Back to GetFilings.com
FORM 10-K.--ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1997
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
(Commission file Number 1-11965) ICG
COMMUNICATIONS, INC.
(Commission file Number 333-40495)
ICG FUNDING, LLC
(Commission file Number 1-11052) ICG
HOLDINGS (CANADA), INC.
(Commission file Number 33-96540) ICG
HOLDINGS, INC.
(Exact names of Registrants as specified in their charters)
- ---------------------------------------- ---------------------------------------
Delaware 84-1342022
Delaware 84-1434980
Canada Not applicable
Colorado 84-1158866
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification No.)
- ---------------------------------------- ---------------------------------------
161 Inverness Drive West,
Englewood, Colorado 80112 Not applicable
161 Inverness Drive West,
Englewood, Colorado 80112 Not applicable
1710-1177 West Hastings Street c/o ICG Communications, Inc.
Vancouver, BC V6E 2L3 161 Inverness Drive West
P.O. Box 6742
Englewood, Colorado 80155-6742
161 Inverness Drive West Not applicable
Englewood, Colorado 80112
(Address of principal executive offices) (Address of U.S. agent for service)
- --------------------------------------------------------------------------------
Registrants' telephone numbers, including area codes: (888) 424-1144 or
(303) 414-5000
Securities registered pursuant to Section 12(b) of the Act:
- --------------------------------------------------------------------------------
Name of each exchange
Title of each class on which registered
- ---------------------------------------- ---------------------------------------
Common Stock, $.01 par value Nasdaq National Market
(44,621,254 shares outstanding on
March 26, 1998)
Not applicable Not applicable
Class A Common Shares, no par value Not applicable
(31,822,756 shares outstanding on
March 26, 1998)
Not applicable Not applicable
- ---------------------------------------- ---------------------------------------
Securities registered pursuant to Section 12(g) of the Act:
- --------------------------------------------------------------------------------
Title of class
- --------------------------------------------------------------------------------
Not applicable
Not applicable
Not applicable
Not applicable
- --------------------------------------------------------------------------------
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. [X]Yes [ ]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 March 26, 1998 the aggregate market value of ICG Communications, Inc. Common
Stock held by non-affiliates (using the closing price of $41.75 on March 26,
1998) was approximately $1,862,937,355.
ICG Communications, Inc. owns all of the issued and outstanding common
securities of ICG Funding, LLC.
On March 26, 1998, the aggregate market value of ICG Holdings (Canada), Inc.
Class A Common Shares held by non-affiliates (using the closing price of ICG
Communications, Inc. Common Stock of $41.75 on March 26, 1998), was
approximately $991,145.
ICG Holdings (Canada), Inc. owns all of the issued and outstanding shares of
Common Stock of ICG Holdings, Inc.
3
TABLE OF CONTENTS
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . 5
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Recent Developments . . . . . . . . . . . . . . . . . . . . . . 6
Telecom Services . . . . . . . . . . . . . . . . . . . . . . . 8
Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Telecom Services Networks . . . . . . . . . . . . . . . . . . 10
Services. . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Industry. . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Network Services . . . . . . . . . . . . . . . . . . . . . . . 16
Satellite Services . . . . . . . . . . . . . . . . . . . . . . 17
Customers And Marketing . . . . . . . . . . . . . . . . . . . . 18
Competition . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . 27
ITEM 3. LEGAL PROCEEDINGS . . . . . . . . . . . . . . . . . . . 27
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . 27
PART II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . . 28
ITEM 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . 29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . . . 32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . . . 53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURES . . . . . . . . . . 54
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANTS. . . . . 55
Executive Officers of ICG . . . . . . . . . . . . . . . . . . . 56
Directors of ICG . . . . . . . . . . . . . . . . . . . . . . . 57
Directors and Executive Officers of ICG Funding,
Holdings-Canada and Holdings. . . . . . . . . . . . . . . . . . 58
ITEM 11. EXECUTIVE COMPENSATION . . . . . . . . . . . . . . . . . 60
Director Compensation . . . . . . . . . . . . . . . . . . . . . 60
Compensation Committee Interlocks and Insider Participation . . 60
Board Compensation Committee Report on Executive Compensation . 60
Executive Compensation . . . . . . . . . . . . . . . . . . . . 62
Summary Compensation Table. . . . . . . . . . . . . . . . . . 63
Option/SAR Grants in Last Fiscal Year . . . . . . . . . . . . 65
Aggregated Option Exercises in Last Fiscal Year End
Option Values . . . . . . . . . . . . . . . . . . . . . . . . 66
Ten-Year Option/SAR Repricings. . . . . . . . . . . . . . . . 66
Executive Employment Contracts . . . . . . . . . . . . . . . . 68
4
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . 70
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS . . . . . 72
PART IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORT ON
FORM 8-K . . . . . . . . . . . . . . . . . . . . . . . . 74
Financial Statements. . . . . . . . . . . . . . . . . . . . . . 74
Report on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . 83
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
Financial Statement Schedule . . . . . . . . . . . . . . . . . 83
FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . . . . F-1
FINANCIAL STATEMENT SCHEDULE. . . . . . . . . . . . . . . . . . . . S-1
5
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 Funding, LLC ("ICG Funding"), ICG Holdings (Canada),
Inc. ("Holdings-Canada") and ICG Holdings, Inc. ("Holdings"); the terms "fiscal"
and "fiscal year" refer to ICG's fiscal year ending December 31 for 1997 and
September 30 for years prior to 1997. The Company changed its fiscal year end to
December 31 from September 30, effective January 1, 1997. All dollar amounts are
in U.S. dollars.
ITEM 1. BUSINESS
Overview
The Company is one of the nation's leading integrated communications
providers ("ICPs") of competitive communications services, based on estimates of
the industry's 1997 revenue. ICPs seek to provide an alternative to incumbent
local exchange carriers ("ILECs"), long distance carriers, Internet service
providers ("ISPs") and other communications service providers for a full range
of communications services in the increasingly deregulated telecommunications
industry. Through its competitive local exchange carrier ("CLEC") operations,
the Company operates networks in four regional clusters covering major
metropolitan statistical areas in California, Colorado, Ohio and the Southeast.
The Company also provides a wide range of network systems integration services,
maritime and international satellite transmission services, and subsequent to
January 21, 1998, a variety of Internet connectivity and other value-added
Internet services. As a leading participant in the rapidly growing competitive
local telecommunications industry, the Company has experienced significant
growth, with total revenue increasing from approximately $111.6 million for
fiscal 1995 to approximately $273.4 million for fiscal 1997.
The Federal Telecommunications Act of 1996 (the "Telecommunications Act")
and 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 competitive local dial tone. The
Company is marketing and selling local dial tone services in major metropolitan
areas in the following regions: California, which began service in late January
1997, followed by Ohio in February 1997, Colorado in March 1997 and the
Southeast in May 1997. During fiscal 1997, the Company sold approximately
178,000 local access lines, of which approximately 141,000 were in service as of
December 31, 1997. As a complement to its local exchange service, the Company
has begun marketing bundled service offerings which include long distance,
enhanced telecommunications services and data services. The Company has 19
operating high capacity digital voice switches and 15 data communications
switches, and plans to install additional switches as demand warrants.
In developing its telecommunications service offerings, the Company
continues to invest significant resources to expand its network. This expansion
is being undertaken through a combination of constructing owned facilities,
entering into long-term agreements with other telecommunications carriers,
establishing strategic alliances with utility companies and through mergers and
acquisitions. See "-Recent Developments."
6
Recent Developments
Merger with NETCOM On-Line Communication Services, Inc. On January 21,
1998, the Company completed a merger with NETCOM On-Line Communication Services,
Inc. ("NETCOM") ("NETCOM Merger"). Located in San Jose, California, NETCOM is a
provider of Internet connectivity and World Wide Web ("Web") site hosting
services and other value-added services. For calendar years 1995, 1996 and 1997,
NETCOM reported revenue of approximately $52.4 million, $120.5 million and
$160.7 million, respectively, and EBITDA losses of approximately $(6.3) million,
$(20.3) million and $(1.7) million, respectively. The Company will account for
the business combination under the pooling of interests method of accounting.
At the effective time of the NETCOM Merger, each outstanding share of
NETCOM common stock, $.01 par value, became automatically convertible into
shares of ICG common stock at an exchange ratio of 0.8628 shares of ICG common
stock per NETCOM common share. As a result of this transaction, the Company
expects to issue an estimated 10.2 million shares of ICG common stock for the
NETCOM common shares outstanding on January 21, 1998. Cash will be paid in lieu
of any fractional shares.
The Company believes that the NETCOM Merger will create a full-service
business communications company providing a single source for a complete range
of voice, data, Internet, Web site hosting and other communications services
over an extensive fiber optic network. Currently, approximately one-half of
NETCOM's customers are located in the Company's existing network territory. It
is anticipated that the NETCOM Merger will enable the combined entity to better
utilize ICG's fiber and frame relay networks by providing NETCOM with extensive
network infrastructure for the on-net transportation of its Internet traffic.
Announcement of New Service Offerings. In March 1998, the Company announced
its plans to offer long distance service via Internet protocol ("IP") technology
at rates as low as 5.9 cents per minute. This service will be offered in 166
cities across the nation, covering 90% of the U.S. long distance market, by the
end of fiscal 1998. ICG and NETCOM will begin to market this service over the
Internet and through its inbound telemarketing center in the second quarter of
1998. The Company also plans to offer by the end of fiscal 1998 competitively
priced high-speed data transmission services via digital subscriber line ("DSL")
technology to all business and end user customers within its existing regional
clusters. DSL technology utilizes the existing twisted copper pair connection to
the business or end user, giving the customer significantly greater bandwidth
when connecting to the Internet.
Acquisition of Communications Buying Group, Inc. On October 17, 1997, the
Company purchased approximately 91% of the outstanding capital stock of
Communications Buying Group, Inc. ("CBG"), an Ohio based local exchange and
centrex reseller (the "CBG Acquisition"). The Company paid total consideration
of approximately $46.5 million, plus the assumption of certain liabilities.
Separately, on October 17, 1997, the Company sold approximately $16.0 million of
common stock, $.01 par value ("Common Stock"), to certain shareholders of CBG.
The Company purchased the remaining approximately 9% interest of CBG on March
24, 1998 for approximately $2.9 million in cash.
7
CBG focuses its sales and marketing efforts on small to medium-sized
businesses in certain cities in Ohio and provides a one-stop solution for the
local and long distance needs of its customers. For calendar years 1996 and
1997, CBG's revenue was approximately $21.4 million and $33.8 million,
respectively, and EBITDA losses were approximately $(1.0) million and $(3.2)
million, respectively.
The Company believes that the business strategy of CBG is closely aligned
with the Company's business strategy and that it can successfully leverage the
services offered by CBG to enhance the Company's offering of similar services in
its existing Ohio markets, including all those currently served by CBG. As of
December 31, 1997, the acquisition of CBG has more than doubled the Company's
sales presence in Ohio to approximately 91 people. In addition, the Company
believes that its ability to migrate, over time, a portion of CBG's existing
customer base to its fiber optic facilities offers significant cost savings. The
Company believes that the transaction has significantly furthered its goal of
becoming the dominant alternative to the ILEC in Ohio.
Network Expansion. The Company continues to expand its network footprint
through several strategic initiatives with utility companies and other
telecommunication carriers. In January 1997, the Company announced an agreement
with a subsidiary of The Southern Company ("Southern") that will permit the
Company to construct a 100-mile fiber optic network in the Atlanta metropolitan
area. In June 1997, the Company entered into an indefeasible right of use
("IRU") agreement with Qwest Communications Corporation for approximately 1,800
miles of fiber optic network and additional broadband capacity in California,
Colorado, Ohio and the Southeast. The Company expects this new capacity will be
used for the transmission of local, long distance and data communications
services in and between the Company's markets.
CSW Strategic Alliance. In January 1997, the Company announced a strategic
alliance with Central and South West Corporation ("CSW") which was formed for
the purpose of developing and marketing telecommunications services in Austin,
Corpus Christi, Dallas, Houston and San Antonio, Texas. The venture entity, a
limited partnership named CSW/ICG ChoiceCom, L.P. ("ChoiceCom"), is based in
Austin, Texas. CSW holds 100% of the interest in ChoiceCom and the Company has
an option to purchase a 50% interest at any time prior to July 1, 2003.
Subsequent to July 1, 1999, if the Company has not exercised its purchase
option, CSW will have the right to sell, at a price pursuant to the terms of the
limited partnership agreement, either 51% or 100% of the partnership interest in
ChoiceCom to the Company. CSW and the Company each have two representatives on
the Management Committee of the general partner of ChoiceCom. ChoiceCom is
currently offering local exchange, long distance and long haul services in
Austin, Corpus Christi, Dallas, Houston and San Antonio, Texas and other
selected areas of Texas and may offer these services as well as data
communications and other services in Arkansas, Louisiana and Oklahoma.
Financings. In March 1997, the Company raised net proceeds of $192.4
million from the sale of 11 5/8% Senior Discount Notes due 2007 (the "11 5/8%
Notes") of Holdings and 14% Exchangeable Preferred Stock Mandatorily Redeemable
2008 (the "14% Preferred Stock") of Holdings. Cash interest on the 11 5/8% Notes
accrues at 11 5/8% per annum beginning March 15, 2002 and is payable each March
15 and September 15, commencing September 15, 2002. The 14% Preferred Stock
accrues dividends quarterly at a rate of 14% per annum. Dividends are payable
quarterly in cash or, on or prior to March 15, 2002, at the sole option of
Holdings, in additional shares of 14% Preferred Stock. The 11 5/8% Notes and the
14% Preferred Stock have been registered under the Securities Act.
8
In September and October 1997, the Company's new wholly owned subsidiary,
ICG Funding, LLC, a Delaware limited liability company, completed a private
placement of $132.25 million of Exchangeable Limited Liability Company Preferred
Securities (the "6 3/4% Preferred Securities"). The 6 3/4% Preferred Securities
are mandatorily redeemable November 15, 2009 at the liquidation preference of
$50.00 per security, plus accrued and unpaid dividends. Dividends on the 6 3/4%
Preferred Securities are cumulative at the rate of 6 3/4% per annum and are
payable in cash through November 15, 2000 and, thereafter, in cash or shares of
Common Stock at the option of ICG Funding. The 6 3/4% Preferred Securities are
exchangeable, at the option of the holder, into Common Stock at an exchange
price of $24.025 per share, subject to adjustment. ICG Funding may, at its
option, redeem the 6 3/4% Preferred Securities at any time on or after November
18, 2000. Prior to that time, ICG Funding may redeem the 6 3/4% Preferred
Securities if the current market value of Common Stock equals or exceeds the
exchange price, for at least 20 days of any consecutive 30-day trading period,
by 170% prior to November 16, 1998; by 160% from November 16, 1998 through
November 15, 1999; and by 150% from November 16, 1999 through November 15, 2000.
The 6 3/4% Preferred Securities and the Common Stock issuable upon exchange of
such securities have been registered under the Securities Act.
In February 1998, the Company raised proceeds, net of underwriting costs,
of approximately $291.6 million from the sale of 10% Senior Discount Notes due
2008 (the "10% Notes") of ICG Services, Inc., a Delaware corporation and newly
formed, wholly owned, unrestricted subsidiary of ICG ("ICG Services"). Cash
interest on the 10% Notes accrues at 10% per annum beginning February 15, 2003
and is payable each February 15 and August 15, commencing August 15, 2003. The
10% Notes will be redeemable at the option of ICG Services, in whole or in part,
on or after February 15, 2003. ICG Services is obligated to register the 10%
Notes under the Securities Act.
ICG Equipment, Inc. In January 1998, the Company formed ICG Equipment,
Inc., a Colorado corporation and wholly owned subsidiary of ICG Services ("ICG
Equipment"). Holdings' subsidiaries intend to enter into arrangements with ICG
Equipment to purchase or lease telecommunications equipment, software and
capacity and related services. The equipment and services provided to Holdings'
subsidiaries will be utilized to upgrade and expand its network infrastructure
to take full advantage of the opportunities and cost savings available as a
result of the acquisitions made by ICG Services. Any such arrangements will be
on an arm's length basis and on comparable terms that Holdings' subsidiaries
would be able to obtain from a third party.
Telecom Services
The Company operates local exchange networks in the following markets
within its four regional clusters: California (Sacramento, San Diego and
portions of the Los Angeles and San Francisco metropolitan areas); Colorado
(Denver, Colorado Springs and Boulder); Ohio (Akron, Cleveland, Columbus, and
Dayton) and the Southeast (Birmingham, Charlotte, Louisville, and Nashville).
The Company plans to build a network in Atlanta, Georgia in conjunction with
Southern. Through its strategic alliance with CSW, the Company is offering
services in Austin, Corpus Christi, Dallas, Houston and San Antonio, Texas and
other selected areas of Texas, and may offer services in Arkansas, Louisiana and
Oklahoma in the future. See "-Recent Developments." The Company will continue to
expand its network through construction, leased facilities and strategic
alliances and through acquisitions. The Company's operating networks have grown
from 627 fiber route miles at the end of fiscal 1995 to 3,043 fiber route miles
as of December 31, 1997. Telecom Services revenue has increased from
approximately $32.3 million for fiscal 1995 to approximately $177.7 million for
fiscal 1997.
9
The Company's new subsidiary, NETCOM, is a leading provider of high quality
Internet solutions to individuals and small and medium-sized businesses in the
United States and also provides the same high quality Internet solutions in
Canada and the United Kingdom. NETCOM offers a broad spectrum of Internet
solutions designed to enhance customer productivity through the integration and
application of technologies by providing a comprehensive software platform to
interface with the Web, premium quality Internet access and support services and
on-line tools to automate Web site creation and development. These offerings
have led to significant growth, with revenue increasing from approximately $2.4
million for 1993 to approximately $160.7 million for the calendar year ended
December 31, 1997. In January 1997, NETCOM announced plans to migrate its
customer focus away from high volume, low margin consumer customers to higher
margin products for small and medium-sized business customers.
Strategy
The Company's objective is to be a premier provider of high quality
communications services to its targeted business, carrier and end user
customers. The key elements of this strategy are:
Increase Revenue and Margins through Bundled Services to Business End
Users. The Company believes that customers are increasingly demanding a broad,
full service approach to providing telecommunications services. By offering
integrated technology-based communications solutions, management believes the
Company will be better able to capture business from
telecommunications-intensive commercial accounts. To this end, the Company plans
to complement its competitive local and long distance telecommunications
offerings with its recently announced IP telephony service and the Internet
products developed by NETCOM, and cross-market these combined products through
ICG's direct sales force. Additionally, NETCOM intends to market ICG's
telecommunications products to its small and medium-sized business customer base
over the Internet. Management believes a targeted business end user strategy can
better leverage ICG's network footprint and telecommunications investment.
10
Concentrate Networks 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 and
expanded service offerings. As a result, the Company has concentrated its
networks in regional clusters serving major metropolitan areas in California,
Colorado, Ohio and the Southeast. The Company is expanding its network footprint
to include certain cities in Texas through a strategic alliance with CSW and
intends to further expand its network footprint to include Atlanta, Georgia
through its agreement with Southern. In addition, NETCOM may be able to realize
extensive cost synergies by focusing future growth within ICG's existing
footprint. For example, a significant portion of NETCOM's customer base is
located in California. To the extent feasible, NETCOM will route its Internet
traffic over ICG's California network. NETCOM plans to continue to operate and
grow its business in the United States outside of ICG's network footprint and in
Canada and the United Kingdom. See "-Recent Developments."
Network Connectivity. Significant amounts of telecommunications traffic are
carried within the Company's regional clusters. Management believes that
integrating these clusters through the connection of individual networks will
provide significant benefits, including cost advantages. These cost advantages
would result from the Company's ability to carry regional traffic on-net,
thereby improving operating margins by reducing payments to other carriers for
the use of their facilities. Accordingly, the Company is in the process of
connecting networks within each of its California, Colorado and Ohio clusters
with intrastate fiber optic cable.
Alliances with Utilities. The Company has established 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,
which is more timely and cost effective than 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.
Integrate Investments and Expand. The Company expects to acquire
telecommunications, Internet and related businesses that complement ICG's
business strategy to offer a wide array of telecommunications, Internet and
related services, primarily to business customers. Acquisition targets could
include U.S. and foreign CLECs, ISPs and long distance companies, among others.
The Company intends to make future acquisitions primarily through the use of
Common Stock, cash on hand and the proceeds from securities offerings.
Telecom Services Networks
The Company's networks are generally comprised 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.
11
The Company's networks are generally configured in redundant synchronous
optical network ("SONET") rings that offer the advantage of uninterrupted
service in the event of a fiber cut or 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 ILEC
networks and services.
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 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 monitors and manages the
Company's transport networks and provides high-level monitoring of the Company's
local exchange switches. Additionally, the Company contracts with Lucent
Technologies, Inc. for detailed performance monitoring of its local exchange
switches. 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.
Switched services involve the transmission of voice, video 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 an 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 physically connected to the Company's owned or leased network.
In addition, a switch is required in order for the Company to provide the full
range of local telephone services. The Company is marketing and selling
competitive local dial tone services in California, Colorado, Ohio and the
Southeast. See "-Regulation-State Regulation."
NETCOM owns and operates a data communications network consisting of 17
hubs containing frame relay switches and high-performance routers connecting a
backbone of leased Asynchronous Transfer Mode ("ATM") switches and leased
high-speed dedicated data lines in the United States, Canada and the United
Kingdom. NETCOM maintains 247 POPs in the United States and Canada and also
offers virtual local access numbers in Canada and the United Kingdom. The design
and architecture of the physical network permits NETCOM to offer highly
flexible, reliable high-speed services to its customers and support significant
subscriber growth. The NETCOM infrastructure is monitored by network operations
centers ("NOCs") in San Jose, California, Dallas, Texas, Toronto, Canada and
London, England.
12
Services
The Company's competitive local exchange services include local dial tone,
long distance, data services, special access and interstate and intrastate
switched access services. 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
believes that having a full complement of communications services, including
local and long distance services, will strengthen its overall market position
and help the Company to better penetrate the local exchange marketplace. The
Company has also developed long distance services, including calling and debit
cards, to complement its local exchange services family of products. The Company
recently announced plans to offer a bundled service of local, long distance and
data services, including Internet services, delivered over a T-1 connection.
This service will be offered primarily to ICG's larger business customers.
The Company announced its initial offering of long distance services in May
1997. The target customers for such services are the Company's existing and end
user customers. The Company's existing switches have facilitated the entry into
this business and reduced its cost of obtaining long distance transmission
capacity. However, the Company has been reliant on other carriers to provide
transmission and termination of long distance traffic. Therefore, the Company
has entered into transmission agreements, which typically provide for
transmission 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.
The Company recently announced its plans to offer IP long distance services
priced as low as 5.9 cents per minute in 166 markets by the end of 1998. The
Company plans to carry the IP traffic over NETCOM's data backbone network and
terminate a large portion of the traffic via NETCOM's 238 POPs in the United
States, thereby eliminating terminating access charges. If a call cannot be
terminated over ICG's facilities, it will be billed at a rate of 7.6 cents per
minute. The Company expects to begin offering this service during the second
quarter of 1998, initially targeting NETCOM's existing customer base of over
500,000 customers. The Company plans to market this product via the Internet and
through the Company's inbound telemarketing center.
The Company also announced that it will offer DSL services with speeds
ranging from 144kbps to 9mbps to offer its customers high-speed Internet access.
The Company plans to lease unbundled local loops from the ILEC in the respective
market and install its DSL equipment in the ILEC central office and the
customer's premises. This service will be offered primarily to the small
business and work-at-home markets, which historically have been a large
percentage of NETCOM's customer base.
13
To complement its telecommunications services offerings, the Company
announced its initial offering of data communications services in California,
Colorado and Ohio during the first quarter of 1997. These services targeted the
Company's existing customers and other businesses with substantial data
communications requirements. Although to date, the Company has not generated
substantial revenue from such services, the Company expects that its new service
offerings, including its IP telephony strategy and DSL technology, and NETCOM's
extensive experience providing data transmission services, will allow the
Company to significantly enhance its presence within the data communications
market during fiscal 1998.
Private line services are generally used to connect the separate locations
of a single business outside of local access and transport area ("LATA").
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 all within the same local calling area or LATA.
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. In order to leverage its
significant network investment, the Company has markets 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.
The Company has experienced negative operating margins from the provision of
wholesale switched services because it relies on ILEC networks to terminate and
originate customers' switched traffic. The Company has recently raised prices on
its wholesale switched services product in order to improve margins and is
de-emphasizing its wholesale switched services to free up switch port capacity
for its higher margin dial tone product. In addition, as the Company provides a
greater portion of the local segment of a call, the Company expects to
experience improved operating margins.
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 advanced intelligence
network platforms, a set of services and signaling options that carriers can use
to create new services or customer options. Carriers purchase connections into
the Company's SS7 network, and also purchase connections to other carriers
(local and long distance) on a monthly recurring basis.
14
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.
NETCOM. Through its merger with NETCOM, the Company currently provides
Internet solutions principally through dial-up, direct access and Web site
hosting services. Direct access and Web site hosting services provide higher
revenue per customer and higher margins than dial-up services. NETCOM also
receives revenue from value-added services such as security, anti-virus and data
storage.
Dial-Up Services. NETCOM's dial-up customers receive an integrated Internet
solution consisting of high quality access, software and 24 hours a day, seven
days a week, automated customer support. NETCOM dial-up customers connect
directly to the Internet via NETCOM's network which provides high speed,
reliable access. All NETCOM dial-up accounts allow access to the Internet's
resources, including E-mail, the Web and USENET newsgroups. In addition, NETCOM
dial-up customers can receive a one megabyte ("Mb") personal Web page, access to
a daily customized newspage via E-mail, and access to on-line financial,
corporate and market information and analytical tools. Enhanced services
available to dial-up customers include features such as additional E-mail
addresses, enhanced support offerings, software and virus updates, access to
research libraries, domain name service, monthly back-up, 10 Mb data storage,
750 Mb per month data transfer capability and premium service and technology
support.
NETCOM customers can quickly register using NETCOMplete software, available
for both Windows and Macintosh platforms via compact disk, and set up a NETCOM
account by following a sequence of simple, on-screen steps. All of the software
needed to connect and access the Internet is automatically installed and
configured, eliminating the need for complex set up procedures. NETCOMplete also
provides an easy-to-use interface as well as software from leading industry
participants, bookmark managers, off-line browsers and additional software that
enhances a customer's Internet experience. Revenue from dial-up services
increased from $102.9 million for the calendar year ended December 31, 1996 to
$133.7 million for the calendar year ended December 31, 1997, representing
approximately 85% and 83%, respectively, of total NETCOM revenue for such
periods.
Direct Access Services. NETCOM offers a full suite of high-speed dedicated
Internet connection and service products which provide its small and
medium-sized business customers with direct access to the full range of Internet
applications. These Internet services are offered to businesses over leased
lines at various speeds, including 56 Kbps, T-1 and T-3 levels, depending upon
the customer's needs. Through its direct access product line, NETCOM offers
Internet access services including domain name and Internet protocol address,
router configurations, on-line usage statistics and security consultation. There
are generally no usage charges for any of NETCOM's dedicated customers, and
E-mail service and USENET news feed are provided at no additional charge. Direct
network connection requires the customer to obtain a leased line from ICG or
another local telephone company. NETCOM provides an Internet connection based on
frame relay technology provided by local telephone carriers. Revenue from direct
access services increased from $16.3 million for the calendar year ended
December 31, 1996 to $19.5 million for the calendar year ended December 31,
1997, representing approximately 14% and 12%, respectively, of total NETCOM
revenue for such periods.
15
Web Site Hosting Services. NETCOM offers Web site hosting services to its
small and medium-sized business customers as well as to individuals. Web site
hosting services include client domain name registration, hosting and site
maintenance. Services provided are fully scalable but would, in a typical
package, include domain name registration, 10 E-mail addresses, access to
NETCOM's on-line business center, CGI scripting (which enables visitors to the
Web site to leave their names and addresses), weekly back-up service, 50 Mb of
data storage, 1,000 Mb per month of data transfers, traffic logs and Web
statistics and premium service and technology support. Revenue from Web site
hosting services increased from $1.3 million for the calendar year ended
December 31, 1996 to $6.3 million for the calendar year ended December 31, 1997,
representing approximately 1% and 4%, respectively, of total NETCOM revenue for
such periods.
Value-Added Services. As part of its dial-up, direct access and Web site
hosting services, NETCOM offers its small and medium-sized business customers
value-added business connectivity solutions package designed to address their
needs of increased security, reliability, access speed and customer service. The
Company believes that businesses are willing to pay premium prices for these
premium services. One such feature is Automatic Reconnect which automatically
re-routes customers' traffic to an alternate Integrated Services Digital Network
("ISDN") line so that in the event of certain kinds of service interruptions
customers may remain connected. In order to provide a secure, private connection
among multiple specific locations, NETCOM's SecureConnect product performs a
security assessment and then implements, monitors and troubleshoots a flexible
security solution to provide secure communication between central offices,
branch offices and off-site employees without jeopardizing the integrity of the
internal network. Another value-added service NETCOM offers is 24 hours a day,
seven days a week support. For larger customers, NETCOM offers flexible,
high-speed dedicated line service that is scalable to grow as traffic increases.
Other value-added services offered include password protected Web sites, usage
statistics, anti-virus software and additional domain names.
Zycom. The Company owns a 70% interest in Zycom Corporation ("Zycom") which
operates an 800/888/900 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 in the local telephone services market as an ICP. The
Company is competing in the local, long distance and data communications
markets, and subsequent to January 21, 1998, the Internet services market, 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.
16
Local telephone service competition was made possible by the
Telecommunications Act and by deregulatory actions at the state level. Prior to
passage of the Telecommunications Act, firms like the Company were generally
confined to providing private line and 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 competitive access providers to offer customers
less expensive and higher quality special access and private line services than
the ILECs.
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 changes in state and federal regulations, CLECs have expanded
their services from providing competitive access and private line services to
providing all local exchange services to become true competitors to the ILECs.
See "-Regulation."
The Internet access services market is one of the fastest growing segments
of the telecommunications services market. According to industry research
analysts, the market for consumer and business Internet connectivity and
enhanced services exceeded $3 billion in 1996, and is estimated to reach $18
billion in revenue by the year 2000, reflecting a compounded annual growth rate
of approximately 50%. Business connectivity and value-added services are
estimated to represent in excess of 50% of the overall market. The use of the
Internet by small and medium-sized businesses in particular is expected to grow
substantially from its current low levels of market penetration.
ISPs provide customers with a variety of services to meet their
Internet-related needs. Internet services include the following categories: (i)
access services (dial-up, direct access and Web site hosting); (ii) value-added
services (security services, anti-virus and data storage); and (iii) content
services (information creation, aggregation and delivery). Some ISPs offer all
of these services while others specialize in only one or two. As the market
continues to segment in these three areas, there are opportunities for both the
specialists who can provide superior service in one area, as well as
full-service providers who can bundle services and offer discounts. There were
over 4,300 ISPs in the United States and Canada as of October 31, 1997 compared
to just over 3,000 as of October 31, 1996. There have been some large
acquisitions of ISPs as CLECs and others attempt to enter the industry. Because
of low barriers to entry, there are local and regional ISPs entering the market,
which has caused the level of competition to intensify.
The availability of an expansive variety of compelling business and
consumer applications over the Internet has attracted a large number of consumer
and business users. The total number of connections to ISP networks, according
to International Data Corporation, was 17 million as of November 1997, and is
predicted to reach over 30 million by the year 2000. Market trends contributing
to the overall growth in connectivity include advancements in technologies
required to navigate the Internet, the availability of Internet connectivity,
and the rich consumer and business content available. The Company believes that
ongoing development of access to and applications of the Internet will continue
to attract a valuable consumer audience for businesses.
Network Services
Through the Company's wholly owned subsidiary, ICG 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 approximately $65.6 million for fiscal 1997.
17
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 ongoing
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 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
Satellite Services operations was approximately $30.0 million for fiscal 1997.
The Company intends to dispose of its Satellite Services operations to better
focus its efforts on its core Telecom services unit, although it has not entered
into a formal arrangement for such disposition.
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 issued by the FCC. MTN provides private
communications networks to various cruise lines allowing for the transmission of
data communications and allowing passengers to make calls from their cabins to
anywhere in the world. MTN additionally provides its communications services to
seismic vessels, to commercial shipping vessels and to the U.S. Navy in
conjunction with a major long distance provider, which serves as the long
distance carrier, while MTN provides the shipboard communications equipment. The
Company believes that the radio spectrum employed under its experimental license
and a recent grant of Special Temporary Authority ("STA"), which uses C-band
radio frequencies, enables it to provide a higher quality maritime service than
is available through the radio frequencies currently allocated to other maritime
service providers.
18
In April 1996, the FCC issued a waiver allowing MTN to apply for a
permanent FCC license to utilize the same C-band frequencies as are being used
under the experimental license. MTN's application is pending. The Company's
experimental license was renewed for an additional two-year period on November
21, 1997. 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 six-month periods. MTN filed for six-month renewals for the STA on
July 25, 1997 and January 27, 1998 and the Company has received verbal grants of
the six-month extensions. There can be no assurance that the Company will be
granted a permanent license, that the experimental license and STA currently
being used will continue to be renewed for future terms 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 MarineSat
Communications Network, Inc. ("MCN") (formally Maritime Cellular TeleNetwork,
Inc.), 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. In April 1997,
the Company received the remaining 10% equity interest in MCN as a partial
consideration for the sale of another of its subsidiaries.
Nova-Net. In May 1994, the Company acquired Nova-Net Communications, Inc.
("Nova-Net"), which provides private data networks utilizing very small aperture
terminals ("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 interconnect 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 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 the Company's business customers at
cost-effective rates. Wholesale customers typically re-market the Company's
services to the retailer's end user, under the retailer'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.
19
The Company markets its Telecom Services products through direct sales to
end users and wholesale accounts, and direct mail, to a limited extent. Telecom
Services revenue from major long distance carriers and resellers constituted
approximately 78%, 71%, 69% and 64% of the Company's Telecom Services revenue in
fiscal 1995 and 1996, the three-month period ended December 31, 1996 and fiscal
1997, 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 bundled service offerings,
increases its sales and marketing teams and focuses more on the end user segment
of the market. In support of this strategy, the Company has substantially
increased its direct sales and marketing staff. The Company's sales force has
grown from 143 people at December 31, 1996 to approximately 356 people
(including sales management, technical sales support and administrative support)
at December 31, 1997. 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's
marketing staff is located in Denver, Colorado.
NETCOM's primary focus is on providing high quality Internet solutions to
individuals and to small and medium-sized businesses. In order to achieve this
objective, NETCOM engages in marketing and advertising activities, alliances
with key strategic partners, seminars in targeted regional markets, and
distribution via both direct and indirect channels. NETCOM's current marketing
efforts emphasize its strategy of focusing on providing premium services to
businesses and individuals through integrated product offerings. The campaign
incorporates the theme of productivity and efficiency and includes an emphasis
on the full range of NETCOM solutions. NETCOM's current marketing and
distribution channels include original equipment manufacturer arrangements,
agreements with value-added resellers, retail distribution, direct marketing
efforts, including trade shows and telesales, and the Web.
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 resale
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, mainly the Regional Bell Operating Companies ("RBOCs") and GTE
which are among the Company's current competitors. Also included among the
Company's current competitors are other ILECs, other CLECs, network systems
integration service 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, ILECs outside their
current local service areas, and the local access operations of long distance
carriers. Consolidation of telecommunications companies, including mergers
20
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, including segments in which the Company participates and expects to
participate. For example, AT&T Corp. ("AT&T"), MCI Communications Corp. ("MCI"),
Time Warner Communications, Inc., Texas Utilities Company and other large
companies 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.
21
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. In May 1997, the FCC released a decision amending and reforming
many of its access charge rules and sought further comment on additional issues.
In addition, the FCC released a separate decision in May 1997 reforming its
rules on universal service subsidies pursuant to the requirements of the
Telecommunications Act. As a whole, the FCC's decision reforming the access
charge rules is not likely to have a material adverse impact on the Company's
access services offerings, because the decision required relatively small
decreases in total access prices charged by the ILECs. The major impact of the
FCC's decision was to shift access cost recovery by the ILECs to flat-based
charges from usage-sensitive (minute-of-use) charges. The continued lowering of
access rates and increased pricing flexibility for the RBOCs and GTE may
adversely affect 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 to seek permission 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.
In addition, the long distance and data transmission businesses are
extremely competitive and prices have declined substantially in recent years and
are expected to continue to decline.
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.
22
Internet Services. Beginning January 21, 1998, the Company also faces
competition within the Internet services market. The market for Internet access
and related services is highly competitive. There are no substantial barriers to
entry and the Company anticipates that competition will continue to intensify as
the use of the Internet grows. The tremendous growth and potential market size
of the Internet access market has attracted many new start-ups as well as
existing businesses from different industries. Current and prospective
competitors include, in addition to other national, regional and local ISPs,
long distance and local exchange telecommunications companies, cable television,
direct broadcast satellite, wireless communications providers, and on-line
service providers.
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 opened the local and long distance markets to
additional competition and changed 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 to some extent for implementing and
enforcing the pro-competitive policies and the provisions for the
Telecommunications Act.
The Telecommunications Act generally requires ILECs to negotiate agreements
to provide interconnection and nondiscriminatory access to their networks on
more favorable terms than were previously 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 desirable 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 federal courts.
There can be no assurance that the Company will be able to negotiate acceptable
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.
On August 8, 1996, in two separate decisions (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. Numerous parties appealed both of the FCC's orders to the Eighth Circuit
Court, and in October 1996 the Eighth Circuit Court stayed the implementation of
many of the rules in the First Report and Order. On July 18, 1997, the Eighth
Circuit Court issued a decision on the First Report and Order which upheld
certain of the FCC's rules and reversed the FCC's rules on other issues,
including the pricing rules. On August 22, 1997, the Eighth Circuit Court issued
its decision on the Second Report and Order, which concluded that the FCC had
exceeded its jurisdiction in issuing certain rules on dialing parity.
23
Separate petitions for rehearing of the July 18 decision were filed with
the Eighth Circuit Court by a group of interexchange carriers, two groups of
ILECs and a group of CLECs. On October 14, 1997, the Eighth Circuit Court
granted the ILEC petitions for rehearing, and denied the CLEC and IXC petitions.
The Court's decision on rehearing vacated an additional FCC rule that addressed
the ability of new entrants to purchase ILEC network elements at cost-based
rates on a bundled rather than an unbundled basis.
The FCC and other parties filed petitions for certiorari seeking review by
the U.S. Supreme Court of the Eighth Circuit Court's decision, and the U.S.
Supreme Court has granted the petitions for certiorari and agreed to review the
case. It is anticipated that the case will be argued before the U.S. Supreme
Court in the fall of 1998, with a final decision issued in 1999. The Eighth
Circuit Court's ruling remains in effect pending final action by the U.S.
Supreme Court.
On December 31, 1997, the United States District Court for the Northern
District of Texas, in a case brought by SBC Communications, Inc., issued a
decision holding that Sections 271 through 275 of the Telecommunications Act are
unconstitutional. The decision addresses the restrictions contained in Sections
271 through 275 of the Telecommunications Act on the lines of businesses in
which the RBOCs may engage, including establishing the conditions that the RBOCs
must satisfy before they may provide interLATA long distance telecommunications
services in their local telephone service areas. On February 11, 1998, a stay of
the decision was issued by the United States District Court for the Northern
District of Texas, which stay will remain in effect pending appeal of the
decision by the Fifth Circuit Court of Appeals.
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
international services on an ongoing basis. The Company's provision of
international long distance services requires prior authorization by the FCC
pursuant to Section 214 of the Telecommunications Act, which the Company has
obtained. The FCC recently eliminated the requirement that non-dominant
interstate access carriers must file tariffs. 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 for services in the United States. The Company may install and
operate non-radio facilities for the transmission of domestic interstate
communications without prior FCC authorization. The Company's use of digital
microwave radio frequencies and satellite earth stations 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."
24
State Regulation. In general, state regulatory agencies have regulatory
jurisdiction over the Company when Company facilities and services are used to
provide local and other 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 and can set prices for
interconnection by CLECs with the ILEC networks. 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, Georgia, Indiana, Kentucky, North
Carolina, Ohio, Oklahoma, Tennessee and Texas. The Company has authority to
provide local and intrastate long distance services in each of these states.
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, often based on a percentage of
gross revenue, in order to provide telecommunications services, although in
certain states including California and Colorado, such fees may be imposed under
current state law. Certain municipalities in Colorado, however, are continuing
to charge franchise fees pending enforcement by the Colorado courts. 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 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.
25
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. 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 point-to-point microwave radio licenses that are used to provide
telecommunications services in California. Additionally, the Company holds a
number of satellite earth station licenses in connection with its operation of
satellite-based 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 and STA. 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. Applications for six-month extensions of the STA were
filed on July 25, 1997 and on January 27, 1998 and verbal grants of the
extensions have been issued by the FCC. There can be no assurance that the
Company will be granted a permanent license, that the experimental license and
STA currently being used will continue to be renewed for future terms or that
any license granted by the FCC will not require substantial payments from the
Company.
Regulation of Internet Services. The Company is currently providing
Internet access services through its recently acquired subsidiary, NETCOM, in
part through data transmissions over public telephone lines. These transmissions
are governed by regulatory policies establishing charges and terms for wire-line
communications. Although the Company is not currently subject to direct
regulation by the FCC or any other governmental agency (other than regulations
applicable to businesses generally), due to the increasingly widespread use of
the Internet, it is possible that additional laws and regulations may be adopted
with respect to the Internet, covering issues such as content, user privacy,
pricing, libel, intellectual property protection and infringement, and
technology export and other controls. It also is possible that the Company could
become subject to regulation by the FCC or another regulatory agency as a
provider of basic telecommunications services. The FCC is currently reviewing
its regulatory positions on whether to impose common carrier regulation on the
network transport and communications facilities aspects of an enhanced or
information service package. Such changes in the regulatory structure and
environment affecting the Internet access market, including regulatory changes
that directly or indirectly affect telecommunications costs or increase the
likelihood of competition from the RBOCs or other telecommunications companies,
could have an adverse effect on the Company's business. For example, the FCC is
considering whether ISPs should be required to pay access charges to local
telephone companies for each minute that dial-access users spend connected to
ISPs through telephone company switches, and is also considering whether ISPs
should be required to make monetary contributions to federal universal service
funds. In addition, some telephone companies are seeking similar relief through
state regulatory agencies. Such rules, if adopted at either the federal or state
level, would have a material adverse effect on the Company. The Company cannot
predict the impact, if any that future regulation or regulatory changes may have
on its business.
26
Certain states have deemed the provision of Internet services to be taxable
and in such states, NETCOM collects such taxes from its customers. Other states
have not yet announced a policy in this regard or have affirmatively decided
that such services are not taxable. If such states retroactively subject the
provision of Internet services to sales tax or if customers are unwilling to pay
sales tax that may be assessed in the future, such events could have a material
adverse effect on the Company.
The Company believes it is entitled to receive reciprocal compensation from
ILECs for the transport and termination of local traffic to ISPs from customers
of the ILECs, pursuant to various interconnection agreements. These ILECs have
not paid most of the bills they have received from the Company and have disputed
substantially all of these charges, arguing that ISP traffic is not local
traffic as defined by the various agreements and under state and federal laws
and public policies. To date, there have been favorable rulings from 15 states
and public utilities commissions and no unfavorable final rulings by any state
public utilities commission or the FCC that would indicate that calls placed by
end users to ISPs would not qualify as local traffic subject to the payment of
reciprocal compensation. While the Company believes that future regulatory
rulings on this issue will continue to treat such calls as local, there can be
no assurance that such future rulings will continue to be favorable.
Employees
On December 31, 1997, the Company employed a total of 2,219 individuals on
a full time basis. There are 48 employees in the Company's Oregon network
systems integration services office who are represented by collective bargaining
agreements which expire on May 31, 1998 and December 31, 2000. The Company
believes that its relations with its employees are good.
27
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 which
houses a portion of the Company's Telecom Services business. The Company leases
approximately 176,000 square feet of office space for operations located in the
Denver metropolitan area and approximately 262,000 square feet in other areas of
the United States.
As of December 31, 1997, the Company had acquired property for and had
partially constructed its new headquarters in Englewood, Colorado, which is
planned to accommodate most of the Company's Colorado operations. In January
1998, the Company sold the substantially completed building to a third party and
entered into an agreement to lease back the approximately 265,000 square foot
facility under a long-term operating lease.
ITEM 3. LEGAL PROCEEDINGS
On April 4, 1997, certain shareholders of Zycom filed a shareholder
derivative suit and class action complaint for unspecified damages, purportedly
on behalf of all minority shareholders of Zycom, in the District Court of Harris
County, Texas (Cause No. 97-17777) against the Company, Zycom and certain of
their subsidiaries. This complaint alleges various statutory and common law
claims. The Company is vigorously defending the claims. While it is not possible
to predict the outcome of this litigation, management believes these proceedings
will not have a material adverse effect on the Company's financial condition,
results of operations or cash flows.
A putative class action lawsuit was filed on July 15, 1997 in Superior
Court of California, Orange County, alleging unfair business practice and
related causes of action against NETCOM in connection with its offers of free
trial periods and cancellation procedures and claiming damages of at least $10.0
million. The case is in the preliminary stages, the complaint has been answered
and plaintiff has served initial requests for discovery. NETCOM believes it has
meritorious defenses to such claims and intends to vigorously defend the action.
The Federal Trade Commission ("FTC") is conducting an inquiry regarding the
advertising, marketing, subscription and billing practices of NETCOM. NETCOM
believes that it has made reasonable efforts to comply with applicable laws. If
the FTC were to conclude that NETCOM violated any applicable law, it could seek
relief in the form of equitable relief, civil monetary penalties or other
remedies.
The Company is a party to certain other litigation which has arisen in the
ordinary course of business. In the opinion of management, the ultimate
resolution of these matters will not have a material adverse effect on the
Company's financial condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
28
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ICG Common Stock, $.01 par value per share, has been quoted on the Nasdaq
National Market ("Nasdaq") since March 25, 1997 under the symbol "ICGX" and was
previously listed on the American Stock Exchange ("AMEX"), from August 5, 1996
to March 24, 1997 under the symbol "ICG." Prior to August 5, 1996,
Holdings-Canada's common shares had been listed on the AMEX under the symbol
"ITR" from January 14, 1993 through February 28, 1996, and under the symbol
"ICG" thereafter through August 2, 1996. Holdings-Canada Class A Common Shares
ceased trading on the AMEX at the close of trading on August 2, 1996.
Holdings-Canada Class A Common Shares, which were listed on the Vancouver Stock
Exchange ("VSE") under the symbol "IHC.A," ceased trading on the VSE at the
close of trading on March 12, 1997.
The following table sets forth, for the fiscal periods indicated, the high
and low sales prices of the Holdings-Canada Class A Common Shares as reported on
the AMEX through August 2, 1996, and the VSE through March 12, 1997, and the
high and low sales prices of the ICG Common Stock as reported on the AMEX from
August 5, 1996 through March 24, 1997 and on the Nasdaq from March 25, 1997
through the date indicated below. The table also sets forth the average of the
monetary exchange rates on the last day of each such relevant fiscal period.
American Stock
Exchange/Nasdaq National Vancouver Exchange
Market (1) Stock Exchange (1) Rate
-------------------------- ------------------------------
High Low High Low (C$/$)
----------- ----------- ------------- ------------- -------------
Fiscal Year Ended September 30, 1996
First Quarter $ 12.75 $ 8.63 C$ - C$ - 1.36
Second Quarter 17.88 10.25 - - 1.36
Third Quarter 27.38 17.13 17.50 17.50 1.36
Fourth Quarter 25.88 18.50 - - 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)
First Quarter $ 18.13 $ 10.38 C$ - C$ - 1.38
Second Quarter 21.13 8.63 N/A N/A N/A
Third Quarter 24.63 17.75 N/A N/A N/A
Fourth Quarter 28.63 19.75 N/A N/A N/A
Fiscal Year Ended December 31, 1998
Through March 26, 1998 $ 43.63 $ 24.25 C$ N/A C$ N/A N/A
(Continued)
29
(1) Effective at the close of trading on August 2, 1996, Holdings-Canada's
Class A Common Shares ceased trading on the AMEX and the ICG Common Stock
commenced trading on the AMEX on August 5, 1996. Effective March 25, 1997,
the ICG Common Stock ceased trading on the AMEX and commenced trading on
the Nasdaq. ICG Common Stock has never traded on the VSE. The Class A
Common Shares traded on the VSE through March 12, 1997 and all information
reported on the above table from August 5, 1996 to March 12, 1997 with
respect to the VSE relates only to the Class A Common Shares.
(2) The Company changed its fiscal year end to December 31 from September 30,
effective January 1, 1997.
See the cover page of this Annual Report for a recent bid price and related
number of shares outstanding of Common Stock. On March 26, 1998, there were 284
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. The Company 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 Second 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.
In September and October 1997, the Company's new wholly owned subsidiary,
ICG Funding, LLC, a Delaware limited liability company, completed a private
placement of $132.25 million of 6 3/4% Preferred Securities. The 6 3/4%
Preferred Securities are mandatorily redeemable November 15, 2009 at the
liquidation preference of $50.00 per security, plus accrued and unpaid
dividends. Dividends on the 6 3/4% Preferred Securities are cumulative at the
rate of 6 3/4% per annum and are payable in cash through November 15, 2000 and,
thereafter, in cash or shares of Common Stock at the option of ICG Funding. The
6 3/4% Preferred Securities are exchangeable, at the option of the holder, into
Common Stock at an exchange price of $24.025 per share, subject to adjustment.
ICG Funding may, at its option, redeem the 6 3/4% Preferred Securities at any
time on or after November 18, 2000. Prior to that time, ICG Funding may redeem
the 6 3/4% Preferred Securities if the current market value of Common Stock
equals or exceeds the exchange price, for at least 20 days of any consecutive
30-day trading period, by 170% prior to November 16, 1998; by 160% from November
16, 1998 through November 15, 1999; and by 150% from November 16, 1999 through
November 15, 2000. The 6 3/4% Preferred Securities and the Common Stock issuable
upon exchange of such securities have been registered under the Securities Act.
The 6 3/4% Preferred Securities are guaranteed by ICG on a full and
unconditional basis.
In October 1997, the Company sold 687,221 shares of Common Stock (the "CBG
Shares") to certain shareholders of CBG in connection with the acquisition of
CBG for a purchase price of approximately $16.0 million. The sale of the CBG
Shares was exempt from registration under Rule 4 (2) under the Securities Act
because the offers and sales were made to a limited number of investors in a
private transaction. Resale of the CBG Shares was subsequently registered on a
Form S-3 registration statement which was declared effective on October 31,
1997.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data for each fiscal year in the four-year period
ended September 30, 1996, the three months ended December 31, 1996 and the
fiscal year ended December 31, 1997 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 Annual Report.
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."
30
Three Months Fiscal
Ended Year Ended
Fiscal Years Ended September 30, December 31, December 31,
-----------------------------------------------------------
1993 1994 1995 1996 1996 1997
------------ ------------ ------------ ------------ ------------ ------------
Statement of Operations Data: (in thousands, except per share amounts)
Revenue:
Telecom services (1) $ 4,803 14,854 32,330 87,681 34,787 177,690
Network services 21,006 36,019 58,778 60,116 15,981 65,678
Satellite services(2) 3,520 8,121 20,502 21,297 6,188 29,986
Other 147 118 - - - -
------------ ------------ ------------ ------------ ------------ ------------
Total revenue 29,476 59,112 111,610 169,094 56,956 273,354
------------ ------------ ------------ ------------ ------------ ------------
Operating costs 18,961 38,165 78,846 135,253 49,929 246,418
Selling, general and
administrative expenses 10,702 28,015 62,954 76,725 24,253 150,767
Depreciation and amortization 3,473 8,198 16,624 30,368 9,825 57,081
Net loss (gain) on disposal of
long-lived assets - - 241 5,128 (772) 671
Provision for impairment of
long-lived assets - - 7,000 9,994 - 11,950
------------ ------------ ------------ ------------ ------------ ------------
Total operating costs and
expenses 33,136 74,378 165,665 257,468 83,235 466,887
Operating loss (3,660) (15,266) (54,055) (88,374) (26,279) (193,533)
Interest expense (2,523) (8,481) (24,368) (85,714) (24,454) (117,545)
Other income, net 325 925 3,639 15,423 5,898 21,247
------------ ------------ ------------ ------------ ------------ ------------
Loss before income taxes,
minority interest, share of
losses and cumulative effect
of change in accounting (5,858) (22,822) (74,784) (158,665) (44,835) (289,831)
Income tax benefit 1,552 - - 5,131 - -
------------ ------------ ------------ ------------ ------------ ------------
Loss before minority interest,
share of losses and
cumulative effect of
change in accounting (4,306) (22,822) (74,784) (153,534) (44,835) (289,831)
Minority interests, including
preferred dividends on
preferred securities (303) 435 (1,123) (25,306) (4,988) (37,812)
Share of losses of joint
venture and investment - (1,481) (741) (1,814) - -
------------ ------------ ------------ ------------ ------------ ------------
Loss before cumulative effect
of change in accounting (4,609) (23,868) (76,648) (180,654) (49,823) (327,643)
Cumulative effect of change in
accounting (1) - - - (3,453) - -
------------ ------------ ------------ ------------ ------------ ------------
Net loss $ (4,609) (23,868) (76,648) (184,107) (49,823) (327,643)
============ ============ ============ ============ ============ ============
Loss per share - basic and
diluted $ (0.39) (1.56) (3.25) (6.83) (1.56) (10.11)
============ ============ ============ ============ ============ ============
Weighted average number of
shares of Common Stock
outstanding - basic and
diluted (3) 11,671 15,342 23,604 26,955 31,840 32,399
============ ============ ============ ============ ============ ============
Other Data:
EBITDA (4) $ (187) (7,068) (30,190) (42,884) (17,226) (123,831)
Net cash used by operating
activities (2,839) (7,532) (42,798) (43,357) (8,636) (126,954)
Net cash used by investing
activities (13,401) (51,452) (71,583) (135,204) (82,342) (429,867)
Net cash provided (used) by
financing activities 30,382 49,428 377,772 360,227 (170) 315,721
Capital expenditures (5) 20,685 54,921 88,736 177,307 70,297 269,593
(Continued)
31
At September 30, At December 31,
----------------------------------------------------------- ----------------------------
1993 1994 1995 1996 1996 1997
----------- ----------- ------------- ----------- ----------- ------------
Balance Sheet Data: (in thousands)
Cash, cash equivalents and
short-term investments
available for sale 15,581 6,025 269,416 457,914 392,535 217,015
Working capital (deficit) 7,990 (8,563) 249,089 446,164 361,601 210,876
Property and equipment, net 52,203 118,875 202,004 336,137 403,676 632,167
Total assets 95,196 201,991 583,553 939,351 944,133 1,107,664
Current portion of long-term
debt and capital lease
obligations 7,657 23,118 27,310 8,282 25,500 7,421
Long-term debt and capital
lease obligations, less
current portion 37,116 104,461 405,535 739,827 761,504 957,507
Redeemable preferred securities
of subsidiaries - - 14,986 153,318 159,120 420,171
Common stock and additional
paid-in capital 56,402 97,806 217,245 299,229 302,560 326,965
Accumulated deficit (21,650) (58,024) (134,710) (318,817) (368,640) (696,283)
Stockholders' equity (deficit) 34,753 39,782 82,535 (19,588) (66,080) (369,318)
(1) During fiscal 1996, the Company changed its method of accounting for
long-term telecom services contracts to recognize revenue as services are
provided. Other than the cumulative effect of adopting this new method of
accounting, the effect of this change in accounting for the periods
presented was not significant. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations Accounting Change."
(2) 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.
(3) Weighted average number of shares outstanding for fiscal years 1993, 1994
and 1995 represents Holdings-Canada common shares outstanding. Weighted
average number of shares outstanding for fiscal 1996, the three months
ended December 31, 1996 and fiscal 1997 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
(not owned by ICG) outstanding for the periods subsequent to August 5,
1996.
(4) EBITDA consists of revenue less operating costs and selling, general and
administrative expenses. 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 flows or results of operations in accordance
with generally accepted accounting principles ("GAAP") for the periods
indicated. EBITDA is not a measurement under GAAP and is not necessarily
comparable with similarly titled measures of other companies. Net cash
flows from operating, investing and financing activities as determined
using GAAP are also presented in Other Data.
(5) Capital expenditures includes assets acquired under capital leases and
through the issuance of debt or warrants, and excludes payments for
construction of the Company's new headquarters which the Company sold in
January 1998 and leased back under a long-term operating lease.
32
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 strategy of offering an integrated telecommunications package of
local, long distance, data and value-added services, continued development of
the Company's network infrastructure and actions of competitors and regulatory
authorities that could cause actual results to differ materially from the
forward-looking statements. The results for the 12 months ended December 31,
1996 and the three months ended December 31, 1995 have been derived from the
Company's Consolidated Financial Statements included elsewhere herein and the
Company's unaudited Consolidated Financial Statements included in the Company's
Forms 10-Q filed with the SEC. The Company changed its fiscal year end to
December 31 from September 30, effective January 1, 1997. All dollar amounts are
in U.S. dollars.
Company Overview
The Company is one of the nation's leading competitive ICPs, based on
estimates of the industry's 1997 revenue. ICPs seek to provide an alternative to
ILECs, long distance carriers, ISPs and other communications service providers
for a full range of communications services in the increasingly deregulated
telecommunications industry. Through its CLEC operations, the Company operates
networks in four regional clusters covering major metropolitan statistical areas
in California, Colorado, Ohio and the Southeast. The Company also provides a
wide range of network systems integration services, maritime and international
satellite transmission services and subsequent to January 21, 1998, a variety of
Internet connectivity and other value-added Internet services. Network Services
consist of information technology services and selected networking products,
focusing on network design, installation, maintenance and support. Satellite
Services consist of satellite voice and data services to major cruise lines,
commercial shipping vessels, yachts, the U.S. Navy and offshore oil platforms.
The Company intends to dispose of its Satellite Services operations to better
focus its efforts on its core Telecom Services unit, although it has not entered
into a formal arrangement for such disposition. As a leading participant in the
rapidly growing competitive local telecommunications industry, the Company has
experienced significant growth, with total revenue increasing from approximately
$111.6 million for fiscal 1995 to approximately $273.4 million for fiscal 1997.
The Company's rapid growth is the result of the initial installation,
acquisition and subsequent expansion of its fiber optic networks and the
expansion of its communication service offerings.
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 core Telecom Services, including revenue generated by its newly
acquired subsidiary, NETCOM. In March 1996, the Company completed the sale of
four of its teleports which were used in the Company's Satellite Services
operations.
33
The Telecommunications Act and 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 competitive
local dial tone. The Company is marketing and selling local dial tone services
in major metropolitan areas in the following regions: California, which began
service in late January 1997, followed by Ohio in February 1997, Colorado in
March 1997 and the Southeast in May 1997. During fiscal 1997, the Company sold
178,470 local access lines, of which 141,035 were in service as of December 31,
1997. In addition, the Company's operating networks have grown from 627 fiber
route miles at the end of fiscal 1995 to 3,043 fiber route miles as of December
31, 1997. The Company has 19 operating high capacity digital voice switches and
15 data communications switches, and plans to install additional switches as
demand warrants. As a complement to its local exchange services, the Company has
begun marketing bundled service offerings which include long distance, enhanced
telecommunications services and data services and plans to intensify the
offerings of such services in the near term.
The Company will continue to expand its network through construction,
leased facilities, strategic alliances and mergers and acquisitions. For
example, in January 1998, the Company completed its merger with NETCOM, a
provider of Internet connectivity and Web site hosting services and other
value-added services, located in San Jose, California. For calendar years 1995,
1996 and 1997, NETCOM reported revenue of $52.4 million, $120.5 million and
$160.7 million, respectively, and EBITDA losses of $(6.3) million, $(20.3)
million and $(1.7) million, respectively. The Company will account for the
business combination under the pooling of interests method of accounting and
accordingly, the Company's financial statements will be restated to reflect the
operations of NETCOM and the Company on a combined basis for all historical
periods. Also, in two transactions occurring October 1997 and March 1998, the
Company purchased 100% of the capital stock of CBG, an Ohio based local exchange
and centrex reseller which had, at December 31, 1997, 48,256 local access lines
in service, principally pursuant to various resale and other agreements with
Ameritech, the ILEC in the markets it serves. Further, for the calendar years
1995, 1996 and 1997, CBG's revenue was approximately $15.4 million, $21.4
million and $33.8 million, respectively, and EBIT