<PAGE>
As filed with the Securities and Exchange Commission on November 3, 1997.
Registration No. 333-35227
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 5 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 (I.R.S. Employer
of incorporation or Industrial Identification
organization) Classification Number)
Code 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 this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, 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>
Proposed Proposed
maximum maximum
Title of each class Amount to offering aggregate
of securities to be be price offering Amount of
registered registered per unit price registration fee
====================================================================================
<S> <C> <C> <C> <C>
Common Stock, Class A $207,000,000* $62,728**
====================================================================================
</TABLE>
- -----------------------
* Estimated solely for the purpose of calculating the registration fee pursuant
to Rule 457.
** $62,672 of the registration fee has already been paid. $56 is being paid
herewith.
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>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+ +
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED NOVEMBER 3, 1997
P R O S P E C T U S
10,000,000 SHARES
[LOGO]
ELECTRIC LIGHTWAVE, INC.
CLASS A COMMON STOCK
----------
All of the shares of Class A Common Stock, par value $.01 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 10,000,000 shares of Class A Common Stock
being offered hereby, 8,000,000 shares are being offered initially in the
United States and Canada (the "U.S. Offering") by the U.S. Underwriters (as
defined herein) and 2,000,000 shares are being offered initially outside of the
United States and Canada (the "International Offering") 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 $.01 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 exchangeable 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 97.5% of the combined voting power of the outstanding Common
Stock (97.16% if the Underwriters' over-allotment 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 Factors--Control 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 $16.00 and $19.00 per share. The initial public offering price and
the underwriting discount and commission per share are identical for each of
the U.S. and International Offerings. See "Underwriting" for a discussion of
the factors considered in determining the initial public offering price. The
Company has applied 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.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share................................. $ $ $
- ---------------------------------------------------------------------------------------------------
Total (3)................................. $ $ $
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(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
1,200,000 and 300,000 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 therefore in immediately available funds.
----------
U.S. Underwriters offering shares in the United States and Canada
LEHMAN BROTHERS
MERRILL LYNCH & CO.
MORGAN STANLEY DEAN WITTER
DEUTSCHE MORGAN GRENFELL
International Managers offering shares outside the United States and Canada
LEHMAN BROTHERS
MERRILL LYNCH INTERNATIONAL
MORGAN STANLEY DEAN WITTER
DEUTSCHE MORGAN GRENFELL
, 1997.
<PAGE>
[Information contained herein is subject to completion or amendment. A
registration statement relating to these securities has been filed with the
Securities and Exchange Commission. These securities may not be sold nor may
offers to buy be accepted prior to the time the registration statement becomes
effective. This prospectus shall not constitute an offer to sell or the
solicitation of an offer to buy nor shall there be any sale of these securities
in any State in which such offer, solicitation or sale would be unlawful prior
to registration or qualification under the securities laws of any such State.]
[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
38,045 local access line equivalents, 2,087 route miles and 123,257 fiber miles
installed and 540 on-net buildings connected as of September 30, 1997. The
Company has interconnected its market clusters with facilities-based owned and
leased long-haul fiber optic networks.
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 14 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; 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.
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 1997.
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.
3
<PAGE>
Since its inception, ELI believes that it has been at the forefront of
industry efforts to introduce competition to the local telecommunications
markets. As such, ELI believes that it 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 pursued regulatory and legislative reforms and consummated certain
interconnection agreements with incumbent local exchange carriers ("ILECs")
that in its view allowed the Company to offer economical and operationally
efficient local exchange services. The Company believes that it 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 believes
that it 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.
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 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 September 30, 1997, Citizens' consolidated assets
totaled $4.5 billion and shareholders' equity totaled $1.7 billion. Citizens'
consolidated revenues for the twelve months ended September 30, 1997 totaled
$1.4 billion. The Company has historically been funded by capital contributions
and advances from Citizens and through a lease agreement guaranteed by
Citizens. Citizens does 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, other than the
guarantees described herein. 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 PacBell, which are the ILECs in its target 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
4
<PAGE>
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.
. 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
("on-net"). 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; (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.
. Penetrate Markets by Leveraging Data Expertise. 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 has 18
frame relay switches as of September 30, 1997 servicing customer
locations. 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.
. 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.
5
<PAGE>
. 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. The Company offers its
services in custom combinations, and utilizes a consultative sales
approach that provides customers a single point of contract at the
Company and an opportunity to work with the Company to design
innovative, turn-key solutions and new product applications which allow
them to take advantage of the broad array of services offered.
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. 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.
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.
6
<PAGE>
THE OFFERING
Class A Common Stock Offered..... 10,000,000 shares (8,000,000 shares in the
U.S. Offering and 2,000,000 shares in the
International Offering) (assuming over-
allotment options not exercised)
Common Stock to be outstanding
after the Offering:
Class A Common Stock............ 10,535,000 shares (1)
Class B Common Stock............ 41,165,000 shares
Total......................... 51,700,000 shares
Use of Proceeds................... The net proceeds of the Offering are
estimated to be approximately $164,244,000,
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 97.5% of the
combined voting power of the Company's
outstanding Common Stock (97.16% 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 Factors--
Control by Citizens" and "Description of
Capital Stock-- Common Stock."
Exchange.......................... Each share of Class B Common Stock is
exchangeable at the option of the holder
into one share of Class A Common Stock. See
"Description of Capital Stock--Common
Stock--Exchange."
Listing........................... The Nasdaq National Market under the symbol
"ELIX"
- --------
(1) Excludes 2,316,000 shares of Class A Common Stock reserved for issuance
under the Equity Incentive Plan issuable upon the exercise of options
granted at an exercise price per share equal to the initial public offering
price of the Class A Common Stock. Includes 535,000 restricted shares of
Class A Common Stock to be issued at the offering date to officers and
employees under the Equity Incentive Plan. A total of 4,170,600 shares of
Class A Common Stock are reserved for issuance under the Equity Incentive
Plan. See "Management--Equity Incentive Plan."
7
<PAGE>
SUMMARY FINANCIAL AND 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 nine months ended September 30, 1996
and 1997 and as of September 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 and as of 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 NINE MONTHS
DECEMBER ENDED SEPT.
31, 30,
---------------------------- ------------------------------
1994 1995 1996 1996 1997
-------- -------- -------- -------------- ---------------
($ in thousands,
except per share
amounts)
<S> <C> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA
Revenues $ 8,152 $ 15,660 $ 31,309 $ 24,965 $ 41,843
Operating ex-
penses:
Network access ex-
penses 6,155 8,728 24,081 16,533 24,217
Sales and market-
ing expenses 4,534 5,704 8,462 6,303 8,716
Depreciation and
amortization 2,476 7,064 7,192 4,997 7,601
Other operating
expenses 4,528 14,114 20,957 16,715 26,831
-------- -------- -------- -------- ---------
Total operating
expenses 17,693 35,610 60,692 44,548 67,365
-------- -------- -------- -------- ---------
Operating loss (9,541) (19,950) (29,383) (19,583) (25,522)
Interest expense 873 372 -- -- 513
-------- -------- -------- -------- ---------
Net loss $(10,414) $(20,322) $(29,383) $(19,583) $ (26,035)
======== ======== ======== ======== =========
Net loss per
share(2) $ (.70) $ (.47) $ (.62)
======== ======== =========
Pro forma net
loss(1) $(32,213) $(21,307) $ (32,254)
======== ======== =========
Pro forma net loss
per share(2) $ (.77) $ (.51) $ (.77)
======== ======== =========
<CAPTION>
AS AT DECEMBER 31,
----------------------------
PRO FORMA AS AT
AS AT SEPT. 30,
1994 1995 1996 SEPT. 30, 1997 1997(3)
-------- -------- -------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital
(deficiency) $ (9,934) $(17,897) $ (9,940) $ (7,734) $ 156,510
Total assets 110,691 128,901 195,656 248,570 412,814
Long-term debt and
capital lease ob-
ligations 6,565 -- -- 10,374 10,374
Due to Citizens 35,109 64,941 155,395 219,171 --
Credit Commitment -- -- -- -- 100,000
Shareholder's eq-
uity (deficiency) 55,991 38,669 9,286 (16,749) 266,666
<CAPTION>
YEARS ENDED DECEMBER 31, NINE MONTHS
---------------------------- ENDED
1994 1995 1996 SEPT. 30, 1997
-------- -------- -------- --------------
<S> <C> <C> <C> <C> <C>
OPERATING DATA
EBITDA(4) $ (7,065) $(12,886) $(22,191) $(17,921)
Cash flows used
for operating ac-
tivities (4,097) (1,570) (28,893) (18,040)
Cash flows used
for investing ac-
tivities (60,774) (16,129) (59,169) (48,717)
Cash flows pro-
vided by financ-
ing activities 64,907 17,751 88,530 67,293
<CAPTION>
AS AT DECEMBER 31,
---------------------------- AS AT
1994 1995 1996 SEPT. 30, 1997
-------- -------- -------- --------------
<S> <C> <C> <C> <C> <C>
Property, plant &
equipment-owned $108,549 $127,297 $189,334 $249,499
--under
lease(5) -- 36,858 57,279 87,426
-------- -------- -------- --------
--Total $108,549 $164,155 $246,613 $336,925
-------- -------- -------- --------
Market clusters 5 5 5 5
Route miles(6) 601 780 1,428 2,087
Fiber miles(6) 37,504 52,013 97,665 123,257
Buildings con-
nected 191 282 438 540
Switches in-
stalled:
Voice 2 2 5 5
Frame relay 2 5 15 18
-------- -------- -------- --------
Total switches
installed 4 7 20 23
-------- -------- -------- --------
127 225 402 482
</TABLE>
-------
See Notes to Summary Financial and Operating Data on next page.
8
<PAGE>
NOTES TO SUMMARY FINANCIAL AND OPERATING DATA
(1) The pro forma net loss represents the historical net loss as adjusted for
the revised administrative services fee and guarantee fees as if such fees
were in effect since January 1, 1996, and interest on the drawdown of the
Credit Commitment utilized to repay the remaining balance due to Citizens
subsequent to the capitalization of $119.2 million of the due to Citizens
amount, as if the Credit Commitment was in effect on January 1, 1996 (see
Notes 6, 7 and 8 of Notes to Financial Statements).
(2) The net loss per share and pro forma net loss per share have been computed
using weighted average shares outstanding determined 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 $119.2
million of due to Citizens to additional paid-in capital as discussed in
Note 6 of Notes to Financial Statements, to the drawdown of the Credit
Commitment to repay the remaining amount due to Citizens, and to the
issuance of the shares of Class A Common Stock offered hereby, as if such
transactions occurred on September 30, 1997.
(4) EBITDA consists of Earnings Before Interest, Income Taxes, Depreciation and
Amortization. EBITDA is a measure commonly used in the communications
industry to analyze companies on the basis of operating performance. EBITDA
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 expands significant amounts on sales, marketing,
customer service, engineering and corporate personnel 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. If the Company is
unable to establish an adequate revenue base in each of its clusters or does not
achieve or sustain profitability or generate sufficient positive cash flow to
fund its operating and capital requirements and/or service its debt obligations,
it may be forced to change its strategic plan and consider alternatives. The
alternatives could include the sale of some or all of ELI's facilities, a
strategic alliance with another telecommunications or utilities company, a
restructuring with or without a new financial partner or with Citizens, or the
failure to continue as a growing concern. The consequences to the Company and
its investors could be materially adverse.
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, the Credit Commitment (as defined below), together
with internally generated cash flow and lease arrangements, proceeds from other
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, other than to
guarantee ELI's obligations under the Credit Commitment and the Lease. If
Citizens intends to reduce its economic interest in ELI to less than 50%,
Citizens will be entitled to request ELI to refinance its obligations under the
Lease and the Credit Commitment and ELI shall be obligated to use its best
efforts to do so. This refinancing would occur when Citizens reduces its
economic interest in ELI to less than 50%. See "Relationship with Citizens-
Citizens' Guarantees of ELI's Obligations." For a description of the Credit
Commitment and Citizens' undertaking to obtain regulatory authorization for its
guarantee of ELI's debt within 90 days after the closing of the Credit
Commitment, see "Management's Discussion and Analysis-Liquidity and Capital
Resources."
10
<PAGE>
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 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
11
<PAGE>
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 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.
12
<PAGE>
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 U S WEST, alleging that it was
blocking competition in local telephone service. See "Business-Legal
Proceedings."
Local Services and Switched Service Strategies
The Company is a recent entrant in the competitive local telecommunications
services industry. The local telecommunications services market has recently
opened up to competition due to the passage of the 1996 Act, state and federal
regulatory rulings designed to implement the 1996 Act, and negotiations with
ILECs under the terms of the 1996 Act and state rulings. The Company believes
that offering a full-service portfolio of local, long distance and data products
is the best method for gaining market share among business customers.
The Company is making significant operating and capital investments and will
have to address numerous operating complexities associated primarily with
providing local services. The Company will be required to enhance current
provisioning and technical support systems and will need to develop new
marketing initiatives and hire and train a continuing growing sales force
responsible for selling its services. There can be no assurance that the
Company can design and install, and coordinate with ILECS regarding, necessary
provisioning, billing and customer management systems in a timely manner to
permit the Company to provision local exchange, toll, long distance or data
communications services as planned.
The Company expects to face significant competition from ILECs, whose core
business is providing local dial tone service. The ILECs, who currently are the
dominant providers of services in their markets, are expected to mount a
significant competitive response to new entrants in their market, such as the
Company. The Company expects to face significant competitive product and
pricing pressures from the ILECs in these markets, as well as from other CLECs.
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 Regulation-State 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
13
<PAGE>
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 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
14
<PAGE>
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 20% of ELI's total revenues. No customer
accounted for 10% or more of total revenues in 1996. In 1997, one customer, IXC
Communications, is expected to account for approximately 10% of the Company's
revenues. A portion of the Company's services provided to IXC Communications
will no longer be required when IXC Communications completes construction of its
own facilities in the first quarter of 1998. 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.
Services Provided by Third Party Vendors
Sophisticated information and processing systems are vital to the Company's
growth and its ability to monitor costs, bill customers, provision customer
orders and achieve operating efficiencies. Billing and information systems for
the Company's historical lines of business have been produced by third party
vendors. These systems have met the Company's needs, due in part to the
Company's low volume of bills and orders. As the Company provides expanded
local, long distance and data transmission services, the need for sophisticated
billing information systems will increase significantly. The Company's current
local billing platform plans rely on products and services provided by third
party vendors. Additionally, the Company is
15
<PAGE>
implementing new automated systems and expanding customer service centers to
provision orders. Information systems are vital to the success of these centers,
and the information systems for these centers have largely been developed by
third party vendors. The failure of (i) the Company's vendors to deliver
proposed products and services in a timely and effective manner, (ii) the
Company to adequately identify all of its information and processing needs or
(iii) the Company to upgrade systems as necessary, could have a material adverse
impact on the ability of the Company to reach its objectives, and on its
financial condition and results of operations.
While the Company believes that its software applications are "year 2000
compliant," there can be no assurance until the year 2000 occurs that all
systems will then function adequately. Further, if the software applications of
local exchange carriers, long distance carriers or others on whose services the
Company depends are not year 2000 compliant, it could have a material adverse
effect on the Company's financial condition and results of operations.
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 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 final 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 97.5% of the combined voting power of all
classes of voting stock of the Company (97.16% 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
16
<PAGE>
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 "Securities Ownership," "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 180 days 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 six members, four of whom
are executive officers and/or directors of Citizens and one of whom is
independent of both Citizens and ELI. Following the Offering, the Board will be
increased to consist of seven members to add an additional independent director.
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 exchange of the Class B Common Stock) which Citizens
or its subsidiaries hold. See "Relationship with Citizens-Registration Rights
Agreement."
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,
and beneficial ownership of at least 80% of the total voting power and 80% of
each class of nonvoting capital stock is required in order for Citizens to
effect a transaction intended to be tax-free under section 355 of the Internal
Revenue Code of 1986, as amended, of the Company or certain other tax-free
transactions. Each member of a consolidated group for federal income tax
purposes is jointly and severally liable for the federal income tax liability of
each other member of the consolidated group. Each member of the Citizens
controlled group, which includes Citizens, the Company and Citizens's other
subsidiaries, is also jointly and severally liable for pension and benefit
funding and termination liabilities of other group members, as well as certain
benefit plan taxes. Accordingly, if the Company is included in Citizens'
consolidated group it could be liable under such provisions in the event any
such liability is incurred, and not discharged, by any other member of the
Citizens consolidated or controlled group. If the Company were no longer to be
included in Citizens's consolidated group for federal tax purposes, there is no
assurance that the
17
<PAGE>
Company's tax position would not be less favorable than it is at
present. See "Relationship With Citizens."
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 directors and/or executive officers of Citizens are directors
of the Company. Also, the Chief Executive Officer of Citizens is the Chairman
of the Board of the Company, the President of Citizens is Vice Chairman and
Chief Executive Officer of the Company and another executive officer of Citizens
is an executive officer 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 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
18
<PAGE>
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. The Company has heretofore been included in Citizens' federal
consolidated income tax group. After the Offering it is expected that the
Company will no longer be included in the federal consolidated income tax group
although, depending upon Citizens' stock ownership of the Company, it is
conceivable that the Company may continue to be so included. In such case the
Company's federal income tax liability would be included in the consolidated
federal income tax liability of Citizens and its subsidiaries. The Company may
also be included with certain Citizens subsidiaries in combined, consolidated or
unitary income tax groups for state and local tax purposes. The Company and
Citizens will enter into a federal, state and local tax-sharing agreement (the
"Tax Sharing Agreement"). Under the Tax Sharing Agreement, Citizens will have
sole authority to respond to and conduct all tax proceedings (including tax
audits) relating to the Company and to file all 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 taxes
that the Company would owe (or refund that it would receive) had it prepared 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. Although the administrative costs to be paid by ELI to
Citizens pursuant to the Administrative Services Agreement are not expected to
exceed the fees that would be paid if such services were to be provided by an
independent third party, the prices charged to the Company at a particular time
for services provided under this or the other agreements 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 10,000,000 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), exchange 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 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
19
<PAGE>
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 has applied 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, 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;
20
<PAGE>
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 10,535,000 shares of Class A
Common Stock issued and outstanding (12,035,000 if the Underwriters' over-
allotment options are exercised in full) and 41,165,000 shares of Class B Common
Stock outstanding. The 10,000,000 shares of Class A Common Stock to be sold in
the Offering will be tradeable without restriction. The shares of Class B Common
Stock and any Class A Common Stock issued upon exchange 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 180 days 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. 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
21
<PAGE>
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 $164,244,000 (approximately $188,919,000 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 additional capital needs with
the proceeds from the Credit Commitment, together with internally generated cash
flow and lease arrangements, proceeds from other 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."
22
<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.
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 which the Company cannot now
predict.
DILUTION
The pro forma net tangible book value of the Company as of September 30, 1997
was approximately $97.6 million or approximately $2.34 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 $119.2 million of the amount due Citizens) divided by the
total number of shares of Common Stock outstanding after giving effect to the
411,650-for-1 stock split contemplated as part of the Offering. After giving
effect to the Offering (at an assumed offering price of $17.50, the midpoint of
the range set forth on the cover of the Prospectus, less underwriting discounts
and estimated expenses of $255,600 payable in connection with the Offering) and
the issuance of 535,000 restricted shares to officers and employees, the pro
forma net tangible book value of the Company as of September 30, 1997 would have
been approximately $261.8 million, or $5.06 per share of Common Stock. This
represents an increase in pro forma net tangible book value of $2.72 per share
to the existing stockholder and dilution of $12.44 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.................... $17.50
Pro forma net tangible book value per share before
the Offering......................................... $2.34
Increase per share attributable to new investors(1) ....... 2.72
Pro forma net tangible book value per share after the Offering 5.06
Dilution per share to new investors(2)(3).................. $12.44
======
__________________________
(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 $5.38 per
share, representing an increase in pro forma net tangible book value of
$3.04 per share and dilution to new investors of $12.12 per share.
The following table summarizes the difference as of September 30, 1997 between
the existing stockholders 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 after giving effect to the 411,650-
for-1 stock split and the issuance of 535,000 shares of restricted stock to
certain officers and employees contemplated as part of the Offering.
<TABLE>
<CAPTION>
Shares Held Total Investment Average Cost
Number Percentage Amount Percentage Per Share
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
New Investors 10,000,000 19.3% $175,000,000 46.9% $17.50
Existing Stockholders(1) 41,700,000 80.7% 198,426,000 53.1% 4.76
---------- ------ ------------ ------
Total(2) 51,700,000 100.0% $373,426,000 100.0%
========== ====== ============ ======
</TABLE>
(1) Based on the number of shares of Common Stock outstanding as of September
30, 1997, as adjusted for the 411,650-for-1 stock split contemplated as part
of the Offering, and the capitalization of $119.2 million of the amount due
to Citizens.
23
<PAGE>
Includes 535,000 shares of restricted Class A Common Stock issuable to
certain officers and employees at the effective date of the Offering.
(2) Excludes 2,316,000 options to purchase Class A Common Stock issuable to
certain officers and employees at the effective date of the Offering.
CAPITALIZATION
The following table sets forth (i) the historical capitalization of the Company
as of September 30, 1997; (ii) such capitalization pro forma to reflect the
contribution of $119.2 million of the amount due to Citizens to additional paid-
in capital, the drawdown under the Credit Commitment and the use thereof to
repay of the remaining balance due to Citizens, the 411,650-for-1 split of
shares of Common Stock, the authorization of Class A and Class B Common Stock,
the designation of all outstanding Common Stock to Class B Common Stock and the
issuance of 535,000 restricted shares of Class A Common Stock to officers and
employees; and (iii) such capitalization as adjusted to reflect the Offering at
an assumed public offering price of $17.50 per share, the midpoint of the range
set forth on the cover of this Prospectus. This table should be read in
conjunction with the Selected Financial and Operating Data and the financial
statements and notes included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
As at September 30, 1997
($ in thousands)
--------------------------------------------------------------
As Adjusted for the
Actual Pro Forma Offering(4)
-------- --------- --------------------
<S> <C> <C> <C>
Capital lease obligation $ 10,374 $ 10,374 $ 10,374
Due to Citizens 219,171 - -
Credit Commitment - 100,000(1) 100,000
Stockholders' (deficiency) equity:
Preferred Stock, $.01 par value;
0,10,000,000 and 10,000,000 shares authorized,
no shares issued and outstanding - -(2) -
Common Stock, no par value;
500, 0 and 0 shares authorized,
100, 0 and 0 shares issued and outstanding - -(2) -
Class A Common Stock, $.01 par value;
0, 110,000,000 and 110,000,000 shares authorized,
0, 535,000 and 10,535,000 shares issued and outstanding - 5(3) 105
Class B Common Stock, $.01 par value;
0, 60,000,000 and 60,000,000 shares authorized
0, 41,165,000 and 41,165,000 shares issued and outstanding - 412(2) 412
Additional paid-in capital 79,255 198,009(1)(3) 362,153
Deficit (96,004) (96,004) (96,004)
Total stockholders' (deficiency) equity (16,749) 102,422 266,666
------- ------- -------
Total capitalization $ 212,796 $ 212,796 $ 377,040
========= ========= =========
</TABLE>
__________________________________
(1) Reflects recapitalization immediately prior to the Offering whereby Citizens
will contribute $119.2 million of the amount due to Citizens to additional
paid-in capital with the remaining balance of $100 million being repaid to
Citizens with the proceeds of a drawdown under the Credit Commitment.
(2) Reflects the amendment to the Certificate of Incorporation in October 1997
to change the authorized capital stock to 180,000,000 shares, including
110,000,000 shares of Class A Common Stock $.01 par value, 60,000,000 shares
of Class B Common Stock $.01 par value, and 10,000,000 shares of Preferred
Stock $.01 par value; to split the Common Stock 411,650-for-1; and to
designate such Common Stock as Class B Common Stock.
(3) Reflects the issuance of 535,000 restricted shares of Class A Common Stock
to officers and employees immediately prior to the Offering.
(4) Reflects the issuance of 10,000,000 shares of Class A Common Stock at $17.50
per share, less expenses of approximately $256,000.
24
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following selected Statement of Operations and Balance Sheet Data for
the years ended and as of December 31, 1992 and 1993 have been derived from
the Company's unaudited Financial Statements which, in the opinion of
management include all adjustments necessary for a fair presentation of the
results of operations and financial condition of the Company for and as of
such periods. The following selected Statement of Operations and Balance Sheet
Data for the years ended and as of December 31, 1994, 1995 and 1996 have been
derived from the Company's Financial Statements and related notes thereto
included elsewhere in this Prospectus, which Financial Statements have been
audited by KPMG Peat Marwick LLP, independent Certified Public Accountants.
The selected Statement of Operations and Balance Sheet Data for the nine
months ended September 30, 1996 and 1997 have been derived from the Company's
unaudited Financial Statements and related notes thereto included elsewhere in
this Prospectus and in the opinion of management, include all adjustments
necessary for a fair presentation of the results of operations and financial
condition of the Company for and as of such periods. The results of operations
for interim periods are not necessarily indicative of a full year's
operations. This information should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations," the
Company's Financial Statements and related notes thereto and the other
financial data contained elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED SEPTEMBER 30,
---------------------------------------------- ------------------------
1992 1993 1994 1995 1996 1996 1997
------- ------- -------- -------- -------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
($ in thousands,
except per share
amounts)
STATEMENT OF
OPERATIONS DATA
Revenues $ 1,206 $ 3,705 $ 8,152 $ 15,660 $ 31,309 $ 24,965 $ 41,843
Operating expenses:
Network access
expenses 142 1,289 6,155 8,728 24,081 16,533 24,217
Sales and marketing
expenses 1,043 841 4,534 5,704 8,462 6,303 8,716
Depreciation and
amortization 879 1,567 2,476 7,064 7,192 4,997 7,601
Other operating
expenses 1,949 2,892 4,528 14,114 20,957 16,715 26,831
------- ------- -------- -------- -------- -------- --------
Total operating
expenses 4,013 6,589 17,693 35,610 60,692 44,548 67,365
------- ------- -------- -------- -------- -------- --------
Operating loss (2,807) (2,884) (9,541) (19,950) (29,383) (19,583) (25,522)
Interest expense 754 1,053 873 372 -- -- 513
------- ------- -------- -------- -------- -------- --------
Net loss $(3,561) $(3,937) $(10,414) $(20,322) $(29,383) $(19,583) $(26,035)
======= ======= ======== ======== ======== ======== ========
Net loss per share(2) $ (.70) $ (.47) $ (.62)
======== ======== ========
Pro forma net loss(1) $(32,213) $(21,307) $(32,254)
======== ======== ========
Pro forma net loss
per share(2) $ (.77) $ (.51) $ (.77)
======== ======== ========
<CAPTION>
PRO FORMA
AS AT DECEMBER 31, AS AT AS AT
---------------------------------------------- SEPT. 30, SEPT. 30,
1992 1993 1994 1995 1996 1997 1997(3)
------- ------- -------- -------- -------- -------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital
(deficiency) $(5,300) $(5,699) $ (9,934) $(17,897) $ (9,940) $ (7,734) $156,510
Total assets 25,476 47,840 110,691 128,901 195,656 248,570 412,814
Long-term debt and
capital lease
obligations 11,053 9,610 6,565 -- -- 10,374 10,374
Due to Citizens 4,581 21,481 35,109 64,941 155,395 219,171 --
Credit Commitment -- -- -- -- -- -- 100,000
Shareholder's equity
(deficiency) 4,437 9,150 55,991 38,669 9,286 (16,749) 266,666
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------- --------------
1994 1995 1996 1997
-------- -------- -------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA
EBITDA(4) $ (7,065) $(12,886) $(22,191) $(17,921)
Cash flows used for operating
activities (4,097) (1,570) (28,893) (18,040)
Cash flows used for investing
activities (60,774) (16,129) (59,169) (48,717)
Cash flows provided by financing
activities 64,907 17,751 88,530 67,293
<CAPTION>
AS AT DECEMBER 31,
---------------------------------------------- AS AT
1992 1993 1994 1995 1996 SEPT. 30, 1997
------- ------- -------- -------- -------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
Property, plant &
equipment-owned $21,083 $45,309 $108,549 $127,297 $189,334 $249,499
--under lease(5) -- -- -- 36,858 57,279 87,426
------- ------- -------- -------- -------- --------
--Total $21,083 $45,309 $108,549 $164,155 $246,613 $336,925
------- ------- -------- -------- -------- --------
Market clusters 2 5 5 5 5 5
Route miles(6) 71 131 601 780 1,428 2,087
Fiber miles(6) 5,140 9,796 37,504 52,013 97,665 123,257
Buildings connected 57 104 191 282 438 540
Switches installed:
Voice -- 1 2 2 5 5
Frame relay -- -- 2 5 15 18
------- ------- -------- -------- -------- --------
Total switches
installed -- 1 4 7 20 23
------- ------- -------- -------- -------- --------
Employees 46 75 127 225 402 482
</TABLE>
- -------
NOTES TO SELECTED FINANCIAL AND OPERATING DATA
(1) The pro forma net loss represents the historical net loss as adjusted for
the revised administrative services fee and guarantee fees as if such fees
were in effect since January 1, 1996, and interest on the drawdown of the
Credit Commitment utilized to repay the remaining balance due to Citizens
subsequent to the capitalization of $119.2 million of the due to Citizens
and amount, as if the Credit Commitment was in effect on January 1, 1996
(see Notes 6, 7 and 8 of Notes to Financial Statements).
(2) The net loss per share and pro forma net loss per share have been computed
using weighted average shares outstanding determined 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
$119.2 million of due to Citizens to additional paid-in capital as
discussed in Note 6 of Notes to Financial Statements, to the drawdown of
the Credit Commitment to repay the remaining amount due to Citizens, and
to the issuance of the shares of Class A Common Stock offered hereby, as
if such transactions occurred on September 30, 1997.
(4) EBITDA consists of Earnings Before Interest, Income Taxes, Depreciation
and Amortization. EBITDA is a measure commonly used in the communications
industry to analyze companies on the basis of operating performance.
EBITDA 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")
25
<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" below for a description of the product and
services) as follows:
. Local Telephone - local dial tone and switched products and services that
include lines, trunks, local access and Centrex( 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.
26
<PAGE>
. Sales and Marketing - includes all direct and indirect sales channel
expenses and commissions. Also includes all product development, advertising
and promotional expenses.
. 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.
The Company experiences very minimal customer churn. 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 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
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1997
Revenues
Revenues increased from $25.0 million to $41.8 million, an increase of $16.8
million, or 67%, for the nine months ended September 30, 1996 as compared with
the nine months ended September 30, 1997, primarily due to the Company's rapid
customer and product growth. The Company's local telephone services revenues
and local access revenues increased from $1.5 million to $4.4 million, an
increase of $2.9 million, or 193%, for the nine months ended September 30, 1996
as compared with the nine months ended September 30, 1997, primarily due to
local switch implementations for new and existing customers in Portland, Salt
Lake City,
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Sacramento and Seattle during the second half of 1996. Annualized monthly local
telephone services revenues increased to $9.1 million based on September 1997
revenues from $3.6 million based on September 1996 revenues as the Company
increased its access line equivalents to 38,045 as of September 1997. Long
distance services revenues decreased from $6.3 million to $6.1 million, a
decrease of $.2 million, or 3%, for the nine months ended September 30, 1996 as
compared with the nine months ended September 30, 1997, primarily due to short
term contract revenues for prepaid debit card services in 1996. The Company's
data and video services revenues increased from $1.4 million to $5.5 million, an
increase of $4.1 million, or 293%, for the nine months ended September 30, 1996
as compared with the nine months ended September 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 $15.7
million to $25.8 million, an increase of $10.1 million, or 64%, for the nine
months ended September 30, 1996 as compared with the nine months ended September
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 $10.1 million increase in network access
services revenues, $3.1 million is pursuant to a contract with a significant
customer which contract will expire in early 1998.
Network Access Expenses
Network access expenses increased from $16.5 million to $24.2 million, an
increase of $7.7 million, or 47%, for the nine months ended September 30, 1996
as compared with the nine months ended September 30, 1997, primarily due to the
Company's expansion of its frame relay product, development of a fully redundant
leased Internet access backbone network with related Internet access costs and
customer growth.
Sales and Marketing Expenses
Sales and marketing expenses increased from $6.3 million to $8.7 million, an
increase of $2.4 million, or 38%, for the nine months ended September 30, 1996
as compared with the nine months ended September 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 $5.0 million to $7.6 million, an
increase of $2.6 million, or 52%, for the nine months ended September 30, 1996
as compared with the nine months ended September 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.
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Administrative Services Expenses
Administrative services expenses increased from $1.6 million to $2.9 million, an
increase of $1.3 million, or 81%, for the nine months ended September 30, 1996
as compared with the nine months ended September 30, 1997, primarily due to
increases in the volume and cost of services provided by Citizens.
Other Operating Expenses
Other operating expenses increased from $15.1 million to $23.9 million, an
increase of $8.8 million, or 58%, for the nine months ended September 30, 1996
as compared with the nine months ended September 30, 1997, primarily due to
increases in salaries, payroll taxes and employee 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 43% for the nine months ended September 30, 1996 as compared with the
nine months ended September 30, 1997.
Interest Expense
Interest expense increased $.5, for the nine months ended September 30, 1996 as
compared with the nine months ended September 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.
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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.
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 79% 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
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services revenues. Local dial tone services were introduced in 1995 in Seattle
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 $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.
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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.
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 $249 million
at September 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 $79.3
million (of which $48.7 million was incurred through September 30, 1997) and
for 1998 are estimated to be $275 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,
the Credit Commitment, together with internally generated cash flow and lease
arrangements, proceeds from other 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 $312.9 million through September 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, other than the
guarantees described herein.
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Prior to the completion of the Offering, $100 million of the amount due to
Citizens as of September 30, 1997 will be contributed to additional paid-in-
capital and the remaining $119.2 million will be repaid with the proceeds from
the Credit Commitment. 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.
On October 23, 1997, ELI and Citizens entered into a $400 million, 5-year
revolving credit commitment letter arrangement ("Credit Commitment") with
Citibank, N.A. ("Citibank"), under which Citizens has agreed, subject to
receiving regulatory authorization, to substitute its guarantee of the entire
$400 million Credit Commitment amount for that of certain subsidiaries of
Citizens within 90 days of the closing of Credit Commitment. Failure of
Citizens to provide such guarantee would constitute a default under the Credit
Commitment. The Credit Commitment provides that ELI may elect to borrow amounts
at the then current short-term Eurodollar rate plus a spread, or at Citibank's
publicly announced base lending rate plus a spread, both spreads being based on
Citizens' long-term unsecured debt ratings, or at a competitive bid option.
Facility fees of .05% are payable under the Credit Commitment.
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 previously made 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 September 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 and human resources 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,
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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 38,045 local
access line equivalents, 2,087 route miles and 123,257 fiber miles installed and
540 on-net buildings connected as of September 30, 1997. The Company has
interconnected its market clusters with facilities-based owned and leased long-
haul fiber optic networks.
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 14 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
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 and maintenance system designed to
monitor and test the Company's networks 24 hours a day, seven days a week and is
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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 order placement,
design and provisioning components of the order management system have been
installed and are operational. A new customized billing system and an up-to-the
minute trouble ticket tracking module, which is an enhancement of the management
and maintenance system, are being installed and are expected to be operational
and integrated into the information system by the end of the first quarter of
1998.
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 1997. 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 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 believes that it has been at the forefront of industry
efforts to introduce competition to the local telecommunications markets. As
such, ELI believes that it 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
pursued regulatory and legislative reforms and consummated certain
interconnection agreements with ILECs that in its view allowed the Company to
offer economical and operationally efficient local exchange services. The
Company believes that it 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 believes that it 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.
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 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
September 30, 1997, Citizens' consolidated assets totaled $4.5 billion and
shareholders' equity totaled $1.7 billion. Citizens' consolidated revenues for
the twelve months ended September 30, 1997 totaled $1.4 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:
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. 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 PacBell, which are the ILECs in its target
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.
. 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-net. 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; (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
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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.
. Penetrate Markets by Leveraging Data Expertise. 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 has 18 frame relay switches
servicing customer locations as of September 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.
. 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.
The Company frequently considers expansion through acquisition
opportunities in the telecommunications industry.
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<PAGE>
EXISTING MARKET CLUSTERS AND LONG-HAUL NETWORKS
COMBINED NETWORK INFORMATION AT SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
EXISTING NUMBER OF ON- NET
MARKET MUNICIPALITIES ROUTE FIBER BUILDINGS VOICE FRAME RELAY
CLUSTERS SERVED MILES MILES CONNECTED SWITCHES SWITCHES
- -------- ------ ----- ----- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Portland.................. 8 287 19,779 239 2 4
Seattle................... 15 130 11,840 72 1 2
Salt Lake City............ 20 222 21,355 121 1 2
Sacramento................ 11 176 16,896 98 1 2
Phoenix(1)................ 5 192 10,485 7 - 1
----------------- --------- ------ ---------- -------- -----------
Total.................... 59 1,007 80,355 537 5 11
=================
Other Frame
Relay Switches(2)........ 7
LONG-HAUL NETWORKS(1)
- --------------------------
Phoenix to Las Vegas.................. 356 18,204 3 - -
Portland to Seattle................... 207 12,410 - - -
Portland to Spokane(3)................ 517 12,288 - - -
--------- ------- ---------- -------- -----------
Total Long-Haul Networks.............. 1,080 42,902 3 - -
--------- ------- ---------- -------- -----------
Total Networks................... 2,087 123,257 540 5 18
========= ======= ========== ======== ===========
</TABLE>
___________________________
(1) Route Miles and Fiber Miles also include 166 route miles of 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 September 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.
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<PAGE>
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 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 to 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
39
<PAGE>
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 the Company signed an
interconnection agreement effective July 2, 1997 with the ILEC, U S WEST. Of the
number of route miles shown in the above table under "-Existing Market Clusters
and Long-Haul Networks-Combined Network Information at September 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 Portland and Seattle. 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 attaining traffic 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, which includes four strands for diverse routing. 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 Portland and
Spokane. 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. Five hundred and seventeen miles of this network had
been constructed as of September 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 attaining traffic minimums to retain exclusivity.
40
<PAGE>
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 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.
Portland to Boise to Salt Lake City to Las Vegas to Los Angeles
In October 1997, the Company entered into a 20-year Pre-Construction Agreement
with FTV Communications, LLC, pursuant to which FTV will construct a fiber optic
communications system linking Portland, Boise, Salt Lake City, Las Vegas and Los
Angeles and the Company will have the right to use 24 optical fibers for its
services. The network is scheduled to be completed in the first quarter of 1999
and will have approximately 1,620 route miles.
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>
<S> <C> <C> <C>
Local Telephone Long Distance Data and Video Network Access
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
Foreign 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.
41
<PAGE>
Local Telephone Services
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(tm)
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 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(tm) 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.
42
<PAGE>
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.
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.
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<PAGE>
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, 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.
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<PAGE>
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.
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%.
45
<PAGE>
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.
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 September 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
46
<PAGE>
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 September 30, 1997, the Company employed 53 salespeople and 43
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 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
47
<PAGE>
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 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.
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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.
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.
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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.
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
and maintenance 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 order
placement, design and provisioning components of the order management system
have been installed and are operational. A new customized billing system and an
up-to-the minute trouble ticket tracking module, which is an enhancement of the
management and maintenance system, are being installed and are expected to be
operational and integrated into the information system by the end of the first
quarter of 1998.
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 September 30, 1997 the Company employed 482 persons. None of the
Company's employees are represented by a union, and the Company considers its
employee relations to be excellent.
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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 July 2014. 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.
Lease
In June 1995 the Company entered into agreements to lease certain equipment to
be constructed for the Company (the "Lease"). 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,
with renewal options, 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 by April
30, 2002, 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 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-Citizens' Guarantee of ELI's Obligations."
Legal Proceedings
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. As indicated under "Risk Factors - Dependence Upon Interconnection
and Relationship with ILECs," to the extent ELI interconnects with and uses U S
WEST's networks to service the Company's customers, ELI is dependent upon the
technology and capabilities of U S WEST to meet the telecommunications
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needs of the Company's customers and to maintain ELI's service standards. ELI
will become increasingly dependent on interconnection with U S WEST as switched
services become a greater percentage of ELI's business. In the event the outcome
in the lawsuit is unfavorable it would not have a materially adverse effect on
the Company's financial condition and results of operations since the Company
expects that U S WEST would continue to provide at least the current level of
interconnection services and facilities to the Company.
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 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
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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 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.
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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 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,
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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 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.
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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:
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
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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 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
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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 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.
58
<PAGE>
Name Age Title
- ---- --- -----
Leonard Tow 69 Chairman of the Board
Daryl A. Ferguson 58 Vice Chairman of the Board and Chief
Executive Officer
David B. Sharkey 47 President, Chief Operating Officer
and Director
Robert J. DeSantis 41 Vice President, Chief Financial
Officer and Treasurer
James Berthot 52 Vice President - Marketing and
Product Development
Todd Hanson 36 Vice President - Engineering
Randall Lis 38 Vice President - Staff Operations
Michael J. Miller 41 Vice President - Planning
Kerry Rea 39 Vice President and Controller
John Wolff 51 Vice President - Sales
Ernest D. Yates 52 Vice President - Operations
Stanley Harfenist 66 Director
Robert A. Stanger 57 Director
Maggie Wilderotter 42 Director
Leonard Tow has been a director and Chairman of the Board of the Company since
August 1994. Mr. Tow has been a director of Citizens since April 1989. In June
1990, he was elected Chairman of the Board and Chief Executive Officer of
Citizens. In October 1991, he was appointed to the additional position of Chief
Financial Officer of Citizens. He has also been a Director, Chief Executive
Officer and Chief Financial Officer of Century Communications Corp. since its
incorporation in 1973, and Chairman of its Board of Directors since October
1989.
Daryl A. Ferguson, has been a director of the Company since September 1995 and
Vice Chairman of the Board and Chief Executive Officer of the Company since
October 1997. Mr. Ferguson has been President 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, has been a director since September 1995, and Chief Operating Officer
since October 1997. 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.
Robert J. DeSantis, Vice President, Chief Financial Officer and Treasurer of the
Company since August 1994, 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.
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
59
<PAGE>
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 Telecom, where he was responsible for network planning and
technology on a national basis. Mr. Hanson was Senior Director of Project
Management and Access Engineering at AT&T Canada in 1992 and 1993. Mr. Hanson's
experience comprises 13 years of telecommunications management including
positions with Sprint, AT&T Canada and MFS in the areas of engineering,
operations and project management.
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.
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.
Kerry D. Rea joined ELI as Vice President and Controller in October 1997. Prior
to joining ELI, Mr. Rea served as Controller for the Portland, Oregon-based
operations of Mattel, Inc. (since March 1997), and its predecessor Tyco Toys,
Inc. (from November 1989 to March 1997). Mr. Rea, a certified public
accountant, previously worked in various accounting and finance positions for
Tyco's predecessor as well as working seven years in public accounting.
John Wolff joined ELI as Vice President-Sales in October 1994. 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 and AT&T
for 16 years. 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, where he
remained until 1987, when he left to join SBC. Mr. Wolff was with SBC from 1987
until 1992, and Mobil Media from 1992 until 1994, at which time he joined the
Company.
Ernest D. Yates joined ELI as Senior Director of Sales in February 1995. In
September 1995 he was promoted to Vice President-Administration and has served
as Vice President-Operations 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.
60
<PAGE>
Stanley Harfenist has been a director of the Company since October 1997. Mr.
Harfenist has been a director of Citizens since 1992. He has been President and
Chief Executive Officer of Adesso, Inc., a manufacturer of hardware for the
Macintosh computer since 1994. He was President, Chief Operating Officer and
Director of Players International, Inc. from 1985 to 1993, an Officer of Sega
Enterprises from 1982 to 1984 and an Officer of Knickerbocker Toy Company, Inc.
from 1978 to 1982.
Robert A. Stanger has been a director of the Company since October 1997. Mr.
Stanger has been a director of Citizens since 1992. He has been Chairman of
Robert A. Stanger & Company, an investment banking and consulting service since
1978. Mr. Stanger is Publisher of The Stanger Real Estate Report. Mr. Stanger
has been a director of Callon Petroleum Company, Inc. since 1995, which is in
the business of exploration and production of oil and natural gas.
Maggie Wilderotter has been a director of the Company since October 1997. Ms.
Wilderotter has been President and Chief Executive Officer of Wink
Communications since 1997. From 1995 to 1997, Ms. Wilderotter was the Executive
Vice President of National Operations for AT&T Wireless Services, Inc. and Chief
Executive Officer of AT&T's Aviation Communications Division. From 1991 to
1995, she served as Senior Vice President of McCaw Cellular Communications, Inc.
and Regional President of its California/Nevada/Hawaii Region. Ms. Wilderotter
was with U.S. Computer Services, Inc./Cable Data, as Senior Vice President and
General Manager from 1985 to 1991. She is also a director of Gaylord
Entertainment Corporation, ANTEC Corporation, Airborne Express, Jacor and the
California Cable Television Association.
Each executive officer of the Company who is also an executive officer of
Citizens expects to dedicate as much time as is necessary to the Company and its
business, which will necessarily vary from time to time.
Board Composition
Directors are elected annually. The Board presently consists of six members,
four of whom are associated with Citizens and one of whom is independent of
both Citizens and ELI. Following the Offering, the Board will be increased to
consist of seven members to add an additional independent director. 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 who is not an employee of either the Company or Citizens is
entitled to receive an annual retainer of $20,000, an additional $1,000 plus
reasonable expenses for attending each meeting of the Board of Directors, $1,000
annually for each committee of the Board of Directors for which such director
serves as chairman and an annual grant of options for 5,000 shares of Class A
Common Stock of the Company, exercisable at an exercise price per share equal to
the market price of the Class A Common Stock on the date of grant. In
connection with the Offering, each director who is not an employee of either the
Company or Citizens will also receive a grant of options for 10,000 shares of
Class A Common Stock of the Company, exercisable at an exercise price per share
equal to the initial public offering price of the Class A Common Stock.
61
<PAGE>
Compensation Committee
The Board of Directors of ELI has established 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.
There was no Compensation Committee of the Company during fiscal year 1996. Mr.
Sharkey, as a member of the Board of Directors of the Company, participated in
deliberations regarding executive officer compensation.
Audit Committee
The Board of Directors has established 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 during 1996 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.
62
<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Compensation Long-term Compensation
------------------------------------------ ----------------------------------------
Awards Payouts
------------------------
Securities
Underlying Long-term All Other
Other Annual Restricted Options/ Incentive Plan Compensation
Salary Salary Bonus(2) Compensation Stock Awards SARs (3) 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 - - 7,987 - 4,750
VP-Sales 1995 120,000 40,000 - - - - 15,535
1994 30,000 - - - 11,326 - 4,681
Randall Lis 1996 114,125 40,000 - - 7,987 - 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. Ferguson and DeSantis are executive 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. Mr.
Sharkey was Chief Executive Officer of the Company from August 1994 until
October 1997, when Mr. Ferguson became Chief Executive Officer.
(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 $33,610 for relocation allowances
paid to Messrs. Wolff, Lis, Hanson and Yates in 1995.
The following table sets forth the options granted to the Named Executive
Officers in 1996. All of the options listed below relate only to options to
purchase shares of Citizens' common stock. No options or stock appreciation
rights relating to the Company's Common Stock, and no stock appreciation rights
relating to Citizens' common stock, were granted in 1996. Options relating to
the Company's Common Stock will be granted as of the effective date of the
Offering to the Named Executive Officers. See "-Equity Incentive Plan."
63
<PAGE>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/SARs EXERCISE
UNDERLYING GRANTED TO OR BASE GRANT DATE
OPTIONS/SARs EMPLOYEES IN PRICE AT EXPIRATION PRESENT
NAME GRANTED (#)(1) FISCAL YEAR GRANT ($/SH)(2) DATE VALUE $(3)
- ------------------- -------------- ------------ --------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
David B. Sharkey 16,000 1% $12.19 02/15/06 $39,030
John Wolff 7,500 .3% 12.19 02/15/06 12,456
Randall Lis 7,500 .3% 12.19 02/15/06 12,456
Todd Hanson - - - - -
Ernest Yates 7,500 .3% 12.19 02/15/06 12,456
</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.
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.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF UNEXERCISED
SHARES VALUE UNEXERCISED IN-THE-MONEY
ACQUIRED ON REALIZED OPTIONS/SARs AT OPTIONS/SARs AT
NAME EXERCISE(#) $ FISCAL YEAR-END (#) FISCAL YEAR-END($)
-------------------- ---------------- ------------- ------------------------------ ------------------------------
Exercisable Unexercisable Exercisable Unexercisable
------------ ---------------- ------------ ----------------
<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
Randall Lis 0 0 2,265 17,050 0 0
Todd Hanson 0 0 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.
64
<PAGE>
Equity Incentive Plan
The Board of Directors established an Equity Incentive Plan (the "Plan") in
October 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 or a company controlled by or
controlling the Company or under common control with the Company or an
individual who performs services for the Company as a director, consultant or
otherwise. The Plan is intended to strengthen the Company's existing operations
through its ability to attract and retain outstanding employees upon whose
judgment, initiative and efforts the continued efficiency, productivity, growth
and development of the Company is dependent. The Plan became effective on
October 15, 1997 and will remain in effect for 10 years. No awards will be
granted more than 10 years after the effective date of the Plan.
As of the effective date of the Offering, (i) Randy Lis, John Wolff, Earnest
Yates, Todd Hansen, James Berthot and Michael Miller, executive officers of the
Company, will each be granted options for 146,000 shares of Class A Common Stock
of the Company, (ii) Robert J. DeSantis, an executive officer of both the
Company and Citizens, and Stanley Harfenist, a director of both the Company and
Citizens, will each be granted options for 90,000 shares of Class A Common Stock
of the Company, (iii) options for 680,000 shares of Class A Common Stock will be
granted to other officers of ELI, (iv) options for an aggregate of 116,000
shares of Class A Common Stock will be granted to four officers of Citizens who
are expected to render services to ELI either directly or through the
Administrative Services Agreement and (v) options for 464,000 shares of Class A
Common Stock will be granted to other employees of ELI. All of such options are
exercisable at an exercise price per share equal to the initial public offering
price of the Class A Common Stock.
Grants of restricted shares of Class A Common Stock were made to the following
directors and named executive officers: Daryl Ferguson 125,000 shares; David
Sharkey 125,000 shares; Leonard Tow 125,000 shares; Todd Hanson 15,000; Randall
Lis 15,000 shares; John Wolff 15,000 shares; and Ernst Yates 15,000 shares.
Seven other key employees of the Company received grants of a total of 100,000
shares. The restrictions will lapse, as to one-third of the shares on the
later of the first anniversary of the date of this Prospectus or the attainment
of the Company of at least $100,000,000 of revenues in a travelling 12-month
period; as to the second-third of the shares, on the later of the second
anniversary of the date of this Prospectus or the attainment of at least
$125,000,000 of revenues of a travelling 12-month period; and as to the
remainder of the shares, on the later of the third anniversary of the date of
this Prospectus or the attainment of at least $155,000,000 of revenues of a
travelling 12-month period; (in each case, provided that the officer is an
employee of the Company or Citizens on the "lapse" date) except that the
restrictions on Dr. Tow's shares will lapse only if the Company attains revenues
of at least $13,000,000 for the month of January 2001 or for any month
thereafter. Dr. Tow's continued employment on the lapse date is not a condition
to the lapse of the restrictions.
All employees of the Company and its affiliate companies and persons who render
services directly or indirectly to the Company as director, consultant or
otherwise are eligible for selection to participate in the Plan. 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 is no more than 4,170,600
shares. Under the Plan, no individual may be granted share-denominated
performance awards in any calendar year covering more than 500,000 shares and
dollar value-
65
<PAGE>
denominated performance awards in any calendar year covering more than $750,000
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
individuals; (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, including the grant of awards, 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 or others who commence to render
services, 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
shall be 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. The
Compensation Committee may also accept the surrender of the right to exercise
any Stock Option for payment in cash or shares 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 individuals, 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,
phantom 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 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 participant'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 participants: (i)
acceleration of time periods for purposes of
66
<PAGE>
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 restrictions and
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; (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 51% or more of 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 and the Board
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 the
affirmative vote of the stockholders of the Company if such approval is
necessary or deemed desirable for the continued validity of the Plan or its
compliance with any tax or securities law rule or regulation of any stock
exchange or stock market, or other legal or regulatory, requirement.
PENSION PLAN
Citizens has a noncontributory qualified retirement plan covering Mr. Sharkey
that provides benefits based on formulas related to base salary and years of
service. Benefits shown are not subject to reduction for Social Security
payments. The following table illustrates the estimated annual plan pension
benefits available to Mr. Sharkey upon retirement at age 65 assuming a
preretirement death benefit election of 100% joint and survivorship benefits.
The remuneration classifications are based on the highest five-year average
annual salary (subject to the limitation of the Internal Revenue Code of 1986 on
the amount of annual compensation which may be credited to a participant's
retirement benefits) and the years of service represent years of credited
service.
Pension Plan Table
Years of Service
----------------
Remuneration 5 10 15 20
----- ------ ------ ------
(000 Omitted)
-------------
$160..................... 12 25 37 49
Full years of credited service for Mr. Sharkey are two.
67
<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 97.5% of the
combined voting power of all of the outstanding Common Stock (or approximately
97.16% 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 exchangeable 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
180 days 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 may 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. In addition,
by virtue of its controlling beneficial ownership and the terms of the Tax
Sharing Agreement between the Company and Citizens, Citizens will effectively
control all of the Company's tax decisions, and conflicts of interest regarding
tax matters between the Company and Citizens may arise. See "-Tax Sharing
Agreement".
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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.
The administrative costs to be paid by ELI to Citizens pursuant to the
Administrative Services Agreement are not expected to exceed the fees that would
be paid if such services were to be provided by an independent third party.
The Administrative Services Agreement will become effective upon the public
offering of shares of Class A Common Stock, and shall terminate on December 31,
2005, unless earlier terminated by Citizens or ELI. The Administrative Services
Agreement will be automatically renewed for additional terms of two years unless
either party gives at least six months written notice prior to a scheduled
termination date. The Administrative Services Agreement can be terminated upon
a material breach and will be terminated upon a change of control of ELI. A
change of control shall be deemed to have occurred if (i) Citizens or the
companies controlled by Citizens should own shares representing less than a
majority of the voting power of the then outstanding common stock; (ii) majority
of the seats of the board of directors shall be occupied by persons who are
neither (a) nominated by Citizens or by the board of directors of ELI, nor (b)
appointed by directors of ELI so nominated or (iii) any person or group other
than Citizens and companies controlled by Citizens shall otherwise directly or
indirectly have the power to exercise a controlling influence over ELI.
Tax Sharing Agreement
The Company has heretofore been included in Citizens' federal consolidated
income tax group. After the Offering it is expected that the Company will no
longer be included in the federal consolidated income tax group although,
depending upon the aggregate value of the Common Stock owned by Citizens after
the Offering, the Company may continue to be so included. In such case the
Company's federal income tax liability would be included in the consolidated
federal income tax liability of Citizens and its subsidiaries. The Company may
also be included with certain Citizens subsidiaries in combined, consolidated or
unitary income tax groups for state and local tax purposes. The Company and
Citizens will enter into a federal, state and local tax-sharing agreement (the
"Tax Sharing Agreement"). Pursuant to the Tax-Sharing Agreement, the Company and
Citizens will make payments between them such that, with respect to any period,
the amount of taxes to be paid by the Company, subject to certain adjustments,
will generally be determined as though the Company were to file separate
federal, state and local income or franchise tax returns (including, except as
provided below, any amounts determined to be due as a result of a
redetermination of the tax liability of Citizens arising from an audit or
otherwise). The Company will be responsible for any tax liability due any
foreign jurisdiction arising from its business activities. The Tax Sharing
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Agreement will remain in effect so long as any taxing jurisdiction requires the
filing of a combined tax return by both Citizens and ELI.
If the Company continues to be included in Citizens' federal consolidated income
tax group, Citizens will continue to have all the rights of a parent of a
consolidated group. If so provided for by applicable state and local law with
respect to a parent of a combined, consolidated or unitary group Citizens will
have similar rights. Citizens will have sole and exclusive responsibility for
(i) preparing any tax returns (including amended returns or claims for refund)
of the Company; (ii) representing the Company with respect to any 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.
In general, the Company will be included in Citizens' consolidated group for
federal income tax purposes for so long as Citizens beneficially owns at least
80% of the total voting power and value of the outstanding common stock. Each
member of a consolidated group is jointly and severally liable for the federal
income tax liability of each other member of the consolidated group.
Accordingly, although the Tax Sharing Agreement allocates tax liabilities
between the Company and Citizens, during the period in which the Company is
included in Citizens' consolidated group, the Company could be liable in the
event that any federal tax liability is incurred, but not discharged, by any
other member of Citizens' consolidated group. See "Risk Factors - Control by
Citizens."
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
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.
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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. 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 until Citizens ceases to own a
majority of the voting interest of the capital stock of the Company or its
designees cease to constitute a majority of the directors.
Citizens' Guarantees of ELI's 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."
In October, 1997, the Company arranged for a bank commitment for a five-year
$400 million revolving Credit Commitment. Citizens has agreed, subject to
receiving regulatory authorization, to substitute its guarantee of all debt
obligations under such Credit Commitment
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for that of certain subsidiaries of Citizens within 90 days of the Closing of
the Credit Commitment. Effective with the Offering, ELI has agreed to pay
Citizens a guarantee fee equal to 3.25% per annum of the average balance of
outstanding debt.
Citizens and ELI have agreed that, if Citizens intends to reduce its economic
interest in ELI to less than 50%, Citizens will be entitled to request ELI to
refinance its obligations under the Lease and the Credit Commitment and ELI
shall be obligated to use its best efforts to do so. This refinancing would
occur when Citizens reduces its economic interest in ELI to less than 50%.
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.
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.
The six current directors of the Company include Leonard Tow, Chairman of the
Board and Chief Executive Officer of Citizens, who is Chairman of the Board of
the Company, Daryl A. Ferguson, President and Chief Operating Officer of
Citizens, who is Vice Chairman of the Board of the Company, and Stanley
Harfenist and Robert Stanger, directors of Citizens. Also, Mr. Ferguson is
Chief Executive Officer of the Company and Robert J. DeSantis, an executive
officer of Citizens is an executive officer of the Company. Directors and
officers of the Company who are also directors and 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
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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.
SECURITIES OWNERSHIP
ELI Common Stock
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 41,165,000 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
79.62% of the economic interest in the Company (77.38% if the Underwriters'
over-allotment options are exercised in full) and representing approximately
97.5% of the combined voting power of the Company's outstanding Common Stock (or
97.16% if the Underwriters' over-allotment options are exercised in full).
The following table provides information, as of September 30, 1997, and as
adjusted to reflect the sale of 10,000,000 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. As of September 30, 1997
none of the directors nor any of the executive officers of the Company
beneficially owned any shares of Class A Common Stock or Class B Common Stock.
See "Management-Equity Incentive Plan" for a discussion of the grant of
restricted shares of Class A Common Stock to directors and officers in
connection with the Offering.
<TABLE>
<CAPTION>
Class A Class B
Common Stock Common Stock
----------------------- ---------------------- Percent of Vote of
Number of Number of All Classes of
Name and Address(1) Shares % Shares % Common Stock
- ------------------- ------------ ---------- ----------- ---------- --------------------
<S> <C> <C> <C> <C> <C>
Citizens Utilities
Company................. 0 0% 41,165,000 100% 97.5%
</TABLE>
- ---------------------
(1) The address of Citizens is High Ridge Park, Stamford, Connecticut 06905.
Citizens Common Stock
The following table reflects shares of common stock of Citizens beneficially
owned (or deemed to be beneficially owned pursuant to the rules of the
Securities and Exchange Commission) as of September 15, 1997 by each director
and Named Executive Officer of the Company and all executive officers and
directors of the Company as a group.
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<TABLE>
<CAPTION>
Acquirable Percentage of
Name Title Shares Owned Within 60 Days(1) Common Stock(2)
- ---- ----- ------------ ----------------- ---------------
<S> <C> <C> <C> <C>
Daryl A. Ferguson Vice Chairman and CEO 325,874 306,875 *
Todd Hanson Vice President 10,829 6,880 *
Stanley Harfenist Director 51,074 37,787 *
Randall Lis Vice President 7,661 6,390 *
David B. Sharkey President and Director 18,519 18,115 *
Robert A. Stanger Director 40,206 37,787 *
Leonard Tow Chairman 8,929,254/(3)(4)/ 2,835,530/(4) 3.6%
John Wolff Vice President 7,738 6,391 *
Earnest Yates Vice President 5,743 1,666 *
All Officers and Directors as
a group 9,544,529/(5)/ 3,393,249/(5)/ 3.9%
</TABLE>
_____________________________
* Represents less than 1% of Citizens' common stock.
(1) Reflects number of shares that could be purchased by exercise of options
available as of September 15, 1997 or within 60 days thereafter under Citizens'
stock option plans.
(2) Based on number of shares outstanding at, or acquirable within 60 days of,
September 15, 1997.
(3) Includes 4,812,549 shares of Citizens' common stock owned by Century
Communications Corp. of which Leonard Tow is Chairman of Board, Chief Executive
Officer, Director and, together with his wife, the holder of a majority
ownership interest in its common stock. These shares are included in the above
table as required by the definition of beneficial ownership of the Securities
and Exchange Commission. Except to the extent of such indirect interest,
Leonard Tow disclaims beneficial ownership of any of these shares of common
stock of Citizens.
(4) Includes 17,438 shares of Citizens' common stock held by his wife as
custodian for her minor grandchildren and 37,787 shares of Citizens' common
stock acquirable by his wife within 60 days. Leonard Tow disclaims beneficial
ownership of all such shares.
(5) Share information is qualified as described in the previous footnotes.
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 180,000,000 shares,
including 110,000,000 shares of Class A Common Stock, $.01 par value per share,
60,000,000 shares of Class B Common Stock, $.01 par value per share, and
10,000,000 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 "Securities Ownership."
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 exchange rights.
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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."
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, exchange 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, exchange 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
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Class A Common Stock or Class B Common Stock, as the case may be, that have been
subdivided or combined.
Exchange
Under the Certificate of Incorporation, each share of Class B Common Stock is
exchangeable 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
exchange 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 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, exchange
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 10,535,000 shares of Class A
Common Stock issued and outstanding (12,035,000 if the Underwriters' over-
allotment options are exercised in full) and 41,165,000 shares Class B Common
Stock issued and outstanding. The 10,000,000 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 exchange 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
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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 180 days after the date of
this Prospectus.
The shares of the Company's Class B Common Stock are exchangeable into shares of
Class A Common Stock and, in the event of exchange of such shares and expiration
of the 180-day lock-up period described above, over 500,000 of the aggregate
shares of Class A Common Stock issuable upon exchange 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
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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 (i) a citizen or
resident of the United States, (ii) a corporation or partnership created or
organized in or under the laws of the United States or any political subdivision
thereof, (iii) an estate the income of which is subject to United Sates federal
income taxation regardless of its source, or (iv) a trust which is subject to
the supervision of a court within the United States and the control of one or
more United States persons. 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 immediately preceding year, and one-sixth
of the days present in the second preceding year). Resident aliens are
generally 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 final U.S. Treasury regulations
issued October 6, 1997, and generally effective for payments made after December
31, 1998 (the "New Regulations"), however, a non-U.S. holder of Common Stock who
wishes to claim the benefit of an applicable treaty rate will be required to
satisfy applicable certification and other requirements. Currently certain
certification and disclosure requirements must be complied with in order to
claim 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 of U.S.
withholding tax pursuant to an income tax treaty may obtain a refund of any
excess amounts
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currently withheld by filing an appropriate claim for refund with the U.S.
Internal Revenue Service (the "IRS").
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, (iii) the non-U.S. Holder
is subject to tax pursuant to the provisions of U.S. tax law applicable to
certain U.S. expatriates (including certain former citizens and residents of the
United States), or (iv) 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.
An individual non-U.S. holder described in clause (i) or (iii) above will be
subject to tax on the net gain derived from the sale under regular graduated
U.S. federal income tax rates. An individual non-U.S. holder described in
clause (ii) above will be subject to a flat 30% tax on the gain derived from the
sale, which may be offset by U.S. source capital losses (even though the
individual is not considered a resident of the United States). If a non-U.S.
holder that is a foreign corporation falls under clause (i) above, it will be
subject to tax on its gain under regular graduated U.S. federal income tax rates
and, in addition, may be subject to the branch profits tax equal to 30% of its
effectively connected earnings and profits within the meaning of the Code for
the taxable year, as adjusted for certain items, unless it qualifies for a lower
rate under an applicable income tax treaty.
Federal Estate Taxes
Common Stock owned or treated as owned by an individual who is neither a citizen
or a resident (as specifically defined for United States federal estate tax
purposes) of the United States 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 IRS and
to each non-U.S. holder the amount of dividends payable in cash or property
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). Under the New
Regulations, however, a non-U.S. holder will be subject to back-up withholding
unless applicable certification requirements are met. Backup withholding and
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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. Under the New Regulations, such
payments by a U.S.-related broker will be subject to back up withholding if such
broker has actual knowledge that the payee is a U.S. person.
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 IRS.
In general, the New Regulations do not alter significantly the substantive
requirements of the rules pertaining to U.S. federal income tax withholding,
backup withholding and information reporting, but, rather, modify certification
procedures and forms and clarify reliance standards. Prospective non-U.S.
holders should consult their own tax advisors regarding the New Regulations and
the effect, if any, the New Regulations will have on their ownership of Common
Stock.
UNDERWRITING
The Underwriters of the U.S. Offering named below (the "U.S. Underwriters"), for
whom Lehman Brothers Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated,
Morgan Stanley & Co. Incorporated and Deutsche Morgan Grenfell Inc., are acting
as representatives (the "Representatives") have severally agreed, subject to the
terms and conditions set forth in the U.S. Underwriting Agreement (the "U.S.
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.
Number
of
U.S. Underwriters Shares
- ----------------- ------
Lehman Brothers Inc.
Merrill Lynch, Pierce, Fenner & Smith Incorporated
Morgan Stanley & Co. Incorporated
Deutsche Morgan Grenfell Inc.
Total................................................ 8,000,000
=========
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The managers of the International Offering named below (the "International
Managers"), for whom Lehman Brothers International (Europe), Merrill Lynch
International, Morgan Stanley & Co. International Limited and Deutsche Bank AG,
London Branch are acting as lead managers (the "Lead Managers"), have severally
agreed, subject to the terms and conditions of the 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.
Number
of
International Managers Shares
- ---------------------- ------
Lehman Brothers International (Europe)
Merrill Lynch International
Morgan Stanley & Co. International Limited
Deutsche Bank AG, London Branch
Total.............................................. 2,000,000
=========
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 the approval of certain legal
matters by counsel and to certain other 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 U.S. Offering
and the International Offering are identical. The closing of the International
Offering is a condition to the closing of the U.S. Offering and the closing of
the U.S. Offering is a condition to the closing of the International Offering.
The Company has granted to the U.S. Underwriters and the International Managers
options to purchase up to an additional 1,200,000 and 300,000 shares of Class A
Common Stock, respectively, at the initial public offering price less the
aggregate underwriting discount, solely to cover over-allotments. The 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 be committed, subject to certain conditions, to purchase a number
of option shares proportionate to such U.S. Underwriter's and International
Manager's 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 public offering price set forth on the cover page of
this Prospectus, and to certain selected 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 concession not in excess of $____ per share on sales to certain other
dealers. After the initial offering of the Class A Common Stock, the public
offering price, concession to selected dealers and reallowance to other dealers
may be changed.
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The Company and Citizens have agreed to indemnify the U.S. Underwriters and the
International Managers against certain liabilities, including liabilities under
the Securities Act of 1933, and to contribute to payments which the U.S.
Underwriters and the International Managers may be required to make in respect
thereof.
The U.S. Underwriters and the International Managers have entered into an
Agreement Among U.S. Underwriters and International Managers (the "Agreement
Among") pursuant to which each U.S. Underwriter has agreed that, as part of the
distribution of the shares of Class A Common Stock offered in the U.S. Offering,
(a) it is not purchasing any of such shares for the account of anyone other than
a U.S. or Canadian Person (as defined below) and (b) it has not offered or sold,
and will not offer, sell, resell or deliver, directly or indirectly, any of such
shares or distribute any prospectus relating to the U.S. Offering outside the
United States or Canada or to anyone other than a U.S. or Canadian Person. In
addition, pursuant to the Agreement Among, each International Manager has agreed
that, as part of the distribution of the shares of Class A Common Stock offered
in the International Offering, (a) it is not purchasing any of such shares for
the account of any U.S. or Canadian Person and (b) it has not offered or sold,
and will not offer, sell, resell or deliver, directly or indirectly, any of such
shares or distribute any prospectus relating to the International Offering
within the United States or Canada or to any U.S. or Canadian Person. The
foregoing limitations do not apply to stabilization transactions or to certain
other transactions specified in the Underwriting Agreements and the Agreement
Among, including: (i) certain purchases and sales between the U.S. Underwriters
and the International Manager; (ii) certain offers, sales, resales, deliveries
or distributions to or through investment advisors or other persons exercising
investment discretion; (iii) purchases, offers or sales by a U.S. Underwriter
who is also acting as an International Manager or by an International Manager
who also is acting as a U.S. Underwriter and (iv) other transactions
specifically approved by the U.S. Underwriters and International Managers. As
used herein, "U.S. or Canadian Person" means any resident or citizen of the
United States or Canada, any corporation, pension, profit sharing or other trust
or other entity organized under or governed by the laws of the United States or
Canada or any political subdivision thereof (other than the foreign branch of
any United States or Canadian Person), any estate or trust the income of which
is subject to United States or Canadian federal income taxation regardless of
the source of its income, and any United States or Canadian branch of a person
other than a United States or Canadian Person. The term "United States" means
the United States of America (including, the states thereof and the District of
Columbia) and its territories, its possessions and other areas subject to its
jurisdiction. The term "Canada" means the provinces of Canada, its territories,
its possessions and other areas subject to its jurisdiction.
Pursuant to the Agreement Among, sales may be made among the U.S. Underwriters
and the International Managers of such number of shares of Class A Common Stock
as may be mutually agreed. The price of any shares so sold shall be the public
offering price as then in effect for Class A Common Stock being sold by the U.S.
Underwriters and International Managers, less an amount not greater than the
selling concession unless otherwise determined by mutual agreement. To the
extent that there are sales pursuant to the Agreement Among, the number of
shares initially available for sale by the U.S. Underwriters and the
International Managers may be more or less than the amount specified on the
cover page of this Prospectus.
Each International Manager has represented and agreed that: (i) it has not
offered or sold and, prior to the date six months after the date of issue of the
shares of Class A Common Stock,
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will not offer or sell any shares of Class A Common Stock to persons in the
United Kingdom except to persons whose ordinary activities involve them in
acquiring, holding, managing or disposing of investments (as principal or agent)
for the purpose of their business or otherwise in circumstances which have not
resulted and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulations 1995; (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
issue of the Class A Common Stock if that person is of a kind described in
Article 11(3) of the Financial Services Act 1986 (Investment Advertisements)
(Exemptions) Order 1995.
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 Representatives have informed the Company that the Underwriters do not
intend to confirm sales of Class A Common Stock to accounts over which they
exercise discretionary authority.
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 180 days 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 of the Class A Common Stock has been
determined by negotiations among the Company and the Underwriters. Among the
principal factors considered in making such determination were the past and
present operations of the Company, the historical results of operations of the
Company and the trend of its revenues and earnings, the prospects for future
earnings of the Company, an assessment of the Company's management, the history
of and prospects for the industry in which the Company competes, the prices of
similar securities of generally comparable companies and the general condition
of the securities markets at the time of the Offering. 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 has applied 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 may consist of bids or purchases for the purpose of
pegging, fixing or maintaining the price of the Class A Common Stock.
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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
herein.
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 Underwriters makes any representation that
the Representatives will engage in such transactions or that such transactions,
once commenced, will not be discontinued without notice.
At the Company's request, the U.S. Underwriters have reserved up to ____% of the
shares for sale at the initial public offering price to certain of the Company's
employees. The number of shares available for sale to the general public will
be reduced to the extent these individuals purchase such reserved shares. Any
reserved shares not purchased will be offered by the U.S. Underwriters to the
general public on the same basis as the other shares offered hereby.
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,
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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 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 connectivity 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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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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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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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 without 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 information. Switches allow
local telecommunications service providers to connect calls directly to their
destination, while providing advanced features and recording
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<PAGE>
connection information for future billing. Nortel DMS-500, Cascade, Titan 3/1
and Alcatel 1/0 are brand names for switches and related equipment.
Switched access. 1) Method to test telecommunications circuits using
electromechanical 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.
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<PAGE>
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 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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<TABLE>
<CAPTION>
ELECTRIC LIGHTWAVE, INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
<S> <C>
Independent Auditors' Report.....................................................................F-1
Statements of Operations for the Years Ended December 31, 1994, 1995 and 1996
and for the Nine Months Ended September 30, 1996 and 1997 (unaudited).......................F-2
Balance Sheets at December 31, 1995 and 1996 and September 30, 1997 (unaudited)..................F-3
Statements of Cash Flows for the Years Ended December 31, 1994, 1995 and 1996
and for the Nine Months Ended September 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 Nine Months Ended
September 30, 1997 (unaudited)..............................................................F-5
Notes to Financial Statements....................................................................F-6
</TABLE>
96
<PAGE>
INDEPENDENT AUDITORS' REPORT
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 nine months ended
For the years ended December 31, September 30,
------------------------------------------------- --------------------------------
1994 1995 1996 1996 1997
-------------- ---------- ----------- ------------ -----------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Revenues $ 8,152 $ 15,660 $ 31,309 $ 24,965 $ 41,843
---------- ---------- ----------- ------------ -----------
Operating expenses:
Network access expenses 6,155 8,728 24,081 16,533 24,217
Sales and marketing expenses 4,534 5,704 8,462 6,303 8,716
Depreciation and amortization 2,476 7,064 7,192 4,997 7,601
Administrative services expenses 1,300 1,511 2,254 1,648 2,945
Other operating expenses 3,228 12,603 18,703 15,067 23,886
---------- ---------- ----------- ------------ -----------
Total operating expenses 17,693 35,610 60,692 44,548 67,365
---------- ---------- ----------- ------------ -----------
Loss from operations (9,541) (19,950) (29,383) (19,583) (25,522)
Interest expense, net 873 372 - - 513
---------- ---------- ----------- ------------ -----------
Net loss $ (10,414) $ (20,322) $ (29,383) $ (19,583) $ (26,035)
========== ========== =========== ============ ===========
</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, September 30,
-------------------------------- ---------------
1995 1996 1997
----------- ----------- -----------
(Unaudited)
<S> <C> <C> <C>
ASSETS:
Current assets:
Cash $ 143 $ 611 $ 1,147
Trade receivables, net 3,097 4,610 10,187
Other receivables 45 8,329 85
Other current assets 168 224 306
----------- ----------- -----------
Total current assets 3,453 13,774 11,725
----------- ----------- -----------
Property, plant and equipment 127,297 189,334 249,499
Less accumulated depreciation and
amortization (11,307) (17,337) (23,144)
----------- ----------- -----------
Property, plant and equipment, net 115,990 171,997 226,355
Other assets 9,458 9,885 10,490
----------- ----------- -----------
Total assets $ 128,901 $ 195,656 $ 248,570
=========== =========== ===========
LIABILITIES and SHAREHOLDER'S EQUITY (DEFICIENCY)
Current liabilities:
Accounts payable $ 18,596 $ 18,892 $ 12,427
Taxes other than income taxes 1,577 2,329 4,996
Other current liabilities 1,177 2,493 2,036
------------ ----------- -----------
Total current liabilities 21,350 23,714 19,459
------------ ----------- -----------
Deferred credits 1,313 1,435 1,793
Capital lease obligation - - 10,374
Deferred income taxes payable 2,628 5,826 14,522
Due to Citizens Utilities Company 64,941 155,395 219,171
Shareholder's equity (deficiency) 38,669 9,286 (16,749)
------------ ----------- -----------
Total liabilities and shareholder's
equity (deficiency) $ 128,901 $ 195,656 $ 248,570
=========== =========== ===========
</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 nine months ended
For the years ended December 31, September 30,
--------------------------------------------- --------------------------
1994 1995 1996 1996 1997
---------- ---------- ---------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flow from operating activities:
Net loss $ (10,414) $ (20,322) $ (29,383) $ (19,583) $ (26,035)
Adjustments to reconcile net loss
to net cash used for operating
activities:
Depreciation and
amortization 2,476 7,064 7,192 4,997 7,601
Administrative services expenses
charged by Citizens 1,300 1,511 2,254 1,648 2,945
Changes in operating assets and liabilities:
Receivables (805) (1,698) (9,797) (10,075) 2,667
Accounts payable and other
accrued liabilities 3,056 10,444 295 (10,427) (6,465)
Taxes other than income taxes 520 967 765 1,681 2,667
Other (230) 464 (219) 1,320 (1,420)
--------- ---------- --------- --------- ---------
Net cash used for operating activities (4,097) (1,570) (28,893) (30,439) (18,040)
--------- ---------- --------- --------- ---------
Cash flow used for investing activities:
Capital expenditures (60,774) (16,129) (59,169) (47,840) (48,717)
--------- ---------- --------- --------- ---------
Cash flow from financing activities:
Citizens fundings 67,636 26,862 88,530 78,626 67,293
Repayment of debt (2,729) (9,111) - - -
--------- ---------- --------- --------- ---------
Net cash provided by financing
activities 64,907 17,751 88,530 78,626 67,293
--------- ---------- --------- --------- ---------
Change in cash 36 52 468 347 536
Cash at beginning of period 55 91 143 143 611
--------- ---------- --------- --------- ---------
Cash at end of period $ 91 $ 143 $ 611 $ 490 $ 1,147
========= ========= ========= ========= =========
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 nine months ended September 30, 1997 (unaudited)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional Shareholder's
------------------------- -------------------- Paid-in- Equity
Shares Amount Shares Amount Capital Deficit (Deficiency)
------ -------- ------- -------- -------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance January 1, 1994 23 $ - 1 $ - $ 19,000 $ (9,850) $ 9,150
Issuance of preferred
shares to Citizens 76 - - - 57,255 - 57,255
Net loss - - - - - (10,414) (10,414)
------- -------- ------- -------- --------- --------- ---------
Balance December 31, 1994 99 - 1 - 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 99 - 1 - 79,255 (40,586) 38,669
Conversion of preferred
stock to common stock (99) - 99 - - - -
Net loss - - - - - (29,383) (29,383)
------- -------- ------- -------- --------- --------- ---------
Balance December 31, 1996 - - 100 - 79,255 (69,969) 9,286
Net loss (unaudited) - - - - - (26,035) (26,035)
------- -------- ------- -------- --------- --------- ---------
Balance September 30, 1997
(unaudited) - $ - 100 $ - $ 79,255 $ (96,004) $ (16,749)
======== ======== ======= ======== ========= ========= =========
</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 September 30, 1997 and for the nine months ended
September 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. In October 1997, the Company
obtained a commitment for a revolving Credit Commitment (see
note 8).
(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
$2,130,000 at December 31, 1995, 1996 and September 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 September 30, 1997 and for the nine months ended
September 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 September 30, 1997 and for the nine months ended
September 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 or 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
Net loss per share is not presented because it is not
meaningful. Weighted average share and per share amounts will
be presented after the recapitalization of the Company
contemplated as part of its Offering (see last paragraph
of Note 5). Net loss per common and common equivalent share
will be 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. Pursuant to SAB No. 83,
all stock issued within one year of the Offering at less than
the offering price and all 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. The
F-8
<PAGE>
ELECTRIC LIGHTWAVE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of September 30, 1997 and for the nine months ended September
30, 1997 and 1996 is unaudited)
application of SAB No. 83 will have the effect of increasing
outstanding shares by 535,000 for all periods.
j) Interim Financial Information
The financial statements and notes related thereto as of
September 30, 1997 and for the nine months ended September 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 September 30, 1997 are as follows:
<TABLE>
<CAPTION>
------------------ (in thousands) ------------------
December 31, September 30,
--------------------------------- -------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Telecommunications networks $ 80,501 $ 113,997 $ 134,204
Electronics and related equipment 14,997 20,417 21,264
Office equipment, leasehold improvements and
other 4,414 11,201 12,842
Construction work in progress 24,980 37,433 77,448
Inventory 2,405 6,286 3,741
------------- ------------- -------------
Property, plant and equipment 127,297 189,334 249,499
Accumulated depreciation and amortization (11,307) (17,337) (23,144)
------------- ------------- --------------
Property, plant and equipment, net $ 115,990 $ 171,997 $ 226,355
============= ============= =============
</TABLE>
Telecommunications networks include a capital lease at September 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 September 30, 1997 and for the nine months ended
September 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 it is expected that, the Company may
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. The Company intends to enter into a federal, state and local
tax sharing agreement with Citizens whereby the Company's income tax
liability (federal liability only in the event the Company is included
in Citizens' federal consolidated income tax group) would be computed
on a stand alone basis. Additionally, upon completion of the Offering,
if the Company is no longer included in Citizens consolidated federal
income tax returns, 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,
F-10
<PAGE>
ELECTRIC LIGHTWAVE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 AND 1996
(Information as of September 30, 1997 and for the nine months ended
September 30, 1997 and 1996 is unaudited)
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. 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. On June 14, 1996 there was a reverse stock
split of common stock in the amount of 100 for 7,600,536. The split
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. All share and per share data
have been restated to reflect the reverse stock split.
Prior to the completion of the Offering, the Company intends to amend
its Certificate of Incorporation to change its authorized capital stock
to 180 million shares, including 110 million shares of Class A Common
Stock, $.01 par value per share, 60 million shares of Class B Common
Stock, $.01 par value per share, and 10 million 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 411,650 for one. Upon completion of the Offering of 10
million shares of Class A Common Stock to the public assuming no
exercise of the underwriter overallotment option, 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 97.5% of the voting
control of the Company (97.16% 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 September 30, 1997 and for the nine months ended
September 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 December 31, Nine months ended
------------------------ September 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 67,293
Acquisition of preferred stock (57,255) - - -
Deferred income taxes (519) (1,160) (3,198) (8,696)
Interest 2,466 2,619 2,868 2,234
Administrative services fees 1,300 1,511 2,254 2,945
------------- -------------- ---------- -----------
Balance end of period $ 35,109 $ 64,941 $ 155,395 $ 219,171
============= ============== ========== ===========
</TABLE>
Prior to the completion of the Offering, $119.2 million of the amount
due to Citizens as of September 30, 1997 will be contributed to
additional paid-in-capital and the remaining $100 million will be
repaid with the proceeds from the Credit Commitment (see Note 8). 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.
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 $7.6 million in 1996 representing the cost of the
Company's usage of these long-haul services plus 5%. This arrangement
with Citizens was replaced effective May 1, 1997 with a 24-month term
agreement which removed the 5% additional fee.
Stock Plans
At December 31, 1996, Company employees participated in two Citizens
stock based compensation plans which are described below. The Company
applies APB Opinion No. 25 and related interpretations in accounting
for the Citizens employee stock plans. Accordingly, no compensation
cost has been recognized in the financial statements for options issued
pursuant to the MEIP or ESPP. The following tables reflect MEIP and
ESPP information for Company employees and exclude full time employees
and officers of Citizens. Had the Company determined compensation cost
based on the fair value at the grant date for the MEIP and ESPP under
SFAS 123, the Company's pro forma net loss would have been as follows:
<TABLE>
<CAPTION>
($ in thousands) 1995 1996
-------------------------------------------------- ------------ ----- ------------
<S> <C> <C>
Net loss As reported $ (20,322) $ (29,383)
Pro forma $ (20,343) $ (29,474)
</TABLE>
F-12
<PAGE>
ELECTRIC LIGHTWAVE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 AND 1996
(Information as of September 30, 1997 and for the nine months ended
September 30, 1997 and 1996 is unaudited)
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 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 Outstanding Options Exercisable
------------------------------------------------------------------------------------------------
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>
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
F-13
<PAGE>
ELECTRIC LIGHTWAVE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 AND 1996
(Information as of September 30, 1997 and for the nine months ended
September 30, 1997 and 1996 is unaudited)
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 or 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.
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 September 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 average 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.
F-14
<PAGE>
ELECTRIC LIGHTWAVE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 AND 1996
(Information as of September 30, 1997 and for the nine months ended
September 30, 1997 and 1996 is unaudited)
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:
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 $79.3 million
and certain commitments have been entered into in connection therewith.
Contingencies
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.
(8) Subsequent Events:
Credit Commitment
In October 1997, the Company arranged for a bank commitment for a
five-year $400 million revolving Credit Commitment. Citizens has agreed
to guarantee all of the Company's obligations under the Credit
Commitment and effective with the Offering, the Company has agreed to
pay Citizens a guarantee fee equal to 3.25% per annum of the average
balance outstanding under the facility. Concurrent with the completion
of the Offering, the Company intends to draw down enough funds to repay
the balance of all amounts due to Citizens at the time of the Offering
(see Note 6).
F-15
<PAGE>
ELECTRIC LIGHTWAVE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 1994, 1995 and 1996
(Information as of September 30, 1997 and for the nine months ended September
30, 1997 and 1996 is unaudited)
Equity Incentive Plan
In October 1997, the Board of Directors adopted the 1997 Equity
Incentive Plan ("the plan"), which authorizes, among other things, the
grant of incentive stock options, nonqualified stock options, stock
appreciation rights or combinations thereof and restricted stock. The
exercise price for such awards shall be determined by the Compensation
Committee of the Board of Directors at the date of grant. The exercise
period for such awards is generally 10 years from the date of grant.
The Company has reserved 4,170,600 shares for issuance under the terms
of the plan.
Concurrent with the effective date of the Offering, the Company will
grant stock options at the Offering price to certain officers and
employees for 2,316,000 shares of Class A Common Stock exercisable at
the Offering price and will grant certain officers and employees
535,000 restricted shares of Class A Common Stock.
Indefeasible Right to Use
In October, 1997, the Company entered into a 20 year indefeasible right
to use contract for 24 optical fibers with an unrelated third party for
approximately $50.2 million. The third party intends to construct a
fiber optic communications system linking Portland, Boise, Salt Lake
City, Las Vegas and Los Angeles. The network is scheduled to be
completed by February 28, 1999 and will have approximately 1,620 route
miles.
F-16
<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 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 OFFERED HEREBY IN ANY JURISDICTION WHERE, OR TO ANY
PERSON TO WHOM, IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY 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................................................ 22
Use Of Proceeds........................................................... 23
Dividend Policy........................................................... 23
Dilution.................................................................. 24
Capitalization............................................................ 25
Selected Financial and Operating Data..................................... 26
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 28
Business.................................................................. 36
Government Regulation..................................................... 54
The Local Telecommunications Services Industry............................ 59
Management................................................................ 61
Relationship With Citizens................................................ 70
Securities Ownership...................................................... 75
Description of Capital Stock.............................................. 76
Shares Eligible for Future Sale........................................... 78
Certain Tax Considerations................................................ 80
Underwriting.............................................................. 83
Legal Matters............................................................. 87
Experts................................................................... 87
Additional Information.................................................... 87
Glossary.................................................................. 89
Index to Financial Statements............................................. 99
</TABLE>
UNTIL , 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE CLASS A COMMON STOCK OFFERED HEREBY, 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.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
10,000,000 SHARES
[LOGO]
ELECTRIC LIGHTWAVE, INC.
CLASS A COMMON STOCK
---------------
PROSPECTUS
, 1997
---------------
U.S. Underwriters
LEHMAN BROTHERS
MERRILL LYNCH & CO.
MORGAN STANLEY DEAN WITTER
DEUTSCHE MORGAN GRENFELL
International Managers
LEHMAN BROTHERS
MERRILL LYNCH INTERNATIONAL
MORGAN STANLEY DEAN WITTER
DEUTSCHE MORGAN GRENFELL
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<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 $ 62,728
registration fee.......................
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.................. 7,879
-----------
TOTAL.................................. $255,607
===========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
As authorized by Section 145 of the General Corporation Law of
Delaware, Electric Lightwave, Inc. (the "Company") has agreed to indemnify each
director and officer of the Company 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, in which he is involved by
reason of the fact that he is or was a director or officer of the Company 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 the Company 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 the Company, 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 the Company unless the Court of Chancery of Delaware
determines otherwise.
Article Seventh of The Company's Certificate of Incorporation provides
that no director of the Company shall be personally liable to the Company 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 the Company or its shareholders, (ii) for acts or omissions not in
good faith or which involve intentional 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.
The Company's By-Laws provide that the Company shall indemnify its
officers and directors to the fullest extent permitted by the General
Corporation Law of Delaware.
II-1
<PAGE>
The Company participated in the directors' and officers' insurance
coverage of Citizens Utilities Company relating to loss, liabilities and
expenses incurred in connection with any legal proceeding arising from his or
her being or having been a director or officer of the Company.
The Company has agreed to indemnify and hold harmless Citizens and its
other subsidiaries and their directors, officers, employees and agents from all
losses, liabilities and costs and expenses resulting from liabilities of the
Company or material breaches by the Company arising out of the offering of the
shares of Class A Common Stock contemplated by this registration statement.
Citizens has undertaken a reciprocal obligation to indemnify the Company and its
directors, officers, employees and agents against losses, liabilities, costs and
expenses resulting from liabilities of Citizens or material breaches by Citizens
arising out of such offering.
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-6.
(b) FINANCIAL STATEMENT SCHEDULES
Schedule II: Valuation and Qualifying Accounts
All other 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 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
II-2
<PAGE>
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. 5 to the registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Stamford, State of Connecticut, on November 3, 1997.
ELECTRIC LIGHTWAVE, INC.
/s/Daryl Ferguson
-------------------------------
By: Daryl Ferguson
Title: Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Amendment No. 5 to the registration statement has been signed by the following
persons in the capacities and on the dates indicated.
SIGNATURE TITLE(S)
--------- --------
Chief Executive Officer, Vice November 3, 1997
/s/Daryl A. Ferguson Chairman and Director
- ---------------------------
Daryl A. Ferguson
President, Chief Operating November 3, 1997
*David B. Sharkey Officer and Director
- ---------------------------
David B. Sharkey
Vice President, Chief
Financial Officer and November 3, 1997
/s/Robert J. DeSantis Treasurer
- ---------------------------
Robert J. DeSantis
*Kerry Rea Vice President and Controller November 3, 1997
- ---------------------------
Kerry Rea
*Leonard Tow Chairman of the Board November 3, 1997
- ---------------------------
Leonard Tow
*Stanley Harfenist Director November 3, 1997
- ---------------------------
Stanley Harfenist
*Robert A. Stanger Director November 3, 1997
- ---------------------------
Robert A. Stanger
II-4
<PAGE>
*Maggie Wilderotter Director November 3, 1997
- ---------------------------
Maggie Wilderotter
*By__/s/Robert J. DeSantis
- ---------------------------
Attorney-in-fact
II-5
<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-6
<PAGE>
EXHIBIT NO. DESCRIPTION
10.12* Bank Credit Agreement 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 Fee Agreement dated as of ___________, 1997
between the Company and Citizens Utilities Company
10.17** Pre-Construction IRU Agreement between the Company and FTV
Communications, LLC dated October 16, 1997
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.
II-7
<PAGE>
SCHEDULE II
Electric Lightwave, Inc.
Valuation and Qualifying Accounts
($ in thousands)
<TABLE>
<CAPTION>
Balance at Charged to Charge to
beginning Cost and other Balance at end
Accounts of period Expense accounts Deductions of period
- --------------------------------- ---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
1994:
Allowance for doubtful accounts $ - (36) - - $ (36)
Deferred income taxes valuation
allowance $ (3,442) - (3,603) - $ (7,045)
1995:
Allowance for doubtful accounts $ (36) (111) - 72 $ (75)
Deferred income taxes valuation
allowance $ (7,045) - (7,063) - $ (14,108)
1996:
Allowance for doubtful accounts $ (75) (3,010) - 1,919 $ (1,166)
Deferred income taxes valuation
allowance $ (14,108) - (10,240) - $ (24,348)
</TABLE>
II-8
<PAGE>
EXHIBIT 23.1
The Board of Directors and Stockholder
Electric Lightwave, Inc.:
The audits referred to in our report dated September 4, 1997, included the
related financial statement schedule as of December 31, 1996, and for each of
the years in the three-year period ended December 31, 1996, included in the
registration statement. This financial statement schedule is the responsibility
of the Company's management. Our responsibility is to express an opinion on
this financial statement schedule based on our audits. In our opinion, this
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
We consent to the use of our reports included herein and to the reference to our
firm under the heading "Summary Financial and Operating Data," "Selected
Financial and Operating Data" and "Experts" in the prospectus.
KPMG Peat Marwick LLP
New York, New York
October 31, 1997
