UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2002
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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 1-15307
BROADWING COMMUNICATIONS INC.
(Exact name of registrant as specified in its charter)
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Delaware |
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74-2644120 |
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(State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) |
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1122 Capital of Texas Highway South, Austin, Texas 78746-6426 |
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(Registrant’s telephone number, including area code): (512) 328-1112
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class |
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Name of
each exchange |
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12 1/2% Series B Junior Exchangeable Preferred Stock Due 2009 (par value $0.01 per share) |
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New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
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 ý No o
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 Registrant’s 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. ý
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ý No o
All outstanding shares of the Registrant’s common stock are owned by Broadwing Inc.
The aggregate market value of the Preferred Stock of the Registrant held by non-affiliates of the Registrant on February 28, 2003 based on the closing price of the Preferred Stock on the New York Stock Exchange on such date, was $23,712,600.
The number of shares of Preferred Stock outstanding was 395,210 on February 28, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Information Statement to be filed with the Securities and Exchange Commission within 120 days of December 31, 2002.
BROADWING COMMUNICATIONS INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2002
TABLE OF CONTENTS
This report contains trademarks, service marks and registered trademarks and registered marks of the Company and its subsidiaries, as indicated.
Private Securities Litigation Reform Act of 1995 Safe Harbor Cautionary Statement
This Form 10-K contains “forward-looking” statements, as defined in federal securities laws including the Private Securities Litigation Reform Act of 1995, which are based on Broadwing Communications Inc (“the Company”) current expectations, estimates and projections. Statements that are not historical facts, including statements about the beliefs, expectations and future plans and strategies of the Company, are forward-looking statements. These include any statements regarding:
• future revenue, profit percentages, income tax refunds, realization of deferred tax assets, earnings per share or other results of operations;
• the continuation of historical trends;
• the sufficiency of cash balances and cash generated from operating and financing activities for future liquidity and capital resource needs;
• the effect of legal and regulatory developments; and
• the economy in general or the future of the communications services industries.
Actual results may differ materially from those expressed or implied in forward-looking statements. These statements involve potential risks and uncertainties, which include, but are not limited to:
• changing market conditions and growth rates within the telecommunications industry or generally within the overall economy;
• world and national events that may affect the Company’s ability to provide services or the market for telecommunication services;
• changes in competition in markets in which the Company operates;
• pressures on the pricing of the Company’s products and services;
• advances in telecommunications technology;
• the ability to generate sufficient cash flow to fund the Company’s business plan and maintain its networks;
• the ability to refinance the Company’s indebtedness when required on commercially reasonable terms;
• changes in the demand for the services and products of the Company;
• the demand for particular products and services within the overall mix of products sold, as the Company’s products and services have varying profit margins;
• the Company’s ability to procure key network components from key vendors;
• the Company’s ability to rely on portions of other company’s networks under operating leases and indefeasible- right-of-use (“IRU”) agreements;
• the Company’s ability to introduce new service and product offerings in a timely and cost effective basis;
• the Company’s ability to attract and retain highly qualified employees; and
• the Company’s ability to access capital markets and the successful execution of restructuring initiatives.
You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they were made. The Company does not undertake any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
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Overview and Recent Events
Broadwing Communications Inc. (“BCI” or “the Company”) is an Austin, Texas based provider of data and voice communications services. These services are provided over approximately 18,700 route miles of fiber-optic transmission facilities. The Company’s revenue is generated by broadband transport through private line and IRU agreements, Internet services utilizing technology based on Internet protocol (“IP”), and switched voice services provided to both wholesale and retail customers. The Company also offers data collocation, information technology consulting, network construction and other services.
The Company is a wholly owned subsidiary of Broadwing Inc. (“Broadwing” or “the Parent Company”). On November 9, 1999 the Company was merged with a wholly owned subsidiary of Broadwing (“the Merger”). The Merger was accounted for as a purchase business combination and, accordingly, the purchase accounting adjustments, including goodwill, have been pushed down and are reflected in these financial statements in all periods subsequent to November 9, 1999.
As of January 1, 2002, the web hosting operations of the Parent Company’s ZoomTown subsidiary were merged with the operations of BCI and are reflected in the data and Internet product line.
On February 22, 2003, certain subsidiaries of the Parent Company entered into a definitive agreement to sell substantially all of the assets of the Company, excluding the information technology consulting assets, to C III Communications (“C III”), for up to $129 million in cash and the assumption of certain long-term operating contractual commitments. The sale is subject to certain closing conditions, including approval by the Federal Communications Commission (“FCC”) and relevant state public utility commissions. The Parent Company expects to close the sale in 2003. The Company will retain a 3% minority interest in the new company. The carrying value of the current and long-lived assets to be sold totaled $103 million and $41 million, respectively, as of December 31, 2002. The carrying value of the current and long-term liabilities to be assumed totaled $180 million and $293 million, respectively, as of December 31, 2002.
In addition, the Parent Company’s local communications subsidiary, Cincinnati Bell Telephone (“CBT”), entered into agreements with C III whereby CBT will continue to market BCI’s broadband products to business customers and purchase capacity on its network in order to sell long distance services, under the Cincinnati Bell Any Distance (“CBAD”) brand, to residential and business customers in the Greater Cincinnati area market after the closing of the sale.
On March 26, 2003, the Parent Company issued $350 million of mezzanine financing through Senior Subordinated Discount Notes Due 2009 (the “Mezzanine Financing”). The Mezzanine Financing was provided by Goldman Sachs, together with certain other institutions and contains financial and non-financial covenants including restrictions on the Parent Company’s ability to fund the operations of the Company. Proceeds from the Mezzanine Financing, net of fees, were used to pay down borrowings under the Parent Company’s credit facility.
In conjunction with the Mezzanine Financing, the Parent Company’s credit facility was also amended and restated ("Amended and Restated Credit Agreement") to, among other things, extend the revolving commitment, revise the financial covenants and allow for the sale of substantially all of the assets of the broadband business. As a result of the terms of the amendment the total borrowing capacity will decrease from $1.825 billion to approximately $1.343 billion through 2003 and the maturities of the revolving portion of the credit
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facility were extended to 2005 and 2006. The amendment was required by the term of the Mezzanine Financing and was necessary to meet the Parent Company’s 2003 liquidity requirements.
The terms of the Mezzanine Financing and Amended and Restated Credit Agreement limit the Parent Company’s ability to make investments in or fund the operations of the Company. Specifically, the Parent Company and its other subsidiaries may not make investments in or fund the operations of the Company beyond an aggregate amount of $118 million after October 1, 2002. This restriction does not apply to guarantees by Broadwing of the Company’s borrowings under the credit facilities, liens on assets of Broadwing securing Company borrowings under the credit facilities, scheduled interest payments made or guaranteed by Broadwing in respect to Company borrowings under the credit facilities, and certain other items. As of February 28, 2003, the Parent Company had the ability to invest an additional $58 million in the Company based on these provisions. The uncertainty of the Company's available liquidity resulting from these funding constraints, has prompted the Company’s independent accountants to include a going concern explanatory paragraph in their audit report. The going concern explanatory paragraph means that, in the opinion of the Company’s independent accountants, there is substantial doubt about the Company’s ability to continue to operate as going concern. If the Company is unable to finance its operations through the closing of the asset sale and meet its remaining obligations, or if a sale is not consummated, it may be forced to seek protection from its creditors through bankruptcy proceedings.
In addition, in March 2003, the Parent Company reached an agreement with holders of more than two-thirds of the Company’s 12½ percent preferred stock and 9 percent senior subordinated notes to exchange these instruments for common stock of the Parent Company.
The Parent Company was initially incorporated under the laws of Ohio in 1873 and remains incorporated under the laws of Ohio. It has its principal executive offices at 201 East Fourth Street, Cincinnati, Ohio 45202 (telephone number (513) 397-9900 and website address http://www.broadwing.com). The Parent Company makes available on its website its and the Company’s reports on form 10-K, 10-Q, and 8-K (as well as all amendments to these reports) as soon as practicable after they have been filed.
The Company files annual, quarterly and special reports, proxy statements and other information with the Securities Exchange Commission (“the SEC”) under the Exchange Act. These reports and other information filed by the Company may be read and copied at the Public Reference Room of the SEC, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. This information may be obtained on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy statements and other information about issuers, like the Company, which file electronically with the SEC. The address of this site is http://www.sec.gov.
Business
Broadband transport services consist of long-haul transmission of data, voice and Internet traffic over dedicated circuits. Revenue from the broadband transport category is mainly generated by private line monthly recurring revenue. However, approximately 44%, 29% and 14% of the broadband transport revenue in 2002, 2001 and 2000, respectively, was provided by IRU agreements, which cover a fixed period of time and represent the lease of capacity or network fibers. The buyer of IRU services typically pays cash upon execution of the contract. The Company’s policy and practice is to amortize these payments into revenue over the life of the contract. In the event the buyer of an IRU terminates a contract prior to the contract expiration and releases the Company from the obligation to provide
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future services, the remaining unamortized unearned revenue is recognized in the period in which the contract is terminated. In 2002, the Company recognized non-cash, non-recurring revenue and operating income related to IRU terminations with bankrupt customers to whom the Company was no longer obligated to provide services, totaling $59 million. Broadband transport services produced 43% of the Company’s total revenue in 2002 and 39% of the Company’s total revenue in 2001 and 2000.
Switched voice services consist of billed minutes of use, primarily for the transmission of voice long distance services on behalf of both wholesale and retail customers. Switched voice service revenue has been decreasing as a percentage of total revenue due to declining rates as a result of intense competition. As the Company focused its efforts on retaining higher margin revenue, the Company minimized sales to less creditworthy customers, tightened credit to wholesale customers in the wake of increasing bankruptcies in the telecommunications industry and exited its telemarketing operations to its low-end customer base. Additionally, in the fourth quarter of 2002, the Company announced its plan to exit the low margin international wholesale voice business. As a result, the Company expects switched voice service revenue to continue to decline going-forward. Switched voice services provided 31%, 32% and 41% of total revenue in 2002, 2001 and 2000, respectively. The international wholesale voice business provided 7%, 8% and 5% of total revenue in 2002, 2001 and 2000, respectively.
Data and Internet services consist of the sale of high-speed data transport services utilizing technology based on Internet protocol (“IP”), ATM/frame relay, data collocation and web hosting. These services continued to grow as a percentage of total revenue, increasing from 7% in 2000 to 10% in 2001 to 12% in 2002. Data collocation services generated revenue of $8 million, $15 million, and $6 million in 2002, 2001 and 2000, respectively. The decrease in data collocation revenue in 2002 was primarily due to the Company closing eight of its eleven data centers as part of its November 2001 restructuring plan discussed in Note 3 of the Consolidated Financial Statements.
IT consulting consists of information technology consulting services and related hardware sales. These services are provided by Broadwing Technology Solutions (“BTS”), a wholly owned subsidiary of BCI. Information technology consulting revenue was $144 million in 2002, or $3 million higher than in 2001 and $78 million higher than in 2000.
Network construction and other services consist of large, joint-use network construction projects and the receipt of warrants in 2000 related to a field trial of optical equipment. The Company typically gains access to rights-of-way or additional fiber routes through its network construction activities. In November 2001, the Company announced its intention to exit the network construction business upon completion of one remaining contract as discussed in Note 3 of the Notes to Consolidated Financial Statements. That contract to build a 1,550 mile fiber route system is in dispute as discussed in Note 14 of the Notes to Consolidated Financial Statements. In 2002, network construction projects provided no revenue, compared to $87 million and $68 million in 2001 and 2000, respectively.
The Company’s network includes an Internet backbone and incorporates optical switching technology. In order to maintain its network, the Company relies on supplies from certain key external vendors and a variety of other sources.
As revenue from the Company is primarily generated by usage-based and monthly service fees, the operations follow no particular seasonal pattern. However, the Company received approximately 57%, 64% and 67% of its revenue in 2002, 2001 and 2000, respectively, from interexchange carriers that have or are capable of constructing their own network facilities but utilize the Company’s broadband transport, switched voice and network construction services to augment their own networks. Cincinnati Bell Any Distance (“CBAD”), a subsidiary of the Parent Company, contributed
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interexchange carrier revenue, included in the amounts above, of 4% to total Company revenue in 2002 and 3% in 2001 and 2000. Remaining revenue is generated by business enterprise customers through the purchase of broadband transport, data and Internet, switched voice and IT consulting services.
Prices and rates for the Company’s service offerings are primarily established through contractual agreements. Accordingly, the Company is influenced by competitive conditions such as the number of competitors, availability of comparable service offerings and the amount of fiber network capacity available from these competitors.
The Company faces significant competition from other fiber-based telecommunications companies such as AT&T Corp., WorldCom, Inc., Sprint Corporation, Level 3 Communications, Inc., Qwest Communications International Inc., and several emerging and recapitalized competitors. These competitors attempt to compete on the basis of price, quality, service and product breadth. BTS, a business unit of BCI, competes with Intranet hardware vendors, wiring vendors, and other information technology consulting businesses. The web hosting operations of BTS face competition from nationally known web hosting providers.
Employees
At December 31, 2002, the Company employed 1,500 people, of whom 400 provided operational and technical services, 500 engaged in sales services, 400 provided information technology consulting services at BTS and the balance engaged in administration and marketing. These employees are not represented by labor unions, and the Company considers employee relations to be good.
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Risk Factors
The Parent Company is highly leveraged
The Parent Company is highly leveraged and has significant debt service obligations. As of December 31, 2002, the Parent Company had outstanding indebtedness of $2,558 million, minority interest of $444 million (which represents the Company’s 12.5% preferred stock security) and total shareowners’ deficit of $2,548 million. As of December 31, 2002 the Parent Company had the ability to borrow an additional $164 million under its revolving credit facility, subject to compliance with certain conditions. In March 2003, the Parent Company completed an amendment to its credit facility, which included the extension of revolving credit maturity to 2005 and 2006, and the acceleration of a portion of the maturities of term loans from banking institutions from 2004 into 2003.
The Parent Company’s substantial debt could have important consequences to the shareowners, including the following:
• the Parent Company will be required to use a substantial portion of its cash flow from operations to pay principal and interest on its debt, thereby reducing the availability of cash flow to fund working capital, capital expenditures, strategic acquisitions, investments and alliances and other general corporate requirements;
• the Parent Company’s interest expense could increase if interest rates in general increase because a substantial portion of its debt bears interest at floating rates;
• the Parent Company’s substantial leverage could increase its vulnerability to general economic downturns and adverse competitive and industry conditions and could place the Company at a competitive disadvantage compared to those of its competitors that are less leveraged;
• the Parent Company’s debt service obligations could limit its flexibility to plan for, or react to, changes in its business and the industries in which it operates;
• the Parent Company’s level of debt may restrict it from raising additional financing on satisfactory terms to fund working capital, capital expenditures, strategic acquisitions, investments and joint ventures and other general corporate requirements; and
• a potential failure to comply with the financial and other restrictive covenants in the Parent Company’s debt instruments, which, among other things, require it to maintain specified financial ratios could, if not cured or waived, have a material adverse effect on the Parent Company’s ability to fulfill its obligations and on its business or prospects generally.
The Company is highly leveraged
The Company is highly leveraged and has significant debt service obligations. As of December 31, 2002, the Company had aggregate outstanding indebtedness of $1,738 million and a total shareowner’s deficit of $2,562 million. Of the Company’s total debt outstanding, $1,498 million is debt owed to the Parent Company.
The Company’s substantial debt could have important consequences, including the following:
• it will be required to use a substantial portion of its cash flow from operations to pay principal and interest on its debt, thereby reducing the availability of its cash flow to pay dividends on the Company’s preferred stock, fund working capital, capital expenditures, strategic acquisitions, investments and alliances and other general corporate requirements;
• its substantial leverage could increase its vulnerability to general economic downturns and adverse competitive and industry conditions and could place it at a competitive
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disadvantage compared to those of its competitors that are less leveraged;
• its debt service obligations could limit its flexibility to plan for, or react to, changes in its business and the industry in which it operates; and
• its level of debt may restrict it from raising additional financing on satisfactory terms to fund working capital, capital expenditures, strategic acquisitions, investments and joint ventures and other general corporate requirements.
The Company depends on the receipt of dividends or other intercompany transfers from its subsidiaries
The Company conducts substantially all of its operations through its subsidiaries and substantially all of its operating assets are held directly by its subsidiaries. The Company will therefore be dependent upon dividends or other intercompany transfers of funds from these subsidiaries in order to pay any dividends on or redeem the Company’s preferred stock, and to meet its other obligations.
Accordingly, in the event of the dissolution, bankruptcy, liquidation or reorganization of the Company, amounts may not be available for payments on the Company’s preferred stock until after the payment in full of the claims of its creditors.
Servicing indebtedness requires a significant amount of cash, and the Parent Company’s ability to generate cash depends on many factors beyond its control
The Parent Company expects to obtain the cash to make payments on its credit facility and other indebtedness and to fund working capital, capital expenditures and other general corporate requirements from operations, additional sources of debt financing and borrowings under its credit facility. The Parent Company’s ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond the Parent Company’s control. The Company cannot be assured that its business will generate sufficient cash flow from operations, additional sources of debt financing will be available to it or that future borrowings will be available to it under the credit facilities, in each case, in amounts sufficient to enable it to service its indebtedness or to fund its other liquidity needs. If the Parent Company cannot service its indebtedness, it will have to take actions such as reducing or delaying capital expenditures, strategic acquisitions, investments and joint ventures, selling assets, restructuring or refinancing indebtedness or seeking additional equity capital, which may adversely affect its customers and affect their willingness to remain customers. There can be no assurances that any of these remedies could, if necessary, be effected on commercially reasonable terms, or at all. In addition, the terms of existing or future debt instruments may restrict the Parent Company from adopting any of these alternatives.
There can be no assurances that the Company’s subsidiaries will be successful in their efforts to complete the sale of the broadband business
On February 22, 2003, certain subsidiaries of the Parent Company entered into a definitive agreement to sell substantially all of the Company's assets, excluding the information technology consulting assets, to C III for up to $129 million in cash and the assumption of certain long-term operating and contractual commitments. The sale is subject to certain closing conditions, including approval by the FCC and relevant state public utility commissions. Broadwing expects that the sale will close in 2003, however, there can be no assurances that the sale will be completed. If the Company’s subsidiaries are unable to complete this sale, the Company could face material adverse impacts, including bankruptcy.
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If the sale to CIII is completed, substantially all of the operating assets of certain of the Company’s subsidiaries will have been sold and the Company will have retained considerable long-term operating contractual commitments
BCI conducts substantially all of its operations through its subsidiaries and is dependent upon dividends or other intercompany transfers of funds from its subsidiaries in order to meet its obligations. After the completion of the sale of the broadband business, the only remaining BCI subsidiary with operating assets will be Broadwing Technology Solutions, an information technology consulting subsidiary. In 2002, Broadwing Technology Solutions generated $164 million in revenue, or 15% of BCI’s total revenue. Furthermore, upon the completion of the sale of the broadband business, BCI will retain certain long-term operating contractual commitments.
There can be no assurances that BCI will be able to generate sufficient cash from its remaining operations or that additional sources of financing will be available to it to enable it to service the long-term operating contractual commitments remaining after the sale of the broadband business or to fund its other liquidity needs.
Servicing indebtedness requires a significant amount of cash, and the Company’s ability to generate cash depends on many factors beyond its control; if the Company is unable to finance its operations, the Company may be forced to seek protection from its creditors by filing for bankruptcy
The Company expects to obtain needed cash from operations and, to the limited extent still allowed under various credit documents, from third party borrowings and intercompany loans from the Parent Company. The Company’s ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond its control. The Company cannot be assured that its business will generate sufficient cash flow from operations, additional sources of funding will be available to it or that future borrowings will be available to it in amounts sufficient to enable it to service its indebtedness or to fund its other liquidity needs.
The terms of the Mezzanine Financing and Amended and Restated Credit Agreement contain certain financial and non-financial covenants including restrictions on the Company’s ability to make investments in the Company. Specifically, Broadwing and its other subsidiaries may not make investments in or fund the operations of the Company beyond an aggregate amount of $118 million after October 1, 2002. As of February 28, 2003, the remaining available investment was $58 million. If the Company requires funds in excess of the amounts described above in order to finance its operations, there can be no assurances that the required lenders will consent to Broadwing investing additional funds to allow the Company to meet its obligations.
If the Parent Company is unable to fund the Company through closing of the sale to C III and meet its remaining obligations going forward after the sale or is unable to close the sale, the Company may explore alternative transactions or sources of financing, including borrowing money or raising equity. There can be no assurances that any such transactions could be consummated on acceptable terms, or at all. The uncertainty of the Company's available liquidity combined with the funding constraints discussed above, has prompted the Company’s independent accountants to issue a going concern explanatory paragraph in their audit report. The going concern explanatory paragraph means that, in the opinion of the Company’s independent accountants, there is substantial doubt about the Company’s ability to continue to operate as a going concern. If the Company is unable to finance its operations through the closing of the sale and meet its remaining obligations, or if a sale is not consummated, it may be forced to seek protection from its creditors under the United States Bankruptcy Code.
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In addition, the Company’s subsidiary, Broadwing Communications Services Inc., has directly borrowed $193 million under the Parent Company’s credit facilities. However, the amended terms of the Parent Company’s credit facilities prohibit any additional borrowings by the Company or its subsidiaries. Because the Company has relied on the Parent Company’s credit facilities in the past to fund its operations, the restrictions on future borrowings might adversely affect its ability to access sufficient cash to meet its obligations.
The Parent Company depends on its bank credit facility to provide liquidity
The Parent Company depends on its bank credit facility to provide for financing requirements in excess of amounts generated by operations.
In November 1999, the Parent Company obtained a credit facility of $1.8 billion from a group of lending institutions. The credit facility was increased to $2.1 billion in January 2000 and again to $2.3 billion in June 2001. Total availability under the credit facility decreased to $1.825 billion as of December 31, 2002 following a $335 million prepayment of the outstanding term debt facilities in the first quarter of 2002 (with proceeds from the sale of substantially all of the assets of CBD), $5 million in scheduled repayments of the term debt facilities and $135 million in scheduled amortization of the revolving credit facility.
In March 2003, the Parent Company completed an amendment to the credit facility, which included the extension of revolving credit maturity to 2005 and 2006, and the acceleration of a portion of the maturities of term loans from banking institutions from 2004 into 2003. As of March 26, 2003, the credit facilities consisted of $644 million in revolving credit maturing on March 1, 2006, $516 million in term loans from banking institutions, maturing in various amounts during 2003 and 2004, and $444 million in term loans from non-banking institutions, maturing in various amounts between 2003 and 2007.
However, the ability to borrow from the credit facility is predicated on the Parent Company’s and its subsidiaries’ compliance with covenants that have been negotiated with the lenders. As a result of the significant capital the Parent Company has invested in the Company as well as the effect the weak U.S. economy and telecommunications industry has had on the Parent Company's and its subsidiaries’ businesses, the Parent Company is highly leveraged and it is uncertain whether the Parent Company will be able to remain in compliance with these covenants. Failure to satisfy these covenants could severely constrain the Parent Company’s ability to borrow under the credit facility. As of December 31, 2003, Broadwing was in compliance with all of the covenants of the credit facility.
The Parent Company’s credit facility and other indebtedness impose significant restrictions on the Parent Company
The Parent Company’s debt instruments impose, and the terms of any future debt may impose, operating and other restrictions on the Parent Company. These restrictions will affect, and in many respects will limit or prohibit, among other things, the Parent Company's and its subsidiaries’ ability to:
• incur additional indebtedness;
• create liens;
• make investments;
• enter into transactions with affiliates;
• sell assets;
• guarantee indebtedness;
• declare or pay dividends or other distributions to shareholders;
• repurchase equity interests;
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• redeem debt that is junior in right of payment to such indebtedness;
• enter into agreements that restrict dividends or other payments from subsidiaries;
• issue or sell capital stock of certain of its subsidiaries; and
• consolidate, merge or transfer all or substantially all of its assets and the assets of its subsidiaries on a consolidated basis.
In addition, the Parent Company’s credit facility includes other and more restrictive covenants and prohibit the Parent Company from prepaying other debt and preferred stock while debt under the credit facility is outstanding. The agreements governing the credit facility also require the Parent Company to achieve specified financial and operating results and maintain compliance with specified financial ratios. The Parent Company is highly leveraged and it is uncertain whether it will continue to remain in compliance with these agreements.
The restrictions contained in the terms of the credit facility and its other debt instruments could:
• limit the Parent Company’s ability to plan for or react to market conditions or meet capital needs or otherwise restrict the Company’s activities or business plans; and
• adversely affect the Parent Company’s ability to finance BCI’s operations, strategic acquisitions, investments or alliances or other capital needs or to engage in other business activities that would be in BCI’s interest.
A breach of any of these restrictive covenants or the inability to comply with the required financial ratios could result in a default under the credit facility.
Increased Competition Could Affect Profitability and Cash Flow
There is substantial competition in the telecommunications industry. Competition may intensify due to the efforts of existing competitors to address difficult market conditions through reduced pricing, bundled offerings or otherwise, as well as a result of the entrance of new competitors and the development of new technologies, products and services. Price competition has been intense and may further intensify. If the Company cannot offer reliable, value-added services on a price competitive basis in any of its markets, it could be adversely impacted by competitive forces. In addition, if the Company does not keep pace with technological advances or fails to respond timely to changes in competitive factors in the industry, it could lose market share or experience a decline in its revenue and profit margins.
The Company faces significant competition from companies such as AT&T Corp., WorldCom, Inc., Sprint Corporation, Level 3 Communications, Inc., Qwest Communications International Inc., and several emerging and recapitalized competitors. The significant capacity of these competitors could result in decreasing prices even if the demand for higher-bandwidth services increases. In addition, some competitors are experiencing financial difficulties or are in bankruptcy reorganization. Competitors in financial distress or competitors emerging from bankruptcy with lower cost capital structures and substantial excess fiber capacity in most markets, and forecasted demand for broadband services not being realized as a result of the state of the economic and financial difficulties experienced by many telecommunications carriers’ could exacerbate downward pricing pressure in the telecommunications industry.
The effect of the foregoing competition could have a material adverse impact on the Company’s businesses, financial condition and results of operations. This could result in increased reliance on borrowed funds and could adversely impact the Company’s ability to maintain its optical network.
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Network Utilization is Dependent on Maintaining Rights-of-Way and Permits
The utilization of the Company’s network depends on maintaining rights-of-way and required permits from railroads, utilities, governmental authorities and third-party landlords on satisfactory terms and conditions. The Company cannot guarantee that it will be able to maintain all of the existing rights and permits. Although the Company expects to maintain and renew its existing agreements, the loss of a substantial number of existing rights and permits could have a material adverse impact on the Company’s business, financial condition and results of operations. For portions of the Company’s network that it leases or purchases use rights from third parties, the Company must rely on such third parties’ maintenance of all necessary rights-of-way and permits. Some agreements that the Company may rely on to use portions of other companies’ networks could be terminated if associated rights-of-way were terminated.
Significant Capital Expenditures Will be Required to Maintain the Network
Capital expenditures of $600 million in 2000 decreased to $472 million in 2001 and decreased again in 2002 to $65 million. The Company could incur significant additional capital expenditures as a result of unanticipated expenses, regulatory changes and other events that impact the business. If the Company fails to adequately maintain its networks to meet customer needs there could be a material adverse impact on the Company’s business, financial condition and results of operations.
Regulatory Initiatives May Impact the Company’s Profitability
The Company is subject to regulatory oversight of varying degrees at the state and federal levels. Regulatory initiatives that would put the Company at a competitive disadvantage or mandate lower rates for its services could result in lower profitability and cash flow. This could compromise the Company’s ability to maintain its national optical network, which could have a material adverse effect on the Company’s business, financial condition and results of operations.
In October 2002, the Company initiated a restructuring that is intended to reduce annual expenses by approximately $200 million compared to 2002 and enable the Company to become cash flow positive. The plan includes initiatives to reduce the workforce by approximately 500 positions; reduce line costs by approximately 25% through network grooming, optimization, and rate negotiations; and exit the international wholesale voice business. The Company recorded a cash restructuring charge of approximately $13 million during the fourth quarter of 2002 related to employee severance benefits and contract terminations. There can be no assurances that any of the actions under the restructuring plans will be successful. If the Company fails to successfully implement these restructuring initiatives, the Company’s business, financial condition and results of operations could be adversely affected.
The Company Relies, in part, on Portions of Competitors’ Networks
The Company uses network resources owned by other companies for portions of its network. The Company obtains the right to use such network portions through operating leases and IRU agreements in which the Company pays for the right to use such other companies’ fiber assets and through agreements in which the Company exchanges the use of portions of its network for the use of portions of such other companies’ networks. In several of those agreements, the counter party is responsible for network maintenance and repair. In the event a counter party to a lease, IRU or an exchange suffers financial distress or bankruptcy, the Company may not be able to enforce its rights to use such
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network assets or, even if the Company could continue to use such network assets, the Company could incur material expenses related to their maintenance and repair. The Company also could incur material expenses if it were required to locate alternative network assets. The Company cannot give assurance that it would be successful in obtaining reasonable alternative network assets if needed. Failure to obtain usage of alternative network assets, if necessary, could have a material adverse impact on the Company’s business, financial condition and results of operations.
Attracting and Retaining Highly Qualified Employees is Necessary for Competitive Advantage
The Company seeks to achieve competitive advantage by hiring and retaining highly skilled personnel. The Company believes this is of particular importance in an industry that depends on innovation and execution in order to attract and retain customers. If the Company fails to attract or retain these skilled personnel, the Company’s financial condition and results of operations could be materially impacted.
The Company’s Success Depends on the Introduction of New Products and Services
The Company’s success depends on being able to anticipate the needs of current and future enterprise and carrier customers. The Company seeks to meet these needs through new product introductions, service quality and technological superiority. Failure of the Company to anticipate the needs of these customers and to introduce the new products and services necessary to attract or retain these customers could have a material adverse impact on the Company’s business, financial condition and results of operations.
Continuing Softness in the Economy is Having a Disproportionate Effect in the Telecommunications Industry
Beginning in 2001, the business environment for the telecommunications industry deteriorated significantly and rapidly and remains weak. This was primarily due to: the general weakness in the U.S. economy, which was exacerbated by the events of September 11, 2001, and concerns regarding terrorism; pressure on prices for broadband services due to substantial excess fiber capacity in most markets; and forecasted demand for broadband services not being realized as a result of the state of the economy, the bankruptcy or liquidation of a substantial number of Internet companies and financial difficulties experienced by many telecommunications customers. The Company expects these trends to continue, including reduced business from financially troubled customers and downward pressure on prices due to reduced demand and overcapacity. If these trends continue, there could be a material adverse impact on the Company’s business, financial condition and results of operations.
A Significant Portion of the Company’s Revenue Is Derived From Telecommunications Carriers
Eight of the Company’s top ten customers, which as a group, accounted for approximately 38% of total revenue, are large telecommunications carriers. Several customers have been impacted by negative industry trends. Four of the Company’s largest customers, who accounted for approximately 14% of revenue in 2002, were in Chapter 11 bankruptcy proceedings. Non-IRU revenue from these customers approximated 7% of total revenue in 2002. The remaining revenue from these customers, approximating 7% of total revenue, was generated by the amortization of IRU agreements and the early termination of two IRUs, for which consideration had been previously received. In addition, interexchange carriers generated approximately 57% of total revenue in 2002. Most of the Company’s arrangements with large customers do not provide the Company with guarantees that customer usage will be maintained at current levels. Industry pressures have caused telecommunications carriers to look aggressively for ways to cut costs which has resulted in reduced demand and reduced prices. In addition, construction of their own facilities by certain of the Company’s customers, construction of additional facilities by competitors or further consolidation in the telecommunications industry
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involving the Company’s customers could lead such customers to reduce or cease their use of the Company’s network. To the extent these large customers cease to employ the Company’s network to deliver their services, or cannot pay outstanding accounts receivable balances, the Company could experience a material adverse impact on its business, financial condition and results of operations.
Terrorist Attacks and Other Acts of Violence or War May Affect the Financial Markets and the Company’s Business, Financial Condition and Results of Operations
As a result of the September 11, 2001 terrorist attacks and subsequent events, there has been considerable uncertainty in world financial markets. The full effect of these events, as well as concerns about future terrorist attacks, could adversely affect the Company’s ability to obtain financing on terms acceptable to it, or at all, to finance the Company’s operations and capital expenditures.
Terrorist attacks or war may negatively affect the Company’s operations and financial condition. There can be no assurance that there will not be further terrorist attacks against the United States of America or U.S. businesses or armed conflict involving the United States of America. These attacks or armed conflicts may directly impact the Company’s physical facilities or those of its customers and vendors. These events could cause consumer confidence and spending to decrease or result in increased volatility in the United States and world financial markets and economy. Any of these occurrences could have a material adverse impact on the Company’s business, financial condition and results of operations.
The Company is Dependent on Limited Sources of Supply for Certain Key Network Components