<PAGE>
Securities and Exchange Commission on October 8, 1997.
Registration No. 333-35227
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
AMENDMENT NO. 2 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
ELECTRIC LIGHTWAVE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 4825 93-1035711
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of incorporation or organization) Classification Code Number) Identification
Number)
8100 N.E. PARKWAY DRIVE, SUITE 150, VANCOUVER, WASHINGTON 98662
(360) 892-1000
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
ROBERT J. DESANTIS
ELECTRIC LIGHTWAVE, INC.
8100 N.E. PARKWAY DRIVE, SUITE 150
VANCOUVER, WASHINGTON 98662
(360) 892-1000
(Name, address, including zip code, and telephone number, including area
code, of agent for service)
COPIES TO:
JONATHAN H. CHURCHILL, ESQ. VINCENT PAGANO, ESQ.
WINTHROP, STIMSON, PUTNAM & ROBERTS SIMPSON THACHER & BARTLETT
ONE BATTERY PARK PLAZA 425 LEXINGTON AVENUE
NEW YORK, NY 10004 NEW YORK, NY 10017
(212) 858-1000 (212) 455-2000
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [_]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
=======================================================================================================
<S> <C> <C> <C> <C>
Proposed
Title of each class Proposed maximum
of securities to be maximum offering aggregate offering Amount of
registered Amount to be registered price per unit price registration fee
- -------------------------------------------------------------------------------------------------------
Common Stock, Class A $200,000,000* $60,607**
=======================================================================================================
</TABLE>
* Estimated solely for the purpose of calculating the registration fee pursuant
to Rule 457.
** Previously paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
================================================================================
<PAGE>
SUBJECT TO COMPLETION DATED OCTOBER 8, 1997
P R O S P E C T U S [LOGO]
[ ] SHARES
ELECTRIC LIGHTWAVE, INC.
CLASS A COMMON STOCK
All of the shares of Class A Common Stock, par value $__ per share (the
"Class A Common Stock"), offered hereby (the "Offering") are being sold by
Electric Lightwave, Inc. ("ELI" or the "Company"), a wholly owned subsidiary of
Citizens Utilities Company. Of the __shares of Class A Common Stock being
offered hereby, shares are being offered initially in the United States and
Canada by the U.S. Underwriters (as defined herein) and ___shares are being
offered initially outside of the United States and Canada in a concurrent
offering by the International Managers (as defined herein and, together with the
U.S. Underwriters, the "Underwriters"). Such offerings are collectively referred
to herein as the "Offering." See "Underwriting."
The Company has two classes of common stock: Class A Common Stock and
Class B Common Stock, par value $___ per share (the "Class B Common Stock" and,
collectively with the Class A Common Stock, the "Common Stock"). The shares of
Common Stock are substantially identical, except that holders of Class A Common
Stock are entitled to one vote per share and holders of Class B Common Stock are
entitled to 10 votes per share on all matters submitted to a vote of
stockholders. Each share of Class B Common Stock is convertible at the option of
the holder into one share of Class A Common Stock. Upon completion of the
Offering, Citizens, the holder of the Class B Common Stock, will have
approximately __% of the combined voting power of the outstanding Common Stock
(%__ if the Underwriters' overallotment options are exercised in full) and will
have the ability to control all matters requiring stockholder approval,
including the election of directors. See "Description of Capital Stock" and
"Risk FactorsControl by Citizens."
Prior to the Offering, there has been no public market for the Class A
Common Stock. It is currently anticipated that the initial public offering price
will be between $__ and $__ per share. See "Underwriting" for a discussion of
the factors considered in determining the initial public offering price. The
Company will apply for listing the Class A Common Stock on the Nasdaq National
Market under the symbol "ELIX."
See "Risk Factors" beginning on page 10 for a discussion of certain
factors that should be considered by prospective purchasers of the Class A
Common Stock offered hereby.
--------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
================================================================================
Underwriting
Price to Discount and Proceeds to
Public Commissions(1) Company(2)
- --------------------------------------------------------------------------------
Per Share...................... $ $ $
- --------------------------------------------------------------------------------
Total (3)...................... $ $ $
================================================================================
(1) The Company and Citizens have agreed to indemnify the U.S. Underwriters and
International Managers against certain liabilities, including liabilities
under the Securities Act of 1933, as amended (the "Securities Act"). See
"Underwriting."
(2) Before deducting expenses of the Offering payable by the Company estimated
at $[ ].
(3) The Company has granted the U.S. Underwriters and International Managers
options exercisable within 30 days after the date hereof to purchase up to [
] and [ ] additional shares of Class A Common Stock, respectively, solely to
cover over-allotments, if any. If such options are exercised in full, the
total Price to Public, Underwriting Discount and Commissions and Proceeds to
Company will be $[ ], $[ ] and $[ ], respectively. See "Underwriting."
________________________________
The shares of Class A Common Stock offered hereby are being offered by
the U.S. Underwriters and International Managers named herein, subject to prior
sale, when, as and if accepted by the U.S. Underwriters and International
Managers, subject to approval of certain legal matters by counsel for the U.S.
Underwriters and International Managers and subject to certain conditions. The
U.S. Underwriters and International Managers reserve the right to withdraw,
cancel or modify such offer and to reject orders in whole or in part. It is
expected that delivery of the shares of Class A Common Stock will be made at the
offices of Lehman Brothers Inc. in New York, New York on or about [ ], 1997
against payment therefor in immediately available funds.
_________________________________
U.S. Underwriters offering shares in the United States
Lehman Brothers
International Managers offering shares outside the United States
Lehman Brothers
The date of this Prospectus is [ ], 1997.
<PAGE>
[MAP]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE CLASS A COMMON STOCK.
SUCH TRANSACTIONS MAY INCLUDE THE PURCHASE OF SHARES OF CLASS A COMMON STOCK
FOLLOWING THE PRICING OF THE OFFERING TO COVER A SYNDICATE SHORT POSITION IN THE
CLASS A COMMON STOCK OR FOR THE PURPOSE OF MAINTAINING THE PRICE OF THE CLASS A
COMMON STOCK, AND THE IMPOSITION OF PENALTY BIDS. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the financial statements (including the notes thereto) appearing
elsewhere in this Prospectus. "ELI" and the "Company" refer to Electric
Lightwave, Inc. Unless otherwise indicated, the information set forth in this
Prospectus does not give effect to the exercise of the Underwriters' over-
allotment options. See "Glossary" for definitions of certain terms used in this
Prospectus.
THE COMPANY
ELI is a full-service, facilities-based competitive local exchange
carrier ("CLEC") providing a broad range of telecommunications services in five
major market clusters in the western United States. The Company provides state-
of-the-art voice and data communications services to retail customers, primarily
large-and medium-sized communications-intensive businesses, and wholesale
customers, primarily telecommunications service providers. The Company operates
high-quality, extensive digital fiber optic networks based on a switched
broadband platform in each of its five market clusters (comprising six
metropolitan statistical areas ("MSAs"), including 59 municipalities) with
31,060 local access line equivalents, 1,728 route miles and 104,718 fiber miles
installed and 521 buildings connected as of June 30, 1997. The Company has
interconnected its market clusters with facilities-based owned and leased long-
haul fiber optic networks. The Company generated revenues of $31 million during
1996 and $57 million on an annualized basis in 1997 based on revenues for the
quarter ended June 30, 1997. The Company currently provides services in five
markets: Portland, Oregon; Seattle, Washington; Salt Lake City, Utah;
Sacramento, California; and Phoenix, Arizona ("hub cities") and their respective
surrounding areas (together with the hub cities, "market clusters" or
"clusters"). The Company's clusters include an extensive fiber optic network.
The Company currently provides switched services, including local dial
tone, utilizing five Nortel DMS 500 switches, in all of its market clusters
except Phoenix, where the Company expects to initiate local dial tone service
upon installing an additional switch in the first half of 1998. The Company's
clusters are also served by its extensive frame relay network, which is
comprised of 18 state-of-the-art switches and 30 points-of-presence ("POPs") in
26 western U.S. cities. The Company has also developed an Internet backbone
network providing Internet connectivity in each of its markets which includes
access on a redundant basis to the three largest Internet service providers in
the United States. The Company's goal is to add or expand its market presence
from six to 12 MSAs and from two to five long-haul networks by the end of 1998.
The Company offers an extensive portfolio of products and services in
four categories: local telephone, long distance, data and video, and network
access. These products and services include: Local dial tone, with voicemail and
enhanced features; long distance with calling cards; advanced data services,
including frame relay, international frame relay and high-speed Internet access,
connectivity and transport; video conferencing and dialable wideband services;
LAN-to-LAN services with very high transport speeds; ISDN; and point-to-point
communications and dedicated DS-1s and DS-3s. The Company expects to provide
Asynchronous Transfer Mode ("ATM") services during 1998. The Company's data
network expertise allows it to provide a broader range of telecommunications
services to customers, which helps to maximize the amount of telecommunications
traffic on its network.
3
<PAGE>
The above services are offered to meet customers' complete
telecommunications requirements. The Company offers its services in custom
combinations, and utilizes a consultative sales approach that provides customers
a single point of contact at the Company and an opportunity to work with the
Company to design innovative, turn-key solutions and new product applications
which allows them to take advantage of the broad array of services offered. The
Company has implemented an integrated network management system designed to
monitor and test the Company's networks 24 hours a day, seven days a week and is
developing a superior customer care system which will automate the entire order
management process (i.e., order placement, design, provisioning and billing
preparation) for both retail and wholesale customers. The Company also is
installing a customized billing system and a new maintenance system capable of
up-to-the minute trouble ticket tracking.
Deregulation in the telecommunications industry has created an enormous
market opportunity for ELI. Based on Federal Communications Commission ("FCC")
data, the Company estimates that in 1996 total revenues from local and long
distance telecommunications services were approximately $183 billion, of which
approximately $107 billion were derived from business telecommunications
services. The Company estimates that based on industry sources, the total
addressable business telecommunications services market in its current five
market clusters (based on access lines) was approximately $4.3 billion in 1996.
The Company believes that the market in its clusters will grow over the next
decade because of the favorable demographics and an increase in use of
telecommunications services and that its share of this market will increase as a
result of the passage of the Telecommunications Act of 1996 (the "1996 Act"),
the actions of various state commissions and other FCC rulings, which
collectively have essentially opened up the market to competition.
Since its inception, ELI has been at the forefront of industry efforts
to introduce competition to the local telecommunications markets. As such, ELI
has achieved significant milestones in the CLEC industry and is well positioned
to benefit from the opening of the local telecommunications market. Before the
passage of the 1996 Act, the Company aggressively pursued regulatory and
legislative reforms and consummated certain interconnection agreements with
incumbent local exchange carriers ("ILECs") that allowed the Company to offer
economical and operationally efficient local exchange services. The Company was
early to market in Portland, Seattle, Salt Lake City and Sacramento and believes
it is the leading CLEC in Portland, Seattle and Salt Lake City. The Company was
the first CLEC to receive authority from a state regulatory authority in a state
west of the Mississippi River to operate and to offer a full switch-based
product portfolio. ELI has also been a leader in the implementation of local
number portability.
Since 1990, the Company has been a subsidiary of Citizens Utilities
Company (which, together with its subsidiaries, is referred to herein as
"Citizens"). Citizens is a publicly-held communications and public services
company which provides, either directly or through subsidiaries,
telecommunications, electric distribution, natural gas transmission and
distribution, and water and wastewater services to over 1.6 million customer
connections in 20 states. Citizens Communications is one of the nation's leading
independent communications companies and operates an integrated distribution
network over which it provides local, long distance, paging, cellular, network
sales and other communications products and services. At June 30, 1997,
Citizens' consolidated assets totaled $4.4 billion and shareholders' equity
totaled $1.6 billion. Citizens' consolidated revenues for the twelve months
ended June 30, 1997 totaled $1.3
4
<PAGE>
billion. The Company has historically been funded by capital contributions and
advances from Citizens and through a lease agreement guaranteed by Citizens. See
"Capitalization" and "Relationship with Citizens."
BUSINESS STRATEGY
Guided by the business strategy adopted in 1990, the Company has become
a leading facilities-based, full-service CLEC. The key elements of this strategy
include:
. TARGET ATTRACTIVE REGIONAL MARKETS. The Company's focus is on MSAs in
the western United States that the Company believes have few CLEC competitors, a
relatively high proportion of communications-dependent businesses and the
prospect of population and economic growth above the national average. Growth in
these regions has been fueled to a large degree by the computer, software,
semiconductor and aerospace industries and other telecommunications-intensive
businesses such as financial services and telemarketing call centers. The
Company's policy has been and will continue to be to establish a new market
cluster where it expects to become the leading facilities-based, full-service
CLEC in such market in competition with the ILEC. Due to its superior customer
service, advanced network technologies and the breadth and quality of its
networks, the Company believes that it has an opportunity to capture a
significant share of the local market for communications in its target regions
in competition with U S WEST Communications, Inc. ("U S WEST") and, in
Sacramento, PacBell, which are the ILECs in its regions.
. DEVELOP MARKET CLUSTERS. The Company builds facilities and offers
services in market clusters which exist in and around a hub city in the selected
MSA. Once a potential market is identified, the Company establishes a network in
the hub city and then expands the network to adjacent cities and communities of
interest. Through the use of this strategy, the Company is able to leverage and
extend the depth of its management resources, communications network, switch
assets and product portfolio and reduce its dependence on the ILEC. The Company
realizes economies of scale in terms of network build out, switch deployment,
provisioning and servicing from its cluster strategy. Clustering also enables
the Company to (i) optimize its networks' switching capacity through the ability
to place switches anywhere in the cluster, (ii) cost-effectively offer services
to smaller markets adjacent to its existing networks and in which the Company is
less likely to face strong competition from other CLECs, and (iii) achieve
increased gross margins and improved network reliability due to higher levels of
on-net traffic. The Company believes communications traffic is heavy between a
metropolitan area and its outlying markets and its cluster strategy takes
advantage of this by offering facilities-based, end-to-end service offerings
that cover these broad geographic areas.
. INTERCONNECT MARKET CLUSTERS. The Company's strategy is to
interconnect the Company's major market clusters with facilities-based
broadband, long-haul fiber optic networks. Interconnecting its market clusters
enables the Company to lower costs and enhance its revenue potential by carrying
increasing amounts of long distance, frame relay, Internet and point-to-point
traffic on its own facilities. By carrying traffic on its own facilities, the
Company is able to improve the utilization of its network facilities and avoid
leased facilities charges and certain interconnection costs.
5
<PAGE>
. PENETRATE MARKETS BY LEVERAGING FRAME RELAY NETWORK. The Company has
undertaken a major expansion of its networks and products to satisfy the growing
demand for enhanced network services, including frame relay networking services
and Internet access. As a result, the Company had 18 frame relay switches
servicing customer locations as of June 30, 1997. Enhanced network services,
which are currently provided primarily on the Company's frame relay network, are
specialized interchange services offered by the Company for customers that need
to transport large amounts of data among multiple locations. ELI's relationship
with certain carriers allows the Company to terminate traffic both nationally
and internationally utilizing other companies' networks and to provide a flow of
traffic into the Company's networks. In addition, to further increase efficient
access to a greater customer base, ELI established approximately 30 POPs which
interconnect their frame relay networks to those of US WEST, PacBell and other
carriers.
. MAXIMIZE ON-NET TRAFFIC BY PROVIDING FACILITIES-BASED SERVICES. The
Company has constructed extensive voice, frame relay, Internet backbone and
interconnecting long-haul networks, and each of the Company's operating clusters
includes an extensive fiber optic network backbone. These extensive networks are
a key aspect of the Company's strategy to maximize the services provided to
customers on the Company's network ("onnet"). Approximately half of the
Company's services provided to customers are currently on-net and the Company's
strategy is to increase this percentage over time. Maximizing the volume of on-
net traffic allows the Company to (i) improve customer loyalty and minimize
churn; (ii) increase network reliability; (iii) provide a wider range of
services; (iv) increase process control and thereby strengthen customer service
through end-to-end management; and (v) reduce its reliance on the ILEC for
technologically up-to-date services which are essential for the Company's
enhanced services. The Company believes that greater on-net traffic will also
increase operating margins by increasing utilization of capacity inherent in the
Company's network.
. ESTABLISH STRATEGIC RELATIONSHIPS WITH UTILITY COMPANIES. A strategy
of the Company has been to form strategic relationships with utility companies
that enable it to (i) utilize existing rights-of-way and fiber optic facilities,
(ii) leverage their construction expertise and local permitting experience and
(iii) have access to capital in order for ELI to extend its network
infrastructure more quickly and economically. The Company's strategic alliances
include agreements for the utilization of existing excess facilities and the
construction of long-haul networks which link the Portland and Seattle clusters
and which will link Portland and Spokane, Washington and Portland and Eugene,
Oregon. Another agreement provides for a fiber optic network in the Phoenix
metropolitan area. These relationships allow the Company to achieve economies of
scale and scope by expanding its existing markets rapidly and cost-effectively
and enabling the Company to concentrate its efforts on sales and marketing.
. CONTINUE ITS EFFECTIVE DIRECT SALES AND SUPERIOR CUSTOMER SERVICE. ELI
has built a highly motivated and experienced direct sales force and customer
service organization that is designed to establish a direct and personal
relationship with its customers. Consistent with its product offerings, the
Company utilizes a three-pronged sales approach comprised of direct retail,
direct wholesale and agents. Salespeople are given incentives through a
commission structure which targets 50% of a salesperson's compensation to be
based on performance. Each customer is provided with a single point of contact
at the Company. A sales account manager is responsible for managing each
customer's account and staying in constant contact with the
6
<PAGE>
customer to satisfy that customer's specific telecommunications needs. Sales
account managers utilize a vertical sales strategy with the goal of selling
additional value-added, high margin services to existing customers. The Company
believes that combining the consultative sales strategy with the vertical sales
strategy will enable it to achieve higher margins on each account. The Company
views its commitment to customer satisfaction as a key success factor and is
developing a superior customer service system which will automate order
processing, including order placement, design, provisioning and billing, for
both retail and wholesale customers. This strategy ensures that the Company's
processes are aligned with customer needs and satisfaction.
The Company's principal executive offices are located at 8100 NE Parkway
Drive, Suite 150, Vancouver, Washington 98662 and its phone number is (360) 892-
1000.
See "Risk Factors" beginning on page 10 for a discussion of certain
risks relevant to an investment in the Common Stock.
7
<PAGE>
THE OFFERING
Class A Common Stock Offered: [ ] shares ([ ] shares in the United
States by the U.S. Underwriters and [ ]
shares outside the United States by the
International Managers) (assuming over-allotment
options not exercised)
Common Stock to be outstanding
after the Offering:
Class A Common Stock.....[ ] shares
Class B Common Stock.....[ ] shares
Total.................[ ] shares
Use of Proceeds...............The net proceeds of the Offering are estimated to
be approximately $[ ] million, after deducting
underwriting discounts and commissions and the
estimated offering expenses payable by the
Company. The Company intends to use such proceeds
to fund its operating and capital expenditure
requirements. See "Use of Proceeds."
Voting Rights.................Holders of Class A Common Stock are entitled to
one vote per share and holders of Class B Common
Stock are entitled to 10 votes per share on all
matters submitted to a vote of stockholders. The
holders of the Class A Common Stock and the Class
B Common Stock vote together as a single class on
all matters submitted to a vote of stockholders,
except as otherwise required by law. Upon
completion of the Offering, Citizens, the holder
of the Class B Common Stock, will have
approximately [ ]% of the combined voting power of
the Company's outstanding Common Stock (__% if the
Underwriters' overallotment options are exercised
in full) and will have the ability to control all
matters requiring stockholder approval, including
the election of directors. See "Risk
FactorsControl by Citizens" and "Description of
Capital StockCommon Stock."
Conversion....................Each share of Class B Common Stock is convertible
at the option of the holder into one share of
Class A Common Stock. See "Description of
Capital--Stock Common Stock-Conversion."
Listing.......................The Nasdaq National Market under the symbol "ELIX"
8
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SUMMARY FINANCIAL AND OTHER OPERATING DATA
The following summary Statement of Operations and Balance Sheet Data for
the years ended and as of December 31, 1994, 1995, and 1996 have been derived
from the Company's Financial Statements and related notes thereto included
elsewhere in this Prospectus, which Financial Statements have been audited by
KPMG Peat Marwick LLP, independent Certified Public Accountants. The summary
Statement of Operations and Balance Sheet Data for the six months ended June 30,
1996 and 1997 and as of June 30, 1997 have been derived from the Company's
unaudited Financial Statements and related notes thereto included elsewhere in
this Prospectus, and in the opinion of management include all adjustments
necessary for a fair presentation of the results of operations and financial
condition of the Company for such periods. The results of operations for interim
periods are not necessarily indicative of a full year's operations. This
information should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the Company's
Financial Statements and related notes thereto and the other financial data
contained elsewhere in this Prospectus.
<TABLE>
<CAPTION>
Years Ended December 31, Six Months Ended June 30,
------------------------------------------------------------
1994 1995 1996 1996 1997
------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
($ in thousands, except per share amounts)
STATEMENT OF OPERATIONS DATA
Revenues $ 8,152 $ 15,660 $ 31,309 $ 13,374 $ 24,765
Operating expenses:
Network access expenses 6,155 8,728 24,081 9,527 15,206
Sales and marketing expenses 4,534 5,704 8,462 3,940 6,271
Depreciation and amortization 2,476 7,064 7,192 3,453 5,603
Other Operating expenses 4,528 14,114 20,957 7,069 17,499
--------------------------------- ----------------------
Total operating expenses 17,693 35,610 60,692 23,989 44,579
--------------------------------- ----------------------
Operating loss (9,541) (19,950) (29,383) (10,615) (19,814)
Interest expense 873 372 - - 302
--------------------------------- ----------------------
Net loss $ (10,414) $ (20,322) $ (29,383) $ (10,615) $ (20,116)
================================= ======================
Pro forma net loss(1) $ $ $
========= ======================
Pro forma net loss per share(2) $ $ $
========= ======================
<CAPTION>
As at December 31,
--------------------------------- As at Pro forma as at
1994 1995 1996 June 30, 1997 June 30, 1997(3)
---------------------------------- ------------- ----------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital (deficiency) $ (9,934) $ (17,897) $ (9,940) $ (19,856)
Total assets 110,691 128,901 195,656 233,835
Long-term debt and capital lease obligations 6,565 - - 10,664
Due to Citizens 35,109 64,941 155,395 194,669
Shareholder's equity (deficiency) 55,991 38,669 9,286 (10,830)
================================= ============
OPERATING DATA
EBIDTA(4) $ (7,065) $ (12,886) $ (22,191) $ (14,211)
Property, plant & equipment-owned $ 108,549 $ 127,297 $ 189,334 $ 235,953
-under lease(5) - 36,858 57,279 87,425
--------------------------------- ------------
-Total $ 108,549 $ 164,155 $ 246,613 $ 323,378
--------------------------------- ------------
Market Clusters 5 5 5 5 5
Route miles(6) 601 780 1,490 940 1,728
Fiber miles(6) 37,504 52,013 96,609 64,574 104,718
Buildings connected 191 282 454 318 521
Switches installed:
Voice 2 2 5 2 5
Frame relay 2 5 15 7 18
--------------------------------- --------------------
Total switches installed 4 7 20 9 23
--------------------------------- ---------------------
Employees 127 225 402 292 486
--------------------------------- ---------------------
</TABLE>
- -----------------------
(1) The pro forma net loss represents the historical net loss as adjusted for
the revised administrative services fees, guarantee fee, and interest to be
charged on the long-term debt due to Citizens (see Note 6 of Notes to
Financial Statements) as if such fees and interest rate were effective
January 1, 1996.
(2) The pro forma net loss per share has been computed on the basis described in
Note 2(i) of Notes to Financial Statements.
(3) The pro forma balance sheet data gives effect to the contribution of a
certain amount of due to Citizens to additional paid-in capital as discussed
in Note 5 of Notes to Financial Statements, and gives effect to the issuance
of the shares of Class A Common Stock offered hereby.
(4) EBIDTA consists of Earnings Before Interest, Income Taxes, Depreciation and
Amortization. EBIDTA is a measure commonly used in the communications
industry to analyze companies on the basis of operating performance. EBIDTA
is not a measure of financial performance under generally accepted
accounting principles and should not be considered as an alternative to net
income as a measure of performance nor as an alternative to cash flow as a
measure of liquidity. See the Company's Financial Statements included
elsewhere in this Prospectus.
(5) Facilities under an operating lease agreement under which the Company has
the option to purchase the facilities at the end of the lease term. See Note
7 of Notes to Financial Statements.
(6) Route miles and Fiber miles also include those to which the Company has
exclusive use pursuant to license and lease arrangements (See "Business
Long-Haul Networks")
9
<PAGE>
RISK FACTORS
Prior to purchasing any shares of Class A Common Stock offered hereby,
prospective investors should consider carefully the following factors in
addition to the other information contained in this Prospectus.
NEGATIVE CASH FLOW AND OPERATING LOSSES
The capital expenditures of ELI associated with the installation,
development and expansion of its existing and new telecommunications networks
are substantial, and a significant portion of these expenditures generally are
incurred before any revenues are realized. These expenditures, together with
associated initial operating expenses, result in negative cash flow and
operating losses until an adequate customer base and revenue stream for these
networks have been established. The Company expects to incur net losses for the
foreseeable future as it continues to install, develop and expand its existing
and new telecommunications networks. There can be no assurance that an adequate
revenue base will be established in each of the Company's clusters or that the
Company will achieve or sustain profitability or generate sufficient positive
cash flow to fund its operating and capital requirements and/or service its debt
obligations.
SIGNIFICANT CAPITAL EXPENDITURES
The development and expansion of the Company's existing and new networks
and services will require significant additional capital expenditures. The
Company's capital expenditures for the eighteen months subsequent to the
completion of the Offering are estimated to be approximately $400 million. The
Company continues to evaluate additional revenue opportunities in each of its
markets and, as additional opportunities develop, the Company plans to make
additional capital investments in its existing networks and to expand networks
as may be required to pursue such opportunities.
ELI has historically been funded by capital contributions, advances and
guarantees from Citizens. The Company expects to meet its capital needs with the
proceeds of the Offering, internally generated cash flow and lease arrangements,
together with the proceeds from bank credit facilities, other borrowings and
possible issuances of additional equity securities. Citizens does not have any
obligation to make additional equity investments in or advances to ELI or to
guarantee or otherwise provide financial support for ELI after the completion of
the Offering.
There can be no assurance that ELI will be successful in generating
sufficient cash flow or raising debt or equity capital in sufficient amounts on
terms acceptable to it. The failure to generate sufficient cash flow or to raise
sufficient funds may require the Company to delay or abandon some or all of its
development and expansion plans, which could have a material adverse effect on
ELI's growth, its ability to compete in the telecommunications services industry
and its ability to achieve positive cash flow. See "Use of Proceeds" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
RISKS INHERENT IN EXPANSION
ELI intends to expand its networks in each of the Portland, Seattle,
Salt Lake City, Sacramento and Phoenix metropolitan areas, has commenced
construction in Boise, Idaho (the
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Salt Lake City cluster) and has completed preparations to begin construction in
Spokane and Tacoma, Washington (the Seattle cluster) and Ogden, Utah (the Salt
Lake City cluster). The Company intends to consider additional expansion in
other areas in the future. There can be no assurance that the Company will be
able to expand its existing clusters or construct new clusters as currently
planned or on a timely basis. The expansion of ELI's existing clusters and its
construction of new clusters will be dependent, among other things, on its
ability to acquire rights-of-way and any required permits on satisfactory terms
and conditions, on its ability to finance such expansion and construction, its
ability to assess markets, design fiber network carrier rings and backbone
routes, install other facilities, and implement interconnection with ILECs, all
in a timely manner, at reasonable costs and on terms and conditions acceptable
to ELI. The Company's ability to manage this expansion effectively will require
it to continue to implement and improve its operational and financial systems
and to expand, train and manage its employee base. ELI's inability to expand its
existing clusters or install new clusters or manage effectively such expansion
and installation could have a material adverse effect upon the Company's
business strategy, financial condition and results of operations.
SUBSTANTIAL COMPETITION
The Company operates in an increasingly competitive environment.
Services substantially similar to those offered by the Company are also offered
by the ILECs serving the markets currently served or intended to be served by
the Company. ILECs have longstanding relationships with their customers, have
financial and technical resources substantially greater than those of the
Company and benefit from federal and state laws and regulations that, ELI
believes, in some instances favor the ILECs over CLECs. Under certain
circumstances, the FCC and state regulatory authorities provide the ILECs with
an ability to lower selectively the price of certain services within the areas
in which the Company operates. In addition, as a result of the 1996 Act, ILECs
are likely to obtain additional pricing flexibility with regard to services that
compete with those offered by the Company. Increased price competition from
ILECs could have a material adverse effect on the Company's financial condition
and results of operations. See "Business--Competition" and "Government
Regulation."
Also, under the 1996 Act, ILECs formerly subject to anti-trust decree
restrictions on interLATA (interexchange) long distance services are no longer
permanently barred from entry into these businesses, subject to certain
requirements in the 1996 Act and rules and policies to be implemented by the FCC
and the states. Also under the 1996 Act, long distances carriers will be
permitted to enter businesses in which they will be in competition with the
Company. The FCC may authorize a Regional Bell Operating Company ("RBOC") to
provide interLATA services in a state when the RBOC enters into a state utility
commission-approved agreement with one or more facilities-based competitors
which provide business and residential local exchange service and such agreement
satisfies 14 specified interconnection requirements. In evaluating an RBOC
application for interLATA entry, the FCC must consult with the U.S. Department
of Justice. Alternatively, if no such facilities-based competitors request such
interconnection, the RBOC may obtain authority from the FCC to provide interLATA
services if the RBOC obtains state utility commission approval of a statement of
generally available terms and conditions of interconnection that satisfies the
requirements. If and when an RBOC obtains authority to provide interLATA
services, it will be able to offer customers local and long distance telephone
services. This will permit the RBOC to offer a full range of services to
potential customers in a new region and thus eliminate an existing competitive
advantage of the Company. Given the
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resources and experience the RBOCs currently possess in the local exchange
market, the ability to provide both local and long distance services could make
the RBOCs very strong competitors.
The 1996 Act is intended to increase competition in the local
telecommunications business. The 1996 Act requires all local exchange providers,
including new entrants, to offer their services for resale and requires ILECs to
offer their network facilities on an unbundled basis. There can be no assurance
that any unbundled rates or facilities offered by ILECs to ELI will be
economically attractive or technically viable. See "Government
Regulation--Telecommunications Act of 1996." These requirements facilitate entry
by new competitors without substantial capital risk or investment. See
"Business--Competition."
The Company faces strong competition from operational facility-based
CLECs in each of the markets in which the Company operates. In each of the
clusters in which ELI operates, at least one other CLEC, and in some cases
several other CLECs, offers many of the same telecommunications services
provided by the Company, generally at similar prices.
Potential and actual new market entrants in the local telecommunications
services business include RBOCs entering new geographic markets, CLECs, Inter-
Exchange Carriers ("IXCs"), cable television companies, electric utilities,
international carriers, satellite carriers, teleports, microwave carriers,
wireless telephone system operators and private networks built by large end
users, many of which may have financial, personnel and other resources
substantially greater than those of ELI. In addition, the current trend of
business combinations and alliances in the telecommunications industry,
including mergers between RBOCs, may increase competition for the Company. The
Company's competitors for high speed data services include major IXCs,
Competitive Access Providers ("CAPs"), other CLECs, and various providers for
niche services (e.g., Internet access providers, router management services and
systems integrators). The market for Internet access and related services in the
United States is extremely competitive, with no substantial barriers to entry.
The Company expects that competition will intensify as existing services and
network providers and new entrants compete for customers. The Company's current
and future competitors include telecommunications companies and other Internet
access providers. Many of these competitors have greater market presence and
greater financial, technical, marketing and human resources, more extensive
infrastructure and stronger customer and strategic relationships than the
Company.
DEPENDENCE UPON INTERCONNECTION AND RELATIONSHIP WITH ILECS
The 1996 Act imposes interconnection obligations on ILECs, and generally
requires that interconnection charges be cost-based and nondiscriminatory. To
the extent ELI interconnects with and uses an ILEC's network to service the
Company's customers, ELI is dependent upon the technology and capabilities of
the ILEC to meet certain telecommunications needs of the Company's customers and
to maintain its service standards. ELI will become increasingly dependent on
interconnection with ILECs as switched services become a greater percentage of
the Company's business. However, there can be no assurance that the Company will
be able to obtain the services it requires at rates, and on terms and
conditions, that permit the Company to offer switched services at rates that are
both profitable and competitive. See "Business--Competition--ILEC Competition."
The Company has commenced legal action against US WEST, alleging that it was
blocking competition in local telephone service. See "Business--Legal
Proceedings."
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FEDERAL AND STATE REGULATION
The Company is subject to federal and state regulation. In most states,
ELI is subject to certification and tariff filing requirements with respect to
intrastate services. See "Government RegulationState Regulation." In some
instances, the certificate obtained by the Company in a particular state limits
the services that it is permitted to provide in that state. These current
restrictions on the services that may be provided by the Company should be
eliminated as a result of the 1996 Act, which prohibits states from imposing
legal restrictions that effectively prohibit the provision of any
telecommunications service. States will, however, under the 1996 Act, retain
authority to impose on the Company and other telecommunications carriers
requirements to preserve universal service, protect public safety, ensure
quality of service and protect consumers. States are also responsible under the
1996 Act for mediating and arbitrating interconnection arrangements between
CLECs and ILECs if the carriers fail to agree on such arrangements.
ELI is currently required to file tariffs for some interstate services
with the FCC, although such tariff requirements are less restrictive than those
imposed on ILECs offering similar services. These tariffs, which are presumed to
be lawful on filing, must contain the rates, terms and conditions under which
service is generally available from ELI. While unlikely, challenges by third
parties to the Company's tariff filings or related contractual arrangements may
cause ELI to incur substantial legal and administrative expenses. The FCC has
promulgated rules to eliminate tariffing of interstate long distance services.
Those rules have been stayed during the pendency of judicial review. If and when
these rules are allowed to go into effect, the Company will no longer be
required to file FCC tariffs for its interstate long distance services.
Additionally, under a recent FCC order, CLECs, including ELI, are no longer
required to file tariffs for interstate exchange access services.
Under the 1996 Act, the Company is subject to certain federal regulatory
obligations when it provides local exchange service in a market. All local
exchange carriers, including CLECs, must interconnect with other carriers, 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 1996 Act requires all telecommunications carriers to ensure that
their services are accessible to and usable by persons with disabilities.
Further, ELI and other CLECs will be required to contribute to federal and state
universal service funds provided for in the 1996 Act, but which have not yet
been implemented. Because many FCC rules implementing the 1996 Act are under
challenge in the courts and are still being analyzed by the industry, and
related state implementation processes are not complete, it is uncertain how
burdensome the requirements of the 1996 Act will be for ELI.
The 1996 Act contains other provisions that may be subject to FCC
rulemaking and judicial interpretation.
The FCC recently adopted rules to reform the interstate access charges
ILECs may impose for use of local networks to originate and terminate interstate
services. Among the effects of those rules will be a substantial reduction in
ILEC access prices. Certain of ELI's services permit the customer to bypass the
ILEC access charges. The downward pressure on access prices resulting from the
FCC's actions may adversely impact ELI's revenues from its competitive access
products. However, ELI also pays ILEC access charges in connection with
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ELI's long distance products, and to this extent reductions in ILEC access
charges will lower ELI's costs.
In addition, no assurance can be given that changes to current
regulations or the adoption of new regulations by the FCC or state regulatory
authorities or legislative initiatives or court decisions would not have a
material adverse effect on ELI. See "Government Regulation."
GOVERNMENTAL AND OTHER AUTHORIZATIONS
The development, expansion and maintenance of the Company's networks
depend on, among other things, its ability to obtain rights-of-way and any other
required governmental authorizations and permits, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions. In addition, ELI
currently leases and plans in the future to enter into facility arrangements for
significant numbers of optical fibers from other parties. In some of the cities
or municipalities where ELI provides network services, it may pay license or
franchise fees, usually based on a percentage of gross revenues or a per foot
right-of-way fee. The 1996 Act permits municipalities to charge such fees only
if they are nondiscriminatory, but there can be no assurance that municipalities
that presently favor a particular carrier, typically the ILEC, will conform
their practices to the requirements of the 1996 Act in a timely manner or
without a legal challenge. Furthermore, there can be no assurance that certain
cities or municipalities that do not now impose fees will not seek to impose
fees, nor can there be any assurance that, following the expiration or
renegotiation of existing franchises, fees will remain at their current levels
or that the franchises will be renewed.
With respect to the Company's ability to lease or enter into facility
arrangements, there can be no assurance that the Company will be able to obtain
all necessary permits, licenses, conduit agreements or pole attachment
agreements from governmental authorities or private rights-of-way providers
necessary to effectuate such transactions. As a result, there can be no
assurance that ELI will be able to expand its existing networks or develop new
networks successfully, which would have a material adverse effect on the
Company's growth and financial condition.
If any of the Company's existing franchise, license or similar
agreements for a particular market were terminated prior to their expiration
dates or not renewed and ELI were forced to remove its fiber or abandon its
network in place, such termination would have a material adverse effect on the
Company's operations in that market and could have a material adverse effect on
ELI.
DEPENDENCE ON SIGNIFICANT CUSTOMERS
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. During 1996, the
Company's top five customers accounted for approximately 21% of ELI's total
revenues. No customer accounted for 10% or more of total revenues. A significant
reduction in the level of services ELI performs for any of these customers could
have a material adverse effect on the Company's results of operations or
financial condition. Most of the Company's customers have short notice
contracts.
MINIMUM REQUIREMENTS OF LONG-HAUL LICENSE AGREEMENTS
The Company's license agreements for the exclusive use of long-haul
facilities connecting its Portland to Seattle, Portland to Spokane and Portland
to Eugene long-haul transport networks and for the exclusive use of the Phoenix
network contain annual minimum
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usage requirements. See "Business--Existing Market Clusters--Long-Haul
Networks." If the Company's traffic on any of these networks falls below the
minimums, the licensor will obtain the right to share usage of a specified
number of fibers with the Company, which could adversely impair the capacity of
such network available to service the Company's customers.
OPERATING LEASE
Under the terms of the operating lease described under
"Business--Properties--Lease," if the Company wishes to continue to make use of
its presently leased facilities past the lease expiration date in 2002, the
Company will be required to exercise its option to purchase the leased
facilities at the termination of the lease in 2002. If the purchase option is
exercised, the purchase price required will be the original cost to the lessor
of purchasing and installing the facilities subject to the maximum amount
available under the lease (expected to be $110,000,000). If the Company does not
purchase the facilities, they will be sold to a third party and the Company will
guarantee that the sales price to be received by the lessor will equal the
acquisition and installation costs, subject generally to a maximum payment under
the guarantee of 80% of such costs.
CONTROL BY CITIZENS
Citizens is currently the only shareholder of the Company. Upon the
completion of the Offering, Citizens will hold all the Class B Common Stock of
the Company (which Class B Common Stock entitles its holders to 10 votes per
share on any matter submitted to a vote of the Company's shareholders). The
Class B Common Stock will represent approximately %__ of the combined voting
power of all classes of voting stock of the Company (%__ if the Underwriters'
over-allotment options are exercised in full) and thus will be able to direct
the election of all of the members of the Company's Board of Directors and
exercise a controlling influence over the business and affairs of the Company,
including any determinations with respect to mergers or other business
combinations, the acquisition or disposition of assets, the incurrence of
indebtedness, the issuance of any additional Common Stock or other equity
securities and the payment of dividends with respect to the Common Stock.
Similarly, Citizens will have the power to determine matters submitted to a vote
of the Company's shareholders without the consent of the Company's other
shareholders, will have the power to prevent a change of control of the Company
and could take other actions that might be favorable to Citizens. The
disproportionate voting rights of the Class B Common Stock relative to the Class
A Common Stock may render impossible any merger proposal, a tender offer or a
proxy contest, even if such actions were favored by a majority of the holders of
the Class A Common Stock. See "Security Ownership by Principal Stockholder,"
"Description of Capital Stock" and "Relationship with Citizens." Citizens has
advised the Company that its current intent is to continue to hold all of its
Class B Common Stock. There can be no assurance, however, concerning the period
of time during which Citizens will maintain its beneficial ownership of Common
Stock. As described below, pursuant to the Underwriting Agreement, Citizens has
agreed, subject to certain exceptions, not to sell or otherwise dispose of,
directly or indirectly, any shares of Common Stock owned by it for a period of
[ ] after the date of this Prospectus without the prior written consent of
Lehman Brothers Inc. on behalf of the Representatives of the Underwriters.
The Company's Board of Directors currently consists of three members,
two of whom are executive officers of Citizens. Following the Offering, the
Board will be expanded to consist of
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seven members, four of whom will be executive officers or employees of Citizens
and two of whom will be independent of both Citizens and ELI. In light of its
ownership of the Company's Class B Common Stock, Citizens will have the ability
to change the size and composition of the Company's Board of Directors and
committees of the Board of Directors.
As of the date of the Prospectus, Citizens has advised ELI that Citizens
has no current plan or intention other than to hold the shares of Class B Common
Stock owned by it for the foreseeable future. However, there is no assurance
that Citizens may not decide in the future to sell all or a portion of its
shares of Common Stock publicly or privately or otherwise. Citizens has the
right to require the Company to register for sale under applicable securities
laws all of the shares of Common Stock (including any shares of Class A Common
Stock acquired by Citizens upon conversion of the Class B Common Stock) which
Citizens or its subsidiaries hold. See "Relationship with Citizens--Registration
Rights Agreement."
CONFLICTS OF INTEREST
Various conflicts of interest between the Company and Citizens may arise
in the future in a number of areas relating to their past and ongoing
relationships, including potential acquisitions of businesses or properties or
other corporate opportunities, the election of new or additional directors,
payment of dividends, incurrence of indebtedness, tax matters, financial
commitments, marketing functions, indemnity arrangements, registration rights,
administration of benefit plans, service arrangements, issuances of capital
stock of the Company, sales or distribution by Citizens of its remaining shares
of Common Stock and the exercise by Citizens of its ability to control the
management and affairs of the Company. In addition, Citizens is in the
telecommunications business and may, now or in the future, provide services
which are the same or similar to those provided by ELI. Citizens will be free to
compete with ELI in certain markets. See "Relationship with Citizens--Customers
and Service Agreement."
Citizens' Representation on Company's Board of Directors and as Officers
of the Company. Certain executive officers and employees of Citizens are and
will be directors of the Company. Also, an executive officer of Citizens is the
Chairman of the Board of the Company and five officers of Citizens are executive
officers of the Company. See "Management." Neither the Company nor Citizens has
instituted any formal plan or arrangement to address potential conflicts of
interest that may arise between the Company and Citizens. The Company's
directors intend to exercise reasonable judgment and take such steps as they
deem necessary under all of the circumstances in resolving any specific conflict
of interest that may occur and will determine what, if any, specific measures
may be necessary or appropriate in light of their fiduciary duties under state
law, including whether to have any specific matter approved by a majority vote
of the disinterested directors. There can be no assurance that any conflicts
will be resolved in favor of the Company.
Future Arrangements. The Company and Citizens have entered into a number
of agreements for the purpose of defining the ongoing relationship between them.
Pursuant to these arrangements, Citizens will provide benefits to the Company
that it might not provide to a third party, and there is no assurance that the
terms and conditions of any future arrangements between Citizens and the Company
will be as favorable to the Company as in effect now.
Competition. To address the potential for conflicts between the Company
and Citizens, the Customers and Service Agreement between the Company and
Citizens contains provisions prohibiting the Company from competing with
Citizens for customers in Citizens' existing
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service areas and in certain new lower density territories which Citizens will
have been first to enter after the Offering. Citizens has agreed that it will
not compete with the Company in the service territories in which the Company is
currently providing services and in certain new higher density territories which
the Company will have been first to provide services after the Offering, except
that Citizens may compete in ELI's new territories in the provision of long
distance services. Neither Citizens nor ELI may solicit an existing wholesale
customer of the other company for services which such customer is currently
receiving under contract from the other company. The relevant provisions are
intended to permit the Company to continue all activities in which it currently
engages, and to expand into related market areas. The Customers and Service
Agreement will remain in effect for so long as Citizens owns a majority of the
economic or voting interest of the shares of Common Stock of the Company. See
"Relationship with Citizens--Customers and Service Agreement."
Tax Sharing. Following the Offering, the Company will no longer be a
member of Citizens' consolidated group for United States federal income tax
purposes. However, because the Company may be included in Citizens' combined,
consolidated or unitary income tax groups for state and local purposes, ELI and
Citizens will enter into a Tax Sharing Agreement (the "Tax Sharing Agreement").
Under the Tax Sharing Agreement, Citizens will have sole authority to respond to
and conduct all state and local tax proceedings (including tax audits) relating
to the Company and to file all state and local returns on behalf of the Company.
The amount of the Company's liability to (or entitlement to payment from)
Citizens under the Tax Sharing Agreement will equal the amount of state or local
taxes that the Company would owe (or refund that it would receive) had it
prepared state or local tax returns on a stand-alone basis. See "Relationship
with Citizens--Tax Sharing Agreement." This arrangement may result in conflicts
of interest between the Company and Citizens. For example, under the Tax Sharing
Agreement, Citizens may choose to contest, compromise or settle any adjustment
or deficiency proposed by the relevant taxing authority in a manner that may be
beneficial to Citizens and detrimental to the Company.
INTERCOMPANY AGREEMENTS NOT SUBJECT TO ARM'S-LENGTH NEGOTIATION
Citizens and the Company have entered into intercompany agreements that
are material to the Company's business. See "--Conflicts of Interest" above and
"Relationship with Citizens." Because the Company has been a wholly owned
subsidiary of Citizens, these agreements are a result of negotiations between
affiliated parties and, therefore, the prices charged to the Company at a
particular time for services provided thereunder may be higher or lower than
prices that might have been charged by an unaffiliated third party.
POTENTIAL ISSUANCE OF PREFERRED STOCK
The Company's Board of Directors has the authority, without any further
vote or action by the Company's stockholders, to issue up to [ ] shares of
Preferred Stock in one or more series and to determine the designations, powers,
preferences and relative, participating, optional or other rights thereof,
including without limitation, the dividend rate (and whether dividends are
cumulative), conversion rights, voting rights, rights and terms of redemption,
redemption price and liquidation preference. Although the Company has no current
plans to issue any shares of Preferred Stock, the rights of the holders of
Common Stock would be subject to, and may be adversely affected by, the rights
of the holders of any Preferred Stock that may be issued in the future. If at
some future time Citizens should have disposed of its majority interest in ELI,
the
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issuance of Preferred Stock could have the effect of delaying, deterring or
preventing a change in control of ELI, including the imposition of various
procedural and other requirements that could make it more difficult for holders
of Common Stock to effect certain corporate actions, including the ability to
replace incumbent directors and to accomplish transactions opposed by the
incumbent Board of Directors. See "Description of Capital Stock."
RAPID TECHNOLOGICAL CHANGES
The telecommunications industry has experienced and is expected to
continue to experience rapid and significant changes in technology. While ELI
believes that, for the foreseeable future, these changes will neither materially
affect the continued use of fiber optic cable or digital switches and
transmission equipment nor materially hinder the Company's ability to acquire
necessary technologies, the effect of technological changes on the Company's
business and operations cannot be predicted. Also, alternative technologies may
develop for the provision of services to customers. ELI may be required to
select in advance one technology over another but it will be impossible to
predict with any certainty, at the time the Company is required to make its
investment, which technology will prove to be the most economic, efficient or
capable of attracting customer usage.
DEPENDENCE ON KEY PERSONNEL AND CITIZENS
The Company's business is managed by a small number of key management
and operating personnel, the loss of certain of whom could have a material
adverse effect on the Company's business. The Company believes that the future
success of ELI will depend in large part on its continued ability to attract and
retain highly skilled and qualified personnel. See "Management."
The Company believes that a significant factor contributing to its
growth has been its affiliation with Citizens and the provision by Citizens of
administrative and other services. Although the Company has entered into various
ongoing service and other agreements with Citizens, there can be no assurance of
ELI's continued relationship with Citizens. A disruption of certain of the
services provided ELI by Citizens could have a material adverse effect on the
Company's financial condition and results of operations. See "Relationship with
Citizens."
ENVIRONMENTAL MATTERS
The Company and its contractors are subject to various laws and
regulations governing hazardous or environmentally sensitive materials or
conditions which may occur in connection with the construction, installation,
operation or maintenance of the Company's facilities. There can be no assurance
that hazardous materials or conditions of ELI's facilities might not expose the
Company to tort or other claims that could have a material adverse effect on
ELI.
ABSENCE OF PRIOR PUBLIC MARKET; POSSIBLE STOCK PRICE VOLATILITY
Prior to the Offering, there has been no public market for the Class A
Common Stock, and, although the Company will apply for listing the Class A
Common Stock on the Nasdaq National Market, there can be no assurance that an
active trading market for the Class A Common Stock will develop or will be
sustained. The initial public offering price of the Class A Common Stock has
been determined through negotiations with the Representatives of the
Underwriters and may not be indicative of the market price for the Class A
Common Stock following the Offering. For a discussion of the factors considered
in determining the initial public offering price, see "Underwriting." No
predictions can be made as to the effect, of any,
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that future market sales of Class A Common Stock, or the availability of such
shares for sale, will have on the prevailing market prices of the Class A Common
Stock following the Offering; and there can be no assurance that future market
prices for the Class A Common Stock will equal or exceed the initial public
offering price set forth on the cover page of this Prospectus. The market prices
of securities of growth companies similar to ELI have historically been highly
volatile. Future developments and announcements on matters concerning ELI or its
competitors, including quarterly results, technological innovations, mergers or
strategic alliances, new services or government legislation or regulation, may
have a significant effect on the market price of the Class A Common Stock. See
"Underwriting."
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, there will be [ ] shares of Class A
Common Stock issued and outstanding (___ if the Underwriters' over-allotment
options are exercised in full) and [ ] shares of Class B Common Stock
outstanding. The [ ] shares of Class A Common Stock to be sold in the Offering
will be tradable without restriction. The shares of Class B Common Stock and any
Class A Common Stock issued upon conversion of Class B Common Stock held or to
be held by Citizens may be offered for sale at any time assuming compliance with
legal requirements. The Company and Citizens, as the holder of the Class B
Common Stock, have agreed not to offer, sell, contract to sell, file a
registration statement pursuant to the Securities Act or otherwise dispose of
any shares of Common Stock without the prior written consent of Lehman Brothers
Inc. on behalf of the Representatives, for a period of [ ] after the date of
this Prospectus. In addition, Citizens has advised ELI that it currently intends
to hold the shares of the Class B Common Stock owned by it for the foreseeable
future. However, no assurance can be given that Citizens will not decide in the
future to register its shares of Common Stock under the Securities Act and to
dispose of all or a portion of such stock on the public market, or privately, or
otherwise. Citizens and ELI have entered into a Registration Rights Agreement,
pursuant to which Citizens has demand and piggyback registration rights. See
"Relationship with Citizens--Registration Rights Agreement." Alternatively,
Citizens could dispose of shares periodically pursuant to Rule 144 of the
Securities and Exchange Commission. See "Shares Eligible for Future Sale."
No predictions can be made about the effect, if any, that market sales
of shares of Class A Common Stock or the availability of such shares for sale
would have on the market price prevailing from time to time. Nevertheless, sales
of substantial amounts of Class A Common Stock in the public market, or the
perception that such sales could occur, may have a material adverse impact on
the market price for the shares of Class A Common Stock offered hereby or on the
ability of the Company to raise capital through a public offering of its equity
securities. See "Shares Eligible for Future Sale."
IMMEDIATE AND SUBSTANTIAL DILUTION
Purchasers of the Class A Common Stock offered hereby will incur
immediate and substantial dilution in pro forma net tangible book value per
share. See "Dilution."
ABSENCE OF DIVIDENDS
ELI has never paid or declared dividends on its capital stock and
intends to retain future earnings, if any, to finance the development and
expansion of its networks and operations.
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Therefore, ELI does not anticipate paying any dividends in the foreseeable
future. The decision whether to pay dividends will be made by the Company's
Board of Directors in light of conditions then existing, including the Company's
results of operations, financial condition and requirements, business
conditions, covenants under loan agreements and other contractual arrangements,
and other factors. See "Dividend Policy."
FORWARD-LOOKING STATEMENTS
Statements made in this Prospectus which are not historical or current
facts, such as descriptions of the Company's intentions to enter new markets,
extend existing facilities, and deploy switches and other facilities outside of
markets, are forward-looking statements and are only predictions or statements
of current plans, which are constantly under review by the Company. Such
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from those expressed or implied in the
forward-looking statements. These risks and uncertainties are referred to in the
Risk Factors section immediately above and elsewhere in this Prospectus and also
include, but are not limited to, the Company's ability to identify future
markets and successfully expand existing ones, design and acquire fiber optic
backbone routes, install cable and facilities including switching electronics,
finance its construction and expansion plans, successfully execute its marketing
strategy, surmount competitive challenges and obtain rights-of-way, building
access rights and any required governmental authorizations, franchises and
permits, all in a timely manner, at reasonable costs and on satisfactory terms
and conditions. Future successful results will also depend on favorable
regulatory, legislative and judicial developments.
USE OF PROCEEDS
The net proceeds to the Company from the Offering are estimated to be
approximately $[ ] million (approximately $[ ] million if the
Underwriters' over-allotment options are exercised in full) after deducting
underwriting discounts and commissions and estimated expenses of the Offering.
ELI intends to use the net proceeds of the Offering to fund its operating and
capital expenditure requirements. The Company estimates that its capital
expenditures for the eighteen months subsequent to the completion of the
Offering will be approximately $400 million.
The Company's business strategy envisions that the Company will build
out its existing clusters, construct new clusters and interconnect its clusters,
which will require substantial additional capital in addition to the capital
raised in this Offering. The Company expects to meet such capital needs with the
proceeds of the Offering, internally generated cash flow and lease arrangements,
together with the proceeds from bank credit facilities, other borrowings and
possible issuances of additional equity securities.
Because of the number and variability of factors that determine the
Company's use of the net proceeds of the Offering, management will retain
discretion over the application of net proceeds. There can be no assurance that
such application will not vary from the Company's current plans. In addition,
there can be no assurance that the Company will be able to generate or raise
sufficient capital to enable it to fully realize all of its strategic
objectives. See "Risk Factors--Significant Capital Expenditures" and "--Risks
Inherent in Expansion."
20
<PAGE>
Pending the foregoing uses, the net proceeds of the Offering will be
invested in short term and intermediate-term interest-bearing investment-grade
securities with maturities that match the operating and capital expenditure
requirements of the Company.
DILUTION
The pro forma net tangible book value of the Company as of June 30, 1997
was approximately $[ ] or approximately $[ ] per share of Common Stock
outstanding on such date. See "Description of Capital Stock." Pro forma net
tangible book value per share represents the amount of total tangible assets of
the Company less the amount of total liabilities (adjusted for the
capitalization of $20.7 million of the amount due Citizens) divided by the total
number of shares of Common Stock outstanding. After giving effect to the
Offering (at an assumed offering price of $, the midpoint of the range set forth
on the cover of the Prospectus, less underwriting discounts and estimated
expenses of $ payable in connection with the Offering) the pro forma net
tangible book value of the Company as of June 30, 1997 would have been
approximately $[ ], or $[ ] per share of Common Stock. This represents an
increase in pro forma net tangible book value of $[ ] per share to the
existing stockholder and dilution of $[ ] per share to new investors
purchasing shares of Class A Common Stock in the Offering. The following table
illustrates dilution to new investors:
Initial public offering price per share................... $
Pro forma net tangible book value per share before
the Offering................................... $
Increase per share attributable to new investors(1) $
---
Pro forma net tangible book value per share after the Offering $
----
Dilution per share to new investors(2)(3)................. $
====
- ---------------------
(1) After deducting the underwriting discount and estimated offering expenses
payable by the Company.
(2) Dilution per share is determined by subtracting the pro forma net tangible
book value per share after the Offering from the initial public offering
price paid by a new investor for a share of Class A Common Stock.
(3) If the Underwriters' over-allotment options are exercised in full, pro forma
net tangible book value of the Company after the Offering would be $[ ] per
share, representing an increase in pro forma net tangible book value of
$[ ] per share and dilution to new investors of $[] per share.
The following table summarizes the difference as of June 30, 1997
between the existing stockholder and new investors with respect to the number of
shares of Common Stock purchased from the Company, the total consideration paid
to the Company and the average price paid per share.
21
<PAGE>
Shares Held Total Investment Average
----------------------- --------------------------- Cost
Number Percentage Amount Percentage Per Share
----------- ----------- --------------- ----------- ---------
New Investors.. % $ % $
Existing
Stockholder(1) % $ % $
---------- --------------- ----------- ---------
Total...... 100.0% $ 100.0%
========== =============== =========== =========
- ---------------
(1) Based on the number of shares of Common Stock outstanding as of June 30,
1997.
DIVIDEND POLICY
ELI has never paid or declared dividends on its capital stock and
intends to retain future earnings, if any, to finance its operations and the
development and expansion of its networks and, therefore, does not anticipate
paying any dividends in the foreseeable future. The decision whether to pay
dividends will be made by the Company's Board of Directors in light of
conditions then existing, including the Company's results of operations,
financial condition and requirements, business conditions, covenants under loan
agreements and other contractual arrangements, and other factors.
22
<PAGE>
CAPITALIZATION
The following table sets forth (i) the historical capitalization of the
Company as of June 30, 1997; (ii) such capitalization as adjusted to reflect the
contribution of a portion of the amount due to Citizens to additional paid-in
capital and the reclassification of the balance to long-term debt payable to
Citizens and the split of shares of Common Stock and the authorization of Class
A and Class B Common Stock; and (iii) such capitalization pro forma to reflect
the Offering at an assumed public offering price of $, the midpoint of the range
set forth on the cover of this Prospectus. This table should be read in
conjunction with the Selected Financial and Operating Data and the financial
statements and notes included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
As at June 30, 1997
--------------------------------------------------------------------
Pro Forma for the
Actual As Adjusted Offering
------------------- ---------------------- -------------------
<S> <C> <C> <C>
Capital lease obligation $ 10,664
Due to Citizens..................................... 194,669
Long-term debt due to Citizens...................... - (1)
Stockholders' (deficiency) equity:
Preferred Stock, $.01 par value; [ ] shares
authorized, no shares issued and outstanding.... - (2)
Common Stock, no par value; 500 shares authorized,
100, 0 and 0 shares issued and outstanding...... - (2)
Class A Common Stock, $.01 par value;
0, [ ] and [ ] shares authorized
0, 0 and [] shares issued and outstanding....... - (2)
Class B Common Stock, $.01 par value;
0, [ ] and [ ] shares authorized
0, [ ] and [ ] shares issued and outstanding - (2)
Additional paid-in capital.......................... 79,255 (1)
Deficit............................................. (90,085)
--------
Total stockholders' (deficiency) equity............. (10,830)
---------
Total capitalization............................ $ 194,503
=========
</TABLE>
- -------------------
(1) Reflects recapitalization immediately prior to the Offering whereby Citizens
contributed $20.7 million of the amount due to Citizens to additional paid-
in capital with the remaining balance of $174 million being converted to __%
long-term debt payable to Citizens, due in __________________.
(2) Reflects the amendment to the Certificate of Incorporation in 1997 to change
the authorized capital stock to _______ shares, including shares of Class
A Common Stock $.01 par value, _______ shares of Class B Common Stock $.01
par value, and __________ shares of Preferred Stock $.01 par value; to
split the Common Stock __ -for-1; and to designate such Common Stock as
Class B Common Stock.
23
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following selected Statement of Operations and Balance Sheet Data
for the years ended and as of December 31, 1992 and 1993 have been derived from
the Company's unaudited Financial Statements which, in the opinion of management
include all adjustments necessary for a fair presentation of the results of
operations and financial condition of the Company for such periods. The
following selected Statement of Operations and Balance Sheet Data for the years
ended and as of December 31, 1994, 1995, and 1996 have been derived from the
Company's Financial Statements and related notes thereto included elsewhere in
this Prospectus, which Financial Statements have been audited by KPMG Peat
Marwick LLP, independent Certified Public Accountants. The selected Statement of
Operations and Balance Sheet Data for the six months ended June 30, 1996 and
1997 have been derived from the Company's unaudited Financial Statements and
related notes thereto included elsewhere in this Prospectus and in the opinion
of management include all adjustments necessary for a fair presentation of the
results of operations and financial condition of the Company for such periods.
The results of operations for interim periods are not necessarily indicative of
a full year's operations. This information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," the Company's Financial Statements and related notes thereto and
the other financial data contained elsewhere in this Prospectus.
<TABLE>
<CAPTION> Six Months
Years Ended December 31, Ended June 30,
------------------------------------------------------------ ---------------------
1992 1993 1994 1995 1996 1996 1997
------------------------------------------------------------ ---------------------
<S> <C> <C> <C> <C> <C> <C> <C>
($ in thousands, except per share amounts)
Statement of Operations Data
Revenues $ 1,206 $ 3,705 $ 8,152 $ 15,660 $ 31,309 $ 13,374 $ 24,765
Operating expenses:
Network access expenses 142 1,289 6,155 8,728 24,081 9,527 15,206
Sales and marketing expenses 1,043 841 4,534 5,704 8,462 3,940 6,271
Depreciation and amortization 879 1,567 2,476 7,064 7,192 3,453 5,603
Other Operating expenses 1,949 2,892 4,528 14,114 20,957 7,069 17,499
------------------------------------------------------------- ---------- --------
Total operating expenses 4,013 6,589 17,693 35,610 60,692 23,989 44,579
------------------------------------------------------------- ---------- --------
Operating loss (2,807) (2,884) (9,541) (19,950) (29,383) (10,615) (19,814)
Interest expense 754 1,053 873 372 - - 302
------------------------------------------------------------- ---------- --------
Net loss $ (3,561) $ (3,937) $ (10,414) $ (20,322) $ (29,383) $(10,615) $(20,116)
============================================================= ========== ========
Pro forma net loss(1) $ $ $
=========== ========== ========
Pro forma net loss per share(2) $ $ $
=========== ========== ========
<CAPTION>
As at December 31,
------------------------------------------------------------- As at
1992 1993 1994 1995 1996 June 30, 1997
------------------------------------------------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital (deficiency) $ (5,300) $ (5,699) $ (9,934) $ (17,897) $ (9,940) $(19,856)
Total assets 25,476 47,840 110,691 128,901 195,656 233,835
Long-term debt and capital lease obligations 11,053 9,610 6,565 - - 10,664
Due to Citizens 4,581 21,481 35,109 64,941 155,395 194,669
Shareholder's equity (deficiency) 4,437 9,150 55,991 38,669 9,286 (10,830)
============================================================= ==========
Operating Data
EBIDTA(4) $ (1,928) $ (1,317) $ (7,065) $ (12,886) $ (22,191) $ (14,211)
Property, plant & equipment owned $ 21,083 $ 45,309 $ 108,549 $ 127,297 $ 189,334 $ 235,953
-under lease(5) - - - 36,858 57,279 87,425
------------------------------------------------------------- ----------
-Total $ 21,083 $ 45,309 $ 108,549 $ 164,155 $ 246,613 $ 323,378
------------------------------------------------------------- ----------
Market Clusters 2 5 5 5 5 5 5
Route miles(6) 71 131 601 780 1,490 940 1,728
Fiber miles(6) 5,140 9,796 37,504 52,013 96,609 64,574 104,718
Buildings connected 57 104 191 282 454 318 521
Switches installed:
Voice - 1 2 2 5 2 5
Frame relay - - 2 5 15 7 18
Total switches installed - 1 4 7 20 9 23
Employees 46 75 127 225 402 292 486
<CAPTION>
Pro Forma as at
June 30, 1997 (3)
-----------------
<S> <C>
BALANCE SHEET DATA
Working capital (deficiency)
Total assets
Long-term debt and capital lease obligations
Due to Citizens
Shareholder's equity (deficiency)
Operating Data
EBIDTA(4)
Property, plant & equipment owned
-under lease(5)
-Total
Market Clusters
Route miles(6)
Fiber miles(6)
Buildings connected
Switches installed:
Voice
Frame relay
Total switches installed
Employees
</TABLE>
- ---------------------------
(1) The pro forma net loss represents the historical net loss as adjusted for
the revised administrative services fees, guarantee fee, and interest to be
charged on the long-term debt due to Citizens (see Note 6 of Notes to
Financial Statements) as if such fees and interest rate were effective
January 1, 1996.
(2) The pro forma net loss per share has been computed on the basis described in
Note 2(i) of Notes to Financial Statements.
(3) The pro forma balance sheet data gives effect to the contribution of certain
amount of due to Citizens to additional paid-in capital as discussed in Note
5 of Notes to Financial Statements, and gives effect to the issuance of the
shares of Class A Common Stock offered hereby.
(4) EBIDTA consists of Earnings Before Interest, Income Taxes, Depreciation and
Amortization. EBIDTA is a measure commonly used in the communications
industry to analyze companies on the basis of operating performance. EBIDTA
is not a measure of financial performance under generally accepted
accounting principles and should not be considered as an alternative to net
income as a measure of performance nor as an alternative to cash flow as a
measure of liquidity. See the Company's Financial Statements included
elsewhere in this Prospectus.
(5) Facilities under an operating lease agreement under which the Company has
the option to purchase the facilities at the end of the lease term. See Note
7 of Notes to Financial Statements.
(6) Route miles and Fiber miles also include those to which the Company has
exclusive use pursuant to license and lease arrangements (See "Business--
Long-Haul Networks")
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
ELI's historical audited financial statements and the notes thereto included
elsewhere in this Prospectus.
OVERVIEW
The Company is a full-service, facilities-based competitive local
exchange carrier providing a broad range of telecommunications services in five
major market clusters in the western United States. The Company currently
provides services in the following markets: Portland, Oregon; Seattle,
Washington; Salt Lake City, Utah; Sacramento, California; and Phoenix, Arizona
("hub cities") and their respective surrounding areas (together with the hub
cities, "market clusters" or "clusters"). Among its five current markets, the
Company has been operating in Portland and Seattle since 1991, Salt Lake City
and Sacramento since 1994 and Phoenix since 1995. The Company began building its
switched data network in 1994. The Company installed its first local switch in
the Seattle market in 1994 and began generating revenues in early 1995 followed
by Portland, Salt Lake City and Sacramento in 1996. The Company intends to
install a local switch in Phoenix in 1998. The Company placed in service its
first long haul network from Phoenix to Las Vegas in 1995 and its second long
haul network from Portland to Seattle in early 1997.
The Company's product portfolio has grown from traditional competitive
access provider services such as point-to-point connectivity for interexchange
carriers and businesses to a full array of switched voice, data and long-haul
services targeted toward communications-intensive businesses in both the retail
and wholesale markets. The Company offers an extensive portfolio of products and
services in four categories: local telephone, long distance, data and video, and
network access services (see "Current Products and Services") as follows:
. Local Telephone - local dial tone and switching products and services
that include lines, trunks, local access and Centrex(TM) among other services.
. Long Distance - wholesale and retail services that include 1+, toll-
free, pre-paid originating and terminating access services.
. Data and Video - switched and dedicated data connectivity services
that include frame relay, video conferencing, ISDN PRI, LAN/WAN and Internet
transport services.
. Network Access - point-to-point services that include special access,
digital private line and other dedicated services both in metropolitan and long-
haul applications.
The Company categorizes its operating expenses into the following five
major groupings:
. Network Access - includes all leased network facilities and resold
product expenses.
. Sales and Marketing - includes all direct and indirect sales channel
expenses and commissions. Also includes all product development, advertising and
promotional expenses.
25
<PAGE>
. Depreciation and Amortization - includes depreciation of
telecommunications network assets including fiber optic cable, network
electronics, network switching and network data equipment.
. Administrative Services - includes administrative services provided by
Citizens. The Company is charged for the direct cost of administrative services
plus an allocation of Citizens' corporate overheads.
. Other Operating - includes all general and other operating and
administrative expenses.
The pace of the Company's revenue and expense growth results from its
market cluster expansion strategy. Once a potential market is identified, the
Company establishes a network in the hub city and then expands the network to
adjacent cities and communities of interest. This strategy requires that
significant capital and operating expenditures be incurred before the
realization of revenues which results in negative cash flow and operating losses
until an adequate customer base and revenue stream for these networks is
established. In addition, the Company is developing a superior customer service
system which will facilitate combining enhanced services such as data and video
with network access services. The growth in enhanced services is expected to
increase revenues with minimal additional expense.
The Company has been a subsidiary of Citizens since 1990. Citizens is a
publicly-held communications and public services company which provides, either
directly or through subsidiaries, telecommunications, electric distribution,
natural gas transmission and distribution and water and wastewater services to
over 1.6 million customer connections in 20 states. Citizens Communications is
one of the nation's leading independent communications companies and operates an
integrated distribution network over which it provides local, long distance,
paging, cellular, network sales and other communications products and services.
Citizens has funded or guaranteed the financing of nearly all of the Company's
capital and operating needs to date.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1996 COMPARED TO SIX MONTHS ENDED JUNE 30,
1997
REVENUES
Revenues increased from $13.4 million to $24.8 million, an increase of
$11.4 million, or 85%, for the six months ended June 30, 1996 as compared with
the six months ended June 30, 1997, primarily due to the Company's rapid
customer growth and expansion in all product categories. The Company's local
telephone services revenues and local access revenues increased from $.8 million
to $2.4 million, an increase of $1.6 million, or 200%, for the six months ended
June 30, 1996 as compared with the six months ended June 30, 1997, primarily due
to local switch implementations and upgrades for new and existing customers in
Portland, Salt Lake City, Sacramento and Seattle during the second half of 1996.
Annualized monthly local telephone services revenues increased to $5.7 million
based on June 1997 revenues from $2.1 million based on June 1996 revenues as the
Company increased its access line equivalents to 31,060 as of June 1997. Long
distance services revenues increased from $1.6 million to $3.5 million, an
increase of $1.9 million, or 119%, for the six months ended June 30, 1996 as
26
<PAGE>
compared with the six months ended June 30, 1997, primarily due to the
introduction of prepaid debit card services and wholesale long distance
services. The Company's data and video services revenues increased from $.8
million to $3.1 million, an increase of $2.3 million , or 288%, for the six
months ended June 30, 1996 as compared with the six months ended June 30, 1997,
primarily due to the introduction of ISDN services and increases in frame relay
and Internet access services. ISDN PRI and Internet access services were
introduced the last half of 1996 and have obtained considerable market
acceptance. The Company believes that these products will continue to experience
exceptional growth based on current market trends. Network access services and
other revenues increased from $10.2 million to $15.8 million, an increase of
$5.6 million, or 55%, for the six months ended June 30, 1996 as compared with
the six months ended June 30, 1997, primarily due to increased volume on its
existing Phoenix to Las Vegas route as well as volume on the Portland to Seattle
route which was placed in service in February, 1997. Of the $5.6 million
increase in network access services revenues, $.7 million is pursuant to a
contract with a significant customer which will expire in early 1998.
NETWORK ACCESS EXPENSES
Network access expenses increased from $9.5 million to $15.2 million, an
increase of $5.7 million, or 60%, for the six months ended June 30, 1996 as
compared with the six months ended June 30, 1997, primarily due to the Company's
expansion of its frame relay product, development of a fully redundant leased
Internet access backbone with related Internet access costs, expanded long
distance sales and customer growth.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased from $3.9 million to $6.3
million, an increase of $2.4 million, or 62%, for the six months ended June 30,
1996 as compared with the six months ended June 30, 1997, primarily due to
increased product development activities related to local services and data
services, such as Internet access and frame relay. The Company's expanded focus
on direct retail sales which targets large- to medium- size telecommunications
intensive businesses resulted in increased sales expenses. The Company believes
that by focusing on these end-user customers vertical selling opportunities will
be maximized.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased from $3.5 million to $5.6
million, an increase of $2.1 million, or 60%, for the six months ended June 30,
1996 as compared with the six months ended June 30, 1997, primarily due to
higher plant in service balances for newly completed telecommunications network
facilities and electronics in the Portland, Salt Lake City and Sacramento
markets.
ADMINISTRATIVE SERVICES EXPENSES
Administrative services expenses increased from $.9 million to $1.6
million, an increase of $.7 million, or 78%, for the six months ended June 30,
1996 as compared with the six months ended June 30, 1997, primarily due to
increases in the volume and cost of services provided by Citizens.
27
<PAGE>
OTHER OPERATING EXPENSES
Other operating expenses increased from $6.2 million to $15.9 million,
an increase of $9.7 million, or 156%, for the six months ended June 30, 1996 as
compared with the six months ended June 30, 1997, primarily due to increases in
labor costs, including increases in salaries, payroll taxes and related benefits
to support the expanded delivery of services, new product development, marketing
activities and an expanded customer service organization. The average number of
employees increased 66% for the six months ended June 30, 1996 as compared
with the six months ended June 30, 1997.
INTEREST EXPENSE
Interest expense increased $.3, for the six months ended June 30, 1996
as compared with the six months ended June 30, 1997, primarily due to interest
associated with the capital lease for the Company's long-haul route between
Portland and Seattle which commenced in February 1997 (see Note 7 of Notes to
Financial Statements).
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Revenues increased from $15.7 million to $31.3 million, an increase of
$15.6 million, or 99%, for the year ended December 31, 1995 as compared with the
year ended December 31, 1996, primarily due to expansion of the customer base,
increased sales of services in Portland and Seattle, and the Company's expansion
in the Salt Lake City and Sacramento markets. The Company's local telephone
services revenues increased from $.6 million to $2.2 million, an increase of
$1.6 million, or 267%, for the year ended December 31, 1995 as compared with the
year ended December 31, 1996, primarily due to increases in the Company's local
dial tone services revenues and local access services revenues associated with
the introduction of local switched services in Portland and Salt Lake City and
expanded local services in the Seattle market. Long distance services revenues
increased from $1.6 million to $5.0 million, an increase of $3.4 million, or
213%, for the year ended December 31, 1995 as compared with the year ended
December 31, 1996, primarily due to revenues associated with a short term
contract which has since expired for wholesale long distance services. The
Company's data and video services increased from $.3 million to $2.4 million, an
increase of $2.1 million, for the year ended December 31, 1995 as compared with
the year ended December 31, 1996, primarily due to increases in frame relay and
Internet access services. Network access services and other revenues increased
from $13.1 million to $21.7 million, an increase of $8.6 million, or 66%, for
the year ended December 31, 1995 as compared with the year ended December 31,
1996, primarily due to the increase of long-haul transport of DS-3 and DS-1
sales.
NETWORK ACCESS EXPENSES
Network access expenses increased from $8.7 million to $24.1 million, an
increase of $15.4 million, or 177%, for the year ended December 31, 1995 as
compared with the year ended December 31, 1996, primarily due to facilities rent
expense associated with the expansion of the customer base and the establishment
of a leased network linking the Company's five market clusters.
28
<PAGE>
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased from $5.7 million to $8.5
million, an increase of $2.8 million, or 49%, for the year ended December 31,
1995 as compared with the year ended December 31, 1996, primarily due to sales
and marketing costs associated with the introduction of local switched services
in Portland, Salt Lake City, and Sacramento, expanded local services in the
Seattle market, the expanded frame relay product and newly-introduced Internet
access and ISDN products in 1996.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization were comparable for both years.
ADMINISTRATIVE SERVICES EXPENSES
Administrative services expenses increased from $1.5 million to $2.3
million, an increase of $.8 million, or 53%, for the year ended December 31,
1995 as compared with the year ended December 31, 1996, primarily due to
increases in the volume and cost of services provided by Citizens.
OTHER OPERATING EXPENSES
Other operating expenses increased from $12.6 million to $18.7 million,
an increase of $6.1 million, or 48%, for the year ended December 31, 1995 as
compared with the year ended December 31, 1996, primarily due to an increased
provision for uncollectible accounts of $2.9 million, labor costs and outside
services to support customer growth and expansion in all service categories. The
number of average employees increased 68% for the year ended December 31, 1995
as compared with the year ended December 31, 1996 resulting in increases in
salaries and payroll taxes.
INTEREST EXPENSE
Interest expense decreased $.4 million, or 100%, for the year ended
December 31, 1995 as compared with the year ended December 31, 1996, primarily
due to the repayment in December 1995 of previously outstanding debt.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES
Revenues increased from $8.2 million to $15.7 million, an increase of
$7.5 million, or 91%, for the year ended December 31, 1994 as compared with the
year ended December 31, 1995, primarily due to the Company's expansion of its
customer base for network access services revenues. Local dial tone services
were introduced in 1995 and generated $.6 million of local telephone services
revenues. Long distance services revenues increased from $1.4 million to $1.6
million, an increase of $.2 million , or 14%, for the year ended December 31,
1994 as compared with the year ended December 31, 1995, primarily due to
increases in retail long distance services. The Company's data and video
services increased from $.1 million to $.3 million, an increase of $.2 million,
or 200%, for the year ended December 31, 1994 as compared with the year ended
December 31, 1995, primarily due to increases in frame relay and Internet access
services. Network access services and other revenues increased from $6.7 million
to
29
<PAGE>
$13.1 million, an increase of $6.4 million, or 96%, for the year ended December
31, 1994 as compared with the year ended December 31, 1995, primarily due to
increased metropolitan area network transport and long haul transport services.
NETWORK ACCESS EXPENSES
Network access expenses increased from $6.2 million to $8.7 million, an
increase of $2.5 million, or 40%, for the year ended December 31, 1994 as
compared with the year ended December 31, 1995, primarily due to the expansion
of its customer base for network access services revenues and the introduction
of local telephone services in Seattle.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased from $4.5 million to $5.7
million, an increase of $1.2 million, or 27%, for the year ended December 31,
1994 as compared with the year ended December 31, 1995, primarily due to
increased sales for its network access services revenues and the introduction of
local telephone services in Seattle. Marketing costs also include costs
associated with product development for frame relay and Internet access services
products and wider product offerings to current and potential customers.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization increased from $2.5 million to $7.1
million, an increase of $4.6 million, or 184%, for the year ended December 31,
1994 as compared with the year ended December 31, 1995, primarily due to
expansion of the telecommunications network and the commencement of amortization
of deferred start-up costs in Salt Lake City and Sacramento.
ADMINISTRATIVE SERVICES EXPENSES
Administrative services expenses increased from $1.3 million to $1.5
million, an increase of $.2 million, or 15%, for the year ended December 31,
1994 as compared with the year ended December 31, 1995, primarily due to
increases in the volume and cost of service provided by Citizens.
OTHER OPERATING EXPENSES
Other operating expenses increased from $3.2 million to $12.6 million,
an increase of $9.4 million, or 294%, for the year ended December 31, 1994 as
compared with the year ended December 31, 1995, primarily due to increased labor
costs associated with the significant growth of the Company. The Company
increased its number of employees resulting in increases in salaries and payroll
taxes. The Company also supplemented staffing with temporary employees to
support the Company's growth.
INTEREST EXPENSE
Interest expense decreased from $.9 million to $.4 million, a decrease
of $.5 million, or 56%, for the year ended December 31, 1994 as compared with
the year ended December 31, 1995, primarily due to the declining balance of
outstanding debt. This debt was fully paid in December 1995.
30
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The capital expenditures of the Company associated with the
installation, development and expansion of its existing and new
telecommunications networks are substantial, and a significant portion of these
expenditures generally are incurred before any revenues are realized. The
Company's gross property, plant and equipment has grown from $109 million at
December 31, 1994 to $236 million at June 30, 1997. These expenditures, together
with associated initial operating expenses, have resulted in negative cash flow
and operating losses and will continue to do so until an adequate customer base
and revenue stream for these networks have been established. The Company expects
to incur net losses for the foreseeable future as it continues to install,
develop and expand its new and existing telecommunications networks. There can
be no assurance that an adequate revenue base will be established or that the
Company will achieve or sustain profitability or generate sufficient positive
cash flow to fund its operating and capital requirements and/or service debt.
The development and expansion of the Company's new and existing networks
and services will require significant additional capital expenditures. The
Company's capital expenditure requirements for 1997 are estimated to be $82
million (of which $39 million was incurred through June 30, 1997) and for 1998
are estimated to be $260 million. In addition, the Company expects to lease an
additional $22.6 million of network facilities through an existing operating
lease agreement. The Company continues to evaluate opportunities for revenue
growth and to make substantial capital investments in connection with the entry
into new markets and the continued development of its existing networks. These
opportunities include, but are not limited to, acquisitions and/or joint
ventures, which are consistent with the Company's long-range business plans.
Additionally, the Company expects to continue to build on its existing
relationships with providers and other strategic customers, suppliers and
telecommunications carriers. Such acquisitions, investments and/or strategic
arrangements, if available, could require financial resources in addition to the
1997 and 1998 capital requirements presented above and could require
reallocation of the Company's financial resources.
The Company expects to meet its capital needs with the proceeds of the
Offering, internally generated cash flow and lease arrangements, together with
the proceeds from bank credit facilities, other borrowings and possible
issuances of additional equity securities. The Company has historically been
funded by capital contributions and advances from Citizens which totaled
approximately $278.2 million through June 30, 1997, and through a lease
agreement guaranteed by Citizens. While Citizens will continue to fund the
Company's operating and capital requirements through the completion of the
Offering, Citizens will not have any obligation to make additional equity
investments in or advances to the Company or to guarantee or otherwise provide
financial support for the Company subsequent to the Offering.
Prior to the completion of the Offering, $20.7 million of the amount due
to Citizens as of June 30, 1997 will be contributed to additional paid-in-
capital and the remaining $174 million will become long-term debt payable to
Citizens. Funds provided to the Company by Citizens subsequent to June 30, 1997
will be treated as long-term debt payable to Citizens. In 1994, 1995 and 1996,
Citizens had been charging interest on the amount due to Citizens only to the
extent that the Company was allowed to capitalize interest under Generally
Accepted Accounting Principles. Effective with the completion of the Offering,
interest on the long-term debt payable
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<PAGE>
to Citizens will be at an annual rate of ____%, will be non-amortizing, and will
mature in ______.
During 1995, the Company entered into an operating lease agreement in
connection with the construction of certain network facilities. The construction
is ongoing and rent is paid on the facilities when completed and placed in
service. The Company will have the option to purchase the facilities at the end
of the lease term. In the event the Company chooses not to exercise this option,
the Company is obligated to arrange for the sale of the facilities to an
unrelated party and is required to pay the lessor any difference between the net
sales proceeds and the lessor's investment in the facilities. However, any
amount required to be paid to the lessor is subject generally to a
maximum of 80% of the lessor's investment, giving effect to lease payments
previously made. The total amount of facilities leased through this agreement is
expected to be $110 million, of which approximately $87.4 million has been
completed and placed in service as of June 30, 1997. Citizens has guaranteed all
obligations of the Company under this operating lease. Effective with the
completion of the Offering, the Company has agreed to pay to Citizens an annual
guarantee fee equal to 3.25% per annum of the lessor's investment in the leased
assets.
Citizens also provides certain administrative services to the Company
including, but not limited to, certain financial management services,
information services, legal and contract services, human resources services and
corporate planning services. The Company has been charged for all reasonable
costs incurred in the provision of these services. The Company will enter into
an administrative services agreement with Citizens effective with the completion
of this Offering for the continuation of such services and will continue to be
billed for all reimbursable costs plus an administrative charge.
EFFECTS OF NEWLY-ISSUED ACCOUNTING STANDARDS
In February, 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 128 ("SFAS 128"),
"Earnings Per Share," which supersedes Accounting Principles Board Opinion No.
15 and establishes standards for computing and presenting earnings per share
("EPS"). It replaces the presentation of primary EPS with a presentation of
basic EPS. Dual presentation of basic and diluted EPS on the face of the income
statement is also required. SFAS 128 is effective for fiscal periods ending
after December 15, 1997. The Company does not expect the adoption of SFAS 128 to
have a material effect on the Company's EPS.
BUSINESS
GENERAL
ELI is a full-service, facilities-based CLEC providing a broad range of
telecommunications services in five major market clusters in the western United
States. The Company provides state-of-the-art voice and data communications
services to retail customers, primarily large- and medium-sized communications-
intensive businesses, and wholesale customers, primarily telecommunications
service providers. The Company operates high quality, extensive digital fiber
optic networks based on a switched broadband platform in each of its five market
clusters (comprising six MSAs, including 59 municipalities) with 31,060 local
access line equivalents, 1,728 route miles and 104,718 fiber miles installed and
521 buildings
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connected as of June 30, 1997. The Company has interconnected its market
clusters with facilities-based owned and leased long-haul fiber optic networks.
The Company generated revenues of $31 million during 1996 and $57 million on an
annualized basis in 1997 based on revenues for the quarter ended June 30, 1997.
The Company currently provides services in five markets: Portland,
Oregon; Seattle, Washington; Salt Lake City, Utah; Sacramento, California; and
Phoenix, Arizona ("hub cities") and their respective surrounding areas (together
with the hub cities, "market clusters" or "clusters"). The Company's clusters
include an extensive fiber optic network. The Company currently provides
switched services, including local dial tone, utilizing five Nortel DMS 500
switches, in all of its market clusters except Phoenix, where the Company
expects to initiate local dial tone service upon installing an additional switch
in the first half of 1998. The Company's clusters are also served by its
extensive frame relay network, which is comprised of 18 state-of-the-art
switches and 30 POPs in 26 western U.S. cities. The Company has also developed
an Internet backbone network providing Internet connectivity in each of its
markets which includes access on a redundant basis to the three largest Internet
service providers in the United States. The Company's goal is to add to its
market presence from six to 12 MSAs and from two to five long-haul networks by
the end of 1998.
The Company offers an extensive portfolio of products and services in
four categories: local telephone, long distance, data and video, and network
access. These products and services include: Local dial tone, with voicemail and
enhanced features; long distance with calling cards; advanced data services,
including frame relay, international frame relay and high-speed Internet access,
connectivity and transport; video conferencing and dialable wideband services;
LAN-to-LAN services with very high transport speeds; ISDN; and point-to-point
communications and dedicated DS-1s and DS-3s. The Company expects to provide ATM
services during 1998. The Company's data network expertise allows it to provide
a broader range of telecommunications services to customers, which helps to
maximize the amount of telecommunications traffic on its network.
The above services are offered to meet customers' complete
telecommunications requirements. The Company offers its services in custom
combinations, and utilizes a consultative sales approach that provides customers
a single point of contact at the Company and an opportunity to work with the
Company to design innovative, turn-key solutions and new product applications
which allows them to take advantage of the broad array of services offered. The
Company has implemented an integrated network management system designed to
monitor and test the Company's networks 24 hours a day, seven days a week and is
developing a superior customer care system which will automate the entire order
management process (i.e., order placement, design, provisioning and billing
preparation) for both retail and wholesale customers. The Company also is
installing a customized billing system and a new maintenance system capable of
up-to-the minute trouble ticket tracking.
Deregulation in the telecommunications industry has created an enormous
market opportunity for ELI. Based on FCC data, the Company estimates that in
1996 total revenues from local and long distance telecommunications services
were approximately $183 billion, of which approximately $107 billion were
derived from business telecommunications services. The Company estimates that
based on industry sources, the total addressable business telecommunications
services market in its current five market clusters (based on access lines) was
approximately $4.3 billion in 1996. The Company believes that the market in its
clusters
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will grow over the next decade because of the favorable demographics and an
increase in use of telecommunications services and that its share of this market
will increase as a result of the passage of the 1996 Act, the actions of various
state commissions and other FCC rulings, which collectively have essentially
opened up the market to competition.
Since its inception, ELI has been at the forefront of industry efforts
to introduce competition to the local telecommunications markets. As such, ELI
has achieved significant milestones in the CLEC industry and is well positioned
to benefit from the opening of the local telecommunications market. Before the
passage of the 1996 Act, the Company aggressively pursued regulatory and
legislative reforms and consummated certain interconnection agreements with
ILECs that allowed the Company to offer economical and operationally efficient
local exchange services. The Company was early to market in Portland, Seattle,
Salt Lake City and Sacramento and believes it is the leading CLEC in Portland,
Seattle and Salt Lake City. The Company was the first CLEC to receive authority
from a state regulatory authority in a state west of the Mississippi River to
operate and to offer a full switch-based product portfolio. ELI has also been a
leader in the implementation of local number portability.
Since 1990, the Company has been a subsidiary of Citizens. Citizens is a
publicly-held communications and public services company which provides, either
directly or through subsidiaries, telecommunications, electric distribution,
natural gas transmission and distribution, and water and wastewater services to
over 1.6 million customer connections in 20 states. Citizens Communications is
one of the nation's leading independent communications companies and operates an
integrated distribution network over which it provides local, long distance,
paging, cellular, network sales and other communications products and services.
At June 30, 1997, Citizens' consolidated assets totaled $4.4 billion and
shareholders' equity totaled $1.6 billion. Citizens' consolidated revenues for
the twelve months ended June 30, 1997 totaled $1.3 billion. The Company has
historically been funded by capital contributions and advances from Citizens and
through a lease agreement guaranteed by Citizens. See "Capitalization" and
"Relationship with Citizens."
BUSINESS STRATEGY
Guided by the business strategy adopted in 1990, the Company has become
a leading facilities-based, full-service CLEC. The key elements of this strategy
include:
. TARGET ATTRACTIVE REGIONAL MARKETS. The Company's focus is on MSAs in
the western United States that the Company believes have few CLEC competitors, a
relatively high proportion of communications-dependent businesses and the
prospect of population and economic growth above the national average. Growth in
these regions has been fueled to a large degree by the computer, software,
semiconductor and aerospace industries and other telecommunications-intensive
businesses such as financial services and telemarketing call centers. The
Company's policy has been and will continue to be to establish a new market
cluster where it expects to become the leading facilities-based, full-service
CLEC in such market in competition with the ILEC. Due to its superior customer
service, advanced network technologies and the breadth and quality of its
networks, the Company believes that it has an opportunity to capture a
significant share of the local market for communications in its target regions
in competition with U S WEST and, in Sacramento, PacBell, which are the ILECs in
its regions.
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. DEVELOP MARKET CLUSTERS. The Company builds facilities and offers
services in market clusters which exist in and around a hub city in the selected
MSA. Once a potential market is identified, the Company establishes a network in
the hub city and then expands the network to adjacent cities and communities of
interest. Through the use of this strategy, the Company is able to leverage and
extend the depth of its management resources, communications network, switch
assets and product portfolio and reduce its dependence on the ILEC. The Company
realizes economies of scale in terms of network build out, switch deployment,
provisioning and servicing from its cluster strategy. Clustering also enables
the Company to (i) optimize its networks' switching capacity through the ability
to place switches anywhere in the cluster, (ii) cost-effectively offer services
to smaller markets adjacent to its existing networks and in which the Company is
less likely to face strong competition from other CLECs, and (iii) achieve
increased gross margins and improved network reliability due to higher levels of
on-net traffic. The Company believes communications traffic is heavy between a
metropolitan area and its outlying markets and its cluster strategy takes
advantage of this by offering facilities-based, end-to-end service offerings
that cover these broad geographic areas.
. INTERCONNECT MARKET CLUSTERS. The Company's strategy is to
interconnect the Company's major market clusters with facilities-based
broadband, long-haul fiber optic networks. Interconnecting its market clusters
enables the Company to lower costs and enhance its revenue potential by carrying
increasing amounts of long distance, frame relay, Internet and point-to-point
traffic on its own facilities. By carrying traffic on its own facilities, the
Company is able to improve the utilization of its network facilities and avoid
leased facilities charges and certain interconnection costs.
. PENETRATE MARKETS BY LEVERAGING FRAME RELAY NETWORK. The Company has
undertaken a major expansion of its networks and products to satisfy the growing
demand for enhanced network services, including frame relay networking services
and Internet access. As a result, the Company had 18 frame relay switches
servicing customer locations as of June 30, 1997. Enhanced network services,
which are currently provided primarily on the Company's frame relay network, are
specialized interchange services offered by the Company for customers that need
to transport large amounts of data among multiple locations. ELI's relationship
with certain carriers allows the Company to terminate traffic both nationally
and internationally utilizing other companies' networks and to provide a flow of
traffic into the Company's networks. In addition, to further increase efficient
access to a greater customer base, ELI established approximately 30 POPs which
interconnect their frame relay networks to those of U S WEST, PacBell and other
carriers.
. MAXIMIZE ON-NET TRAFFIC BY PROVIDING FACILITIES-BASED SERVICES. The
Company has constructed extensive voice, frame relay, Internet backbone and
interconnecting long-haul networks, and each of the Company's operating clusters
includes an extensive fiber optic network backbone. These extensive networks are
a key aspect of the Company's strategy to maximize the services provided to
customers onnet. Approximately half of the Company's services provided to
customers are currently on-net and the Company's strategy is to increase this
percentage over time. Maximizing the volume of on-net traffic allows the Company
to (i) improve customer loyalty and minimize churn; (ii) increase network
reliability; (iii) provide a wider range of services; (iv) increase process
control and thereby strengthen customer service through end-to-end management;
and (v) reduce its reliance on the ILEC for technologically up-
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<PAGE>
to-date services which are essential for the Company's enhanced services. The
Company believes that greater on-net traffic will also increase operating
margins by increasing utilization of capacity inherent in the Company's network.
. ESTABLISH STRATEGIC RELATIONSHIPS WITH UTILITY COMPANIES. A strategy
of the Company has been to form strategic relationships with utility companies
that enable it to (i) utilize existing rights-of-way and fiber optic facilities,
(ii) leverage their construction expertise and local permitting experience and
(iii) have access to capital in order for ELI to extend its network
infrastructure more quickly and economically. The Company's strategic alliances
include agreements for the utilization of existing excess facilities and the
construction of long-haul networks which link the Portland and Seattle clusters
and which will link Portland and Spokane, Washington and Portland and Eugene,
Oregon. Another agreement provides for a fiber optic network in the Phoenix
metropolitan area. These relationships allow the Company to achieve economies of
scale and scope by expanding its existing markets rapidly and cost-effectively
and enabling the Company to concentrate its efforts on sales and marketing.
. CONTINUE ITS EFFECTIVE DIRECT SALES AND SUPERIOR CUSTOMER SERVICE. ELI
has built a highly motivated and experienced direct sales force and customer
service organization that is designed to establish a direct and personal
relationship with its customers. Consistent with its product offerings, the
Company utilizes a three-pronged sales approach comprised of direct retail,
direct wholesale and agents. Salespeople are given incentives through a
commission structure which targets 50% of a salesperson's compensation to be
based on performance. Each customer is provided with a single point of contact
at the Company. A sales account manager is responsible for managing each
customer's account and staying in constant contact with the customer to satisfy
that customer's specific telecommunications needs. Sales account managers
utilize a vertical sales strategy with the goal of selling additional value-
added, high margin services to existing customers. The Company believes that
combining the consultative sales strategy with the vertical sales strategy will
enable it to achieve higher margins on each account. The Company views its
commitment to customer satisfaction as a key success factor and is developing a
superior customer service system which will automate order processing, including
order placement, design, provisioning and billing, for both retail and wholesale
customers. This strategy ensures that the Company's processes are aligned with
customer needs and satisfaction.
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EXISTING MARKET CLUSTERS AND LONG -HAUL NETWORKS
COMBINED NETWORK INFORMATION AT JUNE 30, 1997
<TABLE>
<CAPTION>
EXISTING NUMBER OF
MARKET MUNICIPALITIES ROUTE FIBER BUILDINGS VOICE FRAME RELAY
CLUSTERS SERVED MILES MILES CONNECTED SWITCHES SWITCHES
- -------- ------ ----- ----- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Portland 8 283 19,563 226 2 4
Seattle 15 118 10,764 84 1 2
Salt Lake City 20 197 19,633 107 1 2
Sacramento 11 176 16,896 97 1 2
Phoenix(1) 5 191 2,438 4 - 1
------ ----- ----- --------- -------- --------
Total 59 965 69,294 518 5 11
======
Other Frame
Relay Switches(2).... 7
LONG-HAUL NETWORKS(1)
- ------------------
Las Vegas to Phoenix 356 18,204 3 - -
Portland to Seattle 207 12,420 - - -
Portland to Spokane(3) 200 4,800 - - -
------ ------- ------- ------ ------
Total Long-Haul Networks 763 35,424 3 - -
------ ------- ------- ------ ------
Total Networks 1,728 104,718 521 5 18
======= ======= ======= ====== ======
</TABLE>
(1) Route Miles and Fiber Miles also include those to which the Company has
exclusive use through license and lease agreements.
(2) The Other Frame Relay Switches are located in San Francisco and Los
Angeles, California; Tremonton, Utah; Kingman and Holbrook, Arizona;
Dallas, Texas; and Gloversville, New York. The Tremonton, Kingman and
Holbrook switches are co-located on the premises of Citizens.
(3) This 570-mile network is currently under construction. Amount shown is
miles completed as of June 30, 1997.
EXISTING MARKET CLUSTERS
The Company's existing market clusters currently consist of the
Portland, Seattle, Salt Lake City, Sacramento and Phoenix hub cities and their
respective surrounding areas.
PORTLAND CLUSTER
Portland represents the Company's most mature network. The Company began
building the network in 1990, generated its first revenues from this cluster in
1991 and installed its first long distance switch in 1993. During 1996, the
hubsite located in downtown Portland doubled in size and more than quadrupled in
capacity. On January 12, 1996, the Company received a Certificate of Authority
to begin providing intrastate services and, on April 18, 1996, ELI reached an
interim interconnection agreement with the ILEC, U S WEST. The Company installed
a new Nortel DMS-500 switch in 1996, providing for both toll and local switched
services. The Company is currently expanding the Portland network into
Vancouver, Washington.
SEATTLE CLUSTER
Seattle represents the Company's first market in terms of the
provisioning of switched services. The Company began construction of the Seattle
network in 1990, generated its first revenues in 1991 and installed its first
switch in 1994. The Company received a Certificate of
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Authority to begin providing telecommunications services on March 24, 1994. On
April 3, 1997, the Company reached a comprehensive interconnection agreement
with U S WEST. Seattle experienced significant network facilities growth since
late 1996. The main Seattle downtown hubsite was significantly expanded and two
mini-hubs were also constructed to allow for better distribution of traffic
loads and to improve fiber cable plant utilization. In addition to the above
facilities growth, the Bellevue, Washington network was completed in 1996. The
Company is currently finishing the Lake Washington project which will complete
the SONET ring around the Seattle metropolitan area.
SALT LAKE CITY CLUSTER
The Company began construction of the Salt Lake City cluster in 1993 and
began generating revenues in 1994. On August 16, 1995, the Company received a
Certificate of Authority to begin providing a wide variety of telecommunications
services. On August 21, 1996, the Company began offering switched telephone
services via a Nortel DMS-500 switch. In addition, the Company completed the
first build-out of its customer market by interconnecting Salt Lake City with
the satellite cities of Orem and Provo in 1996.
The Company has begun the construction of a backbone network in Boise,
Idaho, and expects to install a Nortel DMS-500 switch during the first half of
1998. ELI was authorized by the Idaho Public Utilities Commission to provide
intrastate service in Idaho as of February 17, 1997. ELI's authority covers long
distance business customers with six or more access lines in the greater Boise
area.
SACRAMENTO CLUSTER
The Company entered the Sacramento market in 1993 and began to generate
revenues from this market in 1994. The Company received a Certificate of
Authority from the California Public Utility Commission on March 16, 1994.
During 1996, the Company accelerated the build-out of this market and installed
its first switch in December 1996. The Company is currently constructing
facilities in the decommissioned Mather Air Force Base which the Company
believes is Sacramento's premier economic development area.
PHOENIX CLUSTER
The Company entered the Phoenix market in 1993 and began to generate
revenues in 1995. The Company intends to install a Nortel DMS-500 switch in the
first half of 1998. On September 11, 1996, the Company and Salt River Project
Agricultural Improvement and Power District ("SRP") entered into an agreement
whereby SRP agreed to lease to the Company an existing fiber optic network
consisting of 166 route miles, which will be expanded by SRP by 490 route miles
in the Phoenix metropolitan area. The Company's rights to use this network are
exclusive subject to required minimums. The Company has committed to
constructing 55 miles of the network and the installation and investment of
electronics equipment for the entire expanded network, at an estimated cost of
$30.4 million. In June of 1997, the Company connected its downtown area network
to SRP's network. The agreement with SRP will significantly reduce the Company's
time to market and capital expenditures in the Phoenix metropolitan area while
increasing network reach and customer access. On January 16, 1997, the Company
received a Certificate of Authority from the Arizona Corporation Commission and
on July 2, 1997 the Company signed an interconnection agreement with the ILEC,
U S WEST.
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Of the number of route miles shown in the above table under "Existing Market
Clusters and Long-Haul NetworksCombined Network Information at June 30, 1997,"
166 represent route miles leased from SRP.
LONG-HAUL NETWORKS
ELI's long-haul networks are, and will continue to be, built to
interconnect the Company's market clusters and form an integral part of the
Company's long-term strategy. Through the long-haul networks, the Company is
able to capture, control and manage a larger end-to-end share of the regional
communications traffic, enjoy greater margins due to the ability to keep more
traffic on-net and improve customer service. Many of the Company's long-haul
routes are the result of alliances with power utilities. These alliances greatly
accelerate network deployment, minimize the Company's capital requirements, and
optimize the synergies of the alliance partners. A brief overview of each of the
Company's long-haul networks is provided below.
PHOENIX TO LAS VEGAS (SOUTHWEST FIBERNET)
In 1993, the Company began construction of a long-haul transport network
connecting Phoenix and Las Vegas. The completed network is 356 route miles long
and contains 48 fiber strands. The Company began generating revenues from this
network in 1995.
PORTLAND TO SEATTLE
In March 1996, the Company and a utility reached a 15-year license
agreement to implement a long-haul transport network linking the Portland and
Seattle clusters. This agreement grants the Company an exclusive right to use
capacity from a fiber optic cable that was constructed by this utility linking
Portland and Seattle, subject to minimums to retain exclusivity. The network is
207 miles long and contains 72 fiber strands. The Company may use 60 fiber
strands for its services, including transport services, enhanced services to
end-users and dark fiber leasing. The Company was also granted the right to
manage four additional fiber strands from the fiber cable in a fiber swap
arrangement with another IXC in order to create a diverse SONET ring. The
Company began generating revenues from this network in 1997.
PORTLAND TO SPOKANE
In November 1996, the Company and the same utility reached a 15-year
license agreement to implement a long-haul transport network to link the
Portland and Spokane clusters. This agreement provides for the construction of
a 570-mile, 36-fiber strand network linking Portland to Spokane, of which the
Company may use 24 strands for its services. Two hundred miles of this network
had been constructed as of June 30, 1997. As in the license agreement for the
Portland to Seattle network, the Company will have an exclusive right to use
capacity subject to minimums to retain exclusivity.
PORTLAND TO EUGENE
In July 1997, the Company and the same utility signed a 15-year license
agreement for the construction of a joint long-haul transport network linking
Portland and Eugene, Oregon. The network is scheduled to be completed by April
1, 1998, and will have approximately 140
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<PAGE>
route miles containing 72 fiber strands, of which the Company will have
exclusive use of 60 for its services subject to minimums to retain exclusivity.
CURRENT PRODUCTS AND SERVICES
Since its inception in 1990, the Company's product portfolio has grown
from traditional competitive access provider ("CAP") services such as point-to-
point connectivity for IXCs and businesses to a full array of switched voice and
data services that target communications-intensive companies in both the retail
and wholesale markets.
The Company's product strategy is to continue being a full-service
communications provider offering customers complete "one-stop shopping" for
their communications needs. By offering a diverse product portfolio, the Company
creates custom-tailored product bundles that are capable of delivering
innovative, turn-key solutions for customers. The Company provides facilities-
based products and services over its switched broadband digital network
platform. With a growing array of software-driven intelligent features, this
network platform enables the Company to cost-effectively integrate high revenue
generating products into its existing portfolio. The product and service
offerings are divided into the following four categories: Local Telephone
Services, Long Distance Services, Data and Video Services, and Network Access
Services. The following table summarizes the Company's current product and
service offerings:
CURRENT PRODUCTS AND SERVICES
<TABLE>
<CAPTION>
LOCAL TELEPHONE LONG DISTANCE DATA AND VIDEO NETWORK ACCESS
<S> <C> <C> <C>
Basic Business Lines Retail Switched 1+Services Dedicated Internet Services 56 KB / 64 KB
PBX/Key Systems Trunks Retail Dedicated 1+Services Frame Relay DS-1
Virtual Private Exchange Wholesale Termination International Frame Relay DS-3
Centrex(TM) Conferencing LAN / WAN FDDI Disaster Recovery
Exchange Services 800 Services - Dedicated Switched 56 KB Multiplexing
Voice Mail 800 Services - Switched Dialable Wideband Service Collocation
Multi-Service Fractional T-1 Prepaid Debit Cards Videoconferencing OC-12
Customer Premise Equipment Travel Cards ISDN PRI Diverse Routing
Fax Mail OC-3 / OC-3C
CLASS(TM) Services
Wholesale LTS
</TABLE>
The following discussion summarizes the Company's primary product and
service offerings.
LOCAL TELEPHONE SERVICES (LOCAL ACCESS)
ELI's Local Telephone Services consist of products which involve the
switching of local calls. There are three primary customer segments for Local
Telephone Service: (i) small customers (less than 10 employees) with multi-key
telephone sets; (ii) medium-sized customers (10-50 employees) who use a key
system, (iii) and customers with more than 50 employees who have either their
own Private Branch Exchange ("PBX"), have a hybrid key system, or use the ILEC's
Centrex product. ELI's Local Telephone Service products are as follows:
Basic Business Lines offer either two-way lines (calls that can be
placed or received) or one-way lines (outgoing calls from the customer) to small
and medium-sized businesses with certain types of customer premise equipment.
Features such as call forwarding, three-way
40
<PAGE>
conferencing/call transfer, directory number hunting, caller/number ID and speed
dialing can also be included.
PBX/Key System Trunk Interface is offered to medium and large businesses
that have their own PBX or key system that require special interface equipment.
ELI offers two types of interfaces: line-side or trunk-side. Trunk-side
connections are used when all calls are directed to an attendant and can
accommodate features such as three-way calling/call transfer, call forwarding
and hunting. Line-side connections are used when calls are directed to each
station line.
Virtual Private Exchange ("VPX") is an alternative to the customer's
PBX, key system or ILEC-provided Centrex for medium and large businesses that
require the advanced functionality of a PBX or key system, such as call park,
call pick-up and last number redial. ELI's switch provides approximately 28
features for a flat monthly rate with optional features available for an
additional charge. Direct inward dialing is an inherent feature of VPX. ELI also
offers the Nortel electronic business sets which are designed to work with VPX,
allowing customers to use features with the touch of a button. VPX can be
purchased separately or with the electronic business set, and voice mail can be
added for an additional monthly charge.
Foreign Exchange Service ("FEX") provides customers local telephone
service from an exchange (central office) other than the exchange from which
they would normally be served. Therefore, the customer would obtain access to
the local calling area (free calling area) of the foreign exchange office.
Customers who experience significant long distance calling between locations
within the same Local Access Transport Area ("LATA") are typical users of FEX
lines in order to pay one flat rate per month for these calls, rather than
usage-based long distance fees.
Voice Mail offers customers the option of using ELI's voice mail product
versus buying their own system. Voice mail is either offered for a flat
additional fee per month or bundled with other products, such as Enhanced
Business Services. Enhanced Business Service ("EBS") is a package for small
business users, usually with less than 10 lines. EBS is a line with selected
special features, including voice mail, offered for a flat monthly charge.
CustomLink (Multi-service Fractional T-1) is a package of services built
around local telephone services. It is the bundling of local lines/trunks with
DS-0s used for other services, all delivered on the same T-1. Since ELI in many
cases is already taking a T-1 to the customer's premises to deliver dial tone,
the customer is offered the opportunity to utilize the empty DS-0s on the T-1
for access. Other ELI services, such as dedicated long distance, frame relay or
Internet, are offered at a lower rate than if these services were purchased
separately.
Customer Premise Equipment ("CPE") which is provided through a
partnership with various equipment vendors, makes available to the Company's
customers Nortel telephone sets, "2500"-type sets and electronic business sets.
LONG DISTANCE SERVICES
ELI's Long Distance Service is comprised of both retail and wholesale,
switched and dedicated, 1+, toll-free and pre-paid services.
Retail Switched 1+ and toll-free service is offered to business
customers, whereby the customer chooses ELI as its long distance/toll-free
carrier and calls are routed to/from ELI through the public switched network.
Customers can call intrastate, interstate, or internationally.
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Retail Dedicated 1+ and toll-free service is offered to high volume
business customers, whereby the customer establishes a point-to-point circuit
(i.e. DS-1 or DS-3) from their switch/PBX to ELI's switch. Outbound long
distance and toll-free calls are routed directly to/from ELI via this dedicated
path. Customers can call intrastate, interstate, or internationally.
Wholesale Termination encompasses an array of 1+ and toll-free services
providing carriers with LATA-wide termination services, enabling lower cost
access to, or diversity from, the ILEC's facilities. This product aggregates the
termination traffic of many carriers at ELI's switch and terminates it at a
lower cost than each of the carriers could obtain individually.
Prepaid Debit Cards and Travel Cards, are product offerings allowing
mobile people the ability to make long distance calls from any phone, anywhere
through accessing a toll-free number and the pre-paid switch. The service can
either be pre- or post-paid and sold through either retail or wholesale
channels. Callers can utilize the calling card from anywhere in the United
States, Canada, or 18 other countries worldwide and can make calls to anywhere
in the world.
"ALL CALLS" offers switched customers lower rates when they commit to
ELI long distance service plus ELI ISDN PRI or ELI local telephone services.
With ALL CALLS, the customer uses ELI for all local and long distance calls they
make.
DATA AND VIDEO SERVICES
The Company offers a wide range of switched and dedicated data
connectivity and internetworking products. These products are marketed through
both retail and wholesale channels.
Dedicated Internet Services provides access to Internet service
providers and large businesses. ELI offers Internet access through frame relay,
dedicated DS-1, dedicated DS-3 and shared Ethernet.
Frame Relay is a data communications alternative to traditional
point-to-point networks for wide area network ("WAN") connectivity. The
service provides multi-point, wide-area connectivity using frame relay packet
technology that reduces the connection costs of distributed data networks.
The service offers a choice of interface speeds with multiple virtual circuits
possible at each site. ELI offers worldwide connectivity to its network
through its frame relay partners.
LAN/WAN Services are turn-key data networking solutions that connect two
or more customer locations at very high speeds, typically, 10Mbps to 100Mbps.
Included in the transparent LAN service is point-to-point connectivity,
installed CPE and the monitoring of the customer's network to insure
connectivity. Through the service, ELI provides native LAN protocols like
Ethernet, Token Ring or FDDI in a variety of configurations.
Videoconferencing is a service whereby ELI operates videoconferencing
rooms in five cities in the western United States: Vancouver, Seattle, Salt Lake
City, Portland and Sacramento. ELI can connect two or more of its rooms together
and can tie in two other non-ELI videoconferencing rooms at the same time.
ISDN PRI provides customers with a high-speed, flexible digital access
connection to ELI's network for voice, video and data applications. Applications
include Internet access,
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telecommuting, videoconferencing and remote access to LANs or mainframes. ELI
offers ISDN PRI in all of its service areas.
The Company expects to offer ATM during 1998. It is a service that
formats, switches, and multiplexes various types of information, including
voice, video and data at speeds ranging from T-1 (1.544 megabits per second
("Mbps")) to OC-3 (155 Mbps). ATM provides Quality of Services ("QoS")
parameters based on the type of information being carried in a statistically
multiplexed architecture to reduce network costs. ELI's ATM service will provide
interworking between frame relay, transparent LAN and native ATM locations.
NETWORK ACCESS SERVICES
The Company's dedicated point-to-point services, which include special
access and digital private line services, use high capacity digital circuits to
carry voice, video and data services. Services are offered in flexible
configurations at standardized transmission speeds.
The Company's network services are grouped together under the name
"LightLine." LightLine is a dedicated interstate and intrastate point-to-point
transmission facility (private line). LightLine may require some specific
equipment on the customer's premises on which the connection can be terminated.
This equipment can be leased from ELI by the customer. In most cases, ELI uses
its own fiber optic networks to provide LightLine services. The Company may
lease facilities from another carrier if it does not have the facilities
available. LightLine is labeled as four separate products differentiated by
transmission speed: DS-0, DS-1, DS-3 and OC-3.
PRODUCT STRATEGY AND DEVELOPMENT
In addition to its voice products, the Company's strategy is to continue
to expand its market role in data products. By expanding the Company's networks
through Network-to-Network Interfaces ("NNIs"), the Company has created an
expansive data network to deliver data solutions in the United States and
internationally. To leverage these networks and expand the Company's product
offerings, the Company is developing video and other high bandwidth
applications. The Company believes that the wholesale market offers a strong fit
with its product offerings. Database, long distance, frame relay, Internet, ISDN
PRI and ATM products can offer ILECs, IXCs and other resellers the opportunity
to expand their product offerings while enabling the Company to leverage its
networks.
The Company is focusing its product marketing and development efforts in
the following categories:
Local Telephone Services. As a supplement to basic access products, the
Company is focusing on software-based, high margin services including automatic
call distribution, Custom Local Area Signaling Service ("CLASS") features,
enhanced fax, integrated voice and fax mail, integrated voice response and other
Advanced Intelligent Network ("AIN")-based services. Expanded CPE offerings will
also be developed in 1997.
Long Distance. The Company is enhancing its existing product set for
both the wholesale and end-user markets by adding such services as international
callback and international 800.
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Data and Video. The Company is focusing on national and international
network expansion and the continued development and delivery of ATM products. In
addition, customer network management products are being developed, as well as
switched access to frame relay and enhanced Internet services. The Company will
continue to focus on developing applications for data intensive markets, with a
particular focus on video applications.
Network and Strategic Services. The Company is focusing on its long-haul
networks and expansion of products into the optical carrier bandwidth range,
enabling customers to take full advantage of the SONET architecture and ATM
offerings. The Company is also developing telecommunications services to aid in
the delivery and management of electric utility services and telemetry
applications.
NETWORK
The Company views the depth and breadth of its networks as a key
strategic asset. The Company's network is designed to simultaneously maximize
both the amount of communications traffic that can travel over the Company's
owned network facilities and the number of products and services that can be
offered. Nortel DMS-500 switches are currently operating in the Portland,
Seattle, Salt Lake City and Sacramento clusters, with an additional switch
scheduled to be installed and operational in Phoenix in the first half of 1998.
The Company's frame relay network, which is comprised of 18 state-of-the-art
Cascade 9000 switches, has 30 POPs established in 26 western U.S. cities and is
expected to be capable of providing ATM services during 1998. The Company has
also developed an Internet backbone network providing Internet connectivity in
each of its markets, which includes access on a redundant basis to the nation's
three largest Internet service providers--UUNET, Sprint and MCI. The Company's
data network expertise allows it to provide a broader range of
telecommunications services to customers, which helps to maximize the amount of
telecommunications traffic on its network.
NETWORK DESIGN
To maximize circuit availability for its customers, the Company designs
its networks utilizing diverse fiber facilities, redundant electronics and back-
up power systems including diesel generators at all switching hubs. These
stringent design principles result in an overall circuit reliability of 99.99%.
The Company deploys the latest network technologies including SONET
rings, integrated digital loop carrier systems, NORTEL DMS-500 switching
platforms, Cascade Frame Relay and ATM switches, Titan 3/1 cross connects and
Alcatel 1/0 cross connect systems. These systems are coupled together to provide
a seamless telecommunications transport infrastructure that is centrally
monitored and managed to deliver services to customers efficiently.
Customer access is provided via several methods, the most prevalent of
which is to connect the customer location directly to the Company's network by
splicing fiber laterals directly into the backbone through diverse paths. A
second method for providing customer access is by way of a 38ghz DS-1 or DS-3
microwave link connecting the customer location to the Company's fiber
infrastructure. The third mechanism of providing customer access is via a leased
circuit connection from a secondary facilities-based service provider to the
Company's own fiber network.
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In addition to providing dedicated customer access, the Company
strategically builds fiber facilities to IXC and LEC POPs and co-locates its own
high capacity SONET systems that provide a medium to facilitate the flow of
significant traffic volumes between an IXC and LEC. Under the 1996 Act, all
ILECs were mandated to provide licensed service providers access to their
embedded networks (referred to as "co-location"). The Company builds diverse
fiber entrance facilities to the chosen ILEC, builds out and then leases floor
space adjacent to ILEC's switching facilities in order to accommodate various
transport, data, and voice frequency ("VF") equipment. In doing so, the Company
significantly reduces the leased circuit costs charged by the ILEC and provides
a very reliable service to the end user. As of June 30, 1997, the Company had
co-located in 17 ILEC offices.
SALES AND MARKETING
GENERAL
The Company serves retail and wholesale customers. The Company's retail
customers cover a broad range of fields. Major customers include companies in
the finance, government, health care, education, and Internet service provider
segments, all of which have high volume and complex telecommunications
requirements. Wholesale customers include IXCs, ILECs, CAPs, CLECs, travel
card/debit card providers and wireless service providers. The Company competes
in this market for point-to-point, high bandwidth products on the basis of
price, reliability, route diversity, ease of ordering, building access and
customer service. This market segment provides the Company with significant
revenues at wholesale margins that contribute to fixed costs coverage. The
Company focuses on serving its wholesale customers in all of its markets with a
view to establishing national preferred vendor relationships. Historically, the
wholesale market has accounted for approximately half of the Company's total
revenues.
The Company targets the higher margin data products category in its
marketing efforts to take advantage of increasing demand customers for
sophisticated data communications solutions.
The Company's sales professionals utilize solutions-based consultative
selling techniques whereby they gain an in-depth understanding of the customer's
operations in order to develop innovative applications-specific solutions for
all of the customer's needs. Each customer is managed by, and directly
interfaces with, a single sales account manager who has an in-depth
understanding of the customer's operations and the Company's product portfolio.
Each sales account manager is supported by a team consisting of a sales engineer
and customer service advisor, who have the ability to offer training to
customers in new product applications. Once the sales relationship has been
firmly established, the sales account manager implements a vertical sales
strategy aimed at selling additional high margin, value-added, switch-based
services to the customer. The Company believes that combining the consultative
sales strategy with the vertical sales strategy should enable it to achieve
higher margins on each account.
SALES CHANNELS
In order to effectively market its products and services, the Company
has established the following sales channels: direct retail, direct wholesale
and agent. At June 30, 1997, the Company employed 53 salespeople and 42 customer
care professionals.
The retail channel targets medium- to large-sized businesses. The
Company utilizes a direct sales force in each market cluster. Each regional
sales force is headed by a regional
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general manager and his/her sales team, which consists of a sales manager, sales
engineers, corporate account executives, account executives and associate
account executives, and local customer support personnel.
The wholesale channel targets telecommunications service providers. The
Company uses a direct sales force, which is comprised of general sales managers,
network service managers, national account managers and account managers.
The Company uses qualified agents in each of its operating markets to
sell its products and services to a wide range of small- to medium-sized end-
users. Using agents for this account size is more cost effective than a direct
sales force. Agents primarily sell local dialtone, long distance and frame relay
services as well as product bundles. The Company supports its agents by
providing market research and training on the Company's products and services.
The Company currently uses approximately 25 agents across all of its markets and
is expanding its agent program.
COMPETITION
ILEC COMPETITION
In each of its markets, the Company faces significant competition from
the ILEC, which currently dominates the local exchange market and is a defacto
monopoly provider of local switched voice services. The Company's primary ILEC
competitors are U S WEST, PacBell and GTE. ILECs have longstanding relationships
with their customers, have financial and technical resources substantially
greater than those of the Company and benefit from federal and state laws and
regulations that, ELI believes, in some instances favor the ILECs over CLECs.
Under certain circumstances, FCC and state regulatory authorities may provide
ILECs with increased flexibility to reprice their services as competition
develops and as ILECs allow competitors to interconnect to their networks. In
addition, some new entrants in the local market may price certain services to
particular customers or for particular routes below the prices charged by the
Company for services to those customers or for those routes, just as the Company
may itself underprice those new entrants for other services, customers or
routes. If the ILECs and other competitors lower their rates and can sustain
significantly lower prices over time, this may adversely affect revenues of the
Company if it is required by market pressure to price at or below the ILECs'
prices. If regulatory decisions permit the ILECs to charge CAPs/CLECs
substantial fees for interconnection to the ILECs' networks or afford ILECs
other regulatory relief, such decisions could also have a material adverse
effect on the Company. However, the Company believes that the negative effects
of the 1996 Act may be more than offset by (i) the increased revenues available
as a result of being able to address the entire local exchange market, (ii)
mutual reciprocal compensation with the ILEC that results in ELI terminating its
local exchange traffic on the ILEC's network at little or no net cost to ELI,
(iii) obtaining access to off-network customers through more reasonably priced
expanded interconnection with ILEC networks and (iv) a shift by IXCs to purchase
access services from CAPs/CLECs instead of ILECs. There can be no assurance,
however, that these anticipated results will offset the effects of increased
competition as a result of the 1996 Act.
Under the 1996 Act, ILECs formerly subject to anti-trust decree
restrictions on interLATA (interexchange) long distance services are no longer
permanently barred from entry into these businesses, subject to certain
requirements in the 1996 Act and rules and policies to be
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implemented by the FCC and the states. The FCC may authorize an RBOC to provide
interLATA services in a state when the RBOC enters into a state utility
commission-approved agreement with one or more facilities-based competitors
which provide business and residential local exchange service and such agreement
satisfies 14 specified interconnection requirements. In evaluating an RBOC
application for interLATA entry, the FCC must consult with the U.S. Department
of Justice. Alternatively, if no such facilities-based competitors request such
interconnection, the RBOC may obtain authority from the FCC to provide interLATA
services if the RBOC obtains state utility commission approval of a statement of
generally available terms and conditions of interconnection that satisfies the
requirements. If and when an RBOC obtains authority to provide interLATA
services, it will be able to offer customers local and long distance telephone
services. This will permit the RBOC to offer a full range of services to
potential customers in a new region and thus eliminate an existing competitive
advantage of the Company. Given the resources and experience the RBOCs currently
possess in the local exchange market, the ability to provide both local and long
distance services could make the RBOCs very strong competitors.
The 1996 Act imposes interconnection obligations on ILECs, and generally
requires that interconnection charges be cost-based and nondiscriminatory. To
the extent ELI interconnects with and uses an ILEC's network to service the
Company's customers, ELI is dependent upon the technology and capabilities of
the ILEC to meet certain telecommunications needs of the Company's customers and
to maintain its service standards. ELI will become increasingly dependent on
interconnection with ILECs as switched services become a greater percentage of
the Company's business. However, there can be no assurance that the Company will
be able to obtain the services it requires at rates, and on terms and
conditions, that permit the Company to offer switched services at rates that are
both profitable and competitive. However, the Company believes that the
wholesale customers, and end-users that it targets, demand state-of-the-art
technology, consistent high quality transmission, superior high-speed data
transmission, diverse product offerings and superior customer service, all of
which the Company believes it can competitively provide. In addition,
historically, the Company has been able to build new networks and expand
existing networks in a more timely and economical manner than most CAP or CLEC
competitors through strategic arrangements such as leasing fiber optic cable
from others that already possess rights-of-way and have facilities in place. The
Company intends to use its experience and presence in the telecommunications
industry to further develop and expand its existing telecommunications
infrastructure.
CLEC COMPETITION
The Company's facility-based operational CLEC competitors in the markets
in which the Company operates include: MCI Metro, Inc.; MFS Telecommunications,
Inc.; Teleport Communications Group, Inc.; Brooks Fiber; NEXTLINK
Communications, Inc.; and GST Telecommunications, Inc.
Based on management's experience, the initial market entrant with an
operational fiber optic CLEC network generally enjoys a competitive advantage
over other CLECs that later enter the market. The Company believes that it is
well positioned in each of its existing clusters due to a combination of
factors, including its early entry into the Portland, Seattle and Salt Lake City
markets, its full-service capabilities, its commitment to superior customer
service and the depth of its network coverage.
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In each of the clusters in which ELI operates, at least one other CLEC,
and in some cases several other CLECs, offers many of the same local
telecommunications services provided by the Company, generally at similar
prices.
COMPETITION FROM OTHERS
Potential and actual new market entrants in the local telecommunications
services business include RBOCs entering new geographic markets, IXCs, cable
television companies, electric utilities, international carriers, satellite
carriers, teleports, microwave carriers, wireless telephone system operators and
private networks built by large end users, many of which may have financial,
personnel and other resources substantially greater than those of ELI. In
addition, the current trend of business combinations and alliances in the
telecommunications industry, including mergers between RBOCs, may increase
competition for the Company. With the passage of the 1996 Act and the entry of
RBOCs into the long distance market, the Company believes that IXCs may be
motivated to construct their own local facilities or otherwise acquire the right
to use local facilities and/or resell the local services of the Company's
competitors.
DEDICATED SERVICES
Competition for dedicated services is based on price, quality, network
reliability, customer service, service features and responsiveness to the
customer's needs. The Company believes that its reliable, state-of-the-art
digital networks, which offer significant transmission capacity at competitive
prices, will allow it to compete effectively with the ILECs, which may have not
yet fully deployed fiber optic networks in many of the Company's target markets.
The Company's fiber optic networks will provide both diverse access routing and
redundant electronics, design features not widely deployed within the ILEC's
networks.
HIGH-SPEED DATA SERVICE
The Company's competitors for high-speed data services include major
IXCs, CAPs, other CLECs, and various providers of niche services (e.g., Internet
access providers, router management services and systems integrators). The
interconnectivity of the Company's markets may create additional competitive
advantages over other data service providers that must obtain local access from
the ILEC or another CLEC in each market or that cannot obtain intercity
transport rates on as favorable terms as the Company.
INTERNET SERVICES
The market for Internet access and related services in the United States
is extremely competitive, with no substantial barriers to entry. The Company
expects that competition will intensify as existing services and network
providers and new entrants compete for customers. The Company's current and
future competitors include telecommunications companies, including the RBOCs,
IXCs, CLECs and CATVs, and other Internet access providers. Many of these
competitors have greater market presence and greater financial, technical,
marketing and human resources, more extensive infrastructure and stronger
customer and strategic relationships than the Company. The Company believes that
it has a competitive advantage because of its existing Internet backbone network
providing Internet connectivity in each of its market clusters, which includes
access on a redundant basis to the three largest Internet providers.
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OPERATIONS/INFORMATION TECHNOLOGY
The Company views the establishment of a superior information technology
platform as a key strategic advantage in the execution of its goal to operate
effectively and deliver superior customer service. The Company has created
business relationships with selected software support organizations known for
state-of-the-art solutions.
The Company views its commitment to customer satisfaction as a key
success factor. The Company focuses on ensuring the Company's processes are
aligned with customer needs and satisfaction. The Company offers high-quality
service with its state-of-the-art network technology, integrated operations and
superior customer support. The Company has implemented an integrated network
management system designed to monitor and test the Company's networks 24 hours a
day, seven days a week and is developing a fully integrated superior customer
care system from three leading vendors which will automate the entire order
management process (i.e., order placement, design, provisioning and billing
preparation) for both wholesale and retail customers. The first phase of the
enhanced order management services has been delivered.
The current billing management system is capable of producing a single
bill detailing all of the products and services provided to both wholesale and
retail customers. The Company is installing a new billing system, which will
allow the Company to bill for incremental services and unique product bundles in
a more rapid and cost-efficient manner. The Company expects to complete the
implementation of the system by the first quarter of 1998.
The Company's goal is to have an efficient operating structure in place
for administering, provisioning and maintaining the Company's products and
services so as to become a low-cost telecommunications provider, while
delivering superior customer service.
EMPLOYEES
As of June 30, 1997 the Company employed 486 persons. None of the
Company's employees are represented by a union, and the Company considers its
employee relations to be excellent.
PROPERTIES
GENERAL
The Company manages its operations through its corporate headquarters,
located in Vancouver, Washington. In addition, the Company has local offices and
warehouse facilities in Portland, Seattle, Sacramento, Phoenix and Salt Lake
City. Currently, all of the Company's office and warehouse space is leased. The
Company also leases network hub and network equipment installation sites in
various locations throughout the metropolitan areas in which it provides
products and services. The office, warehouse and other facilities leases expire
on various dates through September 2005. Additional facilities will be needed as
the Company expands its markets. Management believes that the Company will be
able to lease space as needed on acceptable terms. The Company owns a 6.6-acre
parcel of land in Vancouver, Washington, on which it is constructing its new
corporate headquarters building. The Company believes its facilities are, and
the new building will be, suitable and adequate for its purposes.
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LEASE
In June 1995 the Company entered into agreements to lease certain
equipment to be constructed for the Company. The lessor has agreed to commit up
to a maximum of $110,000,000 of the cost of purchasing and installing the
equipment. Rental obligations for the equipment commenced in June 1995 and will
expire on April 30, 2002. The Company may, at its option, purchase the equipment
either at or before the end of the lease at a price approximating the amounts
expended by the lessor to acquire and install the leased equipment. If the
Company does not purchase the equipment, it will be sold to a third party and
the Company will guarantee that the sales price to be received by the lessor
will equal the acquisition and installation costs, subject generally to a
maximum payment under the guarantee of 80% of such costs. Payments under the
lease arrangements depend on then current interest rates, and assuming
continuation of current interest rates and full utilization of the lease
facility, payments would amount to approximately $6,500,000 annually through
April 30, 2002 and, assuming exercise of the purchase option, approximately
$110,000,000 in 2002. Citizens has guaranteed all obligations of ELI under the
lease and ELI will pay Citizens a guarantee fee of 3.25% per annum of the amount
of the lessor's investment in the leased assets. See "Relationship with
Citizens--Guarantee of Lease Obligations."
LEGAL PROCEEDINGS
In Optec v. Electric Lightwave, filed in the Circuit Court of Oregon for
Multnomah County on September 16, 1996, Optec alleged that ELI violated an
agreement prohibiting ELI from approaching the employees of Optec Corporation
with offers of employment. ELI had entered into this agreement with Optec, a
potential acquisition target, in order for ELI to evaluate a potential
acquisition. ELI believes that the three former employees of Optec who came to
work for ELI initiated their change of employment. Damages claimed are $10
million. On August 15, 1997, the court issued an oral ruling granting ELI's
Motion for Summary Judgment and dismissed the case. Unless Optec files an appeal
by September 26, 1997, the judgment in favor of ELI will be final.
On June 30, 1997, the Company filed a lawsuit in the U.S. District Court
in Seattle, Washington, against U S WEST, Electric Lightwave v. U S WEST
Communications, Inc., alleging that U S WEST was illegally blocking competition
in local telephone service. The lawsuit charges that U S WEST was violating
federal and state antitrust laws, as well as various federal and state
regulatory statutes, by failing to provide adequate interconnection services and
facilities to enable ELI to provide quality services to its customers. ELI is
seeking an unspecified amount of damages to be determined by a jury. In
addition, ELI is seeking an injunction to prohibit U S WEST from discriminating
against ELI and its customers when it provides interconnection facilities and
equipment.
GOVERNMENT REGULATION
ELI's services are subject to federal and state regulation. In general,
ELI's interstate and international telecommunications services are regulated by
the FCC. ELI's intrastate services are regulated by the public utilities
commission of each state in which ELI operates. Nationally, the recent trend has
been for federal and state legislators and regulators to permit and encourage
additional competition in the local telecommunications industry. ELI believes
this public policy
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trend should contribute to an increase in the Company's market opportunities,
although the pace and extent of such positive benefits cannot be predicted with
any precision.
FEDERAL REGULATION
The FCC exercises regulatory jurisdiction over all facilities of, and
services offered by, telecommunications common carriers to the extent those
facilities are used to provide, originate or terminate interstate or
international communications. The FCC has established through its rules
different levels of regulation for "dominant" carriers and "nondominant"
carriers. For domestic interstate telecommunications services, only the ILECs
(subject to limited exceptions that are not material) are classified as dominant
carriers, and all other carriers are classified as nondominant carriers.
Additionally, to the extent a BOC is engaged in out-of-region long distance
services it is also classified as nondominant as to those services. Non-BOC
ILEC-affiliated long distance services are classified as nondominant regardless
of whether conducted inside or outside the ILEC service area. The FCC regulates
many of the rates, charges and services of dominant carriers to a greater degree
than those of nondominant carriers. As a result of its nondominant carrier
status, the Company believes it has significant flexibility to respond to
changes in interstate market conditions on a timely basis.
As a nondominant carrier, ELI may install and operate facilities for
domestic interstate communications without prior FCC authorization. ELI is
presently required to tariff certain of its domestic interstate tariff services.
The FCC has promulgated rules to eliminate tariffing of interstate long distance
services. Those rules have been stayed during the pendency of judicial review.
If and when these rules are allowed to go into effect, the Company will no
longer be required to file FCC tariffs for its interstate long distance
services. Additionally, under a recent FCC order, CLECs, including ELI, are no
longer required to file tariffs for interstate exchange access services. As a
provider of international long distance services, ELI obtained FCC operating
authority and maintains an international tariff. ELI is also required to submit
certain periodic reports to the FCC and to pay regulatory fees.
TELECOMMUNICATIONS ACT OF 1996
The national public policy framework for telecommunications was changed
dramatically by the 1996 Act. A central focus of this sweeping policy reform was
to open local telecommunications markets to workable competition. ELI believes
that the 1996 Act has begun and will continue to result in substantial changes
in the marketplace that largely are favorable for the Company.
The 1996 Act preempts state and local laws to the extent that they
prevent competitive entry into the provision of any telecommunications service.
Under the 1996 Act, however, states retain authority to impose on carriers,
including ELI, requirements necessary to preserve universal telecommunications
service, protect public safety and welfare, ensure quality of service and
protect consumers. States are also responsible for mediating and arbitrating
interconnection agreements between CLECs and ILECs if voluntary negotiations
fail.
In order to create an environment in which local competition is a
practical possibility, the 1996 Act imposes a number of access and
interconnection requirements on all local telecommunications providers. All
local carriers, including ELI, must interconnect with other carriers, permit
resale of their services, provide local telephone number portability and dialing
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parity, provide access to poles, ducts, conduits, and rights-of-way, and
complete calls originated by competing carriers under reciprocal compensation or
mutual termination arrangements.
The 1996 Act also imposes some additional specific obligations on ILECs
(although certain small and rural ILECs may qualify for exemption from some of
these obligations). In particular, ILECs must allow interconnection at any
technically feasible point, provide interconnection service quality at least
equal to that provided to their own customers and other carriers, provide
nondiscriminatory access to unbundled network elements at any technically
feasible point at cost-based rates, provide wholesale discounts to carriers who
wish to resell ILEC services, give notice of network changes, provide physical
co-location, and negotiate in good faith with competitors. ELI believes its
opportunity for success in local telephone service markets is enhanced as a
result of these obligations imposed by federal law on ILECs. The access offered
by the 1996 Act to physical co-location, unbundled local loops and resale
discounts will give the Company the opportunity to expand the geographic reach
of its services in advance of facilities construction. Full implementation of
these provisions of the 1996 Act will require further federal and state rule
makings, industry negotiations, and possible legal enforcement actions and
remedies. Portions of the FCC's rules implementing interconnection, particularly
those related to the FCC's imposition of pricing methodology upon state
regulators, have been vacated by a federal appellate court (as discussed below
under "Court of Appeals Decision." The appellate court found that, under the
1996 Act, the states are the primary arbiters of charges for interconnection,
unbundled access, resale and the prices for the transport and termination of
calls. However, ELI should be able to continue and expand its CLEC operations
under a variety of negotiated interconnection arrangements and state
interconnection rules and policies, state arbitrated agreements, public policy
processes and judicial proceedings.
RBOCs have generally been barred from participating in the market for
interLATA (primarily long distance) services since the break up of the Bell
System in 1984. Under the 1996 Act, an RBOC now is allowed to provide interLATA
services outside of its local telephone service region. RBOC interLATA long
distance entry will increase the level of competition faced by ELI's retail long
distance services. However, ELI believes that RBOCs providing long distance
service outside their telephone service areas may represent new potential
customers of ELI's wholesale services.
The 1996 Act also authorizes the FCC to allow an RBOC to provide
interLATA services within its local telephone service area in a state in which
the RBOC has satisfied certain conditions.
During 1996 and 1997 the FCC took several additional actions with
respect to competitive local telecommunications pursuant to the 1996 Act.
On August 1, 1996, the FCC issued an order amending its pole attachment
rules to reflect the 1996 Act by requiring utilities, including ILECs and most
electric companies, to make poles, conduit and rights-of-way available to
certain carriers, including CLECs, at reasonable cost and on a nondiscriminatory
basis. Several utilities have appealed the FCC order to the U.S. Court of
Appeals, which has not yet issued a decision.
On August 8, 1996, the FCC issued an order containing rules providing
guidance to the ILECs, CLECs, long distance companies and state public utility
commissions ("PUCs") on several provisions of the 1996 Act. The rules include,
among other things, FCC guidance on: (i) discounts for end-to-end resale of ILEC
local exchange services; (ii) availability of unbundled
52
<PAGE>
local loops and other unbundled ILEC network elements; (iii) the use of Total
Element Long Run Incremental Costs in the pricing of these unbundled network
elements; (iv) average default proxy prices for unbundled local loops in each
state; (v) mutual compensation proxy rates for termination of ILEC/CLEC local
calls; and (vi) the ability of CLECs and other interconnecters to opt into
portions of interconnection agreements negotiated by the ILECs with other
parties on the basis of the ability to "pick and choose" among the provisions of
an existing agreement. See below for a discussion of the Eighth Circuit Court of
Appeals decision overturning certain aspects of this order.
The 1996 Act requires the FCC to establish explicit mechanisms for
subsidizing service to rural areas, low-income customers, schools and libraries,
and rural health care providers. On May 8, 1997, the FCC adopted an Order in its
universal service proceeding to implement this mandate. All telecommunications
carriers, including ELI and other CLECs, are required under that Order to
contribute to a federal universal service fund. Schools, libraries and other
entities eligible for universal service support represent a potential target
market for the Company. The availability of such support will assist such
entities in obtaining advanced telecommunications and information services, thus
potentially increasing demand for services of the type the Company provides.
Most states are expected to implement state-specific universal service funds to
supplement the federal programs. All carriers, including ELI, will be required
to contribute to those state and federal funds. At this time, the Company is
unable to quantify the total amount of these payments it will be required to
make or the effect these required payments will have on its financial condition.
In a combined Report and Order and Notice of Proposed Rulemaking
released on December 24, 1996, the FCC made changes and proposed further changes
in the interstate access charge structure. In the Report and Order, the FCC
removed restrictions on the ILECs' ability to lower access prices and proposed
the relaxation of the regulation of new switched access services in those
markets where there are other providers of access services. If any such
increased pricing flexibility is allowed but is not effectively monitored by
federal regulators, it could have a material adverse effect on the Company's
revenues from interstate access services. However, the Company believes this
potential impact will be limited by the fact that its private line revenues are
only partially derived from bypass of ILEC switched access services. On May 16,
1997, the FCC released an order revising its access charge rate structure. The
new rules substantially increase the costs that ILECs subject to the FCC's price
cap rules ("price cap LECs") recover through monthly, non-traffic sensitive
access charges and substantially decrease the costs that price cap LECs recover
through traffic sensitive access charges. In the May 16 order, the FCC also
announced its plan to bring interstate access rate levels more in line with
cost. The plan will include rules to be established sometime this year that
grant price cap LECs increased pricing flexibility upon demonstrations of
increased competition (or potential competition) in relevant markets. The manner
in which the FCC implements this approach to lowering access charge levels may
have a material adverse effect on the Company's ability to compete in providing
interstate access services. However, the Company also believes it may benefit
from certain aspects of the FCC's access charge restructuring. Under the FCC's
rules, which are the subject of a petition for reconsideration, the Company will
no longer be required to pay a portion of ILEC access charges (the terminating
interconnection charge) by connecting directly to ILEC end offices.
Additionally, the Company may be able to differentiate its access prices from
those of competing ILECs by eliminating certain other rate elements. Several
parties
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<PAGE>
have appealed the May 16 order. Those appeals have been consolidated and
transferred to the United States Court of Appeals for the Eighth Circuit where
they are currently pending.
As part of the overall plan to lower interstate access rates, the FCC
also released an order on May 21, 1997, in which the FCC revised its price cap
rules. In the order, the FCC increased the so-called X-Factor (the percentage by
which price cap LECs must lower their interstate access charges every year, net
of inflation and exogenous cost increases) and made it uniform for all price cap
LECs. The results of these rule changes will be both a one-time overall
reduction in price cap ILEC interstate access charges and an increase in the
rate at which those charges will be reduced in the future. Several parties have
appealed the May 21 order. Those appeals have been consolidated and transferred
to the United States Court of Appeals for the Tenth Circuit where they are
currently pending.
COURT OF APPEALS DECISION
Various parties, including ILECs and state PUCs, filed appeals of the
FCC's August 8, 1996 interconnection order, many of which were consolidated and
transferred to the U.S. Court of Appeals for the Eighth Circuit. On July 18,
1997, the Eight Circuit rendered its decision, which held that, in general, the
FCC does not have jurisdiction over prices for interconnection, resale, leased
unbundled network elements and traffic termination. The Eighth Circuit also
overturned the FCC's "pick and choose" rules as well as certain other FCC rules
implementing the 1996 Act's local competition provisions. In addition, the
Eighth Circuit decision substantially limits the FCC's authority to enforce the
local competition provisions of the 1996 Act. The FCC has indicated that it will
seek Supreme Court review of the decision.
In the short term the Company believes that the Eighth Circuit decision
will not have a material adverse effect on it, because the Company already has
interconnection agreements in place, or expects to have such agreements in
place, under the provisions of the FCC's order and the 1996 Act which were not
invalidated by the Court. The decision does not delay the implementation of the
1996 Act by the parties and by the state PUCs, but rather eliminates the
guidance on pricing and pick and choose as well as other issues that the FCC
sought to provide to the parties and the state PUCs.
In the long term, the Eighth Circuit's decision makes it more likely
that the rules governing local competition will vary from state to state. Most
states have already begun to establish rules for local competition that are
consistent with the FCC rules overturned by the Eighth Circuit. If a patchwork
of state regulations were to develop, it could increase the Company's costs of
regulatory compliance and could make competitive entry in some markets more
difficult and expensive than in others.
STATE REGULATION
Most state public utilities commissions require telecommunications
providers such as ELI to obtain operating authority prior to initiating
intrastate services. Most states also require the filing of tariffs or price
lists and/or customer-specific contracts. In the states in which ELI currently
operates, ELI is not subject to rate-of-return or price regulation. ELI is
subject, however, to state-specific quality of service, universal service,
periodic reporting and other regulatory requirements, although the extent of
such requirements is generally less than that applicable to ILECs. ELI currently
has intrastate operating authority in the following states:
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<PAGE>
Arizona: ELI is authorized as a competitive provider to provide
intrastate long distance statewide and other intrastate services in all U S WEST
service territories pursuant to tariff.
California: ELI is authorized as a Competitive Local Carrier to provide
basic local service within PacBell and GTE Corp. service territories and other
intrastate services statewide pursuant to tariff. ELI has a pending application
to provide basic local service within the service territory of Roseville
Telephone Co.
Idaho: ELI is authorized to provide basic local service to business
customers with more than five lines in U S WEST service territory in Southern
Idaho and other intrastate services statewide pursuant to tariff.
Minnesota: ELI is authorized to provide intrastate long distance
statewide and local services in the greater Minneapolis-St. Paul metropolitan
area pursuant to tariff.
Nevada: ELI is authorized to provide intrastate services statewide,
excluding points within the Citizens Telecommunications Company of Nevada
service territory, pursuant to price list.
Oregon: ELI is authorized as a Competitive Telecommunications Provider
to provide intrastate long distance service statewide and local exchange
services in the greater Portland metropolitan area. ELI is not required to file
tariffs, price lists or contracts.
Utah: ELI is authorized as a Competitive Telecommunications Company to
provide intrastate services statewide pursuant to price list or customer-
specific contracts.
Washington: ELI is authorized as a Competitive Telecommunications
Company to provide intrastate services statewide pursuant to price list or
customer-specific contracts.
LOCAL GOVERNMENT AUTHORIZATIONS
ELI generally is required to obtain street opening and construction
permits from city and county authorities prior to installing or expanding its
fiber optic network facilities. In most states in which ELI currently operates
as a CLEC, it must first obtain a franchise or license from each incorporated
city and town, and sometimes from each county, in which it wishes to utilize
public rights of way. The franchise or license establishes the overall terms,
conditions and fees for use of the rights of way in the particular jurisdiction.
In California, ELI and other holders of certification from the California Public
Utilities Commission are not required to obtain municipal franchises nor pay
franchise fees.
The 1996 Act now provides that while local governments may continue to
manage the public rights of way, they may not impose conditions on companies
like ELI which constitute barriers to entry in the telecommunications market.
Further, the 1996 Act requires that municipal right-of-way authorizations be
granted on a nondiscriminatory basis and that any fees be reasonable.
THE LOCAL TELECOMMUNICATIONS SERVICES INDUSTRY
On January 1, 1984, AT&T (then referred to as the "Bell System") divested itself
of the Bell Operating Companies (the "BOCs"), which were transferred to seven
holding companies. Following this divestiture (the "Divestiture"), each BOC
continued to conduct local telephone
55
<PAGE>
and other telecommunications business in geographically defined areas, referred
to as "Local Access and Transport Areas" or "LATAs."
Prior to the Divestiture, the BOCs and "independent" local exchange
telephone companies not affiliated with the Bell System had government-regulated
monopolies for most local telephone services. The Divestiture encouraged the
growth of competition for long distance services and equipment manufacturing by
prohibiting the BOCs from entering these markets. However, the BOCs retained
monopoly control over the market for local telephone services. Competition in
the long distance market accelerated dramatically and, by the end of 1995,
AT&T's long distance competitors had captured approximately 40% of the
interstate long distance market.
The Divestiture did not directly provide for competition in local
markets. After the Divestiture, however, a number of factors served to promote
competition in some local telecommunications market segments, including (i)
increasing customer desire for an alternative to the ILEC monopoly, particularly
among business customers, prompted in part by competition in the long distance
market, (ii) technological advances in the transmission of data and video
requiring greater capacity and reliability levels than copper-based ILEC
networks were able to accommodate, (iii) a monopoly position and rate of return-
based pricing structure that provided little incentive for the ILECs to upgrade
their networks or meet specialized customer needs, (iv) the development of fiber
optics and digital electronic technology, which combined the ability to
economically build a high-capacity digital network with the ability to transmit
voice, data and video signals at high speeds and (v) the significant "access
charges" that long distance carriers were required to pay to the ILECs to
originate and terminate long distance telephone calls on the ILECs' networks.
The first competitors in the local market were designated as
"competitive access providers" or "CAPs" by the FCC because they provided
special access services (e.g., dedicated lines for local access links to long
distance networks). Initially, CAPs provided special access (dedicated access
lines) by installing fiber optic facilities connecting long distance carriers'
POPs within a metropolitan area and, in some cases, connecting end users
(primarily large businesses) to long distance carriers' POPs. CAPs also provided
private line services connecting multiple locations of a single end user within
a local market area with dedicated fiber optic lines. CAPs used the
technological advantage and substantial capacity and economies of scale inherent
in fiber optic technology to offer customers service that initially was
generally less expensive and of higher quality than could be obtained from the
ILECs, due in part to the ILECs' copper-based facilities and higher overhead
costs. In addition, CAPs generally offered shorter installation and repair
intervals and improved reliability in comparison to the ILECs. In recent years,
the ILECs steadily have been increasing the amount of fiber used in their
networks, thereby decreasing the competitive advantage held by the CAPs in the
special access and private line markets.
As CAPs proliferated during the latter part of the 1980s, federal and
some state regulators issued rulings which permitted and sometimes encouraged
local competition and opened some local market segments to new entrants. These
rulings allowed CAPs to offer a number of new services, including, in certain
states, certain switched services (but not basic local exchange telephone
service). A series of state public utility commission decisions beginning in
1989 and FCC decisions beginning in 1991 requiring expanded interconnection (or
"co-location") permitted CAPs to interconnect their networks with the largest
ILECs' networks. This expanded interconnection gave CAPs the option to access
customers by either leasing facilities from an
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<PAGE>
ILEC through a co-location arrangement or installing extensions to the CAP's own
network, depending on the relative cost and other factors. Beginning in 1994, a
few states permitted CAPs, including ELI, to become "competitive local exchange
carriers" or "CLECs," and thus to begin providing local exchange services,
primarily to business customers. By the time the 1996 Act was adopted,
approximately half the states had removed legal prohibitions on the provision of
competitive local exchange service. Legal and regulatory restrictions in the
remaining states will be significantly reduced by the 1996 Act.
While many companies have been organized over the last decade to provide
CAP or CLEC services, only a few have grown to significant size. These large
CAPs and CLECs operate in multiple local markets and have acquired a number of
smaller CAPs. Recently, new CAPs or CLECs have been created, primarily to serve
small markets.
The competitive position of the CAPs and CLECs has been improved by the
regulatory commissions of an increasing number of states, which have encouraged
competition in various aspects of the intrastate local telecommunications
market. The intrastate local market consists of intrastate access services,
basic local exchange services and local private line special access services.
While the majority of state initiatives were originally limited to intrastate
private line and special access services, many states are in the process of
changing their statutes or regulations to permit competition for switched
services, including basic local exchange telephone services. Those states that
have not made these changes will be required to do so under the 1996 Act.
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company and their respective
ages and positions are set forth below.
Name Age Title
- ---- --- -----
Daryl A. Ferguson 58 Chairman of the Board
David B. Sharkey 47 President, Chief Executive Officer and Director
James Berthot 52 Vice President--Marketing and Product Development
Todd Hanson 36 Vice President--Engineering
Joseph Hommel 44 Vice President--Business Development
Randall Lis 38 Vice President--Staff Operations
Susan McAdams 49 Vice President--Government Affairs
Michael J. Miller 41 Vice President--Planning
John Wolff 51 Vice President--Sales
Ernest D. Yates 52 Vice President--Operations
Robert J. DeSantis 41 Vice President, Chief Financial Officer, Treasurer and
Director
Nicholas L. Ioli 53 Vice President and Chief Information Officer
L. Russell Mitten 46 Vice President and General Counsel
James D. Ranton 42 Vice President--Human Resources
Livingston E. Ross 47 Vice President and Controller
Daryl A. Ferguson, has been a director of the Company since September
1995 and Chairman of the Board of the Company since September 1997. Mr. Ferguson
has been President
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<PAGE>
and Chief Operating Officer of Citizens since June 1990. Mr. Ferguson was Vice
President, Administration of Citizens from July 1989 through March 1990 and
Senior Vice President, Operations and Engineering of Citizens from March 1990
through June 1990. From April 1987 through July 1989, Mr. Ferguson was President
and Chief Executive Officer of Microtecture Corporation. He is currently also a
Director of Centennial Cellular Corp.
David B. Sharkey joined ELI as President and Chief Executive Officer in
August 1994 and has been a director since September 1995. Mr. Sharkey has 29
years of telecommunications experience. Prior to joining ELI, from 1989 to 1994,
he held the position of Vice President and General Manager at Mobile Media,
Inc., a radio common carrier provider. Mr. Sharkey spent 21 years with New
Jersey Bell Telephone and AT&T in technical operations and sales & marketing.
James Berthot joined ELI as Vice President of Marketing and Product
Development in July 1995. Prior to joining ELI, from January 1990 to July 1995,
Mr. Berthot was Director of Marketing and Public Relations for Century Telephone
Enterprises, Inc.'s Telephone Group, where he led marketing, sales and public
relations activities. Mr. Berthot has served as Sales Director for The
Information Line, a joint venture with United Telecommunications (Sprint) and
Volt Information Sciences Inc. He has more than 25 years experience in the high-
technology industry including management positions with Southwestern Bell
Corporation and AT&T.
Todd Hanson joined ELI as Vice President of Engineering in June 1995.
Prior to joining ELI, from 1993 to 1995, Mr. Hanson served as Vice President of
Network Engineering for MFS Telecommunications, Inc., where he was responsible
for network planning and implementation on a national basis. Mr. Hanson was
Director of Project Management and Access Engineering at AT&T Canada prior to
1993. Mr. Hanson's experience comprises 13 years of telecommunications
management including positions with Sprint and Unitel in the areas of
engineering, operations and project management.
Joseph Hommel joined ELI as Director of Regulatory Affairs in December
1993 and became Vice PresidentBusiness Development in October 1996. Before
joining ELI, from 1985 to 1993, Mr. Hommel was Chief Telecommunications Policy
Advisor to the Washington Utilities and Transportation Commission and served two
terms as an elected Public Utility District Commissioner. Previously, he served
as Policy Specialist with the Joint Select Committee on Telecommunications of
the Washington State Legislature.
Randall Lis joined ELI as Vice President--Operations in February 1995
and has served as Vice President--Staff Operations since April 1996. Prior to
joining ELI, from 1993 to 1995, Mr. Lis was General Manager of the Mid-Atlantic
Region of Nextel Communications. His nearly 20 years of telecommunications
experience includes positions with Southwestern Bell Corporation and Ram Mobil
Data. From 1985 through 1993, Mr. Lis held several positions with Metromedia and
Metromedia Paging, in which he served as Business Manager, General Manager and
Senior Director of Operations.
Susan McAdams joined ELI in March 1992 as Director of Regulatory Affairs
and became Vice PresidentGovernment Affairs on January 1, 1995. Prior to joining
ELI, from 1988 to 1992, Ms. McAdams was a Senior Policy Analyst at the Policy
Office of the Washington Utilities and Transportation Commission. Ms. McAdams'
experience includes 20 years of telecommunications policy-making at the federal,
state and local levels including positions with
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the National League of Cities, the National Telecommunications and Information
Administration, the State of North Carolina, and as a partner in a private
consulting firm.
Michael J. Miller joined ELI as Director of Accounting in March 1994,
was promoted to Vice President of Finance in October 1995 and became Vice
President-Planning in September 1997. Prior to joining ELI, from February 1988
to December 1993, Mr. Miller was Manager of Financial Planning and Analysis for
NERCO, Inc., a diversified natural resource company in Portland, Oregon. At
NERCO, Mr. Miller performed economic analyses and evaluations for the
operations, accounting and marketing groups. He is a Certified Public
Accountant.
John Wolff joined ELI as Vice PresidentSales in October 1994. Prior to
joining ELI, from 1969 to 1994, he was Vice President and General Manager of the
Southwest Region for SBC. Mr. Wolff has 25 years in the telecommunications
industry with experience in sales, marketing, operations, and training. Mr.
Wolff was employed by New Jersey Bell for 10 years, rising to Director of
Sales/Marketing Training Center. From 1980 to 1983, Mr. Wolff acted as the
personal representative of the Vice President of Sales of AT&T on the
Divestiture Reorganization Committee. After the breakup of the Bell System in
1983, he served as General Sales Manager at AT&T Communications. Mr. Wolff left
AT&T in 1985 to join Metromedia Paging Service, Inc., as Director of Sales and
Marketing.
Ernest D. Yates joined ELI as Senior Director of Sales in February 1995.
In September 1995 he was promoted to Vice PresidentAdministration and has served
as Vice PresidentOperations since April 1996. Prior to joining ELI, Mr. Yates,
from 1965 through 1995, was employed by AT&T and Southwestern Bell Corporation
where he held various sales, technical and general management positions. Mr.
Yates is currently responsible for the implementation of ELI's new order
tracking, provisioning and billing systems as well as operations in all ELI-
staffed cities.
Robert J. DeSantis, Vice President, Chief Financial Officer and
Treasurer of the Company since August 1994, and a director since September 1995,
has been Vice President and Treasurer of Citizens since October 1991. Mr.
DeSantis was Assistant Treasurer of Citizens from June 1986 through September
1991 and was Assistant to the Treasurer of Citizens from January 1986 to June
1986.
Nicholas L. Ioli has been associated with the Company and Citizens since
October 1994, and has been Vice President and Chief Information Officer of the
Company since September 1997. Mr. Ioli has been Vice President and Chief
Information Officer of Citizens since February 1996. Before joining the Company
and Citizens, Mr. Ioli was Corporate Director of Information Systems at Ethan
Allen, Inc.
L. Russell Mitten was General Counsel of the Company from its inception
in July 1990 until June 1991. Mr. Mitten has been Vice President and General
Counsel and Assistant Secretary of the Company from June 1991 to the present.
Mr. Mitten has been Vice President and General Counsel and Assistant Secretary
of Citizens since June 1990.
James D. Ranton has been associated with the Company and Citizens
Utilities Company as Vice President, Human Resources since July 1996. Mr. Ranton
was Corporate Director of Compensation and Benefits at Carrier Corporation from
1993 to July 1996 and was Director of Headquarters Personnel at Pepsi-Cola
International from 1992 to 1993.
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Livingston E. Ross has been Vice President of the Company since August
1994 and has been Controller of the Company since September 1997. Mr. Ross has
been Vice President and Controller of Citizens since December 1991. In his
association with Citizens, Mr. Ross was Manager of Reporting from September 1984
through March 1988, Manager of General Accounting from April 1988 through
September 1990 and Assistant Controller from October 1990 through November 1991.
BOARD COMPOSITION
Directors are elected annually. The Board presently consists of three
members. Following the Offering, the Board of Directors will consist of seven
directors, four of whom will be associated with Citizens and two of whom will be
independent of both Citizens and ELI. At each annual meeting of the Company's
stockholders at which directors are elected, the holders of Class A Common Stock
and Class B Common Stock (all of which will be held by Citizens) may vote for
directors. The holders of Class A Common Stock are entitled to one vote per
share of Class A Common Stock and the holders of Class B Common Stock are
entitled to ten votes per share of Class B Common Stock. Each director is
entitled to receive an annual retainer of $[___] and an additional $[___] plus
reasonable expenses for attending each meeting of the Board of Directors. Each
director is also entitled to be paid $[___] annually for each committee of the
Board of Directors for which such director serves as chairman.
COMPENSATION COMMITTEE
The Board of Directors of ELI will establish a Compensation and Benefits
Committee to address and make recommendations with respect to the compensation
of executive officers and the establishment of compensation and benefit plans.
AUDIT COMMITTEE
The Board of Directors will establish an Audit Committee to meet with
and consider suggestions from members of management, as well as with the
Company's independent accountants, concerning matters of internal controls. The
Audit Committee also will have the responsibility to review the audited
financial statements of the Company and consider and recommend the employment
of, and approve the fee arrangements with, independent accountants for both
audit functions and for advisory and other consulting services.
EXECUTIVE COMPENSATION
The following table shows compensation paid to, deferred or accrued for
the benefit of, the Company's Chief Executive Officer and each of the four
remaining most highly compensated executive officers (the "Named Executive
Officers") for all services rendered to ELI during the three most recent fiscal
years ended December 31, 1996.
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation Long-term Compensation
------------------------------------- ------------------------------------------
Awards Payouts
--------------------------
Securities
Restricted Underlying Long-term All Other
Other Annual Stock Options/ Incentive Compensation
Salary Bonus(2) Compensation Awards SARs(3) Plan Payouts (4)
Name and Position(1) Year $ $ $ $ (#) $ $
- ------------------------ ------ ------- -------- ------------ ----------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
David B. Sharkey 1996 155,833 80,000 - - 17,039 - 26,703
President and CEO 1995 150,000 75,000 - - - - -
1994 79,612 - - - 23,267 - -
John Wolff 1996 127,500 40,000 - - 8,117 - 4,750
VP-Sales 1995 120,000 40,000 - - - - 15,535
1994 30,000 - - - 11,326 - 4,681
Randy Lis 1996 114,125 40,000 - - 8,117 - 32,163
VP-Staff Operations 1995 99,634 30,000 - - 11,327 - 18,450
1994 - - - - - - -
Todd Hanson 1996 131,401 40,000 - - - 3,651
VP-Engineering 1995 95,804 40,000 - - 16,490 30,338
1994 - - - - - -
Ernest Yates 1996 107,833 40,000 - - 7,987 3,997
VP-Operations 1995 71,942 18,000 - - - 34,907
1994 - - - - - -
</TABLE>
- ----------
(1) Messrs. DeSantis, Ioli, Mitten, Ranton and Ross are officers of Citizens.
Their 1996 compensation for services to ELI does not place any of them
among the five most highly compensated executive officers of the Company.
(2) Bonus amounts awarded were for performance for the stated Salary Year,
notwithstanding determination of the bonus amount in the subsequent year.
(3) All Options in this column are exercisable for shares of common stock, par
value $.01 per share, of Citizens. Options are adjusted to reflect stock
dividends paid subsequent to date of grant. All awards shown are options
granted under the Citizens Utilities Company Management Employee Incentive
Plan or its successor Plan, the Employee Incentive Plan. In 1996, no
compensation was paid to any executive officer or employee in stock or
restricted stock of ELI, and no stock options or SARs denominated in stock
of ELI were awarded or granted to any executive officer or employee of ELI.
(4) Represents the Company's matching contribution to each Executive's 401(k)
plan. Additionally represents $25,453 which represents the 1996 economic
benefit of split-dollar life insurance for Mr. Sharkey, $28,271 and $222
for relocation allowances paid to Mr. Lis and Mr. Yates, respectively, in
1996, and $9,935, $18,450, $28,898 and $33,610 for relocation allowances
paid to Messrs. Wolff, Lis, Hanson and Yates in 1995.
1996 OPTION GRANTS AND STOCK APPRECIATION RIGHTS
The following table sets forth the options granted to the Named Executive
Officers in 1996. All of the options listed below relate only to options to
purchase shares of Citizens' common stock. No options or stock appreciation
rights relating to the Company's Common Stock, and no stock appreciation rights
relating to Citizens' common stock, were granted in 1996.
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARs EXERCISE
UNDERLYING GRANTED TO OR BASE GRANT DATE
OPTIONS/SARs EMPLOYEES IN PRICE AT EXPIRATION PRESENT
NAME GRANTED (#)(1) FISCAL YEAR GRANT ($/SH)L(2) DATE VALUE $(3)
- ------------------------ -------------- ------------- ---------------- ----------- ----------
<S> <C> <C> <C> <C> <C>
David B. Sharkey 17,039 1% $11.44 02/15/06 $39,030
John Wolff 8,117 .3% 11.44 02/15/06 12,456
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARs EXERCISE
UNDERLYING GRANTED TO OR BASE GRANT DATE
OPTIONS/SARs EMPLOYEES IN PRICE AT EXPIRATION PRESENT
NAME GRANTED (#)(1) FISCAL YEAR GRANT ($/SH)L(2) DATE VALUE $(3)
- ------------------------ -------------- ------------- ---------------- ----------- ----------
<S> <C> <C> <C> <C> <C>
RANDY LIS 8,117 .3% 11.44 02/15/06 12,456
TODD HANSON - - - - -
ERNEST YATES - - - - -
</TABLE>
- ----------
(1) All options are for shares of common stock of Citizens. All options become
exercisable at the rate of 20% per year on February 15, 1997, 1998,
1999, 2000 and 2001.
(2) Fair Market Price at time of grant.
(3) Based on the Black-Scholes option pricing model adapted for use in valuing
executive stock options. The actual value, if any, an executive may realize
will depend on the excess of the stock price over the exercise price on the
date the option is exercised, so that there is no assurance the value
realized, if any, by an executive will be at or near the value estimated by
the Black-Scholes model. The estimated values under that model are based on
arbitrary assumptions as to variables such as interest rates, stock price
volatility and future dividend yield. The pricing model assumes a dividend
yield of 6.2%, a riskless rate of return of 5.6%, a seven-year term of
exercise and volatility of 0.198.
AGGREGATED 1996 OPTION/SAR EXERCISES AND VALUE OF
OUTSTANDING OPTIONS/SARS AT DECEMBER 31,1996
The following table sets forth option and stock appreciation rights
exercised by the Named Executive Officers during 1996 and the number and
value of options held by them at December 31, 1996. All of the options
listed below relate only to Citizens' common stock. There were no
outstanding stock appreciation rights relating to Citizens' common stock at
December 31, 1996. No exercises occurred during 1996 of options or stock
appreciation rights relating to the Company's Common Stock and, at December
31, 1996 there were no outstanding options or stock appreciation rights
relating to the Company's Common Stock.
<TABLE>
<CAPTION>
VALUE OF
SHARES NUMBER OF UNEXERCISED
ACQUIRED ON VALUE UNEXERCISED IN-THE-MONEY
EXERCISE(#) REALIZED OPTIONS/SARs AT OPTIONS/SARs AT
NAME COMMON STOCK $ FISCAL YEAR END(#) FISCAL YEAR-END($)
- ------------------ ----------------- -------- ----------------------------- -----------------------------
Exercisable Unexercisable(2) Exercisable Unexercisable(2)
------------ ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
David B. Sharkey 0 0 9,304 31,001 0 0
John Wolff 0 0 4,453 14,783 0 0
Randy Lis 0 O 2,265 17,050 0 0
Todd Hanson 0 O 3,298 13,192 0 0
Ernest Yates 0 0 0 7,987 0 0
</TABLE>
All numbers are as of December 31, 1996 and reflect adjustment for
stock dividends paid subsequent to the date of grant. The closing price of
Citizens' common stock on December 31, 1996 was $11.125.
EQUITY INCENTIVE PLAN
The Board of Directors established an Equity Incentive Plan (the
"Plan") in September 1997, which has been approved by the sole stockholder.
The purpose of the plan is to provide incentives for high levels of
performance and productivity by employees of the Company. The Plan is
intended to strengthen the Company's existing operations through its
ability to attract and
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retain outstanding employees upon whose judgment, initiative and efforts the
continued efficiency, productivity, growth and development of the Company is
dependent.
All employees of the Company are eligible for selection to participate
in the Plan. Directors who are not employees of the Company are ineligible.
Awards granted under the Plan consist of stock options or other stock-based
awards relating to shares of the Company's Class A Common Stock. The maximum
number of shares of Common Stock which may be issued pursuant to awards at any
time is no more than _____ shares. Under the Plan, no individual may be granted
share-denominated performance awards in any calendar year covering more than
shares and dollar value-denominated performance awards in any calendar year
covering more than $250,000 in dollar value. No awards will be granted more than
_____ ten years after the effective date of the Plan.
The Plan is administered by the Compensation Committee of the Board of
Directors. Subject to the express provisions of the Plan, the Compensation
Committee is authorized, among other things, to (a) grant awards to eligible
employees; (b) determine the terms and conditions of each award; (c) establish
and modify performance objectives; and (d) modify or amend any award unless the
effect adversely and materially affects the rights of any recipient. If the
Compensation Committee so determines, any action or discretion delegated in the
Plan to the Compensation Committee may be carried out by, or delegated to, the
Board of Directors or the stockholders.
Under the Plan, a Stock Option, which may be a nonqualified or an
incentive stock option, may be granted either alone or in conjunction with one
or more other awards. The exercise price, except in the discretion of the
Compensation Committee in the case of new employees, shall be equal to or
greater than the 85% of the fair market value of the underlying Common Stock on
the date of grant. The term of each Stock Option is also determined by the
Compensation Committee but may not exceed ten years from the date of grant. Upon
exercise, the option price of each Stock Option is payable by the option holder
in cash or, in the sole discretion of the Compensation Committee, through the
delivery of shares of the Company's Common Stock valued at their fair market
value, or in a combination of cash and shares. The Compensation Committee may
grant a replacement Stock Option to an option holder to replace the shares which
the option holder delivered to Company in payment of the option price in a
stock-for-stock exercise or of any withholding taxes. The exercise price of any
replacement Stock Option may not be less than 100% of the fair market value of
the Common Stock delivered to the Company on the date of such payment. The
Compensation Committee may also accept the surrender of the right to exercise
any Stock Option for alternative settlement by payment to the option holder of
an amount not to exceed the difference between the exercise price and the then
fair market value of the shares as to which such right of exercise is
surrendered. Such payment may be made in cash or in shares of the Company's
Common Stock (valued at the then fair market value) or any combination thereof.
The Compensation Committee may also grant stock appreciation rights, free
standing or in tandem with Stock Options, which entitle the holder thereof to
receive a similar payment at his or her election.
The Plan also authorizes the Compensation Committee to grant other
stock-based awards to eligible employees, which consist of awards that are
valued in whole or in part by reference to, or otherwise based on, the Company's
Common Stock and may include, but are not limited to, restricted stock,
performance shares and deferred stock. Subject to the terms of the Plan, the
Compensation Committee may determine any and all terms and conditions of other
stock-based
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<PAGE>
awards. The performance objectives determined by the Committee for each
performance share award shall be based on stock price; market share; sales;
earnings per share; operating cash flow; free cash flow; net income or loss; net
income or loss adjusted to exclude specified items such as gain or losses from
extraordinary or non-recurring items and non-cash expense and income and before
specified expense items such as interest, depreciation, amortization and income
taxes; EBITDA; revenues; return on equity or assets; cost control; or a
combination of any of the foregoing. Payment or settlement of other stock-based
awards will be in cash or in shares of the Company's Common Stock or in any
combination thereof as the Compensation Committee determines in its sole
discretion. The Compensation Committee may permit the payment of withholding
taxes due in connection with awards under the Plan by the withholding of shares
to be issued under the award or by the employee's delivery of other shares of
Common Stock of the Company.
Awards may include terms which provide that any or all of the following
actions may occur as a result of, or in anticipation of, any "Change in Control"
(as defined below) to assure fair and equitable treatment of employees: (i)
acceleration of time periods for purposes of vesting, or realizing gain from,
any outstanding award; (ii) purchase of any outstanding award from the holder
for its equivalent value, as determined by the Compensation Committee; (iii)
adjustments or modifications to outstanding awards, including the modification
or elimination of performance goals, as the Compensation Committee deems
appropriate to maintain and protect the rights and interests of participants. A
"Change in Control" is defined to mean the occurrence of any of the following
events: (i) a person or group (other than Citizens) becomes the owner of stock
having 20% or more of the total number of votes that may be cast for the
election of directors of the Board or 20% or more of the fair market value of
the Company's issued and outstanding stock; (ii) a consolidation or merger or
sale of assets in which the Company is not the surviving corporation or pursuant
to which the Company's stock will be converted into cash, securities or other
property or a sale, lease, exchange or other transfer of all or substantially
all the assets of the Company; or (iii) as a result of any cash tender or
exchange offer, merger or other business combination, sale of assets or
contested election, or any combination of the foregoing Transactions, the
persons who are members of the Board before the Transaction shall cease to
constitute a majority of the Board of the Company.
These provisions in the Plan allowing the Compensation Committee to
award accelerated vesting upon a Change in Control could in some circumstances
have the effect of an "antitakeover" defense because, as a result of these
provisions, a Change in Control of the Company could be more difficult or
costly.
The Plan is subject to suspension, amendment, modification or
termination at any time by the Company's Board of Directors or the stockholders.
However, no amendment or modification would become effective unless approved by
affirmative vote of the stockholders of the Company if such approval is
necessary or desirable for the continued validity of the Plan or its compliance
with any tax or securities law rule or regulation or any stock exchange in stock
market, or other legal or regulatory, requirement.
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<PAGE>
RELATIONSHIP WITH CITIZENS
GENERAL
Upon completion of the Offering, Citizens will own 100% of the
outstanding Class B Common Stock of the Company which will represent
approximately ___% of the combined voting power of all of the outstanding Common
Stock (or approximately ___% if the Underwriters' over-allotment options are
exercised in full). For so long as Citizens continues to own shares of Common
Stock representing more than 50% of the combined voting power of the Common
Stock of the Company, Citizens will be able, among other things, to determine
any corporate action requiring approval of holders of Common Stock, including
the election of the entire Board of Directors of the Company, certain amendments
to the Certificate of Incorporation and By-Laws of the Company and approval of
certain mergers and other control transactions, without the consent of the other
shareholders of the Company. See "Description of Capital Stock."
In addition, through its beneficial ownership of Common Stock and,
following the Offering, its control of the Board of Directors, Citizens will be
able to control certain decisions, including decisions with respect to the
Company's dividend policy, the Company's access to capital (including borrowing
from third-party lenders and the issuance of additional equity securities),
mergers or other business combinations involving the Company, the acquisition or
disposition of assets by the Company and any change in control of the Company.
Citizens has advised the Company that Citizens has no present plan or intention
other than to hold all of the Class B Common Stock beneficially owned by it for
the foreseeable future. Citizens has no agreement with the Company not to sell
or distribute such shares, other than pursuant to the Underwriting Agreement in
which Citizens has agreed not to offer, sell, contract to sell or otherwise
dispose of any shares of Common Stock or any securities convertible into or
exercisable or exchangeable for Common Stock or file any registration statement
under the Securities Act with respect to any of the foregoing for a period of
[ ] from the date of this Prospectus without the prior written consent of
Lehman Brothers Inc. on behalf of the Representatives. There can be no assurance
concerning the period of time during which Citizens will maintain its beneficial
ownership of Common Stock.
Beneficial ownership of at least 80% of the total voting power and value
of the outstanding Common Stock is required in order for Citizens to continue to
include the Company in its consolidated group for federal income tax purposes.
Completion of the Offering made by this Prospectus will terminate the
consolidated group which includes the Company. Beneficial ownership of at least
80% of the total voting power and at least 80% of any class of nonvoting capital
stock is required in order for Citizens to be able to effect a tax-free spin-
off. The Company's relationship with Citizens will also be governed by
agreements to be entered into in connection with the Offering with Citizens,
including an Administrative Services Agreement, a Tax Sharing Agreement, an
Indemnification Agreement, a Customers and Service Agreement and a Registration
Rights Agreement, the material terms of which are described below.
The arrangements described below are the result of negotiations between
affiliated parties and, therefore, there can be no assurance that the prices
charged to the Company at a particular time for services provided thereunder may
not be higher or lower than prices that might have been charged by an
unaffiliated third party.
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The descriptions set forth below are intended to be summaries, and while
material terms of the agreements are set forth herein, the descriptions are
qualified in their entirety to reference to the relevant agreement filed as an
exhibit to the Registration Statement of which this Prospectus is a part.
ADMINISTRATIVE SERVICES AGREEMENT
The Administrative Services Agreement (the "Administrative Services
Agreement") provides for Citizens to continue to provide certain financial
management services, information services, legal and contract services, human
resources services and corporate planning services to the Company. Under the
terms of the Administrative Services Agreement, all of the services will be
rendered by Citizens subject to the oversight, supervision and approval of ELI,
acting through its Board of Directors. Reimbursable costs plus an administrative
fee will be paid by ELI to Citizens pursuant to the Administrative Services
Agreement.
TAX SHARING AGREEMENT
Because the Company may be included in Citizens' combined, consolidated
or unitary income tax groups for state and local tax purposes, the Company and
Citizens will enter into the Tax Sharing Agreement (the "Tax Sharing
Agreement"). Pursuant to the Tax Sharing Agreement, the Company will be
responsible for any and all liabilities arising as a result of state or local
income, franchise, excise, single business, gross receipts or withholding tax
returns filed by it on a separate-return basis. With respect to the portions of
Citizens' state or local unitary, combined or consolidated income or franchise
tax liabilities that are allocable to the Company, the Company will pay Citizens
an amount equal to the taxes which the Company would have been required to pay
if it had filed a separate return. The Company will be responsible for any tax
liability due any foreign jurisdiction arising from its business activities.
Citizens will have sole and exclusive responsibility for (i) preparing
any state and local tax returns (including amended returns or claims for refund)
of the Company; (ii) representing the Company with respect to any state and
local tax audit or tax contest; (iii) engaging outside counsel and accountants
with respect to tax matters regarding the Company; and (iv) performing such
other acts and duties with respect to the Company's tax returns as Citizens
determines is appropriate. Under the Administrative Services Agreement, the
amounts that the Company will pay Citizens will encompass reimbursement to
Citizens for all direct and indirect costs and expenses incurred with respect to
the Company's share of the overall costs and expenses incurred by Citizens with
respect to tax related services.
INDEMNIFICATION AGREEMENT
The Company and Citizens have entered into an indemnification agreement
(the "Indemnification Agreement"). The Indemnification Agreement provides that
each party thereto (the "Indemnifying Party") will indemnify the other party
thereto and its directors, officers, employees, agents and representatives (the
"Indemnified Party") for liabilities under federal or state securities laws as a
result of the Offering, including liabilities arising out of or based upon
alleged misrepresentations in or omissions from the Registration Statement, of
which this Prospectus is a part, and for liabilities that may be incurred by the
Indemnified Party relating to, resulting from or arising out of (i) the
businesses and operations conducted or formerly conducted, or assets owned or
formerly-owned, by the Indemnifying Party and its subsidiaries (except, in the
case where Citizens is the Indemnifying Party, such businesses, operations and
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<PAGE>
assets of the Company and its subsidiaries) or (ii) the failure by the
Indemnifying Party to comply with any other agreements executed in connection
with the Offering, except to the extent caused by the Indemnified Party.
The Indemnification Agreement also provides that the Company will
indemnify Citizens for any liabilities incurred by Citizens under any guarantees
of ELI's obligations or liabilities of the Company and that the Company will pay
Citizens for its direct costs, if any, of maintaining such guarantees.
REGISTRATION RIGHTS AGREEMENT
The Company and Citizens have entered into a Registration Rights
Agreement (the "Registration Rights Agreement"). The Registration Rights
Agreement provides that, upon the request of Citizens, the Company will use its
best efforts to effect the registration under the applicable federal and state
securities laws of any of the shares of Common Stock (and any other securities
issued in respect of or in exchange therefor) held by Citizens for sale in
accordance with Citizens' intended method of disposition thereof and will take
such other actions necessary to permit the sale thereof in other jurisdictions,
subject to certain specified limitations. Although as of the date of this
Prospectus, Citizens has advised the Company that Citizens has no current plan
or intention other than to hold its shares of Class B Common Stock for the
foreseeable future, Citizens will also have the right, which it may exercise at
any time and from time to time, to include the shares of Common Stock held by it
in certain other registrations of common equity securities of the Company
initiated by the Company on its own behalf or on behalf of its other
shareholders. Citizens will pay the out-of-pocket costs and expenses of
registration for registrations which it initiates. The Company has agreed to pay
all out-of-pocket costs and expenses (other than underwriting discounts and
commissions) in connection with registrations initiated by the Company or others
in which Citizens participates. Subject to certain limitations specified in the
Registration Rights Agreement, such registration rights will be assignable by
Citizens and its assigns. The Registration Rights Agreement contains
indemnification and contribution provisions (i) by Citizens and its permitted
assigns for the benefit of the Company and related persons and (ii) by the
Company for the benefit of Citizens and the other persons entitled to effect
registrations of Common Stock and related persons.
CUSTOMERS AND SERVICE AGREEMENT
The Company and Citizens have entered into a Customers and Service
Agreement (the "Customers and Service Agreement"). The Customers and Service
Agreement contains provisions prohibiting the Company from competing with
Citizens for customers in Citizens' existing service areas and in certain new
lower density territories which Citizens will have been first to enter after the
Offering. Citizens has agreed that it will not compete with the Company in the
service territories in which the Company is currently providing services and in
certain new higher density territories which the Company will have been first to
provide services after Offering except that Citizens may compete in ELI's new
territories in the provision of long distance services. Neither Citizens nor ELI
may solicit an existing wholesale customer of the other company for services
which such customer is currently receiving under contract from the other
company. The relevant provisions are intended to permit the Company to continue
all activities in which it currently engages, and to expand into related
markets. The Customers and Service Agreement will remain in effect for so long
as Citizens owns a majority of the economic or voting interest of the shares of
Common Stock of the Company.
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<PAGE>
GUARANTEE OF LEASE OBLIGATIONS
Citizens has guaranteed all obligations of ELI under a lease of certain
equipment described under "Business--Properties." Effective with the Offering,
ELI has agreed to pay Citizens a guarantee fee equal to 3.25% per annum of the
amount of the lessor's investment in the leased assets. See "Business--
Properties--Lease."
TELECOMMUNICATIONS SERVICES
Citizens has leased "dark" fiber optic lines from ELI for which Citizens
has agreed to pay an annual fee of $360,000. Also, Citizens and ELI have agreed
to combine their purchases of long-haul services in an arrangement with a long
distance company in order to receive a lower unit cost. ELI has agreed to
reimburse Citizens for the cost of ELI's usage and pay an additional fee
consisting of 5% of such cost. In 1996, ELI paid Citizens a total of
approximately $7.6 million. The agreement was replaced effective May 1, 1997
with a 24-month term agreement which removed the 5% additional fee.
ELI'S LONG-TERM DEBT PAYABLE TO CITIZENS
Prior to completion of the Offering, $20.7 million of the balance due to
Citizens as of June 30, 1997 will be contributed to additional paid-in capital
and the remaining $174 million will become long-term debt payable to Citizens
(the "Company Debt"). Funds provided to the Company by Citizens subsequent to
June 30, 1997 will be added to the Company Debt. The Company will issue a
promissory note to Citizens evidencing the Company Debt. The note will be
nonamortizing with a maturity date of . Effective with the completion of the
Offering, interest on the note will be payable at an annual rate of ___%.
CONFLICTS OF INTEREST
Conflicts of interest may arise between the Company and Citizens in a
number of areas relating to their past and ongoing relationships, including
potential acquisitions of businesses or properties or other corporate
opportunities, potential competitive business activities, the election of a new
or additional directors, payment of dividends, incurrence of indebtedness, tax
matters, financial commitments, marketing functions, indemnity arrangements,
registration rights, administration of benefits plans, service arrangements,
issuances of capital stock of the Company, sales or distributions by Citizens of
its remaining shares of Common Stock and the exercise of Citizens of its ability
to control the management and affairs of the Company. The Customers and Service
Agreement contains certain noncompete provisions; however, in many
circumstances, the Company and Citizens are free to engage in competition with
one another.
The Company and Citizens may enter into material transactions and
agreements in the future in addition to those described above. The Board will
utilize such procedures in evaluating the terms and provisions of any material
transactions between the Company and Citizens or its affiliates as the Board may
deem appropriate in light of its fiduciary duties under the state law. In any
such evaluation, the Board may rely on management's statements and opinions and
may or may not utilize outside experts or consultants or obtain independent
appraisals or opinions.
One of the three current directors of the Company is Daryl A. Ferguson,
an executive officer of Citizens, who is also Chairman of the Board of the
Company. Another director of the Company is Robert J. DeSantis, also an
executive officer of Citizens. Following the Offering, the number of directors
will increase to seven, four of whom will be executive officers or
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<PAGE>
employees of Citizens, including Mr. Ferguson and Mr. DeSantis, and two of the
directors will be independent of both Citizens and ELI. Mr. DeSantis and four
other officers of Citizens are executive officers of the Company. Directors and
officers of the Company who are officers of Citizens will have conflicts of
interest with respect to matters potentially or actually involving or affecting
the Company or Citizens, such as acquisitions, financing and other corporate
opportunities that may be suitable for the Company and Citizens. To the extent
that such opportunities arise, such directors may consult with their legal
advisors and make a determination after consideration of a number of factors,
including whether such opportunity is within the Company's line of business or
consistent with its strategic objectives and whether the Company will be able to
undertake or benefit from such opportunity. In addition, determination may be
made by the Board, when appropriate, by the vote of the disinterested directors
only. Notwithstanding the foregoing, there can be no assurance that conflicts
will be resolved in favor of the Company.
So long as the Company remains a subsidiary of Citizens, the directors
and officers of the Company will, subject to certain limitations, be indemnified
by Citizens and insured under insurance policies maintained by Citizens against
liability for actions taken or omitted to be taken in their capacities as
directors and officers of the Company, including actions or omissions that may
be alleged to constitute breaches of the fiduciary duties owed by such persons
to the Company and its shareholders. This insurance may not be applicable to
certain of the claims which Citizens may have against the Company pursuant to
the Indemnification Agreement or otherwise.
SECURITY OWNERSHIP BY PRINCIPAL
STOCKHOLDER
No shares of Class A Common Stock were outstanding or beneficially owned
prior to the Offering. Immediately after the Offering, the only shares of Class
A Common Stock that will be outstanding are those that will be issued in the
Offering (including any shares issued upon exercise of the Underwriters' over-
allotment options). All of the shares of Class B Common Stock outstanding are
beneficially owned by Citizens. Accordingly, upon consummation of the Offering,
Citizens will own Common Stock representing approximately % of the economic
interest in the Company (% if the Underwriters' over-allotment options are
exercised in full) and representing approximately % of the combined voting power
of the Company's outstanding Common Stock (or % if the Underwriters' over-
allotment options are exercised in full).
The following table provides information, as of June 30, 1997, and as
adjusted to reflect the sale of [ ] shares of Class A Common Stock by ELI in
the Offering, with respect to the beneficial ownership of the Company's
Common Stock by each person known by ELI to be the beneficial owner of more
than 5% of any class of the Company's voting securities. None of the directors
nor any of the executive officers of the Company beneficially owns any shares
of Class A Common Stock or Class B Common Stock.
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<TABLE>
<CAPTION>
Class A Class B
Common Stock Common Stock
------------------------ ------------------------ Percent of Vote of
Number of Number of All Classes of
Name and Adress(1) Shares % Shares % Common Stock
- --------------- ------------- ---------- ----------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
Citizens Utilities
Company.................... 0 0 %
</TABLE>
- ---------------------------
(1) The address of Citizens is High Ridge Park, Stamford, Connecticut 06905.
DESCRIPTION OF CAPITAL STOCK
Prior to the consummation of the Offering, ELI will amend its
Certificate of Incorporation to change its authorized capital stock to [ ]
shares, including [ ] shares of Class A Common Stock, $.01 par value per share,
[ ] shares of Class B Common Stock, $.01 par value per share, and [ ] shares
of preferred stock, $.01 par value per share (the "Preferred Stock"). Upon
completion of the Offering, there will be no preferred stock outstanding and
Citizens will own of record all of the outstanding shares of Class B Common
Stock. See "Security Ownership by Principal Stockholder."
The following summary description relating to the capital stock of the
Company does not purport to be complete. The rights of the holders of ELI's
capital stock will be set forth in ELI's Certificate of Incorporation, the form
of which is filed as an exhibit to the Registration Statement of which this
Prospectus forms a part. The summary set forth below is qualified by reference
to such exhibit and to the applicable provisions of the Delaware General
Corporation Law (the "DGCL").
COMMON STOCK
The preferences and relative rights of the Class A Common Stock and
Class B Common Stock are substantially identical in all respects, except for
voting rights and conversion rights.
VOTING RIGHTS
Each share of Class A Common Stock entities the holder to one vote and
each share of Class B Common Stock entities the holder to 10 votes on each
matter to be voted upon by the holders of the Common Stock. The holders of the
shares of Class A Common Stock and Class B Common Stock vote as one class on all
matters to be voted on by stockholders, including, without limitation, the
election of directors and any proposed amendment to the Certificate of
Incorporation of ELI that would increase the authorized number of shares of
Common Stock or any class thereof or any other class or series of stock or
decrease the number of authorized shares of any class or series of stock (but
not below the number thereof then outstanding), except as required by the DGCL.
Neither the holders of Class A Common Stock nor the holders of Class B
Common Stock have cumulative voting rights. For a discussion of the effects of
the disproportionate voting rights of the Class A Common Stock and Class B
Common Stock, see "Risk Factors"--Control by Principal Stockholder" and
- --"Conflicts of Interest."
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DIVIDENDS
Each share of Common Stock is entitled to receive dividends from funds
legally available therefor if, as and when declared by the Board of Directors of
ELI. Class A Common Stock and Class B Common Stock share equally, on a share-
for-share basis, in any dividends declared by the Board of Directors. If at
any time a distribution of the Class A Common Stock or Class B Common Stock is
to be paid in shares of Class A Common Stock, Class B Common Stock or any other
securities of the Company or any other person, such dividends may be declared
and paid only as follows: (1) a share distribution consisting of Class A Common
Stock to holders of Class A Common Stock and Class B Common Stock, on an equal
per share basis; or to holders of Class A Common Stock only, but in such event
there shall also be a simultaneous share distribution to holders of Class B
Common Stock consisting of shares of Class B Common Stock on an equal per share
basis; (2) a share distribution consisting of Class B Common Stock to holders of
Class B Common Stock and Class A Common Stock, on an equal per share basis; or
to holders of Class B Common Stock only, but in such event there shall also be a
simultaneous share distribution to holders of Class A Common Stock consisting of
shares of Class A Common Stock on an equal per share basis; and (3) a share
distribution of shares of any class of securities of the Company or of any other
person other than the Common Stock, either on the basis of a distribution of
identical securities, on an equal per share basis to the holders of Class A
Common Stock and Class B Common Stock, or on the basis of a distribution of one
class of securities to the holders of Class A Common Stock and another class of
securities to holders of Class B Common Stock, provided that the securities so
distributed do not differ in any respect, other than relative voting rights and
related differences, in designations, conversion and share distribution
provisions, with the holders of Class B Common Stock receiving the class having
the higher relative voting rights, provided that if the securities so
distributed constitute capital stock of a subsidiary of the Company, such rights
shall not differ to a greater extent than the corresponding existing differences
in voting rights, designations, conversion and distribution provisions between
Class A Common Stock and Class B Common Stock. If the Company shall in any
manner subdivide or combine the outstanding shares of Class A Common Stock or
Class B Common Stock, the outstanding shares of the other class of Common Stock
shall be proportionally subdivided or combined in the same manner and on the
same basis as the outstanding shares of Class A Common Stock or Class B Common
Stock, as the case may be, that have been subdivided or combined.
CONVERSION
Under the Certificate of Incorporation, each share of Class B Common
Stock is convertible at any time and from time to time at the option of the
holder thereof into one share of Class A Common Stock. The Class A Common Stock
has no conversion rights.
OTHER
Stockholders of ELI have no preemptive or other rights to subscribe for
additional shares. All holders of Common Stock, regardless of class, are
entitled to share equally on a share-for-share basis in any assets available for
distribution to stockholders on liquidation, dissolution or winding up of ELI.
No shares of the Common Stock are subject to redemption or a sinking fund. All
outstanding shares are, and all shares offered by this Prospectus will be, when
sold, validly issued, fully paid and nonassessable. ELI may not subdivide or
combine shares of Common
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Stock without at the same time proportionally subdividing or combining shares of
the other classes.
PREFERRED STOCK
The Company's Board of Directors is authorized to provide for the
issuance of Preferred Stock in one or more series and to fix the designations,
preferences, powers and relative, participating, optional and other rights,
qualifications, limitations and restrictions thereof, including the dividend
rate, conversion rights, voting rights, redemption price and liquidation
preference and to fix the number of shares to be included in any such series.
Any such Preferred Stock so issued may rank senior to the Common Stock with
respect to the payment of dividends or amounts upon liquidation, dissolution or
winding up, or both. In addition, any such shares of Preferred Stock may have
class or series voting rights.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is the Illinois
Stock Transfer Company.
SHARES ELIGIBLE FOR FUTURE SALE
Upon the completion of the Offering, there will be [ ] shares of Class
A Common Stock issued and outstanding (if the Underwriters' over-allotment
options are exercised in full) and [ ] shares Class B Common Stock issued and
outstanding. The [ ] shares of Class A Common Stock to be sold in the Offering
will be tradable without restriction by persons other than "affiliates" of ELI.
The shares of Class B Common Stock and any Class A Common Stock issued upon
conversion of Class B Common Stock held or to be held by Citizens will be deemed
"restricted securities" within the meaning of the Securities Act, and, as such,
may not be sold in the absence of registration under the Securities Act or an
exemption therefrom, including the exemptions contained in Rule 144.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are required to be aggregated) who has been deemed to have
beneficially owned shares of an issuer for at least one year, including an
"affiliate," is entitled to sell, within any three-month period, a number of
shares that does not exceed the greater of 1% of the then outstanding number of
shares of such class or the average weekly trading volume in composite trading
in all national securities exchanges during the four calendar weeks preceding
the filing of the required notice of such sale, provided that such issuer has
been a reporting company for at least 90 days. As defined in Rule 144, an
"affiliate" of an issuer is a person that directly or indirectly, through one or
more intermediaries, controls or is controlled by, or is under common control
with, such issuer. Citizens would be deemed an "affiliate" of ELI under the
Securities Act.
The Company and Citizens, as the holder of the Class B Common Stock,
have agreed not to offer, sell, contract to sell, file a registration statement
pursuant to the Securities Act (except for certain registration statements
relating to the issuance of stock and stock options to employees) or otherwise
dispose of any shares of Common Stock without the prior written consent of
Lehman Brothers Inc. on behalf of the Representatives, for a period of [ ]
after the date of this Prospectus.
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The shares of the Company's Class B Common Stock are convertible into
shares of Class A Common Stock and, in the event of conversion of such shares
and expiration of the [ ] lock-up period described above, [ ] of the aggregate
shares of Class A Common Stock issuable upon conversion of the Class B Common
Stock would be immediately eligible for sale pursuant to the provisions of Rule
144 under the Securities Act or upon registration under the Securities Act.
Citizens has advised ELI that Citizens has no current plan or intention other
than to hold the shares of Class B Common Stock owned by it for the foreseeable
future. However, no assurance can be given that Citizens will not decide in the
future to register its shares under the Securities Act and to dispose of all or
a portion of such stock on the public market from time to time, in an
underwritten transaction, or privately or otherwise. See "Relationship with
Citizens--Registration Rights Agreement." Alternatively, Citizens could dispose
of shares periodically pursuant to Rule 144. Any such offers or dispositions
could have a material adverse effect on the market price of the Class A Common
Stock.
Prior to the Offering, there has been no public market for the Class A
Common Stock, and no predictions can be made about the effect, if any, that
market sales of shares of Class A Common Stock or the availability of such
shares for sale would have on the market price prevailing from time to time.
Nevertheless, sales of substantial amounts of Class A Common Stock in the public
market, or the perception that such sales could occur, may have a material
adverse impact on the market price for the shares of Class A Common Stock
offered hereby or on the ability of the Company to raise capital through a
public offering of its equity securities. See "Risk Factors--Shares Eligible for
Future Sale."
CERTAIN TAX CONSIDERATIONS
The following is a general discussion of certain U.S. federal income and
estate tax consequences of the ownership and disposition of Common Stock. This
discussion is intended only as a descriptive summary and does not purport to be
a complete analysis or listing of all possible tax considerations. The
discussion deals only with Common Stock held as capital assets and does not
address any special United States tax consequences that may be applicable to
holders that are subject to special treatment under the United States Internal
Revenue Code of 1986, as amended (the "Code"). Furthermore, the following
discussion is based on provisions of the Code and administrative and judicial
interpretations as of the date hereof, all of which are subject to change. Each
prospective holder is urged to consult a tax advisor with respect to the federal
tax consequences of holding and disposing of Common Stock in light of its
particular situation, as well as any tax consequences that may arise under the
laws of any U.S. state, municipality or other taxing jurisdiction.
CERTAIN TAX CONSIDERATIONS APPLICABLE TO A NON-U.S. HOLDER
As used herein, a "non-U.S. holder" is a holder that is not a citizen or
resident of the United States, a corporation, partnership or other entity
created or organized in or under the laws of the United States or any political
subdivision thereof, or an estate or trust the income of which is subject to
United Sates federal income taxation regardless of its source. An individual
may, among other ways, be deemed to be a resident alien (as opposed to a non-
resident alien) by virtue of being present in the United States on at least 31
days in the calendar year and for an aggregate of 183 days during a three-year
period ending in the current calendar year (counting for such purposes all of
the days present in the current year, one-third of the days present in the
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immediately preceding year, and one-sixth of the days present in the second
preceding year). Resident aliens are subject to U.S. federal tax as if they were
U.S. citizens.
DIVIDENDS
As indicated above, the Company has no current intention to pay
dividends on its Common Stock. The following discussion of U.S. federal income
taxes would apply in the event taxable dividends are declared in the future and
are paid to non-U.S. holders. In general, dividends payable in cash or property
(or which are otherwise taxable) received by a non-U.S. holder of Common Stock
will be subject to withholding of U.S. federal income tax at a 30% rate or such
rate as may be specified by an applicable income tax treaty, unless the
dividends are effectively connected with the conduct of a trade or business by
the non-U.S. holder within the United States. Dividends that are effectively
connected with such holder's conduct of a trade or business in the United States
are subject to tax on a net income basis at rates applicable to U.S. holders and
are not generally subject to withholding. Any such effectively connected
dividends received by a non-U.S. corporation may also, under certain
circumstances, be subject to an additional "branch profits tax" at a 30% rate or
such rate as may be specified by an applicable income tax treaty.
Under current U.S. Treasury regulations, dividends paid to an address
outside the United States are presumed to be paid to a resident of such country
for purposes of the withholding rules discussed above, and, under the current
interpretation of U.S. Treasury regulations, for purposes of determining the
applicability of a tax treaty rate. Under proposed U.S. Treasury regulations,
not currently in effect, however, a non-U.S. holder of Common Stock who wishes
to claim the benefit of an applicable treaty rate would be required to satisfy
applicable certification and other requirements. Currently certain certification
and disclosure requirements must be complied with in order to claim a reduction
or an exemption from withholding under the effectively connected income
exemption.
A non-U.S. holder of Common Stock that is eligible for a reduced rate or
an exemption of U.S. withholding tax pursuant to an income tax treaty may obtain
a refund of any excess amounts currently withheld by filing an appropriate claim
for refund with the U.S. Internal Revenue Service.
GAIN ON DISPOSITION OF COMMON STOCK
A non-U.S. holder generally will not be subject to U.S. federal income
tax in respect of gain recognized on a disposition of Common Stock including
stock dividend shares unless (i) the gain is effectively connected with a trade
or business of the non-U.S. holder in the United States, (ii) in the case of a
non-U.S. holder who is an individual and holds the Common Stock as a capital
asset, such holder is present in the United States for 183 or more days in the
taxable year of the sale and certain other conditions are met, or (iii) the
Company is or has been a "U.S. real property holding corporation" for federal
income tax purposes. The Company has not been, is not and does not anticipate
becoming, a "U.S. real property holding corporation" for U.S. federal income tax
purposes.
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FEDERAL ESTATE TAXES
Common Stock owned or treated as owned by a non-U.S. holder at the time
of death will be included in such holder's gross estate for U.S. federal estate
tax purposes, unless an applicable estate tax treaty provides otherwise.
U.S. REPORTING REQUIREMENTS AND BACKUP WITHHOLDING TAX
Under U.S. Treasury regulations, the Company must report annually to the
Internal Revenue Service and to each non-U.S. holder the amount of dividends
payable in cash or property (or which are otherwise taxable) received by such
holder and the tax withheld with respect to such dividends, regardless of
whether withholding was required. Copies of the returns reporting such dividends
and withholding may also be made available to the tax authorities in the country
in which the non-U.S. holder resides under the provisions of an applicable
income tax treaty.
Backup withholding (which generally is a withholding tax imposed at the
rate of 31% on certain payments to persons that fail to furnish certain
information under the U.S. information reporting requirements) will generally
not apply to dividends paid to a non-U.S. holder at an address outside the
United States (unless the payer has knowledge that the payee is a U.S. person).
Backup withholding and information reporting generally will apply to dividends
paid to addresses inside the United States on shares of Common Stock to
beneficial owners that are not "exempt recipients" and that fail to provide in
the manner required by regulation certain identifying information.
In general, backup withholding and information reporting will not apply
to a payment of the proceeds of a sale of Common Stock to or through a foreign
office of a broker. If, however, such broker is, for U.S. federal income tax
purposes, a U.S. person, a controlled foreign corporation, or a foreign person
that derives 50% or more of its gross income for certain periods from the
conduct of a trade or business in the United States, such payments will not be
subject to backup withholding but will be subject to information reporting,
unless (i) such broker has documentary evidence in its records that the
beneficial owner is a non-U.S. holder and certain other conditions are met, or
(ii) the beneficial owner otherwise establishes an exemption.
Payment to or through a U.S. office of a broker of the proceeds of a
sale of Common Stock is subject to both backup withholding and information
reporting unless the beneficial owner certifies under penalties of perjury that
it is a non-U.S. holder, or otherwise establishes an exemption.
Any amounts withheld under the backup withholding rules will be allowed
as a refund or a credit against such holder's U.S. federal income tax liability
provided the required information is furnished to the Internal Revenue Service.
The backup withholding and information reporting rules are currently
under review by the U.S. Treasury Department and their application to the Common
Stock could be changed by future regulations.
A non-U.S. holder should consult its own tax advisor regarding the
federal income tax consequences of the disposition of Common Stock in light of
its particular situation.
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UNDERWRITING
The Underwriters of the Class A Common Stock in the United States named
below (the "U.S. Underwriters") for whom Lehman Brothers Inc. is
acting as representatives ("Representatives") have severally agreed, subject to
the terms and conditions set forth in a U.S. Underwriting Agreement (the
"Underwriting Agreement") with the Company, to purchase from the Company, and
the Company has agreed to sell to each U.S. Underwriter, the aggregate number of
shares of Class A Common Stock set forth opposite their respective names below.
U.S. Underwriters Number of
- ----------------- Shares
---------
Total................................................ [ ]
The managers of the offering of the Class A Common Stock outside the
United States (the "International Managers"), for whom Lehman Brothers
International (Europe) is acting as lead managers (the "Lead Managers"), have
severally agreed, subject to the terms and conditions of an International
Underwriting Agreement (the "International Underwriting Agreement"), to purchase
from the Company, and the Company has agreed to sell to each International
Manager, the aggregate number of shares of Class A Common Stock set forth
opposite their respective names below.
INTERNATIONAL MANAGERS NUMBER OF
- ---------------------- Shares
----------
Total.................................................. [ ]
The U.S. Underwriting Agreement and the International Underwriting
Agreement (collectively, the "Underwriting Agreements") provide that the
obligations of the U.S. Underwriters and the International Managers,
respectively, to purchase shares of Class A Common Stock are subject to certain
conditions. Each Underwriting Agreement provides that, if any shares of Class A
Common Stock are purchased pursuant to such Underwriting Agreement, all the
shares of Class A Common Stock agreed to be purchased pursuant to such
Underwriting Agreement must be so purchased. The offering price and underwriting
discounts and commissions for the offering in the United States and Canada and
the offering outside the United States and Canada are identical. The closing of
the offering outside the United States and Canada is a condition to the closing
of the offering in the United States and Canada and the closing of the offering
in the United States and Canada is a condition to the closing of the offering
outside the United States and Canada.
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The U.S. Underwriters and the International Managers have entered into
an Intersyndicate Agreement which provides for the coordination of their
activities. The U.S. Underwriters and the International Managers are permitted
to sell shares of Class A Common Stock to each other for purposes of resale at
the initial public offering price, less an amount not greater than the selling
concession.
The Company has granted to the U.S. Underwriters and the International
Managers options to purchase up to an additional ___ and ___ shares of Class A
Common Stock, respectively, at the initial public offering price less the
aggregate underwriting discount, solely to cover over-allotments. Either or
both options may be exercised at any time up to 30 days after the date of this
Prospectus. To the extent that the U.S. Underwriters and International
Managers exercise such options, each of the U.S. Underwriters or International
Managers, as the case may be, will have a firm commitment, subject to certain
conditions, to purchase a number of option shares proportionate to such U.S.
Underwriters' and International Managers' initial commitment.
The Company has been advised that the U.S. Underwriters and the
International Managers propose to offer the shares of Class A Common Stock
directly to the public initially at the offering price set forth on the cover
page of this Prospectus, and to certain dealers (who may include the U.S.
Underwriters and the International Managers) at such public offering price less
a selling concession not in excess of $ per share. The selected dealers may
reallow a discount not in excess of $ per share on sales to certain other
dealers. After the Offering of the Class A Common Stock, the public offering
price, concession and discount may be changed.
The Company and Citizens have agreed to indemnify the U.S. Underwriters
and the International Managers against certain liabilities which may be incurred
in connection with the offering of the Class A Common Stock and the exercise of
the over-allotment options, including liabilities under the Securities Act of
1933, as amended.
Under the terms of the Intersyndicate Agreement, the U.S. Underwriters
and any dealer to whom they sell shares of Class A Common Stock will not offer
to sell or sell shares of Class A Common Stock to persons who are non-U.S.
persons or to persons they believe intend to resell to persons who are non-U.S.
persons, and the International Managers and any dealer to whom they sell shares
of Class A Common Stock will not offer to sell or sell shares of Class A Common
Stock to persons who are U.S. persons or to persons they believe intend to
resell to persons who are U.S. persons, except in each case for transactions
pursuant to such agreement.
Each International Manager has agreed that (i) it has not offered or
sold, and it will not offer or sell, any shares of Class A Common Stock in the
United Kingdom by means of any documents, other than to persons whose ordinary
business is to buy or sell shares or debentures whether as principal or agent
(except in circumstances which do not constitute an offer to the public within
the meaning of the Companies Act of 1985), (ii) it has complied and will comply
with all applicable provisions of the Financial Services Act 1986 with respect
to anything done by it in relation to the Class A Common Stock in, from, or
otherwise involving the United Kingdom, and (iii) it has only issued or passed
on and will only issue or pass on to any person in the United Kingdom any
document received by it in connection with the issuance or sale of Class A
Common Stock to a person who is of a kind described in Article 9(3) of the
Financial Services Act 1986 (Investment Advertisements) (Exemptions) Order 1988
(as amended) or is a person to whom the document may otherwise be lawfully
issued or passed on.
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Purchasers of the shares offered hereby may be required to pay stamp
taxes and other charges in accordance with the laws and practices of the country
of purchase in addition to the public offering price.
The Company and Citizens, as the holder of the Class B Common Stock,
have agreed not to offer, sell, contract to sell, file a registration statement
pursuant to the Securities Act (except for certain registration statements
relating to the issuance of stock and stock options to employees) or otherwise
dispose of any shares of Common Stock without the prior written consent of
Lehman Brothers Inc. on behalf of the Representatives, for a period of [ ] after
the date of this Prospectus.
Prior to the Offering, there has been no public market for the Class A
Common Stock. The initial public offering price will be determined by
negotiations among the Company and the Underwriters. Among the factors to be
considered in such negotiations are an assessment of the Company's recent
results of operations, the future prospects of the Company and its industry in
general, market prices of securities of companies engaged in activities similar
to those of the Company and prevailing conditions in the securities market.
There can be no assurance that an active trading market will develop for the
Class A Common Stock or that the Class A Common Stock will trade in the public
market subsequent to the Offering at or above the initial public offering price.
The Company will apply for listing the Class A Common on the Nasdaq
National Market under the symbol "ELIX."
Until the distribution of the Class A Common Stock is completed, rules
of the Securities and Exchange Commission may limit the ability of the
Underwriters and certain selling group members to bid for and purchase shares of
Class A Common Stock. As an exception to these rules, the Representatives are
permitted to engage in certain transactions that stabilize the price of the
Class A Common Stock. Such transactions consist of bids or purchases for the
purpose of pegging, fixing or maintaining the price of the Class A Common Stock.
If the Underwriters create a short position in the Class A Common Stock
in connection with the Offering (i.e., if they sell more shares of Class A
Common Stock than are set forth on the cover page of this Prospectus), the
Representatives may reduce that short position by purchasing Class A Common
Stock in the open market. The Representatives may also elect to reduce any short
position by exercising all or part of the over-allotment options described
above.
The Representative may also impose a penalty bid on certain Underwriters
and selling group members. This means that if the Representatives purchase
shares of Class A Common Stock in the open market to reduce the Underwriters'
short position or to stabilize the price of the Class A Common Stock, they may
reclaim the amount of the selling concession from the Underwriters and selling
group members who sold those shares as part of the Offering.
In general, purchases of a security for the purpose of stabilization or
to reduce a short position could cause the price of the security to be higher
than it might be in the absence of such purchases. The imposition of a penalty
bid might also have an effect on the price of a security to the extent that it
were to discourage resales of the security by purchasers in the Offering.
Neither the Company nor any of the Underwriters makes any representation
or prediction as to the direction or magnitude of any effect that the
transactions described above may have on the price of the Class A Common Stock.
In addition, neither the Company nor any of the
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Underwriters makes any representation that the Underwriters will engage in such
transactions or that such transactions, once commenced, will not be discontinued
without notice.
Certain of the U.S. Underwriters and International Managers have
provided, from time to time, and expect to provide in the future, brokerage and
investment banking services to the Company and its affiliates for which they
receive customary fees and compensation.
LEGAL MATTERS
The legality of the Class A Common Stock offered hereby and certain
other legal matters will be passed upon for the Company by Winthrop, Stimson,
Putnam & Roberts, New York, New York, and for the Underwriters by Simpson
Thacher & Bartlett (a partnership which includes professional corporations), New
York, New York. Legal matters relating to required authorization, if any, of the
Common Stock Series A by the public utilities commissions in the various states
will be passed upon by local counsel to the Company in the states of Washington,
Oregon, California, Utah, Nevada, Arizona and Idaho. Winthrop, Stimson, Putnam &
Roberts and Simpson Thacher & Bartlett may rely upon such counsel as to certain
matters governed by the laws of such states.
EXPERTS
The financial statements of Electric Lightwave, Inc. as of December 31,
1995 and 1996 and for each of the years in the three-year period ended December
31, 1996, have been included herein and in the registration statement in
reliance upon the report of KPMG Peat Marwick LLP, independent certified public
accountants, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.
ADDITIONAL INFORMATION
ELI has filed with the Securities and Exchange Commission (the "SEC") a
Registration Statement on Form S-1 under the Securities Act with respect to the
Class A Common Stock being offered in the Offering. For the purposes hereof, the
term "Registration Statement" means the original Registration Statement and any
and all amendments thereto, including the schedules and exhibits to such
original Registration Statement or any such amendment. This Prospectus does not
contain all of the information set forth in the Registration Statement, to which
reference hereby is made. Each statement made in this Prospectus concerning a
document filed as an exhibit to the Registration Statement is qualified in its
entirety by reference to such exhibit for a complete statement of its
provisions.
ELI is not currently subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). As a result of
the Offering, ELI will become subject to the informational requirements of the
Exchange Act and in accordance therewith will file periodic reports, proxy and
information statements and other information relating to its business, financial
statements and other matters. Any interested party may inspect the Registration
Statement, the reports, proxy and information statements and other information
without charge, at the public reference facilities of the SEC at its principal
office at Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C.
20549, and at its regional offices in Chicago (Citicorp Center, Suite 1400, 500
West Madison Street, Chicago, Illinois 60601), and in New York (Seven World
Trade Center, Suite 1300, New York, New York 10048). Any
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interested party may obtain copies of all or any portion of the Registration
Statement, the reports, proxy statements and other information at prescribed
rates from the Public Reference Section of the SEC at its principal office at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. The
SEC also maintains a web site (http://www.sec.gov.) that contains reports, proxy
and information statements and other information regarding Citizens.
Citizens is subject to the informational requirements of the Exchange
Act and its periodic reports, proxy statements and other information relating to
its business, financial statements and other matters may be inspected and
obtained as described above.
The Company intends to distribute to all holders of the shares of Class
A Common Stock offered hereby annual reports containing audited consolidated
financial statements and a report thereon by its independent certified public
accountants and quarterly reports containing unaudited consolidated financial
information for each of the first three quarters of each fiscal year.
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GLOSSARY
Access. 1) Point at which entry is gained into a circuit or a network
interconnection may be switched or dedicated. 2) Ability to obtain data from a
storage device or peripheral. 3) Type of connection between customer premises
equipment and an interexchange carrier's network.
Access Charge. When the local facilities of the local exchange carrier
are used for the origination or termination of long distance calls, the access
charge is the fee paid by the long distance carrier to the local telephone
companies for the use of local facilities to gain access to or make connection
with, the originating and terminating telephone subscribers.
Access Line. 1) Circuit between a subscriber and a switching center. 2)
Private lines feeding a common control switching arrangement or enhanced private
switched communications service switch from a PBX.
Asynchronous Transfer Mode (ATM). 1) High bandwidth, low-delay packet
switching and multiplexing technique used to transfer voice, video, images and
character-based data. 2) Method of formatting, multiplexing, cross-connecting
and switching information in 53-byte cells (see below). 3) Transmission method
that operates over various physical media. including Synchronous Optical Network
(SONET), Synchronous Digital Hierarchy (SDH) and digital cross-connect (DCS)
systems. ATM is recently commercialized switching and transmission technology
that is one of a general class of packet technologies that relay traffic by way
of an address contained within the first five bits of a standard fifty-three
bit-long packet or cell. ATM-based packet transport was specifically developed
to allow switching and transmission of mixed voice, data and video at varying
rates. The ATM includes a protocol that specifies how diverse kinds of traffic,
mixed voice, data and video, are transformed into standardized packets whose
transport can be managed uniformly within the network. The ATM format can be
used by many different information systems, including LANs.
Backbone. The core high-density infrastructure of a network. The portion
of the network that transports information from one central location to another
central location where it is off-loaded onto a local system.
Bandwidth. Difference between the top and bottom limiting frequency
band. 2) Indicates the information-carrying capacity of a channel. Analog
transmission is usually expressed in kHz or MHz. Digital transmission in bps or
Mbps. Fiber-optic bandwidth is usually given as its capacity to transmit
information in a specific time period for a specific length (e.g., 10 Mbps/km).
BOC (Bell Operating Company). A local exchange carrier owned by any of
the seven Regional Bell Operating Companies, which are holding companies
established following the Divestiture to serve as parent companies for the BOCs.
Broadband. 1) Transmission facility having a bandwidth greater than 20
kHz. capable of high-speed data transmission. 2) Analog transmission technique
used with data and video transmission that provides multiple channels for uses
through frequency division multiplexing. Broadband communications systems can
transmit large quantities of voice, data and video by way of digital or analog
signals. Examples of broadband communication systems include DS-3 fiber optic
systems, which can transmit 672 simultaneous voice conversations, or a broadcast
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television station signal, that transmits high resolution audio and video
signals into the home. Broadband connec-tivity is also an essential element for
interactive multimedia applications.
CAP (Competitive Access Provider). A company that provides its customers
with an alternative to the local telephone company for local transport of
private line, special access and interstate transport of switched access
telecommunications services. CAPs are also referred to in the industry as
alternative local telecommunications service providers (ALTs) and metropolitan
area network providers (MANs) and were formerly referred to as alternative
access vendors (AAVs).
Central Office. 1) Location of telephone switching equipment at which
customer's lines are terminated and interconnected. 2) Switching center that
provides local access to the public network. Synonyms: end office, local office,
wire center, or switching center. CAPs may connect with local telephone company
networks either at this location or through a remote location.
Centrex (TM). A telephone company switched service that uses central
office switching equipment to route internal calls from one extension to
another, to route incoming calls directly to the appropriate extension, to
handle direct dialing of outbound calls, and to provide many PBX-like service
features. Centrex offers dial tone and other features similar to those of
Private Branch Exchange ("PBX"), except the switching equipment is located at
the carrier's premises and not at the customer's premises. Centrex uses a
separate dedicated line between each telephone at the customer premises and
the switch at the telephone company's central office. Centrex features include
direct dialing within a given telephone system, direct dialing of outgoing
telephone calls and automatic identification of incoming telephone calls.
This is a value-added service that carriers can provide to a wide range of
business customers.
CLEC (Competitive Local Exchange Carrier). A CAP that also provides
switched local services, such as local dial tone and Centrex, in competition
with the incumbent local exchange carrier.
Co-location. The ability of a telecommunications carrier, such as a CAP
or CLEC, to interconnect its network to the ILEC's network by extending its
facilities to the ILEC's central office. Physical co-location occurs when the
interconnecting carrier places its network equipment within the ILEC's central
offices. Virtual co-location is an alternative to physical co-location under
which the ILEC permits a carrier to interconnect its network to the ILEC's
network in a manner which is technically, operationally and economically
comparable to physical co-location, even though the interconnecting carrier's
network connection equipment is not physically located within the central
offices.
Common Carrier. Government-regulated, private company that furnishes the
general public with telecommunications services and facilities (e.g., telephone
or telegraph company).
Customer Premises Equipment. Equipment employed on the premises of a
person (other than a carrier) to originate, route, or terminate
telecommunications.
Dedicated Lines. Telecommunications lines dedicated to, or reserved for
use by, a particular customer along predetermined routes and charged on a flat,
usually monthly basis (in contrast to links which are temporarily established
and in contrast to telecommunications lines within the ILEC's public switched
network.
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Dedicated Access. Connection between a customer's premises and a long
distance carrier. All transmissions on this dedicated line are automatically
routed to the carrier. Provided by a local phone company, alternate access
provider or long distance carrier.
Dialing Parity. "Dialing Parity" means that a person that is not an
affiliate of a local exchange carrier is able to provide telecommunications
services in such a manner that customers have the ability to route
automatically, without the use of any access code, their telecommunications to
the telecommunications services provider of the customer's designation from
among two or more telecommunications services providers (including such local
exchange carrier).
Digital. A means of storing, processing and transmitting information by
using distinct electronic or optical pulses that represent the binary digits 0
and 1. Digital transmission and switching technologies use a sequence of these
pulses to represent information as opposed to the continuously variable analog
signal. The precise digital numbers preclude any distortion (such as graininess
or snow in the case of video transmission, or static or other background
distortion in the case of audio transmission). Digital transmission and
switching technologies offer a threefold improvement in speed and capacity over
analog techniques, allowing much more efficient and cost-effective transmission
of voice, video, and data.
Diverse routing. A telecommunications network configuration in which
signals are transmitted simultaneously along two different paths so that if one
path is cut or impaired, traffic can continue on the other path without
interrupting service.
Divestiture. The 1984 divestment of AT&T of its wholly owned BOCs from
its Long Lines Division and manufacturing operations and generally prohibited
BOCs from providing long distance telephone service between LATAs.
Dominant Carrier. A carrier found by the FCC [or a local state
commission] to have market power, i.e., the power to control prices for its
services.
DS-0, DS-1, DS-3. Standard North American telecommunications industry
digital signal formats, which are distinguishable by bit rate (the number of
binary digits (0 and 1) transmitted per second). DS-0 service has a bit rate of
64 kilobits per second. DS-1 service (also referred to as T1) has a bit rate of
1.544 megabits per second (the equivalent of 24 DS0 circuits) and DS-3 service
(also referred to as T-3) has a bit rate of 44.736 megabits per second (the
equivalent of 28 DS1 circuits). A DS-0 can transmit a single uncompressed voice
conversation.
Enhanced Service. Any for-profit telecommunications service that adds
value to users' voice and data messages during the course of transmission.
Examples of enhanced services would include storage of a spoken message within
the network for forwarding or retrieval at some future time, or processing data
within the network and sending the results to the intended recipient.
Ethernet. A local area network technology used for connecting computers,
printers, workstations terminals, etc., within the same building. Ethernet
operates over twisted wire or coaxial cable at speeds up to 100 megabits per
second. Ethernet is the most popular LAN technology.
Exchange. A central office telephone switch.
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<PAGE>
Exchange Access. The offering of access to telephone exchange services
or facilities for the purpose of the origination or termination of telephone
toll services i.e., intraLATA and long distance.
FCC. Federal Communications Commission.
FDDI (Fiber Distributed Data Interface). Based on fiber optics, FDDI is
a 100 megabit per second local area network technology used to connect
computers, printers, and workstations at very high speeds. FDDI is also used as
backbone technology to interconnect other LANs.
Fiber mile. The number of route miles installed (excluding pending
installations) along a telecommunications path multiplied by the number of
fibers along that path. See the definition of "route mile" below.
Fiber Optics. Means of providing a high-speed transmission, using light
to send images through a flexible bundle of glass fibers. The technology
involves sending coded laser light pulses across glass strands in order to
transmit digital information. Fiber optic cable is the medium of choice for the
telecommunications and cable industries. Fiber is immune to electrical
interference and environmental factors that affect copper wiring and satellite
transmission.
Frame Relay. Frame Relay is a high-speed data packet switching service
used to transmit data between computers. Frame relay employs statistical
multiplexing over a shared network, intended for use between intelligent end-
points and implemented over high-quality transmission facilities that connect
programmable switches. Frame Relay supports data units of variable lengths at
access speeds ranging from 56kbs to 1.5mbs. This service is ideal for connecting
LANS, but is not appropriate for voice and video applications due to the
variable delays which can occur. Frame Relay was designed to operate at higher
speeds on modern fiber optic networks. Frame relay reduces redundant processing
within the packet network by relieving intermediate relay nodes of
responsibility for ensuring that data is transmitted accurately. The
intermediate nodes check only the outer "frame" of a data packet that gives the
addresses and routing instructions. Accuracy of packet "payload" is checked only
after the packet arrives at the terminating location. Frame relay is being used
in private data networks. Some U.S. interexchange carriers offer frame relay in
data networking applications and many manufacturers offer frame relay equipment.
Hubs. Collection centers located centrally in an area where
telecommunications traffic can be aggregated at a central point for transport
and distribution.
ILECs (Incumbent Local Exchange Carrier). The local phone companies
either a BOC or an independent (such as GTE), which provides local exchange
services.
Interconnection. Connection of a piece of telephone equipment to the
telephone network, or a data terminal to a data communications network. Also
refers to the connection of one communications network to another so that users
of one network can communicate with users of another network.
IntraLATA Long Distance. IntraLATA long distance calls, also known as
short-haul calls, are those calls that originate and terminate within the same
LATA, but are outside the local calling area. Such calls are usually priced on a
measured basis. At present, the RBOCs are prohibited from providing IntraLATA
long distance service within their service areas.
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<PAGE>
InterLATA service. Telecommunications between a point located in a local
access and transport area and a point located outside such area.
Internet. The name used to describe the global open network of computers
that permits a person with access to the Internet to exchange information with
any other computer connected to the network.
ISDN (Integrated Services Digital Network). ISDN is an internationally
agreed standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission line.
ISDN permits video conferencing over a single line, and other enhanced services,
such as high-speed data file transfer, desk top videoconferencing,
telepublishing, telecommuting, telepresence learning (distance learning), remote
collaboration (screened sharing), data network linking and home information
services. It also supports a multitude of value-added switched service
applications such as Incoming Calling Line Identification. ISDN's combined voice
and data networking capabilities reduce costs for end users and result in more
efficient use of available facilities. ISDN combines standards for highly
flexible customer to network signaling with both voice and data within a common
facility.
IXC (Inter-Exchange Carriers). Usually referred to as long distance
providers. There are many facilities-based IXCs including AT&T, MCI, WorldCom,
Sprint and Frontier, as well as a select few CAPs that are authorized for IXC
service.
Kilobit. One thousand bits of information. The information-carrying
capacity (i.e., bandwidth) of a circuit may be measured in "kilobits per
second." One kilobit is approximately sufficient to encode a standard telegram.
LAN (Local Area Network). The interconnection of computers for the
purpose of sharing files, programs and peripheral devices such as printers and
high-speed modems. More generally, a private data communications network linking
a variety of data devices, such as computer terminals, personal computers and
minicomputers, all housed in a defined building, plant or geographic area. LANs
are generally confined to a single customer's premises and may be extended or
interconnected to other locations through the use of bridges and routers. LANs
range widely in size and complexity, from simple user--installable networks
connecting together a few personal computers to vast networks tying thousands of
terminals to multiple mainframe computers. LANs will allow a computer user to
access a computer other than the user's own in order to send and retrieve
electronic mail and data files at transmission rates generally between 100Kbps
and 50Mbps. LANs are owned or leased by customers; they generally do not employ
circuits from telephone common carriers or other network service provider. LANs
may, however, provide a bridge or gateway to other public or private networks.
Some telephone common carriers offer data communications services with
capabilities resembling those of LANs, as an alternative to the purchase of a
LAN.
LATA (Local Access Transport Area). The approximately 164 geographic
areas which define the regions in which each RBOC is allowed to provide service,
as defined in the divestiture order known as the Modified Final Judgment ("MFJ")
unless and until redefined by the FCC pursuant to the Telecommunications Act of
1996. These LATAs roughly reflect the population density of their respective
states (California has 11 LATAs while Wyoming has only one). The BOCs are
generally prohibited from providing long distance service between LATA in their
territory.
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<PAGE>
LEC (Local Exchange Carrier). A company providing local telephone
services, also referred to in the industry as a "local exchange telephone
company." These include the BOCs, GTE and more than 1,000 other independents.
The term includes ILECs and CLECs, that is, Incumbent and Competitive Local
Exchange Carriers.
Local competition. The term "local competition" describes the events
which are presently in an early state in the local arena to afford true "co-
carrier" status to CAPs. Specifically, the ILECs, who once had a monopoly on
local exchange telephone service, are beginning to experience competition at the
local level from CAPs, CLECs, and other providers of local exchange services.
Critical issues such as number portability, dialing parity, reciprocal
compensation arrangements, and number assignments must be negotiated in order to
ensure that true co-carrier status is achieved for CAPs and CLECs.
Local exchange. (1) A geographic area defined by the appropriate state
regulatory authority in which telephone calls generally are transmitted without
toll charges to the calling or called party. (2) An exchange where subscribers'
lines are terminated.
Local exchange carrier. Any person that is engaged in the provision of
telephone exchange service or exchange access.
Local Exchange Services. Local Exchange Services generally refers to all
services provided by an ILEC or CLEC including local dial tone, the provision of
telephone numbers, calling within the local exchange area, Centrex and Long
Distance Access Services. Sometimes also referred to as Local Telephone Services
and Local Telecommunications Services.
Local Loop. Communications lines/services between the telephone
subscriber and the phone company switching center.
Local Telecommunications or Local Telephone Services. See Local Exchange
Services.
Long distance access services. Long distance access services are the
services provided by an ILEC or CLEC to a long distance company that connect the
IXC POP to end users, including special access services and switched access
services.
Long Distance Carrier. A company providing inter-LATA or long distance
services between local exchanges on an intrastate or interstate basis. Long
distance carriers may also be long distance reseller companies. A long distance
carrier may offer services over its own or another carrier's facilities. Major
long distance carriers include AT&T, MCI, Sprint, WorldCom and Frontier, and may
also include resellers of long distance capacity.
Megabit. One million bits of information. The information-carrying
capacity (i.e., bandwidth) of a circuit may be measured in "megabits per
second." One megabit is approximately sufficient to encode a 3-inch by 5-inch
photograph.
Multiplex. 1) To interleave or simultaneously transmit two or more
messages on a single channel. 2) Optical or electronic communications
arrangements whereby multiple devices share a common transmission channel,
though only one may transmit at a time. 3) Process or equipment that combines
data from two or more individual circuits onto a higher speed circuit for
transmission. Two methods are used; (a) splitting the total available bandwidth
into narrower bands and transmitting all channels at the same time (frequency
division) or (b) allotting a common channel to several different messages or
transmitting devices, one at a time in sequence (time division).
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<PAGE>
Network. Any system designed to provide one or more access paths for
communications between users at different geographic locations. Communications
networks may be designed for voice, text, data, facsimile image and/or video.
They may feature limited access (private networks) or open access (public
networks) and will employ whatever switching and transmission technologies are
appropriate.
NNI. Network-to-Network Interfaces.
Node. An individual point of origination and termination of data on the
network transported using frame relay or similar technology.
Number portability. The ability of users of telecommunications services
to retain, at the same location, existing telecommunications numbers without
impairment of quality, reliability, or convenience when switching from one
telecommunications carrier to another. If number portability does not exist,
customers will have to change phone numbers when they change local exchange
carriers.
Off-net. A customer of the Company that is not physically connected to
one of the Company's networks but who is accessed through interconnection with
an ILEC network.
On-net. A customer of the Company that is physically connected to one of
the Company's networks.
PBX. A Private Branch Exchange is a switching system within the user's
premises which allows calls from outside to be routed directly to the individual
instead of through a central number. PBX also provides for the automatic
selection of outgoing lines in accordance with user-defined criteria. PBX may
also allow for calling within an office by way of four digit extensions. Centrex
is a service which can simulate this service from an outside switching source,
thereby eliminating the need for a large capital expenditure on a PBX.
Physical Co-location. Physical Co-location occurs when a CAP or CLEC
places its own network connection equipment inside the ILEC central office. A
recent Court of Appeals decision found that, while ILECs must allow CAPs or CLEC
to interconnect with their facilities, ILECs are not required by law to allow
CAPs or CLECs to place its own equipment inside the ILEC central office. The
1996 Act overturned the decision.
Points of Presence (POPs). Physical locations where a long distance
carrier has installed transmission equipment in a service area that serves as,
or relays calls to, a network switching center of that long distance carrier and
connects with the lines of the local telephone company serving the LATA within
which the POP is located.
PRI. Primary rate interface, a service offering of ISDN which operates
at T-1 bandwidth. See ISDN.
Private line. 1) A telephone access line provided to a single subscriber
connecting different locations of the same subsidiaries and used exclusively by
that subscriber (does not include long distance carriers' POPs). 2) A dedicated,
non-switched telecommunications channel provided between two or more points and
leased or purchased by a telecom subscriber for high-volume voice, data, audio
or video transmissions. 3) Leased, owned or otherwise dedicated channel. 4)
Channel and channel equipment furnished to a user as a unit for exclusive use
without interexchange switching arrangements.
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<PAGE>
Public switched network. That portion of a ILEC's network available to
all users generally on a shared basis (i.e., not dedicated to a particular
user). Traffic along the public switched network is generally switched at the
ILEC's central offices.
Public Utility Commission (PUC). A state regulatory body, established in
most states, which regulates utilities, including telephone companies providing
intrastate services.
Regional Bell Operating Company (RBOC). One of regional companies
created by the AT&T divestiture to take over ownership of the Bell operating
companies within their region. They are Ameritech, Bell Atlantic, BellSouth,
NYNEX, SBC Corporation (formerly Southwestern Bell) and U S WEST. The RBOCs also
have set up numerous unregulated subsidiaries engaged in variety of
communications-related and non-communications businesses. The divestiture
agreement barred RBOCs from providing inter-LATA services within their service
areas and from manufacturing telecommunications equipment and certain other
business activities, such as providing long distance service, but provided
mechanisms for review, waiver, modification or removal of the prohibitions. The
RBOCs are also known as regional holding companies. In this Prospectus, the term
RBOC may include the Bell operating companies.
Redundant. A telecommunications facility using two separate electronic
devices to transmit a telecommunications signal so that if one device
malfunctions, the signal may continue with-out interruption.
Resale. To hire circuits or services from a major carrier and resell
them to individual users.
Reseller. A carrier that does not operate its own transmission
facilities (although it may own its own switches or other equipment), but
obtains communications services from another carrier for resale to the public
for profit.
Route Mile. A geographical measure defined as one physical mile of fiber
optic cable, regardless of the number of fibers or telecommunications paths
within that cable.
Signaling System #7. Sophisticated network signaling system that
utilizes out-of-band signaling where signaling information is sent over a
separate channel than the call itself. improves call processing set-up times and
frees circuits for voice, data and video transmissions.
Special access services. The lease of private, dedicated
telecommunications lines or "circuits" along the network of an ILEC or a CAP,
which lines or circuits run to or from the long distance carrier POPs. Examples
of special access services are telecommunications lines running between POPs of
a single long distance carrier, from one long distance carrier POP to the POP of
another long distance carrier or from an end user to its long distance carrier
POP. Special access services do not require the use of switches.
Switch. A mechanical or electronic device that opens or closes circuits
or selects the paths or circuits to be used for the transmission of information.
Switching is a process of interconnecting different circuits to create a
temporary transmission path between users. In operation a switch may be a
sophisticated computer that accepts instructions from a caller in the form of a
telephone number. Like an address on an envelope, the numbers tell the switch
where to route the call. The switch opens or closes circuits or selects the
paths or circuits to be used for transmission of informa-tion. Switches allow
local telecommunications service providers to connect calls directly to their
destination, while providing advanced features and recording connection
information for future billing.
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<PAGE>
Switched access. 1) Method to test telecommunications circuits using
electro-mechanical circuitry. 2) Calls transmitted partially on shared or common
transport circuits. Used primarily by residential or small business companies
using regular home or business lines.
Switched access services. Switched access services are the services
provided by an ILEC or CLEC through its switching facilities to a long distance
carrier, in addition to switched access transport, to connect the IXC POP to end
users, for the purpose of originating or terminating toll calls. Long distance
companies pay switched access charges to the ILECs and CLEC for each switched
call originated or terminated on the ILEC's or CLEC's network.
Switched access transport. Transportation of switched traffic along
dedicated lines between the ILEC central offices and long distance carrier POPs.
Switched traffic. Telecommunications traffic along the public switched
network that is charged on a per-minute or other range sensitive basis. This
traffic is generally switched at the ILEC's central offices.
Synchronous Optical Network (SONET). SONET is the electronics and
network architecture which enable transmission of voice, video and data
(multimedia) at very high speeds. This state-of-the-art self-healing ring
network offers advantages over older linear networks in that a cut line or
equipment failure can be overcome by rerouting calls within the network. If the
line is cut, the traffic is simply reversed and sent to its destination around
the other side of the ring.
Telephone Exchange Service. The term "telephone exchange service" means
(A) service within a telephone exchange, or within a connected system of
telephone exchanges within the same exchange area operated to furnish to
subscribers intercommunicating service of the character ordinarily furnished by
a single exchange, and which is covered by the exchange service charge, or (B)
comparable service provided through a system of switches, transmission
equipment, or other facilities (or combination thereof) by which a subscriber
can originate and terminate a telecommunications service.
Telephone Toll Service. The term "telephone toll service" means
telephone service between stations in different exchange areas for which there
is made a separate charge not included in contracts with subscribers for
exchange service.
Token Ring. A local area network technology used to interconnect
personal computers, file servers, printers, and other devices. Token Ring LANs
typically operate at either 4 megabits per second or 16 megabits per second.
Toll services. Otherwise known as EAS or intraLATA toll services are
those calls that are beyond the local calling area but originate and terminate
within the same LATA; such calls are usually priced on a measured basis.
Traffic. A generic term that includes any and all calls, messages and
data sent and received by means of telecommunications.
Trunk. 1) Group of circuits that carry call traffic in and out of the
switch; 2) Circuit or channel connecting two exchanges or two switching devices;
3) Circuit capable of being switched at both ends.
Unbundling. 1) The separate pricing of hardware, software and related
services. 2) The separate pricing of each component or element of a
communications product or service, so that
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<PAGE>
the customer may select only those components or elements it needs without
having to accept unnecessary element or components.
800 Service. A telecommunications service for businesses that allows
calls to be made to a specific location at no charge to the calling party. Use
of the "800" service code denotes calls that are to be billed to the receiving
party. A computer database in the provider's network translates the 800 number
into a conventional telephone number.
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ELECTRIC LIGHTWAVE, INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report...............................................F-1
Statements of Operations for the Years Ended December 31, 1994, 1995 and
1996 and for the Six Months Ended June 30, 1996 and 1997
(unaudited).............................................................F-2
Balance Sheets at December 31, 1995 and 1996 and June 30, 1997 (unaudited).F-3
Statements of Cash Flows for the Years Ended December 31, 1994, 1995 and
1996 and for the Six Months Ended June 30, 1996 and 1997
(unaudited).............................................................F-4
Statements of Changes in Stockholder's Equity (Deficiency) for the Years Ended
December 31, 1994, 1995 and 1996 and for the Six Months Ended June 30, 1997
(unaudited).............................................................F-5
Notes to Financial Statements..............................................F-6
91
<PAGE>
The Board of Directors and Stockholder
Electric Lightwave, Inc.
We have audited the balance sheets of Electric Lightwave, Inc. (a wholly-
owned subsidiary of Citizens Utilities Company) as of December 31, 1995 and 1996
and the consolidated statements of operations, stockholder's equity (deficiency)
and cash flows for each of the years in the three-year period ended December 31,
1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Electric Lightwave, Inc. as
of December 31, 1995 and 1996, and the results of its operations and its cash
flows for each of the years in the three-year period ended December 31, 1996, in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
New York, New York
September 4, 1997
F-1
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Operations
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the six months ended
For the years ended December 31, June 30,
--------------------------------------------- --------------------------------
1994 1995 1996 1996 1997
---------- ---------- ----------- ------------ -----------
(Unaudited)
Revenues $ 8,152 $ 15,660 $ 31,309 $ 13,374 $ 24,765
---------- ---------- ----------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Operating expenses:
Network access expenses 6,155 8,728 24,081 9,527 15,206
Sales and marketing expenses 4,534 5,704 8,462 3,940 6,271
Depreciation and amortization 2,476 7,064 7,192 3,453 5,603
Administrative services
expenses 1,300 1,511 2,254 851 1,594
Other operating expenses 3,228 12,603 18,703 6,218 15,905
---------- ---------- ----------- ------------ -----------
Total operating expenses 17,693 35,610 60,692 23,989 44,579
---------- ---------- ----------- ------------ -----------
Loss from operations (9,541) (19,950) (29,383) (10,615) (19,814)
Interest expense, net 873 372 - - 302
---------- ---------- ----------- ------------ -----------
Net loss $ (10,414) $ (20,322) $ (29,383) $ (10,615) $ (20,116)
========== ========== =========== ============ ===========
Pro forma net loss per share $ $ $
=========== ============ ===========
Pro forma weighted average shares
outstanding
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-2
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
December 31, June 30,
--------------------------------------------- ------------------
1995 1996 1997
------------------ ------------------ ------------------
(Unaudited)
<S> <C> <C> <C>
ASSETS:
Current assets:
Cash $ 143 $ 611 $ 1,109
Trade receivables, net 3,097 4,610 7,364
Other receivables 45 8,329 167
Other current assets 168 224 404
------------------ ----------------- -----------------
Total current assets 3,453 13,774 9,044
------------------ ----------------- -----------------
Property, plant and equipment 127,297 189,334 235,953
Less accumulated depreciation and
amortization (11,307) (17,337) (20,703)
------------------ ----------------- -----------------
Property, plant and equipment, net 115,990 171,997 215,250
Other assets 9,458 9,885 9,541
------------------ ----------------- -----------------
Total assets $ 128,901 $ 195,656 $ 233,835
================== ================= =================
LIABILITIES AND SHAREHOLDER'S EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 18,596 $ 18,892 $ 21,201
Taxes other than income taxes 1,577 2,329 3,766
Other current liabilities 1,177 2,493 3,933
------------------ ----------------- -----------------
Total current liabilities 21,350 23,714 28,900
------------------ ----------------- -----------------
Deferred credits 1,313 1,435 1,488
Capital lease obligation - - 10,664
Deferred income taxes payable 2,628 5,826 8,944
Due to Citizens Utilities Company 64,941 155,395 194,669
Shareholder's equity (deficiency) 38,669 9,286 (10,830)
------------------ ----------------- -----------------
Total liabilities and
shareholder's
equity (deficiency) $ 128,901 $ 195,656 $ 233,835
================== ================= =================
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-3
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Cash Flows
(in thousands)
<TABLE>
<CAPTION>
For six months ended
For the years ended December 31, June 30,
-------------------------------- ----------------------------
1994 1995 1996 1996 1997
--------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Cash flow from operating activities:
Net loss $(10,414) $(20,322) $(29,383) $(10,615) $(20,116)
Adjustments to reconcile net loss
to net cash used for operating
activities:
Depreciation and
amortization 2,476 7,064 7,192 3,453 5,603
Administrative services expenses
charged by Citizens 1,300 1,511 2,254 851 1,594
Changes in operating assets and
liabilities:
Receivables (805) (1,698) (9,797) (1,883) 5,408
Accounts payable and other accrued
liabilities 3,056 10,444 295 (13,508) 2,309
Taxes other than income taxes 520 967 765 970 1,437
Other (230) 464 (219) (2,720) (1,014)
--------- --------- --------- ----------- ------------
Net cash used for operating
activities (4,097) (1,570) (28,893) (23,452) (4,779)
Cash flow used for investing activities:
Capital expenditures (60,774) (16,129) (59,169) (18,402) (33,595)
--------- --------- --------- ----------- ------------
Cash flow from financing activities:
Citizens fundings 67,636 26,862 88,530 41,963 38,872
Repayment of debt (2,729) (9,111) - - -
--------- --------- --------- ----------- ------------
Net cash provided by financing
activities 64,907 17,751 88,530 41,963 38,872
Change in cash 36 52 468 109 498
Cash at beginning of period 55 91 143 143 611
--------- --------- --------- ----------- ------------
Cash at end of period $ 91 $ 143 $ 611 $ 252 $ 1,109
========= ========= ========= =========== ============
Supplemental cash flow information:
Cash paid for interest $ 1,086 $ 630 $ -
========= ========= =========
Other non-cash transactions:
Issuance of preferred stock in
exchange for reduction of amount
due to Citizens $ 57,255 $ - $ -
========= ========= =========
Acquisition of minority interest by
Citizens $ - $ 3,000 $ -
========= ========= =========
Deferred income taxes charged to
due to Citizens $ 519 $ 1,160 $ 3,198
========= ========= =========
Capitalized interest added to due
to Citizens $ 2,466 $ 2,619 $ 2,868
========= ========= =========
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-4
<PAGE>
ELECTRIC LIGHTWAVE, INC.
Statements of Shareholder's Equity (Deficiency)
For the years ended December 31, 1994, 1995 and
1996 and for the six months ended June 30, 1997
(unaudited)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Preferred Stock Common Stock
--------------------------------- ----------------------------------
Shares Amount Shares Amount
-------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Balance January 1, 1994 23 $ - 1 $ -
Issuance of preferred
shares to Citizens 76 - - -
Net loss - - - -
-------------- -------------- --------------- --------------
Balance December 31, 1994 99 - 1 -
Acquisition of minority
interest by Citizens - - - -
Net Loss - - -
-------------- -------------- --------------- --------------
Balance December 31, 1995 99 - 1 -
Conversion of preferred
stock to common stock (99) - 99 -
Net loss - - - -
-------------- -------------- --------------- --------------
Balance December 31, 1996 - - 100 -
Net loss (unaudited) - - - -
-------------- -------------- --------------- --------------
Balance June 30, 1997 (unaudited) - $ - 100 $ -
============== ============== =============== ==============
<CAPTION>
Additional Shareholder's
Paid-in- Equity
Capital Deficit (Deficiency)
--------------- --------------- -------------------
<S> <C> <C> <C>
Balance January 1, 1994 $ 19,000 $ (9,850) $ 9,150
Issuance of preferred
shares to Citizens 57,255 - 57,255
Net loss - (10,414) (10,414)
--------------- --------------- -------------------
Balance December 31, 1994 76,255 (20,264) 55,991
Acquisition of minority
interest by Citizens 3,000 - 3,000
Net Loss - (20,322) (20,322)
--------------- --------------- -------------------
Balance December 31, 1995 79,255 (40,586) 38,669
Conversion of preferred
stock to common stock - - -
Net loss - (29,383) (29,383)
--------------- --------------- -------------------
Balance December 31, 1996 79,255 (69,969) 9,286
Net loss (unaudited) - (20,116) (20,116)
--------------- --------------- -------------------
Balance June 30, 1997 (unaudited) $ 79,255 $ (90,085) $ (10,830)
=============== =============== ===================
</TABLE>
The accompanying Notes are an integral part of these Financial Statements.
F-5
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
(1) Organization and Description of Business
----------------------------------------
The Company is a full service, facilities based provider of
communications services in five major market clusters in and around the
western United States cities of Portland, Oregon; Seattle, Washington;
Salt Lake City, Utah; Sacramento, California; and Phoenix, Arizona. The
Company targets retail customers, primarily large- and medium-sized
communications-intensive businesses, and wholesale customers, primarily
telecommunications service providers, that require state-of-the-art
communications and data services.
The Company is a subsidiary of Citizens Utilities Company ("Citizens").
The Company has invested solely in its telecommunications networks and
is experiencing significant recurring losses and negative cash flows
during the construction and start up phase of its business. Since the
Company does not presently generate operating profits or sufficient
operating cash flows to meet operating and capital requirements, the
Company is dependent upon its ability to obtain financing from either
Citizens or external sources. Currently, the Company's sources of
funding are Citizens and a lease facility guaranteed by Citizens.
Citizens has indicated its intent to continue to provide the necessary
operating and capital funding through the successful completion of the
Company's initial public offering ("Offering"), currently expected to
be completed before the end of 1997.
(2) Summary of Significant Accounting Policies
------------------------------------------
(a) Basis of Presentation and Use of Estimates
The financial statements have been prepared in accordance with
Generally Accepted Accounting Principles ("GAAP"). The preparation of
financial statements in conformity with GAAP requires management to
make estimates and assumptions which affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual
results could differ from those estimates.
(b) Revenue Recognition
Revenues from telecommunications services are recognized when the
services are provided. The revenue from long-term leases of fiber optic
cable is recognized on a straight line basis over the terms of the
related leases.
(c) Trade and Other Receivables
The Company's trade customers are primarily large- and medium-sized
communications-intensive businesses and telecommunications service
providers that require state-of-the-art communications and data
services. Trade accounts receivable is shown net of an allowance for
doubtful accounts in amounts of approximately $75,000, $1,166,000 and
$1,073,000 at December 31, 1995, 1996 and June 30, 1997, respectively.
At December 31, 1996, the Company's trade receivables are concentrated
in and around the five cities referred to in note 1. Other receivables
at December 31, 1996 include approximately $6.7 million due under a
construction agency agreement, which amount was received by the Company
in January, 1997.
F-6
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
(d) Property, Plant and Equipment
Property, plant and equipment are stated at cost and include certain
costs which are capitalized during the installation and expansion of
telecommunications networks including interest costs related to
construction of approximately $2,466,000, $2,619,000, and $2,868,000
for the years ended December 31, 1994, 1995 and 1996, respectively.
Depreciation is computed using the straight line method over the
estimated useful lives of the assets. Leasehold improvements are
amortized using the straight line method over the shorter of the
estimated useful lives of the assets or the remaining terms of the
leases. A capital lease included in telecommunications networks is
being amortized using the straight line method over the life of the
capital lease. The estimated useful lives of owned assets are as
follows:
Telecommunications networks 25 years
Electronics and related equipment 7 - 8 years
Office equipment and other 5 - 7 years
The Company's telecommunications networks are subject to technological
risks and rapid market changes due to new products and services and
changing customer demand. These changes may result in future
adjustments to the estimated useful lives of these assets.
(e) Other Assets
Other assets include third party direct costs incurred in connection
with negotiating and securing initial rights-of-way and developing
network design for new market clusters or locations, which costs are
deferred until service is ready to commence. Such costs are then
amortized over a 5 year period utilizing the straight line method. Also
included in other assets at December 31, 1995 and 1996 is goodwill of
$4,866,000 and $4,680,000, respectively, resulting from the acquisition
of the minority interests in the Company by Citizens, which amounts
were recorded in the Company's accounts. Goodwill is being amortized
utilizing the straight line method over a 25 year period.
(f) Income Taxes
The Company is included in the consolidated federal income tax return
of Citizens. The Company utilizes the asset and liability method of
accounting for income taxes. Under the asset and liability method,
deferred income taxes are recorded for the tax effect of temporary
differences between the financial statements and the tax bases of
assets and liabilities using tax rates expected to be in effect when
the temporary differences are expected to turn around. Citizens' policy
has been to record tax provisions, assets and liabilities at the
subsidiary level on a stand alone basis. However, Citizens reimburses
the Company on an annual basis (through reductions in the "Due to
Citizens" account) for the benefit of the Company's changes in
temporary differences utilized by Citizens in its consolidated federal
income tax return, but not for the book losses or permanent tax
adjustments until such items can be used on a stand alone basis.
F-7
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
(g) Impairment
In accordance with Statement of Financial Accounting Standards No. 121
("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed of," the Company reviews for the
impairment of long-lived assets and certain identifiable intangibles
to be held and used by the Company whenever events or changes in
circumstances indicate that the carrying amount of the asset may not
be recoverable.
The Company assesses the recoverability of an asset by determining
whether the amortization of the asset balance over its remaining life
can be recovered through projections of undiscounted future cash flows
of the related asset. The amount of asset impairment, if any, is
measured based on projected discounted future cash flows using a
discount rate reflecting the Company's average cost of funds.
(h) Employee Stock Plans
The Company currently participates in the Management Equity Incentive
Plan ("MEIP") of Citizens, which may grant awards of Citizens Common
Stock to eligible officers, management employees and non-management
exempt employees of Citizens and its subsidiaries in the form of
incentive stock options, non-qualified stock options, stock
appreciation rights, restricted stock or other stock-based awards and
in the Employee Stock Purchase Plan ("ESPP") of Citizens in which
employees of Citizens and its subsidiaries may subscribe to purchase
shares of Citizens' common stock at 85% of the lower of the average
market price on the first day of the purchase period or the last day
of the purchase period.
Prior to January 1, 1996, the Company accounted for the Citizens
employee stock option plans in accordance with the provisions of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. As such,
compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise
price. On January 1, 1996, the Company adopted SFAS 123, "Accounting
for Stock-Based Compensation", which permits entities to recognize as
expense over the vesting period the fair value of all stock-based
awards on the date of grant. Alternatively, SFAS 123 also allows
entities to continue to apply the provisions of APB Opinion No. 25 and
provide pro forma net income and pro forma earnings per share
disclosures for employee stock option grants made in 1995 and future
years as if the fair-value based method defined in SFAS 123 had been
applied. The Company elected to continue to apply the provisions of
APB Opinion No. 25 and provide the pro forma disclosure provisions of
SFAS 123 (see Note 6). The Company had no stock plans involving its
own stock as of December 31, 1996.
(i) Pro Forma Net Loss Per Share
Historical net loss per share is not presented because it is not
meaningful. Pro forma share and pro forma per share amounts will be
presented to reflect the recapitalization of the Company contemplated
as part of its Offering (see last paragraph of note 5). Pro forma net
loss per common and common equivalent share is based on the weighted
average number of common shares outstanding during the year, as
adjusted for the effects of the application of Securities and Exchange
Commission Staff Accounting Bulletin ("SAB") No. 83 (__ shares in all
periods). Pursuant to SAB No. 83, options granted within one year of
the Company's Offering which have an exercise price less than the
Offering price are treated as outstanding for all periods presented
(using the treasury stock method at the assumed Offering price) even
though the effect is to reduce the loss per share.
F-8
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
(j) Interim Financial Information
The financial statements and notes related thereto as of June 30, 1997
and for the six months ended June 30, 1996 and 1997 are unaudited, but
in the opinion of management, include all normal recurring adjustments
necessary for a fair presentation of financial position and results of
operations. The operating results for the interim periods are not
necessarily indicative of a full year's operations.
(3) Property, Plant and Equipment:
-----------------------------
The components of property, plant and equipment at December 31, 1995 and
1996 and at June 30, 1997 are as follows:
<TABLE>
<CAPTION>
-------------------(in thousands)-----------------
December 31, June 30
----------------------------- ----------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Telecommunications networks $80,501 $113,997 $125,151
Electronics and related equipment 14,997 20,417 20,486
Office equipment, leasehold improvements and other 4,414 11,201 12,593
Construction work in progress 24,980 37,433 72,616
Inventory 2,405 6,286 5,107
--------- --------- --------
Property, plant and equipment 127,297 189,334 235,953
Accumulated depreciation and amortization (11,307) (17,337) (20,703)
--------- --------- --------
Property, plant and equipment, net $115,990 $171,997 $215,250
========= ========== ========
</TABLE>
Telecommunications networks include a capital lease at June 30, 1997 in the
amount of $11,320,000.
Inventory consists primarily of new and reusable parts to maintain and build
fiber optic networks.
The Company has leased fiber optic cable included in its telecommunications
networks to an unrelated long distance carrier for 10 years beginning in 1995
and to Citizens for 10 years. The lease agreement with the long distance
carrier provided for $1,500,000 in cash at inception, which amount is being
amortized utilizing the straight line method over the lease period, and $144,000
per month over the 10 year lease period. The lease agreement with Citizens
calls for monthly rentals of $30,000 over the 10 year lease period (see note 6).
F-9
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
(4) Income Taxes:
The components of deferred income taxes are as follows:
<TABLE>
<CAPTION>
-------(in thousands)--------
December 31,
-----------------------------
1995 1996
-------- ---------
<S> <C> <C>
Benefit of operating loss carryforwards $ 14,108 $ 24,348
Less valuation allowance (14,108) (24,348)
--------- --------
$ - $ -
--------- --------
Deferred income tax liability,
primarily property, plant and equipment $ 2,628 $ 5,826
========= ========
</TABLE>
The benefit of the operating loss carryforwards represent amounts due from
Citizens for the utilization by Citizens of the Company's operating losses in
the consolidated federal income tax return, and is net of amounts reimbursed to
the Company by Citizens for the benefit of the Company's changes in temporary
differences. A 100% valuation allowance has been recognized to offset the
benefit of the operating loss carryforwards since Citizens' policy is to
reimburse the Company for such losses only when the Company becomes profitable.
Since the Company has a history of recurring losses, a full valuation allowance
has been provided each year against the benefit of the operating loss
carryforwards.
The effective income tax rates were zero for the years ended December 31, 1994,
1995 and 1996 as a result of the Company incurring net operating losses for
which the tax benefit thereon was fully reserved. The tax expense consisted of
deferred tax expenses of $519,000, $1,160,000 and $3,198,000 net of current tax
benefits of $519,000, $1,160,000 and $3,198,000 for the years ended December 31,
1994, 1995 and 1996, respectively.
Upon consummation of the Offering, the Company will no longer be included in the
consolidated federal income tax return of Citizens, and in such case would file
its own federal income tax return. However, for state income tax return
purposes, the Company intends to enter into a tax sharing agreement with
Citizens, whereby, the Company's state income tax liability would be computed on
a stand alone basis. Additionally, upon completion of the Offering, the
Company, on a stand alone basis, may not have any federal net operating loss
carryovers, and in such case Citizens would not reimburse the Company for losses
incurred prior to the Offering, except as described above.
(5) Capital Stock:
--------------
At December 31, 1993, the Company had authorized 1,750,000 shares of
preferred stock, $.01 par value, and 2,000,000 shares of common stock, $.01
par value. The preferred shares were convertible into common stock on a
one-for-one basis and contained voting rights whereby each share entitled
the holder to one vote on all matters. At December 31, 1993, the Company
had 1,750,000 shares of preferred stock outstanding, all of which were
owned by Citizens, and 125,009 shares of common stock outstanding, of which
66,259 were owned by Citizens. In 1994, the Company increased its
authorized preferred to 10,750,000 shares and issued 5,725,527 additional
shares of preferred stock to Citizens for $57,255,000, raising the number
of outstanding preferred shares to 7,475,527. The shares were paid for by
recording $57,255,000 of the amount due to Citizens as additional paid-in-
capital.
F-10
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
During 1995, Citizens acquired 58,750 shares of common stock from the minority
shareholder of the Company for $3,000,000 giving Citizens 100% ownership of the
Company. Such amount has been recorded in the Company's accounts as goodwill
and additional paid-in-capital.
During 1996, all of the preferred stock was converted into 7,475,527 shares of
common stock. Also during 1996, there was a reverse stock split of common stock
in the amount of 100 for 7,600,536 which reduced the shares of common stock
outstanding from 7,600,536 to 100 shares, and the number of authorized shares
was reduced to 500 shares of preferred and 500 shares of common.
Prior to the completion of the Offering, the Company intends to amend its
Certificate of Incorporation to change its authorized capital stock to ____
shares, including ____ shares of Class A Common Stock, $.01 par value per share,
___ shares of Class B Common Stock, $.01 par value per share, and ____ shares of
preferred stock, $.01 par value per share. At that time, the outstanding common
stock will convert to Class B common stock and the Company will declare a stock
split of ____ for one. Upon completion of the Offering of ______ shares of
Class A Common Stock to the public, there will be no preferred stock outstanding
and Citizens will own all of the outstanding shares of Class B Common Stock.
Each share of Class A Common Stock will entitle the holder to one vote and each
share of Class B Common Stock will entitle the holder to 10 votes on each matter
to be voted upon by the holders of the Common Stock. As a result, after the
completion of the Offering, Citizens will have __% of the voting control of the
Company (____% if the underwriters' overallotment options are exercised in
full). With the exception of voting rights, the rights and privileges of Class
A and Class B Common Stock are identical. Class B Common Stock is convertible
into Class A Common Stock on a one-for-one basis.
(6) Related Party Transactions:
--------------------------
Transactions with Citizens
The Company has been a subsidiary of Citizens since 1990. In connection
with this ownership interest, Citizens has advanced funds to the Company to
finance operations, construction and capital expenditures. Interest is not
charged on Citizens advances for operations and capital expenditures,
except for intercompany advances used to fund construction-in-progress.
Subsequent to the construction period, the advances become non-interest
bearing. Interest on Citizens advances are recorded as an increase to the
amount due to Citizens. The amount of interest charged on construction-in-
progress has in turn been capitalized as part of property plant and
equipment.
The Company is also charged by Citizens for administrative services which
includes an allocation of Citizens' corporate overhead. The overhead
allocation rate is based on four factors: the Company's plant assets,
operating expenses, number of customers and payroll expenses. Effective
with the completion of the Offering, the Company will enter into an
Administrative Services Agreement ("Agreement") under which Citizens will
provide administrative services to the Company, including but not limited
to, certain financial management services, information services, legal and
contract services and human resources services. Under the terms of such
Agreement, the Company will pay Citizens for reimbursable costs as defined
in the Agreement plus an administrative charge.
F-11
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
A summary of the activity in the amount due to Citizens is as follows:
<TABLE>
<CAPTION>
-------------------(in thousands)----------------
Years Ended Six months ended
December 31, June 30,
------------------------------ -----------------
1994 1995 1996 1997
------------------------------ -----------------
<S> <C> <C> <C> <C>
Balance beginning of period $ 21,481 $35,109 $ 64,941 $155,395
Cash advances from Citizens, net 67,636 26,862 88,530 38,872
Acquisition of preferred stock (57,255) - - -
Deferred income taxes (519) (1,160) (3,198) (3,119)
Interest 2,466 2,619 2,868 1,927
Administrative services fees 1,300 1,511 2,254 1,594
-------- ------- -------- --------
Balance end of period $ 35,109 $64,941 $155,395 $194,669
========= ======= ======== ========
</TABLE>
Prior to the completion of the Offering, $20.7 million of the amount due to
Citizens as of June 30, 1997 will be contributed to additional paid-in-capital
and the remaining $174 million will become long-term debt payable to Citizens.
Funds provided to the Company by Citizens subsequent to June 30, 1997 will be
treated as long-term debt payable to Citizens. In 1994, 1995 and 1996,
Citizens had been charging interest on the amount due to Citizens only to the
extent that the Company was allowed to capitalize interest under Generally
Accepted Accounting Principles. Effective with the completion of the Offering,
interest on the long-term debt payable to Citizens will be at an annual rate of
___%, will be non-amortizing and will mature in ______.
Telecommunications Services
Citizens entered into a lease for fiber optic cable from the Company for 10
years and calls for rentals of $30,000 per month. Also during 1996, Citizens
and the Company combined their purchasing power of long-haul services in
arrangements Citizens entered into with a long distance carrier in order to
receive a lower unit cost. The Company reimbursed Citizens $7.6 million in 1996
representing the cost of the Company's usage of these long-haul services plus
5%. This arrangement with Citizens was replaced effective May 1, 1997 with a
24-month term agreement which removed the 5% additional fee.
Stock Plans
At December 31, 1996, Company employees participated in two Citizens stock based
compensation plans which are described below. The Company applies APB Opinion
No. 25 and related interpretations in accounting for the Citizens employee stock
plans. Accordingly, no compensation cost has been recognized in the financial
statements for options issued pursuant to the MEIP or ESPP. The following
tables reflect MEIP and ESPP information for Company employees and exclude full
time employees and officers of Citizens. Had the Company determined
compensation cost based on the fair value at the grant date for the MEIP and
ESPP under SFAS 123, the Company's pro forma net loss would have been as
follows:
($ in thousands) 1995 1996
- -------------------------------------------------------------
Net loss As reported $ 20,322 $ 29,383
Pro forma $ 20,343 $ 29,474
Under the Citizens' MEIP, the exercise price of stock options and SARs shall be
equal to or greater than the fair market value of the underlying Citizens common
stock on the date of grant. Stock options are generally
F-12
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
not exercisable on the date of grant but vest over a period of time. A summary
of Citizens shares subject to option for Company employees is as follows:
Shares Weighted
Subject to Average Option
Option Price Per Share
---------- ---------------
Balance at January 1, 1994 36,184 $ 13.52
Options granted 73,138 11.56
Options exercised - -
Options canceled or lapsed - -
--------- ---------
Balance at December 31, 1994 109,322 12.60
Options granted 27,831 10.57
Options exercised - -
Options canceled or lapsed 19,722 12.29
--------- ---------
Balance at December 31, 1995 117,431 12.19
Options granted 102,877 11.08
Options exercised - -
Options canceled or lapsed 5,909 11.52
--------- ---------
Balance at December 31, 1996 214,399 $ 11.84
========= =========
The following table summarizes information about Citizens shares
subject to option for Company employees under the MEIP at December 31, 1996.
<TABLE>
<CAPTION>
Options Exercisable Options Outstanding
- ---------------------------------------------------------- --------------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Number Range of Exercise Life in Number Exercise
Outstanding Exercise Prices Price Years Exercisable Price
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
214,399 $9.85 - $14.96 $11.84 6.5 45,817 $12.06
</TABLE>
The weighted-average fair value of options granted during 1995 and 1996 were
$2.12 and $1.51, respectively. For purposes of the pro forma calculation under
SFAS 123, the fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1995 and 1996:
1995 1996
- -----------------------------------------------------------------------
Dividend yield 5.6% 6.2%
Expected volatility 20% 20%
Risk-free interest rate 6.25% 5.63%
Expected life 7 years 7 years
The ESPP allows eligible employees of Citizens and its subsidiaries to
subscribe to purchase shares of Citizens Common Stock at 85% of the lower of the
average market price on the first day of the purchase period or on the last day
of the purchase period. An employee may elect to have up to 20% of annual base
pay withheld in equal installments throughout the designated payroll-deduction
period for the purchase of shares. The value of an employee's subscription may
not exceed $25,000 in any one calendar year. As of December 31, 1996, 175
Company employees were participating in the ESPP.
F-13
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
The weighted-average fair value of purchase rights granted in 1995 and 1996 was
$3.18 and $3.30, respectively. For purposes of the pro forma calculation under
SFAS 123, compensation cost is recognized for the fair value of the employees'
purchase rights, which was estimated using the Black-Scholes Model with the
following assumptions for subscription periods beginning in 1995 and 1996:
1995 1996
- --------------------------------------------------------------------------------
Dividend yield 6.2% 6.4%
Expected volatility 20% 20%
Risk-free interest rate 5.56% 5.30%
Expected life 6 months 6 months
(7) Commitments and Contingencies:
-----------------------------
In 1995, the Company entered into a $110 million construction agency
agreement and an operating lease agreement in connection with the
construction of certain telecommunications networks and fiber cable links.
The Company serves as agent for the construction of these projects and upon
completion of each project has agreed to lease the facilities for a three
year term, with one year renewals available through April 30, 2002. At
December 31, 1995, 1996 and at June 30, 1997, the Company was leasing
assets with an original cost of $36.8 million, $57.3 million and $87.4
million, respectively, under this agreement. The Company has the option to
purchase the facilities at the end of the lease terms for the amount of the
lessor's investment in the facilities, which is expected to be $110
million. In the event the Company chooses not to exercise this option, the
Company is obligated to arrange for the sale of the facilities to an
unrelated party and is required to pay the lessor any difference between
the net sales proceeds and the lessor's investment in the facilities.
However, any amount required to be paid to the lessor is subject generally
to a maximum of 80% of the lessor's investment, giving effect to lease
payments previously made. The performance of these lease obligations is
guaranteed by Citizens. Effective with the completion of the Offering, the
Company has agreed to pay to Citizens an annual guarantee fee equal to
3.25% per annum of the lessor's investment in the leased assets.
The Company conducts certain of its operations in leased premises and also
leases certain equipment. Obligations, renewals and maintenance costs vary
by lease.
The Company has entered into an operating lease contract and a capital
lease contract with a third party in order to develop long-haul routes
between Portland, Oregon and Seattle, Washington and between Portland,
Oregon and Spokane, Washington. The operating lease agreement provides for
rental payments based on a percentage of the Company's monthly leased
traffic over such route and is expected to become operational before the
end of 1997. The capital lease agreement provides for a monthly minimum
lease payment of $105,000 plus a percentage of leased traffic over such
route in excess of certain minimums and became operational in February
1997. Both agreements have terms of 15 years.
The Company has entered into an operating lease contract to develop a local
network in Phoenix, Arizona. The operating lease provides for rental
payments based on a percentage of the network's operating income for a
period of 15 years.
Future minimum rental commitments for all long-term noncancelable operating
leases as of December 31, 1996 are:
F-14
<PAGE>
ELECTRIC LIGHTWAVE,INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of June 30, 1997 and for the six months
ended June 30, 1997 and 1996 is unaudited)
Year Amount
---------------------------
1997 $ 7,727,000
1998 7,364,000
1999 7,401,000
2000 7,295,000
2001 6,176,000
2002 to 2007 4,306,000
---------------------------
Total $40,269,000
===========================
Total rental expense included in the Company's results of operations for the
years ended December 31, 1994, 1995 and 1996 was $663,000, $2,475,000 and
$5,193,000, respectively.
The Company is also a party to contracts with several unrelated long distance
carriers. The contracts provide for fees based on leased traffic subject to
minimum monthly fees which aggregate $2.6 million for 1997, $12.1 million for
1998 and $16.8 million for 1999.
The Company's budgeted capital expenditures for 1997 are $82 million and certain
commitments have been entered into in connection therewith.
Contingencies
In Optec v Electric Lightwave, filed in the Circuit Court of Oregon for
Multnomah County on September 16, 1996, Optec alleged that the Company violated
an agreement prohibiting the Company from approaching the employees of Optec
Corporation with offers of employment. The Company had entered into this
agreement with Optec, a potential acquisition target, in order for the Company
to evaluate a potential acquisition. The Company believes that the three former
employees of Optec who came to work for the Company initiated their change of
employment. Damages claimed are $10 million. On August 15, 1997, the court
issued an oral ruling granting the Company's Motion for Summary Judgment and
dismissed the case. Unless Optec files an appeal by September 26, 1997, the
judgment in favor of the Company will be final.
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on the
Company's results of operations, financial position or liquidity.
F-15
<PAGE>
No dealer, salesperson or other individual has been authorized to give any
information or to make any representations not contained in this Prospectus in
connection with the offering covered by this ProspectusPC#6PC#6
NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN
OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, THE SHARES OF CLASS A
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION
THAT THERE HAS NOT BEEN ANY CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR
THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
____________________
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
- -----------------------------------------------------------------------------------------------
<S> <C>
Prospectus Summary............................................................................. 3
Risk Factors................................................................................... 10
Forward-looking Statements..................................................................... 20
Use Of Proceeds................................................................................ 20
Dilution....................................................................................... 21
Dividend Policy................................................................................ 22
Capitalization................................................................................. 23
Selected Financial and Operating Data.......................................................... 24
Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 25
Business....................................................................................... 32
Existing Market Clusters and Long-Haul Networks Combined Network Information at June 30, 1997.. 37
Government Regulation.......................................................................... 50
The Local Telecommunications Services Industry................................................. 55
Management..................................................................................... 57
Relationship With Citizens..................................................................... 65
Security Ownership by Principal Stockholder.................................................... 69
Description of Capital Stock................................................................... 70
Shares Eligible for Future Sale................................................................ 72
Certain Tax Considerations..................................................................... 73
Underwriting................................................................................... 76
Legal Matters.................................................................................. 79
Experts........................................................................................ 79
Additional Information......................................................................... 79
Glossary....................................................................................... 81
Index to Financial Statements.................................................................. 91
</TABLE>
UNTIL _______, 1997, ALL DEALERS EFFECTING TRANSACTIONS IN THE CLASS A COMMON
STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE
OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND
WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
[ ] SHARES
[LOGO]
======
ELECTRIC LIGHTWAVE, INC.
CLASS A COMMON STOCK
___________
PROSPECTUS
_____________
Lehman Brothers
Lehman Brothers
[__________], 1997
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Set forth below are the expenses (other than underwriting discounts and
commissions) expected to be incurred in connection with the issuance and
distribution of the securities to be registered hereby. With the exceptions of
the Securities and Exchange Commission registration fee and the NASDAQ
registration fee, the amounts set forth below are estimates.
Securities and Exchange Commission registration fee................. $ 60,607
NASDAQ registration fee............................................. 5,000
Transfer agent and registrar fees................................... 10,000
Costs of printing and engraving..................................... 70,000
Legal fees and expenses............................................. 60,000
Accounting fees and expenses........................................ 30,000
Blue Sky fees and expenses.......................................... 10,000
Miscellaneous expenses.............................................. 10,000
---------
TOTAL........................... $ 255,607
=========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
As authorized by Section 145 of the General Corporation Law of Delaware,
each director and officer of Electric Lightwave, Inc. may be indemnified by
Electric Lightwave, Inc. against expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by him in connection with the defense or settlement of any threatened, pending
or completed action, suit or proceeding, whether civil, criminal, administrative
or investigative, in which he is involved by reason of the fact that he is or
was a director or officer of Electric Lightwave, Inc. if he acted in good faith
and in a manner that he reasonably believed to be in or not opposed to the best
interests of Electric Lightwave, Inc., and, with respect to any criminal action
or proceeding, if he had no reasonable cause to believe that his conduct was
unlawful. If, however, any threatened, pending or completed action, suit or
proceeding is by or in the right of Electric Lightwave, Inc., the director or
officer shall not be indemnified in respect of any claim, issue or matter as to
which he is adjudged to be liable to Electric Lightwave, Inc. unless the Court
of Chancery of Delaware, which is vested with exclusive jurisdiction to hear and
determine all actions for advancement of expenses or indemnification brought
under Section 145 of the General Corporation Law of Delaware, determines
otherwise.
Article Seventh of Electric Lightwave, Inc.'s Certificate of
Incorporation provides that no director of Electric Lightwave, Inc. shall be
personally liable to Electric Lightwave, Inc. or any of its stockholders for
monetary damages for any breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to Electric
Lightwave, Inc. or its shareholders, (ii) for acts or omissions not in good
faith or which involve intentional
II-1
<PAGE>
misconduct or a knowing violation of the law, (iii) under Section 174 of the
General Corporation Law of Delaware, or (iv) for any transaction from which the
director derived an improper personal benefit. In addition, Article Seventh
provides that if the General Corporation Law of Delaware is amended to authorize
corporate action further eliminating or limiting the personal liability of
directors, then the liability of a director of Electric Lightwave, Inc. shall be
eliminated or limited to the fullest extent permitted by the General Corporation
Law of Delaware, as so amended. No modification or repeal of the provisions of
Article Seventh shall adversely affect any right or protection of any director
of Electric Lightwave, Inc. existing at the date of such modification or repeal
or create any liability or adversely affect any such right or protection for any
acts or omissions of such director prior to such modification or repeal.
Electric Lightwave, Inc.'s By-Laws provide that Electric Lightwave, Inc.
shall indemnify its officers and directors to the fullest extent permitted by
the General Corporation Law of Delaware.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In 1994, the Company issued 5,725,527 shares of preferred stock of the
Company to Citizens for $57,255,270 in a private placement. Exemption from
registration is claimed under Section 4.2 of the Securities Act of 1933. No
underwriters were involved in such issuance. In 1996, 76 shares of common stock
were issued upon conversion of such preferred stock to common stock. Exemption
from registration under the Securities Act is claimed under Section 3(a)(9) of
the Securities Act of 1933.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(A) EXHIBITS
An Exhibit Index, containing a list of all exhibits to this registration
statement, commences on page II-5.
(B) FINANCIAL STATEMENT SCHEDULES
All schedules are omitted because the information is not required, is
not material or is otherwise included in the financial statements or related
notes thereto.
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes to provide to the
underwriter at the closing specified in the underwriting agreements certificates
in such denominations and registered in such names as required by the
underwriter to permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the
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<PAGE>
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(i) for purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or
497(h) hereunder the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(ii) for the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has caused this Amendment No. 2 to the registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Vancouver, State of Washington, on October 8, 1997.
ELECTRIC LIGHTWAVE, INC.
/s/Robert J. DeSantis
-------------------------------------
By: Robert J. DeSantis
Title: Vice President
Pursuant to the requirements of the Securities Act of 1933, this
Amendment No. 2 to the registration statement has been signed by the following
persons in the capacities and on the dates indicated.
SIGNATURE TITLE(S)
--------- --------
President, Chief Executive October 8, 1997
*David B. Sharkey Officer and Director
- ---------------------------
David B. Sharkey
Chairman of the Board and October 8, 1997
*Daryl A. Ferguson Director
- ---------------------------
Daryl A. Ferguson
Principal Financial Officer October 8, 1997
/s/ Robert J. DeSantis and Director
- ---------------------------
Robert J. DeSantis
Principal Accounting Officer October 8, 1997
*Livingston E. Ross
- ---------------------------
Livingston E. Ross
*By Robert J. DeSantis
------------------------
Attorney-in-fact
II-4
<PAGE>
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
1.1* Underwriting agreement
3.1* Amended and Restated Certificate of Incorporation
3.2* By-laws
4.1* (Contained in Exhibit 3.1)
5.1* Opinion regarding legality of the securities being registered
10.1** License Agreement between the Company and the United States of
America Department of Energy acting by and through the
Bonneville Power Administration dated March 29, 1996
10.2** License Agreement between the Company and the United States of
America Department of Energy acting by and through the
Bonneville Power Administration dated November 11, 1996
10.3** License Agreement between the Company and the United
States of America Department of Energy acting by and through the
Bonneville Power Administration dated July 18, 1997
10.4** Optical Fiber License Agreement between the Company and Salt
River Project Agricultural Improvement and Power District dated
as of September 11, 1996
10.5**** Participation Agreement between the Company, Shawmut Bank
Connecticut, National Association, the Certificate Purchasers
named therein, the Lenders named therein, BA Leasing & Capital
Corporation and Citizens Utilities Company dated as of April 28,
1995, and the related operating documents
10.6**** Agreement For Lease of Dark Fiber between the Company and
Citizens Utilities Company dated as of March 24, 1995
10.7* Form of Administrative Services Agreement between the Company
and Citizens Utilities Company dated as of _______, 1997
10.8**** Form of Tax Sharing Agreement between the Company and Citizens
Utilities Company dated as of _______, 1997
10.9**** Form of Indemnification Agreement between the Company and
Citizens Utilities Company dated as of _______, 1997
10.10* Form of Registration Rights Agreement between the Company and
Citizens Utilities Company dated as of _______, 1997
10.11* Form of Customers and Service Agreement between the Company and
Citizens Utilities Company dated as of _______, 1997
II-5
<PAGE>
EXHIBIT NO. DESCRIPTION
10.12* Promissory Note of the Company dated _________, 1997
10.13* Equity Incentive Plan of the Company
10.14* Form of Option Agreement for the Company's Equity Incentive Plan
10.15*** Citizens Utilities Company 1996 Equity Incentive Plan, as
amended
10.16* Form of Guaranty Agreement dated as of ___________, 1997 between
the Company and Citizens Utilities Company
11.1* Statement regarding computation of per share earnings
23.1**** Consent of KPMG Peat Marwick LLP
23.2* Consent of Winthrop, Stimson, Putnam & Roberts (to be contained
in Exhibit No 5.1)
24.1**** Powers of attorney
27.1**** Financial Data Schedule
__________
* To be filed by Amendment.
** Previously filed. Portions of such exhibit are omitted pursuant to a
request for confidential treatment.
*** The 1996 Equity Incentive Plan is incorporated by reference to Citizens'
Proxy Statement dated March 29, 1996, File No. 001-11001. Amendment No. 1
to the 1996 Equity Incentive Plan is incorporated by reference to
Citizens' Current Report on Form 8-K dated August 7, 1997, File No. 001-
11001.
**** Previously filed.
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