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 September 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 November 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.
<PAGE>
<TABLE>
<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 September 30, 1997...................3
Condensed Consolidated Statements of Operations - Three and Six months ended
September 30, 1996 and 1997....................................................................4
Condensed Consolidated Statements of Cash Flows - Six months ended
September 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...................................................................................11
Item 3. Quantitative and Qualitative Disclosures about Market Risk....................................30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................31
Item 2. Changes in Securities.........................................................................31
Item 3. Defaults Upon Senior Securities..............................................................31
Item 4. Submission of Matters to a Vote of Security Holders..........................................31
Item 5. Other Information............................................................................32
Item 6. Exhibits and Reports on Form 8-K..............................................................33
SIGNATURES.............................................................................................35
</TABLE>
<PAGE>
Item 1. Financial Statements
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands, except share amounts)
March 31, September 30,
1997 1997
------------ -----------
ASSETS:
Current assets:
Cash and cash equivalents $ 59,814 $ 153,900
Other current assets 768 1,876
---------- ---------
Total current assets 60,582 155,776
U.S. government securities - pledged -- 83,849
Investments 44,685 53,206
Property, plant and equipment - net 53,921 101,832
Other assets - net 15,376 28,053
Deferred income taxes - net 37 37
---------- ---------
Total $ 174,601 $ 422,753
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY):
Current liabilities:
Accounts payable $ 2,342 $ 5,045
Due to affiliates - net 6,081 3,045
Other current liabilities 757 7,083
---------- ---------
Total current liabilities 9,180 15,173
13% Senior Discount Notes due 2003 187,173 200,704
12 1/4% Senior Secured Notes due 2004 -- 250,000
Note payable - Adelphia 25,855 33,089
Other debt 2,647 5,219
---------- ---------
Total liabilities 224,855 504,185
---------- ---------
Commitments and contingencies (Note 3)
Stockholders' equity (deficiency):
Class A Common Stock, $0.01 par value, 300,000,000
shares authorized, 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) (89,802)
---------- ---------
Total stockholders' equity (deficiency) (50,254) (81,432)
---------- ---------
Total $ 174,601 $ 422,753
========== =========
See notes to condensed consolidated financial statements.
<PAGE>
<TABLE>
<CAPTION>
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended Six Months Ended
September 30, September 30,
1996 1997 1996 1997
----------- ----------- --------- ---------
<S> <C> <C> <C> <C>
Revenues $ 1,175 $ 2,187 $ 2,277 $ 3,707
---------- --------- --------- ---------
Operating expenses:
Network operations 728 1,426 1,587 2,606
Selling, general and administrative 1,164 2,879 2,191 5,259
Depreciation and amortization 886 2,311 1,581 3,683
---------- --------- --------- ---------
Total 2,778 6,616 5,359 11,548
---------- --------- --------- ---------
Operating loss (1,603) (4,429) (3,082) (7,841)
Other income (expense):
Gain on sale of investment -- -- 8,405 --
Interest income 1,696 1,463 3,129 2,226
Interest expense and fees (7,108) (11,087) (13,277) (19,164)
---------- --------- --------- ---------
Loss before income taxes and
equity in net loss of joint ventures (7,015) (14,053) (4,825) (24,779)
Income tax benefit 120 -- 117 --
---------- --------- --------- ---------
Loss before equity in net loss of joint ventures (6,895) (14,053) (4,708) (24,779)
Equity in net loss of joint ventures (1,362) (3,886) (2,998) (6,426)
---------- --------- --------- ---------
Net loss $ (8,257) $ (17,939) $ (7,706) $(31,205)
========== ========= ======== ========
Net loss per weighted average share of
common stock $ (0.78) $ (1.67) $ (0.73) $ (2.91)
========== ========= ======== ========
Weighted average shares of common stock outstanding
(in thousands) 10,613 10,735 10,576 10,735
========= ========= ======== ========
See notes to condensed consolidated financial statements.
</TABLE>
<PAGE>
HYPERION TELECOMMUNICATIONS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
Six Months
Ended September 30,
---------------------------
1996 1997
------------ ------------
Cash flows from operating activities:
Net loss $ (7,706) $ (31,205)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 848 2,776
Amortization 733 907
Noncash interest expense 10,865 16,101
Equity in net loss of joint ventures 2,998 6,426
Gain on sale of investment (8,405) --
Issuance of Class A Common Stock Bonus -- 27
Deferred income tax benefit (120) --
Change in operating assets and liabilities net of
effects of acquisitions:
Other assets - net (719) (1,206)
Accounts payable and other current liabilities (586) 5,673
---------- ----------
Net cash used in operating activities (2,092) (501)
---------- ----------
Cash flows from investing activities:
Net cash used for acquisitions (5,040) (7,638)
Expenditures for property, plant and equipment (10,680) (26,231)
Proceeds from sale of investment 11,618 --
Investments in joint ventures (13,991) (26,640)
Investment in U.S. government securities - pledged -- (83,849)
---------- ----------
Net cash used in investing activities (18,093) (144,358)
---------- ----------
Cash flows from financing activities:
Proceeds from debt 163,705 250,000
Repayment of debt -- (317)
Advances (to) from related parties (9,638) 1,567
Proceeds from issuance of stock warrants 11,087 --
Costs associated with debt financing (6,374) (12,305)
Loans to stockholders (3,000) --
Repayment of note payable - Adelphia (25,000) --
---------- ----------
Net cash provided by financing activities 130,780 238,945
---------- ----------
Increase in cash and cash equivalents 110,595 94,086
Cash and cash equivalents, beginning of period -- 59,814
---------- ----------
Cash and cash equivalents, end of period $ 110,595 $ 153,900
========== ==========
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 and six months ended September 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 and six months ended September 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 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, the Company's ownership interest
in each of these markets will increase to 100%.
On August 27, 1997, the Company issued $250,000 aggregate principal
amount of 12 1/4% Senior Secured Notes due September 1, 2004 (the "Senior
Secured Notes") in a private placement. The Senior Secured Notes are
collateralized through the pledge of the common stock of certain of its
wholly-owned subsidiaries. Of the proceeds to the Company of approximately
$244,000, net of commissions and other transaction costs, $83,400 was invested
in U.S. government securities and placed in an escrow account for payment in
<PAGE>
full when due of the first six scheduled semi-annual interest payments on the
Senior Secured Notes as required by the Indenture. The remainder of such
proceeds will be used to fund the acquisition of increased ownership interests
in certain of its networks, for capital expenditures, including the construction
and expansion of new and existing networks, and for general corporate and
working capital purposes.
On September 12, 1997, the Company consummated 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 paid TWEAN
$7,638 and increased its ownership in the networks serving Buffalo and Syracuse,
New York to 60% and 100%, respectively, and eliminated its interest in the
Albany and Binghamton networks, which became wholly owned by TWEAN. Accordingly,
the results of operations of the Buffalo and Syracuse networks have been
included in the Company's consolidated operating results effective September 12,
1997.
On October 9, 1997, the Company issued $200,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due October
15, 2007 in a private placement. Proceeds to the Company, net of commissions and
other transaction costs, were approximately $195,000. Such proceeds will be used
to fund the acquisition of increased ownership interests in certain of its
networks, for capital expenditures, including the construction and expansion of
new and existing networks, and for general corporate and working capital
purposes.
The Company has entered into purchase agreements dated as of October
31, 1997, with subsidiaries of TCI and Sutton Capital Associates, Inc.
("Sutton"), local partners in the New Brunswick and Morristown, NJ networks,
whereby TCI and Sutton will receive approximately $26,000 and $328,
respectively, for their partnership interests in these New Jersey networks. Upon
consummation of these transactions, which are subject to normal closing
conditions and receipt of regulatory approval, the Company's ownership interest
in these networks 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.
<PAGE>
The Company's nonconsolidated investments are as follows:
<TABLE>
<CAPTION>
Ownership March 31, September 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 (1) 4,683 8,769
NewChannels Hyperion Telecommunications (Albany) -- (2) 924 --
NewChannels Hyperion Telecommunications (Binghamton) -- (2) 504 --
NHT Partnership (Buffalo) 60.0 (1)(3) 4,717 --
NewChannels Hyperion Telecommunications (Syracuse) 100.0 (4) 4,215 --
Hyperion of Harrisburg 50.0 (1) 5,246 9,975
Alternet of Virginia (Richmond) 37.0 7,018 7,212
New Jersey Fiber Technologies (New Brunswick and Morristown) 19.7 (1) 3,340 3,519
PECO-Hyperion (Philadelphia; and Allentown, Bethlehem, Easton, Reading
"ABER") 50.0 10,750 16,523
Lexington Lightwave 50.0 (1) 2,311 4,346
Hyperion of York 50.0 1,402 2,000
Entergy Hyperion Telecommunications of Louisiana 50.0 -- 1,050
Entergy Hyperion Telecommunications of Mississippi 50.0 -- 1,350
Entergy Hyperion Telecommunications of Arkansas 50.0 -- 1,100
Other Various 949 1,243
---------------- --------------------
56,695 68,372
Cumulative equity in net losses (12,010) (15,166)
---------------- --------------------
Total Investments $ 44,685 $ 53,206
================ ====================
<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 increase
its ownership to 100% in these networks.
(2) As discussed below, the Company consummated an agreement which eliminated
its interest in these networks. The previous ownership percentages in the Albany
and Binghamton networks were 50% and 20% respectively.
(3) As discussed below, the Company consummated an agreement which increased
its ownership in the Buffalo network to 60% from 40% and accordingly has
consolidated this investment effective September 12, 1997.
(4) As discussed below, the Company consummated an agreement which increased
its ownership in the Syracuse network to 100% from 50% and accordingly
has consolidated this investment effective September 12, 1997.
</FN>
</TABLE>
<PAGE>
Summarized combined unaudited financial information for the
Company's investments being accounted for using the equity method of accounting,
excluding the entities involved in the TWEAN agreement (Albany, Binghamton,
Buffalo and Syracuse networks) as of and for the periods ended, is as follows:
March 31, September 30,
1997 1997
------------- --------------
Current assets $ 3,843 $ 9,261
Non-current assets 134,680 171,935
Current liabilities 5,629 13,462
Non-current liabilities 43,974 53,956
Six months ended September 30,
-----------------------------
1996 1997
------------- --------------
Revenues $ 3,261 $ 6,615
Net loss (6,438) (12,289)
<PAGE>
On September 12, 1997, the Company consummated an agreement with TWEAN
to exchange interests in four New York CLEC networks. As a result of the
transaction, the Company paid TWEAN $7,638 and increased its ownership in the
networks serving Buffalo and Syracuse, New York to 60% and 100%, respectively,
and eliminated its interest in the Albany and Binghamton networks, which became
wholly owned by TWEAN. Accordingly, the results of operations of the Buffalo and
Syracuse networks have been included in the Company's consolidated operating
results effective September 12, 1997. The following unaudited financial
information of the Company assumes that this transaction had occurred on April
1, 1996.
Six Months Ended
September 30,
-----------------------------
1996 1997
------------- --------------
Revenues $ 3,473 $ 5,047
Net loss (7,728) (31,689)
Net loss per weighted average
share of common stock (.73) (2.95)
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.
4. Supplemental Cash Flow Information:
The Company has an unsecured subordinated Note payable to Adelphia due
April 16, 2003. This obligation bears interest at 16.5% per annum with interest
payable quarterly in cash; by issuing additional subordinated notes; or a
combination of cash and additional subordinated notes, all of which is at the
Company's option. Interest converted to additional subordinated note principal
totaled $7,234 for the six months ended September 30, 1997.
On September 12, 1997, the Company and TWEAN consummated a transaction
whereby a partnership that owned three operating networks was liquidated. Prior
to the liquidation, the Company contributed approximately $5,700 in cash to the
partnership and upon liquidation the Company received 100% ownership in the
Syracuse network and TWEAN received 100% ownership in the Albany and Binghamton
networks and the cash contributed.
-------------------------------------------------
<PAGE>
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 and six
months ended September 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 20 telecommunications networks (including five networks under
construction) owned as of September 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 September 30, 1997, the Company has experienced substantial growth,
building from its original two partnerships covering two networks to covering 20
networks and 42 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.
As of September 30, 1997, the Company's Operating Companies are made up
of four wholly-owned subsidiaries, two partnerships in which it is a majority
owner and 11 joint venture investments (through which the Company has an
interest in 14 networks) in which the Company owns 50% or less. Results of the
wholly and majority owned subsidiaries and partnerships 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
<PAGE>
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. Proforma for the
purchase of certain partners' interests, (see "Recent Developments"), Hyperion's
weighted average ownership in these Operating Companies will be 73%, based upon
gross property plant and equipment.
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.
The Company initiated its switched services deployment plan in 1997 and
currently provides switched services in 13 markets, ten of which were placed in
operation during the six month period ended September 30, 1997, with switching
for the remaining operating markets expected to be operational by the end of
fiscal 1998. In the markets it currently serves, the Company estimates that
there are approximately 11 million business access lines in service. The Company
has experienced initial success in the sale of access lines with approximately
16,000 access lines sold as of September 30, 1997, of which approximately 5,500
lines are installed, all of which are serviced over the Company's networks.
Since its inception through September 30, 1997, the Company, in
conjunction with its local partners, has made substantial investments totaling
approximately $357,600 in designing, constructing and enhancing the Operating
Companies' fiber optic networks. As of September 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 $312,600. As of September 30, 1997, the Company's
operating networks had approximately 3,561 route miles, approximately 170,945
fiber miles and were connected to approximately 1,645 buildings and 105 LEC
central offices ("COs").
Recent Developments
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
<PAGE>
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 networks, whereby TCI will receive
approximately $18,300 in cash for TCI's partnership interest in these networks.
Upon consummation of this transaction, which is subject to normal closing
conditions and receipt of regulatory approval, the Company's ownership interest
in each of these networks will increase to 100%.
On August 27, 1997, the Company issued $250,000 aggregate principal
amount of 12 1/4% Senior Secured Notes due September 1, 2004 (the "Senior
Secured Notes") in a private placement. The Senior Secured Notes are
collateralized through the pledge of the common stock of certain of its
wholly-owned subsidiaries. Of the proceeds to the Company of approximately
$244,000, net of commissions and other transaction costs, $83,400, was invested
in U.S. government securities and placed in an escrow account for payment in
full when due of the first six scheduled semi-annual interest payments on the
Senior Secured Notes as required by the Indenture. The remainder of such
proceeds will be used to fund the acquisition of increased ownership interests
in certain of it's networks, for capital expenditures, including the
construction and expansion of new and existing networks, and for general
corporate and working capital purposes.
On September 12, 1997, the Company consummated 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 paid TWEAN
$7,638 and increased its ownership in the networks serving Buffalo and Syracuse,
New York to 60% and 100%, respectively, and eliminated its interest in the
Albany and Binghamton networks, which became wholly owned by TWEAN. Accordingly,
the results of operations of the Buffalo and Syracuse networks have been
included in the Company's consolidated operating results effective September 12,
1997.
On October 9, 1997, the Company issued $200,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due October
15, 2007 in a private placement. Proceeds to the Company, net of commissions and
other transaction costs, were approximately $195,000. Such proceeds will be used
to fund the acquisition of increased ownership interests in certain of its
networks, for capital expenditures, including the construction and expansion of
new and existing networks, and for general corporate and working capital
purposes.
The Company has entered into purchase agreements dated as of October
31, 1997, with subsidiaries of TCI and Sutton Capital Associates, Inc.
("Sutton"), local partners in the New Brunswick and Morristown, NJ networks,
whereby TCI and Sutton will receive approximately $26,000 and $328,
respectively, for their partnership interests in these New Jersey networks. Upon
consummation of these transactions, which are subject to normal closing
conditions and receipt of regulatory approval, the Company's ownership interest
in these networks will increase to 100%.
Results of Operations
Three Months Ended September 30, 1997 in Comparison with Three Months Ended
September 30, 1996
Revenues increased 86% to $2,187 for the three months ended September
30, 1997, from $1,175 for the same quarter in the prior fiscal year. Growth in
<PAGE>
revenues of $1,012 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.
Network operations expense increased 96% to $1,426 for the three months
ended September 30, 1997 from $728 for the same quarter in the prior fiscal
year. The increase was attributable to the expansion of operations at the NOCC
as well as the increased number and size of the Operating Companies which
resulted in increased employee related costs and equipment maintenance costs.
Selling, general and administrative expense increased 147% to $2,879
for the three months ended September 30, 1997 from $1,164 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, size and
operations of Operating Companies managed and monitored by the Company.
Depreciation and amortization expense increased 161% to $2,311 during
the three months ended September 30, 1997 from $886 for the same quarter in the
prior fiscal year primarily as a result of increased depreciation resulting from
the higher depreciable asset base at the NOCC and the majority and wholly owned
Operating Companies.
Interest income for the three months ended September 30, 1997 decreased
14% to $1,463 from $1,696 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, offset by the interest income on
the investment of the proceeds of the Senior Secured Notes.
Interest expense and fees increased 56% to $11,087 during the three
months ended September 30, 1997 from $7,108 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 and interest on the Senior
Secured Notes.
Equity in net loss of joint ventures increased by 185% to $3,886 during
the three months ended September 30, 1997 from $1,362 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
September 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 September 30, 1996 to 12 at September
30, 1997. These Operating Companies and networks under construction paid
management and monitoring fees to the Company, which are included in revenues,
aggregating approximately $839 for the three months ended September 30, 1997, as
compared with $736 for the same quarter in the prior fiscal year. The
nonconsolidated Operating Companies' net losses, including networks under
construction, but not including the Albany, Binghamton, Buffalo, and Syracuse
networks, for the three months ended September 30, 1996 and 1997 aggregated
approximately $3,686 and $7,336 respectively.
Net loss increased from $8,257 for the three months ended September 30,
1996 to $17,939 for the same quarter in the current fiscal year. The increased
net loss was primarily attributable to increases in operating losses, interest
expense and equity in the net losses of the Company's joint ventures.
<PAGE>
Six Months Ended September 30, 1997 in Comparison with Six Months Ended
September 30, 1996
Revenues increased 63% to $3,707 for the six months ended September 30,
1997 from $2,277 for the same period in the prior fiscal year. Growth in
revenues of $1,430 resulted from continued expansion in the number and size of
Operating Companies and the resultant increase in management fees of $135 over
the same period in the prior fiscal year. Revenues from majority and
wholly-owned Operating Companies also increased approximately $1,191 as compared
to the same period in the prior fiscal year due to increases in the customer
base.
Network operations expense increased 64% to $2,606 for the six months
ended September 30, 1997 from $1,587 for the same period in the prior fiscal
year. Substantially all of the increase was attributable to the expansion of
operations at the NOCC, as well as the increased number and size of the
Operating Companies which resulted in increased employee related costs and
equipment maintenance costs.
Selling, general and administrative expense increased 140% to $5,259
for the six months ended September 30, 1997 from $2,191 for the same period in
the prior fiscal year. Corporate and NOCC overhead costs increased due to growth
in the number of Operating Companies managed and monitored by the Company.
Depreciation and amortization expense increased 133% to $3,683 during
the six months ended September 30, 1997 from $1,581 for the same period in the
prior fiscal year primarily as a result of increased depreciation resulting from
higher capital expenditures, and thus a higher depreciable asset base, at the
NOCC and the wholly and majority owned Operating Companies.
Interest income for the six months ended September 30, 1997 decreased
by 29% to $2,226 from $3,129 for the same period 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 offset by the interest income on the investment
of the proceeds of the Senior Secured Notes.
Interest expense and fees increased 44% to $19,164 during the six
months ended September 30, 1997 from $13,277 for the same period in the prior
fiscal year. The increase was directly attributable to interest expense
associated with the 13% Senior Discount Notes and the Senior Secured Notes.
Equity in net loss of joint ventures increased by 114% to $6,426 during
the six months ended September 30, 1997 from $2,998 for the same period in the
prior fiscal year as more nonconsolidated Operating Companies began operations.
The net losses of the Operating Companies for the six months ended September 30,
1997 were primarily the result of 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 September 30, 1996 to 12 at September
30, 1997. These Operating Companies and networks under construction paid
management and monitoring fees to the Company, which are included in revenues,
aggregating approximately $1,669 for the six months ended September 30, 1997, an
increase of approximately $135 over the same period in the prior fiscal year.
The nonconsolidated Operating Companies' net losses, including networks under
construction, but not including the Albany, Binghamton, Buffalo, and Syracuse
networks, for the six months ended September 30, 1997 aggregated approximately
$12,289.
<PAGE>
Net loss increased from $7,706 for the six months ended September 30,
1996 to $31,205 for the same period in the current fiscal year. The increase was
primarily attributable to a higher operating loss, interest expense, equity in
the net losses of the Company's joint ventures, and no gain similar to that
recognized in the prior period for the sale of the Company's investment in TCG
of South Florida.
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 information below includes the results of Albany and
Binghamton, NY networks through September 12, 1997. The financial information
set forth below, however, is not indicative of the Company's overall financial
position.
<TABLE>
<CAPTION>
REVENUES
------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
September 30, September 30,
Cluster 1996 1997 1996 1997
- -------
-------------------- ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Northeast $ 1,296 $ 2,068 $ 2,561 $ 3,595
Mid-Atlantic 467 1,512 812 2,706
Mid-South 276 522 515 948
Other Networks 1,212 2,182 2,289 4,378
-------------------- --------------------- --------------------- ----------------------
Total $ 3,251 $ 6,284 $ 6,177 $ 11,627
==================== ===================== ===================== ======================
</TABLE>
<PAGE>
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.
<TABLE>
<CAPTION>
EBITDA
------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
September 30, September 30,
Cluster 1996 1997 1996 1997
- -------
-------------------- ------------------ ------------------ ------------------
<S> <C> <C> <C> <C>
Northeast $ 43 $ 226 $ 258 $ (231)
Mid-Atlantic (1,026) (1,993) (1,779) (3,152)
Mid-South (193) (758) (424) (1,037)
Other Networks 431 642 684 1,254
-------------------- --------------------- --------------------- ----------------------
Total $ (745) $ (1,883) $ (1,261) $ (3,166)
==================== ===================== ===================== ======================
Capital Expenditures
------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
September 30, September 30,
Cluster 1996 1997 1996 1997
- -------
-------------------- ------------------ ------------------ ------------------
Northeast $ 8,161 $ 3,985 $ 10,192 $ 9,181
Mid-Atlantic 24,264 6,914 32,066 27,909
Mid-South 4,580 10,365 6,190 20,627
Other Networks 4,340 3,841 6,784 16,471
-------------------- --------------------- --------------------- ----------------------
Total $ 41,345 $ 25,105 $ 55,232 $ 74,188
==================== ===================== ===================== ======================
</TABLE>
<PAGE>
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 $10,680 and $26,231 for the six months ended September 30, 1996 and 1997,
respectively. Further, investments made by the Company in nonconsolidated
Operating Companies were $13,991 and $26,640 for the six months ended September
30, 1996 and 1997, respectively. The significant increase for the six months
ended September 30, 1997 as compared with the same period in the prior fiscal
year is largely attributable to capital expenditures necessary to enter and
develop 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.
On August 27, 1997, the Company issued $250,000 aggregate principal
amount of 12 1/4% Senior Secured Notes due September 1, 2004 (the "Senior
Secured Notes") in a private placement. The Senior Secured Notes are
collateralized through the pledge of the common stock of certain of its
wholly-owned subsidiaries. Of the proceeds to the Company of approximately
$244,000, net of commissions and other transaction costs, $83,400, was invested
in U.S. government securities and placed in an escrow account for payment in
full when due of the first six scheduled semi-annual interest payments on the
Senior Secured Notes as required by the Indenture. The remainder of such
proceeds will be used to fund the acquisition of increased ownership interests
in certain of its networks, for capital expenditures, including the construction
and expansion of new and existing networks, and for general corporate and
working capital purposes.
On October 9, 1997, the Company issued $200,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due October
15, 2007. Proceeds to the Company, net of commissions and other transaction
costs, were approximately $195,000. Such proceeds will be used to fund the
acquisition of increased ownership interests in certain of it's networks, for
capital expenditures, including the construction and expansion of new and
existing networks, and for general corporate and working capital purposes.
The Company recently received a firm commitment for a $25,000 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 December 1997 quarter.
Through September 30, 1997, Adelphia has made loans and advances
totaling approximately $70,900, including accrued interest, to the Company and
leased $3,400 in fiber network construction to certain Operating Companies.
During April 1996, the Company repaid $37,800 of such loans and advances. In
addition, Local Partners have invested approximately $85,600 as their pro rata
investment in those networks through September 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 $56,300 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
$141,400 to fund its pro rata investment in the networks, capital expenditures
and operations. Collectively, these investments and the Fiber Lease Financings
have totaled $357,600 from the Company's inception through September 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 and majority-owned networks and its state-of-the-art
NOCC, and incremental investments in the Operating Companies has resulted in
<PAGE>
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 on borrowings from
Adelphia 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 existing networks and (iii) the
design, construction and development of additional networks. The Company plans
to make substantial capital investments and investments in Operating Companies
in connection with the deployment of switches in all of its operating markets by
the end of fiscal 1998. In addition, the Company intends to increase spending on
marketing and sales significantly in the foreseeable future in connection with
the expansion of its sales force and marketing efforts generally. The Company
estimates that is will require approximately $230,000 to $260,000 to fund
anticipated capital expenditures, working capital requirements and operating
losses of the Company, investments in its existing Operating Companies and the
acquisition of 100% of the ownership interests in the Buffalo, Louisville,
Lexington, New Brunswick and Morristown networks through the fiscal year ending
March 31, 1999. In addition, expansion of the Company's networks will include
the geographic expansion of the Company's existing clusters and the 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 utility partners and, in the future, the Company may increase its
ownership in the Operating Companies and acquire existing networks. The Company
expects that it will have adequate resources to fund such expenditures through
the net proceeds from the 13% Senior Discount Notes and related Warrants, the
Senior Secured Notes, the 12 7/8% Senior Exchangeable Redeemable Preferred Stock
offerings, anticipated bank and/or vendor financings by the Operating Companies,
internal sources of funds, including cash flow from operations generated by the
Company, and additional debt or equity financings, as appropriate. There can be
no assurance, however, as to the availability of funds from internal cash flow
or from the private or public equity or debt markets. In addition, the
expectations of required future capital expenditures are based on the Company's
current estimate. There can be no assurance that actual expenditures will not
significantly exceed current estimates or that the Company will not accelerate
its capital expenditures program.
In addition, the Company expects that pro rata investments by the
Company and its Local Partners as well as Fiber Lease Financings and anticipated
bank or vendor financings will be adequate to fund the requirements of the
Operating Companies for capital expenditures, operating losses and working
capital for existing networks, networks currently under construction and certain
of the Company's planned additional markets during fiscal years 1998 and 1999.
There can be no assurance 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 indentures relating to the 13% Senior Discount
Notes and the Senior Secured 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.
<PAGE>
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
<PAGE>
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.
<PAGE>
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.
Dependence on RBOCs and incumbent LECs. While the Telecommunications
Act generally requires incumbent LECs, including RBOCs, to offer
interconnection, unbundled network elements and resold services to CLECs,
LEC-CLEC interconnection agreements may have short terms, requiring the CLEC to
continually renegotiate the agreements. LECs may not provide timely provisioning
or adequate service quality thereby impairing a CLEC's reputation with customers
who can easily switch back to the LEC. In addition, the prices set in the
agreements may be subject to significant rate increases if state regulatory
commissions establish prices designed to pass on to the CLECs part of the cost
of providing universal service.
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.
<PAGE>
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.
On October 14, 1997, the Eighth Circuit issued an Order on Rehearing of
the ruling that incumbent LECs need not provide combinations of network elements
to CLECs, even when the incumbent LEC has already combined the same elements
within its network. This recent Order broadens the restrictions previously
placed on combinations of network elements by the Eighth Circuit in its July
18,1997 opinion striking down many of the pricing and unbundling rules issued by
the FCC. In the July 18 opinion, the Eighth Circuit held, among other things,
that incumbent LECs had no obligation under the Telecommunications Act to
combine network elements for CLECs. The court held that the incumbent LECs' only
obligation with respect to unbundling was to provide CLECs with access to the
individual network elements, leaving each CLEC to combine those network elements
itself. Accordingly, the Eighth Circuit vacated Section 51.315 (c)-(f) of the
FCC's unbundling rules, which had required incumbent LECs to combine network
elements at the request of CLECs except where such combinations were technically
infeasible or would impair the quality of the network. As a result of this
Order, incumbent LECs can now separate already combined network elements before
handing them off to the CLEC to recombine. The Company expects that this issue
will be incorporated among the issues that will likely be argued before the
Supreme Court on appeal.
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
<PAGE>
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
incumbent 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. On September 30,
1997, BellSouth filed a request with the FCC for in-region interLATA service in
<PAGE>
South Carolina, and a similar request is expected for Louisiana in the near
future. More RBOC requests to provide in-region interLATA service are expected
to be filed with the FCC during the coming year.
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. 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 the Company's petition, the FCC requested further comment on whether
not 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 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,
<PAGE>
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. On
August 4, 1997, the FCC released its Universal Service worksheet which estimates
a universal service contribution of 9% of total interstate and international
revenues. Although the actual contribution is expected to be lower, the
Company's actual contribution cannot be determined until the FCC finalizes its
universal service cost mechanisms. Also, the FCC's existing system for
subsidizing universal service remains in effect and only ILECs are likely to be
eligible to receive such subsidies until such time as the FCC determines the new
subsidy mechanism, even though CLECs like Hyperion may be obligated to provide
universal service.
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
<PAGE>
not unreasonably discriminatory, subject to the complaint provisions of the
Communications Act of 1934, as amended.
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
<PAGE>
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, Louisiana,
Mississippi, New Jersey, New York, Pennsylvania, Tennessee, Vermont and
Virginia. The certificates or other authorizations in Florida, Kentucky,
Louisiana, Mississippi, New Jersey, New York, Tennessee, Vermont and Virginia
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 telecommunications services are pending in Arkansas and Kansas. 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, mandatory detariffing, 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
<PAGE>
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, two interconnection agreements have been
approved by operation of law in Pennsylvania (Bell Atlantic; GTE). Finally,
Operating Companies in New York interconnect with NYNEX (BA), pursuant to NYNEX
tariffs on file with the New York Public Service Commission, rather than through
interconnection agreements. The Operating companies have signed an
interconnection agreement in Arkansas (Southwestern Bell) and are negotiating an
interconnection agreement with NYNEX (BA) in New York.
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, special contract
(selective discounting) 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.
Several northeastern states have required NYNEX to comply with the
Telecommunications Act's requirements for in-region interLATA service as a
condition to approval of its merger with Bell Atlantic. Such requirements may
serve to expedite NYNEX-Bell Atlantic's entry into this marker and may also
reduce the incentive these RBOCs now have to negotiate and renegotiate
interconnection agreements with the Operating Companies since the existence of
such agreements is a prerequisite to such entry.
Local Government Authorizations
An Operating Company may be required to obtain from municipal
authorities street opening and construction permits, or operating franchises, to
<PAGE>
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 certain
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
(c) Sales of Unregistered Securities
On March 4, 1997 and April 1, 1997, the Company issued 104,000 shares
and 18,000 shares, respectively, of Class A Common Stock of the Company to
Daniel R. Milliard, the President of the Company, as stock bonus awards pursuant
to his employment agreement. Such issuances were made under the Company's 1996
Long-Term Incentive Compensation Plan pursuant to the exemption from
registration under Section 4(2) of the Securities Act.
On June 13, 1997, the Company issued a warrant to MCIMetro Access
Transmission Services, Inc. ("MCI") to purchase 281,040 shares of Class A Common
Stock of the Company, which expires June 13, 2000, 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. The warrant was issued in reliance on the exemption from
registration under Section 4(2) of the Securities Act in connection with the
Company's designation as MCI's preferred provider of certain products and
services in the Company's markets pursuant to a new Preferred Provider Agreement
between the parties.
On October 9, 1997, Hyperion issued $200,000,000 aggregate liquidation
preference of 12 7/8% Senior Exchangeable Redeemable Preferred Stock due 2007
(the "Preferred Stock") in a private placement to institutional investors
pursuant to exemptions from registration under Section 4(2) of the Securities
Act and Rule 144A and in reliance upon Regulation S. Gross proceeds were
$200,000,000 and net proceeds were approximately $195,000,000 after underwriting
discounts and commissions of approximately $5,000,000 and other transaction
costs. The initial purchaser for the Preferred Stock was Bear Stearns & Co. Inc.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
<PAGE>
Item 5. Other Information
The attached Exhibit 99.01 provides certain financial and business
information of the Company for the three months ended September 30, 1997,
pursuant to Section 4.03(a)(iii) of the Indenture dated April 15, 1996 with
respect to the 13% Senior Discount Notes.
The attached Exhibit 99.02 provides certain financial and business
information of the Company for the three months ended September 30, 1997,
pursuant to Section 4.03(a)(iii) of the Indenture dated August 27, 1997 with
respect to the 12 1/4% Senior Secured Notes.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit 3.01 Certificate of Incorporation of Registrant, together with all
amendments thereto (Incorporated herein by reference is Exhibit
3.01 to Registrant's Current Report on Form 8-K for the event
dated October 9, 997
Exhibit 4.01 Indenture, dated as of August 27, 1997, with respect to
Registrant's 12 1/4% Senior Secured Notes due 2004, between the
Registrant and the Bank of Montreal Trust Company. (Incorporated
herein by reference is Exhibit 4.01 to Form 8-K for the event
dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.02 Form of 12 1/4% Senior Secured Note due 2004. (Contained in
Exhibit 4.01 to Registrant's Current Report on Form 8-K for the
event dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.03 Pledge Agreement between the Registrant and the Bank of Montreal
Trust Company as Collateral Agent, dated as of August 27, 1997.
(Incorporated herein by reference is Exhibit 4.03 to Form 8-K for
the event dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.04 Registration Rights Agreement between the Registrant and the
Initial Purchasers, dated August 27, 1997, regarding the 12 1/4%
Senior Secured Notes due 2004. (Incorporated herein by reference is
Exhibit 4.04 to Form 8-K for the event dated August 27, 1997 (File
No. 0-21605)).
Exhibit 4.05 Pledge, Escrow and Disbursement Agreement, between the Registrant
and the Bank of Montreal Trust Company, dated as of August 27,1997.
(Incorporated herein by reference is Exhibit 4.05 to Form 8-K for
the event dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.06 Second Supplemental Indenture, dated as of August 27, 1997, between
the Registrant and the Bank of Montreal Trust Company, regarding
the Registrant's 13% Senior Discount Notes due 2003. (Incorporated
herein by reference is Exhibit 4.06 to Form 8-K for the event dated
August 27, 1997 (File No. 0-21605)).
Exhibit 4.07 Certificate of Designation for 12 7/8% Series A and Series B Senior
Exchangeable Redeemable Preferred Stock due 2007. (Contained in
Exhibit 3.01 to Registrant's Current Report on Form 8-K for the
event dated October 9, 1997 which is incorporated herein by
reference.)
Exhibit 4.08 Form of Certificate for 12 7/8% Senior Exchangeable Redeemable
Preferred Stock due 2007. (Incorporated herein by reference is
Exhibit 4.02 to the Registrant's Current Report on Form 8-K for the
event dated October 9, 1997.)
Exhibit 4.09 Form of Indenture, with respect to the Registrant's 12 7/8%
Senior Subordinated Exchange Debentures due 2007. (Contained as
Annex A in Exhibit 3.01 to Registrant's Current Report on Form 8-K
for the event dated October 9, 1997 which is incorporated herein by
reference.)
Exhibit 4.10 Registration Rights Agreement between the Registration and the
Initial Purchaser dated October 9, 1997, regarding the 12 7/8%
Senior Exchangeable Redeemable Preferred Stock due 2007.
(Incorporated herein by reference is Exhibit 4.04 to the
Registrant's Current Report on Form 8-K for the event dated October
9, 1997.)
Exhibit 10.01 Purchase Agreement among the Registrant, Bear Stearns & Co. Inc.,
Chase Securities Inc., TD Securities (USA) Inc., CIBC Wood Gundy
Securities Corp., and Scotia Capital Markets dated August 21, 1997.
(Incorporated herein by reference is Exhibit 10.01 to Form 8-K for
the event dated August 27, 1997 (File No. 0-21605).)
Exhibit 10.02 Purchase Agreement among the Registrant and Bear Stearns & Co.
Inc. (the "Initial Purchaser") dated October 1, 1997, regarding the
12 7/8% Senior Exchangeable Redeemable Preferred Stock due 2007.
(Incorporated by reference is Exhibit 10.01 to the Registrant's
Current Report on Form 8-K for the event dated October 9, 1997.)
Exhibit 27.01 Financial Data Schedule (supplied for the information of the
Commission).
Exhibit 99.01 "Schedule E - Form of Financial Information and Operating Data of
the Subsidiaries and the Joint Ventures Presented by Cluster".
Exhibit 99.02 "Schedule F - Form of Financial Information and Operating Data of
the Pledged Subsidiaries and the Joint Ventures".
(b) Reports on Form 8-K:
Form 8-Ks were filed on August 14, August 26, August 29, September 15,
October 7 and October 23, 1997 which reported information under items 5 and
7 thereof. No financial statements 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: November 13, 1997 By: /s/ Timothy J. Rigas
----------------------
Timothy J. Rigas
Vice Chairman, Chief Financial
Officer (authorized officer) and
Treasurer
Date: November 13, 1997 By: /s/ Edward E. Babcock, Jr.
--------------------------
Edward E. Babcock, Jr.
Vice President, Finance and Chief
Accounting Officer
<PAGE>
Exhibit Index
Exhibit 3.01 Certificate of Incorporation of Registrant, together with all
amendments thereto (Incorporated herein by reference is Exhibit
3.01 to Registrant's Current Report on Form 8-K for the event
dated October 9, 997
Exhibit 4.01 Indenture, dated as of August 27, 1997, with respect to
Registrant's 12 1/4% Senior Secured Notes due 2004, between the
Registrant and the Bank of Montreal Trust Company. (Incorporated
herein by reference is Exhibit 4.01 to Form 8-K for the event
dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.02 Form of 12 1/4% Senior Secured Note due 2004. (Contained in
Exhibit 4.01 to Registrant's Current Report on Form 8-K for the
event dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.03 Pledge Agreement between the Registrant and the Bank of Montreal
Trust Company as Collateral Agent, dated as of August 27, 1997.
(Incorporated herein by reference is Exhibit 4.03 to Form 8-K for
the event dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.04 Registration Rights Agreement between the Registrant and the
Initial Purchasers, dated August 27, 1997, regarding the 12 1/4%
Senior Secured Notes due 2004. (Incorporated herein by reference is
Exhibit 4.04 to Form 8-K for the event dated August 27, 1997 (File
No. 0-21605)).
Exhibit 4.05 Pledge, Escrow and Disbursement Agreement, between the Registrant
and the Bank of Montreal Trust Company, dated as of August 27,1997.
(Incorporated herein by reference is Exhibit 4.05 to Form 8-K for
the event dated August 27, 1997 (File No. 0-21605)).
Exhibit 4.06 Second Supplemental Indenture, dated as of August 27, 1997, between
the Registrant and the Bank of Montreal Trust Company, regarding
the Registrant's 13% Senior Discount Notes due 2003. (Incorporated
herein by reference is Exhibit 4.06 to Form 8-K for the event dated
August 27, 1997 (File No. 0-21605)).
Exhibit 4.07 Certificate of Designation for 12 7/8% Series A and Series B Senior
Exchangeable Redeemable Preferred Stock due 2007. (Contained in
Exhibit 3.01 to Registrant's Current Report on Form 8-K for the
event dated October 9, 1997 which is incorporated herein by
reference.)
Exhibit 4.08 Form of Certificate for 12 7/8% Senior Exchangeable Redeemable
Preferred Stock due 2007. (Incorporated herein by reference is
Exhibit 4.02 to the Registrant's Current Report on Form 8-K for the
event dated October 9, 1997.)
Exhibit 4.09 Form of Indenture, with respect to the Registrant's 12 7/8%
Senior Subordinated Exchange Debentures due 2007. (Contained as
Annex A in Exhibit 3.01 to Registrant's Current Report on Form 8-K
for the event dated October 9, 1997 which is incorporated herein by
reference.)
Exhibit 4.10 Registration Rights Agreement between the Registration and the
Initial Purchaser dated October 9, 1997, regarding the 12 7/8%
Senior Exchangeable Redeemable Preferred Stock due 2007.
(Incorporated herein by reference is Exhibit 4.04 to the
Registrant's Current Report on Form 8-K for the event dated October
9, 1997.)
Exhibit 10.01 Purchase Agreement among the Registrant, Bear Stearns & Co. Inc.,
Chase Securities Inc., TD Securities (USA) Inc., CIBC Wood Gundy
Securities Corp., and Scotia Capital Markets dated August 21, 1997.
(Incorporated herein by reference is Exhibit 10.01 to Form 8-K for
the event dated August 27, 1997 (File No. 0-21605).)
Exhibit 10.02 Purchase Agreement among the Registrant and Bear Stearns & Co.
Inc. (the "Initial Purchaser") dated October 1, 1997, regarding the
12 7/8% Senior Exchangeable Redeemable Preferred Stock due 2007.
(Incorporated by reference is Exhibit 10.01 to the Registrant's
Current Report on Form 8-K for the event dated October 9, 1997.)
Exhibit 27.01 Financial Data Schedule (supplied for the information of the
Commission).
Exhibit 99.01 "Schedule E - Form of Financial Information and Operating Data of
the Subsidiaries and the Joint Ventures Presented by Cluster".
Exhibit 99.02 "Schedule F - Form of Financial Information and Operating Data of
the Pledged Subsidiaries and the Joint Ventures".
Exhibit 99.01
<TABLE>
<CAPTION>
SCHEDULE E
Hyperion Telecommunications, Inc.
Form of Financial Information and Operating Data
of the Subsidiaries and the Joint Ventures Presented by Cluster
Data presented for the quarter ended: 9/30/97
Unaudited ***
North East Mid-Atlantic Mid-South Other Networks Total
FINANCIAL DATA (dollars in thousands):
<S> <C> <C> <C> <C> <C>
Total Revenue $ 2,068.2 $ 1,512.0 $ 521.9 $ 2,181.6 $ 6,283.7
Total Capital Expenditures $ 3,985.1 $ 6,913.7 $ 10,365.3 $ 3,840.7 $ 25,104.8
Total EBITDA $ 225.7 $ (1,992.7) $ (757.4) $ 642.0 $ (1,882.4)
Gross Property, Plant & Equipment $ 62,020.5 $ 116,921.0 $ 47,323.2 $ 77,806.6 $ 304,071.3
Proportional Revenue * $ 1,610.7 $ 673.7 $ 387.2 $ 558.6 $ 3,230.2
Proportional Capital Expenditures * $ 3,631.2 $ 3,646.0 $ 5,507.6 $ 3,293.1 $ 16,077.9
Proportional EBITDA * $ 388.1 $ (1,030.1) $ (488.0) $ 230.8 $ (899.2)
Proportional Gross PP&E * $ 43,505.2 $ 52,365.6 $ 32,333.1 $ 53,466.4 $ 181,670.3
STATISTICAL DATA
Increase for September 30, 1997 quarter:
Networks in Operation
Route Miles (212) 45 73 15 (79)
Fiber Miles (10,198) 2,172 3,495 768 (3,763)
Buildings connected (41) 61 19 3 42
LEC-COs collocated ** (2) - 1 - (1)
Voice Grade Equivalent Circuits (16,032) 8,592 2,592 (5,568) (10,416)
As of June 30, 1997:
Networks in Operation
Route Miles 1,128 1,248 506 758 3,640
Fiber Miles 54,156 59,885 24,283 36,384 174,708
Buildings connected 366 457 436 344 1,603
LEC-COs collocated ** 14 59 17 16 106
Voice Grade Equivalent Circuits 132,288 170,304 64,488 164,064 531,144
As of September 30, 1997:
Networks in Operation
Route Miles 916 1,293 579 773 3,561
Fiber Miles 43,958 62,057 27,778 37,152 170,945
Buildings connected 325 518 455 347 1,645
LEC-COs collocated ** 12 59 18 16 105
Voice Grade Equivalent Circuits 116,256 178,896 67,080 158,496 520,728
<FN>
* Represents portion of revenue attributable to the Company.
** Local Exchange Carrier's central office
*** Other Network amounts includes Network Control Centers and Corporate Capital Expenditures
and Gross Property, Plant and Equipment
</FN>
</TABLE>
Exhibit 99.02
SCHEDULE F
Hyperion Telecommunications, Inc.
Form of Financial Information and Operating Data
of the Pledged Subsidiaries and the Joint Ventures
Data presented for the quarter ended: 9/30/97
Unaudited
Total
FINANCIAL DATA (dollars in thousands)(a):
Total Revenue $ 2,501.6
Total Capital Expenditures $ 7,407.5
Total EBITDA $ (226.9)
Gross Property, Plant & Equipment $110,089.2
STATISTICAL DATA(b):
As of September 30, 1997:
Networks in Operation
Route Miles 2,096
Fiber Miles 100,584
Buildings connected 1,003
LEC-COs collocated
46
Voice Grade Equivalent Circuits 301,368
Access Lines Sold 8,953
Access Lines Installed 4,065
(a) Financial Data represents 100% of the operations of all entities except
Hyperion of Florida, which is reflected at Hyperion's ownership in the
Jacksonville network, which is 20%.
(b) Statistical Data represents 100% of operating data for all entities
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
Hyperion Telecommunications Inc. Financial Data Schedule for the six months
ended September 30, 1997.
</LEGEND>
<CIK> 0001017648
<NAME> HYPERION TELECOMMUNICATIONS INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 153,900
<SECURITIES> 0
<RECEIVABLES> 1,876
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 155,776
<PP&E> 101,832<F1>
<DEPRECIATION> 0<F1>
<TOTAL-ASSETS> 422,753
<CURRENT-LIABILITIES> 15,173
<BONDS> 483,793
0
0
<COMMON> 101
<OTHER-SE> (81,533)
<TOTAL-LIABILITY-AND-EQUITY> 422,793
<SALES> 0
<TOTAL-REVENUES> 3,707
<CGS> 0
<TOTAL-COSTS> 11,548
<OTHER-EXPENSES> 4,200
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,164
<INCOME-PRETAX> (31,205)
<INCOME-TAX> 0
<INCOME-CONTINUING> (31,205)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (31,205)
<EPS-PRIMARY> (2.91)
<EPS-DILUTED> (2.91)
<FN>
<F1>PP&E net of Depreciation
</FN>
</TABLE>
