10-Q 1 d26441_10-q.txt QUARTERLY REPORT 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 June 30, 2001 OR [ ] 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 333-41040 NUVOX, INC. (Exact name of registrant as specified in its charter) DELAWARE 43-1820855 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 16090 Swingley Ridge Road, Suite 500, Chesterfield, Missouri 63017 (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (636) 537-5700 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 |_| At July 31, 2001, 19,778,401 shares of the registrant's common stock were outstanding. NUVOX, INC. QUARTERLY REPORT ON FORM 10-Q TABLE OF CONTENTS Page No. Part I Financial Information..................................................1 Item 1. Financial Statements...................................................1 Condensed Consolidated Balance Sheets as of June 30, 2001 (Unaudited) and December 31, 2000.........................................2 Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2001 and 2000 (Unaudited).............3 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000 (Unaudited).......................4 Notes to Condensed Consolidated Financial Statements...........................5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................10 Item 3. Quantitative and Qualitative Disclosures About Market Risk............19 Part II Other Information....................................................19 Item 6. Exhibits and Reports On form 8-K......................................19 Signatures....................................................................20 Index to Exhibits.............................................................21 PART I FINANCIAL INFORMATION Item 1. Financial Statements. NUVOX, INC. AND SUBSIDIARIES Condensed Consolidated Balance Sheets (in thousands, except share and per share data)

See accompanying notes to condensed consolidated financial statements. 2 NUVOX, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Operations (in thousands, except for share and per share data) (unaudited)

See accompanying notes to condensed consolidated financial statements. 3 NUVOX, INC. AND SUBSIDIARIES Condensed Consolidated Statements of Cash Flows (in thousands) (unaudited)

See accompanying notes to condensed consolidated financial statements. 4 NUVOX, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Dollars in Thousands, except share and per share data) (1) General NuVox, Inc. (NuVox or the Company), formerly known as Gabriel Communications, Inc., was incorporated as a Delaware corporation in June 1998 for the purpose of being a facilities-based provider of integrated voice, data and Internet telecommunications services in selected markets in the United States. As of June 30, 2001, NuVox was operational in 30 markets throughout the midwestern and southeastern United States. NuVox has incurred substantial operating losses and capital expenditures, resulting in negative cash flow since its inception, and expects to continue to experience significant operating losses and negative cash flow as it expands its operations and grows its customer base. NuVox intends to fund the negative operating cash flows through its debt and equity capital. (2) Basis of Presentation The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. The interim consolidated financial statements include the consolidated accounts of NuVox, Inc., its wholly-owned subsidiaries and affiliated companies in which NuVox has a controlling interest (collectively, "NuVox"). Until April 30, 2001 NuVox had a fifty percent interest in a joint venture which was accounted for under the equity method. On April 30, 2001 the joint venture was liquidated. Affiliated companies in which NuVox does not have a significant influence are accounted for using the cost method. All significant intercompany balances and transactions have been eliminated. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the interim information have been included. Certain footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such SEC rules and regulations. These financial statements should be read in conjunction with NuVox's audited consolidated financial statements as of and for the year ended December 31, 2000 which are included in NuVox's Form 10-K (Commission File No. 333-41040). The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. (3) Adoption of Accounting Standards In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133 - Accounting for Derivative Instruments and Hedging Activities (SFAS 133). In June 1999 and June 2000, the FASB issued SFAS No. 137 - Accounting for Derivating Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, an Amendment of FASB Statement No. 133 and, SFAS No. 138 - Accounting for Derviative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133, respectively. SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS 133, as amended, requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as a hedge in one of three categories. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. Under SFAS 133, as amended, an entity that elects to apply hedge accounting is required to establish, at the inception of the hedge, the method it will use for assessing the effectiveness or ineffectiveness of the hedging derivative. Those methods must be consistent with the entity's approach to managing risk. On January 1, 2001, the Company implemented SFAS 133, as amended. The implementation of SFAS 133, as amended, resulted in a cumulative effect of change in accounting principle of approximately $2.5 million and an unrealized loss on derivative instrument of approximately $1.3 million for the six months ended June 30, 2001. 5 NUVOX, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Dollars in Thousands, except share and per share data) (4) Property and Equipment Property and equipment consist of the following: June 30, December 31, 2001 2000 -------- ----------- Network equipment $205,024 $152,487 Computer hardware and software 34,443 30,668 Leasehold improvements 13,921 12,937 Transportation equipment 8,116 7,864 Furniture and office equipment 6,412 4,842 Other 1,008 956 -------- -------- Property and equipment, in service 268,924 209,774 Less accumulated depreciation and amortization 38,906 16,955 -------- -------- Property and equipment, in service, net 230,018 192,819 Construction-in-progress 42,636 59,660 -------- -------- Property and equipment, net $272,654 $252,479 ======== ======== (5) Investments On December 2, 1999, NuVox invested $2.0 million to purchase 583,090 Series B convertible preferred shares of Tachion Networks, Inc. (Tachion), a privately-held "next generation" switch manufacturer. Conversion of such shares would result in NuVox owning less than 2% of Tachion. During the three months ended June 30, 2001, NuVox wrote off the investment in Tachion due to the cessation of operations by that company, resulting in a loss on write-off of investment of $2.0 million which is included in other income (expense) in the accompanying condensed consolidated statements of operations. On March 22, 2000, NuVox entered into a joint venture, WebBizApps, L.L.C. Under the terms of the agreement, NuVox agreed to contribute $4.5 million in exchange for a 50% interest in the joint venture. NuVox contributed $3.3 million in March 2000. The joint venture partner contributed $4.5 million in assets and received a distribution of $2.0 million in March 2000. In January 2001, NuVox contributed its remaining $1.2 million. During the three months ended June 30, 2001, this joint venture was liquidated and rights to continue marketing the product line were acquired by NuVox. NuVox also received cash of $656,000 and a loss on write-off of investment of $3.0 million was recorded which is included in other income (expense) in the accompanying condensed consolidated statements of operations. (6) Acquisitions In February 2001, NuVox purchased all of the outstanding stock of American Telecommunications, Inc. of Charleston and an affiliated company, a Charleston, South Carolina based interconnect equipment and services company (AT). Under terms of the agreement, NuVox paid $1.8 million in cash, issued common stock and assumed certain liabilities of AT. The acquisition has been accounted for using the purchase method of accounting. Accordingly, the results of operations of AT are included in NuVox's results of operations subsequent to the date of the purchase. 6 NUVOX, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Dollars in Thousands, except share and per share data) During 2000, NuVox merged with State Communications, Inc. d/b/a TriVergent Communications and acquired Shared Telecom Services, Inc. (STS). Both transactions were accounted for using the purchase method of accounting. The following represents the unaudited pro forma results of operations of NuVox for the three and six months ended June 30, 2000 as if the Trivergent merger and the STS acquisition had been consummated as of January 1, 2000. The pro forma results of operations are prepared for comparative purposes only and do not necessarily reflect the results that would have occurred had those transactions occurred at the beginning of the period presented or the results which may occur in the future. Three Months Six Months Ended Ended June 30, 2000 June 30, 2000 ------------- ------------- Revenues 8,092 15,245 Net loss (27,350) (47,622) Net loss per share, basic and diluted $ (1.38) $ (2.41) (7) Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following: June 30, December 31, 2001 2000 ------- ---------- Accrued capital expenditures $ 3,770 $22,392 Acquisition liabilities 8,856 19,724 Accrued employee expenses 3,692 3,464 Accrued costs of communications services 2,256 3,212 Accrued taxes 5,678 3,655 Other 5,540 7,262 ------- ------- Total $29,792 $59,709 ======= ======= (8) Derivative Instruments and Hedging Activities The Company utilizes derivative instruments to assist in the management of interest rate sensitivity and to solely reduce its interest rate exposure. The following is a summary of the Company's derivative instruments under SFAS 133, as amended: Interest Rate Swaption Agreement. The Company's interest rate swaption agreement is accounted for at fair value. The change in the fair value of the swaption is recognized in earnings on each financial statement reporting measurement date. Interest Rate Cap and Floor Agreements. The Company's interest rate cap and floor agreements are accounted for at fair value. Changes in the fair value of the interest rate cap and floor agreements are recognized in earnings on each financial statement reporting measurement date. 7 NUVOX, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Dollars in Thousands, except share and per share data) (9) Loss Per Share A reconciliation of the number of shares used in the calculation of basic and diluted loss per share and the calculated amounts of loss per share follows:

In calculating diluted loss per share for the periods ended June 30, 2001 and June 30, 2000, employee and investor stock options and warrants to purchase 30,678,171 and 4,179,033 shares of common stock, respectively, and preferred stock convertible into common shares of 99,302,505 and 39,905,295, respectively, were outstanding but were not included in the computation of diluted loss per share due to their antidilutive effect. 8 NUVOX, INC. AND SUBSIDIARIES Notes to Condensed Consolidated Financial Statements (Dollars in Thousands, except share and per share data) (10) Stock Based Compensation The following is a summary of activity with respect to stock options and warrants under NuVox's 1998 Stock Incentive Plan: Shares Subject to Weighted Average Options & Warrants Price Exercise Price ------------------ ----- -------------- Options and warrants outstanding at December 31, 1999 2,765,500 $2.40 $2.40 Granted 3,658,800 $2.40 - $5.60 $4.06 Canceled (474,683) $2.40 - $5.60 $3.66 Exercised (6,040) $2.40 $2.40 ----------- Options and warrants outstanding at December 31, 2000 5,943,577 Granted 1,090,263 $4.00 $4.00 Canceled (444,406) $2.40 - $5.60 $3.84 Exercised (2,600) $2.40 $2.40 ----------- Options and warrants outstanding at June 30, 2001 6,584,168 =========== Exercisable options and warrants totaled 1,655,409 and 1,355,092 at June 30, 2001 and December 31, 2000, respectively. Pursuant to the terms of the TriVergent merger agreement, NuVox assumed and adopted, at November 1, 2000, the plan under which TriVergent had granted options to its employees. The following is a summary of activity with respect to NuVox stock options issued at November 1, 2000 in substitution for options outstanding immediately prior to the effective time of the merger under the TriVergent plan. Shares Subject to Weighted Average Options Price Exercise Price ----------------- ----- ---------------- Options outstanding at November 1, 2000 10,946,207 $1.36 - $13.56 $4.09 Granted -- -- -- Canceled (55,408) $5.56 $5.56 Exercised -- -- -- ----------- Options outstanding at December 31, 2000 10,890,799 Granted -- -- -- Canceled (1,049,727) $2.03 - $5.56 $3.66 Exercised (206,563) $1.36 - $3.84 $2.23 ----------- Options outstanding at June 30, 2001 9,634,509 =========== Exercisable options totaled 5,736,825 at June 30, 2001 and 4,007,438 at December 31, 2000. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. References in this Form 10-Q to "we," "us," "our" and "NuVox" mean NuVox, Inc. (formerly known as Gabriel Communications, Inc.), a Delaware corporation, and its subsidiaries and predecessors, unless the context suggests otherwise. Some of the statements contained in this Form 10-Q discuss our business plans or future prospects or state other forward-looking information. These statements are forward-looking statements within the meaning of Section 27A of the Securities Act and are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by these statements. These forward-looking statements are based on various factors and have been derived using numerous assumptions. In some cases, you can identify these "forward-looking statements" by words like "may," "will," "should," "expect," "plan," "anticipate," "believe, "estimate," "predict," "project," "intend" or "potential" or the negative of those words and other similar expressions. You should be aware that those statements only reflect our predictions, assumptions and estimates regarding future events and circumstances. Actual events or results may differ substantially as a result of risks and uncertainties facing us. Important factors that could cause our actual results to be materially different from these forward-looking statements are disclosed in Item 1 of our Form 10-K Report for the year ended December 31, 2000 under the heading "Business-Risk Factors Relating to Our Business and Operations" and elsewhere in this Report. Overview NuVox, Inc. is a rapidly growing, facilities-based, integrated communications provider offering a wide array of broadband products and services primarily to small and medium-sized businesses in second and third tier markets. We compete with incumbent telephone companies and other providers by providing high quality, integrated voice and data services, excellent service and prices below those charged by the incumbent telephone companies. The principal elements of our business strategy include targeting end users with a wide range of innovative products and services that provide comprehensive business solutions for all of their communications requirements; focusing primarily on small to medium-sized businesses; providing superior customer service through our local sales and customer support personnel; deploying data-centric network platforms in a capital efficient manner; leveraging our experienced management team; and pursuing acquisitions, and strategic alliances to expand and complement our business. We have been providing these products and services in an expanding number of U.S. markets since we commenced commercial operations in June 1999. As of June 30, 2001, NuVox was providing services in 30 markets in seven midwestern states and six southeastern states to more than 30,000 customers with more than 100,000 total access lines in service (including approximately 6,300 on-net customers with approximately 85,000 total access lines in service). In contrast to carriers that construct their own fiber optic transmission facilities to reach customers, we have not built our own network connections to each individual customer. Instead, as part of our "smart build" network construction strategy, we have installed our own voice and data switches but we lease our transmission facilities from incumbent telephone companies and other providers within our local markets. We have also installed and connected our own access equipment in collocation sites that we lease in the central offices of the incumbent telephone companies in our markets, a process which is commonly referred to in the telecommunications industry as "collocation." This network construction strategy enables us to reach the entire targeted customer base in each market without having to build our own fiber optic transmission facilities in order to establish network connections to each customer. To date, capital expenditures have been primarily for the build out of our network and operations support systems infrastructure. Future incremental network infrastructure costs are expected to be substantially lower and more directly related to demand driven capital expenditures associated with the installation of new revenue producing services. 10 We believe that our smart-build construction strategy offers a number of advantages over the network build-out strategy of the fiber-based competitive local telephone companies by allowing us to o improve our return on capital by generating revenue with a smaller capital investment, o defer capital expenditures for additional network assets until the time when revenue generated by customer demand justifies such expenditures, and o address business customers throughout our markets and not just in those areas accessible from owned fiber transmission facilities. The development of our business and the deployment and expansion of our networks require significant expenditures, a portion of which is incurred before the realization of revenue. We have experienced negative operating cash flow from our inception through June 30, 2001 totaling approximately $138.1 million. Our negative cash flow from operations increased to $64.3 million for the six months ended June 30, 2001 from $11.8 million in the same period in 2000. We expect to continue to incur negative operating cash flow for a period of time as we expand our operations and grow our customer base. Expenses are expected to exceed revenue in each location in which we offer service until a sufficient customer base is established. TriVergent Merger On November 1, 2000, NuVox completed its merger with State Communications, Inc., d/b/a TriVergent Communications, a broadband telecommunications company based in Greenville, South Carolina, which merged with and into a wholly-owned subsidiary of NuVox. The combined company now has networks in the Midwest located in Missouri, Kansas, Oklahoma, Arkansas, Illinois, Indiana and Ohio and networks in the Southeast located in South Carolina, North Carolina, Georgia, Florida, Kentucky and Tennessee. We have made substantial progress in integrating the two companies by o restructuring into a unified organization with common salary structures, commission plans, benefit programs and payroll and e-mail systems, o developing a common product portfolio throughout our entire 30-market service area, o adopting common operations support system platforms for billing, collection, provisioning, trouble management, surveillance, customer service, financial and operational reporting, and other essential business functions, and o aggressively pursuing cost containment measures, including reductions in network costs through use of less costly network elements and more efficient network utilization, as well as reductions in selling, general and administrative expenses. NuVox issued approximately 52.2 million shares of common and preferred stock and options and warrants to acquire approximately 12.2 million shares of common stock to consummate the transaction. Total consideration, inclusive of transaction costs and options and warrants assumed, was approximately $245.6 million. The acquisition has been accounted for using the purchase method of accounting. Shared Telcom Acquisition On December 11, 2000, NuVox purchased all of the outstanding stock of Shared Telcom Services, Inc., a provider of local and long distance telecommunications services in Indianapolis. NuVox paid $10.4 million in cash and assumed certain liabilities of Shared Telcom. The acquisition has been accounted for using the purchase method of accounting. American Telecommunications of Charleston Acquisition On February 1, 2001, NuVox purchased all of the outstanding stock of American Telecommunications, Inc. of Charleston and an affiliated company, a Charleston, South Carolina based interconnect equipment and services company. NuVox paid $1.6 million in cash, issued common stock and assumed certain liabilities of American Telecommunications. The acquisition has been accounted for using the purchase method of accounting. 11 Operating Statistics The following table provides selected operational data:

-------------- (a) Includes 22,606 lines in service through which we provide resale services to 16,402 customers, which is expected to decrease as a percentage of the total lines in service as we pursue our business strategy of providing services primarily over our own network platforms. During the three months ended June 30, 2001, on-net lines installed totaled 31,305 lines, a 31% quarter to quarter sequential increase from the first quarter. (b) "On-net" customers are those to which we provide our services over our own network platforms. All customers have signed either one, two or three year contracts. Results of Operations Inasmuch as we have significantly increased the scope and size of our operations, our revenues and expenses for the three and six months ended June 30, 2001 were significantly greater than the revenues and expenses for the three and six months ended June 30, 2000. Also, since we are using the purchase method of accounting for acquisitions, we have only recognized revenues earned related to these transactions since the acquisition dates. Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000 REVENUE Our revenues increased to $19.1 million for the three months ended June 30, 2001 from $2.0 million for the three months ended June 30, 2000. The substantial increase in revenue reflects the impact of our development activities and acquisitions during 2000 and 2001 and the increase from 7 operational markets in service as of June 30, 2000 to 30 in service at June 30, 2001. We generate revenues from: o local calling services, including basic voice calling services and advanced local features such as call waiting and call forwarding, 12 o long distance services, which include a full range of domestic, international and toll-free long distance services, o dedicated, high speed Internet access services, including DSL Internet access, o website design and development, web page hosting and domain name services, audio conferencing, and remote access service, o advanced data services, such as high speed data transmission and unified voice mail, e-mail and fax messaging services, local and wide area network management and virtual private networks, o access charges, which we earn by connecting our customers to their selected long distance carrier for outbound calls or by delivering inbound long distance traffic to the local service customers of long distance carriers, o reciprocal compensation, which entitles us to compensation for terminating local calls made by customers of other carriers to our customers, o managed server services in our data centers, and o network design and installation services and telecommunications equipment sales. We price our local calling services competitively with those of the incumbent telephone companies and offer our customers combined service discounts designed to give them incentives to purchase bundled local, long distance and data services under one, two and three year commitments. Local voice service revenues for the three months ended June 30, 2001 and 2000 were $10.2 million and $1.0 million, respectively (of which $8.4 million and $1.0 million respectively, were derived from services provided on-net). Local voice service revenues include the monthly recurring charges for basic service, charges for advanced local features and reciprocal compensation. Long distance service revenues for the three months ended June 30, 2001 and 2000 were $2.7 million and $495,000, respectively. Revenues generated from Internet access, web, data and other services and products for the three months ended June 30, 2001 and 2000 were $6.2 million and $418,000, respectively. As a result of the TriVergent and Shared Telecom acquisitions, we also generate revenues from resale services to approximately 16,000 customers. Resale revenues for the three months ended June 30, 2001 totaled $1.8 million. Resale revenues are expected to decrease as a percentage of total revenues as we pursue our business strategy of providing services primarily over our own networks and transition business resale customers to such networks. A significant contributor to our overall revenue growth has been the addition of new markets as well as the growth in existing markets. Annualized revenues increased to $81.9 million based on June 2001 revenues from $8.5 million based on June 2000 revenues. Annualized revenues for the seven markets in service as of June 30, 2000 increased to $22 million, based on June 2001 revenues. We continue to grow our revenue base as evidenced by the total number of access lines in service increasing to 106,610 at June 30, 2001, of which 84,004 were on-net, as compared to 11,636 on-net access lines in service at June 30, 2000. Total customers have grown to 31,533 as of June 30, 2001, of which 6,286 were served on-net, as compared with 773 on-net customers at June 30, 2000. COST AND EXPENSES Our cost of communication services amounted to $15.6 million for the three months ended June 30, 2001 compared to $1.5 million for the same period in 2000. The increase in cost of communication services resulted from the deployment of our networks and growth in access lines in service, and correlates to the increase in revenue between the three month period ended June 30, 2001 and the same period from the prior year. Gross margin decreased to 18.41% of revenue for the three month period ended June 30, 2001 as compared with a gross margin of 23.08% in the three month period ended June 30, 2000 due to the recurring costs of collocation facilities included in the cost of communications services in 2001. While we are implementing initiatives to reduce these costs through the elimination of underutilized collocation sites, we expect that these costs will adversely impact our gross margins until we achieve a sufficient level of utilization to cover the costs of the remaining sites. Our cost of communication services includes recurring costs associated with 13 o leasing the high capacity transport facilities that connect our switching equipment to our equipment located in incumbent telephone companies' central offices, o leasing and obtaining electrical power for our collocation facilities, o leasing space used to collocate our customer access equipment in incumbent telephone companies' central offices, o purchasing long distance services for resale to our customers, and o providing Internet access to our customers. We have interconnection agreements with Southwestern Bell, Ameritech, BellSouth, GTE, Broadwing Communications and Sprint/United for network and collocation facilities. The costs to lease the local loop lines and high-capacity digital transport facilities from incumbent telephone companies vary by company and are regulated by state authorities. We believe that there are multiple vendors of high-speed transport facilities in each of our markets in addition to the incumbent telephone company. These vendors are an alternate source for transport facilities and generally provide these facilities at lower costs than those charged by the incumbent telephone companies. We expect that the total cost of leasing communications services will increase with the volume of customers, and expect these costs to be a significant part of ongoing costs of services. We have agreements with WorldCom, Inc., Qwest Communications and Global Crossing to provide us with long distance transmission services. These agreements provide for the resale of long distance services on a per-minute basis and the Global Crossing agreement has minimum usage requirements. We expect that total costs for transmission capacity will increase as customers' long distance calling volume increases, and that these costs will be a significant portion of the cost of long distance services. The primary expenses associated with providing Internet access to customers are the cost of interconnecting our network with national Internet service providers and the cost of hosting or paying for the hosting of web services. Our selling, general and administrative expenses increased to $25.8 million for the three months ended June 30, 2001 compared to $9.6 million for the same period in 2000. The increase in selling, general and administrative expenses is primarily due to increases in the number of employees and other costs associated with the expansion of our networks and services. We added 652 employees, including an additional 96 account executives, between June 30, 2000 and June 30, 2001 as 23 additional markets became operational, including 16 former TriVergent markets. Our selling, general and administrative expenses include salaries and related personnel costs, facilities expenses, sales and marketing, information systems costs, education and training costs, and professional services and consulting fees. As a result of cost containment measures being taken, we do not expect significant increases in selling, general and administrative expenses other than expenses directly related to the growth in our customer base. We employ a direct local sales force in each of our markets. We use quota-based commission plans and incentive programs to compensate our sales personnel. We supplement our direct sales force through the use of agents such as value-added resellers and system integrators, who are compensated on a commission basis. We also use print and other media advertising campaigns to a limited extent to create product and brand awareness. In connection with the TriVergent merger, a portion of the purchase price was allocated to the intrinsic value of the unvested portion of NuVox options issued to TriVergent employees. This amount totaled $6.0 million, and was recorded as unearned stock-based compensation and included in stockholders' equity in accounting for the transaction as of November 1, 2000. This intrinsic value of the unearned stock-based compensation is being amortized over the remaining vesting period of the related options through 2003. Accordingly, $645,000 was recorded as amortization of stock-based compensation in the three months ended June 30, 2001. Depreciation and amortization expense increased to $15.8 million for the three months ended June 30, 2001 from $2.5 million for the same period in 2000. This reflects the completion of networks and initiation of services in 23 additional markets, including 16 former TriVergent markets, as well as the recording of amortization of intangible assets related to acquisitions. 14 Interest expense for the three months ended June 30, 2001 was $2.8 million as compared to interest expense of $689,000 in the same period in 2000. The increase in interest expense relates to borrowings and commitment fees under our expanded senior secured credit facility which replaced the former facility on November 1, 2000. See "Liquidity and Capital Resources" below. Interest income is earned on the short-term investment of available cash. Interest income decreased from $1.2 million in the three months ended June 30, 2000 to $341,000 in the same period in 2001, due to decreases in our average cash balances. The $1.2 million unrealized gain on derivative instrument during the three months ended June 30, 2001 is attributable to changes in the fair value of our interest rate swaption agreement and interest rate cap and floor agreement since March 31, 2001. The cumulative effect of change in accounting principle results from the implementation of SFAS 133, as adopted on January 1, 2001. The $5.0 million loss on write-off of investments during the three months ended June 30, 2001 is attributable to the cessation of operations by two companies in which we had such investments. We had an operating loss of $38.7 million and negative adjusted EBITDA of $22.2 million for the three months ended June 30, 2001, compared to an operating loss of $11.7 million and negative adjusted EBITDA of $9.1 million for the three months ended June 30, 2000. We expect to continue to experience operating losses and negative adjusted EBITDA as we expand our operations and grow our customer base. EBITDA consists of earnings (loss) before net interest, income taxes, depreciation and amortization. Amounts reported as adjusted EBITDA have been adjusted to exclude the cumulative effect of change in accounting principle, unrealized loss on derivative instrument, minority interests, equity in loss of affiliate, loss on write-off of investments and stock-based compensation expense. Management believes EBITDA is a measure commonly used in the telecommunications industry in assessing companies' operating performance, leverage and ability to incur and service debt. Adjusted EBITDA is presented to enhance an understanding of NuVox's operating results and is not intended to represent cash flow or results of operation in accordance with accounting principles generally accepted in the United States of America. NuVox's senior secured credit facility contains covenants based on EBITDA that require the borrower to maintain interest coverage and leverage ratios. EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States of America and should not be considered an alternative to earnings (loss) from operations and net income (loss) as a measure of performance or an alternative to cash flow as a measure of liquidity. Neither EBITDA nor adjusted EBITDA is necessarily comparable to similarly titled measures of other companies. Each is thus susceptible to varying calculations. Our net loss for the three months ended June 30, 2001 was $44.9 million compared to $11.3 million for the three months ended June 30, 2000. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Our operations for the six months ended June 30, 2001 have generated $33.6 million of revenue compared to $3.3 million for the same period in 2000. The substantial increase in revenue reflects the impact of our continued development activities and the increase from seven operational markets in service as of June 30, 2000 to 30 in service at June 30, 2001. Our cost of communication services amounted to $29.0 million for the six months ended June 30, 2001 compared to $2.6 million for the same period in 2000. The increase in cost of communication services resulted from the deployment of our networks and growth in access lines in service, and correlates to the increase in revenue between the six month period ended June 30, 2001 and the same period from the prior year. Our selling, general and administrative expenses increased to $49.8 million for the six months ended June 30, 2001 compared to $17.1 million for the same period in 2000. The increase in selling, general and administrative expenses is primarily due to increases in the number of employees and other costs associated with the expansion of our networks and services. The amortization of unearned stock-based compensation expense attributable to the TriVergent merger totaled $1.3 million during the six months ended June 30, 2001. Depreciation and amortization expense increased to $30.2 million for the six months ended June 30, 2001 from $4.4 million for the same period in 2000. This reflects the completion of networks and initiation of services in 15 23 additional markets, including 16 former TriVergent markets, as well as the recording of amortization of intangible assets related to acquisitions. Interest expense for the six months ended June 30, 2001 was $5.6 million as compared to interest expense of $1.4 million in the same period in 2000. The increase in interest expense relates to borrowings and commitment fees under our expanded senior secured credit facility which replaced the former facility on November 1, 2000. See "Liquidity and Capital Resources" below. Interest income decreased to $1.5 million in the six months ended June 30, 2001 from $1.8 million in the same period in 2000, due to decreases in our average cash balances. The $1.3 million unrealized loss on derivative instrument is attributable to changes in the fair value of our interest rate swaption agreement and interest rate cap and floor agreement. The $2.5 million cumulative effect of change in accounting principle results from the implementation of SFAS 133, as adopted on January 1, 2001. Other expenses during the six months ended June 30, 2001 included the $5.0 million loss on write-off of investments recorded in the second quarter. We had an operating loss of $76.8 million and negative adjusted EBITDA of $45.2 million for the six months ended June 30, 2001, compared to an operating loss of $20.8 million and negative adjusted EBITDA of $16.4 million for the six months ended June 30, 2000. We expect to continue to experience operating losses and negative adjusted EBITDA as we expand our operations and grow our customer base. Our net loss for the six months ended June 30, 2001 was $89.9 million compared to $20.5 million for the six months ended June 30, 2000. Liquidity and Capital Resources As of June 30, 2001, we had $16.6 million of cash and short-term investments, and $93.9 million of undrawn financing available under our senior secured credit facility, providing total available capital of $110.5 million. On November 1, 2000, Gabriel Communications Finance Company, an indirect wholly-owned subsidiary of NuVox, secured an expanded $225 million eight-year senior secured credit facility, which replaced its existing $90 million senior credit facility. Approximately $98.2 million was drawn at that date to repay the previous secured credit facilities of Gabriel Communications Finance and TriVergent and to pay other expenses relating to the TriVergent merger. This credit facility consists of a $40 million term loan facility, a $60 million eight-year revolving credit facility, and $125 million in two-year delayed draw term loan facilities. Borrowings are available, subject to the satisfaction of certain terms and conditions, primarily to provide financing for capital expenditures and working capital and is predicated on our 30-market business plan. Quarterly repayment of outstanding borrowings under the term loan and revolving credit facilities will commence on December 31, 2003 and continue through September 30, 2008. Interest on outstanding borrowings varies based on the borrower's leverage ratio (the weighted average interest rate at June 30, 2001 was 8.48%). The initial commitment fee on the unused portion of the credit facility was 1.50% per annum, payable quarterly, and the rate is reduced based upon usage (the applicable commitment fee percentage at June 30, 2001 was 1.00%). Obligations under the credit facility are guaranteed by NuVox, its direct wholly-owned subsidiary, Gabriel Communications Properties, Inc., and all of the existing and subsequently acquired subsidiaries of the borrower. The facility is secured by a pledge of all of the capital stock of Gabriel Communications Properties, Inc., the borrower and each of the borrower's subsidiaries and a security interest in the assets of Gabriel Communications Properties, Inc., other than its unrestricted subsidiaries, and of the borrower and each of the borrower's subsidiaries. The credit facility contains restrictive covenants that, among other things, impose limitations on indebtedness, liens, investments, capital expenditures, dividends and other specified transactions and payments, and require the borrower and NuVox to maintain operating and financial performance measures. These covenants effectively prohibit us from paying any cash dividends on the common stock and preferred stock for the foreseeable future. Borrowings under the credit facility during the three months ended June 30, 2001 totaled $33.0 million. For the six months ended June 30, 2001 and 2000, capital expenditures totaled $59.1 million and $42.1 million, respectively. Such capital expenditures have included assets necessary for deploying the networks in our initial 30 markets, establishing our network operations control centers and providing the operations and other support systems 16 necessary for our business. We estimate that our capital expenditures for the balance of 2001 will total approximately $27.0 million. Our financing plan is predicated on obtaining the funding required for each market to reach positive free cash flow prior to committing to the development of that market. By using this approach, we seek to avoid being in the position of seeking additional capital to fund a market after we have already made a significant capital investment in that market. We believe that by raising all required capital prior to making any commitments in a market, we can raise capital on more favorable terms and conditions. As of June 30, 2001, we have raised equity and debt capital of $688.0 million, consisting of: o equity capital of $313.0 million invested by NuVox stockholders o equity capital of $150.0 million invested by TriVergent stockholders, and o debt capital of up to $225.0 million under our senior secured credit facility. As a result of our recent review of our current and future business plans, financial position, market position, growth opportunities, operational and regulatory challenges, and other factors affecting our business, we have determined that it is prudent and in the best interests of our investors to raise additional equity capital to fund the ongoing operations of our business. We plan to seek at least $75 million of additional equity capital pursuant to a rights offering during the third quarter of 2001 from our existing investors. Based upon our expected performance, we believe that this amount, together with our $110.5 million of total funding available at June 30, 2001, will be sufficient to fully fund all of the necessary capital for our initial 30 markets currently in operation, including capital to fund initial operating losses of those markets. However, risks we face that could cause us not to obtain this funding and/or remain fully funded include, but are not limited to, the willingness of our existing investors to commit additional equity and the willingness of our lenders to approve our revised financial model, our ability to successfully market our services to current and new customers, interconnect with and develop cooperative working relationships with the incumbent local carriers, successfully transfer new customers to our networks, and borrow under our credit facility or alternative financing sources. We will continue to deploy capital for the development of our existing markets and to allow for demand-driven capital spending. We intend to continue our financing plan of obtaining the funding necessary to support additional markets until we reach positive free cash flow, prior to committing to the development of those markets. In response to demand initially encountered for our services, we may consider the development of additional markets beyond our initial 30 markets and may raise additional funding through the sale of debt or equity securities. In addition, we may require additional funding to take advantage of additional opportunities, effect acquisitions, develop new services or otherwise respond to changing business conditions or developments in the telecommunications industry. The actual amount and timing of our future capital requirements may differ materially from our estimates as a result of, among other things o a change in or inaccuracy of our development plans or projections, o the demand for our services, o regulatory and technological developments, including new opportunities in the telecommunications industry, and o the consummation of acquisitions. Our revenues and our costs of deploying our networks and operating our business will depend on a variety of factors, including o the extent of price and service competition for telecommunications services in our markets, o our ability to develop, acquire and integrate the necessary operations support systems, o the number of customers and the services for which they subscribe and the time required to provision those customers, 17 o our ability to implement on-going cost containment measures and to avoid significant increases in selling, general and administrative expenses, and o the impact of changes in technology and telecommunication regulations. Actual costs and revenues may vary from expected amounts, possibly to a material degree, and these variations may affect our future capital requirements. Impact of Recently Issued Accounting Standards In July 2001, the Financial Accounting Standards Board issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. Statement 141 also specifies criteria for intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company is required to adopt the provisions of Statement 141 immediately and Statement 142 effective January 1, 2002. The Company's existing goodwill and intangible assets will continue to be amortized prior to the adoption of Statement 142. Statement 141 will require that, upon adoption of Statement 142, the Company evaluate its existing intangible assets and goodwill, and make any necessary reclassifications in order to conform with the new criteria in Statement 141. Upon adoption of Statement 142, the Company will be required to reassess the useful lives and residual values of all recorded intangible assets, and make any necessary amortization period adjustments by June 30, 2002. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 by June 30, 2002. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle. As of January 1, 2002, the Company expects to have unamortized goodwill of $209.4 million, which will be subject to the transition provisions of Statements 141 and 142. Amortization expense related to goodwill was $4.0 million and $7.8 million for the three months ended June 30, 2001 and the six months ended June 30, 2001, respectively. Because of the extensive effort needed to comply with adopting Statements 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as a cumulative effect of a change in accounting principle. 18 Item 3. Quantitative and Qualitative Disclosures About Market Risk. At June 30, 2001 and December 31, 2000, the carrying value of our debt obligations was $131.2 and $98.2 million respectively and the weighted average interest rate on our debt obligations was 8.48% and 11.02% respectively. Because the interest rates on our senior secured credit facility are at floating rates, we are exposed to interest rate risks. If market interest rates had been 1% higher, our interest expense for the three months ended June 30, 2001 and 2000 would have been increased by $257,015 and $50,556, respectively and our interest expense for the six months ended June 30, 2001 and 2000 would have been increased by $502,398 and $101,111, respectively. Effective March 30, 2001, there is in place a derivative financial agreement which included an interest rate swaption agreement and interest rate cap and floor agreements. As we expand our operations, we may begin to use various other financial instruments, including derivative financial instruments, in the ordinary course of business, for purposes other than trading. These instruments could include letters of credit, guarantees of debt and interest rate swap agreements. We do not intend to use derivative financial instruments for speculative purposes. Similar to the existing derivative financial agreement utilized by the Company, interest rate swap agreements would be used to reduce our exposure to risks associated with interest rate fluctuations. By their nature, these instruments involve risk, including the risk of nonperformance by counterparties, and our maximum potential loss may exceed the amount recognized in our balance sheet. We will attempt to control our exposure to counterparty credit risk through monitoring procedures. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits filed with (or incorporated by reference into) this report: Exhibit No. Description ----------- ----------- 3.1 Amended and Restated Certificate of Incorporation effective November 1, 2000, incorporated herein by reference to Exhibit 3.1 to registrant's Form 10-K for the fiscal year ended December 31, 2000 (the "2000 Form 10-K"). 3.2 Certificate of Amendment to Article First of the Amended and Restated Certificate of Incorporation effective February 13, 2001, incorporated herein by reference to Exhibit 3.2 to the 2000 Form 10-K. 3.3 By-laws, as amended as of March 21, 2000, incorporated herein by reference to Exhibit 3.2 to the registrant's Registration Statement on Form S-4 (File No. 333-41040). --------------- (b) Reports on Form 8-K: During the quarter ended June 31, 2001, NuVox did not file a report on Form 8-K. 19 SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NUVOX, INC. August 13, 2001 By: /s/ David L. Solomon ------------------------------------------ David L. Solomon, Chairman and Chief Executive Officer August 13, 2001 By: /s/ Michael E. Gibson ------------------------------------------ Michael E. Gibson, Senior Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) 20 INDEX TO EXHIBITS Exhibit No. Description ----------- ----------- 3.1 Amended and Restated Certificate of Incorporation effective November 1, 2000, incorporated herein by reference to Exhibit 3.1 to registrant's Form 10-K for the fiscal year ended December 31, 2000 (the "2000 Form 10-K"). 3.2 Certificate of Amendment to Article First of the Amended and Restated Certificate of Incorporation effective February 13, 2001, incorporated herein by reference to Exhibit 3.2 to the 2000 Form 10-K. 3.3 By-laws, as amended as of March 21, 2000, incorporated herein by reference to Exhibit 3.2 to the registrant's Registration Statement on Form S-4 (File No. 333-41040). -----------------------

NUVOX INC /DE/ 10-Q