UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
20549
FORM 10-Q
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended September 30, 2002 |
OR
| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from to |
Commission File Number 0-30218
TIME WARNER TELECOM INC.
(Exact name of Registrant as specified in its
charter)
| State of Delaware (State or other jurisdiction of incorporation or organization) |
84-1500624 (I.R.S. Employer Identification Number) |
| 10475 Park Meadows Drive Littleton, Colorado (Address of principal executive offices) |
80124 (Zip Code) |
Registrant’s telephone number, including area code: (303) 566-1000
Indicate by check mark whether the Registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No o
The number of shares outstanding of Time Warner Telecom Inc.’s common stock as of October 31, 2002 was:
Time Warner Telecom Inc. Class A common stock — 48,890,771 shares
Time Warner Telecom Inc. Class B common stock — 65,936,658 shares
TIME WARNER TELECOM INC.
INDEX TO FORM 10-Q
| Page | |||||||
| Part I. | Financial Information | ||||||
| Item 1. | Financial Statements: | ||||||
| Consolidated and Condensed Balance Sheets at September 30, 2002 and December 31, 2001 | 1 | ||||||
| Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001 | 2 | ||||||
| Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 | 3 | ||||||
| Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2002 | 4 | ||||||
| Notes to Consolidated and Condensed Financial Statements | 5 | ||||||
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 | |||||
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 33 | |||||
| Item 4. | Controls and Procedures | 33 | |||||
| Part II. | Other Information | ||||||
| Item 1. | Legal Proceedings | 34 | |||||
| Item 6. | Exhibits and Reports on Form 8-K | 34 | |||||
CONSOLIDATED AND CONDENSED BALANCE SHEETS
| September 30, 2002 |
December 31, 2001 |
|||||||
| (unaudited) | ||||||||
| (amounts in thousands, except share amounts) | ||||||||
| ASSETS | ||||||||
| Current assets: | ||||||||
| Cash and cash equivalents | $ | 305,026 | 365,600 | |||||
| Marketable debt securities | 4,020 | 18,454 | ||||||
| Receivables, less allowances of $26,279 and $29,778, respectively | 64,351 | 78,431 | ||||||
| Prepaid expenses | 8,531 | 3,305 | ||||||
| Deferred income taxes | 22,573 | 35,570 | ||||||
| Total current assets | 404,501 | 501,360 | ||||||
| Property, plant, and equipment | 2,375,228 | 2,286,278 | ||||||
| Less accumulated depreciation | (647,948 | ) | (475,182 | ) | ||||
| 1,727,280 | 1,811,096 | |||||||
| Deferred income taxes | 36,516 | 23,630 | ||||||
| Goodwill, net of accumulated amortization | 26,773 | 26,773 | ||||||
| Intangible and other assets, net of accumulated amortization (notes 1 and 2) | 29,718 | 36,095 | ||||||
| Total assets | $ | 2,224,788 | 2,398,954 | |||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Current liabilities: | ||||||||
| Accounts payable | $ | 45,807 | 79,429 | |||||
| Deferred revenue | 43,894 | 47,528 | ||||||
| Other current liabilities | 248,768 | 259,916 | ||||||
| Total current liabilities | 338,469 | 386,873 | ||||||
| Long-term debt and capital lease obligations (note 3) | 1,058,256 | 1,063,368 | ||||||
| Stockholders’ equity (note 1): | ||||||||
| Preferred stock, $0.01 par value, 20,000,000 shares authorized, no shares issued and outstanding |
— | — | ||||||
| Class A common stock, $0.01 par value, 277,300,000 shares authorized, 48,890,771 and 48,789,111 shares issued and outstanding in 2002 and 2001, respectively |
489 | 488 | ||||||
| Class B common stock, $0.01 par value, 162,500,000 shares authorized, 65,936,658 shares issued and outstanding in 2002 and 2001 |
659 | 659 | ||||||
| Additional paid-in capital | 1,167,240 | 1,165,804 | ||||||
| Accumulated other comprehensive loss, net of taxes | — | (206 | ) | |||||
| Accumulated deficit | (340,325 | ) | (218,032 | ) | ||||
| Total stockholders’ equity | 828,063 | 948,713 | ||||||
| Total liabilities and stockholders’ equity | $ | 2,224,788 | 2,398,954 | |||||
See accompanying notes.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
||||||||||||
| 2002 | 2001 | 2002 | 2001 | ||||||||||
| (amounts in thousands, except per share amounts) | |||||||||||||
| Revenue (a): | |||||||||||||
| Dedicated transport services | $ | 92,556 | 98,193 | 280,170 | 293,661 | ||||||||
| Switched services | 36,078 | 38,950 | 110,007 | 114,647 | |||||||||
| Data and Internet services | 23,410 | 15,507 | 65,758 | 46,037 | |||||||||
| Intercarrier compensation | 15,121 | 20,075 | 64,525 | 109,404 | |||||||||
| Total revenue | 167,165 | 172,725 | 520,460 | 563,749 | |||||||||
| Costs and expenses (a): | |||||||||||||
| Operating (exclusive of depreciation and amortization shown separately below) |
70,799 | 77,505 | 216,966 | 237,872 | |||||||||
| Selling, general, and administrative | 56,293 | 58,238 | 171,710 | 180,170 | |||||||||
| Depreciation and amortization | 61,763 | 51,951 | 176,269 | 150,848 | |||||||||
| Total costs and expenses | 188,855 | 187,694 | 564,945 | 568,890 | |||||||||
| Operating loss | (21,690 | ) | (14,969 | ) | (44,485 | ) | (5,141 | ) | |||||
| Interest expense | (26,760 | ) | (26,980 | ) | (78,435 | ) | (88,050 | ) | |||||
| Interest income | 1,517 | 3,795 | 4,317 | 16,370 | |||||||||
| Investment losses, net | (1,283 | ) | (1,464 | ) | (3,240 | ) | (1,464 | ) | |||||
| Net loss before income taxes | (48,216 | ) | (39,618 | ) | (121,843 | ) | (78,285 | ) | |||||
| Income tax expense (benefit) | 150 | (15,295 | ) | 450 | (29,640 | ) | |||||||
| Net loss | $ | (48,366 | ) | (24,323 | ) | (122,293 | ) | (48,645 | ) | ||||
| Basic and diluted loss per share | $ | (0.42 | ) | (0.21 | ) | (1.07 | ) | (0.43 | ) | ||||
| Weighted average shares outstanding: | |||||||||||||
| Basic | 114,827 | 114,340 | 114,772 | 113,466 | |||||||||
| Diluted | 114,827 | 114,340 | 114,772 | 113,466 | |||||||||
(a) Includes revenue and expenses resulting from transactions with affiliates (note 4):
| Revenue | $ | 5,966 | 6,458 | 21,828 | 18,051 | ||||||||
| Operating expenses | $ | 754 | 680 | 2,239 | 2,038 | ||||||||
| Selling, general, and administrative | $ | 403 | 452 | 1,197 | 1,222 | ||||||||
| Depreciation and amortization | $ | 3,001 | 2,977 | 8,967 | 8,908 | ||||||||
See accompanying notes.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| Nine Months Ended September 30, |
|||||||
| 2002 | 2001 | ||||||
| (amounts in thousands) | |||||||
| Cash flows from operating activities: | |||||||
| Net loss | $ | (122,293 | ) | (48,645 | ) | ||
| Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||
| Depreciation and amortization | 176,269 | 150,848 | |||||
| Impairment of deferred debt issue costs | — | 5,814 | |||||
| Investment losses, net | 3,240 | 1,464 | |||||
| Stock-based compensation | 1,201 | 393 | |||||
| Amortization of deferred debt issue costs | 3,440 | 3,334 | |||||
| Deferred income tax benefit | — | (29,874 | ) | ||||
| Changes in operating assets and liabilities, net of the effect of an acquisition: | |||||||
| Receivables and prepaid expenses | 8,804 | (3,135 | ) | ||||
| Accounts payable, deferred revenue, and other current liabilities | (48,348 | ) | 26,817 | ||||
| Accrued reorganization | (2,223 | ) | — | ||||
| Net cash provided by operating activities | 20,090 | 107,016 | |||||
| Cash flows from investing activities: | |||||||
| Capital expenditures | (92,096 | ) | (337,136 | ) | |||
| Cash paid for an acquisition | — | (651,689 | ) | ||||
| Purchases of marketable securities | (8,566 | ) | (71,073 | ) | |||
| Proceeds from maturities of marketable securities | 23,000 | 58,624 | |||||
| Other investing activities | — | 3,363 | |||||
| Net cash used in investing activities | (77,662 | ) | (997,911 | ) | |||
| Cash flows from financing activities: | |||||||
| Net proceeds from issuance of common stock | — | 532,178 | |||||
| Net proceeds from issuance of debt | — | 1,159,586 | |||||
| Repayments of debt | — | (700,000 | ) | ||||
| Net proceeds from issuance of common stock upon exercise of stock options | 145 | 12,604 | |||||
| Net proceeds from issuance of common stock in connection with the employee stock purchase plan |
90 | 1,004 | |||||
| Payment of capital lease obligations | (3,237 | ) | (2,120 | ) | |||
| Deferred debt issue costs, net | — | 1,078 | |||||
| Net cash provided by (used in) financing activities | (3,002 | ) | 1,004,330 | ||||
| Increase (decrease) in cash, cash equivalents, and cash held in escrow | (60,574 | ) | 113,435 | ||||
| Cash, cash equivalents, and cash held in escrow at beginning of period | 365,600 | 250,739 | |||||
| Cash and cash equivalents at end of period | $ | 305,026 | 364,174 | ||||
| Supplemental disclosures of cash flow information: | |||||||
| Cash paid for interest | $ | 98,240 | 82,468 | ||||
| Tax benefit related to exercise of non-qualified stock options | $ | — | 17,174 | ||||
| Cash paid for income taxes | $ | 477 | 728 | ||||
See accompanying notes.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
Nine Months Ended September 30,
2002
(Unaudited)
| Common Stock | |||||||||||||||||||||||||
| Class A | Class B | ||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Additional paid-in capital |
Accumulated other comprehensive loss, net of taxes |
Accumulated deficit |
Total stockholders’ equity |
||||||||||||||||||
| (amounts in thousands) | |||||||||||||||||||||||||
| Balance at December 31, 2001 | 48,789 | $ | 488 | 65,937 | $ | 659 | 1,165,804 | (206 | ) | (218,032 | ) | 948,713 | |||||||||||||
| Change in unrealized holding gain for available-for-sale security, net of taxes |
— | — | — | — | — | 206 | — | 206 | |||||||||||||||||
| Net loss | — | — | — | — | — | — | (122,293 | ) | (122,293 | ) | |||||||||||||||
| Comprehensive loss | (122,087 | ) | |||||||||||||||||||||||
| Shares issued for cash in connection with the exercise of stock options |
10 | — | — | — | 145 | — | — | 145 | |||||||||||||||||
| Shares issued for cash in connection with the employee stock purchase plan |
67 | 1 | — | — | 89 | — | — | 90 | |||||||||||||||||
| Stock based compensation | 25 | — | — | — | 1,202 | — | — | 1,202 | |||||||||||||||||
| Balance at September 30, 2002 | 48,891 | $ | 489 | 65,937 | $ | 659 | 1,167,240 | — | (340,325 | ) | 828,063 | ||||||||||||||
See accompanying notes.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS
September 30, 2002
(unaudited)
1. Organization and Summary of Significant Accounting Policies
| Description of Business and Capital Structure |
| Time Warner Telecom Inc. (the “Company”), a Delaware corporation, is a fiber, facilities-based provider of metropolitan and regional optical broadband networks and services to business customers in 44 metropolitan markets in the United States. The Company delivers broadband data, dedicated Internet access, and local and long distance voice services. |
| The Company has two classes of common stock outstanding, Class A common stock and Class B common stock. Holders of Class A common stock have one vote per share and holders of Class B common stock have ten votes per share. Each share of Class B common stock is convertible, at the option of the holder, into one share of Class A common stock. The Class B common stock is collectively owned by subsidiaries of AOL Time Warner Inc. (“AOL Time Warner”) and Advance Telecom Holdings Corporation and Newhouse Telecom Holdings Corporation (“Advance/Newhouse”). Holders of Class A common stock and Class B common stock generally vote together as a single class. However, some matters require the approval of 100% of the holders of the Class B common stock voting separately as a class, and some matters require the approval of a majority of the holders of the Class A common stock, voting separately as a class. As of September 30, 2002, the Class B stockholders had approximately 93.1% of the combined voting power of the outstanding common stock. |
| Basis of Presentation |
| The accompanying interim consolidated and condensed financial statements are unaudited, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the results for the periods indicated. The results of operations for any interim period are not necessarily indicative of results for the full year. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2001. |
| The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. |
| Basis of Consolidation |
| The consolidated and condensed financial statements include the accounts of the Company and all entities in which the Company has a controlling voting interest (“subsidiaries”). Significant intercompany accounts and transactions have been eliminated. Significant accounts and transactions with AOL Time Warner are disclosed as related party transactions. |
| Investments |
| Marketable equity securities held by the Company are classified as available-for-sale. Accordingly, these securities are included in other assets at fair value. Unrealized holding gains and losses on securities classified as available-for-sale are carried, net of taxes, as a component of accumulated other comprehensive loss in stockholders’ equity. Other equity investments which are not considered marketable securities and in which the Company’s ownership interest is less than 20% |
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
| are generally carried at the lower of cost or net realizable value. Realized gains and losses are determined on a specific identification basis. |
| At September 30, 2002, the fair value of the Company’s available-for-sale securities totaled $440,000. During the nine months ended September 30, 2002, the Company recognized a net loss of $3.2 million on investments. The net loss included $2.7 million in losses related to marketable securities whose decline in value was not temporary in nature and a $1.0 million impairment on an equity investment in a non-public company that is not considered a marketable security. These losses were partially offset by a $400,000 gain on the exchange of shares in a privately held company for shares in a publicly held company. |
| Since the beginning of 2001, the Company has recognized an aggregate $6.5 million impairment on equity investments that are not considered marketable. The impairment charges represent the difference between historical prices of the investments and their estimated net realizable value as of the date of financial statements. The Company recorded these charges based on its conclusion that the decline in value of these investments was not temporary in nature. The Company reached its conclusion because the investee companies had not executed their business plans as originally anticipated, in part due to the adverse economic conditions surrounding the telecommunications and technology sectors during 2001 and 2002, and had conducted further financing activities that diluted the value of the Company’s investments. The subsequent financing activities at these companies served as independent indicators that the impairment was not temporary. The estimates of net realizable value were primarily derived from the recent financing activities at these companies. |
| Impairment of Assets |
| During the nine months ended September 30, 2001, the Company recorded a $9.6 million impairment charge when it abandoned a software system it was developing for use in its back office operations. In the third quarter of 2002, the Company recorded impairment charges totaling $3.5 million for obsolete assets taken out of service. These charges were included as a component of depreciation and amortization expense. During the fourth quarter of 2001, the Company recorded a $2.4 million impairment charge related to the decision to consolidate its network operations centers as described in Note 5 to the consolidated and condensed financial statements. The charge represents the difference between the expected sales value of the facilities and their book value and was included as a component of the restructure charge in the consolidated statements of operations for the year ended December 31, 2001. |
| Revenue |
| The Company’s revenue is derived primarily from business communications services, including dedicated transport, local switched, long distance, data and Internet access services, and intercarrier compensation, which is comprised of reciprocal compensation and switched access services. The Company’s customers are principally telecommunications-intensive business end-users, long distance carriers, Internet service providers (“ISPs”), wireless communications companies, incumbent local exchange carriers (“ILECs”), and governmental entities. |
| Revenue for dedicated transport, data, Internet, and the majority of switched services is generally billed in advance on a fixed rate basis and recognized over the period the services are provided. Revenue for the majority of switched access services and long distance is generally billed on a transactional basis determined by customer usage with some fixed rate elements. The transactional elements of switched services are billed in arrears and estimates are used to recognize revenue in the period earned. |
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
| Reciprocal compensation is an element of intercarrier compensation revenue that represents compensation from local exchange carriers (‘‘LECs’’) for local exchange traffic originated by other LECs and terminated on the Company’s facilities. The Company recognizes reciprocal compensation revenue primarily on a cash basis except in those cases where the revenue is under dispute or at risk, in which case the Company defers recognition of the revenue until the outstanding issues are resolved. Reciprocal compensation represented 5% and 6% of revenue, excluding the effects of the recognition of $13.9 million and $37.0 million of non-recurring reciprocal compensation revenue during the nine months ended September 30, 2002 and 2001, respectively. The non-recurring amounts reflect recognition of reciprocal compensation revenue previously deferred under the Company’s revenue recognition policy, resulting from resolution of disputed reciprocal compensation billing with other LECs. Reciprocal compensation rates are established by interconnection agreements between the parties based on federal and state regulatory and judicial rulings. A 2001 Federal Communications Commission (“FCC”) ruling on reciprocal compensation for ISP-bound traffic has reduced rates and will further reduce rates in June 2003. The ruling also capped the number of minutes for which ISP-bound traffic can be compensated. In some cases, the Company’s contractual right to receive reciprocal compensation for traffic terminated to its ISP customers was dependent on the outcome of regulatory proceedings addressing reciprocal compensation. The impact of the FCC’s ruling on the payment of reciprocal compensation under some of those agreements is still in dispute with certain ILECs. As of September 30, 2002, the Company had deferred recognition of $16.4 million in reciprocal compensation revenue for payments in dispute that may be subject to adjustment based on regulatory rulings or contractual negotiations. The Company pays reciprocal compensation expense to the other LECs for local exchange traffic it terminates on the LEC’s facilities. These costs are recognized as incurred. |
| Switched access is an element of intercarrier compensation revenue that represents the connection between a long distance carrier’s point of presence and an end-user’s premises provided through the Company’s switching facilities. Historically, the FCC has regulated the access rates imposed by the ILECs, while the access rates of competitive local exchange carriers (“CLECs”), such as the Company, have been less regulated. However, the FCC released an order effective in June 2001 that subjects CLECs’ interstate switched access charges to regulation. Pursuant to that order, the Company’s rates were reduced and will continue to decline, through June 2004, to parity with the ILEC rates competing in each area. In addition, when a CLEC enters a new market, its access charges may be no higher than the ILEC’s. The order does not affect rates under contracts that the Company has entered into with certain long distance carriers. The Company and several other CLECs have filed petitions with the FCC for reconsideration of the provisions of the order relating to new markets, and other CLECs have appealed the order in federal appeals court. There is no assurance that any legal challenge will be successful or that a successful challenge will change the trend toward lower access charges. Switched access revenue represented 5% and 7% of total revenue, excluding the effects of the recognition of $13.9 million and $37.0 million of non-recurring reciprocal compensation during the nine months ended September 30, 2002 and 2001, respectively. In addition, the Company has contracts with certain carriers that have access rate reductions in relationship to volume commitments. The Company expects that switched access revenue will continue to decline as a percentage of the Company’s total revenue due to further mandated rate reductions that will occur through June 2004, and contracted rate reductions. There is no assurance that the Company will be able to compensate for reductions in switched access revenue with revenue from other sources. |
| Receivables |
| The Company performs ongoing credit evaluations of significant customers’ financial conditions and has established an allowance for doubtful accounts based on the expected collectability of all receivables. A higher risk of collectability is assigned to certain customers with deteriorating financial conditions and customers in bankruptcy that continue service subsequent to filing bankruptcy, resulting in greater allowance for doubtful accounts. Considerable management |
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued
| judgment is required in evaluating the collectability of receivables and establishing the related allowance for doubtful accounts. If the financial condition of the Company’s customers continues to deteriorate, the Company’s bad debt expense and cash collections will be negatively impacted. The allowance for doubtful accounts was $26.3 million and $29.8 million at September 30, 2002 and December 31, 2001, respectively. |
| Significant Customers |
| The Company has substantial business relationships with a few large customers, including major long distance carriers. The Company’s top 10 customers accounted for 46% and 48% of the Company’s consolidated revenue for the nine months ended September 30, 2002 and 2001, respectively. Excluding intercarrier compensation revenue, the Company’s top 10 customers would have accounted for 36% and 31% of the Company’s total revenue for the nine months ended September 30, 2002 and 2001, respectively. Intercarrier compensation revenue would not go away with the loss of any particular customer and therefore this measure more closely reflects revenue generated directly by these customers. WorldCom, Inc. (“WorldCom”), which filed for Chapter 11 bankruptcy protection in July 2002, accounted for 12% of the Company’s total revenue during the nine months ended September 30, 2002 and 2001. Subsequent to September 30, the Company received notice from WorldCom to disconnect certain services representing approximately 0.7% of the Company’s recurring revenue. The Company expects further disconnection of WorldCom services. While the revenue impact of further service disconnection is not currently known, the amount could be significant. No other customer, including customers that direct their business through long distance carriers, accounted for 10% or more of total revenue for the nine months ended September 30, 2002. In the nine months ended September 30, 2002, the three companies that individually represented more than 5% of total revenue were WorldCom, AT&T Corp., and Qwest Communications. |