-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, P3z7rT38mMDXDbp1jBhy/bLWZeKxUb0YeIe5vMPbSOcumhBg7MK4UoVSM5tCWbnu dL16HbSiorsI2VybnpRtdQ== 0000950109-01-502893.txt : 20010815 0000950109-01-502893.hdr.sgml : 20010815 ACCESSION NUMBER: 0000950109-01-502893 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TIME WARNER TELECOM INC CENTRAL INDEX KEY: 0001057758 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 841500624 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-30218 FILM NUMBER: 1713133 BUSINESS ADDRESS: STREET 1: 10475 PARK MEADOWS DRIVE CITY: LITTLETON STATE: CO ZIP: 80124 BUSINESS PHONE: 3035661000 MAIL ADDRESS: STREET 1: 10475 PARK MEADOWS DRIVE CITY: LITTLETON STATE: CO ZIP: 80124 10-Q 1 d10q.txt FOR THE PERIOD ENDED JUNE 30, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended 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 0-30218 TIME WARNER TELECOM INC. ------------------------ (Exact name of Registrant as specified in its charter) State of Delaware 84-1500624 - -------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 10475 Park Meadows Drive Littleton, Colorado 80124 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (303) 566-1000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] The number of shares outstanding of Time Warner Telecom Inc.'s common stock as of July 31, 2001 was: Time Warner Telecom Inc. Class A common stock -- 48,395,858 shares Time Warner Telecom Inc. Class B common stock -- 65,936,658 shares TIME WARNER TELECOM INC. INDEX TO FORM 10-Q ------------------
Page ---- Part I. Financial Information --------------------- Item 1. Financial Statements: --------------------- Consolidated and Condensed Balance Sheets at June 30, 2001 and December 31, 2000 1 Consolidated Statements of Operations for the three and six months ended June 30, 2001 and 2000 2 Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000 3 Consolidated Statement of Changes in Stockholders' Equity for the six months ended June 30, 2001 4 Notes to Consolidated and Condensed Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Part II. Other Information ----------------- Item 1. Legal Proceedings 24 Item 4. Submission of Matters to a Vote of Security Holders 24 Item 6. Exhibits and Reports on Form 8-K 25
TIME WARNER TELECOM INC. CONSOLIDATED AND CONDENSED BALANCE SHEETS
June 30, December 31, 2001 2000 ------------------------------------------- (unaudited) (amounts in thousands, except share amounts) ASSETS Current assets: Cash and cash equivalents................................................................ $ 450,458 71,739 Cash held in escrow...................................................................... - 179,000 Marketable debt securities............................................................... 30,153 3,496 Receivables, less allowances of $29,487 and $17,610, respectively ....................... 88,484 83,027 Prepaid expenses......................................................................... 3,742 2,505 Deferred income taxes.................................................................... 32,955 34,418 ----------- ----------- Total current assets................................................................ 605,792 374,185 ----------- ----------- Property, plant and equipment................................................................. 2,122,770 1,195,744 Less accumulated depreciation............................................................ (367,962) (283,572) ----------- ----------- 1,754,808 912,172 ----------- ----------- Intangible and other assets, net of accumulated amortization (notes 1 and 2).................. 84,250 101,397 ----------- ----------- Total assets........................................................................ $ 2,444,850 1,387,754 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable......................................................................... $ 80,958 72,041 Deferred revenue......................................................................... 35,752 53,286 Other current liabilities................................................................ 239,943 159,390 ----------- ----------- Total current liabilities.......................................................... 356,653 284,717 ----------- ----------- Long-term debt and capital lease obligations (note 3)......................................... 1,066,716 585,107 Deferred income taxes......................................................................... 10,854 46,163 Stockholders' equity (note 1): Preferred stock, $0.01 par value, 20,000,000 shares authorized, no shares issued and outstanding............................................................................ - - Class A common stock, $0.01 par value, 277,300,000 shares authorized, 48,359,612 and 33,702,461 shares issued and outstanding in 2001 and 2000, respectively................ 483 337 Class B common stock, $0.01 par value, 162,500,000 shares authorized, 65,936,658 and 72,226,500 shares issued and outstanding in 2001 and 2000, respectively................ 659 722 Additional paid-in capital............................................................... 1,164,800 601,081 Accumulated other comprehensive income, net of taxes..................................... 5,872 6,492 Accumulated deficit...................................................................... (161,187) (136,865) ----------- ----------- Total stockholders' equity.......................................................... 1,010,627 471,767 ----------- ----------- Total liabilities and stockholders' equity.......................................... $ 2,444,850 1,387,754 =========== ===========
See accompanying notes. 1 TIME WARNER TELECOM INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended June 30, June 30, ---------------------------- -------------------------- 2001 2000 2001 2000 --------- -------- -------- -------- (amounts in thousands, except per share amounts) Revenue (a): Dedicated transport services................. $ 107,187 60,692 213,773 112,630 Switched services............................ 110,710 71,081 177,251 119,281 --------- --------- -------- -------- Total revenue........................... 217,897 131,773 391,024 231,911 --------- --------- -------- -------- Costs and expenses (a): Operating.................................... 81,662 43,558 160,367 82,547 Selling, general and administrative.......... 61,362 40,497 121,932 78,188 Depreciation and amortization................ 46,222 22,935 98,897 44,799 --------- --------- -------- -------- Total costs and expenses................ 189,246 106,990 381,196 205,534 --------- --------- -------- -------- Operating income .................................. 28,651 24,783 9,828 26,377 Interest expense .................................. (26,334) (10,887) (61,070) (20,614) Interest income.................................... 5,915 3,276 12,575 6,796 --------- --------- -------- -------- Net income (loss) before income taxes.............. 8,232 17,172 (38,667) 12,559 Income tax expense (benefit)....................... 3,847 7,405 (14,345) 5,652 --------- --------- -------- -------- Net income (loss).................................. $ 4,385 9,767 (24,322) 6,907 ========= ========= ======== ======== Earnings (loss) per share: Basic......................................... $ 0.04 0.09 (0.22) 0.07 ========= ========= ======== ======== Diluted....................................... $ 0.04 0.09 (0.22) 0.06 ========= ========= ======== ======== Weighted average shares outstanding: Basic......................................... 114,216 105,277 113,021 105,126 ========= ========= ======== ======== Diluted....................................... 115,926 108,334 113,021 108,363 ========= ========= ======== ======== (a) Includes revenue and expenses resulting from transactions with affilitates (note 4): Revenue............................... $ 5,691 4,028 10,731 5,067 ========= ========= ======== ======== Operating............................. $ 680 727 1,359 1,363 ========= ========= ======== ======== Selling, general, and administrative.. $ 387 398 771 701 ========= ========= ======== ======== Depreciation and amortization......... $ 3,628 2,772 6,653 5,544 ========= ========= ======== ========
See accompanying notes. 2 TIME WARNER TELECOM INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended June 30, --------------------------------- 2001 2000 -------------- -------------- (amounts in thousands) Cash flows from operating activities: Net income (loss)....................................................................... $ (24,322) 6,907 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization........................................................ 98,897 44,799 Impairment of deferred debt issue costs.............................................. 5,814 - Amortization of deferred debt issue costs............................................ 2,151 625 Deferred income tax expense (benefit)................................................ (14,720) 5,652 Changes in operating assets and liabilities, net of the effect of an acquisition: Receivables and prepaid expenses.................................................. 8,187 (14,403) Accounts payable, deferred revenue and other current liabilities.................. 40,926 11,061 -------------- -------------- Net cash provided by operating activities...................................... 116,933 54,641 -------------- -------------- Cash flows from investing activities: Capital expenditures.................................................................... (242,735) (143,561) Cash paid for an acquisition............................................................ (651,689) - Purchases of marketable securities...................................................... (57,981) (83,998) Proceeds from maturities of marketable securities....................................... 31,324 189,516 Other investing activities.............................................................. (626) (6,063) -------------- -------------- Net cash used in investing activities........................................... (921,707) (44,106) -------------- -------------- Cash flows from financing activities: Net proceeds from issuance of common stock.............................................. 532,178 - Net proceeds from issuance of debt...................................................... 1,159,586 - Repayments of debt...................................................................... (700,000) - Net proceeds from issuance of common stock upon exercise of stock options............... 11,913 7,227 Net proceeds from issuance of common stock in connection with the employee stock purchase plan.................................................................. 1,003 2,087 Payment of capital lease obligations.................................................... (1,265) (208) Deferred debt issue costs, net.......................................................... 1,078 (5,070) -------------- -------------- Net cash provided by financing activities....................................... 1,004,493 4,036 -------------- -------------- Increase in cash, cash equivalents, and cash held in escrow..................... 199,719 14,571 Cash, cash equivalents, and cash held in escrow at beginning of period.......... 250,739 90,586 -------------- -------------- Cash, cash equivalents, and cash held in escrow at end of period................ $ 450,458 105,157 ============== ============== Supplemental disclosures of cash flow information: Cash paid for interest $ 34,632 19,988 ============== ============== Tax benefit related to exercise of non-qualified stock options................... $ 18,708 4,914 ============== ============== Cash paid for income taxes....................................................... $ 656 207 ============== ==============
See accompanying notes. 3 TIME WARNER TELECOM INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY Six Months Ended June 30, 2001 (Unaudited)
Common Stock -------------------------------------------- Class A Class B Additional --------------------- --------------------- paid-in Shares Amount Shares Amount capital ---------- ---------- ---------- ---------- ----------- (amounts in thousands) Balance at January 1, 2001................... 33,702 $ 337 72,227 $ 722 601,081 Issuance of common stock, net of offering expenses of $24,243 (note 1)................................... 7,475 75 - - 532,103 Shares issued for cash in connection with the exercise of stock options......... 856 8 - - 30,613 Shares issued for cash in connection with the employee stock purchase plan....................................... 36 - - - 1,003 Conversion of shares by related party...... 6,290 63 (6,290) (63) - Change in unrealized holding gain for available-for-sale security, net of taxes................................... - - - - - Net loss................................... - - - - - --------- -------- -------- -------- ----------- Balance at June 30, 2001..................... 48,359 $ 483 65,937 $ 659 1,164,800 ========= ======== ======== ======== =========== Accumulated other comprehensive Total income, Accumulated stockholders' net of taxes deficit equity -------------- ------------ -------------- Balance at January 1, 2001........................ 6,492 (136,865) 471,767 Issuance of common stock, net of offering expenses of $24,243 (note 1)........................................ - - 532,178 Shares issued for cash in connection with the exercise of stock options.............. - - 30,621 Shares issued for cash in connection with the employee stock purchase plan............................................ - - 1,003 Conversion of shares by related party........... - - - Change in unrealized holding gain for available-for-sale security, net of taxes........................................ (620) - (620) Net loss........................................ - (24,322) (24,322) ---------- ---------- ---------- Balance at June 30, 2001.......................... 5,872 (161,187) 1,010,627 ========== ========== ==========
See accompanying notes. 4 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS June 30, 2001 (unaudited) 1. Organization and Summary of Significant Accounting Policies Description of Business and Capital Structure Time Warner Telecom Inc. (the "Company"), a Delaware corporation, is a leading fiber facilities-based provider of integrated communications services and solutions to medium and large-sized business customers in selected metropolitan markets across the United States. The Company offers local businesses "last-mile" broadband connections for data, high-speed Internet access, local voice, and long distance services. The Company has two classes of common stock outstanding, Class A common stock and Class B common stock. Holders of Class A common stock have one vote per share and holders of Class B common stock have ten votes per share. Each share of Class B common stock is convertible, at the option of the holder, into one share of Class A common stock. The Class B common stock is collectively owned by Time Warner Inc., a wholly owned subsidiary of AOL Time Warner Inc. ("Time Warner"), Advance Telecom Holdings Corporation, and Newhouse Telecom Holdings Corporation. Holders of Class A common stock and Class B common stock generally vote together as a single class. However, some matters require the approval of 100% of the holders of the Class B common stock voting separately as a class, and some matters require the approval of a majority of the holders of the Class A common stock, voting separately as a class. During the three months ended June 30, 2001, AT&T Corp. converted their Class B common stock into Class A common stock. As of June 30, 2001, the Class B Stockholders had approximately 93.2% of the combined voting power of the outstanding common stock. On January 25, 2001, the Company completed a public offering of 7,475,000 shares of Class A common stock at a price of $74 7/16 per share (the "Offering"). The Offering generated $532.2 million in proceeds for the Company, net of underwriting discounts and expenses. Also on January 25, 2001, the Company completed a private placement of $400 million principal amount of 10 1/8% Senior Notes due February 2011 (the "Old Notes"). Pursuant to an exchange offer in March 2001, all of the holders of the Old Notes exchanged their Old Notes for new 10 1/8% Senior Notes due February 2011 (the "10 1/8% Senior Notes") with the same financial terms that were registered under the Securities Act of 1933. The Company used all of the net proceeds from the Offering and a portion of the net proceeds from the offering of the Old Notes to repay the $700 million senior unsecured bridge facility, that initially financed the acquisition of substantially all of the assets of GST Telecommunications, Inc. ("GST") (see note 2). The remaining net proceeds from the offering of the Old Notes will be used for capital expenditures, working capital, and general corporate purposes. Basis of Presentation The accompanying interim consolidated and condensed financial statements are unaudited, but in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the results for such periods. The results of operations for any interim period are not necessarily indicative of results for the full year. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2000. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. 5 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued Basis of Consolidation The consolidated financial statements include the accounts of the Company and all entities in which the Company has a controlling voting interest ("subsidiaries"). Significant intercompany accounts and transactions have been eliminated. Significant accounts and transactions with Time Warner are disclosed as related party transactions. Investments Marketable equity securities held by the Company are classified as available-for-sale. Accordingly, these securities are included in other assets at fair value. Unrealized holding gains and losses on securities classified as available-for-sale are carried net of taxes as a component of accumulated other comprehensive income in stockholders' equity. Other equity investments which are not considered marketable securities and in which ownership interest is less than 20% are generally carried at the lower of cost or net realizable value. Realized gains and losses are determined on a specific identification basis. At June 30, 2001, the fair value of the Company's available-for-sale security was $12.8 million. The unrealized holding gain on this marketable equity security is reported as accumulated other comprehensive income, net of taxes, in the accompanying consolidated financial statements. As of June 30, 2001, the unrealized holding gain on this security was $5.9 million, net of taxes. There were no sales of marketable securities for the six months ended June 30, 2001 and 2000, respectively. Revenue The Company's revenue has been derived primarily from business telephony services, including dedicated transport, local switched, long distance, data and high-speed Internet access services. The Company's customers are principally telecommunications-intensive business end-users, long distance carriers, Internet service providers ("ISPs"), wireless communications companies, and governmental entities. Revenue for dedicated transport services and dedicated Internet access is generally billed in advance on a fixed rate basis and recognized over the period the services are provided. Revenue for switched services, data and Internet services, and long distance are generally billed on a transactional basis determined by customer usage with some fixed rate elements. The transactional elements of switched services are billed in arrears and estimates are used to recognize revenue in the period earned. The fixed rate elements are billed in advance and recognized over the period the services are provided. Reciprocal compensation revenue is an element of switched services revenue, which represents compensation from local exchange carriers ("LECs") for local exchange traffic terminated on the Company's facilities originated by other LECs. Reciprocal compensation represented 7% and 6% of revenue for the six months ended June 30, 2001 and 2000, respectively, excluding the effects of the recognition of $37.0 million and $27.3 million of non-recurring reciprocal compensation, primarily reflecting resolution of disputes, during the six months ended June 30, 2001 and 2000, respectively. Reciprocal compensation is based on contracts between the Company and LECs. The Company recognizes reciprocal compensation revenue as it is earned, except in those cases where the revenue is under dispute or at risk. The payment of reciprocal compensation under certain of the Company's interconnection agreements is, by the terms of those agreements, subject to adjustment or repayment depending on prospective federal or state generic rulings with respect to reciprocal compensation for ISP traffic. The Company pays reciprocal compensation expense to the other LECs for local exchange traffic it terminates on the LEC's facilities. These costs are recognized as incurred. 6 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued As of June 30, 2001, the Company had deferred recognition of $17.3 million in reciprocal compensation revenue for payments received associated with pending disputes and agreements that are subject to future reciprocal compensation adjustments. Switched access is the connection between a long distance carrier's point of presence and an end-user's premises provided through the switching facilities of a LEC. Historically, the FCC has regulated the access rates imposed by the incumbent local exchange carriers ("ILECs"), while the competitive local exchange carriers' ("CLECs") access rates have been less regulated. However, on April 27, 2001, the FCC released an order in its ongoing Access Reform proceeding that subjects CLECs' interstate switched access charges to regulation. Effective with that order, the Company's rates will be reduced over a three-year period to parity with the ILEC rates competing in each area. In addition, when a CLEC enters a new market its access charges may be no higher than the incumbent LEC's. This order does not affect rates subject to contracts that the Company has entered into with certain long distance carriers. The Company and several other CLECs have filed petitions with the FCC for reconsideration of the provisions of the order relating to new markets and expects that there will be other legal challenges to the order filed in federal court. There is no assurance that any legal challenge will be successful or that a successful challenge will change the trend toward lower access charges. Switched access revenue represented 8% and 11% of total revenue for the six months ended June 30, 2001 and 2000, respectively, excluding the effects of the recognition of $37.0 million and $27.3 million of non- recurring reciprocal compensation during the six months ended June 30, 2001 and 2000, respectively. The Company expects that switched access revenue will decline as a percentage of the Company's total revenue. There is no assurance that the Company will be able to compensate for reductions in switched access revenue resulting from the FCC order with revenue from other sources. Segment Reporting As of June 30, 2001, the Company operated in 39 service areas and the Company's management has made decisions on resource allocation and assesses performance based on total revenue, EBITDA, and capital spending of these operating locations. Each of the service areas offers similar products and services, has similar customers and networks, is regulated by the same type of authorities, and is managed directly by the Company's executives, allowing the 39 service areas to be aggregated, resulting in one reportable line of business. Earnings (Loss) Per Common Share and Potential Common Share Basic earnings (loss) per share for all periods presented herein was computed by dividing the net income (loss) by the weighted average shares outstanding for the period. The diluted earnings per share for the three and six months ended June 30, 2000, and the three months ended June 30, 2001 was computed by dividing the net income by the weighted average number of common shares and dilutive potential common shares outstanding during the period. The diluted loss per common share for the six months ended June 30, 2001 was computed by dividing the net loss attributable to common shares by the weighted average outstanding common shares for the period. Potential common shares were not included in the computation of weighted average shares outstanding because their inclusion would be anti-dilutive. 7 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued Set forth below is a reconciliation of the basic and diluted earnings (loss) per share for each period:
Three Months Ended Six Months Ended June 30, June 30, --------------------------------- ----------------------------- 2001 2000 2001 2000 -------------- ----------------- ----------- ------------- (amounts in thousands, except per share amounts) Net income (loss) for basic and diluted earnings (loss) per share $ 4,385 9,767 (24,322) 6,907 ============== ================= =========== ============== Weighted-average number of shares-basic 114,216 105,277 113,021 105,126 Dilutive effect of stock options 1,710 3,057 - 3,237 -------------- ----------------- ----------- ------------- Weighted-average number of shares-diluted 115,926 108,334 113,021 108,363 ============== ================= =========== ============== Earnings (loss) per share: Basic 0.04 0.09 (0.22) 0.07 ============== ================= =========== ============== Diluted 0.04 0.09 (0.22) 0.06 ============== ================= =========== ==============
Reclassifications Certain prior period amounts have been reclassified for comparability with the 2001 presentation. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), as amended by SFAS 138, which was adopted by the Company on January 1, 2001. SFAS 133 requires that all derivatives be recorded on the balance sheet at fair value. Changes in derivatives that are not hedges are adjusted to fair value through income. Changes in derivatives that meet SFAS 133's hedge criteria are either offset through income or recognized in other comprehensive income until the hedged item is recognized in earnings. The adoption of SFAS 133 on January 1, 2001 did not have a material effect on the Company's financial condition, results of operations, or cash flows because the Company does not own any derivative instruments. In July 2001, the Financial Accounting Standards Board issued Statement No. 141, Business Combinations ("SFAS 141") and Statement No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS 141 requires companies to reflect intangible assets apart from goodwill and supercedes previous guidance related to business combinations. SFAS 142 eliminates amortization of goodwill and amortization of indefinite lived intangible assets. However, SFAS 142 also requires the Company to perform impairment tests at least annually on all goodwill and other intangible assets. These statements are required to be adopted by the Company on January 1, 2002 and for any acquisitions entered into after July 1, 2001. The Company is evaluating the impact of the statements on its financial position, results of operations, and cash flows. 8 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued 2. Acquisition On January 10, 2001, the Company completed the acquisition of substantially all of the assets of GST out of bankruptcy (the "GST Acquisition") for cash consideration of approximately $627 million, including a $10 million deposit paid in 2000, plus the payment of certain liabilities and fees of approximately $42 million, and the assumption of an approximate $21 million obligation to complete certain fiber networks, for a total purchase price of $690 million. As a result of this acquisition, the Company added 15 markets, approximately 4,210 route miles, and approximately 227,674 fiber miles in the western United States. This transaction has been accounted for under the purchase method of accounting. The acquisition is summarized as follows (amounts in thousands): 2001 ---- Recorded value of fixed assets acquired $697,331 Receivables, prepaids, and other assets 15,244 Deposit paid in 2000 (10,000) Assumed liabilities (50,886) -------- Cash paid for acquisition in 2001 $651,689 ======== The allocation of the purchase price is preliminary, but was based in part on appraised values. However, the allocation is subject to final evaluation of the assets purchased and liabilities assumed, which will be completed by the end of the year. Since this acquisition is accounted for as a purchase, the results of operations are consolidated with the Company's results of operations from the acquisition date. Had this acquisition occurred on January 1, 2000, total revenue, net loss, and basic and diluted loss per common share for the six months ended June 30, 2000 would have been approximately $289.2 million, $88.2 million, and $(0.84), respectively. 3. Long-Term Debt Long-term debt is summarized as follows: June 30, December 31, 2001 2000 -------- ------------ (amounts in thousands) 9 3/4% Senior Notes $ 400,000 400,000 10 1/8% Senior Notes 400,000 -- Credit Facility 250,000 179,000 ----------- --------- $ 1,050,000 579,000 =========== ========= The $400 million principal amount 9 3/4% Senior Notes due July 2008 (the "9 3/4% Senior Notes") are unsecured, unsubordinated obligations of the Company. Interest on the 9 3/4% Senior Notes is payable semi-annually on January 15 and July 15, and began on January 15, 1999. Interest expense, including amortization of debt discount, relating to the 9 3/4% Senior Notes totaled approximately $20.1 million for both the six months ended June 30, 2001 and 2000. At June 30, 2001, the fair market value of the $400 million of 9 3/4% Senior Notes was $356 million, based on market prices. The $400 million principal amount 10 1/8% Senior Notes are unsecured, subordinated obligations of the Company. Interest on the 10 1/8% Senior Notes is payable semiannually on February 1 and August 1, beginning on August 1, 2001. Interest expense, including amortization of 9 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued debt discount, relating to the 10 1/8% Senior Notes totaled approximately $18.1 million for the six months ended June 30, 2001. At June 30, 2001, the fair market value of the $400 million of 10 1/8% Senior Notes was $360 million, based on market prices. The 9 3/4% Senior Notes and the 10 1/8% Senior Notes are governed by Indentures that contain certain restrictive covenants. These restrictions affect, and in many respects significantly limit or prohibit, among other things, the ability of the Company to incur indebtedness, make prepayments of certain indebtedness, pay dividends, make investments, engage in transactions with shareholders and affiliates, issue capital stock of subsidiaries, create liens, sell assets, and engage in mergers and consolidations. On April 10, 2000, the Company executed a $475 million Senior Secured Revolving Credit Facility (the "Revolver"). The Revolver had a final maturity of December 31, 2007, with annual reductions in the principal amount available under the Revolver commencing on December 31, 2004. In connection with the GST Acquisition and the Company's capital expenditure plans, the Company obtained commitments for $1.225 billion of additional financing to increase its total commitments to $1.7 billion. The Company replaced its Revolver with an amended and restated senior secured credit facility (the "Credit Facility") providing for an aggregate of $1 billion in borrowings, comprised of $525 million of senior secured term loan facilities and a $475 million senior secured revolving credit facility. The Credit Facility has a final maturity of December 31, 2007, with annual reductions in the principal amount available under the $475 million senior secured revolving credit facility commencing on December 31, 2004. The Company also obtained $700 million in senior unsecured bridge financing that it used to initially finance the GST Acquisition. The borrowings under the senior unsecured bridge loan facility were made and repaid in full in January 2001, with the net proceeds from the Offering and a portion of the net proceeds from the sale of the Old Notes. In connection with the repayment of the senior unsecured bridge loan facility, the Company recorded $5.8 million of deferred financing costs as a non-recurring expense, as well as $3.5 million in interest expense for the six months ended June 30, 2001. In December 2000, the Company was required to draw and hold in escrow, $179 million of the Credit Facility until the closing of the GST Acquisition, at which time the draw increased to $250 million. Interest expense on the $250 million drawn under the Credit Facility is computed utilizing a specific Eurodollar Rate plus 4.0%, which totaled 8.7% as of June 30, 2001. Interest is payable at least quarterly. Interest expense, including amortization of debt discount, relating to the $250 million draw was $12.0 million for the six months ended June 30, 2001. At June 30, 2001, the undrawn available commitment under the Credit Facility was $750 million. The Company is required to pay commitment fees on a quarterly basis ranging from 0.500% to 1.000% per annum on the undrawn available commitment of the Credit Facility. Commitment fee expense was $3.7 million for the six months ended June 30, 2001 and has been classified as a component of interest expense in the accompanying consolidated statements of operations. Borrowings under the Credit Facility are secured by substantially all of the assets of the Company, including the assets acquired from GST, except for certain assets with respect to which the grant of a security interest is prohibited by governing agreements. The Credit Facility requires the Company to prepay outstanding loans when its cash flow exceeds certain levels and with the proceeds received from a number of specified events or transactions, including certain asset sales and insurance recoveries for assets not replaced. In addition, obligations under the Credit Facility are subject to various covenants that limit the Company's ability to: . borrow and incur liens on its property; . pay dividends or make other distributions; and 10 TIME WARNER TELECOM INC. NOTES TO CONSOLIDATED AND CONDENSED FINANCIAL STATEMENTS - continued . make capital expenditures. The Credit Facility also contains financial covenants, including a consolidated leverage ratio, a consolidated interest coverage ratio, and a consolidated debt service coverage ratio, as well as cross default provisions. Under the cross default provisions, the Company is deemed to be in default under the Credit Facility if the Company has defaulted under any of the other material outstanding obligations, such as the 9 3/4% Senior Notes or the 10 1/8% Senior Notes. 4. Related Party Transactions In the normal course of business, the Company engages in various transactions with Time Warner, generally on negotiated terms among the affected units that, in management's opinion, result in reasonable allocations. The Company benefits from its strategic relationship with Time Warner both through access to local right-of-way and construction cost- sharing. The Company's networks have been constructed primarily through the use of fiber capacity licensed from Time Warner. Under this licensing arrangement, the Company paid Time Warner $1.1 million and $484,000 for the six months ended June 30, 2001 and 2000, respectively. These costs have been capitalized by the Company. The amortization expense of these costs and fiber previously capitalized in the amount of $6.7 million and $5.5 million for the six months ended June 30, 2001 and 2000, respectively, has been classified as a component of depreciation and amortization expense in the accompanying consolidated statements of operations. In addition, under this licensing arrangement, the Company reimburses Time Warner for facility maintenance and pole rental costs, which aggregated $1.4 million for both the six months ended June 30, 2001 and 2000. The Company's operations, which in certain cases are co-located with Time Warner's divisions, are allocated a charge for various overhead expenses for services provided by these divisions. The Company is also allocated rent based on the square footage of space occupied by the Company at Time Warner's facilities. These costs are based on contracts with Time Warner. These charges aggregated $771,000 and $701,000 for the six months ended June 30, 2001 and 2000, respectively. Time Warner also purchases dedicated transport and switched services from the Company. Revenue aggregated $10.7 million and $5.1 million for the six months ended June 30, 2001 and 2000, respectively. 5. Commitments and Contingencies Pending legal proceedings are substantially limited to litigation incidental to the business of the Company. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the Company's financial statements. 11 TIME WARNER TELECOM INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Cautions Concerning Forward Looking Statements The following discussion and analysis provides information concerning the results of operations and financial condition of Time Warner Telecom Inc. (the "Company") and should be read in conjunction with the accompanying financial statements and notes thereto. Additionally, the following discussion and analysis should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements included in Part II of Time Warner Telecom Inc.'s Annual Report on Form 10-K for the year ended December 31, 2000. This document contains certain "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding, among other items, the expected financial position, expansion plans, product plans, business, financing plans, and the impacts of regulatory developments. These forward-looking statements are based on management's current expectations and are naturally subject to risks, uncertainties, and changes in circumstances, many of which are beyond the Company's control. Actual results may differ materially from those expressed or implied by such forward-looking statements. The words "believe," "expect," "plans," "intends," and "anticipate," and similar expressions identify forward-looking statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that those expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the expectations described in this report are set forth in the Company's previous filings with the Securities and Exchange Commission, especially those set forth under "Risk Factors" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2000 and elsewhere in that report and this report. Other factors could also cause actual results to differ from those contained in the forward-looking statements, including increased customer financial difficulties or bankruptcies, adverse regulatory decisions or unfavorable legislation, further economic slowdown, increased interest rates, failure to meet cash flow expectations, and changes to the Company's plans or strategies. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of their dates. The Company undertakes no obligations to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Overview The Company is a leading fiber facilities-based integrated communications provider offering local businesses "last-mile" broadband connections for data, high-speed Internet access, local voice, and long distance services. On January 10, 2001, the Company expanded its geographic coverage by acquiring substantially all of the assets of GST Telecommunications, Inc. ("GST") out of bankruptcy. See "Acquisition" below. The Company now serves customers in 42 metropolitan markets in the United States and plans to activate networks in Atlanta, Georgia and Denver, Colorado prior to the end of 2001. The Company has two classes of common stock outstanding, Class A common stock and Class B common stock. Holders of Class A common stock have one vote per share and holders of Class B common stock have ten votes per share. Each share of Class B common stock is convertible, at the option of the holder, into one share of Class A common stock. The Class B common stock is collectively owned by Time Warner Inc., a wholly owned subsidiary of the AOL Time Warner Inc. ("Time Warner"), Advance Telecom Holdings Corporation, and Newhouse Telecom Holdings Corporation. Holders of Class A common stock and Class B common stock generally vote together as a single class. However, some matters require the approval of 100% of the holders of the Class B common stock voting separately as a class, and some matters require the approval of a majority of the holders of the Class A common stock, voting separately as a class. During the three months ended June 30, 2001, AT&T Corp. converted their Class B common stock into Class A 12 TIME WARNER TELECOM INC. common stock. As of June 30, 2001, the Class B Stockholders had approximately 93.2% of the combined voting power of the outstanding common stock. On January 25, 2001, the Company completed a public offering of 7,475,000 shares of Class A common stock at a price of $74 7/16 per share (the "Offering"). The Offering generated $532.2 million in proceeds for the Company, net of underwriting discounts and expenses. Also on January 25, 2001, the Company completed a private placement of $400 million principal amount of 10 1/8% Senior Notes due February 2011 (the "Old Notes"). Pursuant to an exchange offer in March 2001, all of the holders of the Old Notes exchanged their Old Notes for new 10 1/8% Senior Notes due February 2011 (the "10 1/8% Senior Notes") with the same financial terms that were registered under the Securities Act of 1933. The Company used all of the net proceeds from the Offering and a portion of the net proceeds from the offering of the Old Notes to repay the $700 million senior unsecured bridge facility that initially financed the acquisition of the GST assets. The remaining net proceeds from the offering of the Old Notes will be used for capital expenditures, working capital, and general corporate purposes. Acquisition On January 10, 2001, the Company completed the acquisition of substantially all of the assets of GST for cash consideration of approximately $627 million, plus the payment of certain liabilities and fees of approximately $42 million, and the assumption of an approximate $21 million obligation to complete certain fiber networks, for a total purchase price of $690 million. The acquisition added to the Company's network approximately 4,210 route miles and approximately 227,674 fiber miles in the western United States. The Company has completed the initial integration of former GST personnel into the Company's organization and has implemented its corporate-wide financial reporting system and front-end ordering system for the acquired operations. The Company has activated a 4,600-mile regional fiber network that was under construction at the time of the acquisition and has begun expanding the metropolitan networks in several of the acquired markets. The Company expects that the integration of systems and network operations will occur in phases over approximately two to three years. As required under the Asset Purchase Agreement with GST, the Company entered into a services agreement with GST to provide certain support services with respect to GST assets that the Company did not purchase for a period of up to six months for most services and up to a year for certain limited services. The Company's acquisition of the GST assets increases its geographic presence, expands its products and services, and enlarges the capacity of its networks. This transaction is considerably larger than the transactions the Company has completed in the past and therefore presents risks related to the successful integration of the acquired assets into the Company's business including costs related to integration and diversion of resources away from the Company's existing operations. In addition, the Company purchased substantially all of the assets of GST with the expectation that the asset purchase would result in certain benefits, including expansion of the markets the Company already serves and increasing its operational efficiencies. Achieving the benefits of the asset purchase will depend upon the successful integration of the acquired businesses into the Company's existing operations. There is no assurance that the Company will be successful in integrating the acquired GST assets into its current businesses. In addition, there is a risk that the costs of integration could have a material adverse effect on the Company's operating results. 13 TIME WARNER TELECOM INC. Results of Operations The following table sets forth certain consolidated statements of operations data of the Company, in thousands of dollars and expressed as a percentage of total revenue, for each of the periods presented. This table should be read together with the Company's financial statements, including the notes thereto, appearing elsewhere in this report:
Three Months Ended June 30, Six Months Ended June 30, -------------------------------- ----------------------------------- 2001 2000 2001 2000 --------------- ------------- ---------------- ------------- (amounts in thousands, except per share amounts) Statements of Operations Data: Revenue(1): Dedicated transport services $ 107,187 49% 60,692 46% 213,773 55% 112,630 49% Switched services(2) 110,710 51 71,081 54 177,251 45 119,281 51 --------- --- ------- --- ---------- --- ------- --- 217,897 100 131,773 100 391,024 100 231,911 100 --------- --- ------- --- ---------- --- ------- --- Costs and expenses(1): Operating 81,662 38 43,558 33 160,367 41 82,547 36 Selling, general and administrative 61,362 28 40,497 31 121,932 31 78,188 34 Depreciation and amortization 46,222 21 22,935 17 98,897 25 44,799 19 --------- --- ------- --- ---------- --- ------- --- Total costs and expenses 189,246 87 106,990 81 381,196 97 205,534 89 --------- --- ------- --- ---------- --- ------- --- Operating income 28,651 13 24,783 19 9,828 3 26,377 11 Interest expense (26,334) (12) (10,887) (8) (61,070) (16) (20,614) (9) Interest income 5,915 3 3,276 2 12,575 3 6,796 3 --------- --- ------- --- ---------- --- ------- --- Net income (loss) before income taxes 8,232 4 17,172 13 (38,667) (10) 12,559 5 Income tax expense (benefit) 3,847 2 7,405 6 (14,345) (4) 5,652 2 --------- --- ------- --- ---------- --- ------- --- Net income (loss) $ 4,385 2% 9,767 7% (24,322) (6)% 6,907 3% ========= === ======= === ========== === ======= === Earnings (loss) per share(4): Basic $ 0.04 0.09 (0.22) 0.07 Diluted $ 0.04 0.09 (0.22) 0.06 Weighted average shares outstanding(4): Basic 114,216 105,277 113,021 105,126 Diluted 115,926 108,334 113,021 108,363 EBITDA(1)(3) $ 74,873 34% 47,718 36% 108,725 28% 71,176 31% Net cash provided by operating activities 76,923 37,802 116,933 54,641 Net cash used in investing activities (142,218) (13,237) (921,707) (44,106) Net cash provided by (used in) financing activities 2,704 (1,422) 1,004,493 4,036
(1) Includes revenue and expenses resulting from transactions with affiliates of $5.7 million, $4.7 million, $4.0 million, and $3.9 million for the three months ended June 30, 2001 and 2000, respectively, and $10.7 million, $8.8 million, $5.1 million, and $7.6 million for the six months ended June 30, 2001 and 2000, respectively. (2) Includes the recognition of $37.0 million and $23.4 million of non-recurring reciprocal compensation for the three months ended June 30, 2001 and 2000, respectively, and $37.0 million and $27.3 million for the six months ended June 30, 2001 and 2000, respectively. (3) "EBITDA" is defined as operating income (loss) before depreciation and amortization expense. It does not include charges for interest expense or provision for income taxes. Accordingly, EBITDA is not intended to replace operating income (loss), net income (loss), cash flow, and other measures of financial performance and liquidity reported in accordance with generally accepted accounting principles. Rather, EBITDA is a measure of operating performance and liquidity that investors may 14 TIME WARNER TELECOM INC. consider in addition to these measures. Management believes that EBITDA is a standard measure of operating performance and liquidity that is commonly reported and widely used by analysts, investors, and other interested parties in the telecommunications industry because it eliminates many differences in financial, capitalization, and tax structures, as well as non-operating one-time charges to earnings. EBITDA is used internally by the Company's management to assess ongoing operations and is a component of a covenant of the 9 3/4% Senior Notes and the 10 1/8% Senior Notes that limits the Company's ability to incur certain additional future indebtedness. However, EBITDA as used in this report may not be comparable to similarly titled measures reported by other companies due to differences in accounting policies. (4) Basic earnings (loss) per share for all periods presented herein was computed by dividing the net income (loss) by the weighted average shares outstanding for the period. The diluted earnings per share for the three and six months ended June 30, 2000, and the three months ended June 30, 2001 was computed by dividing the net income by the weighted average number of common shares and dilutive potential common shares outstanding during the period. The diluted loss per common share for the six months ended June 30, 2001 was computed by dividing the net loss attributable to common shares by the weighted average outstanding common shares for the period. Potential common shares were not included in the computation of weighted average shares outstanding for the six months ended June 30, 2001, because their inclusion would be anti- dilutive. General The Company operates in metropolitan areas that have high concentrations of medium- and large-sized businesses. Historically, the Company has focused its sales and marketing efforts on such businesses, as they are potentially high volume users of the Company's services. To drive revenue growth in these markets, the Company has expanded its direct sales force to focus on these business customers while it develops managed service offerings to meet their voice, data, and Internet needs. The Company's revenue has been derived primarily from business telephony services, including dedicated transport, local switched, long distance, data and high-speed Internet access services. The Company believes that data services will become increasingly more important to the Company's target customer base. In particular, the Company believes that the demand for high-speed, high quality local area network and wide area network connectivity will continue to grow over time. The Company continues to expand its footprint within its existing markets by expanding its network into new buildings. Through the acquisition of the GST assets in the first quarter of 2001, the Company added 15 additional western metropolitan markets. The Company activated three additional markets in July 2001 and plans to activate two additional markets in 2001. The Company is also interconnecting existing service areas within regional clusters with owned or leased fiber optic facilities. The goal is to rapidly deploy new services and technologies when technically proven and when customer demand is evident. As new technologies that enable the switching of voice calls over an Internet Protocol and local area network infrastructure are becoming commercially available, the Company is integrating this soft switch technology into its infrastructure. There is no assurance that the Company will bring any or all of these products to market successfully or profitably. The Company plans to continue expanding its revenue base by utilizing available network capacity in its existing markets, by adding networks in new markets, and by continuing to develop and selectively tailor new services in competitively-priced packages to meet the needs of its medium- and large-sized business customers. The Company intends to expand its product offerings on a continuous basis to achieve a diverse revenue base. As part of that process, the Company is targeting the expansion of data and Internet products that can be offered on the Company's existing network. Due to the impacts of a slowing economy, which has resulted in customers going out of business, filing bankruptcies, or looking for opportunities to cut costs, the Company has experienced an acceleration of customers disconnecting services, including network grooming, that has resulted in downward pressure on revenue performance. Management believes that this downward pressure may continue impacting revenue performance 15 TIME WARNER TELECOM INC. through the end of the year. However, the dislocation in the telecommunications and Internet service provider sectors may benefit the Company in the following respects: . as some emerging providers go out of business, their customers may seek to purchase services from the Company; . the failure of some emerging telecommunications providers may reduce some of the artificially low pricing of services that exists in the market for certain telecommunications services; and . the availability of experienced telecommunications personnel may improve. There is no assurance that the Company will realize any benefits from the downturn in these sectors or that the Company will not be adversely affected by conditions in its market sectors or the economy in general. Since the GST assets were purchased out of bankruptcy and require considerable integration work before they perform to the standards of the Company's other markets, the Company does not expect significant revenue growth from the GST assets during 2001. Reciprocal compensation revenue is an element of switched services revenue, which represents compensation from local exchange carriers ("LECs") for local exchange traffic terminated on the Company's facilities originated by other LECs. Reciprocal compensation represented 7% and 6% of revenue for the six months ended June 30, 2001 and 2000, respectively, excluding the effects of the recognition of $37.0 million and $27.3 million of non-recurring reciprocal compensation, primarily reflecting resolution of disputes, during the six months ended June 30, 2001 and 2000, respectively. Reciprocal compensation is based on contracts between the Company and LECs. The Company recognizes reciprocal compensation revenue as it is earned, except in those cases where the revenue is under dispute or at risk. The payment of reciprocal compensation under certain of the Company's interconnection agreements is, by the terms of those agreements, subject to adjustment or repayment depending on prospective federal or state generic rulings with respect to reciprocal compensation for ISP traffic. The Company pays reciprocal compensation expense to the other LECs for local exchange traffic it terminates on the LEC's facilities. These costs are recognized as incurred. On April 27, 2001, the Federal Communications Commission ("FCC") released an order addressing a prior ruling of the U.S. Court of Appeals for the District of Columbia Circuit in which the FCC reaffirmed its jurisdiction over dial-up Internet-bound traffic, and adopted an interim carrier-to-carrier cost recovery scheme for such traffic. The new scheme will reduce the maximum compensation rate for dial-up Internet-bound traffic in phases over a three-year period. Simultaneously the FCC initiated a rulemaking to consider whether it should replace all existing intercarrier compensation schemes with some form of "bill and keep." Additionally, the ruling, once effective, will require "bill and keep" payment arrangements for Internet-bound traffic as carriers enter new markets. "Bill and keep" means that the carrier would neither pay reciprocal compensation to other carriers nor receive reciprocal compensation from other carriers for Internet-bound traffic in those markets. The ruling was effective June 14, 2001. Historically, the Company has not relied on generation of reciprocal compensation revenue to achieve payback when entering new markets and therefore does not expect the ruling to impact its ability to achieve its financial objective for its new markets. Effective with the new rules, state commissions will no longer have authority over matters pertaining to the compensation of Internet-bound traffic. However, state commission decisions regarding this traffic for prior periods are not affected by the order. The Company and several other CLECs have filed legal challenges to the FCC's order in federal court. There is no assurance, however, that any legal challenge will be successful or that a successful challenge will change the trend toward reduced reciprocal compensation. The Company expects that the ruling, if it stands, will result in reciprocal compensation revenue decreasing as a percentage of total revenue over time. However, total revenue from reciprocal compensation is not expected to significantly decline in the short-term since the Company's policy has historically been to defer a portion of reciprocal compensation revenue that was subject to future adjustment. However, the Company cannot predict whether the LECs will dispute reciprocal compensation charges for ISP traffic even if the charges comply with the FCC's order. Because the ruling is only interim in nature, is subject to further interpretation or could be replaced with a different regulatory scheme, there is no assurance that the Company's reciprocal compensation revenue will not be further decreased or eliminated completely. 16 TIME WARNER TELECOM INC. As of June 30, 2001, the Company had deferred recognition of $17.3 million in reciprocal compensation revenue for payments received associated with pending disputes and agreements that are subject to future reciprocal compensation adjustments. Switched access is the connection between a long distance carrier's point of presence and an end-user's premises provided through the switching facilities of a LEC. Historically, the FCC has regulated the access rates imposed by the incumbent local exchange carriers ("ILECs"), while the competitive local exchange carriers' ("CLEC") access rates have been less regulated. However, on April 27, 2001, the FCC released an order in its ongoing Access Reform proceeding that subjects CLECs' interstate switched access charges to regulation. Effective with that order, the Company's rates will be reduced over a three-year period to parity with the ILEC rates competing in each area. In addition, when a CLEC enters a new market its access charges may be no higher than the ILEC's. This order does not affect rates subject to contracts that the Company has entered into with certain long distance carriers. The Company and several other CLECs have filed petitions with the FCC for reconsideration of the provisions of the order relating to new markets and expects that there will be other legal challenges to the order filed in federal court. There is no assurance that any legal challenge will be successful or that a successful challenge will change the trend toward lower access charges. Switched access revenue represented 8% and 11% of total revenue for the six months ended June 30, 2001 and 2000, respectively, excluding the effects of the recognition of $37.0 million and $27.3 million of non-recurring reciprocal compensation during the six months ended June 30, 2001 and 2000, respectively. The Company expects, as it previously anticipated, that switched access revenue will decline as a percentage of the Company's total revenue. There is no assurance that the Company will be able to compensate for reductions in switched access revenue resulting from the FCC order with revenue from other sources. The Company benefits from its strategic relationship with Time Warner both through access to local right-of-way and construction cost-sharing. Except for networks acquired from GST, the Company's networks have been constructed primarily through the use of fiber capacity licensed from Time Warner. As of June 30, 2001, the Company operated networks in 39 metropolitan areas that spanned 15,249 route miles, contained 674,284 fiber miles, and offered service to 9,852 on-net and off-net buildings. Operating expenses consist of costs directly related to the operation and maintenance of the networks and the provision of the Company's services. This includes the salaries and related expenses of operations and engineering personnel, as well as costs incurred from the ILECs, other competitors, and long distance providers for facility leases and interconnection. These costs have increased over time as the Company has increased its operations and revenue. The Company expects these costs to continue to increase as the Company's revenue growth continues. The fact that a significant portion of the Company's traffic rides on its own fiber infrastructure enhances the Company's ability to control its costs. Selling, general, and administrative expenses consist of salaries and related costs for employees other than those involved in operations and engineering. These expenses include costs related to sales and marketing, including bad debt expense, information technology, billing, regulatory, and legal costs. These costs have increased over time as the Company has increased its operations and revenue. The Company expects these costs to continue to increase as the Company's revenue growth continues. In the normal course of business, the Company engages in various transactions with Time Warner, generally on negotiated terms among the affected units that, in management's view, result in reasonable allocations. The Company entered into several contracts with Time Warner with respect to certain of these transactions. The Company's dedicated transport and switched services revenue includes services provided to Time Warner. The Company's selling, general, and administrative expenses include charges allocated from Time Warner for office rent and overhead charges for various administrative functions they perform for the Company. These charges are required to reflect all costs of doing business and are based on various methods, which management believes result in reasonable allocations of those costs that are necessary to present the Company's operations as if they are operated on a stand alone basis. In addition, the Company licenses the right to use a significant portion of its local fiber capacity from Time Warner through prepaid right-to-use agreements and reimburses Time Warner for facility maintenance and pole rental costs. The maintenance and pole rental costs are included in the Company's operating expenses. 17 TIME WARNER TELECOM INC. Three Months Ended June 30, 2001 Compared to Three Months Ended June 30, 2000 Revenue. Total revenue increased $86.1 million, or 65%, to $217.9 million for the three months ended June 30, 2001, from $131.8 million for the comparable period in 2000. Revenue from the provision of dedicated transport services increased $46.5 million, or 77%, to $107.2 million for the three months ended June 30, 2001, from $60.7 million for the comparable period in 2000. Switched service revenue increased $39.6 million, or 56%, to $110.7 million for the three months ended June 30, 2001, from $71.1 million for the comparable period in 2000. Included in total revenue for the three months ended June 30, 2001 is $1.8 million in services provided to the GST bankruptcy estate and to transitional customers, which is not expected to continue. Also included in total revenue for the three months ended June 30, 2001 and 2000, is $37.0 million and $23.4 million, respectively, of non-recurring reciprocal compensation. Reciprocal compensation represented 8% and 5% of total revenue for the three months ended June 30, 2001 and 2000, respectively, excluding the effects of the recognition of non-recurring reciprocal compensation. At June 30, 2001, the Company offered dedicated transport services in 39 metropolitan areas, all of which also offered switched services. At June 30, 2000, the Company offered dedicated transport services in 22 consolidated metropolitan areas, 21 of which also offered switched services. Exclusive of the effects of the GST asset acquisition during the three months ended June 30, 2001 and the effects of the recognition of $37.0 million and $23.4 million of non-recurring reciprocal compensation during the three months ended June 30, 2001 and 2000, respectively, total revenue increased $46.7 million, or 43% to $155.0 million, from $108.4 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition during the three months ended June 30, 2001 and the effects of the recognition of $37.0 million and $23.4 million of non-recurring reciprocal compensation during the three months ended June 30, 2001 and 2000, respectively, dedicated transport service and switched service revenue increased 55% and 27%, respectively. The increase in revenue from dedicated transport services primarily reflects a 20% increase in average dedicated transport customers and a broader array of products and services offered in existing markets. The increase in switched service revenue reflects a 52% increase in average switched service customers, increased revenue from switched access services and reciprocal compensation, and a broader array of products and services offered in existing markets. Although revenue from switched access services and reciprocal compensation increased, the average rates have decreased and are expected to continue declining in the foreseeable future. Operating Expenses. Operating expenses increased $38.1 million, or 87%, to $81.7 million for the three months ended June 30, 2001, from $43.6 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition, these expenses increased 36%. The increase in operating expenses was primarily attributable to the Company's expansion of its business, the ongoing development of existing markets resulting in higher LEC charges for circuit leases and interconnection, and higher headcount for technical personnel. As a percentage of total revenue, operating expenses increased to 38% for the three months ended June 30, 2001 from 33% for the comparable period in 2000, primarily as a result of the acquired assets and development of new markets. Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased $20.9 million, or 52%, to $61.4 million for the three months ended June 30, 2001, from $40.5 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition, these expenses increased 26%. The increase in selling, general, and administrative expenses was primarily attributable to an increase in employee headcount and higher direct sales costs associated with the increase in revenue, higher property tax expense, and an increase in the provision for doubtful accounts related to the increase in revenue. As a percentage of total revenue, selling, general, and administrative expenses decreased to 28% for the three months ended June 30, 2001 from 31% for the comparable period in 2000. Depreciation and Amortization Expense. Depreciation and amortization expense increased $23.3 million, or 102%, to $46.2 million for the three months ended June 30, 2001, from $22.9 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition, this expense increased 39%. The increase in net depreciation and amortization expense was primarily attributable to increased capital expenditures. 18 TIME WARNER TELECOM INC. EBITDA. EBITDA for the three months ended June 30, 2001 increased $27.2 million to $74.9 million, from $47.7 million in 2000. The increase was $24.3 million, exclusive of the effects of the GST asset acquisition. This improvement was primarily the result of a $13.6 million increase in the recognition of non-recurring reciprocal compensation from $23.4 million in 2000 to $37.0 million in 2001, economies of scale as more revenue was generated in existing markets, increased utilization of networks and facilities, and a more skilled and productive workforce. Interest Expense. On July 21, 1998, the Company issued $400 million in 9 3/4% Senior Notes in a public offering. During the first quarter of 2001, the Company issued $400 million in 10 1/8% Senior Notes and drew $250 million on its Credit Facility. Interest expense relating to the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and the Credit Facility was $28.1 million for the three months ended June 30, 2001. Interest expense relating to the 9 3/4% Senior Notes was $10.1 million for the three months ended June 30, 2000. Net Income. Net income decreased $5.4 million to $4.4 million for the three months ended June 30, 2001, from $9.8 million for the comparable period in 2000. The net income change is primarily due to an increase in depreciation expense and net interest expense related to the GST asset acquisition, partially offset by a decrease in income tax expense and an increase in EBITDA. Six Months Ended June 30, 2001 Compared to Six Months Ended June 30, 2000 Revenue. Total revenue increased $159.1 million, or 69% to $391.0 million for the six months ended June 30, 2001, from $231.9 million for the comparable period in 2000. Revenue from the provision of dedicated transport services increased $101.1 million, or 90%, to $213.8 million for the six months ended June 30, 2001, from $112.6 million for the comparable period in 2000. Switched service revenue increased $58.0 million, or 49%, to $177.3 million for the six months ended June 30, 2001, from $119.3 million for the comparable period in 2000. Included in total revenue for the six months ended June 30, 2001 is $6.4 million in services provided to the GST bankruptcy estate and to transitional customers, which is not expected to continue. Reciprocal compensation represented 7% and 6% of total revenue for the six months ended June 30, 2001 and 2000, respectively, excluding the effects of the recognition of $37.0 million and $27.3 million of non-recurring reciprocal compensation during the six months ended June 30, 2001 and 2000, respectively. At June 30, 2001, the Company offered dedicated transport services in 39 metropolitan areas, all of which also offered switched services. At June 30, 2000, the Company offered dedicated transport services in 22 consolidated metropolitan areas, 21 of which also offered switched services. Exclusive of the effects of the GST asset acquisition during the six months ended June 30, 2001 and the effects of the recognition of $37.0 million and $27.3 million of non-recurring reciprocal compensation during the six months ended June 30, 2001 and 2000, respectively, total revenue increased $97.6 million, or 48% to $302.2 million, from $204.6 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition during the six months ended June 30, 2001 and the effects of the recognition of $37.0 million and $27.3 million of non-recurring reciprocal compensation during the six months ended June 30, 2001 and 2000, respectively, dedicated transport service and switched service revenue increased 65% and 26% respectively. The increase in revenue from dedicated transport services primarily reflects a 21% increase in average dedicated transport customers and a broader array of products and services offered in existing markets. The increase in switched service revenue reflects a 55% increase in average switched service customers, increased revenue from switched access services and reciprocal compensation, and a broader array of products and services offered in existing markets. Although revenue from switched access services and reciprocal compensation increased, the average rates have decreased and are expected to continue declining in the foreseeable future. Operating Expenses. Operating expenses increased $77.8 million, or 94%, to $160.4 million for the six months ended June 30, 2001, from $82.5 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition, these expenses increased 43%. The increase in operating expenses was primarily attributable to the Company's expansion of its business, the ongoing development of existing markets resulting in higher LEC charges for circuit leases and interconnection, and higher headcount for technical personnel. As a percentage of total revenue, operating expenses increased to 41% for the six months 19 TIME WARNER TELECOM INC. ended June 30, 2001 from 36% for the comparable period in 2000, primarily as a result of the acquired assets and development of new markets. Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased $43.7 million, or 56%, to $121.9 million for the six months ended June 30, 2001, from $78.2 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition, these expenses increased 30%. The increase in selling, general, and administrative expenses was primarily attributable to an increase in employee headcount and higher direct sales costs associated with the increase in revenue, higher property tax expense, and an increase in the provision for doubtful accounts related to the increase in revenue. As a percentage of total revenue, selling, general, and administrative expenses decreased to 31% for the six months ended June 30, 2001 from 34% for the comparable period in 2000. Depreciation and Amortization Expense. Depreciation and amortization expense increased $54.1 million, or 121%, to $98.9 million for the six months ended June 30, 2001, from $44.8 million for the comparable period in 2000. Exclusive of the effects of the GST asset acquisition, this expense increased 57%. The increase in net depreciation and amortization expense was primarily attributable to an impairment of certain non-revenue generating assets and increased capital expenditures. EBITDA. EBITDA for the six months ended June 30, 2001 increased $37.5 million to $108.7 million, from $71.2 million in 2000. The increase was $38.7 million, exclusive of the effects of the GST asset acquisition. This improvement was primarily the result of a $9.7 million increase in the recognition of non-recurring reciprocal compensation from $27.3 million in 2000 to $37.0 million in 2001, economies of scale as more revenue was generated in existing markets, increased utilization of networks and facilities, and a more skilled and productive workforce. Interest Expense. On July 21, 1998, the Company issued $400 million in 9 3/4% Senior Notes in a public offering. During the first quarter of 2001, the Company issued $400 million in 10 1/8% Senior Notes and drew $250 million on its Credit Facility. Interest expense relating to the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and the Credit Facility was $54.0 million for the six months ended June 30, 2001. Additionally, in connection with the repayment of the senior unsecured bridge loan facility, the Company recorded $5.8 million of deferred financing costs as a non-recurring expense as well as $3.5 million in interest expense. Interest expense relating to the 9 3/4% Senior Notes was $25.2 million for the six months ended June 30, 2000. Net Loss. Net loss changed $31.2 million to a loss of $24.3 million for the six months ended June 30, 2001, from earnings of $6.9 million for the comparable period in 2000. The earnings change is primarily due to an increase in depreciation expense and net interest expense related to the GST asset acquisition, partially offset by an increase in the deferred tax benefit and an increase in EBITDA. Liquidity and Capital Resources Operations. The Company's cash provided by operating activities was $116.9 million for the six months ended June 30, 2001, as compared to $54.6 million for the comparable period in 2000. This increase in cash provided by operating activities of $62.3 million principally resulted from an increase in EBITDA and a change in certain working capital items. As the Company continues its expansion plan to enter into new markets, the expenditures incurred, together with initial operating expenses, will generally result in negative EBITDA and operating losses from the new market until an adequate customer base and revenue stream for the new market has been established. Accordingly, the Company expects that the network constructed in each new market will generally produce negative EBITDA from the new market for at least two years after operations commence in that market. Additionally, the Company currently expects the operations related to the assets purchased from GST to generate negative EBITDA until an adequate customer base and revenue stream for the network have been established. Although overall the Company expects to continue to have positive EBITDA for the near future as it develops and expands its business, as well as integrates the GST acquisition, there can be no assurance that the Company will sustain sufficient positive EBITDA to meet its working capital requirements and to service its indebtedness. 20 TIME WARNER TELECOM INC. Investing. Cash used in investing activities was $921.7 million for the six months ended June 30, 2001, as compared to $44.1 million for the comparable period in 2000. During the six months ended June 30, 2001, the Company used its proceeds from the issuance of common stock and a portion of the proceeds from the issuance of debt to fund the GST acquisition, capital expenditures, and net purchases of marketable securities. During the six months ended June 30, 2000, proceeds from the maturities of marketable securities and cash flow from operating activities were primarily used to fund capital expenditures. During the six months ended June 30, 2001, capital expenditures were $242.7 million, an increase of $99.2 million from the comparable period in 2000. The largest commitment of capital was related to the installation of transport and switch related electronics to support the increase in sales activity and the addition of 1,240 route miles of fiber since December 31, 2000, which is exclusive of 4,210 route miles of fiber acquired in connection with the GST asset acquisition. Based on historic capital requirements for network construction in relation to sales volumes and network expansion plans, the Company anticipates it will commit approximately $550 million in 2001 to fund its capital expenditures. This target spending includes requirements for current operating markets, the Company's expansion plans including markets acquired from GST, and integrating the GST acquisition. However, if revenue growth slows, the Company may further reduce its capital spending as a large portion of the Company's capital spending is success-based. The facilities-based telecommunications service business is a capital-intensive business. The Company's operations have required and will continue to require substantial capital investment for: . the purchase and installation of switches, electronics, fiber, and other technologies in existing networks and in additional networks to be constructed in new service areas; and . the evolution of the network to support new products, services, and technologies. The Company's expected capital expenditures for general corporate and working capital purposes include expenditures with respect to the Company's management information system and corporate service support infrastructure. The Company plans to make substantial capital investments in connection with plans to construct and develop new networks, as well as for technology upgrades. Expansion of the Company's networks will include the geographic expansion of the Company's existing operations, and the Company will consider the development of new markets. In addition, the Company may acquire existing networks in the future. The development and expansion of the Company's existing and future networks and services will require significant capital expenditures. The Company regularly evaluates potential acquisitions and joint ventures that would extend its geographic markets, expand its products and services, or enlarge the capacity of its networks. If the Company enters into a definitive agreement with respect to any acquisition or joint venture, it may require additional financing. If the Company enters into a definitive agreement with respect to any material transaction, it could result in the Company increasing its leverage or issuing additional common stock or both. There can be no assurance, however, that the Company will enter into any transaction or, if it does, on what terms. While the Company intends to continue to leverage its relationship with Time Warner in pursuing expansion opportunities, to the extent the Company seeks to expand into service areas where Time Warner does not conduct cable operations, the Company may incur additional costs in excess of those historically incurred when expanding into existing Time Warner service areas. In addition, Time Warner is not obligated to construct or provide additional fiber optic capacity in excess of what is already licensed to the Company under certain operating agreements. Accordingly, if the Company is unable to lease additional capacity at the same rates as are currently provided for under certain operating agreements, the Company may be required to obtain additional capacity on more expensive terms. 21 TIME WARNER TELECOM INC. In order to fund the GST asset acquisition, the development of those assets, and its other capital expenditure needs, in December 2000 the Company replaced its $475 million senior secured revolving credit facility with a $1 billion amended and restated senior secured credit facility which provides for $525 million of senior secured term loan facilities and a $475 million senior secured revolving credit facility. The Credit Facility has a final maturity of December 31, 2007, with annual reductions in the principal amount available under the $475 million senior secured credit facility commencing on December 31, 2004. In December 2000, the Company was required to draw and hold in escrow $179 million of the revolving credit facility until the closing of the GST asset acquisition, at which time the draw increased to $250 million. See "Financing" below. In January 2001, the Company issued $400 million principal amount of 10 1/8% Senior Notes due 2011 and 7,475,000 shares of Class A common stock in a public offering at an offering price of $74 7/16 per share, in part to repay a senior unsecured bridge loan facility under which the Company borrowed $700 million to finance the purchase of the GST assets and pay related fees and expenses. In connection with the repayment of the senior unsecured bridge loan facility, the Company recorded $5.8 million of deferred financing costs as a non-recurring expense as well as $3.5 million in interest expense for the six months ended June 30, 2001. In connection with the issuance of Class A common stock, approximately $24.2 million of unamortized deferred financing costs was reclassified to additional paid-in capital in the first quarter of 2001. The Company expects that the $480.6 million in cash, cash equivalents, and marketable debt securities at June 30, 2001, borrowings under the $1 billion credit facility, along with internally generated funds, will provide sufficient funds for the Company to meet its expected capital and liquidity needs to expand its business and pay interest on the 9 3/4% Senior Notes, the 10 1/8% Senior Notes, and on current and future borrowings under the secured revolving credit facility. In the event that the Company's plans or assumptions change or prove to be inaccurate, or the foregoing sources of funds prove to be insufficient to fund the Company's growth and operations, or if the Company consummates acquisitions or joint ventures, the Company may be required to seek additional capital. The Company's revenue and costs are partially dependent upon factors that are not within the Company's control, such as regulatory changes, changes in technology, and increased competition. Due to the uncertainty of these and other factors, actual revenue and costs may vary from expected amounts, possibly to a material degree, and these variations are likely to affect the level of the Company's future capital expenditures and expansion plans. Sources of any future financing may include public or private debt, equity financing by the Company or its subsidiaries, or other financing arrangements. Financing. Net cash provided by financing activities for the six months ended June 30, 2001 was $1.0 billion and was primarily due to the net proceeds from both the issuance of common stock and debt. The $400 million principal amount in 9 3/4% Senior Notes that the Company issued in July 1998 are unsecured, unsubordinated obligations of the Company. Interest on the 9 3/4% Senior Notes is payable semiannually on January 15 and July 15, beginning on January 15, 1999. Aggregate annual interest payments on the 9 3/4% Senior Notes through 2008 are expected to be approximately $39 million. The 9 3/4% Senior Notes are required to be repaid on July 15, 2008. The $400 million in principal amount of 10 1/8% Senior Notes that the Company issued in the first quarter of 2001 are unsecured, unsubordinated obligations of the Company. Interest on the 10 1/8% Senior Notes is payable semiannually on February 1 and August 1, beginning on August 1, 2001. Aggregate annual interest payments on the 10 1/8% Senior Notes through 2011 are expected to be approximately $41 million. The 9 3/4% Senior Notes and the 10 1/8% Senior Notes are governed by indentures that contain certain restrictive covenants. These restrictions affect, and in many respects significantly limit or prohibit, among other things, the ability of the Company to incur indebtedness, make prepayments of certain indebtedness, pay dividends, make investments, engage in transactions with shareholders and affiliates, issue capital stock of subsidiaries, create liens, sell assets, and engage in mergers and consolidations. Interest on the $250 million drawn under the revolving credit facility is computed utilizing a specified Eurodollar Rate plus 4.0%, which totaled 8.7% on June 30, 2001. Interest is payable at least 22 TIME WARNER TELECOM INC. quarterly at the end of each quarter, beginning in March 2001. Based on the rate in effect on June 30, 2001, aggregate annual interest payments are expected to be approximately $21.7 million through 2008. These anticipated payments will fluctuate with changes in amounts borrowed and changes in the interest rate. The obligations under the amended and restated senior secured credit facility are secured by substantially all of the assets of the Company, including the assets acquired from GST, except for certain assets with respect to which the grant of a security interest is prohibited by governing agreements. The senior secured credit facility requires the Company to prepay outstanding loans when its cash flow exceeds certain levels and with the proceeds received from a number of specified events or transactions, including certain asset sales and insurance recoveries for assets not replaced. In addition, obligations under the senior secured credit facility are subject to various covenants that limit the Company's ability to: . borrow and incur liens on its property; . pay dividends or make other distributions; and . make capital expenditures. The senior secured credit facility also contains financial covenants, including a consolidated leverage ratio, and a consolidated interest coverage ratio, as well as cross default provisions. Under the cross default provisions, the Company is deemed to be in default under the amended and restated facility if it has defaulted under any of the other material outstanding obligations, such as the 9 3/4% Senior Notes or the 10 1/8% Senior Notes. 23 TIME WARNER TELECOM INC. Part II Other Information Item 1. Legal Proceedings The Company has no material legal proceedings pending. Item 4. Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Stockholders of Time Warner Telecom Inc. was held on June 7, 2001 (the "2001 Annual Meeting"). (b)(c) The following matters were voted upon at the 2001 Annual Meeting: (i) The following persons were elected directors of Time Warner Telecom Inc. for terms expiring in 2002: Votes For Votes Withheld ----------- -------------- Larissa Herda 758,333,721 526,714 Glenn A. Britt 753,292,179 5,568,256 Bruce Claflin 758,416,098 444,337 Richard J. Davies 753,323,449 5,536,986 Spencer B. Hays 753,015,937 5,844,498 Lisa Hook 758,333,261 527,174 Robert J. Miron 758,334,078 526,357 William T. Schleyer 758,415,997 444,458 Theodore H. Schell 758,415,960 444,475 (ii) Approval of the Time Warner Telecom Inc. 2000 Employee Stock Plan: Votes For: 736,582,059 Votes Against: 16,833,549 Abstentions: 28,342 Broker Non-Votes: 5,416,485 (iii) Ratification of the appointment of Ernst & Young LLP as independent auditors of Time Warner Telecom Inc. for 2001: Votes For: 757,895,023 Votes Against: 953,489 Abstentions: 11,923 Broker Non-Votes: 0 24 TIME WARNER TELECOM INC. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this report and the Exhibit Index is incorporated herein by reference. (b) Reports on Form 8-K (i) 8-K dated May 7, 2001 reporting the issuance of a press release announcing the Company's first quarter 2001 financial results. 25 TIME WARNER TELECOM INC. EXHIBIT INDEX Exhibit Number Description of Exhibit - ------ ---------------------- 2.1 -- Reorganization Agreement among Time Warner Companies, Inc., MediaOne Group, Inc., Advance/Newhouse Partnership, Time Warner Entertainment Company, L.P., and Time Warner Entertainment- Advance/Newhouse Partnership (filed as Exhibit 2.1 to Time Warner Telecom ("TWT") LLC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. * 2.2 -- Merger Agreement among the Company, TWT LLC, and TWT Inc. (filed as Exhibit 2.2 to the Company's Registration Statement on Form S- 1 (Registration No. 333-49439)). * 2.3 -- Asset Purchase Agreement dated as of September 11, 2000 among Time Warner Telecom Inc., GST Telecommunications, Inc., GST USA, Inc. and the other parties identified on Exhibit A thereto (filed as Exhibit 2.1 to the Company's Report on Form 8-K dated September 18, 2000 and dated September 11, 2000). * 3.1 -- Restated Certificate of Incorporation of the Company (filed as Exhibit 2.2 to Company's Registration Statement on Form S-1 (Registration No. 333-49439)). * 3.2 -- Restated By-Laws of the Company (filed as Exhibit 3.2 to Company's Registration Statement on Form S-1 (Registration No. 333-49439)). * 4.1 -- Stockholders' Agreement, among the Company, Time Warner Companies, Inc., American Television and Communications Corporation, Warner Communications Inc., TW/TAE Inc., FibrCOM Holdings, L.P., Paragon Communications, MediaOne Group, Inc., Multimedia Communications, Inc. and Advance/Newhouse Partnership (filed as Exhibit 4.1 to Company's Registration Statement on Form S-1 (Registration No. 333-49439)). * 4.2 -- Indenture, between TWT LLC, TWT Inc. and The Chase Manhattan Bank, as Trustee (filed as Exhibit 4.1 to TWT LLC's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998). * 4.3 -- Indenture between Time Warner Telecom Inc. and The Chase Manhattan Bank, as Trustee (filed as Exhibit 4 to Amendment No. 1 to the Company's Registration Statement on Form S-3. (Registration No. 333-49818)). * 10.19 -- Employment Agreement between the Company and Mark Hernandez. * Incorporated by reference. 26 Signature Pursuant to the requirements 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. TIME WARNER TELECOM INC. Date: August 14, 2001 By: /s/ Jill R. Stuart ----------------------------- Jill R. Stuart Vice President, Accounting and Finance and Chief Accounting Officer EX-10.19 3 dex1019.txt EMPLOYMENT AGREEMENT Exhibit 10.19 EMPLOYMENT AGREEMENT Employment Agreement dated as of June 20, 2001, (the "effective date") between Time Warner Telecom, Inc., (the "Company"), and the employee whose name appears on the last page hereof (the "Employee"). The Company shall employ the Employee on the following terms and conditions: 1. Term. The Company hereby employs Employee and Employee hereby accepts ---- such employment upon the terms and conditions hereof for an initial term commencing on the "Effective Date" and ending, subject to renewal or termination as provided herein, on the third anniversary of the Effective Date (the "Initial Term"); provided, however, that this Agreement shall automatically continue for successive one month periods thereafter (each such period being an "Additional Term") unless either party has delivered written notice of termination to the other party no later than six months prior to the end of the Initial Term or 60 days prior to the end of any Additional Term. Sections 8, 10 through 22 and 24 through 28 shall survive any termination of Employee's employment under this Agreement. The Employee hereby covenants that as of the Effective Date any agreement between Employee and the Company, or any of it's affiliates, entered into prior to the date hereof, relating to Employee's employment with such entity, shall terminate as of, or have been terminated prior to, the Effective Date. 2. Duties. Employee shall serve as Senior Vice President, Chief ------ Information Officer or subject to Section 5, in such other senior management position as the Company shall determine. Subject to the foregoing, Employee shall perform such duties as may be assigned by the Company to Employee from time to time, and shall travel for business purposes to the extent reasonably necessary or appropriate in the performance of such duties. Employee shall perform such duties on a full time basis (subject to the Company's written policies on vacations, illness, government service, etc. applicable to employees at Employee's level in effect from time to time), provided, however, that Employee shall not be precluded from devoting such time - -------- to personal affairs as shall not interfere with the performance of his or her duties hereunder. In performing his or her duties hereunder, Employee shall comply with the Company's policies and procedures in effect from time to time. Unless Employee otherwise consents, the headquarters for the performance of Employee's services shall be the principal executive offices of the Company and /or the Denver area, subject to such reasonable travel as may be appropriate or required in the performance of Employee's duties in the business of the Company. 3. Compensation. The Company shall pay or cause to be paid to Employee, ------------ during the term of employment, an annual salary in respect of each calendar year at the rate of not less than $215,000 per annum. The Company may increase, but not decrease, such annual salary at any time and from time to time during the term of employment. In addition to annual salary, Employee may be entitled to receive an annual bonus in respect of each calendar year based on a target percentage of the salary paid to Employee during such calendar year of 75%. Subject to Section 5, and the second paragraph of this 1 Section 3, Employee acknowledges that his or her actual annual bonus may vary and range from 0% to 150% of the target amount, depending on actual performance of the Company and Employee. Subject to Section 5 and the second sentence of this Section 3, the Company shall determine, in its sole discretion, the amount of any salary increase, the amount of any annual bonus and whether to increase the target percentage of Employee's annual bonus. The payment of any bonus compensation shall be made in accordance with the Company's then current practices and policies, including without limitation, less the usual required payroll deductions and withholding. The Company shall pay or reimburse Employee, in accordance with Company policies applicable to employees at Employee's level, for all travel, entertainment and other business expenses actually incurred or paid by Employee in the performance of his or her duties hereunder, if properly substantiated and submitted. 4. Benefits. Employee shall be eligible to participate in any pension, -------- profit-sharing, employee stock ownership, vacation, insurance, hospitalization, medical, health, disability and other employee benefit or welfare plan, program or policy whether now existing or established hereafter (collectively, the "Benefit Plans"), to the extent that employees at Employee's level are generally deemed eligible under the general provisions thereof. The Company reserves the right to amend or cancel any such Benefit Plan in its sole discretion. 5. Termination by Employee Following a Change in Control. ----------------------------------------------------- (a) Provided that notice of termination has not previously been given under any other Section hereof, Employee shall have the right to terminate his or her employment with the Company under this Agreement for cause upon 30 days prior written notice delivered to the Company at any time within 180 days after Employee has actual knowledge of the occurrence of any of the following events following a Change in Control, indicating in such notice which event has occurred: A. A change in the location of Employee's office or of the Company's principal executive offices to a place which is more than 50 miles from the location of Employee's office or the location of the Company's principal executive offices immediately prior to the occurrence of a Change in Control; B. A material reduction in Employee's decision-making, budgetary, operating, staff and other responsibilities, taken as a whole, from such responsibilities immediately prior to the occurrence of a Change in Control, or a change in the person or persons to whom Employee reported immediately prior to the occurrence of a Change in Control, to a person or persons of lesser rank, title or responsibility; or 2 C. Any material breach of this Agreement by the Company. (b) Upon the expiration of the 30-day notice period provided in Section 5(a), Employee shall be relieved of his or her management position with the Company and his or her duties hereunder. In the notice delivered by Employee to the Company pursuant to Section 5(a), Employee shall elect either (A) to terminate his or her employment with the Company, in which case Employee shall receive: (x) subject to the terms thereof, all benefits which may be due to Employee under the provisions of any Benefit Plan; and (y) in a lump sum severance payment, within 30 days following the effective date of such termination, the present value (using the discount rate described below) of an amount equal to the sum of the annual salary at the rate in effect on the date of termination of employment or immediately prior to the Change in Control, whichever is greater, plus an annual bonus in a minimum amount equal to Employee's then applicable target bonus amount or the Employee's applicable target bonus amount in effect immediately prior to the Change in Control, whichever is greater, for the remainder of the existing term of this Agreement, without any further renewal or continuation, provided that such amount shall be not less than the sum of such salary and bonus pro rated for a 18-month period, or (B) to remain an employee of the Company for a period (as determined by Employee) of up to 18 months following the date notice of termination is given by Employee pursuant to Section 5(a), in which case Employee shall be relieved of his or her management position with the Company and his or her duties hereunder, and shall (i) continue to receive both salary, based on a rate equal to his or her annual rate in effect on the date of termination of employment or immediately prior to the Change in Control, whichever is greater, and annual bonus in respect of such period (in each case payable within 30 days after the end of the respective calendar year and prorated for any portion of a year), each such bonus to be based on an amount equal to Employee's then applicable target bonus amount or the Employee's applicable target bonus amount in effect immediately prior to the Change in Control, whichever is greater, and (ii) receive a discounted lump sum payment pursuant to Section 5(b)(A)(y) for any portion of the term of employment remaining after such period; provided, -------- however, that if Employee accepts full-time employment with any other corporation, partnership, trust, government or other entity ("Entity") during such period or notifies the Company in writing of his or her intention to terminate his or her employment during such period, Employee shall cease to be an employee of the Company effective upon the commencement of such employment or the effective date of such termination as specified by Employee in such notice, and shall be entitled to receive, subject to the terms thereof, all benefits due to Employee under the provisions of any Benefit Plan and a discounted lump sum cash payment for the balance of the salary and bonus Employee would have been entitled to receive pursuant to this Section 5(b)(B) had Employee remained on the Company's payroll until the end of the Initial Term or such 18 month period whichever is greater, provided, further, however, that Employee shall not be -------- ------- ------- entitled to receive any such lump sum cash payment if he or she accepts full-time employment with any subsidiary or Affiliate of the Company. For purposes of this Agreement, the term "Affiliate" shall mean an Entity which, directly or indirectly, controls, is controlled by or is under common control with, the Company or Time Warner Inc ("TWI"). 3 In addition, whether Employee elects 5(b)(A) or 5(b)(B), for a period of the earlier of one year from the date of termination of employment or the date Employee is eligible to receive health benefits by virtue of other employment, Employee shall receive continued eligibility and enrollment (including family coverage, if any), without a premium charge therefor, in hospital, medical and dental insurance plans providing substantially equivalent benefit coverage to those plans in which Employee was enrolled immediately prior to the Change in Control unless waived in writing by Employee (or, in the event such coverage cannot be provided, substantially similar benefits). Any lump sum payments required to be made pursuant to this Section 5(b) shall be discounted to present value from the times at which such amounts would have been paid absent any such termination at an annual discount rate for the relevant period equal to the "applicable Federal rate" (within the meaning of Section 1274(d) of the Internal Revenue Code of 1986 (the "Code")), compounded semi-annually, in effect on the date of such termination, the use of which rate is hereby elected by the Company and Employee pursuant to Treas. Reg. Section 1.28OG-1 Q/A32 (provided that in the event such election is not permitted, such other rate determined as of such other date as is applicable for determining present value under Section 28OG of the Code shall be used). 6. Termination by Company. ---------------------- (a) For Cause. Provided that notice of termination has not previously been given under any other Section hereof, the Company shall have the right to terminate Employee's employment for cause upon written notice to Employee at any time. In such event, Employee's employment with the Company shall terminate immediately and Employee shall be entitled to receive (i) any earned and unpaid salary accrued through the date of such termination, and (ii) subject to the terms thereof, any benefits which may be due to Employee under the provisions of any Benefit Plan. Employee hereby disclaims any right to receive a pro rata portion of his or her annual bonus with respect to the year in which such termination occurs. For purposes hereof, "cause" shall mean termination by action of the Company's Board of Directors or any committee thereof because of Employee's conviction (treating a nolo & contendere plea as a conviction) of a felony (whether or not any right to appeal has been exercised) or willful refusal without proper cause to perform his or her obligations under this Agreement or because of Employee's material breach of the covenants provided for in Sections 10, 11 and 12 of this Agreement. In the event (i) such termination is because of the Employee's willful refusal without proper cause to perform any one or more of his obligations under this Agreement (ii) such notice is the first such notice of termination for any reason delivered by the Company to the Employee under this Section 6(a), and (iii) within 10 days following the date of such notice the Employee shall cease his or her refusal and shall use his or her best efforts to perform such obligations, the termination shall not be effective. (b) Other. Provided that notice of termination has not previously been given under any other Section hereof, the Company shall have the right at any time to terminate Employee's employment under this Agreement without cause, by giving written notice thereof to Employee. 4 (i) If such notice is so given to Employee, Employee shall be entitled to receive subject to the terms thereof, all benefits which may be due to Employee under the provisions of any Benefit Plan and to elect, within 30 days after receiving such notice, to receive either a lump sum severance payment in the amount, and upon the terms and conditions, provided in Section 5(b)(A) and calculated as set forth in the last paragraph of Section 5(b), or to remain an employee of the Company upon the terms and conditions provided in Section 5(b)(B); provided, however, that (i) any reference therein to Section 5(a) shall ----------------- be deemed for purposes of this Section 6(b) to be a reference to this Section 6(b)(i), and (ii) if a Change in Control has not occurred, then (x) Employee's salary shall be determined with reference to his or her then current annual salary and (y) Employee's annual bonus shall equal at least the Employee's target amount immediately prior to Employee's termination under this Section 6(b)(i). (ii) For the period beginning when Employee receives notice of termination from the Company pursuant to this Section 6(b), and ending six months thereafter, Employee will, without charge to Employee, have use of reasonable office space and reasonable office Facilities at Employee's principal job location immediately prior to his or her termination of employment, or other location reasonably close to such location, together with reasonable secretarial services in each case appropriate to an employee of Employee's position and responsibilities prior to such termination of employment but taking into account Employee's reduced need for such office space and secretarial services. Employee will continue to be eligible to participate in the Company's Benefit Plans and to receive, subject to the terms thereof, all benefits, which are received by other employees at Employee's level thereunder other than options or similar equity-based or incentive awards. (iii) In the event that Employee's employment is terminated prior to the occurrence of a Change in Control, or more than three years following a Change in Control, then, in partial consideration for the Company's obligation to make the payments described in this Section 6(b), Employee shall execute and deliver to the Company a release in the form as set forth in Exhibit A. The Company shall deliver such release to Employee at the time the Company delivers notice of termination pursuant to this Section 6(b). Employee shall execute and deliver such release to the General Counsel of the Company within 21 days of receipt of notice of termination. If Employee shall fail to execute and deliver to the Company such release within 30 days of Employee's receipt thereof from the Company, Employee's employment with the Company shall terminate effective at the end of such 30-day period and Employee shall receive, in lieu of the severance arrangements described in Section 6(b), a lump sum cash payment in an amount determined in accordance with the personnel policies of the Company then applicable. 7. Death; Disability. ----------------- (a) Death. If Employee shall die while employed by the Company, ----- Employee's employment under this Agreement shall thereupon terminate and Employee's estate or beneficiaries, as the case may be, shall be entitled to receive as promptly as 5 practicable but in any event within 30 days after reasonably satisfactory evidence of Employee's death is received by the Company (i) any earned and unpaid salary accrued to Employee through the period ending 30 days following the date of Employee's death and a pro rata portion of the target annual bonus amount in effect immediately prior to Employee's death; and (ii) subject to the terms thereof, any benefits which may be due to Employee's estate or beneficiaries under the provisions of any Benefit Plan. (b) Disability. Provided that notice of termination has not ---------- previously been given under any Section hereof, if employee becomes ill or is injured or disabled during the term of this Agreement such that Employee fails to perform all or substantially all the duties to be rendered hereunder and such failure continues for a period in excess of 26 consecutive weeks (a "Disability"), the Company may terminate the employment of Employee under this Agreement upon written notice to Employee at any time and thereupon Employee shall be entitled to receive (i) any earned and unpaid salary accrued through the date of such termination; (ii) subject to the terms thereof, any benefits which may be due to Employee under the provisions of any Benefit Plan; and (iii) a lump sum cash payment equal to the sum of 75% of Employee's then current annual salary and then applicable target annual bonus amount prorated for an 18-month period, less the amount of any disability insurance proceeds payable to Employee under any disability insurance policy or program covering Employee. --------- 8. Stock Options and Other Incentive Awards. Upon Employee's termination ---------------------------------------- of employment with the Company for any reason, Employee's rights to benefits and payments under any stock options, restricted shares or other incentive plans shall be determined in accordance with the terms and provisions of such plans and any agreements under which such stock options, restricted shares or other awards were granted. 9. Change in Control. For purposes of this Agreement, a "Change in ----------------- Control" of the Company shall be deemed to have occurred at such time as the Founding Stockholders (and their respective affiliates) as a group cease to have the ability to elect a majority of the directors on the Board of Directors of the Company (other than the chief executive officer of the Company and independent directors; provided that independent directors shall be included in calculating whether the foregoing majority requirement is satisfied if the directors nominated by the Founding Stockholders (and their respective affiliates) do not constitute a majority of the committee that selects the Board of Director's nominees for independent directors) and a "person" or "group" (within the meaning of Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act) (other than the Founding Stockholders and their respective affiliates) has become the ultimate "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) of more than 35% of the total voting power of the voting interests of the Company on a fully diluted basis and such ownership represents a greater percentage of the total voting power of the voting interests of the Company, on a fully diluted basis, than is held by the Founding Stockholders (and their respective affiliates) as a group on such date. 6 10. TradeSecrets; WorkProducts, Etc. Except in connection with the ------------------------------- performance of his or her duties hereunder, Employee hereby expressly covenants and agrees that Employee will not at any time while employed by the Company or thereafter, exploit, use, sell, publish, disclose, communicate or divulge to any person or Entity, other than the Company and its subsidiaries, either directly or indirectly, any trade secrets or confidential information, knowledge or data regarding the Company or any of its subsidiaries or Affiliates or any of their respective officers, directors or employees including, without limitation, the existence and terms of this Agreement, other than such information, knowledge or data which has been released by the Company or such subsidiaries, Affiliates or others to the Public (except that with respect to the terms of this Agreement Employee may communicate such terms to Employee's spouse and Employee's attorneys and financial advisors). Notwithstanding the foregoing, Employee may disclose such trade secrets or confidential information, knowledge, data or terms when required to do so by a court or government agency or legislative body of competent jurisdiction, provided Employee first notifies the Company orally and in writing as promptly as possible of such requirement so that the Company may either seek an appropriate protective order or waive compliance with the provisions of this Section, and provided further that if, in the absence of such protective order or waiver, Employee is nevertheless, in the written opinion of his or her counsel, reasonably acceptable to the Company addressed to and delivered to the Company, otherwise required to disclose such information to any such court, government agency or legislative body or else stand liable for contempt or suffer other material penalty, Employee may disclose such information in such case without liability hereunder so long as such disclosure does not exceed that required by such court government agency or legislative body. Employee hereby grants and assigns to the Company all rights (including, without limitation, any copyright or patent) in the results and proceeds of all services provided by Employee hereunder and all such services shall be subject in all respects to the supervision, control and direction of the Company. Any work in connection with such services shall be considered "work made for hire" under the Copyright Law of 1976 or any successor thereof, and the Company shall be the owner of such work as if the Company were the author of such work. 11. Non-Compete; Solicitation. Employee hereby expressly covenants and ------------------------- agrees that: (a) Employee will not at any time during the Term of employment and for a period of one year following the date a notice of termination of Employee's employment is effective as provided herein, be or become an officer, director, partner or employee of or consultant to or act in any managerial capacity with or own any equity interest in any Entity (an "Affiliated Person") which is a "Competitive Business Entity" (as such term is defined on Exhibit B hereto); provided, however, that (i) ownership of less than 1% of the ----------------- outstanding equity securities of any Entity listed on any national securities exchange or traded on the National Association of Securities Dealers Automated Quotation System shall not be prohibited hereby, and (ii) in the event Employee is terminated pursuant to Section 6(b) and notice of termination is so given to Employee following the occurrence of a Change in Control, Employee is hereby permitted to accept employment with any 7 Founding Stockholder and such employment shall not violate the provisions of this Section 11. (b) Employee will not at any time during the Term of employment and for a period of one year after the date a notice of termination of Employee's employment is effective as provided herein, solicit (or assist or encourage the solicitation of) any employee of the Company or any of its subsidiaries or Affiliates to work for Employee or for any Entity in which Employee owns or expects to own more than a 1% equity interest or for which Employee serves or expects to serve as an Affiliated Person. For the purposes of this Section II (b), the term "solicit any employee" shall mean Employee's contacting, or providing information to others who may be expected to contact any employee of the Company or any of its subsidiaries or Affiliates regarding their employment status, job satisfaction, interest in seeking employment with Employee or any Affiliated Person or any related matter, but shall not include general print advertising for personnel or responding to an unsolicited request for a personal recommendation for or evaluation of an employee of the Company or any of its subsidiaries or Affiliates. 12. Documents; Conduct. Employee hereby expressly covenants and agrees ------------------ that: (a) Following termination of Employee's employment with the Company for any, reason or at any time upon the Company's request Employee will promptly return to the Company all property of the Company and its subsidiaries and Affiliates in his or her possession or control (whether maintained at his or her office, home or elsewhere), including, without limitation, all copies of all management studies, business or strategic plans, budgets, notebooks and other printed, typed or written materials, documents, diaries, calendars and data of or relating to the Company or its subsidiaries or Affiliates or their respective personnel or affairs; and (b) Employee will not at any time denigrate, ridicule or intentionally criticize the Company or any of its subsidiaries or Affiliates or any of their respective products, properties, employees, officers or directors, including, without limitation, by way of news interviews, or the expression of personal views, opinions or judgments to the news media. 13. Breach by Employee. Employee hereby expressly covenants and agrees ------------------ that the Company will suffer irreparable damage in the event any provisions of Sections 10, 11 and 12 are not performed or are otherwise breached and that the Company shall be entitled as a matter of right to an injunction or injunctions and other relief to prevent a breach or violation by Employee and to secure its enforcement of Section 10, 11 and 12 resort to such equitable relief, however, shall not constitute a waiver of any other rights or remedies which the Company may have. 14. Representations. --------------- (a) Employee represents and warrants to the Company that this Agreement is legal, valid and binding upon Employee and Employee is not a party to any 8 agreement or understanding which would prevent the fulfillment by Employee of the terms of this Agreement. Employee has consulted with his or her legal, tax, financial and other advisors, to the extent desired, prior to execution and delivery of this Agreement. (b) The Company represents and warrants to Employee that this Agreement is legal, valid and binding upon the Company and the Company is not a party to any agreement or understanding which would prevent the fulfillment by the Company of the terms of this Agreement. 15. Notice. Any notice required or permitted to be given hereunder shall ------ be in writing (except where required to be given orally) and shall be sufficiently given or sent by registered or certified mail or delivered, in person, if to Employee at the address set forth on the last paragraph hereof, or at such other address as Employee shall designate by written notice to the Company, and if to the Company at 5700 South Quebec Street, Greenwood Village, CO 80111 attention of the General Counsel or at such other address as the Company shall designate by written notice to Employee. 16. Successors and Assigns. This Agreement is personal in its nature and ---------------------- neither of the parties hereto shall, without the consent of the other, assign or transfer this Agreement or any right or obligations hereunder; provided however, -------- that the provisions hereof shall inure to the benefit of, and be binding upon, any successor of the Company, whether by merger, consolidation, transfer of all or substantially all of the assets of the Company, or otherwise. 17. Governing Law. This Agreement shall be governed by and construed and ------------- enforced in accordance with the laws of the State Colorado irrespective of its conflicts of law rules, except for the By-laws referred to in Section 26, which shall be governed by and construed and enforced in accordance with the laws of the State of Colorado. To the extent that any applicable state or Federal law, rule or regulation confers upon Employee any greater benefit or right than that set forth in this Agreement, such law, rule or regulation shall control in lieu of the provisions hereof relating to such benefit or right. 18. Mitigation. Employee shall have no obligation to mitigate damages in ---------- the event of termination of Employee's employment under this Agreement under Section 5(a), 6(b) or 7, other than as necessary to prevent the Company from losing any tax deductions to which it otherwise would have been entitled for any payments deemed to be "contingent on a change" under the Code and any payments received by Employee hereunder shall not be offset or reduced in any way by any other earnings or payments which may be received by Employee from any source, except as provided by this Section 18. It is acknowledged and agreed that any payment which may be made by the Company to Employee under Section 5(b), 6(b) or 7 is in the nature of severance and is not a penalty payment. 19. Withholding. All payments required to be paid by the Company to ----------- Employee under this Agreement will be paid in accordance with the payroll practices of the Company or the terms of the Benefit Plans, as the case may be, and will be subject to 9 withholding taxes, social security and other payroll deductions in accordance with the Company's policies applicable to employees at Employee's level and the terms of the Benefit Plan. 20. Complete Understanding. This Agreement supersedes any prior contracts, ---------------------- understandings, discussions and agreements relating to employment between Employee, on the one hand, and the Company and its subsidiaries and Affiliates, on the other, and constitutes the complete understanding between the parties with respect to the subject matter hereof. No statement, representation, warranty or covenant has' been made by either party with respect thereto except as expressly set forth herein. 21. Modification; Waiver. This Agreement cannot be changed, modified or -------------------- amended and no provision or requirement hereof may be waived without the consent in writing of both the parties hereto. No waiver by either party at any time of any breach by the other party of any condition or provision of this Agreement shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. Subject to Section 28, no policy, procedure or practice of the Company whether now or hereafter in effect shall be deemed to modify, mend or supersede any provision of this Agreement except as contemplated or provided otherwise in this Agreement. 22. Headings. The headings in this Agreement are for convenience of -------- reference only and shall not control or affect the meaning or construction of this Agreement. 23. Use of Likeness. The Company shall have the right to use Employee's --------------- name, biography and likeness in connection with their respective businesses and that of their subsidiaries and Affiliates, but not for use as a direct endorsement. 24. Validity. The invalidity or unenforceability of any provision of this -------- Agreement shall not affect the validity or enforceability of any other provision of this Agreement which shall remain in full force and effect. 25. Set-off. The Company and its subsidiaries and Affiliates shall have no ------- right to set-off payments owed to Employee hereunder against amounts owed or claimed to be owed by Employee to the Company or its subsidiaries or Affiliates under this Agreement or otherwise. 26. Indemnification. The Company shall indemnify Employee to no lesser --------------- extent than provided in the Company's By-laws on the date hereof (the provisions of which are hereby incorporated by reference herein), notwithstanding any changes or amendments to such By-laws after the date hereof adversely affecting, limiting or reducing such indemnification. 27. Counterparts. This Agreement may be executed in one or more ------------ counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. 10 28. Changes. Subject to Section 5, the Company and its subsidiaries and ------- Affiliates are entitled to amend, modify, terminate or otherwise change at any time or from time to time any and all Benefit Plans and policies, practices or procedures referred to in this Agreement and all references herein to such Benefit Plans and policies, practices and procedures shall be to such as from time to time in effect prior to a Change in Control except as otherwise specifically herein provided. 29. Beneficiaries. Whenever this Agreement provides for any payment to the ------------- Employee's estate, such payment may be made instead to such beneficiary or beneficiaries as the Employee may designate in writing (using the form of Beneficiary Designation attached hereto as Exhibit C) and file with the Company. --------- The Employee shall have the right to revoke such Beneficiary Designation and redesignate a beneficiary by filing with the Company (and any applicable insurance company) a later dated Beneficiary Designation to such effect. 11 IN WITNESS WHEREOF, Employee and the Company have caused this Agreement to be executed as of the date first above written. By: /s/ Larissa Herda ---------------------------------------- Title: President and Chief Executive Officer Agreed to and accepted as of the date first above written /s/ Mark Hernandez - ---------------------------- Name SVP, CIO - ------------------------------ Title Address for Notices: - ------------------------------ - ------------------------------ - ------------------------------ 12 -----END PRIVACY-ENHANCED MESSAGE-----