<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934
Date of Report (Date of earliest event reported) July 6, 1998
ADVANCED COMMUNICATIONS GROUP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 001-13875 76-0549396
--------------- ---------------------- ------------------
(State or other Commission File Number (IRS Employer
jurisdiction of Identification No.)
incorporation)
390 South Woods Mill Road, Suite 150, St. Louis, Missouri 63017
- --------------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (314) 205-8668
-------------------------
------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE> 2
Item 5. Other Events
On July 9, 1998, Advanced Communications Group, Inc. (the "Company")
mailed the following documents to shareholders of record as of the close of
business on June 3, 1998:
* Report to Stockholders dated July 6, 1998 (the "Report");
* Notice of Annual Meeting dated July 9, 1998 (the "Notice");
* Proxy Statement dated July 9, 1998 (the "Proxy Statement"); and
* Form of Proxy for Annual Meeting of Stockholders (the "Form of
Proxy").
The Report, the Notice, the Proxy Statement and the Form of Proxy were
prepared in connection with the Company's first Annual Meeting of Stockholders
scheduled to be held on July 29, 1998 at the time and at the location set forth
in the Notice, the Proxy Statement and the form of Proxy.
The Report is filed as Exhibit 99 hereto and is incorporated into this
Item 5 by reference as fully and as completely as if set forth in its entirety
in this Item 5. The Notice, the Proxy Statement and the Form of Proxy were filed
with the Commission on July 9, 1998 on Schedule 14A.
<PAGE> 3
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
ADVANCED COMMUNICATIONS GROUP, INC.
By: /s/ Richard P. Anthony
----------------------------------------
Name: Richard P. Anthony
----------------------------------------
Title: Chairman of the Board, President and
----------------------------------------
Chief Executive Officer
----------------------------------------
Date: July 9, 1998
<PAGE> 4
EXHIBIT INDEX
These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of
Regulation S-K.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
1 Omitted--inapplicable
2 Omitted--inapplicable
4 Omitted--inapplicable
16 Omitted--inapplicable
17 Omitted--inapplicable
20 Omitted--inapplicable
23 Omitted--inapplicable
24 Omitted--inapplicable
27 Omitted--inapplicable
99 Report to Stockholders dated July 6, 1998
</TABLE>
<PAGE> 1
ACG CORPORATION LOGO
REPORT TO STOCKHOLDERS
JULY 6, 1998
<PAGE> 2
<TABLE>
CONTENTS
<CAPTION>
PAGE
----
<S> <C>
Company Profile............................. 1
Letter to Shareholders...................... 2
Business Strategy........................... 4
Selected Financial Data..................... 7
Management's Discussion and Analysis........ 8
Index to Financial Statements............... 13
Corporate Information....................... 32
</TABLE>
<PAGE> 3
COMPANY PROFILE
Advanced Communications Group, Inc. and its subsidiaries (the
"Company") is a rapidly growing regional competitive local exchange
carrier ("CLEC") that provides an integrated portfolio of
telecommunications services in selected service areas of Southwestern
Bell Telephone Company ("Southwestern Bell") and U S WEST
Communications, Inc. ("U S WEST"). The Company offers a full range
of telecommunications services, including local and long distance
services, Internet access and cellular services, to residential
customers and to small and medium-sized business customers primarily
in Kansas, Minnesota, Nebraska, North Dakota, Oklahoma, South Dakota,
and Texas.
The Company owns and operates a telecommunications network that
includes six digital tandem switches located in Kansas, Oklahoma,
South Dakota, and Texas. The Company also holds a 49% interest in
KINNET, which operates one of the largest fiber optic networks in
Kansas, covering over 880 route miles, and utilizes a Northern
Telecom DMS 100/200 Switch. KINNET is currently completing a network
buildout, which will increase the size of its network to
approximately 1,417 miles. The Company plans to deploy additional
switching infrastructure in several of its current markets over the
next 24 months.
ACG completed its initial public offering ("IPO") of its common
stock, par value $.0001 per share ("Common Stock") on February 18,
1998. Cash proceeds from the offering, net of offering costs, were
$99.9 million. Of this amount, $84.1 million was used to pay the cash
portion of the acquired companies, $3.6 million was used to retire
debt of the Company and the Acquired Companies, and $1.75 million was
paid to a stockholder for a five-year non-compete agreement. In
connection with the IPO, the Company simultaneously acquired all of
the outstanding capital stock of Great Western Directories, Inc.
("Great Western"), Valu-Line of Longview, Inc. ("Valu-Line"),
Feist Long Distance Service, Inc. ("Feist"), FirsTel, Inc.
("FirsTel") and Tele-Systems, Inc. ("Tele-Systems"),
substantially all of the assets of Long Distance Management II, Inc.
("LDM II"), Long Distance Management of Kansas, Inc. ("LDM of
Kansas"), The Switchboard of Oklahoma City, Inc. ("Switchboard"),
and National Telecom, a proprietorship, and 49% of the outstanding
capital stock of KIN Network, Inc. ("KINNET") (collectively
"Acquisitions" or "Acquired Companies").
1
<PAGE> 4
LETTER TO SHAREHOLDERS
To Our Stockholders,
At the time of this mailing, Advanced Communications Group, Inc. will have
just completed its first full quarter of operations and will have been
operating for just over 130 days since its initial public offering. During this
time, we have successfully integrated and leveraged the operations of the nine
companies acquired in connection with the IPO to create a unified enterprise.
This unique roll-up strategy has placed ACG years ahead of where the Company
would be, had we undertaken a traditional start-up strategy. Although we have
been operating for only a short period of time, I feel it is important to take
this opportunity to provide you with this report on our progress.
I am pleased to report on the following achievements in our first days of
operations:
* We achieved strong first-quarter operating results, continuing to
maintain positive EBITDA. First quarter pro forma revenues were $32.2
million, an increase of 17 percent from the $27.5 million in the first
quarter of 1997. First quarter pro forma EBITDA was $5.0 million. We are
currently EBITDA positive--a significant achievement in our industry.
* We increased the number of our local access lines in service to 26,893 at
March 31, 1998, from the 18,270 we had installed at year end 1997.
* Led by our sales and marketing management team, we increased our
quota-bearing sales force to 280 people and opened 20 sales offices. Our
sales and marketing leadership team not only have proven track records of
outstanding performance in telecommunications sales, but they also have
the energy and vision that has already been manifested through the growth
of our customer base.
* We have begun to cross-sell telecommunications services to our yellow
pages customers using that sales force to augment our telecommunications
sales force. Our publishing division has established relationships with
over 40,000 yellow pages advertising customers. By leveraging these
existing relationships, ACG has the opportunity to make an immediate
impact on growing our customer base.
* We have made some outstanding additions to our management team in all
functional areas of the Company. They have the skills and experience to
play in the big leagues. Forty-two of the Company's key management, and
four senior members of KINNET, participated in an intense three day
DesignShop, during which we designed an organization and created the
business rule requirements for an Operations Support System (OSS) which
will allow us to make the transition to a more efficient company, deploy
switches, products, and services quickly, as well as better serve our
customers. We are well on the way to selecting a new OSS and should begin
deployment of its initial elements in the third quarter.
2
<PAGE> 5
* During the past 130 days, we have also continued to focus on building the
infrastructure which will allow us to meet the scale and scope of
operations anticipated in our business plan and which will allow us to
become a successful facilities based integrated communications service
provider. Specifically, we have a) centralized cash management, b)
installed a new general ledger system that will allow us to consolidate
all accounting by the fourth quarter, c) implemented a single sales
compensation plan and d) consolidated marketing, and sales training
across the entire company.
We will continue our "Five Smarts" strategy by aggressively reselling
services until we have sufficient market share in service areas to justify the
capital deployment. So far, this strategy has enabled us to minimize capital
expenditures and deployment risk while still allowing us to grow our customer
base. We expect that by the end of the third quarter our customer base in
select markets will have reached a critical mass that will enable us to convert
to a facilities-based operations.
Our goal is to maximize value to our customers, employees and stockholders.
On the following pages we have outlined our plan, which I believe will allow us
to accomplish this goal. We are in the midst of a very dynamic
telecommunications environment with significant opportunities. Today, I am
enthusiastic about the Company's prospects because I have a great deal of
confidence in the ability of all our employees.
Thank you for your support.
/s/ Richard Anthony
Richard Anthony
Chairman of the Board and
Chief Executive Officer
3
<PAGE> 6
BUSINESS STRATEGY
The Company believes that the ongoing deregulation of the telecommunications
industry has created significant opportunities for companies that offer an
integrated bundle of services at prices below those offered by incumbent
service providers. The Company's objective is to strengthen its market position
within its markets by focusing on underserved customers in small and
medium-sized markets. By utilizing a combination of leased and owned network
facilities the Company believes it has a competitive advantage over incumbent
carriers and other providers against which the Company competes. The Company
intends to pursue its strategy of offering a bundle of "one-stop" integrated
telecommunications services tailored to its customers' specific requirements
and needs.
The Company's objective is to become a leading provider of integrated
telecommunications services primarily to businesses in Kansas, Minnesota,
Nebraska, North Dakota, Oklahoma, South Dakota and Texas and a significant
provider of those services in Arkansas, Colorado and Montana (the "Region").
The Company believes that it can achieve those goals with the following
strategy:
PLAN SMART
* Focus on small and medium-sized businesses, residential customers and
select vertical market segments in small to mid-sized cities in the
Region. The Company believes that competition from other CLECs and ILECs
is less intense in these areas because, in many cases, the ILECs have
reduced their efforts to serve and defend these smaller territories in
response to the competitive threat in their major market cities. In
addition, by focusing its sales efforts in territories served by ILEC
central offices where collocation is a viable economic alternative, the
Company believes it can build a loyal customer base through the resale of
local services prior to building the infrastructure necessary to support
facilities-based local service.
SELL SMART
* Sell into established customer relationships by marketing local telephone
services to the Company's existing yellow page and long distance
customers. Because the Company only recently began to offer additional
telecommunications services to its long distance customers, only a small
portion of these customers has been targeted to subscribe to the
Company's local, Internet access or cellular services. In addition, the
Company will begin to offer its bundle of telecommunications services to
the approximately 70,000 yellow page customers to whom it has access. The
Company believes that it has a substantial reservoir of prospective
business customers who are already familiar with some aspects of its
services.
4
<PAGE> 7
* Bundle services to bring value to the Company's customers, increase total
revenue per customer, reduce selling costs and minimize customer churn.
The Company currently bundles and bills local, long distance, and
cellular services and believes it can enhance its overall margins by
combining its yellow page and Internet services with these traditional
telecommunications services.
* Offer enhanced services that have less competition and higher margin
potential, such as high speed data transport, Internet access, Web Page
design and support, and integrated voice, data and video communications
services.
BUILD SMART
* Predicate growth strategies on the recognition that network capacity is
increasingly becoming a commodity. By first focusing on acquiring
customers through resale of local, long distance, cellular and Internet
services, the Company believes that it can secure customer relationships,
produce a consistent revenue stream, and evolve an economic strategy for
serving customers.
* The Company currently resells the network facilities of ILECs to provide
local service to its customers. During 1999 and thereafter, the Company
will continue to focus on reselling local service, while at the same time
implementing a substantial effort to acquire unbundled loops and local
fiber. By interconnecting with the ILEC in its central office and
acquiring unbundled loops, the Company should be able to reduce its cost
of providing service and capture the additional revenue paid by
interexchange carriers ("IXCs") for local access. The Company should
also be able to further reduce its local and long distance costs by
acquiring rights to local and intercity fiber and other high bandwidth
capacity within the Region. By adding its own circuit and packet switches
to this bandwidth, the Company believes it can add value, offer new
products, and better control the quality of its service. Finally, where
economically advantageous, the Company intends to construct fiber and
other network facilities.
* The Company's service strategy includes not only developing network
facilities to directly serve customers, but also enhancing its
operational support system ("OSS") to provide network monitoring and
control, flow-through provisioning, customer care, and enhanced billing
functionality.
5
<PAGE> 8
GROW SMART
* Increase the Company's sales force to rapidly market the Company's
services in all targeted service areas and thereafter to expand into
other areas within the Region. The Company recognizes it has an
opportunity to expand its yellow page base into other market areas as
well as to expand its service offering with World Pages, a specialized
Web site development and hosting service to which the Company has the
exclusive marketing rights in its service area.
* Evaluate attractive acquisition candidates in the Region. The Company
intends to target leading local companies whose customers can be added to
the Company's existing network without significant expenditures for
infrastructure additions. By aggregating the traffic of several companies
with its existing network, the Company expects to increase the
utilization of its equipment, consolidate its buying power and enhance
its ability to negotiate more attractive contracts with third-party
suppliers of network services.
* Pursue the formation of additional strategic alliances with other yellow
page publishers, utility companies, cooperatives and others in order to
create marketing alliances that give the Company access to large, stable
customer bases to whom it can sell its bundle of telecommunications
services. The Company currently has a five-year strategic relationship
with Feist Publications, Inc. ("FPI"), a 20-year publisher of yellow
page directories in 15 markets in the Region, through which the Company's
telecommunications sales force has access to FPI's 29,000 yellow page
advertisers in the Region. The Company has another strategic relationship
that will allow it to solicit approximately 15,000 business customers of
PAM Oil, Inc. primarily in Idaho, Minnesota, Montana, North Dakota and
South Dakota. Finally, the Company and Northwestern Public Service
Company ("Northwestern") have entered into an agreement regarding the
possible creation of a strategic alliance that would permit the Company
to market its telecommunications services to that utility's approximately
100,000 electric and natural gas business and residential customers in
South Dakota and Nebraska.
SERVE SMART
* Provide not only the highest quality customer service but also become an
industry leader in the deployment of innovative technology and services.
The Company believes that by prudently using new technology and by
offering new services, especially enhanced data applications, it can
become a low cost provider, maintain high value for its customers and
differentiate itself from other commodity providers. These services will
include data transport services such as frame relay, transparent LAN,
Internet content, and other packet-based integrated multimedia services.
The Company's senior management team has considerable experience in
developing and deploying these services.
6
<PAGE> 9
<TABLE>
SELECTED FINANCIAL DATA
(In thousands, except per share data and "Other Data")
<CAPTION>
Pro Forma
Fiscal Year Pro Forma Three Actual Three
Ended<F1> Months Ended<F1> Months Ended<F2>
------------- ---------------------------- ----------------
December 31, March 31, March 31, March 31,
1997 1997 1998 1998
RESULTS OF OPERATIONS ------------ ------------ ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Telecommunications............. $46,045 $11,054 $13,766 $ 6,551
Directory...................... 43,247 16,474 18,429 9,183
------- ------- ------- -------
Total revenue.............. 89,292 27,528 32,195 15,734
Operating costs:
Cost of services............... 50,435 14,054 16,951 7,647
Selling, general and
administrative expenses...... 30,705 8,795 10,304 5,963
Depreciation and
amortization................. 9,306 2,293 2,344 1,202
Stock-based compensation....... 870 -- 1,760 1,760
------- ------- ------- -------
Income (loss) from
operations............... (2,024) 2,386 836 (838)
Other income (expense):
Other.......................... 253 45 58 30
Interest expense............... (775) (352) (392) (282)
Equity in losses of KINNET..... (854) (253) (154) (68)
------- ------- ------- -------
Income (loss) before income
taxes............................ (3,400) 1,826 348 (1,158)
Income tax expense................. 2,177 1,565 948 (34)
------- ------- ------- -------
Net income (loss).......... $(5,577) $ 261 $ (600) $(1,124)
======= ======= ======= =======
Basic and diluted earnings (loss)
per share........................ $ (.28) $ .01 $ (.03) $ (.07)
======= ======= ======= =======
<CAPTION>
FINANCIAL POSITION<F2>
March 31, 1998
--------------
<S> <C>
Net working capital............ $ 20,519
Total assets................... 172,055
Total debt..................... 18,611
Total equity................... 136,515
OTHER DATA
March 31, 1998
--------------
Business customers............. 31,415
Residential customers.......... 12,814
Local access lines in
service...................... 26,893
Directories distributed in
1997......................... 2,736,000
<FN>
- --------
<F1>The Company completed its initial public offering on February 18, 1998,
concurrently with the acquisition of nine operating companies and a 49%
interest in another company. The pro forma results for fiscal years 1996
and 1997, and the three months ended March 31, 1997 and 1998, were prepared
giving effect to the offering and the acquisitions as if they had occurred
on January 1, 1997. This pro forma financial information should be read in
conjunction with the pro forma financial statements included elsewhere in
this Report.
<F2>Actual results include the operation of the parent Company for the three
month period ended March 31, 1998, and the results of the acquired
companies only for the period February 18, 1998, to March 31, 1998.
Such information was derived from the unaudited financial statements
of the Company for the three months ended March 31, 1998, included
elsewhere in this report.
</TABLE>
7
<PAGE> 10
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial
statements, the notes thereto and the other financial data included elsewhere
in this Report. The Business Strategy section and the following discussion
contains certain forward-looking statements with respect to the Company's
expectations regarding its business. These forward-looking statements are
subject to certain risks and uncertainties described below which may cause
actual results to differ significantly from such forward-looking statements.
The Company expects to generate negative earnings before interest, income
taxes, depreciation and amortization ("EBITDA") while it focuses on further
development of its telecommunications services business and until it
establishes a sufficient revenue-generating customer base. There can be no
assurance that an adequate revenue base will be established. There can be no
assurance that it will achieve or sustain profitability or generate sufficient
EBITDA to meet its working capital, capital expenditures and debt service
requirements, which could have a material adverse effect on the Company's
business, operating results and financial condition.
The Company's viability, profitability and growth will depend upon its
ability to implement its business plan which will be subject to numerous risks,
many of which are outside of the Company's control, and any of which could
require substantial changes to its plans or otherwise alter the time frame or
budgets the Company currently contemplates. Such risks include (i) the risks of
unfavorable regulatory changes; (ii) identifying, financing and completing
suitable acquisitions; (iii) risks associated with developing its operational
support and back office systems; (iv) risks associated with entry into new
markets; (v) risks associated with recruiting and training new employees; and
(vi) risks typically associated with any business venture, such as
unanticipated costs and expenses. There can be no assurance that the
implementation of the Company's current business plan will be successful.
YEAR 2000
Many computer software systems, as well as certain hardware and equipment
containing date sensitive data, were structured to utilize a two-digit year
field, meaning, among other things, that they may not be able to properly
recognize dates in the year 2000. This could result in significant system and
equipment failures. 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 actually 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
resulting in any loss of such services, it could have a material adverse effect
on the Company's business, financial condition, results of operations and cash
flows. Unanticipated problems in any of the above areas, or the Company's
inability to implement solutions in a timely manner or to upgrade existing
systems as necessary, could have a material adverse impact on the ability of
the Company to reach its objectives and on its financial condition, results of
operations and cash flows. It is not possible to quantify the aggregate cost to
the Company with respect to customers and suppliers with Year 2000 problems.
The Company is currently in the planning stages of developing new data
processing systems throughout its organization for management, operating and
financial information.
OVERVIEW OF THE COMPANIES' SOURCES OF REVENUES AND EXPENSES
The Company derives its revenues primarily from the provision of
telecommunications services and the sale of advertising space in yellow page
directories.
Telecommunications Services Revenues and Price Declines. The Company's
telecommunications services principally include long distance and local
services, Internet access, cellular service and other enhanced services. Their
telecommunications revenues are derived principally from minutes of long
distance telecommunications traffic carried. The domestic revenue per minute
and domestic cost per minute have declined steadily over the last several
years, while the domestic billable minutes of use attributable to long distance
operations have increased substantially over the same period.
The Company generally prices its long distance services at a discount to
the primary carrier or carriers in each of its markets. The Company has
generally experienced and expects to continue to experience declining revenue
per minute in all of its markets as a result of increased competition; however,
due to technological innovation and substantial available transmission
capacity, transmission costs in the telecommunications industry have often
declined
8
<PAGE> 11
at a more rapid rate than prices. There can be no assurance that this
relationship will continue. Industry observers predict that, early in the next
decade, telephone charges will no longer be based on the distance a call is
carried. As a consequence, the Company could experience a substantial reduction
in its margins on long distance calls which, absent a significant increase in
billable minutes of traffic carried or charges for additional services, could
have a material adverse effect on the Company's financial position and results
of operations.
Local service revenues, which the Company expects to increase in future
periods, represent the resale at a discount of the local carrier services
provided primarily by Southwestern Bell and U S WEST. In most of the Company's
market areas, local service is sold on a flat monthly fee basis. Certain of the
subsidiaries of the Company have recently commenced reselling cellular service
in certain markets and the revenues generated to date from these activities
have not been material.
Yellow Page Publishing Revenues. Yellow page publishing revenues are
attributable to the sale of advertising space in the directories that serve its
17 market areas in Texas, three market areas in Oklahoma and three market areas
in California. Revenues are recognized when each directory is substantially
delivered. While the yellow page business is not seasonal, five of its
directories which have for the last several years accounted for approximately
one-third of its annual revenues are published in the first quarter. The gross
margin on these directories is generally significantly higher than other
directories published. Consequently, yellow page publishing, gross margin and
gross profit in the first quarter are usually higher than those in subsequent
quarters. Directories are typically published annually in each market area.
Increases in revenues have generally been attributable to increases in the
number and size of advertisements in the directories.
When the Company's publishing subsidiary, Great Western, expands into a new
yellow page market, it typically seeks to attract its targeted customers by
producing and publishing a full scale initial directory in which it gives away
advertising space. Thus on a first directory in a new market (the "prototype
year"), Great Western may have substantial expenses, depending on the size of
the market, with little or no offsetting revenues. During the last three fiscal
years, the expenses associated with the first publication of a directory in a
market have ranged from approximately $.5 million to $2.0 million, depending on
the size of the market. Great Western sells advertising in the second directory
in a market (the "first sold year"), after the advertisers have had an
opportunity to experience the reception of the new yellow page directory and
their advertisements in the marketplace. Generally, the Company is able to
convert the majority of the advertisers who receive free advertising in the
prototype directory into paying customers for the first sold year. In a new
market, however, the Company has no prior first-hand credit experience with its
advertising customers, and therefore usually has disproportionate bad debt
expense with respect to the directory for the first sold year. Once in a
market, Great Western may seek to increase its geographic coverage by expanding
outward from its initial service area.
Cost of Services--Telecommunications Services. The Company has an extensive
network that connects a number of cities in its service area and upon which it
can transmit its customers' long distance calls. These "on-net" facilities
include the Company's switches, a web of leased access trunks that connect
those switches to the local exchange carrier's switches, DS1 and DS3 lines that
connect certain high volume customers to the Company's switches and leased
lines from other long-haul carriers. Once a long distance call reaches one of
the Company's switches, it can be routed over the Company's network or, if the
Company does not have an "on-net" connection, over the network of another
long-haul carrier from which the Company purchases access. The bulk of the
Company's "off-net" termination services are provided by large long distance
companies with long haul transmission capabilities.
Because of its ownership interest in KINNET, the Company expects to
consolidate some of its traffic in KINNET's area of operations on the KINNET
network. Further, the Company expects that it will obtain pricing reductions
from KINNET with respect to the traffic that the Company consolidates on the
KINNET network.
The Company's cost of long distance services comprises the costs associated
with acquiring switched transmission and leased line capacity. Switched
transmission capacity is acquired on a per-minute basis (with volume discounts)
and is, therefore, a variable cost. Virtually all calls carried by the Company
must be originated or terminated over another carrier's facilities and access
charges must be paid to utilize those facilities. Termination, origination and
access charges on calls are paid by the Company to incumbent local exchange
carriers. Leased transmission capacity is typically acquired on a fixed cost
basis, generally involving fixed monthly payments regardless of usage levels.
Accordingly, once certain volume levels are reached, leased line capacity is
more cost effective than switched transmission capacity. The Company expects to
be able to obtain better pricing because of the substantial
9
<PAGE> 12
number of minutes of traffic generated by its subsidiaries on a combined basis.
Although the Company has entered into four take-or-pay agreements with other
carriers in order to maximize volume discounts, since their inception the
minimum usage levels under these contracts have been met, and the Company has
not incurred any obligation to make cash payments in lieu of usage under these
agreements.
At present the Company provides local services by reselling the local
services of other local exchange carriers at a discount from the prices charged
by those carriers to individual customers. The cost of providing such services
depends on the rates which the Company can negotiate from those carriers.
Cost of Services--Yellow Page Publishing. The principal components of cost
of service relate to sales commissions, paper and publishing costs, colorizing
advertisements and delivery expenses. The introduction of a new directory of
significant size would increase the Company's aggregate yellow page cost of
services. Great Western contracts with third parties for printing and
delivering its directories and routinely purchases its paper requirements from
third party suppliers.
Selling, General and Administrative Expenses. The Company sells its
telecommunications services and advertising space in its yellow page
directories primarily through commissioned sales personnel, advertising,
internal and external marketers and agents. Therefore, selling expenses consist
primarily of advertising and promotion costs, salaries and commissions of
employees and agents and expenses related to the provision of customer service.
RESULTS OF OPERATIONS
GENERAL
Prior to February 1998, Advanced Communications Group, Inc. had not
conducted any operations other than those relating to the IPO and the
Acquisitions. Consequently, the actual financial statements included herein
relate only to the parent company prior to February 18, 1998, but include the
results of the Acquired Companies for the period February 18, 1998 to March 31,
1998. Certain pro forma operating information is presented for comparative
purposes as if the IPO and the Acquisitions had occurred on January 1, 1997.
The pro forma financial information does not purport to represent the Company's
results of operations that would have actually occurred if the IPO and the
Acquisitions had in fact occurred on the date stated above. Since the Acquired
Companies were not under common control or management, historical combined
results of operations may not be comparable to, or indicative of, future
performance. This information should be read in conjunction with the unaudited
pro forma financial statements that reflect the results of operations of the
Acquired Companies and were derived from the respective Acquired Companies'
financial statements.
The following table sets forth, for the periods presented, certain pro
forma information relating to the operations of the Company, expressed as a
percentage of revenues, excluding stock-based compensation expense and the
nonrecurring litigation settlement:
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA THREE MONTHS ACTUAL THREE
YEAR ENDED ENDED MONTHS ENDED
------------ ------------------ -------------
DECEMBER 31, MARCH 31, MARCH 31,
1997 1997 1998 1998
------------ ----- ---- -------------
<S> <C> <C> <C> <C>
Telecom revenues................................. 51.6% 40.2% 42.8% 41.6%
Directory revenues............................... 48.4 59.8 57.2 58.4
----- ----- ----- -----
Total revenues........................... 100.0 100.0 100.0 100.0
Cost of services................................. 56.5 51.1 52.7 48.6
Selling, general and administrative expenses..... 34.4 31.9 32.0 37.9
Depreciation and amortization.................... 10.4 8.3 7.3 7.6
----- ----- ----- -----
Income from operations................... (1.3) 8.7 8.0 5.9
===== ===== ===== =====
</TABLE>
10
<PAGE> 13
PRO FORMA COMBINED RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31,
1997, COMPARED TO THE THREE MONTHS ENDED MARCH 31, 1998
Pro forma revenues for the three months ended March 31, 1998, increased
17.0% to $32.2 million from $27.5 million in the first quarter of 1997.
Revenues from telecommunication services were $13.7 million, or 42.8% of total
revenues, compared to $11.1 million and 40.2% of total revenues in 1997. The
increase in telecommunications revenues is due to increased local service
revenue as the Company implemented aggressive sales and marketing of local
services in addition to its traditional long-distance services. The Company did
not provide any local service in the first quarter of 1997, compared to first
quarter 1998 pro forma local service revenue of $2.2 million on approximately
27,000 local access lines in service at March 31, 1998. Pro forma directory
revenues increased 11.9% to $18.4 million from $16.5 million in the 1997 first
quarter. The Company distributed five directories in both the first quarter of
1998 and 1997. Approximately $1.0 million of the increase is due to higher
advertising revenue from recurring directories, and approximately $1.6 million
of the increase is due to the net impact of a larger directory distributed
during the first quarter of 1998 which was partially offset by another
directory that was completed in the 1997 first quarter but not in the first
quarter of 1998.
Pro forma cost of services for the three months ended March 31, 1998,
increased to $17.0 million from $14.1 million in 1997, an increase of 20.6%.
Pro forma cost of services as a percentage of total revenues was 52.7% in 1998
compared to 51.1% in 1997. Telecommunication services pro forma gross margin
was 30.0% in the first quarter of 1998 compared to 36.4% in 1997. The lower
gross margin percentage of the telecommunication segment in the first quarter
of 1998 is due to the aforementioned increase in local service revenues because
gross margin from local service is lower than long distance gross margin. The
Company is currently a reseller of local and other services, which
substantially increases costs. To improve margins, the Company ultimately plans
on becoming a facilities-based provider of local service in selected markets as
its customer base increases in those markets to justify investment in
facilities. The lower pro forma gross margin in the first quarter of 1998 is
also partially attributable to higher costs associated with directory
publications. The pro forma gross margin percentage from the directory
publishing division was 56.5% in the first quarter of 1998, a decrease of .9%
from 57.4% in 1997.
Pro forma selling, general and administrative expenses for the first
quarter ended March 31, 1998, increased to $10.3 million from $8.8 million in
1997. As a percentage of total revenues, pro forma selling and administrative
costs were 32.0% in the first quarter of 1998, and 31.9 % in 1997. The increase
is due primarily to the direct costs associated with the higher sales volume.
The Company expects that its selling, general and administrative costs as a
percentage of sales will increase as the Company undertakes more aggressive
sales and marketing programs to develop its businesses.
Stock-based compensation of $1.8 million was expensed in the three months
ended March 31, 1998, relating to 300,000 stock options issued in December
1997. The options vested equally over a three-month period beginning on the
date of the grant. This amount represents the remaining two thirds of the total
compensation expense expected to be realized based on the estimated fair market
value of the options on the date of the grant. The balance was recognized in
the fourth quarter of 1997.
Pro forma income tax expense was $.9 million in the first quarter of 1998
compared to $1.6 million in 1997. The decrease is due to lower taxable income
in 1998 than in 1997. The Company's effective tax rate is substantially higher
than statutory tax rates principally because amortization of certain intangible
assets is not deductible for tax purposes.
Pro forma net loss was $.6 million, or $.03 per share, in the three months
ended March 31, 1998, compared to pro forma net income of $.3 million, or $.01
per share in 1997 first quarter. The decrease is due primarily to the stock-
based compensation expense of $1.8 million. Excluding this item, net income for
the quarter ended March 31, 1998, would have been $.5 million, or $.02 per
share. The increase in net income excluding the stock-based compensation
expense is due to the increased income from the directory publishing division
offset partially by higher costs associated with local service revenue.
Pro forma earnings before interest, taxes, depreciation, amortization,
equity interest in KINNET and stock-based compensation (EBITDA) increased to
$5.0 million for the three months ended March 31, 1998, from $4.7 million for
the three months ended March 31, 1997. The increase is primarily due to
increases in earnings from both the directory and telecommunications
operations in 1998 offset partially by higher general and administrative costs
11
<PAGE> 14
associated with the Company's new organization structure. EBITDA is a measure
commonly used in the telecommunications industry and is presented to assist in
an understanding of the Company's operating results and is not intended to
represent cash flow or results of operations in accordance with generally
accepted accounting principals. EBITDA may not be comparable with other
similarly titled measures of other companies.
ACTUAL PERIOD ENDED MARCH 31, 1998
Actual results for the period ended March 31, 1998, include only activity
of the parent Company from January 1, 1998 to February 18, 1998. On February
18, the Company completed the Acquisitions and therefore, actual results
include only the activity of the Acquired Companies from February 18, 1998 to
March 31, 1998. For the period ended March 31, 1998, actual loss from
operations was $.8 million. Excluding the stock-based compensation of $1.8
million, $1.1 million net of tax, the Company had income from operations of $.9
million, or 5.9% of total revenues, and a net loss of $.1 million, or (.4%) of
total revenues. The decrease in income from operations and net income, excluding
the stock-based compensation expense, expressed as a percentage of revenues when
compared to pro forma results is due primarily to higher general and
administrative costs associated with the Company's new organization structure.
The Company had no operating revenue in 1997 and was engaged principally in
activities relating to the IPO and the acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital at March 31, 1998, was $20.5 million and its
ratio of current assets to current liabilities was 2.1 to 1.0. Total debt
outstanding was $18.6 million and its debt to equity ratio was approximately
one to seven.
On February 18, 1998, the Company completed its initial public offering and
simultaneously acquired nine operating companies and a 49% interest in another
company. Cash proceeds from the offering, net of offering costs, were $99.9
million. Of this amount, $84.1 million was used to pay the cash portion of the
acquired companies, $3.6 million was used to retire debt of the Company and the
Acquired Companies, and $1.75 million was paid to a stockholder for a five-year
non-compete agreement. Stockholders of the Acquired Companies that became
executive officers or directors of the Company upon the consummation of the
Acquisitions received approximately $35.6 million of the cash purchase price
paid for the Acquisitions.
The Company expects that it will meet its short-term working capital and
capital requirements from a combination of cash remaining from the initial
public offering, internally generated funds, and a revolving credit facility
which it intends to negotiate. The Company continues to evaluate other
financing opportunities while utilizing cash from operations and the IPO.
The $17.0 million of notes issued to stockholders of Great Western and
FirsTel in the Acquisitions will be subordinated to the first $50.0 million of
outstanding bank debt.
The Company expects to expend approximately $33.0 million in 1998 to fund
the acquisition of additional circuit and packet switches, the leasing of bulk
fiber optic capacity from others and the purchase of other capital assets.
12
<PAGE> 15
<TABLE>
INDEX TO FINANCIAL STATEMENTS
<CAPTION>
PAGE
----
<S> <C>
ADVANCED COMMUNICATIONS GROUP, INC. UNAUDITED PRO FORMA
COMBINED FINANCIAL STATEMENTS
Unaudited Pro Forma Combined Statements of Operations for
the year ended December 31, 1997 and the three months
ended March 31, 1997 and 1998............................. 14
Unaudited Pro Forma Combining Statement of Operations for
the year ended December 31, 1997.......................... 15
Unaudited Pro Forma Combining Statement of Operations for
the three months ended March 31, 1998..................... 16
Notes to Unaudited Pro Forma Combined Statements of
Operations................................................ 17
ADVANCED COMMUNICATIONS GROUP, INC.
Report of Independent Auditors.............................. 19
Consolidated Statements of Operations for the Period from
Inception (June 6, 1996) to December 31, 1996, the year
ended December 31, 1997 and the three months ended March
31, 1997 and 1998 (unaudited)............................. 21
Consolidated Balance Sheets as of December 31, 1996 and 1997
and March 31, 1998 (unaudited)............................ 22
Consolidated Statements of Changes in Stockholders' Deficit
for the Period from Inception (June 6, 1996) to March 31,
1998 (unaudited).......................................... 23
Consolidated Statements of Cash Flows for the Period from
Inception (June 6, 1996) to December 31, 1996, the year
ended December 31, 1997 and the three months ended March
31, 1997 and 1998 (unaudited)............................. 24
Notes to Consolidated Financial Statements.................. 25
</TABLE>
13
<PAGE> 16
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
PRO FORMA
FISCAL YEAR PRO FORMA THREE
ENDED<F1> MONTHS ENDED<F1>
------------ ----------------------------
DECEMBER 31, MARCH 31, MARCH 31,
1997 1997 1998
------------ ------------ ---------
<S> <C> <C> <C>
Revenues:
Telecommunications.............................. $46,045 $11,054 $13,766
Directory....................................... 43,247 16,474 18,429
------- ------- -------
Total revenue............................... 89,292 27,528 32,195
Operating costs:
Cost of services................................ 50,435 14,054 16,951
Selling, general and administrative expenses.... 30,705 8,795 10,304
Depreciation and amortization................... 9,306 2,293 2,344
Stock-based compensation........................ 870 -- 1,760
------- ------- -------
Income (loss) from operations............... (2,024) 2,386 836
Other income (expense):
Other........................................... 253 45 58
Interest expense................................ (775) (352) (392)
Equity in losses of KINNET...................... (854) (253) (154)
------- ------- -------
Income (loss) before income taxes................... (3,400) 1,826 348
Income tax expense.................................. 2,177 1,565 948
------- ------- -------
Net income (loss)........................... $(5,577) $ 261 $ (600)
======= ======= =======
Basic and diluted earnings (loss) per share......... $ (.28) $ .01 $ (.03)
======= ======= =======
<FN>
- --------
<F1>The Company completed its initial public offering on February 18, 1998,
concurrently with the acquisition of nine operating companies and a 49%
interest in another Company. The pro forma results for fiscal year 1997,
and the three months ended March 31, 1997 and 1998, were prepared giving
effect to the offering and the acquisitions as if they had occurred on
January 1, 1997.
See accompanying notes to unaudited pro forma financial statements.
</TABLE>
14
<PAGE> 17
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA COMBINING STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
OTHER HISTORICAL PRO FORMA
GREAT FOUNDING BASIS ADJUSTMENTS PRO FORMA
WESTERN VALU-LINE COMPANIES ACG COMBINED (SEE NOTE 3) COMBINED
------- --------- --------- --- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Telecommunications
services........... $ -- $12,022 $34,023 $ -- $46,045 $ -- $ 46,045
Yellow page
publishing......... 43,247 -- -- -- 43,247 -- 43,247
------- ------- ------- ------- ------- ------- ----------
Total revenues... 43,247 12,022 34,023 -- 89,292 -- 89,292
Cost of services......... 20,521 6,615 23,299 -- 50,435 -- 50,435
Selling, general and
administrative
expenses............... 16,186 3,772 8,676 2,071 30,705 -- 30,705
Depreciation and
amortization........... 235 475 606 3 1,319 7,987 <Fa> 9,306
Stock-based
compensation........... -- -- -- 870 870 -- 870
------- ------- ------- ------- ------- ------- ----------
Income (loss)
from operations 6,305 1,160 1,442 (2,944) 5,963 (7,987) (2,024)
Other income (expense):
Other income and
expense, net....... 86 (36) 203 -- 253 -- 253
Interest expense..... (50) (135) (214) (256) (655) (120)<Fb> (775)
Equity in losses of
KINNET............. -- -- -- -- -- (854)<Fc> (854)
------- ------- ------- ------- ------- ------- ----------
Income (loss) before
income taxes........... 6,341 989 1,431 (3,200) 5,561 (8,961) (3,400)
Provision for income
taxes.................. 1,804 -- -- -- 1,804 373 <Fd> 2,177
------- ------- ------- ------- ------- ------- ----------
Net income (loss)........ $ 4,537 $ 989 $ 1,431 $(3,200) $ 3,757 $(9,334) $ (5,577)
======= ======= ======= ======= ======= ======= ==========
Pro forma net income per
share.................. $ (0.28)
==========
Shares used in computing
pro forma net income
per share.............. 20,061,801
==========
See accompanying notes to unaudited pro forma financial statements.
</TABLE>
15
<PAGE> 18
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC.
UNAUDITED PRO FORMA COMBINING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
OTHER HISTORICAL PRO FORMA
GREAT FOUNDING BASIS ADJUSTMENTS PRO FORMA
WESTERN VALU-LINE COMPANIES ACG COMBINED (SEE NOTE 3) COMBINED
------- --------- --------- --- ---------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Telecommunications
services........... $ -- $ 3,250 $10,516 $ -- $13,766 $ -- $ 13,766
Yellow page
publishing......... 18,429 -- -- -- 18,429 -- 18,429
------- ------- ------- ------- ------- ------- ----------
Total revenues... 18,429 3,250 10,516 -- 32,195 -- 32,195
Cost of services......... 8,019 1,862 7,070 -- 16,951 -- 16,951
Selling, general and
administrative
expenses............... 6,194 909 2,489 712 10,304 -- 10,304
Depreciation and
amortization........... 60 78 129 935 1,202 1,142 <Fa> 2,344
Stock-based
compensation........... -- -- -- 1,760 1,760 -- 1,760
------- ------- ------- ------- ------- ------- ----------
Income (loss)
from operations 4,156 401 828 (3,407) 1,978 (1,142) 836
Other income (expense):
Other income and
expense, net....... 21 18 -- 19 58 -- 58
Interest expense..... -- (29) (19) (262) (310) (82)<Fb> (392)
Equity in losses of
KINNET............. -- -- -- (69) (69) (85)<Fc> (154)
------- ------- ------- ------- ------- ------- ----------
Income (loss) before
income taxes........... 4,177 390 809 (3,719) 1,657 (1,309) 348
Provision for income
taxes.................. -- -- -- -- -- 948 <Fd> 948
------- ------- ------- ------- ------- ------- ----------
Net income (loss)........ 4,177 390 809 (3,719) 1,657 (2,257) (600)
======= ======= ======= ======= ======= ======= ==========
Pro forma net income per
share.................. $ (0.03)
==========
Shares used in computing
pro forma net income
per share.............. 19,624,920
==========
See accompanying notes to unaudited pro forma financial statements.
</TABLE>
16
<PAGE> 19
ADVANCED COMMUNICATIONS GROUP, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
The unaudited pro forma combined financial statements give effect to the
acquisitions by Advanced Communications Group, Inc. (collectively with its
predecessor, which it acquired in conjunction with the acquisitions described
below, "ACG") of the outstanding capital stock or, in certain cases, the
assets of Great Western Directories, Inc. ("Great Western"), Valu-Line of
Longview, Inc. and Related Companies ("Valu-Line"), Feist Long Distance
Service, Inc. ("Feist Long Distance"), FirsTel, Inc. ("FirsTel"), Long
Distance Management I, Inc. and Long Distance Management of Kansas, Inc.
(collectively, "LDM"), The Switchboard of Oklahoma City, Inc.
("Switchboard"), Tele-Systems, Inc. ("Tele-Systems"), and National Telecom
("National Telecom") and ACG's acquisition of 49% of the outstanding shares
of KIN Network, Inc. ("KINNET") (Great Western, Valu-Line, Feist Long
Distance, FirsTel, LDM, Switchboard, Tele-Systems and National Telecom
collectively, the "Acquired Companies", and Feist Long Distance, FirsTel,
LDM, Switchboard, Tele-Systems and National Telecom collectively, the "Other
Acquired Companies"). These acquisitions (the "Acquisitions") occurred
concurrent with the closing of the IPO. The Acquisitions were accounted for
using the purchase method of accounting. With respect to the Acquisitions, ACG
is identified as the accounting acquirer for financial statement presentation
purposes.
The pro forma adjustments are based on estimates, available information and
certain assumptions and may be revised as additional information becomes
available. The pro forma financial data do not purport to represent what ACG's
financial position or results of operations would actually have been if such
transactions in fact had occurred on January 1, 1996 and are not necessarily
representative of ACG's financial position or results of operations for any
future period. Since the Acquired Companies were not under common control or
management, historical combined results of operations may not be comparable to,
or indicative of, future performance. The unaudited pro forma combined
financial statements should be read in conjunction with the other financial
statements and notes thereto included elsewhere.
1. GENERAL
ACG was founded to create a regional competitive local exchange carrier
that primarily provides a portfolio of telecommunications services primarily to
business customers in selected service areas of Southwestern Bell and U S WEST
and publishes yellow page directories in selected markets in these Regions. ACG
conducted no operations prior to the closing of the Offering.
The historical financial statements reflect the financial position and
results of operations of the Acquired Companies and were derived from the
respective Acquired Companies' financial statements. The acquisition of the
interest in KINNET is accounted for using the equity method of accounting, and
the information with respect to KINNET was derived from its financial
statements. The periods included in these pro forma financial statements for
the individual Acquired Companies and KINNET are for the year ended December
31, 1997.
2. ACQUISITION OF ACQUIRED COMPANIES
Concurrent with and as a condition to the closing of the Offering, ACG
acquired all of the outstanding capital stock of Great Western, Valu-Line,
Feist Long Distance, FirsTel and Tele-Systems, substantially all of the assets
of LDM, Switchboard and National Telecom, and 49% of the outstanding capital
stock of KINNET pursuant to the Acquisitions. The Acquisitions are accounted
for using the purchase method of accounting with ACG being treated as the
accounting acquirer.
The consideration paid for the Acquisitions included (i) cash, (ii) Common
Stock, (iii) promissory notes, and (iv) options and warrants to purchase 1.4
million shares of Common Stock. The number of shares of Common Stock issued in
the Acquisitions was determined by dividing the agreed aggregate amount of
$47.5 million by the initial public offering of the Common Stock price ($14.00
per share). In determining the amount to be recorded for accounting purposes
for the component of the purchase price attributable to the shares of Common
Stock issuable in the Acquisitions, the value of such shares was determined to
be $37.9 million, which represents a discount of twenty percent due to
restrictions on the sale and transferability of the shares issued.
17
<PAGE> 20
ADVANCED COMMUNICATIONS GROUP, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS (CONTINUED)
The promissory notes issued in the Acquisitions consist of (i) $15.0
million in notes payable two years from the closing of the Acquisitions and
bearing an annual rate of interest of five percent (5%), which notes may be
prepaid at any time and are subordinated to the Company's senior debt (as
defined), (ii) $2.0 million in notes convertible into shares of Common Stock at
the initial public offering price, payable two years from the closing of the
Acquisitions and bearing an annual rate of interest of ten percent (10%), which
notes may be prepaid at any time and are subordinated to the Company's senior
debt (as defined), and (iii) a $350,000 promissory note payable in three equal
annual installments and bearing an annual interest rate of seven percent (7%),
which note may be prepaid at any time. Pursuant to the terms of the notes
discussed in (i) and (ii) above, an event of default would exist if the
Company's senior debt (as defined) exceeds $50.0 million.
The following table sets forth the components for accounting purposes of
the consideration with respect to the Acquisitions:
<TABLE>
<CAPTION>
OPTIONS AND
WARRANTS
EXERCISABLE
VALUE OF FOR
COMMON PROMISSORY COMMON
ACQUISITION CASH STOCK NOTES OTHER STOCK
- ----------- ---- -------- ---------- ----- -----------
<S> <C> <C> <C> <C> <C>
Great Western.......................... $55,000 $ 8,000 $15,000 $ -- 1,256,078
Valu-Line.............................. 6,613 4,160 -- -- --
Other Acquired Companies............... 12,522 17,236 2,350 361 137,135
Minority Investment in KINNET.......... 10,000 8,000 -- -- --
------- ------- ------- ---- ---------
Total.................................. $84,135 $37,896 $17,350 $361 1,393,213
======= ======= ======= ==== =========
</TABLE>
4. UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS ADJUSTMENTS
PRO FORMA ADJUSTMENTS FOR THE YEAR ENDED DECEMBER 31, 1997
(a) Reflects the amortization of excess purchase price relating to the
Acquired Companies which has been allocated to identifiable intangible
assets including customer lists and goodwill. The customer lists are
being amortized over periods ranging from 5-10 years and goodwill is
being amortized over periods ranging from 25-40 years. Also, reflects
the amortization of the five year, $1.1 million strategic alliance and
non-compete agreement entered into with Northwestern Public Service
Company.
(b) Reflects an increase of $775,000 of interest expense attributable to
debt issued as consideration for the Acquisitions, net of a reduction
of $654,000 in interest expense on debt of the Acquired Companies which
is to be repaid from the proceeds of the Offering.
(c) Reflects the equity in losses of KINNET of $171,000 and $683,000 of
amortization related to the excess purchase price which has been
recorded as goodwill and is amortized over 25 years.
(d) Reflects the incremental provisions for federal and state income taxes
relating to the other pro forma adjustments and for income taxes on
heretofore S Corporation income.
PRO FORMA ADJUSTMENTS FOR THE THREE MONTHS ENDED MARCH 31, 1998
(a) Reflects the amortization of excess purchase price relating to the
Acquired Companies and the amortization of the five year, $1.1 million
strategic alliance and non-competition agreement entered into with
Northwestern Public Service Company for the period from January 1, 1998
to February 18, 1998, the date of closing of the IPO.
(b) Reflects an increase of $82,000 of interest expense attributable to
debt issued as consideration for the Acquisitions.
(c) Reflects the equity in earnings of KINNET of $17,000 offset by $102,000
of amortization related to the excess purchase price for the period
January 1, 1998 to February 18, 1998.
(d) Reflects the incremental provisions for federal and state income taxes
relating to the other pro forma adjustments and for income taxes on
heretofore S Corporation income.
18
<PAGE> 21
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Advanced Communications Group, Inc.
We have audited the accompanying consolidated balance sheets
of Advanced Communications Group, Inc. as of December 31, 1996
and 1997, and the related consolidated statements of operations,
changes in stockholders' deficit, and cash flows for the period
from inception (June 6, 1996) through December 31, 1996 and for
the year ended December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated
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 audits 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 consolidated financial statements
referred to above present fairly, in all material respects, the
financial position of Advanced Communications Group, Inc. as of
December 31, 1996 and 1997, and the results of its operations and
its cash flows for the period from inception (June 6, 1996)
through December 31, 1996 and for the year ended December 31,
1997, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Houston, Texas
March 23, 1998
19
<PAGE> 22
INDEPENDENT ACCOUNTANT'S REPORT
The Board of Directors
Advanced Communications Group, Inc.
We have reviewed the accompanying consolidated balance sheets
of Advanced Communications Group, Inc. and subsidiaries as of March
31, 1998 and 1997, and the related consolidated statements of
operations, changes in stockholders' equity (deficit), and cash flows
for the three-month periods then ended. These financial statements
are the responsibility of the Company's management.
We conducted our review in accordance with standards established
by the American Institute of Certified Public Accountants. A review
of interim financial information consists principally of applying
analytical procedures to financial data and making inquiries of persons
responsible for financial and accounting matters. It is substantially
less in scope than an audit conducted in accordance with generally
accepted auditing standards, the objective of which is the expression
of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications
that should be made to the accompanying financial statements as of and
for the three months ended March 31, 1998 and 1997 for them to be in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
St. Louis, Missouri
May 14, 1998
20
<PAGE> 23
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
(UNAUDITED)
THREE MONTHS ENDED
INCEPTION TO YEAR ENDED ---------------------------
DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31,
1996 1997 1997 1998
------------ ------------ --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Telecommunications.......................... $ -- $ -- $ -- $ 6,551
Directory................................... -- -- -- 9,183
--------- --------- --------- ----------
Total revenue........................... -- -- -- 15,734
Operating costs:
Cost of services............................ -- -- -- 7,647
Selling, general and administrative
expenses.................................. 649 2,071 270 5,963
Depreciation and amortization............... -- 3 -- 1,202
Stock-based compensation.................... -- 870 -- 1,760
--------- --------- --------- ----------
Income (loss) from operations........... (649) (2,944) (270) (838)
Other income (expense):
Interest expense............................ (10) (256) -- (282)
Equity in earnings (loss) of KINNET......... -- -- -- (68)
Other....................................... -- -- -- 30
--------- --------- --------- ----------
Income (loss) before incomes taxes.............. (659) (3,200) (270) (1,158)
Income tax expense.............................. -- -- -- (34)
--------- --------- --------- ----------
Net income (loss)....................... $ (659) $ (3,200) $ (270) $ (1,124)
========= ========= ========= ==========
Basic and diluted earnings (loss) per share..... $ (.08) $ (.39) $ (.03) $ (.07)
========= ========= ========= ==========
Weighted average common shares outstanding...... 8,227,736 8,230,006 8,227,736 15,269,364
========= ========= ========= ==========
See accompanying notes to consolidated financial statements.
</TABLE>
21
<PAGE> 24
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
(UNAUDITED)
DEC. 31, DEC. 31, MARCH 31,
1996 1997 1998
-------- -------- -----------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................... $ 34 $ -- $ 11,472
Accounts receivable, net................................ -- -- 23,509
Deferred costs.......................................... -- -- 2,638
Prepaid expenses and other current assets............... 1 -- 987
----- ------- --------
Total current assets............................ 35 -- 38,606
----- ------- --------
Property, plant and equipment, net.......................... 8 6 4,099
Intangible assets, net...................................... -- -- 110,674
Equity investment in KINNET................................. -- -- 17,887
Other noncurrent assets..................................... 49 2,689 789
----- ------- --------
Total other assets.............................. 57 2,695 133,449
----- ------- --------
$ 92 $ 2,695 $172,055
===== ======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities................ $ 149 $ 2,098 $ 14,308
Current maturities of long-term debt (related party).... 575 3,141 1,378
Other current liabilities............................... -- -- 2,401
----- ------- --------
Total current liabilities....................... 724 5,239 18,087
Long-term obligations:
Long-term debt (related party).......................... -- -- 17,233
Other noncurrent liabilities............................ -- -- 220
----- ------- --------
Total liabilities............................... 724 5,239 35,540
----- ------- --------
Stockholders' equity:
Preferred Stock, Series A Redeemable Convertible........ -- -- 1,122
Common stock, $.0001 par value: 180,000,000 authorized;
8,227,736; 8,232,276 and 19,624,920 shares issued,
respectively.......................................... -- -- 2
Additional paid-in capital.............................. 27 1,315 140,374
Retained earnings (accumulated deficit)................. (659) (3,859) (4,983)
----- ------- --------
Total stockholders' equity (deficit)............ (632) (2,544) 136,515
----- ------- --------
$ 92 $ 2,695 $172,055
===== ======= ========
See accompanying notes to consolidated financial statements.
</TABLE>
22
<PAGE> 25
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE PERIOD FROM INCEPTION (JUNE 6, 1996)
TO MARCH 31, 1998
(IN THOUSANDS, EXCEPT SHARE DATA)
<CAPTION>
TOTAL
COMMON STOCK ADDITIONAL STOCKHOLDERS'
-------------------- PREFERRED PAID IN ACCUMULATED EQUITY
SHARES AMOUNT STOCK CAPITAL DEFICIT (DEFICIT)
------ ------ --------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Initial capitalization......... 8,277,736 $ 1 $ -- $ 27 $ -- $ 27
Net loss....................... -- -- -- -- (659) (659)
---------- ---- ------ -------- ------- --------
BALANCE, December 31, 1996..... 8,277,736 $ 1 $ -- $ 27 $ (659) $ (632)
Issuance of stock options and
warrants..................... -- -- -- 1,237 -- 1,237
Issuance of stock for services
performed.................... 4,540 -- -- 50 -- 51
Net loss....................... -- -- -- -- (3,200) (3,200)
---------- ---- ------ -------- ------- --------
BALANCE, December 31, 1997..... 8,232,276 $ 1 $ -- $ 1,314 $(3,859) $ (2,544)
Issuance of stock options and
warrants (unaudited)......... -- -- -- 1,265 -- 1,265
Issuance of preferred stock
(unaudited).................. -- -- 1,122 -- -- 1,122
Initial public offering, net of
offering costs (unaudited)... 8,000,000 1 -- 99,899 -- 99,900
Issuance of stock for acquired
companies (unaudited)........ 3,392,644 -- -- 37,896 -- 37,896
Net loss (unaudited)........... -- -- -- -- (1,124) (1,124)
---------- ---- ------ -------- ------- --------
BALANCE, March 31, 1998
(unaudited).................. 19,624,920 $ 2 $1,122 $140,374 $(4,983) $136,515
========== ==== ====== ======== ======= ========
See accompanying notes to consolidated financial statements.
</TABLE>
23
<PAGE> 26
<TABLE>
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<CAPTION>
(UNAUDITED)
THREE MONTHS ENDED
INCEPTION TO YEAR ENDED MARCH 31,
DECEMBER 31, DECEMBER 31, -------------------
1996 1997 1997 1998
------------ ------------ ---- ----
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................................... $(659) $(3,200) $(270) $ (1,124)
Adjustments to reconcile net earnings to net cash:
Depreciation and amortization...................... -- 3 -- 1,202
Stock-based compensation expense................... -- 870 -- 1,760
Equity in loss of KINNET........................... -- -- -- 68
Change in assets and liabilities:
Decrease (increase) in:
Accounts receivable, net................... (1) 1 -- (4,078)
Deferred costs............................. -- -- -- 1,988
Prepaid expenses and other current
assets.................................. -- -- -- 455
Other assets, net.......................... -- -- -- (239)
Increase (decrease) in:
Accounts payable and accrued liabilities... 148 1,950 -- (1,270)
----- ------- ----- --------
Net cash used in operating activities.......... (512) (376) (270) (1,238)
----- ------- ----- --------
Cash flows from investing activities:
Cash paid for businesses acquired, net of $828 cash
acquired............................................. -- -- -- (83,277)
Additions to property, plant and equipment, net........ (8) -- -- (276)
----- ------- ----- --------
Net cash used in investing activities.......... (8) -- -- (83,553)
----- ------- ----- --------
Cash flows from financing activities:
Borrowings (repayment) of long-term debt, net.......... 574 2,566 270 (3,637)
Increase in deferred offering costs.................... (48) (2,223) -- --
Proceeds from common stock issuances, net of
offering costs....................................... 27 -- -- 99,900
----- ------- ----- --------
Net cash provided by financing activities...... 553 343 270 96,263
----- ------- ----- --------
Net increase (decrease) in cash and cash equivalents....... 33 (33) -- 11,472
Cash and cash equivalents--beginning of period............. -- 33 -- --
----- ------- ----- --------
Cash and cash equivalents--end of period................... $ 33 $ -- $ -- $ 11,472
===== ======= ===== ========
See accompanying notes to consolidated financial statements.
</TABLE>
24
<PAGE> 27
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED DECEMBER 31, 1996, THE YEAR ENDED DECEMBER 31, 1997 AND
THE THREE MONTHS ENDED MARCH 31, 1997 AND 1998
(ALL INFORMATION AS OF AND FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1998 IS UNAUDITED)
1. BASIS OF PRESENTATION
Advanced Communications Group, Inc. ("ACG" or "Company"), a Delaware
corporation, was founded to create a regional competitive local exchange
carrier that primarily provides a portfolio of telecommunications services
primarily to business customers in selected service areas of Southwestern Bell
and U S WEST and publishes yellow page directories in selected markets.
ACG completed its initial public offering ("IPO") of its common stock,
par value $.0001 per share ("Common Stock") on February 18, 1998. Cash
proceeds from the offering, net of offering costs, were $99.9 million. Of this
amount, $84.1 million was used to pay the cash portion of the acquired
companies, $3.6 million was used to retire debt of the Company and the Acquired
Companies, and $1.75 million was paid to a stockholder for a five-year non-
compete agreement. In connection with the IPO, the Company simultaneously
acquired all of the outstanding capital stock of Great Western Directories,
Inc. ("Great Western"), Valu-Line of Longview, Inc. ("Valu-Line"), Feist
Long Distance Service, Inc. ("Feist"), FirsTel, Inc. ("FirsTel") and
Tele-Systems, Inc. ("Tele-Systems"), substantially all of the assets of Long
Distance Management II, Inc. ("LDM II"), Long Distance Management of Kansas,
Inc. ("LDM of Kansas"), The Switchboard of Oklahoma City, Inc.
("Switchboard"), and National Telecom, a proprietorship, and 49% of the
outstanding capital stock of KIN Network, Inc. ("KINNET") (collectively
"Acquisitions" or "Acquired Companies").
Prior to February 1998, ACG had not conducted any operations other than
those relating to the IPO and the Acquisitions. Consequently, the actual
financial statements included herein relate only to the parent company prior to
February 18, 1998, but include the results of the Acquired Companies for the
period February 18, 1998 to March 31, 1998. All intercompany accounts have been
eliminated in consolidation.
The interim financial statements for the three months ended March 31, 1997
and 1998, are unaudited. These interim financial statements have been prepared
on the same basis as the annual financial statements included herewith. In the
opinion of management, all adjustments, consisting only of normal recurring
adjustments, necessary to fairly present the balance sheets, results of
operations and cash flows with respect to the interim financial statements,
have been included. The results of operations for the interim period are not
necessarily indicative of the results for the entire fiscal year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS--For purposes of reporting cash flows, cash
equivalents include highly-liquid investments purchased with a maturity of
three months or less.
PROPERTY, PLANT AND EQUIPMENT--Property, plant and equipment are stated at
cost, less accumulated depreciation. Depreciation is computed using the
straight-line or an accelerated method over the respective lives of the assets.
The estimated useful lives of the assets range from 3 to 31 years.
INTANGIBLE ASSETS FROM BUSINESS ACQUISITIONS--Intangible assets resulting
from the cost of businesses acquired exceeding the fair value of net assets
acquired consist principally of the customer lists and goodwill. The value of
customer lists and their estimated useful lives were determined using
preliminary independent appraisals. Customer lists and goodwill are amortized
on a straight-line basis over their estimated useful lives ranging from 5 to 10
years and 25 to 40 years, respectively. For the three months ended March 31,
1998, amortization expense relating to intangible assets was $971,000.
DEFERRED COSTS--At December 31, 1997, the Company had deferred certain
legal, accounting, appraisal and other costs incurred in connection with the
Acquisitions and the IPO. At December 31, 1996 and 1997, deferred acquisition
costs amounted to approximately $40,900 and $929,000, respectively, and
deferred offering costs amounted to $2,700 and $1,756,800, respectively. When
the Acquisitions were completed, deferred acquisition costs
25
<PAGE> 28
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
were included in the determination of excess purchase price. Deferred offering
costs were charged to additional paid-in capital upon the closing of the IPO.
Deferred line acquisition costs include the direct costs incurred in
connection with establishing local access line service for customers and are
being amortized on a straight-line basis over the estimated life of the average
customer local service contract.
INCOME TAXES--Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the carrying
amounts of existing assets and liabilities for financial reporting purposes and
for income tax purposes. The Company's effective tax rate is substantially
higher than statutory tax rates principally because amortization of certain
intangible assets is not considered deductible for tax purposes. No provision
for Federal, state and local income taxes has been made at December 31, 1996
and 1997 because the Company has sustained cumulative losses since its
inception in June 1996. A 100% valuation allowance has been established for the
related deferred tax asset.
REVENUE RECOGNITION--Directory revenues are derived from the sale of
advertising space in telephone directories and are recognized on the date that
the directory is published and substantially delivered. If the estimate of
total directory costs exceeds advertising revenues for a specific region's
telephone directory, a provision is made for the entire amount of such
estimated loss. Directory costs are deferred until the date that the directory
is published and substantially delivered. Directory costs include all direct
costs related to the publishing of a region's telephone directory, such as
publishing and distribution expenses and commissions on sales, other sales
expenses and depreciation and amortization. General and administrative costs
are charged to expense as incurred.
Costs incurred with the expansion into new markets include all direct costs
related to the publishing of a first-year telephone directory (prototype
directory). Advertising space in prototype directories is generally provided to
advertisers at no cost; therefore, no advertising revenues are derived from
prototype directories. Because the future economic benefit of the direct costs
related to prototype directories cannot be determined, such direct costs are
charged to expense as incurred. The Company had no prototype directories for
the periods ended March 31, 1998 and 1997.
Telecommunications revenues are recognized when long-distance, local and
toll free services are provided. Billings made in advance for local services
are deferred until earned.
STOCK BASED COMPENSATION--SFAS No. 123, "Accounting for Stock-Based
Compensation," allows entities to choose between a new fair value based method
of accounting for employee stock options or similar equity instruments and the
current intrinsic, value-based method of accounting required by Accounting
Principles Board Opinion No. 25 ("APB No. 25"). The Company has elected to
remain with the accounting in APB No. 25 and has included in these financial
statements pro forma disclosures of net loss and net loss per share as if the
fair value method of accounting had been applied. No employee stock options or
similar equity instruments were issued by the Company prior to January 1, 1997.
NET EARNINGS (LOSS) PER SHARE--The Company has adopted the provisions of
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share", which replaces the presentation of primary earnings per share and
fully diluted earnings per share with a presentation of basic earnings per
share ("Basic EPS") and diluted earnings per share ("Diluted EPS"). Basic
EPS excludes dilution and is determined by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted EPS reflects the potential dilution that could occur if
securities and other contracts to issue common stock were exercised or
converted into common stock. In periods of net loss the dilutive impact of
outstanding stock options, stock warrants and other common stock equivalents
are anti-dilutive and are therefore not considered in calculating Diluted EPS.
The weighted average shares outstanding were 8,227,736 for the period from
inception (June 6, 1996) through December 31, 1996 and 8,230,006 for the year
ended December 31, 1997. In calculating diluted EPS for the year ended December
31, 1997, options to purchase 1,525,000 shares of common stock at exercise
prices ranging from $2.50 to $14.00 per share, and warrants to purchase
1,296,199 shares of common stock at exercise prices ranging from $2.50 to
26
<PAGE> 29
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
$6.61 per share were outstanding during part of 1997 but were not included in
the computation of diluted EPS due to their antidilutive effect.
USE OF ESTIMATES--The preparation of the financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS--The Company's only financial
instruments are cash, short-term trade receivables and payables, notes payable
and capital lease obligations. Management believes the carrying amounts of the
financial instruments classified as current assets and liabilities approximate
their fair values because of their short-term nature. Management believes the
interest rates on its notes payable and capital lease obligations represent
fair market rates, and therefore their carrying value approximates fair value.
COMPREHENSIVE INCOME--The Company has adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," as
of the first quarter of 1998. SFAS No. 130 establishes new rules for the
reporting and display of comprehensive income and its components, however it
has no impact on the Company's net income or stockholders' equity. For the
quarters ended March 31,1998 and 1997, the Company did not incur items to be
reported in comprehensive income that were not already included in the reported
net earnings; therefore, comprehensive income (loss) and net income (loss) were
the same for these periods.
3. ACQUISITIONS
During the three months ended March 31, 1998, the Company completed the
IPO. Concurrent with and as a condition to the closing of the IPO, ACG acquired
all of the outstanding capital stock of Great Western, Valu-Line, Feist Long
Distance, FirsTel and Tele-Systems, substantially all of the assets of LDM II
and LDM of Kansas, Switchboard and National Telecom, and 49% of the outstanding
capital stock of KINNET pursuant to the terms of the Acquisitions. The
Acquisitions are accounted for using the purchase method of accounting with ACG
being treated as the accounting acquirer. The interest in KINNET is accounted
for under the equity method of accounting.
The consideration paid for the Acquisitions included (i) cash, (ii) Common
Stock, (iii) promissory notes, (iv) a payable for reimbursement of cash paid to
purchase two companies in September 1997, and (v) options and warrants to
purchase shares of Common Stock. For accounting purposes, in determining the
amount to be recorded as the purchase price attributable to the shares of
Common Stock issued for the Acquisitions, the value of such shares was
determined to be $38.0 million, which represents a discount of twenty percent
due to restrictions on the sale and transferability of the shares issued. The
following table sets forth for accounting purposes the fair value of
consideration paid with respect to the Acquisitions and the assets acquired:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Consideration Paid for Acquired Companies:
Cash.................................................... $ 84,135
Common Stock............................................ 37,896
Notes Payable........................................... 17,350
Options and Warrants.................................... 361
--------
Total Purchase Price............................ $139,742
========
Net Assets Acquired:
Net working capital..................................... $ 9,829
Property and equipment.................................. 3,941
Customer Lists.......................................... 44,900
Goodwill................................................ 81,072
--------
Total Assets Acquired........................... $139,742
========
</TABLE>
27
<PAGE> 30
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The promissory notes issued in the Acquisitions consist of (i) $15.0
million in notes payable two years from the closing of the Acquisitions and
bearing an annual rate of interest of five percent (5%), which notes may be
prepaid at any time and are subordinated to the Company's senior debt, (ii)
$2.0 million in notes convertible into shares of Common Stock at the initial
public offering price, payable two years from the closing of the Acquisitions
and bearing an annual rate of interest of ten percent (10%), which notes may be
prepaid at any time and are subordinated to the Company's senior debt, and
(iii) a $350,000 promissory note payable in three equal annual installments and
bearing an annual interest rate of seven percent (7%), which note may be
prepaid at any time.
The following pro forma information presents results of operations as if
the Acquisitions had occurred at the beginning of the periods presented. This
pro forma information is based on historical information and does not
necessarily reflect the actual results that would have occurred nor is it
necessarily indicative of future results of the combined companies.
<TABLE>
<CAPTION>
PRO FORMA INFORMATION (Unaudited) (In Thousands)
THREE MONTHS ENDED
-----------------------
MARCH 31, MARCH 31,
1996 1997 1997 1998
---- ---- --------- ---------
<S> <C> <C> <C> <C>
Total revenues $85,414 $89,292 $27,528 $32,195
Net income (loss) $ 171 $(5,577) $ 261 $ (600)
Earnings (loss) per share $ .00 $ (.28) $ .01 $ (.03)
</TABLE>
4. TRANSACTIONS WITH RELATED PARTIES
COMMON OWNERSHIP AND MANAGEMENT
At December 31, 1996 and 1997, a total of 7,986,074 shares and 7,915,192
shares, respectively, of the Company's Common Stock was owned by Consolidation
Partners Founding Fund, L.L.C., ("CPFF") and by individuals who then served
as directors of both the Company and CPFF and who own the controlling interest
in CPFF.
SUBORDINATED PROMISSORY NOTE IN FAVOR OF CPFF
The Company's activities have been financed through a subordinated note
agreement with CPFF. In September 1996, the Company executed a Subordinated
Promissory Note (the "Note") in favor of CPFF in the principal amount of
$1,200,000 and bearing an annual interest rate of eight (8%) percent. Under its
original terms, the principal and accrued interest under the Note were to be
paid in full on the earlier of September 15, 1997, or the date on which the
Company's common stock became listed or quoted on a national basis. During 1996
and 1997, the Company incurred interest expense of $9,890 and $256,289,
respectively, under the Note. Between September 1997 and February 1998, the
Company and CPFF amended the terms of the Note three times to provide for
increases in the principal balance to $3,230,000, and to extend the maturity of
the Note to the earlier of December 31, 1998 or the consummation of the IPO. At
December 31, 1997 and 1996, the principal balance under the Note was
approximately $565,000 and $2,875,000, respectively. In connection with the IPO
in February 1998, the entire Note balance was repaid.
OTHER COMMITMENTS
In January 1997, the Company entered into a four year lease agreement with
CPFF pursuant to which the Company leases furniture and office equipment. Under
this agreement the Company is obligated to make monthly rental payments to CPFF
of $1,163. For the year ended December 31, 1997, the Company recognized
approximately $14,000 of rental expense related to this lease agreement.
The Company has entered into six-year employment agreements with three
officers of the Company. These agreements provide for annual salaries plus
potential bonuses and stock option grants as determined by the Compensation
Committee of the Board of Directors.
28
<PAGE> 31
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. STOCK OPTIONS AND WARRANTS
In May 1997, the Company granted to one of its consultants a warrant for
the purchase of 7,561 shares of common stock at an exercise price of $2.65 per
share. This warrant is exercisable in whole or in part at any time up to its
expiration date in May 2007. In connection with the issuance of this warrant,
the Company recorded a non-recurring, non-cash compensation expense of $20,000
reflecting the difference between the exercise price for the shares and the
estimated fair value of the warrant at the date of grant.
In connection with the Great Western Directories, Inc. ("Great Western")
acquisition agreement, the Company issued warrants to purchase 756,078 shares
of common stock at $6.61 per share. Based on an independent appraisal, the fair
value of these warrants was determined to be $367,000 on the date of grant,
which was recorded as deferred acquisition costs by the Company.
In June 1997, the Company granted options for the purchase of 775,000
shares of common stock at an exercise price equal to the fair value of a share
of common stock at the date of grant, specifically $2.50 per share, to three
individuals. In December 1997, two of these individuals exchanged their options
to purchase 525,000 shares of common stock for ten-year, fully vested warrants
to purchase a like number of shares of common stock at the same exercise price.
In June 1997, the Company's Board of Directors approved a Stock Awards Plan
(the "Plan") which provides for the granting or awarding of incentive or
non-qualified stock options, stock appreciation rights, restricted or deferred
stock, dividend equivalents and other incentive awards to directors, officers,
and key employees of the Company. The number of shares of common stock
authorized and reserved for issuance under the Plan is 3,500,000 shares.
During 1997, the Company agreed to make various grants and awards under the
Plan to employees and officers of the Acquired Companies, and to certain
individuals who became officers of the Company. These options will be
exercisable at the initial offering price and have various vesting and
termination provisions. In addition, the Company has agreed to compensate each
of its outside directors with an option award for 15,000 shares of common stock
upon election to the board and an additional option award of 5,000 shares of
common stock upon each subsequent re-election of the director. At December 31,
1997, no director options had yet been granted.
During December 1997, the Company awarded to three of its officers ten-year
options to purchase 1,275,000 shares of common stock, consisting of options for
300,000 shares exercisable at $2.50 per share which vest in full at the end of
three months, and options for 975,000 shares of common stock exercisable at the
initial public offering price ($14.00) which vest in three equal increments on
the first three anniversaries of the date of grant. During the year ended
December 31, 1997, the Company recognized $870,000 of compensation expense
related to these options.
At December 31, 1997, there were 2,225,000 additional shares available for
grant under the Plan. The per share weighted-average value of stock options
granted during 1997 was $8.63 using the Black-Scholes model with the following
assumptions: weighted-average risk-free interest rate of 6.50%, expected life
of 10 years, expected volatility of 60%, and an expected dividend yield of zero
percent.
The Company applies APB Opinion No. 25 in accounting for the Plan.
Accordingly, apart from the compensation expense referred to above, the Company
has not recognized compensation expense related to the issuance of options for
the purchase of its common stock. Had the Company determined compensation
expense based on the fair value at the date of grant for its stock options
under SFAS No. 123, the Company's net loss would have been increased to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
1997
----
<S> <C>
Net loss:
As reported................................... $3,200,035
Pro forma..................................... $5,972,195
Basic and diluted loss per share:
As reported................................... $ 0.39
Pro forma..................................... $ 0.73
</TABLE>
29
<PAGE> 32
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
At December 31, 1997, the range of exercise prices and weighted-average
remaining contractual lives of the options was $2.50 to $14.00 per share and 10
years, respectively. No options were exercisable at December 31, 1997. Stock
option activity during the periods indicated is as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Balance, December 31, 1996....... -- $ --
Options granted.............. 1,275,000 11.29
--------- ------
Balance, December 31, 1997....... 1,275,000 $11.29
========= ======
</TABLE>
6. SUBSEQUENT EVENTS
In January 1998, the Company entered into an agreement with a certain
utility company regarding the possible creation of a strategic alliance. Under
the terms of the agreement, which was consummated contemporaneously with the
closing of the initial public offering, the Company issued 142,857 shares of
Series A Redeemable Convertible Preferred Stock ("Preferred Stock") with an
aggregate liquidation preference of $2 million. The Preferred Stock is
convertible into shares of common stock at the initial public offering price
($14.00) eighteen months after the consummation of the initial public
offering. The Preferred Stock does not pay dividends and is not entitled to
vote in the election of directors. If a strategic alliance has not been
entered into by the 13th month after the initial public offering, the Company
may, at its option, redeem the Preferred Stock for total proceeds of $1.25
million. The Company has discussed, and continues to discuss, similar strategic
alliances with other utility companies.
In February 1998, the Company's Board of Directors approved an
approximately 1-for-2.645 reverse stock split, subject to stockholder approval.
This reverse stock split has been reflected retroactively for all periods
presented.
In February 1998, the Company completed an initial public offering of
8,000,000 shares of its common stock, and closed on the Acquisitions. Proceeds
from the IPO, net of offering costs, were $99.9 million of which $84.1 million
was paid to acquire the Acquired Companies, $3.6 million was paid to retire
debt of the Company and the Acquired Companies, and $1.75 million was paid to a
stockholder for a five-year non-compete agreement. Stockholders of the Acquired
Companies who became executive officers or directors of the Company upon the
consummation of the Acquisitions received approximately $35.6 million of the
cash purchase price paid in the Acquisitions.
Prior to the pricing of the IPO, Richard O'Neal, the principal shareholder
of Great Western, expressed disagreement with the effect of the reverse stock
split on certain warrants that had been issued to the stockholders of Great
Western at the time of the execution of the initial acquisition agreement
between the Company and Great Western (the "Warrants"). CPFF and Mr. O'Neal
agreed to engage in good faith negotiations to determine the type and amount of
any consideration appropriately payable by CPFF to the holders of the Warrants
following the consummation of the IPO. As of March 23, 1998, no negotiated
settlement had been reached and Mr. O'Neal had delivered to CPFF a demand for
binding arbitration. CPFF has agreed not to effect any distribution of the
Company's Common Stock to its interest owners prior to the resolution of these
matters. The resolution of this matter is solely between CPFF and the principal
shareholder of Great Western. The Company shall have no liability with respect
to the resolution of this matter and no additional Common Stock or equivalents
will be issued in connection therewith. In no event shall any assets of the
Company be used too satisfy any negotiated settlement or arbitration award.
30
<PAGE> 33
ADVANCED COMMUNICATIONS GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," which
establishes standards for reporting information about operating segments in
annual financial statements and requires that enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. The Company will adopt the statement for its year end 1998
financial statements. The Company is currently evaluating the impact that the
statement will have on its reportable segments. Adoption of this statement will
have no impact on the Company's net income, financial position or cash flows.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits", ("SFAS 132"). This statement requires additional
pension related disclosures. Adoption of this statement will have no impact on
the Company's net income, financial position or cash flows.
In March 1998, the American Institute of Certified Public Accountants
(AICPA), issued Statement of Position 98-1 (SOP 98-1), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." This SOP
is effective for financial statements for fiscal years beginning after December
15, 1998, with earlier application encouraged. The Company currently accounts
for its software costs generally in accordance with this SOP.
In April 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of
Start-Up Activities." This SOP provides guidance on the financial reporting of
start-up costs and organization costs. It requires costs of start-up activities
and organization costs to be expensed as incurred. The Company is in compliance
with this SOP.
31
<PAGE> 34
BOARD OF DIRECTORS
RICHARD P. ANTHONY
Chairman of the Board, President and Chief Executive Officer of Advanced
Communications Group, Inc.
FENTRESS BRACEWELL
Director of First Investors Financial Services, Inc., retired partner of
Bracewell & Patterson, Attorneys at Law.
JAMES F. CRAGG
Executive Vice President, Sales and Marketing, Advanced Communications Group,
Inc.
TODD J. FEIST
Vice President of Telecommunications Services Group Central Region of Advanced
Communications Group, Inc.
E. CLARKE GARNETT
President of KINNET, KINNI, L.C. and Liberty Cellular, Inc.
REGINALD J. HOLLINGER
Managing Director and Group Head of the Telecommunications Investment Banking
Group at PaineWebber Incorporated.
DAVID M. MITCHELL
Investor in the telephone business.
RICHARD O'NEAL
President--Directory Services Group of Advanced Communications Group, Inc.
FRED L. THURMAN
President of the Telecommunications Services Group of Advanced Communications
Group, Inc.
WILLIAM H. ZIMMER III
Executive Vice President, Chief Financial Officer, Treasurer and Secretary of
Advanced Communications Group, Inc.
CORPORATE INFORMATION
CORPORATE HEADQUARTERS
Advanced Communications Group, Inc.
390 South Woods Mill Road, Suite 150
St. Louis, Missouri 63017
(314) 205-8668
TRANSFER AGENT AND REGISTRAR
Continental Stock Transfer and Trust Company
2 Broadway
New York, New York 10004
SHAREHOLDER ADMINISTRATION
Inquiries relating to address corrections, lost certificates, changes of
registration, stock certificate holdings and other shareholder account
matters should be directed to Advanced Communications Group, Inc.'s transfer
agent, Continental Stock Transfer and Trust Company, at the address or
telephone number above.
COMMON STOCKHOLDERS
As of May 31, 1998, there were approximately 94 holders of record of Advanced
Communications Group, Inc. common stock.
COMMON STOCK PRICE RANGE
<TABLE>
<CAPTION>
1998
----------------
HIGH LOW
---- ---
<S> <C> <C>
1st Quarter (February 12, 1998
through March 31, 1998)...... 16 3/4 13 1/4
2nd Quarter.................... 15 1/2 6 15/16
</TABLE>
STOCK EXCHANGE LISTING
Advanced Communications Inc. common stock is listed on the New York Stock
Exchange and trades under the ticker symbol ADG.
FORWARD-LOOKING STATEMENTS
This Report contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from those
anticipated in these forward-looking statements. Readers are referred to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" which identifies important risk factors that could cause actual
results to differ materially from those contained in the forward-looking
statements.
FORM 10-K
A copy of the Annual Report to the Securities and Exchange Commission on Form
10-K/A may be obtained from the Company at no charge. Direct your requests in
writing to:
Corporate Secretary
Advanced Communications Group, Inc.
390 South Woods Mill Road, Suite 150
St. Louis, Missouri 63017
ANNUAL MEETING
The Annual Meeting of Stockholders will be held July 29, 1998, at 11:00 a.m.
at the Marriott West Hotel and Conference Center, 660 Maryville Centre Drive,
St. Louis, Missouri 63141
INDEPENDENT PUBLIC ACCOUNTANTS
KPMG Peat Marwick LLP
10 S. Broadway
St. Louis, Missouri 63102
GENERAL COUNSEL
Blackwell Sanders Peper Martin LLP
720 Olive Street
St. Louis, Missouri 63101
32
<PAGE> 35
ACG CORPORATION LOGO
390 SOUTH WOODS MILL ROAD
SUITE 150
ST. LOUIS, MO 63017
(314) 205-8668
