Quarterly Report
Table of Contents

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, 2005

 

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 1-8519

 


 

CINCINNATI BELL INC.

Incorporated under the laws of the State of Ohio

 


 

201 East Fourth Street, Cincinnati, Ohio 45202

 

I.R.S. Employer Identification Number 31-1056105

 

Telephone - Area Code (513) 397-9900

 


 

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  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  x    No  ¨

 

At July 31, 2005, there were 246,132,175 common shares outstanding and 155,250 shares of 6 3/4% convertible preferred shares outstanding.

 



Table of Contents

TABLE OF CONTENTS

 

PART I. Financial Information

 

Description


   Page

Item 1.

  Financial Statements     
   

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Unaudited) Three Months and Six Months Ended June 30, 2005 and 2004

   1
    Condensed Consolidated Balance Sheets (Unaudited) June 30, 2005 and December 31, 2004    2
    Condensed Consolidated Statements of Cash Flows (Unaudited) Six Months Ended June 30, 2005 and 2004    3
    Notes to Condensed Consolidated Financial Statements (Unaudited)    4

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    28

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    51

Item 4.

  Controls and Procedures    52
    PART II. Other Information     

Description


   Page

Item 1.

  Legal Proceedings    53

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds    53

Item 3.

  Defaults Upon Senior Securities    53

Item 4.

  Submission of Matters to a Vote of Security Holders    53

Item 5.

  Other Information    53

Item 6.

  Exhibits    54
    Signatures    61


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Dollars in millions, except per share amounts)

(Unaudited)

 

     Three Months
Ended June 30,


   

Six Months

Ended June 30,


 
     2005

    2004

    2005

    2004

 

Revenues

   $ 315.4     $ 297.0     $ 604.0     $ 599.4  

Costs and expenses

                                

Cost of services and products (excluding depreciation of $42.3, $38.1, $78.7, and $75.8 included below)

     133.7       117.6       242.9       243.3  

Selling, general and administrative

     57.4       53.6       115.5       111.5  

Depreciation

     48.4       45.1       91.4       90.3  

Amortization

     —         0.5       —         1.0  

Restructuring

     —         —         —         0.2  

Asset impairments and other charges (credits)

     —         (0.2 )     23.1       (0.1 )
    


 


 


 


Total operating costs and expenses

     239.5       216.6       472.9       446.2  
    


 


 


 


Operating income

     75.9       80.4       131.1       153.2  

Minority interest expense (income)

     (0.5 )     1.2       (4.8 )     1.3  

Interest expense

     49.6       50.5       100.1       101.4  

Loss on extinguishment of debt

     —         —         7.9       —    

Other income, net

     (0.7 )     —         (0.2 )     (0.1 )
    


 


 


 


Income before income taxes

     27.5       28.7       28.1       50.6  

Income tax expense

     57.3       13.8       61.1       24.8  
    


 


 


 


Net income (loss)

     (29.8 )     14.9       (33.0 )     25.8  

Preferred stock dividends

     2.6       2.6       5.2       5.2  
    


 


 


 


Net income (loss) applicable to common shareowners

   $ (32.4 )   $ 12.3     $ (38.2 )   $ 20.6  
    


 


 


 


Net income (loss)

   $ (29.8 )   $ 14.9     $ (33.0 )   $ 25.8  

Other comprehensive loss, net of tax

     (0.4 )     (0.2 )     (0.6 )     (0.2 )
    


 


 


 


Comprehensive income (loss)

   $ (30.2 )   $ 14.7     $ (33.6 )   $ 25.6  
    


 


 


 


Basic earnings (loss) per common share

   $ (0.13 )   $ 0.05     $ (0.16 )   $ 0.08  

Diluted earnings (loss) per common share

   $ (0.13 )   $ 0.05     $ (0.16 )   $ 0.08  

Weighted average common shares outstanding (millions)

                                

Basic

     245.8       245.0       245.7       245.0  

Diluted

     245.8       250.4       245.7       252.0  

 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

1


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in millions)

(Unaudited)

 

     June 30,
2005


    December 31,
2004


 
Assets                 

Current assets

                

Cash and cash equivalents

   $ 22.7     $ 24.9  

Receivables, less allowances of $14.1 and $14.5

     145.5       139.0  

Materials and supplies

     25.7       22.7  

Deferred income tax benefits, net

     52.8       51.1  

Prepaid expenses and other current assets

     23.6       15.5  
    


 


Total current assets

     270.3       253.2  

Property, plant and equipment, net

     821.5       857.7  

Goodwill

     40.9       40.9  

Other intangible assets, net

     35.8       35.8  

Deferred income tax benefits, net

     594.8       656.7  

Other noncurrent assets

     128.1       114.4  
    


 


Total assets

   $ 1,891.4     $ 1,958.7  
    


 


Liabilities and Shareowners’ Deficit                 

Current liabilities

                

Current portion of long-term debt

   $ 24.2     $ 30.1  

Accounts payable

     61.4       58.9  

Current portion of unearned revenue and customer deposits

     39.8       42.5  

Accrued taxes

     33.4       45.4  

Accrued interest

     49.7       43.2  

Accrued payroll and benefits

     32.1       33.2  

Other current liabilities

     47.9       44.1  
    


 


Total current liabilities

     288.5       297.4  

Long-term debt, less current portion

     2,076.0       2,111.1  

Unearned revenue, less current portion

     8.1       8.9  

Accrued pension and postretirement benefits

     104.4       87.5  

Other noncurrent liabilities

     39.3       39.1  
    


 


Total liabilities

     2,516.3       2,544.0  

Minority interest

     34.4       39.2  

Commitments and contingencies

                

Shareowners’ deficit

                

Preferred shares, 2,357,299 shares authorized, 155,250 shares of 6 3/4% Cumulative Preferred Stock issued and outstanding (3,105,000 depository shares)

     129.4       129.4  

Common shares, $.01 par value, 480,000,000 shares authorized, 253,854,608 and 253,270,244 shares issued, 245,910,441 and 245,401,480 outstanding at June 30, 2005 and December 31, 2004

     2.5       2.5  

Additional paid-in capital

     2,933.3       2,934.5  

Accumulated deficit

     (3,573.0 )     (3,540.0 )

Accumulated other comprehensive loss

     (6.1 )     (5.5 )

Common shares in treasury, at cost, 7,944,167 and 7,868,764 shares at June 30, 2005 and December 31, 2004

     (145.4 )     (145.4 )
    


 


Total shareowners’ deficit

     (659.3 )     (624.5 )
    


 


Total liabilities and shareowners’ deficit

   $ 1,891.4     $ 1,958.7  
    


 


 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

2


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in millions)

(Unaudited)

 

    

Six Months

Ended June 30,


 
     2005

    2004

 

Cash Flows from Operating Activities

                

Net income (loss)

   $ (33.0 )   $ 25.8  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

                

Depreciation

     91.4       90.3  

Amortization

     —         1.0  

Asset impairments and other charges (credits)

     23.1       (0.1 )

Loss on extinguishment of debt

     7.9       —    

Provision for loss on receivables

     8.5       6.3  

Noncash interest expense

     15.5       17.6  

Minority interest expense (income)

     (4.8 )     1.3  

Deferred income tax expense, including valuation allowance change

     61.0       24.3  

Tax benefits from employee stock option plans

     0.1       0.5  

Other, net

     2.1       (0.6 )

Changes in operating assets and liabilities:

                

Increase in receivables

     (15.0 )     (6.0 )

Increase in prepaid expenses and other current assets

     (11.1 )     (19.0 )

Increase in accounts payable

     2.5       11.4  

Decrease in accrued and other current liabilities

     (10.6 )     (11.9 )

Decrease in unearned revenue

     (3.5 )     (0.5 )

Increase in accrued pension and postretirement benefits

     16.9       7.3  

Change in other assets and liabilities, net

     0.2       (3.3 )
    


 


Net cash provided by operating activities

     151.2       144.4  
    


 


Cash Flows from Investing Activities

                

Capital expenditures

     (71.0 )     (61.3 )

Proceeds from sale of assets

     —         1.9  

Other, net

     —         1.5  
    


 


Net cash used in investing activities

     (71.0 )     (57.9 )
    


 


Cash Flows from Financing Activities

                

Issuance of long-term debt

     352.1       —    

Increase in new credit facility, net

     32.0       —    

Repayment of previous credit facility and other debt

     (442.0 )     (88.1 )

Debt issuance costs and consent fees

     (21.0 )     —    

Issuance of common shares - exercise of stock options

     1.7       1.8  

Preferred stock dividends

     (5.2 )     (5.2 )

Other

     —         1.3  
    


 


Net cash used in financing activities

     (82.4 )     (90.2 )
    


 


Net decrease in cash and cash equivalents

     (2.2 )     (3.7 )

Cash and cash equivalents at beginning of period

     24.9       26.0  
    


 


Cash and cash equivalents at end of period

   $ 22.7     $ 22.3  
    


 


 

The accompanying notes are an integral part of the condensed consolidated financial statements.

 

3


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1. Description of Business and Accounting Policies

 

The following represents a summary of the Company’s business and accounting policies. A more detailed presentation can be found in the 2004 Annual Report on Form 10-K.

 

Description of Business — Cincinnati Bell Inc. (the “Company”) provides diversified telecommunications services through businesses in five segments: Local, Wireless, Hardware and Managed Services, Other and Broadband. The Broadband segment no longer has substantive, ongoing operations as a result of the sale of the related operating assets in 2003.

 

Basis of Presentation — The Condensed Consolidated Financial Statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, include all adjustments necessary for a fair presentation of the results of operations, financial position and cash flows for each period presented.

 

The adjustments referred to above are of a normal and recurring nature except for those outlined in “Impairment of Long-Lived Assets, Other than Goodwill and Indefinite-Lived Intangibles,” “Income Taxes,” and Note 3. Certain prior year amounts have been reclassified to conform to the current classifications with no effect on results of operations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC rules and regulations.

 

The Condensed Consolidated Balance Sheet as of December 31, 2004 was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. These Condensed Consolidated Financial Statements should be read in conjunction with the Company’s 2004 Annual Report on Form 10-K. Operating results for the three month period and six month period ended June 30, 2005 are not necessarily indicative of the results expected in subsequent quarters or for the year ending December 31, 2005.

 

Basis of Consolidation — The Condensed Consolidated Financial Statements include the consolidated accounts of Cincinnati Bell Inc. and its majority-owned subsidiaries over which it exercises control. Intercompany accounts and transactions have been eliminated in consolidation.

 

Use of Estimates — Preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported. Actual results could differ from those estimates.

 

Impairment of Long-Lived Assets, Other than Goodwill and Indefinite-Lived Intangibles — The Company reviews the carrying value of long-lived assets, other than goodwill and indefinite-lived intangible assets, when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. An impairment loss is recognized when the estimated future undiscounted cash flows expected to result from the use of an asset (or group of assets) and its eventual disposition are less than its carrying amount. An impairment loss is measured as the amount by which the asset’s carrying value exceeds its estimated fair value.

 

As part of the process of redeploying spectrum from the Company’s legacy Time Division Multiple Access (“TDMA”) wireless network to its Global System for Mobile Communications (“GSM”) network to meet increasing demand for its GSM services, the Company made the decision in the first quarter of 2005 to retire

 

4


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

certain TDMA assets early in the second quarter of 2005 in order to optimize its TDMA network performance. Minimal projected cash flows were associated with these TDMA assets retired in the second quarter and, as such, the Company recorded a $22.7 million impairment charge in the first quarter of 2005. The $22.7 million impairment charge is included in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) under the caption “Asset impairments and other charges (credits).” In the second quarter of 2005, the Company shortened its estimate of the useful life of certain of the remaining TDMA assets from the December 31, 2006 date being used. This change was based on updates to the expected rate of migration of TDMA customers to the GSM network, the effect of this migration on the reallocation of spectrum from the TDMA network to the GSM network, and the necessary deployment or retirement of network assets to optimize the quality of both the GSM and TDMA networks while the migration of customers and spectrum from the TDMA network to the GSM network is occurring. This change in estimated useful life resulted in additional depreciation expense of approximately $3.7 million for the second quarter of 2005. The Company also analyzed the remaining $33 million of TDMA assets for impairment, and found that no impairment condition exists at June 30, 2005.

 

Competition from new or more cost effective technologies could affect the Company’s ability to generate cash flow from its network-based services. This competition could ultimately result in an impairment of certain of the Company’s tangible or intangible assets. This could have a substantial impact on the operating results of the consolidated Company.

 

Stock-Based Compensation — The Company accounts for stock-based compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. Compensation cost is measured under the intrinsic value method. Stock-based employee compensation cost is not reflected in net income (loss), as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. If the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), the difference between actual and pro forma expense, net of tax, that would have been recognized totaled $0.9 million and $2.1 million in the second quarters of 2005 and 2004, respectively, and $1.8 million and $4.1 million in the year-to-date periods ended June 30, 2005 and 2004, respectively. The following table illustrates the effect on net income (loss) and basic and diluted earnings (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation in all periods presented.

 

(dollars in millions, except per share amounts)


   Three Months
Ended June 30,


  

Six Months

Ended June 30,


   2005

    2004

   2005

    2004

Net income (loss)

                             

As reported

   $ (29.8 )   $ 14.9    $ (33.0 )   $ 25.8

Pro forma, net of related taxes

   $ (30.7 )   $ 12.8    $ (34.8 )   $ 21.7

Basic earnings (loss) per common share:

                             

As reported

   $ (0.13 )   $ 0.05    $ (0.16 )   $ 0.08

Pro forma, net of related taxes

   $ (0.13 )   $ 0.04    $ (0.16 )   $ 0.07

Numerator for basic and diluted earnings (loss) per share:

                             

As reported

   $ (32.4 )   $ 12.3    $ (38.2 )   $ 20.6

Pro forma, net of related taxes

   $ (33.3 )   $ 10.2    $ (40.0 )   $ 16.5

Diluted earnings (loss) per share:

                             

As reported

   $ (0.13 )   $ 0.05    $ (0.16 )   $ 0.08

Pro forma, net of related taxes

   $ (0.13 )   $ 0.04    $ (0.16 )   $ 0.07

 

The Company granted 135,500 and 72,000 options during the three months ended June 30, 2005 and 2004, respectively, and granted 181,700 and 390,800 options during the six months ended June 30, 2005 and 2004, respectively. The weighted average fair values at the date of grant for the Company options granted to employees were $1.09 and $0.92 for the three months ended June 30, 2005 and 2004, respectively, and were $1.11 and $1.25 for the six months ended June 30, 2005 and 2004, respectively.

 

5


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

The Company granted 749,700 shares of restricted stock during the first six months of 2005, which vest after three years and the achievement of certain performance-based objectives. The fair value at the date of grant was $4.30 per share. The Company granted 140,000 shares of restricted stock during the first six months of 2004, which vest completely after two years. The fair value at the date of grant was $5.43 per share. The Company recognized $0.3 million and $0.1 million in expense in the three months ended June 30, 2005 and 2004, respectively, and $0.6 million and $0.2 million in expense in the six months ended June 30, 2005 and 2004, respectively, related to restricted stock compensation.

 

Income Taxes – The income tax provision consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods. The Company’s previous tax filings are subject to normal reviews by regulatory agencies until the related statute of limitations expires. The Company believes adequate provision has been made for all open tax years. Deferred investment tax credits are being amortized as a reduction of the provision for income taxes over the estimated useful lives of the related property, plant and equipment. As of June 30, 2005, the Company had $647.6 million in net deferred tax assets.

 

On June 30, 2005, legislation was passed in the state of Ohio instituting a gross receipts tax and phasing out Ohio’s corporate franchise and income tax over a 5 year period. As a result of this legislation, the Company does not expect it will be able to realize income tax benefits associated with $44 million of deferred tax assets previously recorded, of which approximately $33 million relates to Ohio net operating losses. The remaining amount of approximately $11 million relates to the revaluation of other Ohio deferred tax assets to estimates of future realizable value. Therefore, the Company recognized additional income tax expense of approximately $44 million in the quarter ended June 30, 2005. This additional income tax expense is based upon projections of taxable income, timing of reversing temporary differences, and the Company’s current business structure. Adjustments to these estimates may be required upon changes in these underlying factors. At June 30, 2005, the Company has net state and local deferred tax assets of $29 million.

 

As of June 30, 2005, the Company had $1.8 billion in federal tax net operating loss carryforwards, with a deferred tax asset value of $640.4 million. The tax loss carryforwards are available to the Company to offset taxable income in current and future periods. The tax loss carryforwards will generally expire between 2011 and 2023 and are not currently limited under U. S. tax laws. The ultimate realization of the deferred income tax assets depends upon the Company’s ability to generate future taxable income during the periods in which basis differences and other deductions become deductible and prior to the expiration of the net operating loss carryforwards. Based on current income levels and anticipated future reversal of existing temporary differences, the Company expects to utilize its federal net operating loss carryforwards within their expiration periods.

 

For reporting periods prior to the end of the Company’s fiscal year, the Company records income tax expense based upon an estimated annual effective tax rate, as adjusted for items affecting income taxes that are discrete to the particular quarter. The estimated annual effective tax rate is computed using statutory tax rates and an estimate of annual income before income taxes adjusted for non-deductible expenses. The Company’s non-deductible expenses include interest expense related to securities originally issued to acquire its broadband business (the “Broadband Securities”), or securities which the Company has subsequently issued to refinance the Broadband Securities. As a result of the non-deductible expenses, the Company’s effective tax rate will exceed statutory rates and the effective rate will vary inversely with the amount of its income before income taxes.

 

Recently Issued Accounting Standards — On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share-Based Payment” (“SFAS 123(R)”) which is a revision of SFAS 123 and supersedes APB 25. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be valued at fair value on the date of grant and to be expensed over the applicable vesting period. In addition, companies must also recognize compensation expense related to any awards that are not fully vested as of the effective date. On April 14, 2005, the SEC changed the effective date

 

6


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

of SFAS 123(R) to the beginning of the first fiscal year beginning after June 15, 2005. Compensation expense for the unvested awards will be measured based on the fair value of the awards previously calculated in developing the pro forma disclosures in accordance with the provisions of SFAS 123. Although the Company is still evaluating the impact of adopting SFAS 123(R) on its consolidated results of operations, the Company expects the impact will be material.

 

On April 4, 2005, FASB issued Financial Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). This interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”) refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The Company recognized a liability for the fair value of all conditional asset retirement obligations in accordance with SFAS 143 and FIN 47. FIN 47 did not have a material impact on the Company’s results of operations.

 

On May 5, 2005, the FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections: a replacement of APB Opinion No. 20 and FASB Statement No. 3.” This statement requires retrospective application for voluntary changes in accounting principles and changes required by an accounting pronouncement that does not include specific transition provisions, unless it is impracticable to do so. Retrospective application results in the restatement of prior periods’ financial statements to reflect the change in accounting principle. The provisions of this statement are to be applied prospectively to accounting changes made in fiscal years beginning after December 15, 2005.

 

2. Restructuring Charges

 

December 2004 Restructuring Plan

 

In December 2004, the Company initiated a restructuring plan intended to improve operating efficiencies and reduce operating expenses. The plan includes a workforce reduction that will be implemented in stages, which began in the fourth quarter of 2004 and will continue in stages through December 31, 2006. The workforce reductions will be accomplished primarily through attrition and voluntary retirement incentives. The Company estimates it will eliminate 150 to 200 positions by December 31, 2005 and as many as 400 positions in total by December 31, 2006. The restructuring charge of $11.2 million in 2004 was comprised of $10.5 million in special termination benefits and $0.7 million in employee separation benefits. The special termination benefits charge of $10.5 million was recorded to the Company’s postretirement benefit obligation at December 31, 2004 (see Note 6). The Company has paid all of the employee separation benefits in cash, which totaled $0.3 million in the fourth quarter of 2004 and $0.4 million in the first quarter of 2005. The Local, Wireless and Hardware and Managed Services segments incurred fourth quarter 2004 charges of $10.5 million, $0.1 million and $0.6 million, respectively.

 

November 2001 Restructuring Plan

 

In November 2001, the Company adopted a restructuring plan which included initiatives to consolidate data centers, reduce the Company’s expense structure, exit the network construction business, eliminate other nonstrategic operations and merge the digital subscriber line (“DSL”) and certain dial-up Internet operations into the Company’s other operations. The Company completed the plan as of December 31, 2002, except for certain lease obligations which are expected to continue through June 2015. The following table illustrates the activity in this reserve from December 31, 2004 through June 30, 2005:

 

Type of cost (dollars in millions):        


   December 31,
2004


   Utilizations

   

March 31,

2005


   Utilizations

    June 30,
2005


Terminate contractual obligations

   $ 10.1    $ (0.5 )   $ 9.6    $ (0.4 )   $ 9.2
    

  


 

  


 

Total

   $ 10.1    $ (0.5 )   $ 9.6    $ (0.4 )   $ 9.2
    

  


 

  


 

 

At June 30, 2005, $0.9 million of the restructuring reserve balance was included in the “Other current liabilities” and $8.3 million was included in “Other noncurrent liabilities” in the Condensed Consolidated

 

7


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

Balance Sheet. At December 31, 2004, $0.7 million of the restructuring reserve balance was included in “Other current liabilities” and $9.4 million was included in “Other noncurrent liabilities” in the Condensed Consolidated Balance Sheet.

 

3. Debt

 

The Company’s debt consists of the following:

 

(dollars in millions)    


   June 30,
2005


    December 31,
2004


 

Current portion of long-term debt:

                

Credit facilities, current portion

   $ —       $ 4.3  

Current maturities of capital lease obligations

     3.2       4.2  

Current maturities of Cincinnati Bell Telephone notes

     20.0       20.0  

Other short-term debt

     1.0       1.6  
    


 


Total current portion of long-term debt

   $ 24.2     $ 30.1  
    


 


Long-term debt, less current portion:

                

Credit facilities, net of current portion

   $ 32.0     $ 434.5  

7 1/4% Senior Notes due 2023

     50.0       50.0  

Capital lease obligations, net of current portion

     9.7       11.4  

7 1/4% Senior Notes due 2013

     500.0       500.0  

7% Senior Notes due 2015*

     252.9       —    

Various Cincinnati Bell Telephone notes, net of current portion

     230.0       230.0  

16% Senior Subordinated Discount Notes due 2009

     382.7       375.2  

8 3/8% Senior Subordinated Notes due 2014 *

     646.3       543.9  

Other long-term debt

     0.4       —    
    


 


Total long-term debt, less current portion

     2,104.0       2,145.0  

Less unamortized discount, net of premiums

     (28.0 )     (33.9 )
    


 


Total long-term debt, less current portion and net of unamortized discounts and premiums

   $ 2,076.0     $ 2,111.1  
    


 


Total debt

   $ 2,100.2     $ 2,141.2  
    


 



* The face amount of these notes has been adjusted to mark hedged debt to fair value at June 30, 2005 and December 31, 2004.

 

On February 16, 2005, as part of its refinancing plan, the Company sold in a private offering $250.0 million of new 7% Senior Notes Due 2015 (the “7% Senior Notes”) and $100.0 million in additional 8 3/8% Senior Subordinated Notes Due 2014 (the “8 3/8% Notes”) (collectively, the “New Bonds”). The net proceeds from the issuance of the New Bonds together with borrowings under the Company’s new credit facility were used to repay $438.8 million in outstanding borrowings under the prior credit facility and to terminate the prior credit facility, as well as to pay all financing, consent and other fees associated with the refinancing plan. The New Bonds are fixed rate bonds to maturity.

 

The $100 million of 8 3/8% Notes issued in February 2005 were offered as an addition to the $540 million 8 3/8% Notes sold in November 2003. The 8 3/8% Notes sold in February 2005 and the 8 3/8% Notes sold in November 2003 constitute a single class of debt securities with the same terms.

 

On February 16, 2005, the Company established a new $250 million revolving credit facility which matures in February 2010. Under the terms of the new credit facility, the Company has the right to request, but no lender

 

8


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

is committed to provide, an increase in the aggregate amount of the new credit facility of up to $500 million in future incremental borrowing capacity (in addition to the $250 million in initial borrowing capacity). Under the new credit facility, interest is charged based on LIBOR plus an applicable margin or the bank prime rate plus an applicable margin, at the Company’s option. The increase may be structured at the Company’s option as either term debt or additional revolving debt.

 

The Company used the net proceeds of approximately $345.7 million from the New Bond issues and initial direct borrowings of approximately $110.0 million from the new credit facility in order to terminate the Company’s prior credit facility and pay financing, consent and other fees associated with the refinancing plan. As of June 30, 2005, the Company had $32.0 million in outstanding borrowings under its new credit facility, and had outstanding letters of credit totaling $6.5 million, leaving $211.5 million in additional borrowing availability under its new credit facility. The Company wrote-off approximately $7.9 million in unamortized deferred financing fees associated with the prior credit facility. As of February 16, 2005, the Company’s subsidiaries that guarantee the new credit facility also unconditionally guarantee the New Bonds, the 7 1/4% Senior Notes Due 2013, the 16% Senior Subordinated Discount Notes Due 2009 (the “16% Notes”) and the 8 3/8% Notes.

 

In the first quarter of 2005, the Company executed additional fixed-to-floating interest rate swaps designated as fair value hedging instruments, with notional amounts of $350 million in order to: (a) hedge a portion of the fair value risk associated with the 8 3/8% and 7% fixed coupon debt and (b) re-balance the fixed-to-floating rate mix with regard to the Company’s capital structure. The bonds have fixed interest rates to their maturity. The interest rate swaps essentially change the fixed rate nature of a portion of these bond issues to approximate the floating rate characteristics of the terminated credit facility.

 

See Note 9 for information on the Company’s announcement to refinance its 16% Notes, and refer to the Company’s 2004 Annual Report on Form 10-K and Form 10-Q for the period ended March 31, 2005 for a more detailed description of the debt instruments listed above.

 

The following table summarizes the Company’s maturities of debt and minimum payments under capital leases for the five years subsequent to June 30, 2005, and thereafter:

 

(dollars in millions)    


   Long-Term
Debt


    Capital
Leases


   Total
Debt


 

For the twelve months ended June 30,

                       

2006

     21.0       3.2      24.2  

2007

     0.4       1.7      2.1  

2008

     —         0.7      0.7  

2009

     382.7       0.7      383.4  

2010

     32.0       0.8      32.8  

Thereafter

     1,679.2       5.8      1,685.0  
    


 

  


Total debt

     2,115.3       12.9      2,128.2  

Less unamortized discounts, net of premiums

     (28.0 )     —        (28.0 )
    


 

  


Total debt, net of discounts and premiums

   $ 2,087.3     $ 12.9    $ 2,100.2  
    


 

  


 

9


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

4. Earnings (Loss) Per Common Share

 

Basic earnings (loss) per common share (“EPS”) is based upon the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that would occur if common stock equivalents were exercised or converted to common stock, but only to the extent that they are considered dilutive to the Company’s earnings. The following table is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for earnings from operations for the following periods:

 

(dollars and shares in millions, except per share amounts)


   Three Months
Ended June 30,


  

Six Months

Ended June 30,


   2005

    2004

   2005

    2004

Numerator:

                             

Net income (loss)

   $ (29.8 )   $ 14.9    $ (33.0 )   $ 25.8

Preferred stock dividends

     2.6       2.6      5.2       5.2
    


 

  


 

Numerator for basic and diluted EPS - net income (loss) applicable to common shareowners

   $ (32.4 )   $ 12.3    $ (38.2 )   $ 20.6
    


 

  


 

Denominator:

                             

Denominator for basic EPS - weighted average common shares outstanding

     245.8       245.0      245.7       245.0

Stock options and warrants

     —         5.3      —         6.9

Stock-based compensation arrangements

     —         0.1      —         0.1
    


 

  


 

Denominator for diluted EPS

     245.8       250.4      245.7       252.0
    


 

  


 

Basic and diluted EPS

   $ (0.13 )   $ 0.05    $ (0.16 )   $ 0.08
    


 

  


 

 

The assumed conversions to common stock of the Company’s stock options, restricted stock, warrants and the Company’s 6 3/4% Cumulative Convertible Preferred Stock are excluded from the diluted EPS computations for periods in which these items, on an individual basis, have an anti-dilutive effect on diluted EPS.

 

5. Commitments and Contingencies

 

Commitments

 

In March 2005, the Company entered into a ten year operating lease for office space in Norwood, Ohio. Annual rental payments under the lease range from $3 to $4 million.

 

During the second quarter, the Company committed to pay a vendor for the expansion of one of its data center facilities. As of June 30, 2005, the Company has recorded fixed assets of approximately $6 million with a corresponding liability in “Other current liabilities” as no cash has been paid. This obligation is expected to be financed as a long-term capital lease in the third quarter of 2005.

 

In 1998, the Company entered into a ten-year contract with Convergys Corporation (“Convergys”), a provider of billing, customer service and other services. The contract states that Convergys will be the primary provider of certain data processing, professional and consulting and technical support services for the Company within Cincinnati Bell Telephone’s operating territory. In return, the Company will be the exclusive provider of local telecommunications services to Convergys. During the second quarter of 2004, the Company and Convergys renegotiated the contract, which extended the contract through December 31, 2010,

 

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Form 10-Q Part I   Cincinnati Bell Inc.

 

reduced prices for certain services provided by Convergys and reduced the Company’s annual commitment in 2004 and 2005 to $35.0 million excluding certain third party costs, from $45.0 million. The Company paid a total amount of $37.5 million under the contract in 2004, and $18 million in the first six months of 2005. Beginning in 2006, the minimum commitment will be reduced by 5% annually.

 

Contingencies

 

In the normal course of business, the Company is subject to various regulatory proceedings, lawsuits, claims and other matters. Such matters are subject to many uncertainties and outcomes that are not predictable with reasonable assurance.

 

In re Broadwing Inc. Securities Class Action Lawsuits, (Gallow v. Broadwing Inc., et al), U.S. District Court, Southern District of Ohio, Western Division, Case No. C-1-02-795.

 

Between October and December 2002, five virtually identical class action lawsuits were filed against Broadwing Inc. and two of its former Chief Executive Officers in U.S. District Court for the Southern District of Ohio.

 

These complaints were filed on behalf of purchasers of the Company’s securities between January 17, 2001 and May 20, 2002, inclusive, and alleged violations of Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 by, inter alia, (1) improperly recognizing revenue associated with Indefeasible Right of Use (“IRU”) agreements; and (2) failing to write-down goodwill associated with the Company’s 1999 acquisition of IXC Communications, Inc. The plaintiffs seek unspecified compensatory damages, attorney’s fees, and expert expenses.

 

On December 30, 2002, the “Local 144 Group” filed a motion seeking consolidation of the complaints and appointment as lead plaintiff. By order dated October 29, 2003, Local 144 Nursing Home Pension Fund, Paul J. Brunner and Joseph Lask were named lead plaintiffs in a putative consolidated class action.

 

On December 1, 2003, lead plaintiffs filed their amended consolidated complaint on behalf of purchasers of the Company’s securities between January 17, 2001 and May 21, 2002, inclusive. This amended complaint contained a number of new allegations. Cincinnati Bell Inc. was added as a defendant in this amended filing. The Company’s motion to dismiss was filed on February 6, 2004. Plaintiffs filed their opposition on April 14, 2004 and the Company filed its reply on June 1, 2004.

 

On September 24, 2004, Judge Walter Rice issued an Order granting in part and denying in part the Company’s motion to dismiss. The Order indicates that a more detailed opinion will follow. Until the detailed opinion is issued, there is no way of knowing which portions of the case have been dismissed. In the interim, Judge Rice directed that the stay of discovery will remain in effect. The Company is vigorously defending these matters. The timing and outcome of these matters are not currently predictable. An unfavorable outcome could have a material effect on the financial condition, results of operations and cash flows of the Company.

 

In re Broadwing Inc. Derivative Complaint, (Garlich v. Broadwing Inc., et al), Hamilton County Court of Common Pleas, Case No. A0302720.

 

This derivative complaint was filed against Broadwing Inc. and ten of its current and former directors on April 9, 2003 alleging breaches of fiduciary duty arising out of the same allegations discussed in In re Broadwing Inc. Securities Class Action Lawsuits above. Pursuant to a stipulation between the parties, defendants are not required, absent further order by the Court, to answer, move, or otherwise respond to this complaint until 30 days after the federal court renders a ruling on defendants’ motion to dismiss in In re Broadwing Inc. Securities Class Action Lawsuits. The Company is vigorously defending these matters. The timing and outcome of these matters are not currently predictable. An unfavorable outcome could have a material effect on the financial condition, results of operations and cash flows of the Company.

 

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Form 10-Q Part I   Cincinnati Bell Inc.

 

In re Broadwing Inc. ERISA Class Action Lawsuits, (Kurtz v. Broadwing Inc., et al), U.S. District Court, Southern District of Ohio, Western Division, Case No. C-1-02-857.

 

Between November 18, 2002 and January 10, 2003, four putative class action lawsuits were filed against Broadwing Inc. and certain of its current and former officers and directors in the United States District Court for the Southern District of Ohio. Fidelity Management Investment Trust Company was also named as a defendant in these actions.

 

These cases, which purport to be brought on behalf of the Cincinnati Bell Inc. Savings and Security Plan, the Broadwing Retirement Savings Plan, and a class of participants in the Plans, generally allege that the defendants breached their fiduciary duties under the Employee Retirement Income Security Act of 1974 (“ERISA”) by improperly encouraging the Plan participant-plaintiffs to elect to invest in the Company stock fund within the relevant Plan and by improperly continuing to make employer contributions to the Company stock fund within the relevant Plan.

 

On October 22, 2003, a putative consolidated class action complaint was filed in the U.S. District Court for the Southern District of Ohio. The Company filed its motion to dismiss on February 6, 2004. Plaintiffs filed their opposition on April 2, 2004, and the Company filed its reply on May 17, 2004.

 

On October 6, 2004, the Judge issued a Scheduling Order in these matters. According to the Scheduling Order, discovery was permitted to commence immediately and must be completed by November 15, 2005. The trial is tentatively scheduled to take place in May 2006. A ruling on the Company’s motion to dismiss is still pending. The Company is vigorously defending these matters. The timing and outcome of these matters are not currently predictable. An unfavorable outcome could have a material effect on the financial condition, results of operations and cash flows of the Company.

 

Other

 

During 2004, a class action complaint against Cincinnati Bell Wireless Company and Cincinnati Bell Wireless, LLC (“CBW”) was filed in Hamilton County, Ohio. The complaint alleges that the plaintiff and all similarly-situated customers of CBW were wrongfully assessed roaming charges for wireless phone calls made or received within CBW’s Home Service Area and/or within major metropolitan areas on the AT&T Wireless Network. On January 31, 2005, a similar class action complaint against CBW was filed in Kenton County, Kentucky. The allegations raised and damages sought by plaintiffs in the Kenton County action are very similar to those in the Hamilton County action.

 

During the second quarter of 2005, a tentative settlement agreement was reached in the above referenced Cincinnati Bell Wireless class action complaints. With the proposed settlement, the Company would establish a fund capped at $6 million from which customers who qualify and submit a claim would receive a voucher of up to $50 toward certain Cincinnati Bell services. Customers who can demonstrate that they had applicable roaming charges in excess of $100 are eligible to be reimbursed for up to half of such charges in lieu of the $50 voucher. This settlement did not have a significant impact on the Company’s results of operations in 2005.

 

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Form 10-Q Part I   Cincinnati Bell Inc.

 

Variable Interest Entities

 

The Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as special purpose entities (“SPEs”) or variable interest entities (“VIEs”), which would have been established for the purpose of facilitating off-balance sheet arrangements or other limited purposes.

 

6. Pension and Postretirement Plans

 

The actuarial expense calculation for the Company’s postretirement health plan is based on numerous assumptions, estimates and judgments including health care cost trend rates and cap-related cost sharing. The Company’s collectively bargained-for labor contracts have historically had limits on the Company-funded portion of retiree medical costs (referred to as “caps”). However, the Company had waived the premiums in excess of the caps for both bargained-for retirees and management retirees who retired during the contract period. Prior to December 31, 2004, the Company’s actuarial calculation of retiree medical costs included the assumption that the caps were in place in accordance with the terms of the collectively bargained-for agreement.

 

Effective December 31, 2004, based on its past practice of waiving the retiree medical cost caps, the Company began accounting for its retiree medical benefit obligation for bargained-for and management retirees who retire during the current and future contract periods as if there were no caps. Primarily due to this change, the Company’s postretirement medical expense increased to $21 million in the first half of 2005 as compared to $11 million in the first half of 2004. The Company expected to recognize postretirement medical expense of $44 million for the full year 2005 as compared to $22 million in 2004.

 

In May 2005, the Company reached agreement with bargained-for employees as to the terms of a new labor contract. These new terms include a cap on medical costs to be paid by the Company for retirees. Contrary to past practice, no agreement was made to waive the cap. However, the new cap increases annually over the life of the labor agreement. Based on this new agreement, effective June 1, 2005, the Company modified its assumptions for the actuarial calculation of retiree medical costs, including the implementation of a cap that increases annually with expected inflation. As a result of this change, the Company expects that its postretirement medical expense will be approximately $40 million for the full year 2005.

 

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”), beginning in 2006, will provide a prescription drug benefit under Medicare Part D, as well as a federal subsidy to plan sponsors of retiree healthcare plans that provide a prescription drug benefit to their participants that is at least actuarially equivalent to the benefit that will be available under Medicare. The amount of the federal subsidy will be based on 28 percent of an individual beneficiary’s annual eligible prescription drug costs ranging between $250 and $5,000. On May 19, 2004, the Financial Accounting Standards Board issued Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP No. 106-2”). FSP No. 106-2 clarified that the federal subsidy provided under the Act should be accounted for as an actuarial gain in calculating the postretirement benefit obligation and annual postretirement expense. Based on its current understanding of the Act, the Company determined that a substantial portion of the prescription drug benefits provided under its postretirement benefit plan would be deemed actuarially equivalent to the benefits provided under Medicare Part D. Effective July 1, 2004, the Company prospectively adopted FSP No. 106-2 and remeasured its postretirement benefit obligation as of that date to account for the federal subsidy, the effects of which resulted in a $10.3 million reduction in the Company’s postretirement benefit obligation and a $1.1 million reduction in the Company’s 2004 postretirement expense. The effect in the first six months of 2005 was approximately a

 

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Form 10-Q Part I   Cincinnati Bell Inc.

 

$3 million reduction in the Company’s postretirement expense. On January 21, 2005, the Department of Health and Human Services issued final federal regulations on the determination of actuarial equivalence of the federal subsidy, which were not substantially different from the proposed rules.

 

During 2004, special termination benefits of $10.5 million were included in the benefit obligation. These special termination benefits related to the 2004 restructuring plan and were offered to certain employees eligible for retirement.

 

The following information relates to all Company noncontributory defined benefit pension plans, postretirement health care, and life insurance benefit plans. Pension and postretirement benefit expense follows:

 

(dollars in millions)

Three Months Ended June 30,


   Pension Benefits

   

Postretirement and

Other Benefits


 
   2005

    2004

    2005

    2004

 

Service cost

   $ 2.1     $ 1.9     $ 1.1     $ 0.5  

Interest cost on projected benefit obligation

     6.8       6.6       5.8       4.1  

Expected return on plan assets

     (9.5 )     (10.3 )     (1.4 )     (1.6 )

Amortization of:

                                

Transition (asset)/obligation

     (0.2 )     (0.4 )     1.0       1.0  

Prior service cost

     0.8       0.8       3.1       0.9  

Net (gain)/loss

     0.3       (0.2 )     0.3       0.5  
    


 


 


 


Pension and Postretirement (income) expense

   $ 0.3     $ (1.6 )   $ 9.9     $ 5.4  
    


 


 


 


     Pension Benefits

   

Postretirement and

Other Benefits


 

(dollars in millions)

Six Months Ended June 30,


   2005

    2004

    2005

    2004

 

Service cost

   $ 4.1     $ 4.1     $ 2.6     $ 1.1  

Interest cost on projected benefit obligation

     13.7       13.5       11.7       8.4  

Expected return on plan assets

     (19.0 )     (20.7 )     (2.7 )     (3.2 )

Amortization of:

                                

Transition (asset)/obligation

     (0.5 )     (0.9 )     2.1       2.1  

Prior service cost

     1.6       1.6       6.5       1.9  

Net (gain)/loss

     0.7       (0.4 )     0.7       1.0  
    


 


 


 


Pension and Postretirement (income) expense

   $ 0.6     $ (2.8 )   $ 20.9     $ 11.3  
    


 


 


 


 

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Form 10-Q Part I   Cincinnati Bell Inc.

 

7. Business Segment Information

 

The Company is organized into five business segments: Local, Wireless, Hardware and Managed Services, Other and Broadband, on the basis of offering distinct products and services. These segments are aligned with specific subsidiaries of the Company.

 

The Local segment provides local voice telephone service, including dozens of enhanced custom calling features, and data services to customers in southwestern Ohio, northern Kentucky and southeastern Indiana. The segment consists of two operating subsidiaries: Cincinnati Bell Telephone (“CBT”), which is the incumbent local exchange carrier (“ILEC”) in the greater Cincinnati area, and Cincinnati Bell Extended Territories (“CBET”), which is a competitive local exchange carrier (“CLEC”) north of CBT’s operating area and in greater Dayton.

 

The Wireless segment consists of the operations of the CBW subsidiary, a venture in which the Company owns 80.1% and Cingular, through its subsidiary New Cingular Wireless PCS, LLC (“Cingular”), owns the remaining 19.9%. This segment provides advanced, digital voice and data communications services and sales of related communications equipment to customers in the Greater Cincinnati and Dayton, Ohio operating areas.

 

The Hardware and Managed Services segment provides data center collocation, IT consulting services, and telecommunications and computer equipment in addition to their related installation and maintenance primarily to enterprises located within the Local segment’s operating area. This segment is comprised of the operations within Cincinnati Bell Technology Solutions (“CBTS”). In March 2004, CBTS sold certain operating assets, which were generally residing outside of the Company’s operating area for approximately $3.2 million in cash. During the second quarter of 2004, CBTS paid $1.3 million to the buyer of the assets in working capital adjustments related to the sale.

 

The Other segment combines the operations of Cincinnati Bell Any Distance (“CBAD”), Cincinnati Bell Complete Protection (“CBCP”) and Cincinnati Bell Public Communications Inc. (“Public”). CBAD resells long distance voice and audio-conferencing services, CBCP provides security and surveillance hardware and monitoring services for consumers and businesses, and Public provides public payphone services. In the fourth quarter of 2004, the Company sold its payphone assets located at correctional institutions and those outside of the Company’s operating area for $1.4 million.

 

The Broadband segment no longer has any substantive, on-going operations because, in 2003, the Company sold substantially all of its broadband assets, which were reported in the Broadband segment. The Broadband segment previously provided data and voice communications services nationwide over approximately 18,700 route miles of fiber-optic transmission facilities.

 

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Form 10-Q Part I   Cincinnati Bell Inc.

 

Certain corporate administrative expenses have been allocated to segments based upon the nature of the expense and the relative size of the segment. The Company’s business segment information follows:

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 

(dollars in millions)    


   2005

    2004

    2005

    2004

 

Revenue

                                

Local

   $ 189.6     $ 189.6     $ 379.7     $ 380.5  

Wireless

     60.3       67.1       121.5       131.2  

Hardware and managed services

     54.5       28.1       81.6       62.5  

Other

     19.6       19.0       38.7       37.8  

Intersegment

     (8.6 )     (6.8 )     (17.5 )     (12.6 )
    


 


 


 


Total revenue

   $ 315.4     $ 297.0     $ 604.0     $ 599.4  
    


 


 


 


Intersegment revenue

                                

Local

   $ 6.1     $ 4.9     $ 12.6     $ 9.2  

Wireless

     0.7       0.6       1.3       1.1  

Hardware and managed services

     1.0       1.2       2.1       2.1  

Other

     0.8       0.1       1.5       0.2  
    


 


 


 


Total intersegment revenue

   $ 8.6     $ 6.8     $ 17.5     $ 12.6  
    


 


 


 


Operating income (loss)

                                

Local

   $ 70.1     $ 70.7     $ 140.1     $ 141.7  

Wireless

     (1.5 )     6.6       (21.7 )     7.7  

Hardware and managed services

     4.3       3.3       6.7       6.3  

Other

     7.1       2.6       13.1       5.0  

Broadband

     1.4       0.3       2.6       1.4  

Corporate

     (5.5 )     (3.1 )     (9.7 )     (8.9 )
    


 


 


 


Total operating income

   $ 75.9     $ 80.4     $ 131.1     $ 153.2  
    


 


 


 


Capital expenditures

                                

Local

   $ 25.1     $ 21.8     $ 46.0     $ 41.1  

Wireless

     14.2       12.1       19.8       15.5  

Hardware and managed services

     3.5       0.2       4.5       0.5  

Other

     0.2       3.9       0.7       4.2  
    


 


 


 


Total capital expenditures

   $ 43.0     $ 38.0     $ 71.0     $ 61.3  
    


 


 


 


Depreciation and amortization

                                

Local

   $ 26.8     $ 29.8     $ 53.9     $ 59.7  

Wireless

     20.2       15.2       35.2       30.2  

Hardware and managed services

     0.6       0.2       1.0       0.4  

Other

     0.5       0.3       0.9       0.7  

Corporate

     0.3       0.1       0.4       0.3  
    


 


 


 


Total depreciation and amortization

   $ 48.4     $ 45.6     $ 91.4     $ 91.3  
    


 


 


 


Assets (at June 30, 2005 and December 31, 2004)

                                

Local

   $ 710.7     $ 717.1                  

Wireless

     300.9       371.6                  

Hardware and managed services

     83.8       60.8                  

Other

     103.3       124.1                  

Broadband

     2.9       2.9                  

Corporate and eliminations

     689.8       682.2                  
    


 


               

Total assets

   $ 1,891.4     $ 1,958.7                  
    


 


               

 

16


Table of Contents
Form 10-Q Part I   Cincinnati Bell Inc.

 

8. Supplemental Guarantor Information

 

Cincinnati Bell Telephone Notes

 

CBT, a wholly owned subsidiary of Cincinnati Bell Inc. (the “Parent Company”), has $250.0 million in notes outstanding that are guaranteed by Cincinnati Bell Inc. and no other subsidiaries of Cincinnati Bell Inc. The guarantee is full and unconditional. Substantially all of the Parent Company’s income and cash flow is generated by its subsidiaries. Generally, funds necessary to meet the Parent Company’s debt service obligations are provided by distributions or advances from its subsidiaries.

 

17


Table of Contents
Form 10-Q Part I   Cincinnati Bell Inc.

 

The following information sets forth the condensed consolidating statements of operations and cash flows for the three month and six month periods ended June 30, 2005 and 2004 and condensed consolidating balance sheets of the Company as of June 30, 2005 and December 31, 2004 of (1) Cincinnati Bell Inc., the Parent Company and guarantor (2) CBT, the issuer, and (3) the non-guarantor subsidiaries on a combined basis:

 

Condensed Consolidating Statements of Operations

(dollars in millions)

 

     Three Months Ended June 30, 2005

 
    

Parent

(Guarantor)


    CBT

   

Other

(Non-guarantors)


    Eliminations

    Total

 

Revenue

   $ —       $ 189.6     $ 134.4     $ (8.6 )   $ 315.4  

Operating costs and expenses

     5.5       119.5       123.1       (8.6 )     239.5  
    


 


 


 


 


Operating income (loss)

     (5.5 )     70.1       11.3       —         75.9  

Equity in earnings of subsidiaries

     1.6       —         —         (1.6 )     —    

Interest expense

     45.4       4.4       6.9       (7.1 )     49.6  

Other expense (income), net

     (6.9 )     (0.8 )     (0.6 )     7.1       (1.2 )
    


 


 


 


 


Income (loss) before income taxes

     (42.4 )     66.5       5.0       (1.6 )     27.5  

Income tax expense (benefit)

     (12.6 )     30.7       39.2       —         57.3  
    


 


 


 


 


Net income (loss)

     (29.8 )     35.8       (34.2 )     (1.6 )     (29.8 )

Preferred stock dividends

     2.6       —         —         —         2.6  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ (32.4 )   $ 35.8     $ (34.2 )   $ (1.6 )   $ (32.4 )
    


 


 


 


 


     Three Months Ended June 30, 2004

 
     Parent
(Guarantor)


    CBT

   

Other

(Non-guarantors)


    Eliminations

    Total

 

Revenue

   $ —       $ 189.6     $ 114.2     $ (6.8 )   $ 297.0  

Operating costs and expenses

     3.1       118.9       101.4       (6.8 )     216.6  
    


 


 


 


 


Operating income (loss)

     (3.1 )     70.7       12.8       —         80.4  

Equity in earnings of subsidiaries

     45.2       —         —         (45.2 )     —    

Interest expense

     46.1       4.4       4.2       (4.2 )     50.5  

Other expense (income), net

     (4.1 )     —         1.1       4.2       1.2  
    


 


 


 


 


Income (loss) before income taxes

     0.1       66.3       7.5       (45.2 )     28.7  

Income tax expense (benefit)

     (14.8 )     25.7       2.9       —         13.8  
    


 


 


 


 


Net income (loss)

     14.9       40.6       4.6       (45.2 )     14.9  

Preferred stock dividends

     2.6       —         —         —         2.6  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ 12.3     $ 40.6     $ 4.6     $ (45.2 )   $ 12.3  
    


 


 


 


 


 

 

18


Table of Contents
Form 10-Q Part I   Cincinnati Bell Inc.

 

Condensed Consolidating Statements of Operations

 

(dollars in millions)

 

     Six Months Ended June 30, 2005

 
    

Parent

(Guarantor)


    CBT

    Other
(Non-guarantors)


    Eliminations

    Total

 

Revenue

   $ —       $ 379.7     $ 241.8     $ (17.5 )   $ 604.0  

Operating costs and expenses

     9.7       239.6       241.1       (17.5 )     472.9  
    


 


 


 


 


Operating income (loss)

     (9.7 )     140.1       0.7       —         131.1  

Equity in earnings of subsidiaries

     31.4       —         —         (31.4 )     —    

Interest expense

     91.4       8.4       13.5       (13.2 )     100.1  

Other expense (income), net

     (3.8 )     (1.6 )     (4.9 )     13.2       2.9  
    


 


 


 


 


Income (loss) before income taxes

     (65.9 )     133.3       (7.9 )     (31.4 )     28.1  

Income tax expense (benefit)

     (32.9 )     57.6       36.4       —         61.1  
    


 


 


 


 


Net income (loss)

     (33.0 )     75.7       (44.3 )     (31.4 )     (33.0 )

Preferred stock dividends

     5.2       —         —         —         5.2  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ (38.2 )   $ 75.7     $ (44.3 )   $ (31.4 )   $ (38.2 )
    


 


 


 


 


     Six Months Ended June 30, 2004

 
     Parent
(Guarantor)


    CBT

   

Other

(Non-guarantors)


    Eliminations

    Total

 

Revenue

   $ —       $ 380.5     $ 231.5     $ (12.6 )   $ 599.4  

Operating costs and expenses

     8.9       238.8       211.1       (12.6 )     446.2  
    


 


 


 


 


Operating income (loss)

     (8.9 )     141.7       20.4       —         153.2  

Equity in earnings of subsidiaries

     87.8       —         —         (87.8 )     —    

Interest expense

     92.9       8.7       8.0       (8.2 )     101.4  

Other expense (income), net

     (8.3 )     0.1       1.2       8.2       1.2  
    


 


 


 


 


Income (loss) before income taxes

     (5.7 )     132.9       11.2       (87.8 )     50.6  

Income tax expense (benefit)

     (31.5 )     51.9       4.4       —         24.8  
    


 


 


 


 


Net income (loss)

     25.8       81.0       6.8       (87.8 )     25.8  

Preferred stock dividends

     5.2       —         —         —         5.2  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ 20.6     $ 81.0     $ 6.8     $ (87.8 )   $ 20.6  
    


 


 


 


 


 

19


Table of Contents
Form 10-Q Part I   Cincinnati Bell Inc.

 

Condensed Consolidating Balance Sheets

 

(dollars in millions)

 

     As of June 30, 2005

 
    

Parent

(Guarantor)


    CBT

   Other
(Non-guarantors)


   Eliminations

    Total

 

Cash and cash equivalents

   $ 21.2     $ 1.0    $ 0.5    $ —       $ 22.7  

Receivables, net

     3.2       63.7      78.6      —         145.5  

Other current assets

     15.0       29.7      73.7      (16.3 )     102.1  
    


 

  

  


 


Total current assets

     39.4       94.4      152.8      (16.3 )     270.3  

Property, plant and equipment, net

     0.5       605.7      215.3      —         821.5  

Goodwill and other intangibles, net

     —         —        76.7      —         76.7  

Investments in and advances to subsidiaries

     998.4       —        —        (998.4 )     —    

Other noncurrent assets

     356.9       10.6      437.4      (82.0 )     722.9  
    


 

  

  


 


Total assets

   $ 1,395.2     $ 710.7    $ 882.2    $ (1,096.7 )   $ 1,891.4  
    


 

  

  


 


Current portion of long-term debt

   $ —       $ 23.1    $ 1.1    $ —       $ 24.2  

Accounts payable

     0.1       36.2      25.1      —         61.4  

Other current liabilities

     75.7       62.8      38.9      25.5       202.9  
    


 

  

  


 


Total current liabilities

     75.8       122.1      65.1      25.5       288.5  

Long-term debt, less current portion

     1,836.4       239.1      0.5      —         2,076.0  

Other noncurrent liabilities

     142.3       73.2      60.1      (123.8 )     151.8  

Intercompany payables

     —         23.6      517.1      (540.7 )     —    
    


 

  

  


 


Total liabilities

     2,054.5       458.0      642.8      (639.0 )     2,516.3  

Minority interest

     —         —        34.4      —         34.4  

Shareowners’ equity (deficit)

     (659.3 )     252.7      205.0      (457.7 )     (659.3 )
    


 

  

  


 


Total liabilities and shareowners’ equity (deficit)

   $ 1,395.2     $ 710.7    $ 882.2    $ (1,096.7 )   $ 1,891.4  
    


 

  

  


 


     As of December 31, 2004

 
    

Parent

(Guarantor)


    CBT

  

Other

(Non-guarantors)


   Eliminations

    Total

 

Cash and cash equivalents

   $ 22.7     $ 1.4    $ 0.8    $ —       $ 24.9  

Receivables, net

     2.4       67.6      69.0      —         139.0  

Other current assets

     13.5       24.6      62.6      (11.4 )     89.3  
    


 

  

  


 


Total current assets

     38.6       93.6      132.4      (11.4 )     253.2  

Property, plant and equipment, net

     0.9       612.0      244.8      —         857.7  

Goodwill and other intangibles, net

     —         —        76.7      —         76.7  

Investments in and advances to subsidiaries

     1,065.2       —        —        (1,065.2 )     —    

Other noncurrent assets

     346.0       11.5      522.5      (108.9 )     771.1  
    


 

  

  


 


Total assets

   $ 1,450.7     $ 717.1    $ 976.4    $ (1,185.5 )   $ 1,958.7  
    


 

  

  


 


Current portion of long-term debt

   $ 4.3     $ 24.1    $ 1.7    $ —       $ 30.1  

Accounts payable

     0.2       34.6      24.1      —         58.9  

Other current liabilities

     76.9       75.2      54.5      1.8       208.4  
    


 

  

  


 


Total current liabilities

     81.4       133.9      80.3      1.8       297.4  

Long-term debt, less current portion

     1,870.2       240.7      0.2      —         2,111.1  

Other noncurrent liabilities

     123.6       67.0      67.0      (122.1 )     135.5  

Intercompany payables

     —         23.9      549.9      (573.8 )     —    
    


 

  

  


 


Total liabilities

     2,075.2       465.5      697.4      (694.1 )     2,544.0  

Minority interest

     —         —        39.2      —         39.2  

Shareowners’ equity (deficit)

     (624.5 )     251.6      239.8      (491.4 )     (624.5 )
    


 

  

  


 


Total liabilities and shareowners’ equity (deficit)

   $ 1,450.7     $ 717.1    $ 976.4    $ (1,185.5 )   $ 1,958.7  
    


 

  

  


 


 

20


Table of Contents
Form 10-Q Part I   Cincinnati Bell Inc.

 

Condensed Consolidating Statements of Cash Flows

(dollars in millions)

 

     Six Months Ended June 30, 2005

 
    

Parent

(Guarantor)


    CBT

    Other
(Non-guarantors)


    Eliminations

   Total

 

Cash flows provided by (used in) operating activities

   $ (20.1 )   $ 123.0     $ 48.3     $ —      $ 151.2  
    


 


 


 

  


Capital expenditures

     —         (46.0 )     (25.0 )     —        (71.0 )

Other investing activities

     —         —         —         —        —    
    


 


 


 

  


Cash flows used in investing activities

     —         (46.0 )     (25.0 )     —        (71.0 )
    


 


 


 

  


Capital contributions

     98.1       (74.8 )     (23.3 )     —        —    

Issuance of long-term debt and new credit facility, net

     384.0       —         0.1       —        384.1  

Repayment of previous credit facility and other debt

     (439.0 )     (2.6 )     (0.4 )     —        (442.0 )

Issuance of common shares - exercise of stock options

     1.7       —         —         —        1.7  

Other financing activities

     (26.2 )     —         —         —        (26.2 )
    


 


 


 

  


Cash flows provided by (used in) financing activities

     18.6       (77.4 )     (23.6 )     —        (82.4 )
    


 


 


 

  


Increase (decrease) in cash and cash equivalents

     (1.5 )     (0.4 )     (0.3 )     —        (2.2 )

Beginning cash and cash equivalents

     22.7       1.4       0.8       —        24.9  
    


 


 


 

  


Ending cash and cash equivalents

   $ 21.2     $ 1.0     $ 0.5     $ —      $ 22.7  
    


 


 


 

  


     Six Months Ended June 30, 2004

 
     Parent
(Guarantor)


    CBT

   

Other

(Non-guarantors)


    Eliminations

   Total

 

Cash flows provided by (used in) operating activities

   $ (12.4 )   $ 122.3     $ 34.5     $ —      $ 144.4  
    


 


 


 

  


Capital expenditures

     —         (41.1 )     (20.2 )     —        (61.3 )

Other investing activities

     —         1.5       1.9       —        3.4  
    


 


 


 

  


Cash flows used in investing activities

     —         (39.6 )     (18.3 )     —        (57.9 )
    


 


 


 

  


Capital contributions

     99.5       (83.2 )     (16.3 )     —        —    

Repayment of previous credit facility and other debt

     (87.8 )     (0.3 )     —         —        (88.1 )

Issuance of common shares - exercise of stock options

     1.8       —         —         —        1.8  

Other financing activities

     (5.0 )     1.1       —         —        (3.9 )
    


 


 


 

  


Cash flows provided by (used in) financing activities

     8.5       (82.4 )     (16.3 )     —        (90.2 )
    


 


 


 

  


Increase (decrease) in cash and cash equivalents

     (3.9 )     0.3       (0.1 )     —        (3.7 )

Beginning cash and cash equivalents

     23.5       1.7       0.8       —        26.0  
    


 


 


 

  


Ending cash and cash equivalents

   $ 19.6     $ 2.0     $ 0.7     $ —      $ 22.3  
    


 


 


 

  


 

21


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

7 1/4% Senior Notes Due 2013, 7% Senior Notes Due 2015, and 8 3/8% Senior Subordinated Notes Due 2014

 

The Company’s 7 1/4% Senior Notes Due 2013, 7% Notes Due 2015, and 8 3/8% Senior Subordinated Notes Due 2014 are guaranteed by the following subsidiaries: Cincinnati Bell Public Communications Inc., Cincinnati Bell Entertainment Inc. (f/k/a ZoomTown.com Inc.), Cincinnati Bell Complete Protection Inc., BRFS LLC, BRHI Inc., Cincinnati Bell Any Distance Inc., Cincinnati Bell Telecommunication Services LLC, Cincinnati Bell Wireless Company, Cincinnati Bell Wireless Holdings LLC, BCSI Inc., BCSIVA Inc., BRCOM Inc., BRWL LLC, BRWSVCS LLC, Cincinnati Bell Technology Solutions Inc., IXC Business Services LLC, and IXC Internet Services Inc. Each guarantor is 100% owned directly or indirectly by the Parent Company, and the guarantees are full and unconditional and joint and several. Substantially all of the Parent Company’s income and cash flow is generated by its subsidiaries. Generally, funds necessary to meet the Parent Company’s debt service obligations are provided by distributions or advances from its subsidiaries.

 

22


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

The following information sets forth the condensed consolidating statements of operations and cash flows for the three month and six month periods ended June 30, 2005 and 2004 and the condensed consolidating balance sheets of the Company as of June 30, 2005 and December 31, 2004 of (1) Cincinnati Bell Inc., the Parent Company and issuer (2) the guarantor subsidiaries on a combined basis and (3) the non-guarantor subsidiaries on a combined basis:

 

Condensed Consolidating Statements of Operations

(dollars in millions)

 

     Three Months Ended June 30, 2005

 
     Parent
(Issuer)


    Guarantors

    Non-guarantors

    Eliminations

    Total

 

Revenue

   $ —       $ 87.3     $ 236.7     $ (8.6 )   $ 315.4  

Operating costs and expenses

     5.5       74.5       168.1       (8.6 )     239.5  
    


 


 


 


 


Operating income (loss)

     (5.5 )     12.8       68.6       —         75.9  

Equity in earnings (loss) of subsidiaries

     1.6       (2.3 )     —         0.7       —    

Interest expense and other financing costs

     45.4       6.4       4.9       (7.1 )     49.6  

Other expense (income), net

     (6.9 )     (0.7 )     (0.7 )     7.1       (1.2 )
    


 


 


 


 


Income (loss) before income taxes

     (42.4 )     4.8       64.4       0.7       27.5  

Income tax expense (benefit)

     (12.6 )     35.4       34.5       —         57.3  
    


 


 


 


 


Net income (loss)

     (29.8 )     (30.6 )     29.9       0.7       (29.8 )

Preferred stock dividends

     2.6       —         —         —         2.6  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ (32.4 )   $ (30.6 )   $ 29.9     $ 0.7     $ (32.4 )
    


 


 


 


 


     Three Months Ended June 30, 2004

 
     Parent
(Issuer)


    Guarantors

    Non-guarantors

    Eliminations

    Total

 

Revenue

   $ —       $ 61.8     $ 242.0     $ (6.8 )   $ 297.0  

Operating costs and expenses

     3.1       55.5       164.8       (6.8 )     216.6  
    


 


 


 


 


Operating income (loss)

     (3.1 )     6.3       77.2       —         80.4  

Equity in earnings (loss) of subsidiaries

     45.2       5.6       —         (50.8 )     —    

Interest expense and other financing costs

     46.1       3.5       5.1       (4.2 )     50.5  

Other expense (income), net

     (4.1 )     1.2       (0.1 )     4.2       1.2  
    


 


 


 


 


Income (loss) before income taxes

     0.1       7.2       72.2       (50.8 )     28.7  

Income tax expense (benefit)

     (14.8 )     0.1       28.5       —         13.8  
    


 


 


 


 


Net income (loss)

     14.9       7.1       43.7       (50.8 )     14.9  

Preferred stock dividends

     2.6       —         —         —         2.6  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ 12.3     $ 7.1     $ 43.7     $ (50.8 )   $ 12.3  
    


 


 


 


 


 

23


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

Condensed Consolidating Statements of Operations

(dollars in millions)

 

     Six Months Ended June 30, 2005

 
     Parent
(Issuer)


    Guarantors

    Non-guarantors

    Eliminations

    Total

 

Revenue

   $ —       $ 146.8     $ 474.7     $ (17.5 )   $ 604.0  

Operating costs and expenses

     9.7       124.7       356.0       (17.5 )     472.9  
    


 


 


 


 


Operating income (loss)

     (9.7 )     22.1       118.7       —         131.1  

Equity in earnings (loss) of subsidiaries

     31.4       (23.9 )     —         (7.5 )     —    

Interest expense and other financing costs

     91.4       12.2       9.7       (13.2 )     100.1  

Other expense (income), net

     (3.8 )     (5.2 )     (1.3 )     13.2       2.9  
    


 


 


 


 


Income (loss) before income taxes

     (65.9 )     (8.8 )     110.3       (7.5 )     28.1  

Income tax expense (benefit)

     (32.9 )     29.4       64.6       —         61.1  
    


 


 


 


 


Net income (loss)

     (33.0 )     (38.2 )     45.7       (7.5 )     (33.0 )

Preferred stock dividends

     5.2       —         —         —         5.2  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ (38.2 )   $ (38.2 )   $ 45.7     $ (7.5 )   $ (38.2 )
    


 


 


 


 


     Six Months Ended June 30, 2004

 
     Parent
(Issuer)


    Guarantors

    Non-guarantors

    Eliminations

    Total

 

Revenue

   $ —       $ 130.5     $ 481.5     $ (12.6 )   $ 599.4  

Operating costs and expenses

     8.9       118.1       331.8       (12.6 )     446.2  
    


 


 


 


 


Operating income (loss)

     (8.9 )     12.4       149.7       —         153.2  

Equity in earnings (loss) of subsidiaries

     87.8       6.3       —         (94.1 )     —    

Interest expense and other financing costs

     92.9       6.9       9.8       (8.2 )     101.4  

Other expense (income), net

     (8.3 )     1.1       0.2       8.2       1.2  
    


 


 


 


 


Income (loss) before income taxes

     (5.7 )     10.7       139.7       (94.1 )     50.6  

Income tax expense (benefit)

     (31.5 )     (1.3 )     57.6       —         24.8  
    


 


 


 


 


Net income (loss)

     25.8       12.0       82.1       (94.1 )     25.8  

Preferred stock dividends

     5.2       —         —         —         5.2  
    


 


 


 


 


Net income (loss) applicable to common shareowners

   $ 20.6     $ 12.0     $ 82.1     $ (94.1 )   $ 20.6  
    


 


 


 


 


 

24


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

Condensed Consolidating Balance Sheets

(dollars in millions)

 

     As of June 30, 2005

 
     Parent
(Issuer)


    Guarantors

   Non-guarantors

   Eliminations

    Total

 

Cash and cash equivalents

   $ 21.2     $ 0.2    $ 1.3    $ —       $ 22.7  

Receivables, net

     3.2       66.6      75.7      —         145.5  

Other current assets

     15.0       84.3      35.2      (32.4 )     102.1  
    


 

  

  


 


Total current assets

     39.4       151.1      112.2      (32.4 )     270.3  

Property, plant and equipment, net

     0.5       35.2      785.8      —         821.5  

Goodwill and other intangibles, net

     —         10.3      66.4      —         76.7  

Investments in and advances to subsidiaries

     998.4       236.1      —        (1,234.5 )     —    

Other noncurrent assets

     356.9       437.1      10.9      (82.0 )     722.9  
    


 

  

  


 


Total assets

   $ 1,395.2     $ 869.8    $ 975.3    $ (1,348.9 )   $ 1,891.4  
    


 

  

  


 


Current portion of long-term debt

   $ —       $ 1.1    $ 23.1    $ —       $ 24.2  

Accounts payable

     0.1       27.2      34.1      —         61.4  

Other current liabilities

     75.7       30.4      87.4      9.4       202.9  
    


 

  

  


 


Total current liabilities

     75.8       58.7      144.6      9.4       288.5  

Long-term debt, less current portion

     1,836.4       0.5      239.1      —         2,076.0  

Other noncurrent liabilities

     142.3       47.7      85.6      (123.8 )     151.8  

Intercompany payables

     —         511.9      98.3      (610.2 )     —    
    


 

  

  


 


Total liabilities

     2,054.5       618.8      567.6      (724.6 )     2,516.3  

Minority interest

     —         34.4      —        —         34.4  

Shareowners’ equity (deficit)

     (659.3 )     216.6      407.7      (624.3 )     (659.3 )
    


 

  

  


 


Total liabilities and shareowners’ equity (deficit)

   $ 1,395.2     $ 869.8    $ 975.3    $ (1,348.9 )   $ 1,891.4  
    


 

  

  


 


     As of December 31, 2004

 
     Parent
(Issuer)


    Guarantors

   Non-guarantors

   Eliminations

    Total

 

Cash and cash equivalents

   $ 22.7     $ 0.2    $ 2.0    $ —       $ 24.9  

Receivables, net

     2.4       54.4      82.2      —         139.0  

Other current assets

     13.5       57.9      29.3      (11.4 )     89.3  
    


 

  

  


 


Total current assets

     38.6       112.5      113.5      (11.4 )     253.2  

Property, plant and equipment, net

     0.9       26.6      830.2      —         857.7  

Goodwill and other intangibles, net

     —         10.3      66.4      —         76.7  

Investments in and advances to subsidiaries

     1,065.2       274.2      —        (1,339.4 )     —    

Other noncurrent assets

     346.0       523.0      11.0      (108.9 )     771.1  
    


 

  

  


 


Total assets

   $ 1,450.7     $ 946.6    $ 1,021.1    $ (1,459.7 )   $ 1,958.7  
    


 

  

  


 


Current portion of long-term debt

   $ 4.3     $ 1.7    $ 24.1    $ —       $ 30.1  

Accounts payable

     0.2       31.4      27.3      —         58.9  

Other current liabilities

     76.9       27.7      102.0      1.8       208.4  
    


 

  

  


 


Total current liabilities

     81.4       60.8      153.4      1.8       297.4  

Long-term debt, less current portion

     1,870.2       0.2      240.7      —         2,111.1  

Other noncurrent liabilities

     123.6       55.2      78.8      (122.1 )     135.5  

Intercompany payables

     —         545.6      111.7      (657.3 )     —    
    


 

  

  


 


Total liabilities

     2,075.2       661.8      584.6      (777.6 )     2,544.0  

Minority interest

     —         39.2      —        —         39.2  

Shareowners’ equity (deficit)

     (624.5 )     245.6      436.5      (682.1 )     (624.5 )
    


 

  

  


 


Total liabilities and shareowners’ equity (deficit)

   $ 1,450.7     $ 946.6    $ 1,021.1    $ (1,459.7 )   $ 1,958.7  
    


 

  

  


 


 

25


Table of Contents

Form 10-Q Part I

  Cincinnati Bell Inc.

 

Condensed Consolidating Statements of Cash Flows

(dollars in millions)

 

     Six Months Ended June 30, 2005

 
     Parent
(Issuer)


    Guarantors

    Non-guarantors

    Eliminations

   Total

 

Cash flows provided by (used in) operating activities

   $ (20.1 )   $ 35.7     $ 135.6     $ —      $ 151.2  
    


 


 


 

  


Capital expenditures

     —         (6.0 )     (65.0 )     —        (71.0 )

Other investing activities

     —         —         —         —        —    
    


 


 


 

  


Cash flows provided by (used in) investing activities

     —         (6.0 )     (65.0 )     —        (71.0 )
    


 


 


 

  


Capital contributions

     98.1       (29.4 )     (68.7 )     —        —    

Issuance of long-term debt and new credit facility, net

     384.0       0.1       —         —        384.1  

Repayment of previous credit facility and other debt

     (439.0 )     (0.4 )     (2.6 )     —        (442.0 )

Issuance of common shares - exercise of stock options

     1.7       —         —         —        1.7  

Other financing activities

     (26.2 )     —         —         —        (26.2 )
    


 


 


 

  


Cash flows provided by (used in) financing activities

     18.6       (29.7 )     (71.3 )     —        (82.4 )
    


 


 


 

  


Increase (decrease) in cash and cash equivalents

     (1.5 )     —         (0.7 )     —        (2.2 )

Beginning cash and cash equivalents

     22.7       0.2       2.0       —        24.9  
    


 


 


 

  


Ending cash and cash equivalents

   $ 21.2     $ 0.2     $ 1.3     $ —      $ 22.7  
    


 


 


 

  


     Six Months Ended June 30, 2004

 
     Parent
(Issuer)


    Guarantors

    Non-guarantors

    Eliminations

   Total

 

Cash flows provided by (used in) operating activities

   $ (12.4 )   $ 54.3     $ 102.5     $ —      $ 144.4  
    


 


 


 

  


Capital expenditures

     —         (5.4 )     (55.9 )     —        (61.3 )

Other investing activities

     —         1.9       1.5       —        3.4  
    


 


 


 

  


Cash flows provided by (used in) investing activities

     —         (3.5 )     (54.4 )     —        (57.9 )
    


 


 


 

  


Capital contributions

     99.5       (50.8 )     (48.7 )     —        —    

Repayment of previous credit facility and other debt

     (87.8 )     —         (0.3 )     —        (88.1 )

Issuance of common shares - exercise of stock options

     1.8       —         —         —        1.8  

Other financing activities

     (5.0 )     —         1.1       —        (3.9 )
    


 


 


 

  


Cash flows provided by (used in) financing activities

     8.5       (50.8 )     (47.9 )     —        (90.2 )
    


 


 


 

  


Increase (decrease) in cash and cash equivalents

     (3.9 )     —         0.2       —        (3.7 )

Beginning cash and cash equivalents

     23.5       0.2       2.3       —        26.0  
    


 


 


 

  


Ending cash and cash equivalents

   $ 19.6     $ 0.2     $ 2.5     $ —      $ 22.3  
    


 


 


 

  


 

26


Table of Contents

9. Subsequent Event – Extinguishment of 16% Senior Subordinated Discount Notes due 2009

 

On August 8, 2005, the Company announced that it has entered into an agreement to repurchase all of its outstanding 16% Notes. The Company expects to pay approximately $448 million, including accrued interest, to repurchase the 16% Notes, which will result in a third quarter pre-tax loss on extinguishment of debt of approximately $92 million (approximately $60 million net of income taxes). The Company expects to finance the repurchase of the 16% Notes with new senior secured bank debt. The Company’s obligation to repurchase the 16% Notes is conditioned upon, among other things, the completion of the new financing. This refinancing will reduce annual interest expense by approximately $45 million to $50 million, which includes non-cash interest expense of approximately $25 million.

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Information included in this Quarterly Report on Form 10-Q contains certain forward-looking statements that involve potential risks and uncertainties. The Company’s future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed herein, and those discussed in the Form 10-K for the year ended December 31, 2004. Readers are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date thereof.

 

The Company was initially incorporated under the laws of Ohio in 1983 and remains incorporated under the laws of Ohio. It has its principal executive offices at 201 East Fourth Street, Cincinnati, Ohio 45202 (telephone number (513) 397-9900 and website address http://www.cincinnatibell.com). The Company makes available on its website at the investor relations tab its reports on Form 10-K, 10-Q, and 8-K (as well as all amendments to these reports) as soon as practicable after they have been electronically filed.

 

The Company files annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (“the SEC”) under the Securities Exchange Act of 1934. These reports and other information filed by the Company may be read and copied at the Public Reference Room of the SEC, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. Information may be obtained about the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy statements and other information about issuers, like the Company, which file electronically with the SEC. The address of this site is http://www.sec.gov.

 

Critical Accounting Policies and Estimates

 

The preparation of condensed consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. The Company continually evaluates its estimates, including, but not limited to, those related to revenue recognition, costs of providing service, bad debts, inventories and any related reserves, income taxes, fixed assets, goodwill, intangible assets, depreciation, restructuring, pensions, other postretirement benefits and contingencies. The Company bases its estimates on historical experience and on various other assumptions believed to be reasonable under the facts and circumstances. Actual results may differ from these estimates under different assumptions or conditions.

 

The Company believes the following critical accounting policies impact the more significant judgments and estimates used in the preparation of its condensed consolidated financial statements. Additionally, the Company’s senior management has discussed the critical accounting policies and estimates with the Board of Directors’ Audit and Finance Committee. For a more detailed discussion of the application of these and other accounting policies, refer to Note 1 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

Revenue Recognition – The Company recognizes revenue as services are provided. Local access fees are billed monthly in advance, while revenue is recognized as the services are provided. Postpaid wireless, long distance, switched access, reciprocal compensation and data and Internet product services are billed monthly in arrears, while the revenue is recognized as the services are provided.

 

The Company bills for services in regular monthly cycles, which are dispersed throughout the days of the month. Because the day of each billing cycle rarely coincides with the end of the Company’s reporting period for usage-based services such as postpaid wireless, long distance and switched access, the Company must estimate service revenues earned but not yet billed. The Company bases its estimates upon historical usage and adjusts these estimates during the period in which the Company can determine actual usage, typically in the following reporting period. These adjustments may have a material impact upon operating results of the Company during the period of the adjustment.

 

28


Table of Contents

The Company recognizes equipment revenue generally upon customer receipt or if contractually specified upon the performance of contractual obligations, such as shipment, delivery, installation or customer acceptance.

 

Income Taxes – The income tax provision consists of an amount for taxes currently payable and an amount for tax consequences deferred to future periods. The Company’s previous tax filings are subject to normal reviews by regulatory agencies until the related statute of limitations expires. The Company believes adequate provision has been made for all open tax years. Deferred investment tax credits are being amortized as a reduction of the provision for income taxes over the estimated useful lives of the related property, plant and equipment. As of June 30, 2005, the Company had $647.6 million in net deferred tax assets.

 

On June 30, 2005, legislation was passed in the state of Ohio instituting a gross receipts tax and phasing out Ohio’s corporate franchise and income tax over a 5 year period. As a result of this legislation, the Company does not expect it will be able to realize income tax benefits associated with $44 million of deferred tax assets previously recorded, of which approximately $33 million relates to Ohio net operating losses. The remaining amount of approximately $11 million relates to the revaluation of other Ohio deferred tax assets to estimates of future realizable value. Therefore, the Company recognized additional income tax expense of approximately $44 million in the quarter ended June 30, 2005. This additional income tax expense is based upon projections of taxable income, timing of reversing temporary differences, and the Company’s current business structure. Adjustments to these estimates may be required upon changes in these underlying factors. At June 30, 2005, the Company has net state and local deferred tax assets of $29 million.

 

As of June 30, 2005, the Company had $1.8 billion in federal tax net operating loss carryforwards, with a deferred tax asset value of $640.4 million. The tax loss carryforwards are available to the Company to offset taxable income in current and future periods. Considering the effect of the loss on extinguishment of the 16% Notes to be recorded in the third quarter (see Note 9 to the condensed consolidated financial statements), the Company expects to utilize approximately $35 million of gross federal tax net operating loss carryforwards during 2005. The tax loss carryforwards will generally expire between 2011 and 2023 and are not currently limited under U. S. tax laws. The ultimate realization of the deferred income tax assets depends upon the Company’s ability to generate future taxable income during the periods in which basis differences and other deductions become deductible and prior to the expiration of the net operating loss carryforwards. Based on current income levels and anticipated future reversal of existing temporary differences, the Company expects to utilize its federal net operating loss carryforwards within their expiration periods.

 

For reporting periods prior to the end of the Company’s fiscal year, the Company records income tax expense based upon an estimated annual effective tax rate, as adjusted for items affecting income taxes that are discrete to the particular quarter. The estimated annual effective tax rate is computed using statutory tax rates and an estimate of annual income before income taxes adjusted for non-deductible expenses. The Company’s non-deductible expenses include interest expense related to securities originally issued to acquire its broadband business (the “Broadband Securities”), or securities which the Company has subsequently issued to refinance the Broadband Securities. As a result of the non-deductible expenses, the Company’s effective tax rate will exceed statutory rates and the effective rate will vary inversely with the amount of its income before income taxes.

 

Allowances for Uncollectible Accounts Receivable – The Company estimates the allowances for uncollectible accounts using both percentages of aged accounts receivable balances to reflect the historical average of credit losses and specific provisions for certain large, potentially uncollectible balances. The Company believes its allowance for uncollectible accounts is adequate based on the methods previously described. However, if one or more of the Company’s larger customers were to default on its accounts receivable obligations or if general economic conditions in the Company’s operating area deteriorated, the Company could be exposed to potentially significant losses in excess of the provisions established. Substantially all of the Company’s outstanding accounts receivable balances are with entities located within its geographic operating areas. Regional and national telecommunications companies account for the remainder of the Company’s accounts receivable balances. No one entity or collection of legally affiliated entities represents 10% of the outstanding accounts receivable balances.

 

29


Table of Contents

Estimated Useful Lives and Depreciation of Property, Plant and Equipment – The Company’s provision for depreciation of the telephone plant is determined on a straight-line basis using the whole life and remaining life methods. Provision for depreciation of other property, other than leasehold improvements, is based on the straight-line method over the estimated economic useful life. Depreciation of leasehold improvements is based on a straight-line method over the lesser of the economic useful life or term of the lease, including option renewal periods if renewal of the lease is probable. Repairs and maintenance expense items are charged to expense as incurred.

 

The Company estimates the useful lives of plant and equipment in order to determine the amount of depreciation expense to be recorded during any reporting period. The majority of the Local segment plant and equipment is depreciated using the group method, which develops a depreciation rate (annually) based on the average useful life of a specific group of assets rather than for each individual asset as would be utilized under the unit method. The estimated life of the group changes as the composition of the group of assets and their related lives change. Such estimated life of the group is based on historical experience with similar assets, as well as taking into account anticipated technological or other changes. If technological changes were to occur more rapidly than anticipated, or in a different form than anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the recognition of increased depreciation expense in future periods. Likewise, if the anticipated technological or other changes occur more slowly than expected, the life of the group could be extended based on the life assigned to new assets added to the group. This could result in a reduction of depreciation expense in future periods. A one-year decrease or increase in the useful life of these assets would increase or decrease annual depreciation expense by approximately $16 million and $11 million, respectively. The Company reviews these types of assets for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable over the remaining lives of the assets. In assessing impairments, the Company follows the provisions of Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”).

 

During the fourth quarter of 2003, the Company revised the estimated economic useful life of its legacy Time Division Multiple Access (“TDMA”) wireless network due to the expected migration of its TDMA customer base to its Global System for Mobile Communications (“GSM”) network. In the fourth quarter of 2003, the Company shortened its estimate of the remaining economic useful life of its TDMA network to December 31, 2006.

 

Subsequently, as part of the process of redeploying spectrum from the Company’s legacy TDMA wireless network to its GSM network to meet unexpected increasing demand for its GSM services, the Company made the decision in the first quarter of 2005 to retire certain TDMA assets early in the second quarter of 2005 in order to optimize its TDMA network performance. Minimal projected cash flows were associated with these TDMA assets retired in the second quarter and, as such, the Company recorded a $22.7 million impairment charge in the first quarter of 2005. The $22.7 million impairment charge is included in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) under the caption “Asset impairments and other charges (credits).” In the second quarter of 2005, the Company shortened its estimate of the useful life of certain of the remaining TDMA assets from the December 31, 2006 date being used. This change was based on updates to the expected rate of migration of TDMA customers to the GSM network, the effect of this migration on the reallocation of spectrum from the TDMA network to the GSM network, and the necessary deployment or retirement of network assets to optimize the quality of both the GSM and TDMA networks while the migration of customers and spectrum from the TDMA network to the GSM network is occurring. This change in estimated useful life resulted in additional depreciation expense of approximately $3.7 million for the second quarter of 2005. The Company also analyzed the remaining $33 million of TDMA assets for impairment, and found that no impairment condition exists at June 30, 2005. Also, in the second quarter, the Company reduced the previously estimated useful life of specific GSM assets that will be replaced in 2005 as part of the Company’s continued initiative to improve GSM network quality, for an additional charge in the quarter of $1.3 million. If technological change were to occur more rapidly than expected, it may have the effect of shortening the estimated depreciable life of other network and operating assets that the Company employs. This could have a substantial impact on the consolidated depreciation expense and net income of the consolidated Company.

 

30


Table of Contents

Impairment of Long-Lived Assets, Other than Goodwill and Indefinite-Lived Intangibles – The Company reviews the carrying value of long-lived assets, other than goodwill and indefinite-lived intangible assets discussed below, when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. An impairment loss is recognized when the estimated future undiscounted cash flows expected to result from the use of an asset (or group of assets) and its eventual disposition are less than its carrying amount. An impairment loss is measured as the amount by which the asset’s carrying value exceeds its estimated fair value. As noted above, the Company’s decision to retire certain TDMA assets resulted in the recording of an impairment charge of $22.7 million during the first quarter of 2005.

 

Competition from new or more cost effective technologies could affect the Company’s ability to generate cash flow from its network-based services. This competition could ultimately result in an impairment of certain of the Company’s tangible or intangible assets. This could have a substantial impact on the operating results of the consolidated Company.

 

Goodwill and Indefinite-Lived Intangible Assets – Goodwill represents the excess of the purchase price consideration over the fair value of assets acquired and recorded in connection with purchase business combinations. Indefinite-lived intangible assets consist primarily of Federal Communications Commission (“FCC”) licenses for spectrum of the Wireless segment. The Company determined that its wireless licenses met the definition of indefinite-lived intangible assets under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), as the Company believes the need for wireless spectrum will continue independent of technology and the Company may renew the wireless licenses in a routine manner every ten years for a nominal fee, provided the Company continues to meet the service and geographic coverage provisions required by the FCC. Upon the adoption of SFAS 142 on January 1, 2002, the Company ceased amortization of remaining goodwill and indefinite-lived intangible assets.

 

Pursuant to SFAS 142, goodwill and intangible assets not subject to amortization are tested for impairment annually, or when events or changes in circumstances indicate that the asset might be impaired. No events indicating impairment were noted during the second quarter of 2005. For goodwill, a two-step impairment test is performed. The first step compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed to measure the amount of impairment loss. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. The implied fair value is determined by allocating the fair value of a reporting unit to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. If the carrying amount of the reporting unit goodwill is in excess of the implied fair value of that goodwill, then an impairment loss is recognized equal to that excess. For indefinite-lived intangible assets, the impairment test consists of a comparison of the fair value of the intangible asset with its carrying value. If the carrying value of an indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.

 

Pension and Postretirement Benefits– The actuarial expense calculation for the Company’s postretirement health plan is based on numerous assumptions, estimates and judgments including health care cost trend rates and cap-related cost sharing. The Company’s collectively bargained-for labor contracts have historically had limits on the Company-funded portion of retiree medical costs (referred to as “caps”). However, the Company had waived the premiums in excess of the caps for both bargained-for retirees and management retirees who retired during the contract period. Prior to December 31, 2004, the Company’s actuarial calculation of retiree medical costs included the assumption that the caps were in place in accordance with the terms of the collectively bargained-for agreement.

 

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Table of Contents

Effective December 31, 2004, based on its past practice of waiving the retiree medical cost caps, the Company began accounting for its retiree medical benefit obligation for bargained-for and management retirees who retire during the current and future contract periods as if there were no caps. Primarily due to this change, the Company’s postretirement medical expense increased to $21 million in the first half of 2005 as compared to $11 million in the first half of 2004. The Company expected to recognize postretirement medical expense of $44 million for the full year 2005 as compared to $22 million in 2004.

 

In May 2005, the Company reached agreement with bargained-for employees as to the terms of a new labor contract. These new terms include a cap on medical costs to be paid by the Company for retirees. Contrary to past practice, no agreement was made to waive the cap. However, the new cap increases annually over the life of the labor agreement. Based on this new agreement, effective June 1, 2005, the Company modified its assumptions for the actuarial calculation of retiree medical costs, including the implementation of a cap that increases annually with expected inflation. As a result of this change, the Company expects that its postretirement medical expense will be approximately $40 million for the full year 2005.

 

The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”), beginning in 2006, will provide a prescription drug benefit under Medicare Part D, as well as a federal subsidy to plan sponsors of retiree healthcare plans that provide a prescription drug benefit to their participants that is at least actuarially equivalent to the benefit that will be available under Medicare. The amount of the federal subsidy will be based on 28 percent of an individual beneficiary’s annual eligible prescription drug costs ranging between $250 and $5,000. On May 19, 2004, the Financial Accounting Standards Board issued Staff Position No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP No. 106-2”). FSP No. 106-2 clarified that the federal subsidy provided under the Act should be accounted for as an actuarial gain in calculating the postretirement benefit obligation and annual postretirement expense. Based on its current understanding of the Act, the Company determined that a substantial portion of the prescription drug benefits provided under its postretirement benefit plan would be deemed actuarially equivalent to the benefits provided under Medicare Part D. Effective July 1, 2004, the Company prospectively adopted FSP No. 106-2 and remeasured its postretirement benefit obligation as of that date to account for the federal subsidy, the effects of which resulted in a $10.3 million reduction in the Company’s postretirement benefit obligation and a $1.1 million reduction in the Company’s 2004 postretirement expense. The effect in the first six months of 2005 was approximately a $3 million reduction in the Company’s postretirement expense. On January 21, 2005, the Department of Health and Human Services issued final federal regulations on the determination of actuarial equivalence of the federal subsidy, which were not substantially different from the proposed rules.

 

During 2004, special termination benefits of $10.5 million were included in the benefit obligation. These special termination benefits related to the 2004 restructuring plan and were offered to certain employees eligible for retirement.

 

Results of Operations

 

The financial results for the three and six months ended June 30, 2005 and 2004 referred to in this discussion should be read in conjunction with the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) on page 1 of this quarterly report on Form 10-Q. Results for interim periods may not be indicative of the results for the full year.

 

Refer to Discussion of Operating Segment Results on page 34 of this Report on Form 10-Q for detailed discussion of operating results by segment.

 

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Table of Contents

CONSOLIDATED OVERVIEW

 

Revenue

 

Consolidated revenue totaled $315.4 million in the second quarter of 2005, an increase of $18.4 million, or 6.2%, compared to the second quarter of 2004. The increase was due to a $23.4 million increase in equipment sales in the Hardware and Managed Services (“HMS”) segment, partially offset by a $6.8 million decrease in the Wireless segment revenue. This increase in HMS equipment sales relates primarily to computer hardware purchases by customers of the Company’s data center services. This revenue is cyclical and will not likely be achieved consistently in future periods.

 

For the six-month period ended June 30, 2005, revenue totaled $604.0 million, as compared to $599.4 million for the same period in 2004, an increase of $4.6 million, or 0.8%. A $30.0 million increase in collocation, equipment, and services revenue related to the Company’s data center business in the HMS segment and a $4.4 million increase in long distance revenue in the Company’s Other segment more than offset a $9.7 million decrease in Wireless segment revenue and $21.8 million of revenue generated in the first half of 2004 and not repeated in the first half of 2005 as the result of the sale or disposition of non-strategic, low-margin producing assets in the HMS and Other segments.

 

Costs and Expenses

 

Cost of services and products sold totaled $133.7 million for the second quarter of 2005, an increase of $16.1 million over the same period in 2004. The increase is due primarily to the $21.5 million cost of products associated with the large equipment sales in the HMS segment discussed above and $3.8 million in additional labor costs, primarily due to post-retiree expenses, partially offset by a $3.9 million decrease in roaming expenses in the Wireless segment related to lower negotiated rates, a $3.0 million reduction in the long distance cost of products in the Other segment related to the installation of switching equipment and lower negotiated rates for transport, and a $2.6 million reduction in operating taxes primarily related to the elimination of the Ohio gross receipts tax in the third quarter of 2004 (see “Critical Accounting Policies and Estimates - Income Taxes” for discussion of legislation that reinstituted the gross receipts tax in the current year).

 

For the first six months of 2005 and 2004, cost of services and products sold was consistent at $243 million. A $26.4 million increase in cost of services and products sold in the HMS segment due to the increase in collocation, equipment, and services revenue related to the Company’s data center business and $9.2 million in additional labor costs primarily due to post-retiree expenses largely offset a $19.2 million decrease in cost of services and products sold related to revenues associated with sold and disposed assets, a $7.9 million reduction in operating taxes primarily related to the elimination of the Ohio gross receipts tax, a $7.2 million decrease in roaming expenses in the Wireless segment related to lower negotiated rates, and a $6.4 million reduction in the long distance costs of products in the Other segment related to the installation of switching equipment and lower negotiated rates of transport.

 

Selling, general, and administrative expenses (“SG&A”) increased to $57.4 million in the second quarter of 2005, compared to $53.6 million in the second quarter of 2004. SG&A increased to $115.5 million for 2005 year-to-date, as compared to $111.5 million for the first half of 2004. The additional expenses are attributed to increases of $4.9 million for the second quarter of 2005 and $7.3 million for the first half of 2005 in labor costs, including post-retiree expenses. As a percentage of revenue, these costs were comparable to the prior year periods.

 

Depreciation expense for the three months ended June 30, 2005 was $48.4 million, an increase of $3.3 million, or 7.3%, from 2004. This increase is primarily due to $3.7 million of accelerated depreciation for planned Wireless TDMA asset retirements. Depreciation expense for the first six months of 2005 and 2004 was $91.4 million and $90.3 million, respectively, as $5.8 million of decreased Local segment depreciation offset $6.0 million of increased Wireless depreciation primarily related to the acceleration of depreciation for the TDMA assets.

 

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Operating income for the quarter was $75.9 million, a decrease of $4.5 million compared to 2004. Year-to-date operating income was $131.1 million for 2005, as compared to $153.2 million in 2004.

 

During the first quarter of 2005, the Company recorded a $22.7 million impairment charge as a result of its decision to retire certain TDMA assets in connection with its redeployment of spectrum used on the TDMA network to the GSM network.

 

The minority interest caption relates to the 19.9% minority interest of Cingular in the net income of Cincinnati Bell Wireless LLC (“CBW”). The TDMA asset impairment charge discussed above gives rise to CBW losses in 2005, and the minority interest income add back of $0.5 million in the second quarter and $4.8 million in the first six months of 2005 represents Cingular’s portion of the CBW losses.

 

Interest expense decreased to $49.6 million for the second quarter of 2005, compared to $50.5 million for the same period in 2004. For the first six months of 2005 and 2004, interest expense was $100.1 million and $101.4 million, respectively. This decrease is a result of the Company’s debt reduction as compared to June 30, 2004.

 

Loss on extinguishment of debt of $7.9 million in the current year was due to the write-off of unamortized deferred financing fees associated with the previously existing credit facilities, which were terminated in February 2005 with the proceeds of the New Bonds and the new credit facility.

 

Income tax expense was $57.3 million in the second quarter of 2005, compared to $13.8 million in the second quarter of 2004. Income tax expense was $61.1 million for the first six months of 2005, compared to $24.8 million for the same period of 2004. The increase is primarily the result of legislation that was passed on June 30, 2005 in the state of Ohio instituting a gross receipts tax and phasing out Ohio’s corporate franchise and income tax over a 5 year period. As a result of this legislation, the Company does not expect it will be able to realize state income tax benefits associated with $44 million of deferred tax assets previously recorded, $33 million of which relate to Ohio net operating losses. Therefore, the Company reduced deferred tax assets and increased income tax expense by $44 million in the quarter ended June 30, 2005. This income tax expense increase was partially offset by reduced taxes due to the Company’s lower pre-tax income. Excluding the effect of the change in state tax laws and the expected extinguishment of the 16% Notes in the third quarter (see Note 9 to the condensed consolidated financial statements), the Company estimates that its effective income tax rate will be approximately 50% for the full year 2005, which differs from the federal statutory rate primarily due to certain non-deductible interest expense.

 

Discussion of Operating Segment Results

 

LOCAL

 

The Local segment provides local voice telephone service, including enhanced custom calling features, and data services, which include dedicated network access, Gigabit Ethernet (“Gig-E”) and Asynchronous Transfer Mode (“ATM”) based data transport, and DSL and dial-up Internet access, to customers in southwestern Ohio, northern Kentucky and southeastern Indiana. These services are provided primarily by CBT, which operates as the Incumbent Local Exchange Carrier (“ILEC”) in its operating territory of approximately 2,400 square miles within an approximate 25-mile radius of Cincinnati, Ohio. CBT’s network includes 681 Synchronous Optical Network (“SONET”) rings and 2,211 fiber network miles, has full digital switching capability and can provide data transmission services to approximately 90% of its addressable access lines via Digital Subscriber Line (“DSL”).

 

Outside of its ILEC territory, the Local segment provides these services through Cincinnati Bell Extended Territories (“CBET”), which operates as a competitive local exchange carrier (“CLEC”) both in the communities north of CBT and in the greater Dayton market. The Local segment provides service on its own network and by purchasing Unbundled Network Elements (“UNE-L’s” or “loop”) or UNE-platform (“UNE-P” or “platform”) from the ILEC. CBET provides service either completely on its own network or through UNE-L

 

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to approximately 75% of its customer base, and expects to migrate substantially all of its Dayton market customers to UNE-L by the end of 2005. The Local segment links its Cincinnati and Dayton geographies through its fiber networks, which provides route diversity via two separate routes.

 

     (Unaudited)     (Unaudited)  
     Three Months Ended June 30,

    Six Months Ended June 30,

 

(dollars in millions)    


   2005

    2004

    $ Change

    % Change

    2005

    2004

    $ Change

    % Change

 

Revenue

                                                            

Voice

   $ 126.4     $ 130.8     $ (4.4 )   (3 )%   $ 254.4     $ 261.4     $ (7.0 )   (3 )%

Data

     54.2       50.4       3.8     8 %     107.3       100.7       6.6     7 %

Other services

     9.0       8.4       0.6     7 %     18.0       18.4       (0.4 )   (2 )%
    


 


 


       


 


 


     

Total revenue

     189.6       189.6       —       0 %     379.7       380.5       (0.8 )   (0 )%

Operating costs and expenses:

                                                            

Cost of services and products

     59.0       55.8       3.2     6 %     116.7       112.1       4.6     4 %

Selling, general and administrative

     33.7       33.3       0.4     1 %     69.0       66.8       2.2     3 %

Depreciation

     26.8       29.8       (3.0 )   (10 )%     53.9       59.7       (5.8 )   (10 )%

Restructuring

     —         —         —       0 %     —         0.2       (0.2 )   (100 )%
    


 


 


       


 


 


     

Total operating costs and expenses

     119.5       118.9       0.6     1 %     239.6       238.8       0.8     0 %
    


 


 


       


 


 


     

Operating income

   $ 70.1     $ 70.7     $ (0.6 )   (1 )%   $ 140.1     $ 141.7     $ (1.6 )   (1 )%

Operating margin

     37.0 %     37.3 %           0 pts       36.9 %     37.2 %           0 pts  

 

Revenue

 

Voice revenue, which includes local service, switched access, information services and value-added services revenues, of $126.4 million and $254.4 million in the second quarter and first six months of 2005, respectively, decreased 3% in both periods, or $4.4 million and $7.0 million, respectively, compared to the second quarter and first six months of 2004. Revenues decreased due to the loss of local service primarily as a result of a 3.4% decrease in access lines in service as well as the loss of value added service revenue primarily as a result of bundle discounts.

 

Access lines within the segment’s ILEC territory decreased 46,000, or 5%, from 960,000 at June 30, 2004 to 914,000 at June 30, 2005, which the Company believes results from several factors including customers electing to use wireless communication (“wireless substitution”) in lieu of the traditional local service, Company-initiated disconnections of customers with credit problems, and customers electing to use service from other providers. In Ma