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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
OR
X TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from
October 1, 1996 to December 31, 1996
(Commission File Number 1-11965)
ICG COMMUNICATIONS, INC.
(Commission File Number 1-11052)
ICG HOLDINGS (CANADA), INC.
(Commission File Number 33-96540)
ICG HOLDINGS, INC.
(Exact name of Registrants as Specified in their Charters)
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Delaware 84-1342022
Canada Not Applicable
Colorado 84-1158866
(State or other jurisdiction (I.R.S. employer
of incorporation) identification number)
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9605 East Maroon Circle Not applicable
Englewood, Colorado 80112
1710-1177 West Hastings Street c/o ICG Communications, Inc.
Vancouver, BC V6E 2L3 9605 East Maroon Circle
P.O. Box 6742
Englewood, Colorado 80155-6742
9605 East Maroon Circle Not applicable
Englewood, Colorado 80112
(Address of principal executive (Address of U.S.agent for service)
offices)
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Registrants' telephone numbers, including area codes: (800) 650-5960 or
(303) 572-5960
Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class Name of Exchange on Which Registered
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Common Stock, $.01 par value American Stock Exchange
(31,299,392 shares outstanding
on February 18, 1997)
Class A Common Shares, no par value Vancouver Stock Exchange
(31,795,270 shares outstanding on
February 18, 1997)
Not Applicable Not Applicable
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Securities registered pursuant to Section 12(g) of the Act:
- --------------------------------------------------------------------------------
Title of Each Class
- --------------------------------------------------------------------------------
Not Applicable
Not Applicable
Not Applicable
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Indicate by check mark whether the Registrants: (1) have 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
Registrants were required to file such reports), and (2) have been subject to
such filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrants' knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
On February 18, 1997, the aggregate market value of ICG Communications, Inc.
Common Stock held by non-affiliates (using the $14.75 American Stock Exchange
closing price on February 18, 1997) was approximately $461,666,032.
On February 18, 1997, the aggregate market value of ICG Holdings (Canada), Inc.
Class A Common Shares held by non-affiliates (using the US$21.32 Vancouver Stock
Exchange closing price on November 6, 1996, the last day on which a sale was
reported) was approximately $14,005,001.
ICG Holdings (Canada), Inc. owns all of the issued and outstanding shares of
Common Stock of ICG Holdings, Inc.
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TABLE OF CONTENTS
PART I . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . 5
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . 5
Overview . . . . . . . . . . . . . . . . . . . . . . . 5
Telecom Services . . . . . . . . . . . . . . . . . . . 6
Strategy . . . . . . . . . . . . . . . . . . . 6
Telecom Services Networks . . . . . . . . . . . 7
Recent Developments . . . . . . . . . . . . . . 8
Services . . . . . . . . . . . . . . . . . . . . 10
Industry . . . . . . . . . . . . . . . . . . . . 12
Network Services . . . . . . . . . . . . . . . . . . . 13
Satellite Services . . . . . . . . . . . . . . . . . . 13
Customers And Marketing . . . . . . . . . . . . . . . 14
Competition . . . . . . . . . . . . . . . . . . . . . . 15
Regulation . . . . . . . . . . . . . . . . . . . . . . 17
Employees . . . . . . . . . . . . . . . . . . . . . . . 20
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . 21
ITEM 3. LEGAL AND ADMINISTRATIVE PROCEEDINGS . . . . . . . . . 21
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS . . 21
PART II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS . . . . . . . . . . . . . . . . . . 22
ITEM 6. SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . . 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS . . . . . . . . . . 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA . . . . . . 45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES . . . . . . . . . 45
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT . . . . 46
Executive Officers of ICG . . . . . . . . . . . . . . . 47
Directors of ICG . . . . . . . . . . . . . . . . . . . 48
Directors and Executive Officers of Holdings-Canada
and Holdings . . . . . . . . . . . . . . . . . . . . . 49
ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . 51
Director Compensation . . . . . . . . . . . . . . . . 51
Compensation Committee Interlocks and Insider
Participation . . . . . . . . . . . . . . . . . . . . . 51
Executive Compensation . . . . . . . . . . . . . . . . 51
Summary Compensation Table . . . . . . . . . . . 52
Aggregated Option Exercises in Last Fiscal
Year End Option Values . . . . . . . . . . . . . . 53
Option/SAR Grants in Last Fiscal Year . . . . . . 53
Executive Employment Contracts . . . . . . . . . . . . 53
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . 55
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . 58
PART IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORT ON
FORM 8-K . . . . . . . . . . . . . . . . . . . . . . . . 60
Financial Statements . . . . . . . . . . . . . . . . . . 60
Report on Form 8-K . . . . . . . . . . . . . . . . . . 68
Exhibits . . . . . . . . . . . . . . . . . . . . . . . 68
Financial Statement Schedule . . . . . . . . . . . . . . 68
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . F-1
FINANCIAL STATEMENT SCHEDULE . . . . . . . . . . . . . . . . . . . . . S-1
4
PART I
Unless the context otherwise requires, the term "Company" or "ICG"
means the combined business operations of ICG Communications, Inc. ("ICG") and
its subsidiaries, including ICG Holdings (Canada), Inc. ("Holdings-Canada") and
ICG Holdings, Inc. ("Holdings"); the terms "fiscal" and "fiscal year" refer to
ICG's fiscal year ending September 30; and all dollar amounts are in U.S.
dollars. The Company has elected to change its fiscal year end to December 31
from September 30, effective January 1, 1997. Industry figures were obtained
from reports published by the Federal Communications Commission ("FCC"), the
U.S. Department of Commerce, Connecticut Research (an industry research
organization) and other industry sources, which the Company has not
independently verified.
ITEM 1. BUSINESS
Overview
The Company is one of the largest providers of competitive local
telephone services in the United States, based on estimates of the industry's
1996 revenue. Competitive local exchange carriers ("CLECs"), formerly known as
CAPs (competitive access providers), seek to provide an alternative to the
incumbent local exchange carriers ("ILECs") for a full range of
telecommunications services in the newly opened regulatory environment. As a
CLEC, the Company operates networks in three regional clusters covering major
metropolitan statistical areas in California, Colorado, and the Ohio Valley, and
in three markets in the Southeast. The Company is expanding its geographic focus
to include Texas and Oklahoma (and may also expand to Arkansas and Louisiana)
through its recently announced joint venture with Central and South West
Corporation ("CSW") that will develop and market telecommunications services,
including local exchange telephone service, in these markets. The Company also
provides a wide range of network systems integration services and maritime and
international satellite transmission services. As a leading participant in the
rapidly growing competitive local telecommunications industry, the Company has
experienced significant growth, with total revenue increasing from $29.5 million
for fiscal 1993 to $190.7 million for the 12-month period ended December 31,
1996.
In August 1996, IntelCom Group Inc. ("IntelCom"), a Canadian federal
corporation, received final approval for its reincorporation into the United
States, pursuant to which its shareholders exchanged approximately 98 percent of
their common shares on a one-for-one basis for shares of Common Stock of ICG, a
Delaware corporation. IntelCom then changed its name to ICG Holdings (Canada),
Inc., and its wholly owned subsidiary, IntelCom Group (U.S.A.), Inc., a Colorado
corporation, changed its name to ICG Holdings, Inc. Shareholders who elected to
continue to hold common shares of Holdings-Canada ("Class A Common Shares") are
entitled to exchange such shares at any time into ICG Common Stock. The
reincorporation was designed to maintain the Company's results of operations,
existing net operating losses and asset values of the Company without causing
any material United States or Canadian federal income tax consequences to the
Company.
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The Federal Telecommunications Act of 1996 (the "Telecommunications
Act") and several pro-competitive state regulatory initiatives have
substantially changed the telecommunications regulatory environment in the
United States. Due to these regulatory changes, the Company is now permitted to
offer all interstate and intrastate telephone services, including local dial
tone, and is developing a full set of complementary services, such as long
distance and data transmission services. The Company began offering competitive
local dial tone services in Orange County, California in September 1996, and
intends to begin offering local dial tone services in most of its markets during
the first half of 1997. The Company has 14 high capacity digital telephony
switches (and one additional switch located in Phoenix which will be operational
through April 1997, after which it will be relocated) and 10 data communications
switches in operation to support its services, and plans to install additional
telephony and data switches as demand warrants. To facilitate the expansion of
its services, the Company has entered into agreements with Lucent Technologies,
Inc. ("Lucent") and Northern Telecom, Inc. ("Nortel"), and has reached a
non-binding agreement in principle with Cascade Communications, Inc.
("Cascade"), to purchase a full range of switching systems, fiber optic cable,
network electronics, software and services. See "-Telecom Services-Recent
Developments."
Telecom Services
The Company operates networks in the following markets within its three
regional clusters: California (Sacramento, San Diego and the Los Angeles and San
Francisco metropolitan areas); Colorado (Denver, Colorado Springs and Boulder);
and the Ohio Valley (Akron, Cincinnati, Cleveland, Columbus, Dayton and
Louisville). The Company also operates networks in Birmingham, Charlotte and
Nashville. The Company will continue to expand its network through construction,
leased facilities and strategic joint ventures, such as the recently announced
joint venture with CSW that will initially serve Austin and Corpus Christi,
Texas and Tulsa, Oklahoma with local telephone, long distance and data
transmission services. The joint venture may also develop business opportunities
in other cities in Texas, Oklahoma, Arkansas and Louisiana. The Company's
operating networks have grown from approximately 168 fiber route miles at the
end of fiscal 1993 to approximately 2,385 fiber route miles as of December 31,
1996. Telecom Services revenue has increased from $4.8 million for fiscal 1993
to $109.0 million for the 12-month period ended December 31, 1996.
Strategy
The Company's objective is to become the dominant alternative to the
ILEC in the markets it serves. In furtherance of this objective, the Company has
developed strategies to leverage its extensive network footprint, its
considerable expertise in the provision of switched telecommunications services,
and its established customer base of long distance carriers. In addition, the
Company has begun to aggressively market its broad range of telecommunications
services to business end users. Key elements of this strategy are:
Expand Service Offerings. The Company's focus is to provide a wide
range of local, long distance and data communications services to business and
carrier customers within the Company's service areas, with an emphasis on local
dial tone services. The Company believes that customers are increasingly
demanding a broad, full service approach to providing
6
telecommunications services. By offering a wide array of services, management
believes the Company will be able to capture high volume business accounts. To
this end, the Company plans to complement its core competitive local exchange
services with competitive local toll, long distance and data communications
services tailored to the needs of its customers.
Market Services to End Users and Carriers. The Company has historically
marketed its services primarily to long distance carriers and resellers and its
"first to market" advantage has enabled it to establish relationships with such
carriers and resellers. As competition in the provision of local telephone
services increases, these carriers and resellers are attempting to expand their
service offerings by developing and delivering local telephone services and new
enhanced products and services, which the Company is able to provide its carrier
customers for resale. In addition, the Company is expanding its sales and
marketing efforts to include end user business customers. Management believes a
targeted end user strategy can accelerate its penetration of the local services
market and better leverage the Company's network investment. In support of this
entrance into the end user market, the Company is substantially expanding its
distribution channels through a significant increase in its direct sales force
and marketing personnel.
Concentrate Markets in Regional Clusters. The Company believes that by
focusing on regional clusters it will be able to more effectively service its
customers' needs and efficiently market, operate and control its networks. As a
result, the Company has concentrated its networks in regional clusters serving
major metropolitan areas in California, Colorado and the Ohio Valley. The
Company also operates networks in the Southeast in Birmingham, Charlotte and
Nashville. The Company is currently expanding its network footprint to include
Texas and Oklahoma (and may also expand to Arkansas and Louisiana) in
partnership with CSW.
Expand Alliances with Utilities. The Company has established and is
actively pursuing strategic alliances with utility companies to take advantage
of their existing fiber optic infrastructures and customer relationships. This
approach affords the Company the opportunity to license or lease fiber optic
facilities on a long-term basis in a more timely, cost effective manner than by
constructing facilities. In addition, utilities possess conduit and other
facilities that enable the Company to more easily install additional fiber to
extend existing networks in a given market. Finally, management expects these
strategic alliances to combine the Company's expertise in providing high quality
telecommunications services with the utility's name recognition and customer
relationships in marketing telecommunications products and services to the
utility's customer base.
Telecom Services Networks
The Company's networks are composed of fiber optic cables, switching
facilities, advanced electronics, transmission equipment and related wiring and
equipment. The Company typically designs a ring architecture with a view toward
making the network accessible to the largest concentration of telecommunication
intensive businesses in a given market.
The Company's networks are configured in redundant synchronous optical
network ("SONET") rings that offer the advantage of uninterrupted service in the
event of a fiber cut or
7
equipment failure, resulting in limited outages and increased network
reliability. The Company generally markets its services at prices below those
charged by the ILEC. Management believes these factors combine to create a more
reliable and cost effective alternative to copper-based networks which are still
used, to some extent, by ILECs.
The Company's networks are constructed to access long distance carriers
as well as areas of significant end user telecommunications traffic in a cost
efficient manner. The construction period of a new network varies depending upon
the scope of the activities, such as the number of backbone route miles to be
installed, the initial number of buildings targeted for connection to the
network backbone and the general deployment of the network infrastructure.
Construction is planned to allow revenue-generating operations to commence prior
to the completion of the entire network backbone. When constructing and relying
principally on its own facilities, the Company has experienced a period of 12 to
18 months from initial design of a network to revenue generation for such
network. Based upon its experience of using ILEC facilities to provide initial
customer service and the Company's new agreements to use utilities' existing
fiber, the Company has experienced revenue generation within nine months after
commencing network design. After installing the initial network backbone,
extensions to additional buildings and expansions to other regions of a
metropolitan area are evaluated, based on detailed assessments of market
potential. The Company is currently expanding all of its existing networks to
reduce its reliance on the ILECs and evaluating development of new networks both
inside and outside its existing regional clusters.
The Company's network monitoring center in Denver operates and manages
all of the Company's networks from one central location. Centralized electronic
monitoring and control of the Company's networks allows the Company to avoid
duplication of this function in each city, thereby reducing costs. The
monitoring capabilities are supplemented through a contract with a Lucent switch
control center in Phoenix for surveillance of substantially all of the Company's
central office switches.
Switched services involve the transmission of voice or data to long
distance carrier-specified or end user-specified termination sites. By contrast,
the special access services provided by the Company and other CLECs involve a
fixed communications link or "pipe," usually between a specific end user and a
specific long distance carrier's point of presence ("POP"). With a switch and
interconnection to various carriers' networks, it is possible for the Company to
direct a long distance carrier's traffic to any end user regardless of whether
the end user is connected to the Company's owned or leased network. In addition,
a switch gives the Company the technological capability to provide the full
range of local telephone services. The Company began offering local telephone
services to business customers in the Orange County, California area in
September 1996. The Company anticipates extending such services over the next 12
months to the remainder of its existing markets. See "-Regulation-State
Regulation."
Recent Developments
CSW Agreement. In January 1997, the Company announced a joint venture
with CSW which will develop and market telecommunications services in Texas and
Oklahoma (and may also expand to Arkansas and Louisiana). The new company will
be based in Austin, Texas and will
8
initially serve Austin and Corpus Christi, Texas and Tulsa, Oklahoma with local
telephone, long distance and data transmission services. ChoiceCom also expects
to develop business opportunities in other cities in Texas, Oklahoma, Arkansas
and Louisiana.
Lucent Agreement. In September 1996, the Company entered into an
equipment purchase agreement with Lucent for advanced telecommunications
products and services. Lucent will provide the Company with a full range of
systems, software and services which will be used by the Company to build and
expand the Company's advanced communications networks, including 5ESS(R)-2000
switching systems, SONET equipment, access equipment, power plants, application
software systems, Advanced Intelligence Network ("AIN") platforms, data
networking products and fiber optic cable. Lucent has also agreed to provide
engineering, installation, onsite technical support and other professional
services. Under the agreement, if the Company does not meet a minimum purchase
level in any given year, Lucent may discontinue certain discounts, allowances
and incentives otherwise provided to the Company for the year in which the
minimum level was not met. In addition, the agreement may be terminated by
either the Company or Lucent upon sixty days prior written notice.
Cascade Agreement. The Company has reached a non-binding agreement in
principle with Cascade for the purchase of data switching components that will
enable the Company to provide high-speed data connectivity to its customers. The
Company expects to execute the agreement shortly. The agreement also provides
for purchase of high-speed frame relay and asynchronous transfer mode ("ATM")
switching products. In addition, the Company will utilize turnkey services from
Cascade for product planning and deployment, including program management,
network design, onsite operations support and training. The Company began
offering its data communications services in selected California markets in
December 1996 and plans to deploy similar networks in its Colorado and Ohio
markets in the first half of 1997.
Nortel Agreement. In December 1996, the Company entered into an
equipment and software licensing agreement with Nortel under which Nortel will
provide the Company with telecommunications equipment and software.
Network Expansion. The Company continues to expand its network footprint
through several strategic initiatives with utility companies and others. These
include a 30-year agreement and two indefeasible rights of use ("IRU")
agreements with the Los Angeles Department of Water and Power ("LADWP") for 105
miles of fiber optic capacity in Los Angeles, including Century City, West Los
Angeles, Mid-Wilshire and Sherman Oaks; a 15-year agreement with the City of
Burbank, California to lease fiber optic capacity on an 11.5 mile network; and a
ten-year agreement, with a five-year renewal, and three ten-year IRU agreements
with the City of Alameda Bureau of Electricity ("Alameda"), each with five-year
renewals, under which the Company will have access to approximately seven miles
of fiber optic cable.
Interconnection Agreements. The Company has executed interconnection
agreements with Pacific Bell in California, Ameritech Corp. ("Ameritech") in
Ohio and SBC Communications, Inc. ("SBC") in Oklahoma and Texas, and interim
agreements have been signed with GTE in California and in Alabama, Florida,
Indiana, Kentucky, North Carolina, Ohio, Oklahoma, and Texas. An interconnection
agreement also has been signed with BellSouth which
9
covers Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North
Carolina and Tennessee. The Company's interconnection agreement with Ameritech
allows for the agreement to be expanded without further negotiations to include
Ameritech's properties in Illinois, Indiana, Michigan and Wisconsin. The
Company's interconnection agreement with SBC allows for the agreement to be
expanded without further negotiations to include SBC's properties in Arkansas,
Kansas and Missouri. The Company also has negotiated with Cincinnati Bell
Telephone Company, but has been unable to reach an agreement to date. On January
28, 1997, the Company filed arbitration petitions with the relevant public
utility commissions in Indiana, Kentucky and Ohio. After participating in an
arbitration hearing before the Colorado Public Utilities Commission (Colorado
"PUC"), the Company executed an agreement with U S WEST Communications, Inc. ("U
S WEST") on December 17, 1996, which agreement was approved by the Colorado PUC
on January 15, 1997. U S WEST has filed an appeal of the PUC's approval of the
arbitrated agreement with the Federal District Court in Denver, Colorado.
Certain of the Company's interconnection agreements do not contain "most favored
nation" pricing clauses. The Company believes it is entitled to "most favored
nation" pricing provisions under federal law, but this issue is being litigated.
If this litigation is finally judicially resolved adversely to the Company's
position, the Company will be subject to the risk that other CLECs may obtain
more favorable pricing terms from ILECs.
Services
The Company's competitive local exchange services include private line,
special access, interstate and intrastate switched access services, local dial
tone, long distance and data services. Private line services are generally used
to connect the separate locations of a single business. Special access services
are generally used to connect end user customers to a long distance telephone
carrier's facilities, to connect long distance carrier's facilities to the local
telephone company's central offices, and to connect different facilities of the
same long distance carrier or facilities of different long distance carriers. As
part of its initial "carrier's carrier" strategy, the Company targeted the
transport between long distance company facilities and the local telephone
company central offices, and, for high volume customers, between the long
distance company and the end user customer's office. The Company has begun to
market its services directly to end user business customers.
The Company's interstate and intrastate switched access services
include the transport and switching of calls between the long distance carrier's
facilities and either the local telephone company central offices or end users.
By performing the switching services, the Company can reduce the long distance
carriers' local access costs, which constitute their major operating expense. As
the Company provides a greater portion of the local segment of a call over its
own facilities, the Company expects to experience improved margins on what has
initially been a negative or low margin revenue stream.
Competitive local dial tone services consist of basic local exchange
lines and trunks for business, related line features (such as voice mail, Direct
Inward Dialing (DID), hunting and custom calling features), local calling, and
intraLATA, also called local toll, calling. The Company plans make these
services available in second quarter of 1997. The Company believes that having a
full complement of communications services, including local and long distance
10
services, will strengthen its overall market position and help the Company to
better penetrate the local exchange marketplace. The Company is also developing
long distance services, including calling and debit cards, to complement its
local exchange services family of products.
The Company expects to begin offering long distance services in the
first half of 1997. The target customers for such services are the Company's
existing and end user customers. The Company's existing switches will facilitate
its entry into this business and reduce its cost of obtaining long distance
transmission capacity. However, the Company will rely on other carriers to
provide transmission and termination services. Therefore, the Company expects to
enter into resale agreements, which typically provide for resale on a per minute
basis, with long distance carriers to fulfill such needs. To reduce its cost of
services, the Company may lease point-to-point circuits on a monthly or longer
term fixed cost basis where it anticipates high traffic volume.
In order to expand into providing long distance services, the Company
has begun to select new equipment and software and integrate these into its
networks, hire and train qualified personnel, enhance its billing, back-office
and information systems to accommodate long distance services and the acceptance
of potential customers. The Company expects to generate low or negative gross
margins and substantial start-up expenses as it rolls out its long distance
service offerings. The Company does not expect long distance services to
generate a material portion of its revenues over the near term.
The Company expects to begin offering data transmission services, which
include frame relay and ATM, in most of its markets in 1997, and has already
been doing so in California since December 1996. The Company has initially
targeted Internet Service Providers ("ISPs") with its frame relay services in
the belief that these firms require increasing amounts of local frame relay to
connect businesses to ISP's services. The Company also intends to offer its data
transmission services to its existing and potential customers, which have
substantial data communications requirements. In providing these services, the
Company will be dependent upon vendors for assistance in the planning and
deployment of its initial data product offerings, as well as ongoing training
and support. Additionally, the Company must select new equipment and software
and integrate these into its networks, hire and train qualified personnel,
enhance its billing, back-office and information systems to accommodate data
transmission services and customer acceptance of such services. The Company does
not expect its data transmission business to generate a material portion of its
revenues over the near term and as a new entrant in the business, expects to
generate low or negative gross margins and substantial start-up costs.
The Company's Signaling System 7 ("SS7") services provide signaling
connections between long distance and local exchange carriers, and between long
distance carriers' networks. SS7, known as look-ahead routing, is used by local
exchange companies, long distance carriers, wireless carriers and others to
signal between network elements, creating faster call set-up, resulting in a
more efficient use of network resources. SS7 is now the standard method for
telecommunications signaling worldwide. The Company has deployed signal transfer
points ("STPs") throughout its networks to efficiently route SS7 data across the
United States. SS7 is also the enabling technology for AIN platforms, a set of
services and signaling options that carriers can use to create new services or
customer options. Carriers purchase connections into the
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Company's SS7 network, and also purchase connections to other carriers (local
and long distance) on a monthly recurring basis.
In August 1996, the Company acquired the SS7 business of Pace Network
Services, Inc., a division of Pace Alternative Communications, Inc. The Company
has also developed a nationwide SS7 service with Southern New England Telephone
("SNET"), one of the nation's ten largest local exchange carriers. The Company
believes that, together with SNET, it is one of the largest independent
suppliers of SS7 services. The Company's STPs are integrated with two SNET
"gateway" STPs in Connecticut.
Zycom. The Company owns a 70% interest in Zycom Corporation ("Zycom")
which operates an 800/900 number service bureau and a switch platform in the
United States supplying information providers and commercial accounts with
audiotext and customer support services.
Industry
The Company operates primarily in the local telephone service market as
a CLEC. The Company also plans to compete in the long distance market, and in
the frame relay and ATM data communications markets, to provide "full service"
to its end user and carrier customers. The Company believes it can maximize
revenue and profit opportunities by leveraging its extensive network facilities
in providing multiple communications services to its customers.
Local telephone service competition was made possible by the
Telecommunications Act and by regulatory initiatives at the state level. Prior
to passage of the Telecommunications Act, firms like the Company were generally
confined to providing special access services. These firms, including the
Company, installed fiber optic cable connecting long distance telephone
carriers' POPs within a metropolitan area and, in some cases, connecting end
users (primarily large businesses and government entities) with long distance
carrier POPs. The greater capacity and economies of scale inherent in fiber
optic cable enabled the CAPs to offer customers less expensive and higher
quality special access and private line services than the ILECs.
Signals carried over digital fiber optic networks are superior in many
respects to older analog signals carried over copper wire, which continue to be
used in varying degrees by the ILECs. In addition to offering faster and more
accurate transmission of voice and data communications, digital fiber optic
networks generally require less maintenance than comparable copper wire
facilities, thereby decreasing operating costs. Furthermore, the transmission
capacity of digital fiber optic cable is determined by the electronic equipment
used on the network. This allows network capacity to be increased with a change
in electronics, not the actual fiber network, as would be the case with a copper
wire architecture. Lastly, digital fiber optic cable is largely immune from
electromagnetic and radio interference, resulting in enhanced transmission
quality.
The Telecommunications Act, subsequent FCC decisions and many state
legislative and regulatory initiatives have substantially changed the
telecommunications regulatory environment in the United States. Due to these
regulatory changes, CLECs are now legally able to offer all communications
services, including local dial tone and all interstate and intrastate switched
services, effectively opening up the local telephone market to full competition.
Because of these
12
changes in state and federal regulations, CLECs have expanded their services
from providing competitive access services such as private line and special
access to providing all local exchange services to become true competitors to
the ILECs. See "-Regulation."
Network Services
Through the Company's wholly owned subsidiary, Fiber Optic
Technologies, Inc. ("FOTI"), the Company supplies information technology
services and selected networking products, focusing on network design,
installation, maintenance and support for a variety of end users, including
Fortune 1000 firms and other large businesses and telecommunications companies.
Revenue from Network Services was $60.4 million for the 12-month period ended
December 31, 1996.
The Company provides network infrastructures, systems and support
services, including the design, engineering and installation of local and wide
area networks ("LANs/WANs") for its customers. These networks (within end user
offices, buildings or campuses) may include fiber optic, twisted-pair, coaxial
and other network technologies. The Company specializes in turnkey network
installations including cabling and electronics that address specific
environments. The Company also provides professional network support services.
These services include network move, add and change services and on-going
maintenance and support services. Network Services revenue is expected to
constitute a smaller portion of the Company's future revenue as Telecom Services
revenue increases.
The Company offers these network integration and support services
through offices located within four regions. The regional headquarters are
located in Dallas, Denver, Portland (Oregon) and San Francisco.
Satellite Services
The Company's Satellite Services operations provide satellite voice and
data transmission services to major cruise lines, commercial shipping vessels,
yachts, the U.S. Navy and offshore oil platforms. The Company also owns a
teleport facility which provides international voice and data transmission
services. Revenue for the Satellite Services operations (adjusted to reflect the
sale of certain teleport assets) was $11.4 million for fiscal 1995 and $21.3
million for the 12-month period ended December 31, 1996.
MTN. In January 1995, the Company and an unaffiliated entity formed
Maritime Telecommunications Network, Inc. ("MTN") which purchased the assets of
a business providing digital wireless communications through satellites to the
maritime cruise industry, U.S. Navy vessels and offshore oil platforms utilizing
an experimental radio frequency license and a grant of Special Temporary
Authority ("STA") issued by the FCC. MTN provides private communications
networks to various cruise lines allowing passengers to make calls from their
cabins to anywhere in the world. MTN additionally provides its communications
services to the U.S. Navy in conjunction with a major long distance provider,
which serves as the long distance carrier, while MTN provides the communications
equipment and network. The Company believes that the radio frequencies employed
under its experimental license enable it to provide a higher quality maritime
13
service than is available through the radio frequencies currently allocated to
other maritime service providers.
In April 1996, the FCC issued a waiver allowing MTN to apply for a
permanent FCC license to utilize the same frequencies as are being used under
the experimental license. The Company's application is pending. Additionally, in
January 1997, the FCC granted an STA which enables MTN to conduct operations as
proposed in the pending application for a permanent license, for up to an
initial six-month period while the FCC's review of the permanent license
applications is pending. Although the Company expects that the FCC will issue a
permanent license, there can be no assurance that the Company will be granted a
permanent license, that the experimental license currently being used will be
renewed for a future term or that any license granted by the FCC will not
require substantial payments from the Company. See "-Regulation."
MCN. In March 1996, the Company acquired a 90% equity interest in
Maritime Cellular Tele-Network, Inc. ("MCN"), a Florida-based provider of
cellular and satellite communications for commercial ships, private vessels and
land-based mobile units. This acquisition expands the Company's business from
C-band satellite services for cruise ships and naval vessels to cover land-based
units and smaller ships.
Nova-Net. In May 1994, the Company acquired Nova-Net Communications,
Inc. ("Nova-Net"), which provides private data networks utilizing VSATs and
specializes in data collection and in monitoring and control of customer
production and transmission facilities in various industries, including oil and
gas, electric and water utilities and environmental monitoring industries.
Nova-Net designs, builds and manages private data networks that enable a variety
of companies to transmit critical sensor and flow readings to key monitoring
points from multiple locations. Nova-Net manages networks 24 hours a day, seven
days a week through its network control center in Englewood, Colorado.
Teleport. The teleport in Holmdel, New Jersey, acquired as part of the
Company's acquisition of MTN, is located 20 miles south of Newark and
specializes in international digital voice and data communications services with
full fiber interconnection to the local telephone company facilities in New York
City. Teleport services are also provided to the maritime industry, including
support of the Company's cruise ship, U.S. Navy and offshore oil platform
telephone and data services business. In addition, the Company markets the
resale of services from the four teleports it sold in the first quarter of 1996.
Customers And Marketing
The Company's primary marketing strategies for Telecom Services are to
offer a broad range of local and long distance communications services,
including data communications, to business customers and the Company's wholesale
(primarily long distance carrier) customers, at cost-effective rates. Wholesale
customers typically re-market the Company's services to the wholesaler's end
user, under the wholesaler's brand name. The Company markets its services in
regional clusters, which it believes is the most effective and efficient way to
penetrate its markets.
14
The Company markets its products through direct sales to end users and
wholesale accounts, and through some direct mail. The Company is launching a
print advertising campaign in the first quarter of 1997 and may intensify direct
mail activities. Telecom Services revenue from major long distance carriers and
resellers constituted approximately 78%, 71% and 69% of the Company's Telecom
Services revenue in fiscal 1995, fiscal 1996 and the three-month period ended
December 31, 1996, respectively. The balance of the Company's Telecom Services
revenue was derived from end users. The Company anticipates revenue from end
users will increase in the future as it continues to expand its local telephone
service offerings and grows its sales and marketing teams to focus on the end
user segment of the market. Telecom service agreements with its customers
typically provide for terms of one to five years, fixed prices and early
termination penalties.
The Company has telecommunications sales offices in: Irvine, Los
Angeles, Oakland, Sacramento and San Diego, California; Denver and Colorado
Springs, Colorado; Cleveland, Columbus and Dayton, Ohio; Birmingham, Alabama;
Louisville, Kentucky; Charlotte, North Carolina; and Nashville, Tennessee. The
Company anticipates opening additional sales offices in California, Ohio, and
Texas in 1997. The Company's marketing staff is located in Denver, Colorado.
The Company markets its network systems integration products and
services through a direct sales force located in the Rocky Mountains, Pacific
Northwest, Texas and California regions. The Company also has entered into
reseller agreements with manufacturers of network integration products and
services.
The Company offers satellite private line transmission services from
its teleport to business customers that can benefit from the Company's
international and domestic transmission capabilities. The Company also markets
voice and data communications to the maritime industry, including cruise ships,
U.S. Navy vessels, commercial vessels, private yachts, offshore oil platforms
and mobile land-based units.
Competition
The Company operates in an increasingly competitive environment
dominated by the ILECs, such as the RBOCs and GTE, which are among the Company's
current competitors. Also included among the Company's current competitors are
independent ILECs, other CLECs, network systems integration services providers,
microwave and satellite service providers, teleport operators, wireless
telecommunications providers and private networks built by large end users.
Potential competitors (using similar or different technologies) include cable
television companies, utilities, local telephone companies outside their current
local service areas, and the local access operations of long distance carriers.
Consolidation of telecommunications companies, including pending mergers between
certain of the RBOCs, and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies,
could give rise to increased competition. One of the primary purposes of the
Telecommunications Act is to promote competition, particularly in the local
telephone market. Since enactment of the Telecommunications Act, several
telecommunications companies have indicated their intention to aggressively
expand their ability to address many segments of the telecommunications
industry,
15
including segments in which the Company participates and expects to participate.
For example, AT&T and MCI are entering the local markets, as competitors of the
Company. This may result in more participants than can ultimately be successful
in a given market.
Telecom Services. The bases of competition in competitive local
telecommunications services are generally price, service, reliability,
transmission speed and availability. The Company believes that its expertise in
developing and operating highly reliable, advanced digital networks which offer
substantial transmission capacity at competitive prices enables the Company to
compete effectively against the ILECs and other CLECs.
In every market in which the Company operates telecom service networks,
the ILECs (which are the historical monopoly providers of local telephone
services) are the primary competitors. The ILECs have long-standing
relationships with their customers and provide those customers with various
transmission and switching services. The ILECs also have the potential to
subsidize access and switched services with revenue from a variety of businesses
and historically have benefited from certain state and federal regulations that
have favored the ILECs over the Company. In certain markets where the Company
operates, other CLECs also operate or have announced plans to enter the market.
Some of those CLECs are affiliated with major long distance companies. Current
competitors also include network systems integration services providers,
wireless telecommunications providers and private networks built by large end
users. Additional competition may emerge from cable television operators and
electric utilities. Many of the Company's actual and potential competitors have
greater financial, technical and marketing resources than the Company.
The Company's networks compete most directly with the RBOCs and GTE. In
general, the provision of interstate access services by the RBOCs and GTE,
including the rates charged for such services, is regulated by the FCC, and the
provision of intrastate access and local services, including the rates charged
for such services, is regulated by the individual state regulatory commissions.
See "-Regulation." In the past, FCC policies have constrained the ability of the
RBOCs and GTE to decrease their prices for interstate access services, based on
their status as dominant carriers. Although FCC regulatory approval for price
reductions (beyond certain parameters) still must be obtained, the FCC has
allowed all recently proposed access reductions to become effective and has
granted the RBOCs flexibility in pricing their interstate access services on a
central office by central office basis. This pricing flexibility resulted in
certain RBOCs lowering their prices in high density zones, the probable arena of
competition with the Company. In addition, the FCC has granted waivers of its
access charge pricing rules to the RBOCs to allow them to further reduce certain
access prices. The FCC also commenced a rule making proceeding in December 1996
that proposes to undertake a comprehensive reform of its access charge pricing
rules, and a separate rule making proceeding is considering a reform of the
existing subsidies that promote universal service. Under the Telecommunications
Act, the FCC is required to complete the universal service reform proceeding and
to adopt new rules by May 8, 1997. The FCC's access charge reform proceeding is
likely to eventually result in a reduction in access rates charged by the RBOCs
and GTE. The lowering of access rates and increased pricing flexibility for the
RBOCs and GTE may adversely affect
16
the Company's ability to compete for certain services. If the RBOCs and GTE
continue to lower access rates, there would be downward pressure on certain
special access and switched access rates charged by CLECs, which pressure may
adversely affect the Company's profitability. See "-Regulation." In addition,
the Telecommunications Act and its implementation by the states and the FCC
allows the RBOCs and GTE to provide a broader range of services and likely will
enable the RBOCs and GTE to more effectively compete against long distance
carriers, which are the Company's primary customers for telecom services.
Network Services. The bases of competition in the network services
market are primarily technological capability and experience, value-added
services and price. In this market, the Company competes with a variety of local
and regional system integrators.
Satellite Services. In the delivery of domestic and international
satellite services, the Company competes with other full service teleports in
the northeast region of the United States. The bases of competition are
primarily reliability, price and transmission quality. Most of the Company's
satellite competitors focus on the domestic video market. Competition is
expected principally from a number of domestic and foreign telecommunications
carriers, many of which have substantially greater financial and other resources
than the Company. In the maritime telecommunications market, MTN competes
primarily with COMSAT Corporation ("COMSAT") in providing similar
telecommunications services. COMSAT has FCC licenses that are similar to MTN's,
it owns its own satellites and it is the sole U.S. point of control for access
to Intelsat satellites.
Regulation
The Company's services are subject to significant federal, state and
local regulation. The Company operates in an industry that is undergoing
substantial change as a result of the passage of the Telecommunications Act.
The Telecommunications Act opens the local and long distance markets to
additional competition and changes the division of oversight between federal and
state regulators. Under previous law, state regulators had authority over those
services that originated and terminated within the state ("intrastate") and
federal regulators had jurisdiction over services that originated within one
state and terminated in another state ("interstate"). State and federal
regulators now share responsibility for implementing and enforcing the
provisions of the Telecommunications Act. In exchange for unbundling their
network elements and allowing competitors to interconnect at cost-based rates
and on nondiscriminatory terms and conditions, the RBOCs are now allowed to seek
authority to provide long distance services.
The Telecommunications Act generally requires ILECs to provide
interconnection and nondiscriminatory access to the ILEC networks on more
favorable terms than have been available in the past. However, such new
agreements are subject to negotiations with each ILEC which may involve
considerable delays and may not necessarily be obtained on terms and conditions
that are acceptable to the Company. In such instances, the Company may petition
the proper state regulatory agency to arbitrate disputed issues. Ultimately, the
terms of an arbitrated agreement are subject to review by the FCC or the federal
courts. There can be no assurance that the Company will be able to negotiate
acceptable new interconnection agreements or that, if state regulatory
authorities impose terms and conditions on the parties in arbitration, such
terms will be acceptable to the Company.
17
On August 8, 1996, in two separate decisions in its FCC Docket 96-98,
referred to as the "First Report and Order" and the "Second Report and Order,"
the FCC adopted rules and policies implementing the local competition provisions
of the Telecommunications Act. The FCC, among other things, adopted national
guidelines with respect to the unbundling of ILECs' network elements, resale of
ILEC services, the pricing of interconnection services and unbundled elements,
and other local competition issues.
Both of the Orders adopted by the FCC on August 8, 1996 have been
challenged in federal courts of appeals by the RBOCs, GTE, other independent
ILECs, long distance carriers, and state regulatory commissions. Petitions also
have been filed with the FCC requesting that the FCC reconsider various aspects
of the interconnection rules. The requests for court review of the FCC's First
Report and Order have been consolidated into one proceeding that will be decided
by the U.S. Court of Appeals for the Eighth Circuit in St. Louis, Missouri.
Requests also were filed by certain ILECs and state commissions to stay the
effective date of the FCC's rules adopted in the First Report and Order pending
the issuance by the Court of a decision on the merits. On October 15, 1996, the
Court issued a stay of certain of the FCC's rules adopted in the First Report
and Order, including implementation of the pricing provisions of the FCC's
rules, which define the methodology by which the ILECs must develop prices for
their unbundled elements and provide the basis for the FCC's interim or
"default" and "proxy" price ceilings and ranges. The Court also stayed the FCC's
"most favored nation" rules which implement Section 252(i) of the
Telecommunications Act and require ILECs to make available any interconnection,
service or network element in an approved interconnection agreement to any other
requesting carrier on the same terms and conditions and at the same price,
thereby enabling new entrants to "pick and choose" elements of established
interconnection agreements. Oral argument on the merits of the FCC's rules was
heard on January 17, 1997 and the Court is not expected to render a decision
until March or April 1997. The Court's stay, however, does not affect the FCC's
other interconnection rules as adopted on August 8, 1996, nor does it affect the
statutory requirements of the Telecommunications Act, including the statutory
requirement that ILECs conduct negotiations, enter into interconnection
agreements with competitive carriers, and unbundle their network elements. A
separate appeal of the FCC's Second Report and Order also is pending.
Federal Regulation. The Company generally operates as a regulated
carrier with fewer regulatory obligations than the ILECs. The Company must
comply with the requirements of the Telecommunications Act, such as offering
service on a non-discriminatory basis at just and reasonable rates. The FCC
treats the Company as a non-dominant carrier. The FCC has established different
levels of regulation for dominant and non-dominant carriers. Of domestic common
carriers, only GTE and the RBOCs are classified as dominant carriers for the
provision of access services, and all other providers of domestic common carrier
services are classified as non-dominant. Under the FCC's streamlined regulation
of non-dominant carriers, the Company must file tariffs with the FCC for certain
interstate services on an ongoing basis. The FCC has, however, recently
eliminated the requirement that non-dominant long distance carriers file
tariffs. Based on this proposal and previous FCC decisions, the Company believes
that the FCC also will eliminate tariff filing requirements for non-dominant
local exchange carriers such as the Company. The Company is not subject to price
cap or rate of return regulation, nor is it currently required to obtain FCC
authorization for the installation or operation of its fiber optic network
facilities used
18
for services in the United States. The Company may install and operate non-radio
facilities for the transmission of interstate communications without prior FCC
authorization. The Company's use of digital microwave radio frequencies in
connection with certain of its telecommunications services is subject to FCC
radio frequency licensing regulation. See "Federal Regulation of Microwave and
Satellite Radio Frequencies" below.
State Regulation. In general, state regulatory agencies have regulatory
jurisdiction over the Company when Company facilities and services are used to
provide intrastate services. Under the Telecommunications Act, states cannot
effectively prohibit any entity from providing telecommunications services, but
the states continue to have general authority to set criteria for reviewing
applications to provide intrastate services (including local services). State
regulators will continue to set the requirements for providers of local and
intrastate services, including quality of services criteria. However, state
regulators can no longer allow (or require) restrictions on the resale of
telecommunications services. State regulators also can regulate the rates
charged by CLECs for intrastate and local services. The Company's provision of
local dial tone and intrastate switched and dedicated services are classified as
intrastate and therefore subject to state regulation. The Company expects that
it will offer more intrastate services as its business and product lines expand.
To provide intrastate service (particularly local dial tone service), the
Company generally must obtain a Certificate of Public Convenience and Necessity
("CPCN") from the state regulatory agency prior to offering service. In most
states, the Company also is required to file tariffs setting forth the terms,
conditions and prices for services that are classified as intrastate, and to
update or amend its tariffs as rates change or new products are added. The
Company may also be subject to various reporting and record-keeping
requirements.
The Company currently holds CPCNs (or their equivalents) from the
states of Alabama, California, Colorado, Florida, Kentucky, North Carolina,
Ohio, Tennessee and Texas. The Company has authority to provide local and
intrastate long distance services in Alabama, California, Colorado, Kentucky,
Ohio, Tennessee and Texas. The Company also has authority in Florida to provide
intrastate long distance services and alternative access services. The Company
also holds a CPCN to provide intrastate long distance services in North Carolina
and applications are pending before the applicable state commission for CPCNs to
provide local telecommunications services in North Carolina and to provide local
and long distance services in Indiana and Oklahoma, as well as to expand the
Company's local telephone service areas in Ohio.
Local Government Authorizations. Under the Telecommunications Act,
local authorities retain jurisdiction under applicable state law to control the
Company's access to municipally owned or controlled rights of way and to require
the Company to obtain street opening and construction permits to install and
expand its fiber optic network. In addition, many municipalities require the
Company to obtain licenses or franchises (which generally have terms of 10 to 20
years) and to pay license or franchise fees, based on a percentage of gross
revenue, in order to provide telecommunication services. In certain states,
however, including California and Colorado, such fees cannot be imposed under
state law. There is no assurance that certain cities that do not impose fees
will not seek to impose fees, nor is there any assurance that, following the
expiration of existing franchises, fees will remain at their current levels. In
many markets, the ILECs have been excused from paying such franchise fees or pay
fees that are materially lower than those required to be paid by the Company for
access to public rights of way. However, under the
19
Telecommunications Act, while municipalities may still regulate use of their
streets and rights of way, municipalities may not prohibit or effectively
prohibit any entity from providing any telecommunications services. In addition,
the Telecommunications Act requires that local governmental authorities treat
telecommunications carriers in a non-discriminatory and competitively neutral
manner. If any of the Company's existing franchise or license agreements are
terminated prior to their expiration dates or not renewed, and the Company is
forced to remove its fiber from the streets or abandon its network in place,
such termination could have a material adverse effect on the Company.
Federal Regulation of Microwave and Satellite Radio Frequencies. The
FCC continues to regulate radio frequency use by both private and common
carriers under the Telecommunications Act. Unlike common carriers, private
carriers contract with select customers to provide services tailored to the
customer's specific needs. The FCC does not currently regulate private carriers
(other than their use of radio frequencies) and has preempted the states from
regulating private carriers insofar as they provide interstate services. The
Company offers certain services as a private carrier.
The Company is required to obtain authorization from the FCC for its
use of radio frequencies to provide satellite and wireless services. The Company
holds a number of satellite earth station licenses in connection with its
operation of satellite-based private carrier networks. The Company also provides
maritime communications services pursuant to an experimental license and a grant
of a STA. In April 1996, the FCC issued a waiver to the Company which may allow
it to obtain a permanent FCC license to provide these services using the same
radio frequencies currently being used under the experimental license. The
Company has filed an application for a permanent license under the terms of the
FCC's waiver decision, and the application is pending. The STA was granted on
January 30, 1997 and enables the Company to conduct operations pursuant to such
application during the FCC's review.
The Telecommunications Act limits ownership or control of an entity
holding a common carrier radio license by non-U.S. citizens, foreign
corporations and foreign governments. Because of these restrictions,
historically the Company and its subsidiaries have not been eligible to hold
common carrier radio licenses used to provide telephone and wireless services.
Therefore, third parties hold certain common carrier licenses and provide
service to the Company over the licensed facilities for resale by the Company to
the Company's customers. The Telecommunications Act permits the FCC to determine
on a case-by-case basis that the public interest will be served by waiving the
foreign ownership restrictions. The Company intends to apply to the FCC for a
waiver of the foreign ownership restrictions that remain applicable to the
Company. If a waiver is granted, or if currently applicable ownership
restrictions are relaxed or removed, the common carrier radio licenses will be
transferred to the Company upon receipt of FCC approval.
Employees
On January 31, 1997, the Company employed a total of 1,483 individuals
on a full time basis. There are 112 employees of one of the Company's
subsidiaries who are subject to collective bargaining agreements which expire on
December 31, 1997 and May 31, 1998. The Company believes that its relations with
its employees are good.
20
ITEM 2. PROPERTIES
The Company's physical properties include owned and leased space for
offices, storage and equipment rooms and collocation sites. Additional space may
be purchased or leased by the Company as networks are expanded. The Company owns
a 30,000 square-foot building located in the Denver metropolitan area. This
facility serves as the Company's corporate headquarters as well as its
nationwide network monitoring and control facility for its Telecom Services
business. The Company currently also leases approximately 116,000 square feet of
office space for operations located in the Denver metropolitan area. As a result
of its recent and anticipated future growth, the Company has acquired property
for its new headquarters and has commenced construction of an office building
that the Company anticipates will accommodate all of the Company's Colorado
operations.
ITEM 3. LEGAL AND ADMINISTRATIVE PROCEEDINGS
SBC has alleged before the San Antonio city council that the Company's
arrangement to license cable being built by City Public Service of San Antonio
("CPS") in greater San Antonio violates state law and has sought to have the San
Antonio city council repudiate the Company's contract with CPS. The assertion of
SBC is that CPS would, through its license arrangement with the Company, be
providing telecommunications services in contravention of Texas state law. In
December 1995, the San Antonio city council imposed a moratorium on network
construction which expired in March 1996. The Company believes it has a valid
contract with CPS and filed suit against SBC in December 1995 in the District
Court for the Western District of Texas, San Antonio Division seeking, among
other things, damages for tortious interference and a declaratory judgment that
the contract with CPS is legal and binding. SBC's motion to dismiss that suit
was granted by the Court and ICG's appeal of that decision is pending before the
U.S. Court of Appeals for the Fifth Circuit. In June 1996, ICG filed suit in
State Court in San Antonio seeking a declaration that the contract is valid
under state law. In addition, in May 1996, the Company filed a petition with the
FCC seeking preemption of Texas state law under the Telecommunications Act. That
petition currently is pending before the FCC.
ICG and its subsidiaries are not parties to any material litigation.
The continuing participation by ICG and its subsidiaries in regulatory
proceedings before the FCC and state regulatory agencies concerning the adoption
of new regulations is unlikely to result in a material adverse effect on the
financial condition and results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
21
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
ICG Common Stock, $.01 par value per share, has been listed on the
American Stock Exchange ("AMEX") since August 5, 1996 under the symbol "ICG."
Prior to that time, Holdings-Canada's Common Shares had been listed on the AMEX
under the symbol "ITR" from January 14, 1993 through February 28, 1996, and
under the symbol "ICG" thereafter through August 2, 1996. Holdings-Canada Common
Shares ceased trading on the AMEX at the close of trading on August 2, 1996.
Holdings-Canada Class A Common Shares are listed on the Vancouver Stock Exchange
("VSE") under the new symbol "IHC.A."
The following table sets forth, for the fiscal periods indicated, the
high and low sale prices of the Common Shares as reported on the AMEX through
August 2, 1996, and the VSE through the date indicated below, and the high and
low sales prices of the Common Stock as reported on the AMEX from August 5, 1996
through the date indicated below. The table also sets forth the average of the
monetary exchange rates on the last day of each such fiscal period.
American Stock Vancouver Stock Exchange
Exchange (1) Exchange (1) Rate
------------------ -------------------- -----------
High Low High Low (C$/$)
------ -------- ------ ----------- -----------
Fiscal Year
Ended September
30, 1995
First Quarter $17.88 $12.38 C$ 33.50 C$ 18.50 1.38
Second Quarter 14.13 9.38 19.75 17.38 1.40
Third Quarter 13.25 6.63 18.00 18.00 1.36
Fourth Quarter 14.00 8.00 - - 1.34
Fiscal Year
Ended September
30, 1996
First Quarter $12.75 $ 8.63 C$ - C$ - 1.36
Second Quarter 17.88 10.25 - - 1.37
Third Quarter 27.38 17.13 17.50 17.50 1.36
Fourth Quarter 25.88 19.13 - - 1.36
Three Months
Ended December
31, 1996 (2) $22.25 $ 14.00 C$ 28.35 C$ 28.35 1.37
Fiscal Year
Ended December
31, 1997(2)
Through February
18, 1997 $18.13 $14.50 C$ - C$ - 1.35
----------------
(1) Effective at the close of trading on August 2, 1996, Holdings-Canada's
Common Shares ceased trading on the AMEX and the Common Stock commenced
trading on the AMEX on August 5, 1996. The Common Stock is not traded
on the VSE. The Class A Common Shares trade on the VSE and all
information reported on the above table from August 5, 1996 to the date
indicated above with respect to the VSE relates only to the Class A
Common Shares.
(2) The Company has elected to change its fiscal year end to December 31
from September 30, effective January 1, 1997.
22
On February 18, 1997, the last reported sale price for the Common Stock on
the AMEX was $14.75 per share. On February 18, 1997, there were 31,299,392
shares of Common Stock outstanding and 101 holders of record.
The Company has never declared or paid dividends on the Common Stock and
does not intend to pay cash dividends on the Common Stock in the foreseeable
future. ICG intends to retain future earnings, if any, to finance the
development and expansion of its business. In addition, the payment of any
dividends on the Common Stock is effectively prohibited by the restrictions
contained in the Company's indentures and in the First Amended and Restated
Articles of Incorporation of Holdings, which prohibits Holdings from making any
material payment to the Company. Certain of the Company's debt facilities
contain covenants which also may restrict the Company's ability to pay cash
dividends.
The Company has not made any sales of unregistered securities during fiscal
1996 or the three months ended December 31, 1996.
23
ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data for each fiscal year in the
five-year period ended September 30, 1996 and for the three months ended
December 31, 1996 has been derived from the audited Consolidated Financial
Statements of the Company. The information set forth below should be read in
conjunction with the Consolidated Financial Statements of the Company and the
notes thereto included elsewhere in this Transition Report. Results of
operations for the three months ended December 31, 1996 are not necessarily
indicative of results of operations for a full year or predictive of future
periods. The Company's development and expansion activities, including
acquisitions, during the periods shown below materially affect the comparability
of this data from one period to another. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Three Months
Years Ended September 30, Ended December
------------------------------------------------------------------------ 31,
Statement of Operations Data: 1992 1993 1994 1995 1996 1996
----------- ----------- ----------- ---------- ------------ -----------------
(in thousands, except per share amounts)
Revenue:
Telecom services $ 1,061 4,803 14,854 32,330 87,681 34,787
Network services 4,955 21,006 36,019 58,778 60,116 15,981
Satellite services (1) 1,468 3,520 8,121 20,502 21,297 6,188
Other 126 147 118 - - -
----------- ----------- ----------- ---------- ------------ -----------------
Total revenue 7,610 29,476 59,112 111,610 169,094 56,956
Operating costs 5,423 18,961 38,165 78,846 135,253 49,929
Selling, general and
administrative expenses 3,921 10,702 28,015 62,954 76,725 24,253
Depreciation and amortization 1,602 3,473 8,198 16,624 30,368 9,825
----------- ----------- ----------- ---------- ------------ -----------------
Total operating costs
and expenses 10,946 33,136 74,378 158,424 242,346 84,007
----------- ----------- ----------- ---------- ------------ -----------------
Operating loss (3,336) (3,660) (15,266) (46,814) (73,252) (27,051)
Interest expense (525) (2,523) (8,481) (24,368) (85,714) (24,454)
Minority interests, including
preferred stock dividends 21 (302) 435 (1,123) (25,306) (4,988)
Other income (expense), net 12 324 (556) (4,343) (1,513) 6,670
----------- ----------- ----------- ---------- ------------ -----------------
Loss before income taxes and
cumulative effect of change
in accounting (3,828) (6,161) (23,868) (76,648) (185,785) (49,823)
Income tax benefit 174 1,552 - - 5,131 -
Cumulative effect of change in
accounting (2) - - - - (3,453) -
----------- ----------- ----------- ---------- ------------ -----------------
Net loss $ (3,654) (4,609) (23,868) (76,648) (184,107) (49,823)
=========== =========== =========== ========== ============ =================
Loss per share $ (0.42) (0.39) (1.56) (3.25) (6.83) (1.56)
=========== =========== =========== ========== ============ =================
Weighted average number of
shares outstanding (3) 8,737 11,671 15,342 23,604 26,955 31,840
=========== =========== =========== ========== ============ =================
Other Data:
EBITDA (4) $ (1,734) (187) (7,068) (30,190) (42,884) (17,226)
Capital expenditures (5) $ 12,599 20,685 54,921 88,495 175,148 78,238
24
At
At September 30, December
-------------------------------------------------------------------- 31,
Balance Sheet Data: 1992 1993 1994 1995 1996 1996
----------- --------- ----------- ----------- ----------- ------------
(in thousands)
Working capital (deficit) $ (392) 7,990 (8,563) 249,089 446,164 361,601
Total assets 54,417 95,196 201,991 583,553 939,351 944,133
Notes payable and current portion of
long-term debt and capital lease 991 7,657 23,118 27,310 8,282 25,500
obligations
Long-term debt and capital lease
obligations, less current portion 15,565 37,116 104,461 405,535 739,827 761,504
Redeemable preferred stock of Holdings - - - 14,986 153,318 159,120
Stockholders' equity (deficit) 21,826 34,753 39,782 82,535 (19,588) (66,080)
(1) Revenue from Satellite Services is generated through the Company's
satellite (voice and data) operations and, after January 1995, also
includes revenue from maritime communications operations. The Company
completed the sale of four of its teleports in March, 1996, and has
reported results of operations from these assets through December 31,
1995.
(2) During fiscal 1996, the Company changed its method of accounting for
long-term telecom services contracts to recognize revenue as services
are provided. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Accounting Changes." As required
by generally accepted accounting principles, the Company has reflected
the effects of the change in accounting as if such change had been
adopted as of October 1, 1995. The Company's results for the year ended
September 30, 1996 reflect a charge of $3.5 million relating to the
cumulative effect of this change in accounting as of October 1, 1995.
The effect of this change in accounting for fiscal year 1996 was not
significant. If the new revenue recognition method had been applied
retroactively, telecom services revenue would have decreased by $0.3
million, $2.0 million, $0.5 million and $0.7 million for fiscal 1992,
1993, 1994 and 1995, respectively.
(3) Weighted average number of shares outstanding for fiscal years 1992,
1993, 1994 and 1995 represents Holdings-Canada common shares
outstanding. Weighted average number of shares outstanding for fiscal
1996 represents Holdings-Canada common shares outstanding for the
period October 1, 1995 through August 2, 1996, and represents ICG
Common Stock and Holdings-Canada Class A common shares (owned by third
parties) outstanding for the period August 5, 1996 through September
30, 1996. Weighted average number of shares outstanding for the
three-month period ended December 31, 1996 represents ICG Common Stock
and Holdings-Canada Class A common shares (owned by third parties)
outstanding for the period October 1, 1996 through December 31, 1996.
(4) EBITDA consists of operating loss plus depreciation and amortization.
EBITDA is provided because it is a measure commonly used in the
telecommunications industry. EBITDA is presented to enhance an
understanding of the Company's operating results and is not intended to
represent cash flow or results of operations in accordance with
generally accepted accounting principles for the periods indicated. See
the Company's Consolidated Financial Statements contained elsewhere in
this Transition Report.
25
(5) Capital expenditures include assets acquired under capital leases and
through the issuance of debt or warrants.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion includes certain forward-looking statements
which are affected by important factors including, but not limited to,
dependence on increased traffic on the Company's facilities, the successful
implementation of the Company's local dial tone and long distance strategies and
actions of competitors and regulatory authorities that could cause actual
results to differ materially from the forward-looking statements. The results
for the three months ended December 31, 1995 have been derived from the
Company's unaudited Consolidated Financial Statements included herein.
Company Overview
The Company provides Telecom Services, Network Services and Satellite
Services. Telecom Services consist primarily of the Company's CLEC operations.
The Company is one of the largest providers of competitive local telephone
services in the United States, based on estimates of the industry's 1995
revenue. Network Services consist of information technology services and
selected networking products, focusing on network design, installation,
maintenance and support. Satellite Services consist of maritime and
international satellite transmission services and provide private data networks
utilizing VSATs. As a leading participant in the rapidly growing competitive
local telecommunications industry, the Company has experienced significant
growth, with total revenues increasing from $59.1 million for fiscal 1994 to
$190.7 million for the 12-month period ended December 31, 1996. The Company's
rapid growth is the result of the initial installation, acquisition and
subsequent expansion of its fiber optic networks, the acquisition and growth of
its network systems integration business and, prior to fiscal 1996, growth in
Satellite Services.
Prior to fiscal 1996, the majority of the Company's revenue had been
derived from Network Services. However, the Company's Network Services revenue
(as well as Satellite Service revenue) will continue to represent a diminishing
percentage of the Company's consolidated revenue as the Company continues to
emphasize its Telecom Services. In March 1996, the Company completed the sale of
four of its teleports which were used in the Company's Satellite Services
operations.
The Company's operating networks have grown from 323 fiber route miles
at the end of fiscal 1994 to 2,385 fiber route miles at December 31, 1996.
Telecom Services revenue has increased from $14.9 million for fiscal 1994 to
$109.0 million for the 12-month period ended December 31, 1996. The Company has
experienced declining access unit prices and increasing price competition which
have been more than offset by increasing network usage. The Company expects to
continue to experience declining access unit prices and increasing price
competition for the foreseeable future.
The Company expects to continue to experience negative operating
margins from the provision of switched access services while its networks are in
the development and construction phases, during which the Company relies on ILEC
networks to carry a significant portion of its customers' switched traffic. The
Company expects to realize improved operating margins from
27
switched services on a given network when (i) increased volumes of traffic are
attained and build-out enables such traffic to be carried on the Company's own
network instead of ILEC facilities, and (ii) higher margin enhanced services are
provided to customers on the Company's network. In addition, the Company
believes that the unbundling of ILEC services and the implementation of local
telephone number portability, which are mandated by the Telecommunications Act,
will reduce the Company's costs of providing switched services and facilitate
the marketing of such services. However, the Company's switched access services
strategy has not yet been profitable and may not become profitable due to, among
other factors, lack of customer demand, competition from other CLECs and
downward pricing pressure from the ILECs.
The Company believes that the provisions of the Telecommunications Act,
including the opening of the local telephone services market to competition, the
unbundling of ILEC services and the implementation of local telephone number
portability, will facilitate the Company's plan to provide a full array of
local, long distance and data communications services. In order to fully
implement its strategy, the Company must make significant capital expenditures
to provide additional switching capacity, network infrastructure and electronic
components. The Company must also make significant investments and expenditures
to develop, train and manage its marketing and sales personnel. The Company has
limited experience providing such services and there can be no assurance that
the Company will be successful.
The continued development, construction and expansion of the Company's
business requires significant capital, a large portion of which is expended
before any revenue is generated. The Company has experienced, and expects to
continue to experience, negative cash flow and significant losses while it
expands its operations to provide a wide range of telecommunications services
and establishes a sufficient revenue-generating customer base. There can be no
assurance that the Company will be able to establish or retain such a customer
base. When constructing and relying principally on its own facilities, the
Company has experienced a period of up to 18 months from initial design of a
network to revenue generation for that network. However, using leased ILEC
facilities to provide initial customer service and the Company's new agreements
to use utilities' existing fiber, the Company has experienced initial revenue
generation within nine months after commencing network design.
28
Results of Operations
The following table provides a breakdown of revenue and operating costs
for Telecom Services, Network Services and Satellite Services and certain other
financial data for the Company for the periods indicated. The table also shows
certain revenue, expenses, operating loss and EBITDA as a percentage of the
Company's total revenue.
Three Months
Years Ended September 30, Ended December 31,
-------------------------------- --------------------------
1994 1995 1996 1995 1996
--------- --------- -------- ----------- ------------
$ % $ % $ % $ % $ %
---- ----- ----- --- --- ---- ----- ----- ----- ----
(Dollars in thousands)
Revenue:
Telecom
services(1) 14,854 25 32,330 29 87,681 52 13,513 38 34,787 61
Network services 36,019 61 58,778 53 60,116 36 15,718 45 15,981 28
Satellite services 8,121 14 20,502 18 21,297 12 6,168 17 6,188 11
Other 118 * - - - - - - - -
------- -- ------ -- ------ -- ------ -- ------ --
Total revenue 59,112 100 111,610 100 169,094 100 35,399 100 56,956 100
Operating costs:
Telecom services 7,050 21,825 78,705 11,882 34,463
Network services 26,334 45,928 46,256 11,998 12,287
Satellite services 4,697 11,093 10,292 3,230 3,179
Other 84 - - - -
------ -- ------ -- ------ -- ------ -- ------ --
Total operating
costs 38,165 65 78,846 71 135,253 80 27,110 77 49,929 88
Selling,general
and adminis-
trative 28,015 47 62,954 56 76,725 45 18,628 53 24,253 43
Depreciation and
amortization 8,198 14 16,624 15 30,368 18 4,919 14 9,825 17
------ -- ------ -- ------ -- ------ -- ------ --
Operating loss (15,266)(26)(48,814)(42)(73,252)(43) (15,258)(43)(27,051)(47)
EBITDA (2) (7,068)(12)(30,190)(27)(42,884)(25) (10,339)(29)(17,226)(30)
- ----------
*Less than 0.5%
(1) During fiscal 1996, the Company change its method of accounting for long-
term telecom services contracts to recognize revenue as services are
provided. See "-Accounting Changes." The effect of this change in
accounting for the periods presented was not significant.
(2) See note 4 under "Selected Financial Data" for the definition of EBITDA.
29
Three Months Ended December 31, 1996 Compared to Three Months Ended December 31,
1995
Revenue. Revenue for the three months ended December 31, 1996 increased
$21.6 million, or 61%, from the three months ended December 31, 1995. The
increase in total revenue reflects continued growth in Telecom Services, Network
Services and Satellite Services, offset slightly by the loss in revenue
resulting from the sale of four of the Company's teleports during the second
quarter of fiscal 1996. Telecom Services revenue increased 157% to $34.8 million
due to an increase in network usage for both special and switched access
services, offset in part by a decline in average unit pricing. Switched services
revenue increased from $6.0 million (44% of Telecom Services revenue) for the
three months ended December 31, 1995, to $23.9 million (69% of Telecom Services
revenue) for the three months ended December 31, 1996, of which $7.5 million
relates to revenue from Zycom compared to $0.9 million for the three months
ended December 31, 1995. Approximately $6.5 million of the increase in Zycom
revenue for the three months ended December 31, 1996 as compared to the same
period in 1995 relates to changes in the classification of certain operating
costs as a result of the Company entering into long-term contracts with its
major customers. Network usage as reflected in voice grade equivalents ("VGEs")
increased 53% from 488,403 VGEs on December 31, 1995 to 748,528 on December 31,
1996. On December 31, 1996, the Company had 2,069 buildings connected to its
networks compared to 1,539 buildings connected on December 31, 1995. Consistent
with expectations, Network Services revenue growth has been moderate, increasing
from $15.7 million to $16.0 million for the three months ended December 31, 1995
and 1996, respectively, while the Company continues to reposition its systems
and operations to improve operating results. Satellite Services revenue remained
relatively stable between the three-month periods ended December 31, 1995 and
1996 as a result of the offsetting effects of increased maritime minutes of use
from cruise ships and no revenue in the three months ended December 31, 1996
from the four teleports sold in March 1996. On a pro forma basis to reflect the
sale of the teleports, the Company's Satellite Services revenue for the three
months ended December 31, 1995 and 1996 was $3.7 million and $6.2 million,
respectively.
Operating costs. Total operating costs for the three months ended
December 31, 1996 increased $22.8 million, or 84%, from the same period in 1995.
Telecom Services operating costs increased from $11.9 million, or 88%, of
Telecom Services revenue for the three months ended December 31, 1995, to $34.5
million, or 99%, of Telecom Services revenue for the three months ended December
31, 1996. Telecom Services operating costs consist of payments to ILECs for the
use of network facilities to support off-net and switched access services,
network operating costs, right of way fees and other costs. The increase in
operating costs in absolute dollars is attributable to the increase in switched
access services and the addition of engineering personnel dedicated to the
development of local exchange services. The increase in operating costs as a
percentage of revenue is due primarily to the increase in switched access
services revenue, which generates negative margins as a result of the higher
costs associated with utilizing ILEC network facilities and the investment in
the development of local exchange services without the benefit of corresponding
revenue in the same period. The Company expects that the Telecom Services ratio
of operating costs to revenue will continue to increase until the Company
provides a greater volume of higher margin services, principally local telephone
services, carries more traffic on its own facilities rather than the ILEC
facilities, and obtains the right to use unbundled ILEC facilities on
satisfactory terms, any or all of which may not occur. Network Services
operating costs
30
increased 2% to $12.3 million for the three months ended December 31, 1996 and
increased as a percentage of Network Services revenue from 76% to 77% for the
three month periods ended December 31, 1995 and 1996, respectively. Network
Services operating costs include the cost of equipment sold, direct hourly labor
and other indirect project costs. Satellite Services operating costs decreased
2% to $3.2 million for the three months ended December 31, 1996. Satellite
Services operating costs as a percentage of revenue declined to 51% of Satellite
Services revenue during the three months ended December 31, 1996, from 52%
during the three months ended December 31, 1995. The decrease in percentage of
revenue as well as absolute dollars is attributable to the decline in revenue
resulting from the sale of four of the Company's teleports in March 1996, offset
by an increase in higher margin maritime services revenue at MTN. Revenue from
teleport operations historically have yielded lower gross margins than maritime
services revenue. Satellite Services operating costs consist primarily of
satellite transponder lease costs and costs of equipment sold.
Selling, general and administrative expense. Selling, general and
administrative ("SG&A") expense for the three months ended December 31, 1996
increased $5.6 million, or 30%, compared to the three months ended December 31,
1995. This increase was principally due to the continued rapid expansion of the
Company's Telecom Services networks and related significant additions to the
Company's management information systems, customer service, marketing and sales
staffs dedicated to the expansion of the Company's networks and implementation
of the Company's expanded services strategy, primarily the development of local
telephone services. SG&A expense as a percentage of total revenue was 43% for
the three months ended December 31, 1996, compared to 53% for the same period in
1995. There is typically a period of higher administrative and marketing expense
prior to the generation of appreciable revenue from new products and services or
newly developed markets. SG&A expense for Network Services decreased both in
absolute dollars and as a percentage of Network Services revenue due to the cost
control efforts by the Company's management and due to approximately $0.7
million in non-recurring charges, primarily legal accruals, recorded during the
three months ended December 31, 1995. Satellite Services SG&A expense decreased
in absolute dollars and as a percentage of Satellite Services revenue due to
cost control efforts by the Company's management. Other corporate expenses
increased from $4.0 million, or 11% of total revenue, for the three months ended
December 31, 1995 to $5.7 million, or 10% of total revenue, for the three months
ended December 31, 1996. This increase is primarily attributable to the addition
of employees, principally human resources and regulatory personnel, for the
purpose of managing the Company's growth and its expansion into new markets as
allowed under the Telecommunications Act. The Company expects SG&A expense
(principally for Telecom Services) to increase in absolute dollars over the near
term to facilitate the development and marketing of local services and the
commencement of marketing services (including long distance and data
transmission services) to business end user customers.
Depreciation and amortization expense. Depreciation and amortization
expense increased $4.9 million, or 100%, for the three months ended December 31,
1996, as compared to the same period in 1995. Depreciation of fixed assets
increased by approximately $2.3 million as a result of the shortening of
estimated depreciable lives during fiscal 1996, as discussed in "-Accounting
Changes," and an increase in depreciable fixed assets due to the continued
expansion of the Company's networks. The increase in depreciation expense was
offset slightly due to the decrease
31
in depreciable assets resulting from the sale of four of the Company's teleports
in March 1996. The Company reports high levels of depreciation expense relative
to revenue during the early years of operation of a new network because the full
cost of a network is depreciated using the straight line method despite the low
rate of capacity utilization in the early stages of network operation.
Interest expense. Interest expense increased by $9.3 million, from
$15.2 million for the three months ended December 31, 1995 to $24.5 million for
the three months ended December 31, 1996, which included $22.7 million of
non-cash interest. This increase was attributable to an increase in long-term
debt, primarily the 12 1/2% Senior Discount Notes (the "12 1/2% Notes") issued
in April 1996, and an increase in capitalized lease obligations to finance
Telecom Services equipment used in the expansion of the Company's networks.
Interest income. Interest income increased $2.2 million from the three
months ended December 31, 1995 to $6.0 million for the three months ended
December 31, 1996. The increase is attributable to the interest earned on the
proceeds from the issuance of the 12 1/2% Notes and the 14 1/4% Exchangeable
Preferred Stock ("14 1/4% Preferred Stock") in April 1996.
Share of losses in joint venture. Effective October 1, 1996, the
Company sold its 50% interest in the Phoenix network joint venture. As a result,
no share of losses in joint venture was recorded during the three months ended
December 31, 1996, as compared to the $0.2 million recorded during the same
period in 1995. Future results will include the Company's share of losses from
the joint venture with CSW.
Other, net. Other, net fluctuated $1.7 million from $1.0 million net
expense in the three months ended December 31, 1995 to $0.7 million net income
in the three months ended December 31, 1996. Other expense recorded in the
three-month period ended December 31, 1995 represents the write-off of deferred
financing costs on a credit facility that was fully paid in December 1995. Other
income recorded in the three-month period ended December 31, 1996 is primarily
attributable to the $0.8 million gain recognized in conjunction with the sale of
the Company's 50% interest in the Phoenix network joint venture.
Minority interest in share of losses, net of accretion and preferred
dividends on subsidiary preferred stock. Minority interest in share of losses,
net of accretion and preferred dividends on subsidiary preferred stock increased
$1.8 million, from $3.2 million for the three months ended December 31, 1995 to
$5.0 million for the three months ended December 31, 1996. The increase is due
primarily to the issuance of the 14 1/4% Preferred Stock in April 1996. Minority
interest in share of losses, net of accretion and preferred dividends on
subsidiary preferred stock recorded during the current three-month period
consists of the accretion of issue costs ($0.1 million) and the accrual of the
preferred stock dividend ($5.7 million) associated with the 14 1/4% Preferred
Stock, offset by minority interest in losses of subsidiaries of $0.8 million.
Cumulative effect of change in accounting for revenue from long-term
telecom services contracts. The cumulative effect of change in accounting for
revenue from long-term telecom services contracts recorded during the three
months ended December 31, 1995 is due to the change in accounting principle as
described in "-Accounting Changes." As the change in accounting was
32
applied retroactively as of October 1, 1995, no similar amounts were recorded
during the three months ended December 31, 1996.
Fiscal 1996 Compared to Fiscal 1995
The following information reflects the results of operations for fiscal
1996 compared to the pro forma results of operations for fiscal 1995, assuming
the change in accounting for long-term telecom services contracts described in
"-Accounting Changes" had been applied retroactively.
Revenue. Revenue for fiscal 1996 increased $58.2 million, or 52%, from
fiscal 1995. The increase in total revenue reflects continued growth in Telecom
Services, Network Services and Satellite Services, offset slightly by the loss
in revenue resulting from the sale of four of the Company's teleports. Telecom
Services revenue increased 177% to $87.7 million due to an increase in network
usage for both special and switched access services, offset in part by a decline
in average unit prices. Switched services revenue increased from $7.2 million
(22% of Telecom Services revenue) for fiscal 1995, to $51.6 million (59% of
Telecom Services revenue) for fiscal 1996, of which $14.9 million relates to
revenue from Zycom compared to $1.4 million in fiscal 1995. Approximately $10.6
million of the increase in Zycom revenue relates to changes in the
classification of certain operating costs as a result of the Company entering
into long-term contracts with its major customers. Network usage as reflected in
VGEs increased 47% from 430,535 VGEs on September 30, 1995, to 630,697 VGEs on
September 30, 1996. On September 30, 1996, the Company had 2,067 buildings
connected to its networks compared to 1,375 buildings connected on September 30,
1995. Consistent with expectations, Network Services revenue growth has been
moderate, increasing from $58.8 million to $60.1 million, while the Company
continues to reposition its systems and operations to improve operating results.
Satellite Services revenue increased 4% to $21.3 million for fiscal 1996
primarily due to increased maritime minutes of use from cruise ships offset in
part by the decrease resulting from the sale of four of the Company's teleports.
Satellite Services revenue for fiscal 1995 and 1996, on a pro forma basis to
reflect the sale of teleports, was $11.4 million and $18.9 million,
respectively. Satellite Services revenue decreased $0.4 million from the third
quarter of fiscal 1996 to the fourth quarter of fiscal 1996. The decrease in
revenue was primarily due to three Navy vessels being in "dry dock."
Operating costs. Total operating costs for fiscal 1996 increased $56.4
million, or 72%, from fiscal 1995. Telecom Services operating costs increased
from $21.8 million, or 69% of Telecom Services revenue for fiscal 1995, to $78.7
million, or 90% of Telecom Services revenue for fiscal 1996. The increase in
operating costs in absolute dollars is attributable to the increase in switched
access services and the expansion in off-net special access service offerings.
The increase in operating costs as a percentage of total revenue is due
primarily to the increase in switched access services revenue, which generates
negative margins as a result of the higher costs associated with utilizing ILEC
network facilities and the investment in the development of local exchange
services without the benefit of corresponding revenue in the same period. The
Company expects that the Telecom Services ratio of operating costs to revenue
will continue to increase until the Company carries more traffic on its own
facilities rather than the ILEC facilities, provides a greater volume of higher
margin services, principally local telephone services, and obtains the right to
use unbundled ILEC facilities on satisfactory terms, any or all of which may not
occur.
33
Network Services operating costs increased 1% to $46.3 million and decreased as
a percentage of Network Services revenue from 78% for fiscal 1995 to 77% for
fiscal 1996. Satellite Services operating costs decreased to $10.3 million for
fiscal 1996, from $11.1 million for fiscal 1995. Satellite Services operating
costs as a percentage of revenue also declined to 48% for fiscal 1996, compared
to 54% for fiscal 1995. The decrease both in absolute dollars and as a
percentage of revenue is attributable to the decline in revenue resulting from
the sale of four of the Company's teleports, partially offset by an increase in
higher margin maritime services revenue at MTN.
Selling, general and administrative expense. SG&A expense for fiscal
1996 increased $13.8 million, or 22%, compared to fiscal 1995. This increase was
principally due to the continued rapid expansion of the Company's Telecom
Services networks and related significant additions to the Company's management
information systems, marketing and sales staff dedicated to the expansion of the
Company's networks and implementation of the Company's switched services
strategy and development of local telephone services. A portion of the increase
was also attributable to approximately $1.8 million of legal, accounting, and
SEC filing fees incurred in the incorporation of a new U.S. publicly traded
holding company, ICG Communications, Inc., and approximately $1.3 million of
consulting fees related to various process improvement initiatives. SG&A expense
as a percentage of total revenue was 45% for fiscal 1996, compared to 57% for
fiscal 1995. SG&A expense for Network Services increased due to increased
engineering, marketing and sales staff to support growth in network system
installations. Satellite Services SG&A expense increased primarily due to the
growth of MTN and MCN.
Depreciation and amortization. Depreciation and amortization increased
$13.7 million, or 83%, for fiscal 1996 compared to fiscal 1995. Depreciation of
fixed assets increased by approximately $7.0 million as a result of the
shortening of estimated depreciable lives discussed in "-Accounting Changes,"
and an increase in depreciable fixed assets due to the continued expansion of
the Company's networks. The increase in depreciation expense was offset slightly
due to the decrease in depreciable assets resulting from the sale of four of the
Company's teleports.
Interest expense. Interest expense increased by $61.3 million, from
$24.4 million for fiscal 1995 to $85.7 million for fiscal 1996, which included
$66.5 million of non-cash interest. This increase was attributable to an
increase in long-term debt, primarily the 13 1/2% Senior Discount Notes (the "13
1/2% Notes") issued in August 1995 and the 12 1/2% Notes issued in April 1996,
and an increase in capitalized lease obligations to finance the purchase of
Telecom Services and Satellite Services equipment. Also included in interest
expense is a charge of approximately $11.5 million for the payments made to
holders of the 13 1/2% Notes with respect to consents to amendments to the
indenture governing the 13 1/2% Notes in order to permit the 1996 Offering (as
defined herein) in April 1996.
Interest income. Interest income increased $15.1 million from fiscal
1995. The increase is attributable to the increase in cash from the proceeds of
the issuance of the 13 1/2% Notes in August 1995 and the 12 1/2% Notes and 14
1/4% Preferred Stock in April 1996.
Share of losses in joint venture. Share of losses in the Phoenix
network joint venture, in which the Company held a 50% equity interest,
increased $1.1 million, or 145%, from fiscal 1995
34
to $1.8 million for fiscal 1996 due to increased losses resulting from the
continued expansion and implementation of switched access services. Effective
October 1, 1996, the Company sold its interest in the Phoenix network joint
venture.
Provision for impairment of goodwill, investment and notes receivable.
Provision for impairment of goodwill, investment and notes receivable increased
$2.9 million from fiscal 1995 to $9.9 million for fiscal 1996. The current year
amount includes valuation allowances for the amounts receivable for advances
made to the Phoenix network joint venture included in long-term notes receivable
($5.8 million), the investment in the Melbourne network ($2.7 million) and the
note receivable from NovoComm, Inc. ($1.3 million). The allowances were a result
of management's estimate of the realizable value of the assets as of September
30, 1996.
Other, net. Other, net increased $8.3 million for fiscal 1996 from $0.8
million for fiscal 1995 due primarily to the loss on the sale of four of the
Company's teleports and certain other satellite assets ($1.1 million), the
write-off of certain assets ($2.5 million), settlement costs of certain
litigation ($1.2 million) and the write-off of deferred financing costs upon
conversion or settlement of debt ($2.7 million).
Minority interest in share of losses, net of accretion and preferred
dividends on subsidiary preferred stock. Minority interest in share of losses,
net of accretion and preferred dividends on subsidiary preferred stock increased
$24.2 million, from $1.1 million for fiscal 1995 to approximately $25.3 million
for fiscal 1996. The increase is due to the accretion of the Unit Warrants (as
defined herein) ($14.4 million) and issue costs ($1.1 million) associated with
the issuance of the 12% redeemable preferred stock of Holdings (the "Redeemable
Preferred Stock"), accretion of issue costs associated with the 14 1/4%
Preferred Stock ($0.3 million), accrual of the preferred stock dividend on the
Redeemable Preferred Stock ($2.1 million) and the 14 1/4% Preferred Stock ($9.1
million) and the excess redemption price over the stated value of the
convertible Series B Preferred Stock of Holdings-Canada ("Convertible Preferred
Stock of Holdings-Canada") ($1.0 million), partially offset by the minority
interest in losses of subsidiaries.
Income tax benefit. Income tax benefit for fiscal 1996 was $5.1 million.
The income tax benefit is due to an adjustment to the deferred tax liability as
a result of the change in estimated depreciable lives.
C