SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the quarterly period ended June 30, 1997
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the transition period from ______________ to _____________
Commission File Number: 333-06957
HYPERION TELECOMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
Delaware 25-1669404
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Main at Water Street
Coudersport, PA 16915-1141
(Address of principal (Zip code)
executive offices)
814-274-9830
(Registrant's telephone number including area code)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
At August 13, 1997, 122,000 shares of Class A Common Stock, par value
$0.01, and 10,000,000 shares of Class B Common Stock, par value $0.01,
of the registrant were outstanding.
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<CAPTION>
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
INDEX
Page Number
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<S> <C>
Condensed Consolidated Balance Sheets - March 31, 1997 and June 30, 1997........................3
Condensed Consolidated Statements of Operations - Three Months Ended
June 30, 1996 and 1997.........................................................................4
Condensed Consolidated Statements of Cash Flows - Three Months Ended
June 30, 1996 and 1997........................................................................5
Notes to Condensed Consolidated Financial Statements............................................6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations...................................................................................9
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................26
Item 2. Changes in Securities.........................................................................26
Item 3. Defaults Upon Senior Securities..............................................................26
Item 4. Submission of Matters to a Vote of Security Holders..........................................26
Item 5. Other Information............................................................................26
Item 6. Exhibits and Reports on Form 8-K..............................................................27
SIGNATURES.............................................................................................28
</TABLE>
<PAGE>
Item 1. Financial Statements
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)
(Dollars in thousands, except share amounts)
March 31, June 30,
1997 1997
------------ ------------
ASSETS:
- - -------
Current assets:
Cash and cash equivalents $ 59,814 $ 21,308
Other current assets 768 1,158
--------- ---------
Total current assets 60,582 22,466
Investments 44,685 60,152
Property, plant and equipment - net 53,921 71,633
Other assets - net 15,376 15,619
Deferred income taxes - net 37 37
--------- ---------
Total $ 174,601 $ 169,907
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY):
Current liabilities:
Accounts payable $ 2,342 $ 2,451
Due to affiliates - net 6,081 6,930
Other current liabilities 757 1,768
--------- ---------
Total current liabilities 9,180 11,149
13% Senior Discount Notes due 2003 187,173 193,900
Note payable - Adelphia 25,855 25,855
Other debt 2,647 2,496
--------- ---------
Total liabilities $ 224,855 $ 233,400
--------- ---------
Commitments and contingencies (Note 3)
Stockholders' equity (deficiency):
Class A Common Stock, $0.01 par value, 300,000,000
shares authorized and 104,000 and 122,000 shares
outstanding, respectively 1 1
Class B Common Stock, $0.01 par value, 150,000,000
shares authorized and 10,000,000 shares outstanding 100 100
Additional paid in capital 155 182
Class B Common Stock Warrants 11,087 11,087
Loans to Stockholders (3,000) (3,000)
Accumulated deficit (58,597) (71,863)
--------- ---------
Total stockholders' equity (deficiency)
(50,254) (63,493)
--------- ---------
Total $ 174,601 $ 169,907
========= =========
See notes to condensed consolidated financial statements.
<PAGE>
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended
June 30,
---------------------------
1996 1997
------------ -----------
Revenues $ 1,102 $ 1,520
---------- ----------
Operating expenses:
Network operations 859 1,180
Selling, general and administrative 1,027 2,380
Depreciation and amortization 695 1,372
---------- ----------
Total 2,581 4,932
---------- ----------
Operating loss (1,479) (3,412)
Other income (expense):
Gain on sale of investment 8,405 --
Interest income 1,433 763
Interest expense and fees (6,169) (8,077)
---------- ----------
Income (loss) before income taxes and
equity in net loss of joint ventures 2,190 (10,726)
Income tax expense (3) --
---------- ----------
Income (loss) before equity in net loss
of joint ventures 2,187 (10,726)
Equity in net loss of joint ventures (1,636) (2,540)
---------- ----------
Net income (loss) $ 551 $ (13,266)
========== ==========
Net income (loss) per weighted average
share of common stock $ 0.05 $ (1.24)
========== ==========
Weighted average shares of
common stock outstanding
(in thousands) 10,525 10,735
========== ==========
See notes to condensed consolidated financial statements.
<PAGE>
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Three Months Ended
June 30,
-------------------------
1996 1997
------------ ------------
Cash flows from operating activities:
Net income (loss) $ 551 $ (13,266)
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Depreciation 335 1,054
Amortization 360 318
Noncash interest expense 4,915 6,727
Equity in net loss of joint ventures 1,636 2,540
Gain on sale of investment (8,405) --
Issuance of Class A Common Stock Bonus -- 27
Change in operating assets and liabilities:
Other assets - net (22) (951)
Accounts payable and other current liabilities (2,027) 1,144
---------- ----------
Net cash used in operating activities (2,657) (2,407)
---------- ----------
Cash flows from investing activities:
Expenditures for property, plant and equipment (1,818) (18,766)
Proceeds from sale of investment 11,618 --
Investments in joint ventures (4,750) (18,031)
---------- ----------
Net cash provided by (used in) investing activities 5,050 (36,797)
---------- ----------
Cash flows from financing activities:
Proceeds from debt 163,705 --
Repayment of debt -- (151)
Advances (to) from related parties (10,822) 849
Proceeds from issuance of stock warrants 11,087 --
Costs associated with debt financing (6,221) --
Loans to stockholders (3,000) --
Repayment of note payable - Adelphia (25,000) --
---------- ----------
Net cash provided by financing activities 129,749 698
---------- ----------
Increase (decrease) in cash and cash equivalents 132,142 (38,506)
Cash and cash equivalents, beginning of period -- 59,814
---------- ----------
Cash and cash equivalents, end of period $ 132,142 $ 21,308
========== ==========
See notes to condensed consolidated financial statements.
<PAGE>
===============================================================================
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
===============================================================================
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(Dollars in thousands)
Hyperion Telecommunications, Inc. is an 88% owned subsidiary of
Adelphia Communications Corporation ("Adelphia"). The accompanying unaudited
condensed financial statements of Hyperion Telecommunications, Inc. and its
majority owned subsidiaries (the "Company") have been prepared in accordance
with the rules and regulations of the Securities and Exchange Commission.
In the opinion of management, all adjustments, consisting of only
normal recurring accruals necessary to present fairly the unaudited results of
operations for the three months ended June 30, 1996 and 1997, have been
included. These condensed consolidated financial statements should be read in
conjunction with the Company's consolidated financial statements included in its
Annual Report on Form 10-K for the fiscal year ended March 31, 1997. The results
of operations for the three months ended June 30, 1997, are not necessarily
indicative of the results to be expected for the fiscal year ending March 31,
1998.
1. Significant Events Subsequent to March 31, 1997:
On May 20, 1997, the Company entered into an agreement with Time Warner
Entertainment-Advance/Newhouse ("TWEAN") to exchange interests in four New York
CLEC networks. As a result of the transaction, the Company will pay TWEAN
approximately $7,700 and increase its ownership in the networks serving Buffalo
and Syracuse, New York to 60% and 100%, respectively, and will eliminate its
interest in the Albany and Binghamton networks, which will become wholly owned
by TWEAN. The transaction is subject to normal closing conditions and receipt of
regulatory approvals.
On June 13, 1997, the Company entered into agreements with MCImetro
Access Transmission Services, Inc. ("MCI") pursuant to which the Company is
designated as MCI's preferred provider for new end user dedicated access
services in virtually all of the markets that the Company currently serves. The
Company also has certain rights of first refusal to provide MCI with certain
telecommunications services. Under this arrangement, the Company issued to MCI a
warrant, which expires June 13, 2000, to purchase 281,040 shares of Class A
Common Stock of the Company at the lower of (i) $20 per share of Class A Common
Stock or (ii) the public offering price of the Company's Class A Common Stock if
the Company completes an initial public offering of its Class A Common Stock.
MCI can receive additional warrants to purchase additional shares of the
Company's Class A Common Stock at fair value, if MCI meets certain purchase
volume thresholds over the term of the agreement. Collectively, the warrants
would entitle MCI to purchase Class A Common Stock of the Company representing
between 2.5% and 8.5% of the total Common Stock of the Company, on a fully
diluted basis, with adjustments for future issuances of Common Stock.
On August 4, 1997, the Company entered into an Equity Contribution and
Exchange Agreement with Lenfest Telephony, Inc. ("Lenfest"), its 50% partner in
Hyperion of Harrisburg, whereby Lenfest will receive 225,115 shares of Class A
Common Stock of the Company in exchange for its 50% partnership interest in
Hyperion of Harrisburg. The transaction is subject to normal closing conditions
and receipt of regulatory approvals.
On August 11, 1997, the Company entered into Purchase Agreements with a
subsidiary of Tele-Communications, Inc. ("TCI"), a local partner in the Buffalo,
NY, Louisville, KY, and Lexington, KY markets, whereby TCI will receive
approximately $18,300 in cash for TCI's partnership interest in these markets.
Upon consummation of this transaction, which is subject to normal closing
conditions and receipt of regulatory approval, and the TWEAN exchange previously
discussed, the Company's ownership interest in each of these markets will
increase to 100%.
2. Investments:
The equity method of accounting is used to account for investments in
joint ventures in which the Company holds less than a majority interest. Under
this method, the Company's initial investment is recorded at cost and
subsequently adjusted for the amount of its equity in the net income or losses
of its joint ventures. Dividends or other distributions are recorded as a
reduction of the Company's investment. Investments in joint ventures accounted
for using the equity method reflect the Company's equity in their underlying net
assets.
The Company's nonconsolidated investments are as follows:
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Ownership March 31, June 30,
Percentage 1997 1997
--------------- ------------ ------------
Investments accounted for using the equity method:
<S> <C> <C> <C>
Continental Fiber Technologies (Jacksonville) 20.0 $ 7,330 $ 7,979
Multimedia Hyperion Telecommunications (Wichita) 49.9 3,306 3,306
Louisville Lightwave 50.0 (2) 4,683 8,644
NewChannels Hyperion Telecommunications (Albany) 50.0 (1) 924 924
NewChannels Hyperion Telecommunications (Binghamton) 20.0 (1) 504 504
NHT Partnership (Buffalo) 40.0(1) (2) 4,717 5,300
NewChannels Hyperion Telecommunications (Syracuse) 50.0 (1) 4,215 5,161
Hyperion of Harrisburg 50.0 (2) 5,246 8,576
Alternet of Virginia (Richmond) 37.0 7,018 7,212
New Jersey Fiber Technologies (New Brunswick and Morristown) 19.7 3,340 4,582
PECO-Hyperion (Philadelphia) 50.0 10,750 15,000
Lexington Lightwave 50.0 (2) 2,311 4,261
Hyperion of York 50.0 1,402 2,000
Other Various 949 1,277
------------ ------------
56,695 74,726
Cumulative equity in net losses (12,010) (14,574)
------------ ------------
Total Investments $ 44,685 $ 60,152
============ ============
<FN>
(1) As discussed in Note 1, the Company has entered into an agreement, subject
to normal closing conditions and receipt of regulatory approvals, to
exchange its interests in these networks.
(2) As discussed in Note 1, the Company has entered into an agreement, subject
to normal closing conditions and receipt of regulatory approvals, to
increase its ownership to 100% in these networks.
</FN>
</TABLE>
<PAGE>
Summarized combined unaudited financial information for the
Company's investments being accounted for using the equity method of accounting,
is as follows:
March 31, June 30,
1997 1997
----------- -----------
Current assets $ 5,684 $ 8,278
Non-current assets 154,950 181,986
Current liabilities 6,797 8,604
Non-current liabilities 48,069 55,214
Three Months Ended June 30,
---------------------------
1996 1997
----------- -----------
Revenues $ 2,651 $ 4,252
Net loss (3,572) (6,259)
3. Commitments and Contingencies:
Reference is made to Management's Discussion and Analysis of Financial
Condition and Results of Operations for a discussion of material commitments and
contingencies.
-------------------------------------------------
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- - -------------------------------------------------------------------------------
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
- - -------------------------------------------------------------------------------
(Dollars in thousands)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction
with the Company's unaudited Condensed Consolidated Financial Statements and the
Notes thereto appearing elsewhere in this Form 10-Q and the Company's audited
Consolidated Financial Statements and Notes thereto filed on Form 10-K for the
fiscal year ended March 31, 1997.
Overview
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements. Certain information included in this
Form 10-Q, including Management's Discussion and Analysis of Financial Condition
and Results of Operations, is forward-looking, such as information relating to
the effects of future regulation, future capital commitments and the effects of
competition. Such forward-looking information involves important risks and
uncertainties that could significantly affect expected results in the future
from those expressed in any forward-looking statements made by, or on behalf of,
the Company. These risks and uncertainties include, but are not limited to,
uncertainties relating to economic conditions, acquisitions and divestitures,
government and regulatory policies, the pricing and availability of equipment,
materials, and inventories, technological developments and changes in the
competitive environment in which the Company operates. Unless otherwise stated,
the information contained in this Form 10-Q is as of and for the three months
ended June 30, 1996 and 1997.
The "Company" or "Hyperion" mean Hyperion Telecommunications, Inc.
together with its majority-owned subsidiaries, except where the context
otherwise requires. Unless the context otherwise requires, references herein to
the "networks," the "Company's networks" or the "Operating Companies' networks"
mean the 22 telecommunications networks (including five networks under
construction) owned as of June 30, 1997 by 17 Operating Companies (which, as
defined herein, are (i) wholly and majority owned subsidiaries of the Company or
(ii) joint venture partnerships and corporations managed by the Company and in
which the Company holds less than a majority equity interest with one or more
other partners).
The Company, through its Operating Companies, provides a competitive
alternative to the telecommunications services offered by the incumbent local
exchange carriers ("LECs") in its markets. Since its inception in October 1991
through June 30, 1997, the Company has experienced substantial growth, building
from its original two partnerships covering two networks to covering 22 networks
and 35 cities through its 17 Operating Companies. The Operating Companies'
customers are principally medium and large businesses and government and
educational end users as well as Interexchange or Long Distance Carriers
("IXCs"). The Company believes that its strategy of utilizing local partners to
develop its networks has allowed the Company to build networks with greater
coverage, lower upfront and ongoing costs and superior service and reliability.
The Company's Operating Companies are made up of three wholly-owned
subsidiaries, one partnership in which it is a majority owner and 13 joint
venture investments (through which the Company has an interest in 18 networks)
in which the Company owns 50% or less as of June 30, 1997. Results of the wholly
and majority owned subsidiaries and partnership are consolidated into the
Company's financial statements. The Company's pro rata share of the results of
the Operating Companies where the Company owns 50% or less are recorded under
the caption "Equity in net loss of joint ventures" in the Company's consolidated
financial statements and results of operations utilizing the equity method of
accounting. Correspondingly, the Company's initial investments in these
Operating Companies have been carried at cost, and subsequently have been
adjusted for the Company's pro rata share of the Operating Companies' net
losses, additional capital contributions to the Operating Companies, and
distributions from the Operating Companies to the Company.
The Company is responsible for the design, construction, management and
operation of the networks owned by the Operating Companies and receives
management fees from the Operating Companies for its management and network
monitoring services. Management fees are determined by local partner agreements
and vary depending upon the market. Management fees are accounted for as
revenues of the Company. To date, the Company's principal source of revenues has
been derived through management fees from its Operating Companies, although in
the future, the Company expects that majority owned Operating Companies'
revenues will represent an increasing proportion of the Company's revenues.
Since its inception through June 30, 1997, the Company, in conjunction
with its local partners, has made substantial investments totaling approximately
$339,400 designing, constructing and enhancing the Operating Companies' fiber
optic networks. As of June 30,1997, the gross property, plant and equipment of
the Company, its networks and the Company's Network Operating and Control Center
(the "NOCC"), including the Company's investment in Telergy, was approximately
$286,000. As of June 30, 1997, the Company's operating networks had
approximately 3,640 route miles, approximately 174,708 fiber miles and were
connected to approximately 1,603 buildings and 106 LEC central offices ("COs").
The Operating Companies have also installed 8 switches or remote modules which
serve 8 markets and one frame relay switch through the Company's partnership
with !nterprise.
Recent Developments
On May 20, 1997, the Company entered into an agreement with Time Warner
Entertainment-Advance/Newhouse and Advance/Newhouse Partnership ("TWEAN") to
exchange interests in four New York CLEC networks. As a result of the
transaction, Hyperion will pay TWEAN approximately $7,700 and increase its
ownership in the networks serving Buffalo and Syracuse, New York to 60% and
100%, respectively, and will eliminate its interest in the Albany and Binghamton
networks which will be wholly owned by TWEAN. The transaction is subject to
normal closing conditions and receipt of regulatory approvals.
On June 13, 1997, the Company entered into agreements with MCImetro
Access Transmission Services, Inc. ("MCI") pursuant to which the Company is
designated as MCI's preferred provider for new end user dedicated access
services in virtually all of the markets that the Company currently serves. The
Company also has certain rights of first refusal to provide MCI with certain
telecommunications services. Under this arrangement, the Company issued to MCI a
warrant, which expires June 13, 2000, to purchase 281,040 shares of Class A
Common Stock of the Company at the lower of (i) $20 per share of Class A Common
Stock or (ii) the public offering price of the Company's Class A Common Stock if
the Company completes an initial public offering of its Class A Common Stock.
MCI can receive additional warrants to purchase additional shares of the
Company's Class A Common Stock at fair value, if MCI meets certain purchase
volume thresholds over the term of the agreement. Collectively, the warrants
would entitle MCI to purchase Class A Common Stock of the Company representing
between 2.5% and 8.5% of the total Common Stock of the Company, on a fully
diluted basis, with adjustments for future issuances of Common Stock.
On August 4, 1997, the Company entered into an Equity Contribution and
Exchange Agreement with Lenfest Telephony, Inc. ("Lenfest"), its 50% partner in
Hyperion of Harrisburg, whereby Lenfest will receive 225,115 shares of Class A
Common Stock of the Company in exchange for its 50% partnership interest in
Hyperion of Harrisburg. The transaction is subject to normal closing conditions
and receipt of regulatory approvals.
On August 11, 1997, the Company entered into Purchase Agreements with a
subsidiary of Tele-Communications, Inc. ("TCI"), a local partner in the Buffalo,
NY, Louisville, KY, and Lexington, KY markets, whereby TCI will receive
approximately $18,300 in cash for TCI's partnership interest in these markets.
Upon consummation of this transaction, which is subject to normal closing
conditions and receipt of regulatory approval, and the TWEAN exchange previously
discussed, the Company's ownership interest in each of these markets will
increase to 100%.
Results of Operations
Three Months Ended June 30, 1997 in Comparison with Three Months Ended
June 30, 1996
Revenues increased 38% to $1,520 for the three months ended June 30,
1997, from $1,102 for the same quarter in the prior fiscal year. Growth in
revenues of $418 resulted primarily from increased revenues from
telecommunications services from majority and wholly owned Operating Companies
as compared to the same quarter in the prior fiscal year due to increases in the
customer base and the impact of consolidation of the Nashville Operating Company
for the current fiscal quarter.
Network operations expense increased 37% to $1,180 for the three months
ended June 30, 1997 from $859 for the same quarter in the prior fiscal year. The
increase was attributable to the expansion of operations at the NOCC and the
consolidation of the Nashville Operating Company for the current fiscal quarter.
Selling, general and administrative expense increased 132% to $2,380
for the three months ended June 30, 1997 from $1,027 for the same quarter in the
prior fiscal year. The increase was due to both corporate and NOCC overhead cost
increases to accommodate the growth in the number of operating companies managed
and monitored by the Company.
Depreciation and amortization expense increased 97% to $1,372 during
the three months ended June 30, 1997 from $695 for the same quarter in the prior
fiscal year primarily as a result of increased depreciation resulting from
higher depreciable asset base at the NOCC and the majority and wholly owned
Operating Companies.
Gain on Sale of Investment for the three months ended June 30, 1996 was
due to the sale of the Company's 15.7% partnership interest in TCG of South
Florida to Teleport Communications Group, Inc. on May 16, 1996 for an aggregate
sales price of $11,618. This sale resulted in a gain of $8,405. There were no
such similar transactions in the three months ended June 30, 1997.
Interest income for the three months ended June 30, 1997 decreased 47%
to $763 from $1,433 for the same quarter in the prior fiscal year as a result of
reduced cash and cash equivalents due to utilization of the proceeds of the 13%
Senior Discount Notes and Warrants.
Interest expense and fees increased 31% to $8,077 during the three
months ended June 30, 1997 from $6,169 for the same period in the prior fiscal
year. The increase was attributable to higher interest expense associated with
the accretion of the 13% Senior Discount Notes.
Equity in net loss of joint ventures increased by 55% to $2,540 during
the three months ended June 30, 1997 from $1,636 for the same quarter in the
prior fiscal year as the nonconsolidated Operating Companies increased
operations. The net losses of the Operating Companies for the three months ended
June 30, 1997 were primarily the result of increased revenues only partially
offsetting startup and other costs and expenses associated with design,
construction, operation and management of the networks of the Operating
Companies, and the effect of the typical lag time between the incurrence of such
costs and expenses and the subsequent generation of revenues by a network.
The number of nonconsolidated Operating Companies paying management
fees to the Company increased from 11 at June 30, 1996 to 14 at June 30, 1997.
These Operating Companies and networks under construction paid management and
monitoring fees to the Company, which are included in revenues, aggregating
approximately $830 for the three months ended June 30, 1997, as compared with
$798 for the same quarter in the prior fiscal year. The nonconsolidated
Operating Companies' net losses, including networks under construction, for the
three months ended June 30, 1996 and 1997 aggregated approximately $3,572 and
$6,259 respectively.
Net income (loss) changed from net income of $551 for the three months
ended June 30, 1996 to a net loss of $13,266 for the same quarter in the current
fiscal year. The increased net loss was primarily attributable to a higher
operating loss, interest expense associated with the 13% Senior Discount Notes,
increased equity in the net losses of the Company's joint ventures and increased
depreciation and amortization combined with lower interest income and no gain on
sale of investment.
Supplementary Operating Company Revenue Analysis
The Company believes that working with local partners to develop
markets has enabled the Company to build larger networks in a rapid and cost
effective manner. The Company has entered into joint ventures with local
partners where the Company owns 50% or less of each partnership or corporation.
As a result of the Company's ownership position in these joint ventures, a
substantial portion of the Operating Companies' results are reported by the
Company on the equity method of accounting for investments which only reflects
the Company's pro rata share of net income or loss of the Operating Companies.
Because all of the assets, liabilities and results of operations of the
Operating Companies are not presented in the Company's consolidated financial
statements, financial analysis of these Operating Companies based only upon the
Company's results does not represent a complete measure of the growth or
operations of the Operating Companies.
In order to provide an additional measure of the growth and performance
of all of the Company's networks, management of the Company analyzes a variety
of financial information including revenues; earnings before interest expense,
income taxes, depreciation and amortization ("EBITDA"); and capital
expenditures. While EBITDA is not an alternative indicator of operating
performance to operating income or an alternative to cash flows from operating
activities as a measure of liquidity as defined by generally accepted accounting
principles, and while EBITDA may not be comparable to other similarly titled
measures of other companies, the Company's management believes EBITDA is a
meaningful measure of performance. Revenues and EBITDA of the Operating
Companies indicate the level of operating activity in the Company's networks.
Capital expenditures of the Operating Companies along with network construction
statistics, such as route miles and buildings connected, indicate the
extensiveness of the Company's network construction and expansion efforts in
those markets. The financial information set forth below, however, is not
indicative of the Company's overall financial position.
<PAGE>
Revenues
----------------------------
Three Months Ended
June 30,
Cluster 1996 1997
- - -------
-------------- -------------
Northeast $ 1,271 $ 1,527
Mid-Atlantic 345 1,194
Mid-South 239 426
Other Networks 1,077 2,196
----------- -----------
Total $ 2,932 $ 5,343
=========== ===========
There can be no assurance, however, that the Operating Companies will
continue to experience revenue growth at this rate, or at all. Furthermore,
there can be no assurance that the Company will be able to benefit from such
growth in revenues if such growth occurs.
EBITDA
----------------------------
Three Months Ended
June 30,
Cluster 1996 1997
- - -------
-------------- -------------
Northeast $ 215 $ (457)
Mid-Atlantic (752) (1,160)
Mid-South (231) (181)
Other Networks 253 614
------------ ------------
Total $ (515) $ (1,184)
============ ============
Capital Expenditures
---------------------------
Three Months Ended
June 30,
Cluster 1996 1997
- - -------
------------- -------------
Northeast $ 2,030 $ 5,822
Mid-Atlantic 7,803 20,879
Mid-South 1,611 10,262
Other Networks 2,443 12,632
------------ ------------
Total $ 13,887 $ 49,595
============ ============
Liquidity and Capital Resources
The development of the Company's business and the installation and
expansion of the Operating Companies' networks, combined with the construction
of the Company's NOCC, have resulted in substantial capital expenditures and
investments during the past several years. Capital expenditures by the Company
were $1,818 and $18,766 for the three months ended June 30, 1996 and 1997,
respectively. Further, investments made by the Company in nonconsolidated
Operating Companies were $4,750 and $18,031 for the three months ended June 30,
1996 and 1997, respectively. The significant increase for the current quarter is
largely attributable to capital expenditures necessary to enter the switching
market. The Company expects that it will continue to have substantial capital
and investment commitments. The Company also expects to continue to fund
operating losses as the Company develops and grows its business.
The Company recently received a firm commitment for a $25 million long
term lease facility from AT&T Capital Corporation. The lease facility provides
for financing for certain of the Operating Companies' switching equipment and is
expected to be available during the September 1997 quarter.
Through June 30, 1997, Adelphia has made loans and advances totaling
approximately $68.3 million, including accrued interest, to the Company and
leased $3.4 million in fiber network construction to certain Operating
Companies. During April 1996, the Company repaid $37.8 million of such loans and
advances. In addition, Local Partners have invested approximately $91.2 million
as their pro rata investment in those networks through June 30, 1997. These
amounts exclude previous investments in the South Florida Partnership which were
sold on May 16, 1996. These partners have also provided additional capital of
$56.4 million for the construction of the Company's networks through the
partnership agreements by funding the fiber construction of the network and
leasing the fiber to the partnership under long-term, renewable agreements. In
addition, the Company used $120.1 million to fund its pro rata investment in the
networks, capital expenditures and operations. Collectively, these investments
and the Fiber Lease Financings have totaled $339.4 million from the Company's
inception through June 30, 1997.
The Company has experienced negative cash flow since its inception. A
combination of operating losses, substantial capital investments required to
build the Company's wholly-owned networks and its state-of-the-art NOCC, and
incremental investments in the Operating Companies has resulted in substantial
negative cash flow. Prior to April 15, 1996, funding of the Company's cash flow
deficiency was principally accomplished through additional borrowings from
Adelphia. Prior to April 15, 1996, interest and fees on this unsecured credit
facility were based upon the weighted average cost of unsecured borrowings of
Adelphia. The average interest rate charged for all periods through April 15,
1996 was 11.3% (excluding fees charged which were based on the amount borrowed)
and 16.5% for the period since April 16, 1996.
The competitive local telecommunication service business is a
capital-intensive business. The Company's operations have required and will
continue to require substantial capital investment for (i) the installation of
electronics for switched services in the Company's networks, (ii) the expansion
and improvement of the Company's NOCC and the Company's networks and (iii) the
design, construction and development of additional networks. The Company plans
to make substantial capital investments in Operating Companies in connection
with: (i) the deployment of switches in all of its markets by the end of 1997,
(ii) the expansion of existing markets and (iii) the construction and
development of new markets. The Company expects to continue to build new
networks in additional markets, which the Company anticipates will include
additional networks with local partners. The Company estimates that it will
require substantial capital to fund anticipated capital expenditures, working
capital requirements and operating losses of the Company and to make investments
in existing and new Operating Companies and to fund requirements in connection
with certain of the Company's planned additional markets during calendar years
1997 and 1998. The Company expects that it will have adequate resources to fund
such short and long term liquidity needs through the proceeds from the offering
of the 13% Senior Discount Notes and Warrants, vendor financings, internal
sources of funds including cash flow from operations and additional debt or
equity financings as appropriate. There can be no assurance, however, as to the
availability of funds from internal cash flow, the local partners or other
external sources or as to the terms of such financings. In addition, the 13%
Senior Discount Notes provide certain restrictions upon the Company's ability to
incur additional indebtedness. The Company's inability to fund pro rata
investments required for the Operating Companies could result in a dilution of
the Company's interest in the individual Operating Companies or could otherwise
have a material adverse effect upon the Company and/or the Operating Companies.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income", and SFAS No. 131 "Disclosures about Segments
of an Enterprise and Related Information," have been issued and are effective
for fiscal years beginning after December 15, 1997. SFAS No. 130 defines
comprehensive income and outlines certain reporting and disclosure requirements
related to comprehensive income. SFAS No. 131 requires certain disclosures about
business segments of an enterprise, if applicable. The adoption of SFAS No. 130
and SFAS No. 131 are not expected to have any effect on the Company's financial
statements or disclosures.
REGULATION
Overview
Telecommunications services provided by the Company and its networks
are subject to regulation by federal, state and local government agencies. At
the federal level, the FCC has jurisdiction over interstate and international
services. Jurisdictionally interstate services, which constitute the majority of
the Operating Companies' current services, are communications that originate in
one state and terminate in another. Intrastate services are communications that
originate and terminate in a single state. State regulatory commissions exercise
jurisdiction over intrastate services. Additionally, municipalities and other
local government agencies may regulate limited aspects of the Company's
business, such as use of rights-of-way. Many of the regulations issued by these
regulatory bodies may be subject to judicial review, the result of which the
Company is unable to predict. The networks are also subject to numerous local
regulations such as building codes and licensing.
Telecommunications Act of 1996
On February 8, 1996, the Telecommunications Act was signed into law. It
is considered to be the most comprehensive reform of the nation's
telecommunications laws since the Communications Act of 1934. The
Telecommunications Act has and will continue to result in substantial changes in
the marketplace for voice, data and video services. These changes include
opening the local exchange market to competition and will result in a
substantial increase in the addressable market for the Company's networks. Among
its more significant provisions, the Telecommunications Act (i) removes legal
barriers to entry in local telephone markets, (ii) requires incumbent LECs to
"interconnect" with competitors, (iii) establishes procedures for incumbent LEC
entry into new markets, such as long distance and cable television, (iv) relaxes
regulation of telecommunications services provided by incumbent LECs and all
other telecommunications service providers, and (v) directs the FCC to establish
an explicit subsidy mechanism for the preservation of universal service. As a
component of the need for explicit subsidy mechanism for universal service, the
FCC was also directed to revise and make explicit subsidies inherent in the
current access change system.
Removal of Entry Barriers
Prior to enactment of the Telecommunications Act, many states limited
the services that could be offered by a company competing with the incumbent
LEC. See "--State Regulation." In these states, the incumbent LEC retained a
monopoly over basic local exchange services pursuant to state statute or
regulatory policy. In states with these legal barriers to entry, the Company had
been limited to the provision of dedicated telecommunications services, which
constitutes only a small portion of the local telephone market.
The Telecommunications Act prohibits state and local governments from
enforcing any law, rule or legal requirement that prohibits or has the effect of
prohibiting any person from providing interstate or intrastate
telecommunications services. States retain jurisdiction under the
Telecommunications Act to adopt laws necessary to preserve universal service,
protect public safety and welfare, ensure the continued quality of
telecommunications services and safeguard the rights of consumers.
This provision of the Telecommunications Act should enable the
Operating Companies to provide a full range of local telecommunications services
in any state. The Operating Companies will continue their policy of not
providing interLATA long distance services that compete with the major IXCs in
order to enable the Company to work with IXCs to provide an integrated local and
long distance service offering to end users. Although the Operating Companies
will be required to obtain certification from the state regulatory commission in
almost all cases, the Telecommunications Act should limit substantially the
ability of a state commission to deny a request for certification filed by an
Operating Company. While this provision of the Telecommunications Act expands
significantly the markets available to the Operating Companies, it also reduces
the barriers to entry by other potential competitors and therefore increases the
level of competition the Operating Companies will face in all their markets. See
"Competition." Delays in receiving regulatory approvals or the enactment of new
adverse regulation or regulatory requirements may have a materially adverse
effect upon the Operating Companies.
Some state commissions are currently considering actions to preserve
universal service and promote the public interest. The actions may impose
conditions on the certificate issued to an Operating Company which would require
it to offer service on a geographically widespread basis through the
construction of facilities to serve all residents and business customers in such
areas, the acquisition from other carriers of network facilities required to
provide such service, or the resale of other carriers' services. The Company
believes that state commissions have limited authority to impose such
requirements under the Telecommunications Act. The imposition of such conditions
by state commissions could increase the cost to the Operating Companies of
providing local exchange services, or could otherwise affect the Operating
Companies' flexibility to offer services.
Interconnection with LEC Facilities
A company cannot compete effectively with the incumbent LEC in the
market for switched local telephone services unless it is able to connect its
facilities with the incumbent LEC and obtain access to certain essential
services and resources under reasonable rates, terms and conditions. Incumbent
LECs historically have been reluctant to provide these services voluntarily and
generally have done so only when ordered to by state regulatory commissions. The
Telecommunications Act imposes a number of access and interconnection
requirements on all local exchange providers, including CLECs, with additional
requirements imposed on non-rural LECs. These requirements will provide access
to certain networks under reasonable rates, terms and conditions. Specifically,
LECs must provide the following:
Telephone Number Portability. Telephone number portability enables a
customer to keep the same telephone number when the customer switches local
exchange carriers. New entrants are at a competitive disadvantage without
telephone number portability because of inconvenience and costs to customers
that must change numbers.
Dialing Parity. All LECs must provide dialing parity, which means that
a customer calling to or from a CLEC network cannot be required to dial more
digits than is required for a comparable call originating and terminating on the
LEC's network.
Reciprocal Compensation. The duty to provide reciprocal compensation
means that LECs must terminate calls that originate on competing networks in
exchange for a given level of compensation and that they are entitled to
termination of calls that originate on their network for which they must pay a
given level of compensation.
Resale. A LEC may not prohibit or place unreasonable restrictions on
the resale of its services. In addition, incumbent LECs must offer bundled local
exchange services to resellers at a wholesale rate that is less than the retail
rate charged to end users.
Access to Rights-of-Way. All LECs, CLECs and other utilities must
provide access to their poles, ducts, conduits and rights-of-way on a
reasonable, nondiscriminatory basis.
Unbundling of Network Elements. LECs must offer access to various
unbundled elements of their network. This requirement allows new entrants to
purchase at cost-based rates, elements of an incumbent LEC's network that may be
necessary to provide service to customers not located in the new entrants'
networks.
On July 2, 1996 the FCC released its First Report and Order and Further
Notice of Proposed Rulemaking promulgating rules and regulations to implement
Congress' statutory directive concerning number portability (the "Number
Portability Order"). The FCC ordered all LECs to begin phased development of a
long-term service provider portability method in the 100 largest Metropolitan
Statistical Areas ("MSAs") no later than October 1, 1997, and to complete
deployment in those MSAs by December 31, 1998. Number portability must be
provided in those areas by all LECs to all requesting telecommunications
carriers. After December 31, 1998, each LEC must make number portability
available within six months after receiving a specific request by another
telecommunications carrier in areas outside the 100 largest area MSAs in which
the requesting carrier is operating or plans to operate. Until long-term service
portability is available, all LECs must provide currently available number
portability measures as soon as reasonably possible after a specific request
from another carrier. As new carriers are at a competitive disadvantage without
telephone number portability, the Number Portability Order should enhance the
Company's ability to offer service in competition with the incumbent LECs, if
these regulations are effective in promoting number portability. The Number
Portability Order sets interim criteria for number portability cost recovery.
The FCC deferred selecting a long-term number portability cost recovery scheme
to a further rulemaking proceeding which is not expected to be decided until
later this year. Further, the Number Portability Order is subject to Petitions
for Reconsideration filed at the FCC. To the extent that the outcome of the
Petitions results in new rules that decrease the LEC obligation to provide
number portability or increase the CLEC obligation to pay for number
portability, changes to the Number Portability Order could decrease the
Company's ability to offer service in competition with the LECs.
On August 8, 1996 the FCC released its First Report and Order and
Second Report and Order and Memorandum Opinion and Order promulgating rules and
regulations to implement Congress' statutory directive concerning the
interconnection obligations of all telecommunications carriers, including
obligations of CLEC and LEC networks and incumbent LEC pricing of
interconnection and unbundled elements (the "Local Competition Orders"). The
Local Competition Orders adopted a national framework for interconnection but
left to the individual states the task of implementing the FCC's rules. The
Local Competition Orders also established rules implementing the
Telecommunications Act requirements that LECs negotiate interconnection
agreements, and provide guidelines for review of such agreements by state
commissions.
On July 18, 1997, the U.S. Court of Appeals for the Eighth Circuit
("Eighth Circuit") vacated certain portions of the Local Competition Orders,
including provisions establishing a pricing methodology, a procedure permitting
new entrants to "pick and choose" among various provisions of existing
interconnection agreements between LECs and their competitors, and certain
provisions relating to the purchase of unbundled access elements. The Operating
Companies have negotiated and obtained state commission approval of a number of
interconnection agreements with incumbent LECs prior to this Eighth Circuit
decision. The Eighth Circuit decision creates uncertainty about individual state
rules governing pricing, terms, and conditions of interconnection decisions, and
could make negotiating and enforcing such agreements in the future more
difficult and protracted. It could also require renegotiation of relevant
portions of existing interconnection agreements, or subject them to agreements
to additional court and regulatory proceedings. It remains to be seen whether
Operating Companies can continue to obtain and maintain interconnection
agreements on terms acceptable to them in every state, though most states have
already adopted pricing rules, if not interim prices which are for the most part
consistent with the FCC's related pricing provisions. The FCC has announced that
it will appeal the Eighth Circuit decision to the United States Supreme Court.
Although the Number Portability Order, the Local Competition Orders and
the underlying statutory requirements are intended to benefit new entrants in
the local exchange market, such as the Operating Companies, it is uncertain how
effective these requirements will be. Ultimately the success of the
Telecommunications Act to bring the benefits of increased competition to
consumers will depend in large part upon state regulators' implementation of the
Telecommunications Act and the Local Competition Orders as well as numerous
rulemakings that should level the playing field between incumbent LECs and new
entrants such as the Company. For example, if CLECs are unable to obtain
favorable agreements with the incumbent LEC regarding call termination and
resale of incumbent LEC facilities and services through negotiation with the
incumbent LEC or arbitration at state public utility commissions, there is a
diminished likelihood that an Operating Company will be successful in its local
exchange market. In addition, the ability of CLECs to resell incumbent LEC
services obtained at wholesale rates may permit some CLECs to compete with the
Operating Companies without investing in facilities.
Moreover, these requirements place burdens on an Operating Company when
it provides switched local exchange services that will benefit potential
competitors. In particular, the obligation to offer services for resale means
that a company can resell the Operating Company's services without investing in
facilities, although unlike incumbent LECs, the Operating Companies are not
required to offer services for resale at discounted rates. Similarly, the
obligation to provide access to rights-of-way is of limited benefit to most of
the Operating Companies, which already have such access through their Local
Partners, but benefits other potential competitors to a greater degree.
LEC Entry into New Markets
The Company's principal competitor in each market it enters is the LEC.
See "Competition." Prior to enactment of the Telecommunications Act, incumbent
LECs generally were prohibited from providing cable television service pursuant
to the "telco/cable cross-ownership prohibition" contained in the Communications
Act of 1934, although the prohibition had been stayed by several courts and was
not being enforced by the FCC. In addition, the RBOCs generally were prohibited
by the Modified Final Judgment ("MFJ") from providing interLATA (i.e., long
distance) services within the region in which they provide local exchange
service.
The Telecommunications Act repeals the telco/cable cross-ownership
prohibition and permits incumbent LECs to provide cable television service.
Prior to the Telecommunications Act repeal, some LECs were investing in fiber
optic networks on a limited basis through the FCC's "video dialtone" regulatory
regime. With the telco/cable cross ownership prohibition removed, LECs are more
likely to invest in fiber optic networks because those facilities will be able
to generate a revenue stream previously unavailable on a widespread basis to the
incumbent LECs. While LEC entry into the video market may be a motivating factor
for construction of new facilities, these facilities also can be used by an
incumbent LEC to provide services that compete with the Company's networks.
The Telecommunications Act also eliminates the prospective effect of
the MFJ and establishes procedures under which an RBOC can enter the market for
interLATA services within its telephone service area. This is referred to as
"in-region" interLATA service. (RBOCs are currently permitted to provide
interLATA long distance services to customers outside of their local service
areas. This is referred to as "out-of-region" long distance service.) Before an
RBOC can provide in-region interLATA service, it must enter into a
state-approved interconnection agreement with a company that provides local
exchange service to business and residential customers predominantly over its
own facilities. Alternatively, if no such competitor requests interconnection,
reasonably expected to lead to facilities-based competition in the residential
and business local exchange markets, the RBOC can request authority to provide
in-region interLATA services if it offers interconnection under state-approved
terms and conditions. The interconnection offered or provided by the RBOC must
comply with a "competitive checklist" that is comparable to the interconnection
requirements discussed above. See "-- Interconnection with LEC Facilities."
The ability of the RBOCs to provide interLATA services enables them to
provide customers with a full range of local and long distance
telecommunications services. The provision of interLATA services by RBOCs is
expected to reduce the market share of the major long distance carriers, which
are the Company's networks' primary customers. Consequently, the entry of the
RBOCs into the long distance market may have adverse consequences on the ability
of CLECs to generate access revenues from the IXCs. To date Ameritech has sought
authority from the FCC to provide in-region interLATA service in Michigan, and
Southwestern Bell Telephone Company ("SWBT") has sought similar authority in
Oklahoma. The Department of Justice has opposed both requests. More RBOC
requests to provide in-region interLATA service are expected to be filed with
the FCC in the near future.
Relaxation of Regulation
A long-term goal of the Telecommunications Act is to increase
competition for telecommunications services, thereby reducing the need for
regulation of these services. To this end, the Telecommunications Act requires
the FCC to streamline its regulation of incumbent LECs and permits the FCC to
forbear from regulating particular classes of telecommunications services or
providers. Since the Company is a non-dominant carrier and, therefore, is not
heavily regulated by the FCC, the potential for regulatory forbearance likely
will be more beneficial to the incumbent LECs than the Company in the long run.
In an exercise of its "forbearance authority," the FCC has ruled that
following a transition period nondominant interexchange carriers will no longer
be able to file tariffs with the FCC concerning their interexchange interstate
long distance services (the "IXC Detariffing Order"). The IXC Detariffing Order
has been appealed to the U.S. Court of Appeals for the District of Columbia. A
portion of the IXC Detariffing Order has been stayed and the appeal is still
pending. Pursuant to the forbearance provisions of the Telecommunications Act,
in March 1996, the Company filed a petition requesting that the FCC also forbear
from imposing tariff filing requirements on interstate exchange access services
provided by carriers other than incumbent LECs. In June 1997, the FCC granted
this request, concluding that allowing providers of exchange access service the
option of tariffing or detariffing their services is in the public interest. In
granting Hyperion's petition, the FCC requested further comment on whether no
mandate the detariffing of exchange access services. This proceeding is pending,
and there can be no assurance how the FCC will rule on this issue, or what
effect any such ruling may have upon competition within the telecommunications
industry generally, or on the competitive position of the Company specifically.
The Telecommunications Act eliminates the requirement that incumbent
LECs obtain FCC authorization before constructing new facilities for interstate
services. The Telecommunications Act also limits the FCC's ability to review LEC
tariff filings. These changes will increase the speed with which incumbent LECs
are able to introduce new service offerings and new pricing of existing
services, thereby increasing the incumbent LECs' ability to compete with the
Company.
Universal Service and Access Charge Reform
One of the primary goals of the original Communications Act of 1934 was
to extend telephone service to all the citizens of the United States. This goal
has been achieved largely by keeping the rates for basic local exchange service
at a reasonable level. It was traditionally thought that incumbent LECs were
able to keep basic residential rates reasonable by subsidizing them with
revenues from business and IXC customers, and by subsidizing rural service at
the expense of urban customers. The existence and level of these subsidies has
been widely disputed in recent years because they are so difficult to quantify.
On May 8, 1997, the FCC issued an order to implement the provisions of
the Telecommunications Act relating to the preservation and advancement of
universal telephone service (the "Universal Service Order"). The Universal
Service Order affirmed the policy principles for universal telephone service set
forth in the Telecommunications Act, including quality service, affordable
rates, access to advanced services, access in rural and high-cost areas,
equitable and non-discriminatory contributions, specific and predictable support
mechanisms, and access to advanced telecommunications services for schools,
health care providers and libraries. The Universal Service Order added
"competitive neutrality" to the FCC's universal service principles by providing
that universal service support mechanisms and rules should not unfairly
advantage or disadvantage one provider over another, nor unfairly favor or
disfavor one technology over another. The Universal Service Order also requires
all telecommunications carriers providing interstate telecommunications
services, including the Company, to contribute to universal service support.
Because the FCC has not yet agreed upon a mechanism to determine costs, the net
revenue effect of these obligations on the Company cannot be determined at this
time.
In a related proceeding on May 16, 1997, the FCC issued an order to
implement certain reforms to its access charge rules (the "Access Charge Reform
Order"). Access charges are charges imposed by LECs on long distance providers
for access to the local exchange network and are designed to compensate the LEC
for its investment in the local network. The FCC regulates interstate access and
the states regulate intrastate access. The Access Charge Reform Order will
require incumbent LECs to substantially decrease over time the prices they
charge for switched and special access and change how access charges are
calculated. These changes are intended to reduce access charges paid by
interexchange carriers to LECs and shift certain usage-based charges to
flat-rated, monthly per-line charges. To the extent that these rules begin to
reduce access charges to reflect the forward-looking cost of providing access,
the Company's competitive advantage in providing customers with access services
might decrease. In addition, the FCC has determined that it will give incumbent
LECs pricing flexibility with respect to access charges. To the extent such
pricing flexibility is granted before substantial facilities-based competition
develops, such flexibility could be misused to the detriment of new entrants,
including the Company. Until the FCC adopts and releases rules detailing the
extent and timing of such pricing flexibility, the impact of these rules on the
Company cannot be determined.
Two aspects of the FCC's Access Charge Reform Order create potential
competitive benefits for alternative access providers, including the Company.
First, the abolition of the unitary rate structure option for local transport
may have an adverse effect on some interexchange carriers, making competitive
access services provided by the Company and others more attractive. Second, the
FCC ruled that incumbent LECs may no longer impose the transport interconnection
charge on competitive providers, such as the Company, that interconnect with the
incumbent LEC at the incumbent's end offices.
Both the Universal Service and Access Charge Reform Orders are subject
to petitions seeking reconsideration by the FCC and direct appeals to U.S.
Courts of Appeals. Until the time when any such petitions or appeals are
decided, there can be no assurance of how the Universal Service and/or Access
Charge Reform Orders will be implemented or enforced, or what effect the Orders
will have on competition within the telecommunications industry, generally, or
on the competitive position of the Company, specifically.
Federal Regulation
Through a series of regulatory proceedings, the FCC has established
different levels of regulation for "dominant carriers" and "non-dominant
carriers." Only LECs are classified as dominant; all other providers of domestic
interstate services, including the Operating Companies, are classified as
non-dominant carriers. As non-dominant carriers, the Operating Companies are
subject to relatively limited regulation by the FCC. The Operating Companies
must offer interstate services at just and reasonable rates in a manner that is
not unreasonably discriminatory, subject to the complaint provisions of the
Communications Act of 1934, as amended.
Presently, the Operating Companies are required to file tariffs listing
the terms, conditions and rates for their services. Under the Telecommunications
Act, the FCC has authority to forbear from regulation (such as toll regulation)
provided that such forbearance is consistent with the public interest. In an
exercise of its "forbearance authority," the FCC has ruled that following a
transition period, nondominant interexchange carriers will no longer be able to
file tariffs with the FCC concerning their interstate long distance services
(the "IXC Detariffing Order"). The IXC Detariffing Order has been appealed to
the U.S. Court of Appeals for the District of Columbia and the provision
requiring interexchange carriers to withdraw their tariffs was stayed by that
court on February 13, 1997. That appeal is still pending. On March 21, 1996, the
Company filed a petition requesting that the FCC forbear from imposing tariff
filing requirements on interstate exchange access services provided by carriers
other LECs. In June 1997, the FCC granted this request, concluding that allowing
providers of exchange access service the option of tariffing or detariffing
their services is in the public interest. In granting Hyperion's petition, the
FCC requested further comment on whether to mandate the detariffing of exchange
access services. This proceeding is pending, and there can be no assurance how
the FCC will rule on this issue, or what effect any such ruling may have upon
competition within the telecommunications industry generally, or on the
competitive position of the Company specifically.
The FCC has adopted rules requiring incumbent LECs to provide
"collocation" to CAPs for the purpose of interconnecting their competing
networks. These rules enable the Operating Companies to carry a portion of a
customer's interstate traffic to an IXC even if the customer is not located on
the Company's network. The Company has requested collocation in some, but not
all, of its markets. The incumbent LECs have proposed collocation rates that are
being investigated by the FCC to determine whether they are excessive. If the
FCC orders the incumbent LECs to reduce these rates, collocation will be a more
attractive option for CLECs. Under the Local Competition Order, incumbent LECs
will also be required to provide both virtual collocation and actual collocation
at their switching offices.
Under the Telecommunications Act, an Operating Company may become
subject to additional federal regulatory obligations when it provides local
exchange service in a market. All LECs, including CLECs, must make their
services available for resale by other carriers, provide nondiscriminatory
access to rights-of-way, offer reciprocal compensation for termination of
traffic and provide dialing parity and telephone number portability. In
addition, the Telecommunications Act requires all telecommunications carriers to
contribute to the universal service mechanism established by the FCC and to
ensure that their services are accessible to and usable by persons with
disabilities. Moreover, the FCC is currently engaged in a number of rulemakings
in which it is considering regulatory implications of various aspects of local
exchange competition. Any or all of the proceedings may negatively affect CLECs,
including the Company. Most recently, the FCC has determined to investigate
whether or not to mandate operational support systems reporting standards for
the LECs, whether to regulate billing and collection functions, and whether to
assert jurisdiction over reciprocal compensation for local calls made to
Internet service providers.
Because the states are in the process of implementing rules consistent
with the Telecommunications Act and rules adopted by the FCC pursuant to the
Act, it is uncertain how burdensome or beneficial such rules will be for the
Company and the Operating Companies. The obligation to provide services for
resale by others potentially limits any competitive advantage held by the
Company by virtue of its state-of-the-art facilities because other carriers,
including the incumbent LEC and the IXCs, can simply resell the Operating
Companies' services. Similarly, the obligation to provide access to
rights-of-way benefits certain competitors more than the Company, which already
has such a significant amount of access through its Local Partners. Most of the
other obligations impose costs on the Operating Companies that also will be
borne by competing carriers so the competitive implication of these requirements
should not be significant if they are implemented fairly.
As part of its decision requiring incumbent LECs to provide virtual
collocation, the FCC also granted incumbent LECs flexibility to reduce their
rates for interstate access services in markets where a CAP is collocated. This
flexibility includes the ability to offer volume and term discounts and to
de-average access rates in different "zones" in a state based on the level of
traffic. In addition, the FCC has granted two incumbent LECs further flexibility
in their most competitive markets and the FCC could grant similar waivers in
markets served by the Operating Companies. The May 21, 1997 Order reforming the
FCC's price cap formula affords LECs greater flexibility in establishing rates
and provides additional incentives to foster efficiency. With the passage of the
Telecommunications Act and the anticipated increase in the level of competition
faced by incumbent LECs, the FCC could grant incumbent LECs substantial pricing
flexibility with regard to interstate access services. It is also anticipated
that the prices incumbent LECs charge for access services will be reduced as a
result of the FCC's reform of the access charge regime and the adoption of
universal service rules. To the extent these regulatory initiatives enable or
require incumbent LECs to offer selectively reduced rates for access services,
the rates the Operating Companies may charge for access services will be
constrained. The Operating Companies' rates also will be constrained by the fact
that competitors other than the incumbent LECs are subject to the same
streamlined regulatory regime as the Operating Companies and can price their
services to meet competition.
State Regulation
Most state public utility commissions require companies that wish to
provide intrastate common carrier services to be certified to provide such
services. These certifications generally require a showing that the carrier has
adequate financial, managerial and technical resources to offer the proposed
services in a manner consistent with the public interest.
Operating Companies have been certificated or are otherwise authorized
to provide telecommunications services in Florida, Kansas, Kentucky,
Mississippi, New Jersey, New York, Pennsylvania, Tennessee, Vermont and
Virginia. The certificates or other authorizations in New Jersey, New York,
Florida, Kentucky, Mississippi, New Jersey, Vermont, Virginia and Tennessee
permit the Operating Companies to provide a full range of local
telecommunications services, including basic local exchange service. The
Operating Companies have interim authority to provide a full range of local
telecommunications services in Pennsylvania, and applications for permanent
certificates are pending in that state. Applications for authority to provide
local telecommunication services are pending in Arkansas, Kansas, and Louisiana.
In light of the Telecommunications Act, the Operating Companies will request
removal of any restrictions that now exist on its certificates in the remaining
states and anticipate that requests will be granted. See "--Telecommunications
Act of 1996--Removal of Entry Barriers." In addition, the Telecommunications Act
will enable the Company to enter new states providing a full range of local
services upon certification. In certain states, each of the Company, its
subsidiaries and the Operating Companies may be subject to additional state
regulatory requirements, including tariff filing requirements, to begin offering
the telecommunications services for which such entities have been certificated.
Many states also may have additional regulatory requirements such as reporting
and customer service and quality requirements, unbundling and universal service
contributions. In addition, in virtually every state, the Company's certificate
or other authorization is subject to the outcome of proceedings by the state
commission that address regulation of LECs and CLECs, competition, geographic
build-out and service requirements and universal service issues.
Certain of the states where the Operating Companies operate have
adopted specific universal service funding obligations. For example, in
Kentucky, the Operating Company is required to put into escrow, pending the
issuance of final Kentucky universal service rules, an amount equal to six
percent of gross receipts from the provision of intrastate service in Kentucky
once it begins providing intraexchange service. In Pennsylvania, pending the
issuance of final rules, the Operating Company will be required to make a
universal service contribution based on an "assessment rate" derived from
dividing the Operating Company's gross intrastate operating revenues into the
statewide intrastate revenues generated by all other carriers. The Operating
Company's contribution to the Pennsylvania universal service fund will be phased
in over four years with 25 percent of the assessment rate collected in the first
year and equal increments added to the payment in the second, third and fourth
years. Vermont imposes a universal service fund surcharge to finance state
lifeline, relay and E-911 programs, and potentially affordable service in high
cost areas, and also imposes a gross revenues tax, like many other states. In
Kansas, the state regulatory commission has ordered telecommunications companies
to pay approximately 9% of their intrastate retail revenues to the Kansas
Universal Service Fund, beginning March 1, 1997. Proceedings to adopt universal
service funding obligation rules are pending or contemplated in the other states
in which the Operating Companies conduct business.
In addition to obtaining certification, an Operating Company must
negotiate terms of interconnection with the incumbent LEC before it can begin
providing switched services. Under the Telecommunications Act, the FCC has
adopted interconnection requirements, certain portions of which have been
overturned by the Eighth Circuit. See "--Telecommunications Act of
1996--Interconnection with LEC Facilities." To date, a number of the Operating
Companies have negotiated interconnection agreements with one or more of the
incumbent LECs. Specifically, state commissions have approved interconnection
agreements in Kansas (Southwestern Bell), Kentucky (BellSouth; GTE), New Jersey
(Bell Atlantic), Tennessee (BellSouth), Vermont (NYNEX), and Virginia (Bell
Atlantic; Sprint-Centel). In addition, an interconnection agreement has been
approved by operation of law in Pennsylvania (Bell Atlantic). Another
interconnection agreement (with GTE) has been filed and is pending approval
before the Pennsylvania Commission. Finally, Operating Companies in New York
interconnect with NYNEX, pursuant to a NYNEX tariff on file with the New York
Public Service Commission, rather than through interconnection agreements.
Notwithstanding the preceding sentence, the Company has commenced negotiations
with NYNEX in New York with respect to interconnection agreements.
The Operating Companies are not presently subject to price regulation
or rate of return regulation in any state, although there can be no assurance
this will not change when the Operating Companies begin providing switched
services in some states. In most states, an Operating Company is required to
file tariffs setting forth the terms, conditions and prices for intrastate
services. In some states, an Operating Company's tariff lists a rate range or
sets prices on an individual case basis.
Several states have allowed incumbent LECs rate and tariff flexibility,
particularly for services deemed subject to competition. This pricing
flexibility increases the ability of the incumbent LEC to compete with an
Operating Company and constrains the rates an Operating Company may charge for
its services. In light of the additional competition that is expected to result
from the Telecommunications Act, states may grant incumbent LECs additional
pricing flexibility. At the same time, some incumbent LECs may request increases
in local exchange rates to offset revenue losses due to competition.
An investor who acquires as little as ten percent of the Company's
outstanding voting securities may have to obtain approval of certain state
public utility commissions before acquiring such an interest, because such
ownership might be deemed to constitute an indirect controlling interest in the
state Operating Company.
As the Company expands its operations into other states, it may become
subject to the jurisdiction of their respective public service commissions.
Local Government Authorizations
An Operating Company may be required to obtain from municipal
authorities street opening and construction permits, or operating franchises, to
install and expand its fiber optic networks in certain cities. In some cities,
the Local Partners or subcontractors may already possess the requisite
authorizations to construct or expand the Company's networks. An Operating
Company or its Local Partners also may be required to obtain a license to attach
facilities to utility poles in order to build and expand facilities. Because
utilities that are owned by a cooperative or municipality are not subject to
federal pole attachment regulation, there are no assurances that an Operating
Company or its Local Partners will be able to obtain pole attachments from these
utilities at reasonable rates, terms and conditions.
In some of the areas where the Operating Companies provide service,
their Local Partners pay license or franchise fees based on a percent of gross
revenue. In addition, in areas where the Company does not use facilities
constructed by a Local Partner, the Operating Company may be required to pay
such fees. There are no assurances that certain municipalities that do not
currently impose fees will not seek to impose fees in the future, nor is there
any assurance that, following the expiration of existing franchises, fees will
remain at their current levels. In many markets, other companies providing local
telecommunications services, particularly the incumbent LECs, currently are
excused from paying license or franchise fees or pay fees that are materially
lower than those required to be paid by the Operating Company or Local Partner.
The Telecommunications Act requires municipalities to charge nondiscriminatory
fees to all telecommunications providers, but it is uncertain how quickly this
requirement will be implemented by particular municipalities in which the
Company operates or plans to operate or whether it will be implemented without a
legal challenge initiated by the Company or another CLEC.
If any of the existing Local Partner Agreements or Fiber Lease
Agreements held by a Local Partner or an Operating Company for a particular
market were terminated prior to its expiration date and the Local Partner or
Operating Company were forced to remove its fiber optic cables from the streets
or abandon its network in place, even with compensation, such termination could
have a material adverse effect on the Company.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable.
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 27.01 Financial Data Schedule (supplied for the
information of the Commission).
(b) Reports on Form 8-K:
A form 8-K was filed on June 20, 1997 which reported information
under items 5 and 7 thereof. No financial statemnets were filed.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HYPERION TELECOMMUNICATIONS, INC.
(Registrant)
Date: August 14, 1997 By: /s/ Timothy J. Rigas
----------------------
Timothy J. Rigas
Vice Chairman, Chief Financial
Officer (authorized officer),
and Treasurer
Date: August 14, 1997 By: /s/ Edward E. Babcock, Jr.
--------------------------
Edward E. Babcock, Jr.
Vice President, Finance and
Chief Accounting Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Hyperion Telecommunications Inc. Financial Data Schedule for the three months
ended June 30, 1997
</LEGEND>
<CIK> 0001017648
<NAME> HYPERION TELECOMMUNICATIONS INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> JUN-30-1997
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0
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