limited to, receiving shareholder approval, the absence of any material
adverse change and satisfaction of certain debt covenants under the Credit
Facilities. A proxy soliciting shareholder approval has been distributed and a
shareholders meeting is scheduled to be held on November 16, 2000. When approval
is received, the Company expects these investors and other investors will
purchase the remaining $75 million in Junior Securities as funding is needed by
the Company. In connection with the issuance of the Exchangeable Preferred
Stock, the Company has agreed to certain restrictive covenants, which are
substantially similar to the covenants that were entered into in connection with
the issuance of the Company's 12 3/4% Redeemable Preferred Stock. The
Certificate of Designation provides that these covenants shall be deemed waived
automatically if waived or amended by the holders of the 12 3/4% preferred
stock.
On March 3, 2000, e.spire completed a private offering of 81,777 shares of
Series A Convertible Preferred Stock and 175,000 warrants with Greenwich Street
Capital Partners II, L.P., The Huff Alternative Income Fund, L.P. and Honeywell
International Inc. Master Retirement Trust, and received $100.7 million in
proceeds therefrom. Each share of Series A Convertible Preferred Stock is
initially convertible into 126.4 shares of Common Stock (an effective conversion
price of $7.91 per share), and each warrant is initially exercisable for 44.1
shares of Common Stock (at an initial exercise price of $9.89 per share). The
warrants will automatically expire on the tenth anniversary after the date that
they are issued. Dividends on the Series A Preferred Stock accrue from the date
of issuance, are cumulative and are payable quarterly in arrears, at a per annum
rate of 7% of $1,000 (the "stated value"), plus the accrued but unpaid dividends
thereon, subject to an adjustment in the dividend rate to 15% upon the
occurrence of certain events and to 20% upon a change of control. Dividends on
the convertible preferred stock are cumulative and shall accrue whether or not
the company has earnings or profits, whether or not there are funds legally
available for the payment of such dividends and whether or not dividends are
declared by the Company. Dividends on the convertible preferred stock are
payable only when and if declared by the Company; provided that all accrued but
unpaid dividends on any share of convertible preferred stock must be paid by the
Company upon the conversion of such share of convertible preferred stock. The
Series A Convertible Preferred Stock is junior to the 14.75% Redeemable
Preferred Stock and ranks pari passu to the 12.75% Redeemable Preferred Stock.
All dividends will be paid by the Company in shares of its Common Stock equal to
accrued dividends divided by a rate equal to the effective conversion price
described above or, if no shareholder approval has been obtained, the closing
price of the common stock on March 6, 2000 ($13.44). In connection with the
issuance of the Series A Convertible Preferred Stock, the Company has agreed to
certain restrictive covenants, which are substantially similar to the covenants
that were entered into in connection with the issuance of the Company's 12 3/4%
Redeemable Preferred Stock. The Certificate of Designation provides that these
covenants shall be deemed waived automatically if waived or amended by the
holders of the 12 3/4% preferred stock.
On August 12, 1999, the Company entered into the Credit Facilities which
consisted of a $35 million revolver, a $55 million multiple draw term loan, each
with a 6.5 year maturity, and a $110 million term loan with a 7 year maturity.
In conjunction with the Credit Facilities, the Company retired a $35 million
credit facility with Newcourt Commercial Finance Corporation on August 12, 1999.
On September 20, 2000 the Credit Facility was amended as discussed below.
17
<PAGE> 18
Pursuant to the amendment and restatement of the credit facility on
September 19, 2000, all commitments to make additional loans under the credit
facility were canceled. The series A revolving loans repaid in connection with
the amended and restated credit facility were no longer permitted to be
re-borrowed and the company prepaid $25 million of loans outstanding under the
credit facility during the third quarter of 2000. After such prepayments, there
were $139 million of loans outstanding under the amended and restated credit
facility which includes the series A revolving loans of $35 million, series B
term loans of $4.3 million and series C term loans of $99.7 million. The
Company also agreed to pay a .5% point increase in interest rates. The
amendment and restatement of our credit agreement required us to pay a
restructuring fee equal to 1.25% of the aggregate principal amount of loans
outstanding thereunder, 1.00% of which was paid in cash on the effective date
of the amended and restated credit facility and the remaining .25% of which was
paid from net asset sale proceeds received following the effective date of the
amended and restated credit facility.
The company and the lenders amended and restated our credit facility
to, among other things, replace certain financial covenants and to amend those
that remain in place in a manner that we believe will allow for future
compliance by the company. The covenants include without limitation, adjusted
EBITDA (Earnings before interest, taxes, depreciation, amortization, and noncash
compensation), debt to capital ratio, capital expenditures, minimum cash balance
requirements, and maintaining certain totals of combined voice, data and ISP
lines. The amended and restated credit facility is subject to mandatory
prepayment provisions in amounts equal to (i) net insurance/condemnation
proceeds, (ii) the net proceeds of the sale or other disposition of any of our
assets, subject to specified exceptions, provided however, e.spire may retain
under certain conditions fifty percent of the net proceeds for reinvestment in
telecommunications assets, and (iii) seventy percent of our consolidated excess
cash flow for each fiscal year commencing with the 2002 fiscal year. As of
September 30, 2000, the Company was in compliance with the amended and restated
credit facility. Going forward, it may be necessary for the Company to draw
against equity commitments in order to maintain compliance under the amendments
to the financial covenants.
The Credit Facilities are collateralized by the capital stock of all of the
restricted subsidiaries of the Company and the assets of the Company and its
restricted subsidiaries, including promissory notes representing intercompany
indebtedness. In addition, the Credit Facilities contain certain covenants,
which impose restrictions on the Company and its restricted subsidiaries. These
include, without limitation, restrictions on the declaration or payment of
dividends with respect to the capital stock of the Company, the conduct of
certain activities, certain investments, the creation of additional liens or
indebtedness, the disposition of assets, transactions with affiliates and
fundamental changes. The Credit Facilities contain financial covenants with
which the Company must comply, including adjusted EBITDA (Earnings before
interest, taxes, depreciation, amortization, and noncash compensation), debt to
capital ratio, and capital expenditures. We were not in compliance with certain
financial covenants of our Credit Facilities on December 31, 1999, March 30,
2000 and June 30, 2000. We entered into a series of standstill agreements and
ultimately received a waiver for such non-compliance.
The Company has never been profitable, has never generated positive cash
flow from consolidated operations and, since its inception has incurred
significant net operating losses and negative cash flow. In accordance with the
terms of its debt facilities, the Company has also deferred payment of most of
its interest charges. During the third quarter of 2000, the Company began making
cash interest payments on its 2007 Senior Notes and Senior Secured Credit
Facility as well as principal payments on the Credit Facility. The Company's
continued development, construction, expansion, and operation of local networks,
as well as the further development of additional services, including local
switched voice and high-speed data services, will require continued substantial
capital expenditures. The Company's ability to fund these expenditures is
dependent upon the Company raising substantial financing. To meet its remaining
capital requirements and to fund operations and cash flow deficiencies, the
Company will be required to sell additional equity securities, increase its
existing credit facility, acquire additional credit facilities, sell additional
debt securities, or sell certain Company assets, some of which may require the
consent of the Company's bondholders. There can be no assurance that the Company
will be able to obtain the additional financing necessary to satisfy its cash
requirements or to successfully implement its growth strategy. Failure to raise
sufficient capital could compel the Company to delay or abandon some or all of
its plans or expenditures, which could have a material adverse effect on its
business, results of operations, and financial condition.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's long-term debt includes both fixed and variable rate
instruments. The fair market value of the Company's fixed rate long-term debt is
sensitive to changes in interest rates. The Company runs the risk that market
rates will decline and the required payments will exceed those based on current
market rate. Under its current policies, the Company does not use interest rate
derivative instruments to manage its exposure to interest rate changes.
18
<PAGE> 19
PART II. OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Ten putative shareholder class action lawsuits were filed against the
Company, and three of its former officers and two of its former directors on or
after April 20, 2000. The lawsuits have since been consolidated in a single
lawsuit that purports to be a class action filed on behalf of purchasers of the
stock of the Company during the period from August 12, 1999 through March 30,
2000. Plaintiff alleges that defendants made false and misleading statements
about the Company's financial condition, revenues, expenses, and results of
operations, in violation of federal securities laws. While the outcome of the
claims against the Company cannot be predicted with certainty, the Company
believes that Plaintiff's claims have no basis and intends to vigorously defend
the action.
In addition, the Company and its subsidiaries are currently parties to
other routine litigation incidental to their business, none of which,
individually or in the aggregate, are expected to have a material adverse effect
on the Company. The Company and its subsidiaries are parties to various court
appeals and regulatory arbitration proceedings relating to certain of the
Company's interconnection agreements and continue to participate in regulatory
proceedings before the FCC and state regulatory agencies
ITEM 2 - CHANGES IN SECURITIES
On September 19, 2000, e.spire issued an aggregate of 50,000 shares of
exchangeable preferred stock to The Huff Alternative Income Fund, Honeywell
Master Retirement Trust and Greenwich Street for an aggregate purchase price of
$50 million. This transaction was consummated as a private transaction pursuant
to Section 4(2) of the Securities Act of 1933. At e.spire's option the
exchangeable preferred stock may be converted into Purchaser Junior Securities,
which includes common stock, preferred stock or warrants to purchase common
stock, the type of security to be determined by Huff.
On November 6, 2000, e.spire issued to William Rogers 179,202 shares of common
stock pursuant to a Confidential Settlement and Release Agreement dated as of
November 6, 2000. This transaction was consummated as a private transaction
pursuant to Section 4(2) of the Securities Act of 1933.
ITEM 5 - OTHER INFORMATION
We have been notified that our common stock will be removed from the Nasdaq
National Market listings if our common stock does not maintain a minimum bid
price of $5.00 for 10 consecutive days prior to December 18, 2000. We intend to
appeal this determination to the Nasdaq Listing Qualifications Panel, and we are
also pursuing other avenues for avoiding this action such as a reverse stock
split or listing on the NASDAQ SmallCap Market.
<PAGE> 20
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------------ -----------------------------------------------------------
<S> <C>
3.1 Amendment No. 2 to the Series A Convertible Stock
Certificate of Designation dated as of September 19, 2000
3.2 Exchangeable Preferred Stock Certificate of Designation
dated as of September 19, 2000
10.1 Purchase Agreement by and among the Huff Alternative
Income Fund, L.P. and e.spire Communications dated
September 19, 2000
10.2 Purchase Agreement by and among Greenwich Street Capital
Partners II, L.P., GSCP Offshore Fund, L.P., Greenwich
Fund, L.P. Greenwich Street Employees Fund, L.P., and TRV
Executive Fund, L.P. and e.spire Communications dated
September 19, 2000
10.3 Purchase Agreement by and among Honeywell International
Inc. Master Retirement Trust and e.spire Communications
dated September 19, 2000
10.4 First Amended and Restated Credit Agreement by and among
e.spire Communications, Inc., e.spire Finance Corporation,
the Lenders, Goldman Sachs Credit Partners L.P., Arranger
and syndication agent, The Bank Of New York, as
administrative agent, First Union National Bank, as
documentation agent, and CIT Lending Services Corporation,
as collateral agent dated as of September 20, 2000
27 Financial Data Schedule
99 Supplemental Financial Information
</TABLE>
(b) Reports on Form 8-K
On July 12, 2000, e.spire filed a Current Report on Form 8-K announcing
that its Interim Chief Financial Officer, Bradley E. Sparks accepted the
position on a permanent basis. Also, the Company announced the
appointment of Donald W. Bush as its Treasurer.
On July 24, 2000, e.spire filed a Current Report on Form 8-K announcing
that it and its syndicated bank group have signed the final terms for an
amendment to its Senior Secured Credit Facility, executed in August
1999. e.spire expects to prepare the documentation, completing the
amendment, in the next few weeks, at which time the specific terms will
be made public.
On July 31, 2000, e.spire filed a Current Report on Form 8-K announcing its
earnings for the quarter ended June 30, 2000.
On September 25,2000, e.spire filed a Current Report on Form 8-K announcing
that it has secured $125 million in equity financing and has signed the
amendment to its Senior Secured Credit Facility with its syndicated bank
group.
On November 2, 2000, e.spire filed a Current Report on Form 8-K announcing
its earnings for the quarter ended September 30, 2000.
20
<PAGE> 21
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
e.spire Communications, Inc.
----------------------------
(Registrant)
By: /s/ GEORGE F. SCHMITT
---------------------
George F. Schmitt,
Chairman of the Board of Directors
And Interim Chief Executive Officer
Date: November 14, 2000
By: /s/ BRADLEY E. SPARKS
---------------------
Bradley E. Sparks,
Chief Financial Officer
Date: November 14, 2000
21
<PAGE> 22
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE NO.
----------------- -------------------------------------------------------------- ----------
<S> <C> <C>
3.1 Amendment No. 2 to the Series A Convertible Stock Certificate E-1
of Designation dated as of September 19, 2000
3.2 Exchangeable Preferred Stock Certificate of Designation dated E-2
as of September 19, 2000
10.1 Purchase Agreement by and among the Huff Alternative Income E-3
Fund, L.P. and e.spire Communications dated September 19, 2000
10.2 Purchase Agreement by and among Greenwich Street Capital E-4
Partners II, L.P., GSCP Offshore Fund, L.P., Greenwich Fund,
L.P. Greenwich Street Employees Fund, L.P., and TRV Executive
Fund, L.P. and e.spire Communications dated September 19, 2000
10.3 Purchase Agreement by and among Honeywell International Inc. E-5
Master Retirement Trust and e.spire Communications dated
September 19, 2000
10.4 First Amended and Restated Credit Agreement by and among E-6
e.spire Communications, Inc., e.spire Finance Corporation,
the Lenders, Goldman Sachs Credit Partners L.P., Arranger and
syndication agent, The Bank Of New York, as administrative
agent, First Union National Bank, as documentation agent, and
CIT Lending Services Corporation, as collateral agent dated
as of September 20, 2000
27 Financial Data Schedules E-7
99 Supplemental Financial Information E-8
</TABLE>
22
