<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 22, 2000
REGISTRATION NO. 333-
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
MGC COMMUNICATIONS, INC.
AND ITS WHOLLY OWNED SUBSIDIARY
MPOWER HOLDING CORPORATION
(EXACT NAME OF REGISTRANTS AS SPECIFIED IN THEIR CHARTER)
<TABLE>
<S> <C> <C>
NEVADA 4813 88-0360042
DELAWARE (PRIMARY STANDARD INDUSTRIAL 52-2232143
(STATE OR OTHER JURISDICTION CLASSIFICATION CODE NUMBER) (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
</TABLE>
171 SULLY'S TRAIL, SUITE 202
PITTSFORD, NEW YORK 14534
(716) 218-6550
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANTS' PRINCIPAL EXECUTIVE OFFICES)
------------------------
KENT F. HEYMAN, ESQ.
171 SULLY'S TRAIL, SUITE 202
PITTSFORD, NEW YORK 14534
(716) 218-6550
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANTS' AGENT FOR SERVICE)
------------------------
WITH A COPY TO:
ANDREW B. JANSZKY, ESQ.
SHEARMAN & STERLING
599 LEXINGTON AVENUE
NEW YORK, NY 10022-6069
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED EXCHANGE OFFER: As soon as
practicable after the effective date of this Registration Statement.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, please check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED UNIT(1) PRICE(1) REGISTRATION FEE
-----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
13% Senior Notes due 2010.......................... $367,063,000 100% $367,063,000 $96,904.62
-----------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Calculated pursuant to Rule 457(f) under the Securities Act of 1933 solely
for the purpose of computing the registration fee in accordance with Rule
457(f)(2) under the Securities Act of 1933. Such amount represents the
aggregate offering price for 13% Senior Notes that the registrants are
offering to accept in exchange for the 13% Senior Notes registered pursuant
to this Registration Statement.
------------------------
THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
SUBJECT TO COMPLETION DATED JUNE , 2000
[MGC COMMUNICATIONS LOGO]
MGC COMMUNICATIONS, INC.
MPOWER HOLDING CORPORATION
OFFER TO EXCHANGE
13% SENIOR NOTES DUE 2010
THAT HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933
FOR
ANY AND ALL OUTSTANDING UNREGISTERED 13% SENIOR NOTES DUE 2010
($367,063,000 AGGREGATE PRINCIPAL AMOUNT OUTSTANDING)
We are offering to exchange up to $367,063,000 aggregate principal amount
of new registered 13% Senior Notes due 2010 for a like principal amount of our
outstanding unregistered 13% Senior Notes due 2010.
KEY TERMS OF THE EXCHANGE OFFER
-- Expires at 5:00 p.m. New York City time, on , 2000, unless
extended.
-- Not subject to any conditions other than that the exchange offer does not
violate applicable law or any applicable interpretation of the Staff of the
Securities and Exchange Commission.
-- All outstanding notes that are validly tendered and not validly withdrawn
will be exchanged.
-- Tenders of outstanding notes may be withdrawn at any time prior to 5:00
p.m., New York City time, on the date of the expiration of the exchange
offer.
-- The exchange of notes will not be a taxable exchange for U.S. federal
income tax purposes.
-- The terms of the exchange notes are substantially identical to the
outstanding notes, except that the exchange notes are registered under the
Securities Act of 1933 and the transfer restrictions and registration
rights applicable to the outstanding notes do not apply to the exchange
notes.
-- We will not receive any proceeds from the exchange offer.
------------------
INVESTING IN THE NOTES INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 12.
------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THE NOTES TO BE DISTRIBUTED IN THE
EXCHANGE OFFER, NOR HAVE THESE ORGANIZATIONS DETERMINED IF THIS PROSPECTUS IS
TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------
The date of this prospectus is , 2000
<PAGE> 3
The exchange offer is not being made to, nor will we accept surrenders of
or exchange from, holders of outstanding notes in any jurisdiction in which the
exchange offer or the acceptance of outstanding notes would not be in compliance
with the securities or blue sky laws of such jurisdiction.
No dealer, salesperson or other individual has been authorized to give any
information or make any representation not contained in this prospectus in
connection with the offering covered by this prospectus. If given or made, such
information or representation must not be relied upon as having been authorized
by us. This prospectus does not constitute an offer or a solicitation. Neither
the delivery of this prospectus, nor any distribution of securities made using
this prospectus shall under any circumstances, create any implication that there
has not been any change in the facts set forth in this prospectus or in our
affairs since the date of this prospectus.
The securities may not be offered or sold in or into the United Kingdom
except in circumstances that do not constitute an offer to the public within the
meaning of the Public Offers of Securities Regulation 1995. All applicable
provisions of the Financial Services Act 1986 must be complied with in respect
of anything done in relation to securities in, from or otherwise involving the
United Kingdom.
i
<PAGE> 4
SUMMARY
The following summary contains basic information about MGC Communications,
Inc., the exchange notes and the exchange offer. It likely does not contain all
the information that is important to you. For a more complete understanding of
our company, the exchange notes and the exchange offer, we encourage you to read
this entire document, the documents incorporated by reference in this document
and the documents to which we have referred you. See "Where You Can Find More
Information" on page 141.
As used in this prospectus, unless the context otherwise requires, "we,"
"us," "our," "Mpower" or " MGC Communications, Inc." refers to the business of
MGC Communications, Inc. and its subsidiaries.
THE EXCHANGE OFFER
On March 24, 2000, we issued $250,000,000 aggregate principal amount of our
13% Senior Notes due 2010 in a private offering pursuant to Rule 144A under the
Securities Act of 1933, as amended. On June 2, 2000 and June 12, 2000, we issued
in a private exchange offer an additional $106,926,000 and $10,137,000,
respectively, aggregate principal amount of our 13% Senior Notes due 2010 in
exchange for a total of $103,884,000 aggregate principal amount of our
outstanding 13% Senior Secured Notes due 2004.
As a result, a total of $367,063,000 aggregate principal amount of our 13%
Senior Notes due 2010 are currently outstanding. In this prospectus, we refer to
these notes as the outstanding notes. None of the outstanding notes are
registered under the Securities Act of 1933.
The outstanding notes are entitled to the benefits of a registration rights
agreement, dated March 24, 2000, which we entered into in connection with the
initial issuance of the outstanding notes. Under the registration rights
agreement, we agreed, among other things, to deliver to you this prospectus and
to consummate the exchange offer for the outstanding notes by October 20, 2000.
The outstanding notes can now be tendered for exchange. You should read the
discussion under the headings "Summary of the Terms of the Exchange Notes" and
"Description of the Notes" for further information regarding the exchange notes.
We believe that the notes to be issued in the exchange offer, which we
refer to in this prospectus as the exchange notes, may be resold by you without
compliance with the registration and prospectus delivery provisions of the
Securities Act of 1933, as amended (the "Securities Act"), subject to certain
conditions. You should read the discussion under the headings "Summary of the
Terms of Exchange Offer" and "The Exchange Offer" for further information
regarding the exchange offer and resale of the exchange notes. The exchange
notes and the outstanding notes are considered collectively to be a single class
for all purposes under the indenture, and are sometimes referred to in this
prospectus collectively as the notes.
OUR BUSINESS
We are a growing communications company currently offering a single package
of services including Internet access, voice over digital subscriber line or
DSL, local dialtone, long distance and other voice and data services. We market
these services primarily to small and medium size business customers. We have
launched bundled voice and high-speed data services using DSL technology in all
of our current markets. DSL technology allows us to use our existing network to
simultaneously carry up to 24 voice calls or multiple voice calls and high-speed
data traffic on a single standard telephone line. Since launching our services,
we have experienced operating losses and generated negative cash flow from
operations. We expect to continue to generate negative cash flow from
1
<PAGE> 5
operations for the foreseeable future while we continue to expand our network
and develop our product offerings and customer base.
- We have installed our own equipment in space we rent at 446 incumbent
carrier central office sites as of March 31, 2000. These incumbent
carrier central office sites represent one of the broadest geographic
service areas of any competitive carrier providing local, long distance
and data products. Approximately 248 of our central office collocation
sites are DSL capable.
- We have developed a sophisticated, proprietary operations support system
designed to manage all aspects of our business, including timely and
accurate provisioning to place our customers on our network. This allows
us to control access to our customers. Our operations support system is
fully integrated and fully capable of accommodating our growth plans.
- We use a capital efficient network consisting of our own switches,
placing our equipment in the central offices of incumbent carriers and
leasing local telephone lines and cables.
- We have an experienced and proven management team led by our president
and chief executive officer, Rolla P. Huff.
- We currently deliver our services in the metropolitan areas of Atlanta,
Chicago, Las Vegas, southern Florida and selected areas of California,
including Los Angeles, San Diego, Sacramento and the San Francisco Bay
Area markets.
- We have established working relationships with five incumbent local
exchange carriers: SBC, Ameritech, BellSouth, GTE, PacBell and Sprint.
- As of March 31, 2000, we had 194,775 customer lines sold, of which
168,786 lines were in service.
- To roll out our network and services on a national basis, during 2000, we
plan to aggressively expand our network to include over 900 incumbent
carrier central office sites providing access to more than 36 million
addressable lines.
- We have announced that we intend to change our name to "Mpower
Communications Corp." in connection with the national rollout of our
services.
- In connection with the expansion of our network, we plan to increase the
size of our sales force from 187 sales personnel at the end of 1999 to
over 500 by the end of 2000.
- We plan to build data centers and enter into co-marketing agreements with
"e-commerce" providers.
We were one of the first competitive carriers to implement a strategy of
building and owning the network equipment that controls how voice and data
transmissions originate and terminate, which we refer to as switches, while
leasing the telephone lines and cable over which the voice calls and data
traffic are transmitted, which we refer to as transport. We believe this
strategy has allowed us to serve a broad geographical area at a comparatively
low cost while maintaining control of the access to our customers. Having
executed this strategy, we are well-positioned to serve the growing demand from
small and medium size business customers for communications services.
By implementing DSL technology and using a single telephone line to deliver
a bundled voice and high-speed data product, we expect to significantly reduce
the per line costs of provisioning customer lines and the associated recurring
costs of leasing telephone lines. These savings should allow us to improve our
cash flow from operations and offer a value-priced package of services to our
customers.
Our official corporate name is MGC Communications, Inc., however, we do
business under the name Mpower Communications Corp. We expect to formally change
our corporate name to Mpower Communications Corp. upon receiving shareholder
approval at the next annual meeting on June 22,
2
<PAGE> 6
2000. Our principal executive offices are at 171 Sully's Trail, Suite 202,
Pittsford, New York 14534. Our telephone number is (716) 218-6550.
RECENT DEVELOPMENTS -- ACQUISITION OF PRIMARY NETWORK
As part of our growth strategy, we are actively considering the acquisition
of other businesses as a means of expanding into new markets or developing new
services. On April 17, 2000, we entered into an agreement to acquire Primary
Network Holdings, Inc. for approximately 1.4 million shares of our common stock
and our assumption of approximately $76 million in debt. The acquisition is
expected to be completed on June 23, 2000. In connection with the Primary
Network transaction, we have agreed to offer to exchange the debt we will assume
in the transaction for our 13% Senior Notes due 2010. With the exception of
Primary Network, we have not reached any agreement to effect any acquisition. We
are, however, currently developing various other acquisition opportunities and
have engaged in discussions regarding some of them. One or more of these
transactions, if consummated, would be material.
Primary Network is an integrated communications provider offering data and
voice telecommunications services to both business and residential customers in
second-tier and third-tier markets in the Midwestern United States. Primary
Network's advanced network is based on a new generation of DSL platforms and ATM
switches.
Primary Network's voice and data service offerings include:
- High-speed Internet access for residences and small to medium-sized
business via both traditional methods and DSL technology;
- Telecommuting network services;
- Local telephone service;
- Long distance telephone service;
- Low cost long distance voice over DSL;
- Web hosting, collocation and other Internet-related services;
- Wide area network solutions for data-intensive businesses; and
- Cellular and paging (as an agent of Southwestern Bell).
Primary Network currently offers these services in four metropolitan areas:
St. Louis, Missouri; Kansas City, Missouri; Springfield, Missouri; and Tulsa,
Oklahoma.
As of March 31, 2000, Primary Network had 43 central offices in service
throughout these four metropolitan areas. As of April 30, 2000, Primary Network
had over 1,000 dedicated access customers, approximately 500 DSL customers in
service, approximately 12,000 other business customers (mainly modem access,
web-hosting and local and long distance) and 30,000 residential customers
(mainly modem access and local and long distance). Current customers include
Boeing, TWA, Arch Coal, Emerson Electric, St. Louis University and Washington
University.
If you would like further information on this transaction and Primary
Network, please see our registration statement on Form S-4 which we filed with
the Securities and Exchange Commission and was declared effective on May 25,
2000. We have specifically incorporated by reference the registration statement
relating to the Primary Network acquisition into the registration statement of
which this prospectus is a part.
3
<PAGE> 7
SUMMARY OF THE TERMS OF THE EXCHANGE OFFER
REGISTRATION RIGHTS........... In March 2000, we entered into a registration
rights agreement whereby we agreed that you, as
a holder of the outstanding notes, would be
entitled to exchange your outstanding notes for
registered notes with substantially identical
terms. The exchange offer is intended to
satisfy your exchange rights. After the
exchange offer is complete, you will no longer
be entitled to any exchange or registration
rights with respect to your outstanding notes.
Accordingly, if you do not exchange your
outstanding notes, you will not be able to
reoffer, resell or otherwise dispose of your
outstanding notes unless you comply with the
registration and prospectus delivery
requirements of the Securities Act or there is
an exemption available.
THE EXCHANGE OFFER............ We are offering to exchange:
- $1,000 principal amount of our 13% Senior
Notes due 2010, which have been
registered under the Securities Act, for
- $1,000 principal amount of our
unregistered 13% Senior Notes due 2010,
of which $367,063,000 aggregate principal
amount are currently outstanding.
EXPIRATION DATE............... The exchange offer will expire at 5:00 p.m.,
New York City time, on
, 2000, unless we extend it. In
that case the phrase "expiration date" will
mean the latest date and time to which we
extend the exchange offer. We will issue
exchange notes as soon as practicable after
that date.
ACCRUED INTEREST ON THE
EXCHANGE NOTES AND THE
OUTSTANDING NOTES........... The exchange notes will bear interest from
March 24, 2000. Holders of outstanding notes
whose notes are accepted for exchange will be
deemed to have waived the right to receive any
payment in respect of interest on such
outstanding notes accrued from March 24, 2000
to the date of the issuance of the exchange
notes. Consequently, holders who exchange their
outstanding notes for exchange notes will
receive the same interest payment on October 1,
2000 (the first interest payment date with
respect to the notes) that they would have
received had they not accepted the exchange
offer.
CONDITIONS TO THE EXCHANGE
OFFER......................... The exchange offer is not subject to any
conditions other than that the exchange offer
does not violate applicable law or any
applicable interpretation of the Staff of the
Securities and Exchange Commission. The
exchange offer is not conditioned upon any
minimum principal amount of outstanding notes
being tendered. We reserve the right
- to delay the acceptance of the
outstanding notes for exchange,
- to terminate the exchange offer,
4
<PAGE> 8
- to extend the expiration date of the
exchange offer and retain all outstanding
notes tendered pursuant to the exchange
offer, subject to the right of holders of
outstanding notes to withdraw their
tendered notes, or
- to waive any condition or otherwise amend
the terms of the exchange offer in any
respect.
We may assert or waive these conditions in our
sole discretion. If we materially change the
terms of the exchange offer, we will resolicit
tenders of the outstanding notes. Please read
the section "The Exchange Offer -- Conditions
of the exchange offer" of this prospectus for
more information regarding conditions to the
exchange offer.
TERMINATION OF THE EXCHANGE
OFFER......................... We may terminate the exchange offer if we
determine that our ability to proceed with the
exchange offer could be materially impaired due
to any legal or governmental action, new law,
statute, rule or regulation or any
interpretation of the staff of the Securities
and Exchange Commission of any existing law,
statute, rule or regulation. We do not expect
any of the foregoing conditions to occur,
although we cannot assure you that such
conditions will not occur. Holders of exchange
notes will have certain rights against us under
the registration rights agreement should we
fail to consummate the exchange offer.
PROCEDURES FOR PARTICIPATING
IN THE EXCHANGE OFFER......... If you wish to participate in the exchange
offer, you must complete, sign and date an
original or faxed letter of transmittal (or a
properly transmitted Agent's Message) in
accordance with the instructions contained in
the letter of transmittal accompanying this
prospectus. Then you must mail, fax or deliver
the completed letter of transmittal, together
with the outstanding notes you wish to exchange
and any other required documentation to the
exchange agent, which the exchange agent must
receive before 5:00 p.m., New York City time,
on the expiration date of the exchange offer.
The address of the exchange agent appears on
the letter of transmittal. By signing the
letter of transmittal (or a properly
transmitted Agent's Message), you will
represent to and agree with us that:
- you are acquiring the exchange notes in
the ordinary course of business;
- you are not participating, do not intend
to participate, and have no arrangement
or understanding with any person to
participate, in the distribution of the
exchange notes;
- you are not a broker-dealer who purchased
the outstanding notes directly from us
for resale pursuant to Rule 144A or any
other available exemption under the
Securities Act of 1933; and
5
<PAGE> 9
- you are not an "affiliate" (as defined in
Rule 405 under the Securities Act) of our
company.
If you are a broker-dealer that will receive
exchange notes for your own account in exchange
for outstanding notes that you acquired as a
result of your market-making or other trading
activities, you will be required to acknowledge
in the letter of transmittal that you will
deliver a prospectus in connection with any
resale of the exchange notes. The letter of
transmittal states that by so acknowledging and
by delivering a prospectus, such broker-dealer
will not be deemed to admit that it is an
"underwriter" within the meaning of the
Securities Act. A broker-dealer may use this
prospectus for an offer to resell the exchange
notes. We have agreed, that for a period of up
to 365 days after the Securities and Exchange
Commission declares the registration statement
relating to this exchange offer effective, we
will make this prospectus and any amendment or
supplement to this prospectus available to any
such broker-dealer for use in connection with
any such resales.
RESALE OF EXCHANGE NOTES...... We believe that you can resell and transfer
your exchange notes without registering them
under the Securities Act and delivering a
prospectus, if you can make the same three
representations that appear above under the
heading "Procedures for participating in the
exchange offer." But, our belief is based on
interpretations of the Securities and Exchange
Commission expressed in some no-action letters
to other issuers in exchange offers similar to
ours. We cannot guarantee that the Securities
Exchange Commission would make a similar
decision about this exchange offer. If our
belief is wrong, or if you cannot truthfully
make the representations mentioned above, and
you transfer any new note issued to you in the
exchange offer without meeting the registration
and prospectus delivery requirements of the
Securities Act, or without an exemption from
such requirements, you could incur liability
under the Securities Act. We are not
indemnifying you for any such liability.
A broker-dealer can only resell or transfer
exchange notes if it delivers a prospectus.
SPECIAL PROCEDURES FOR
BENEFICIAL OWNERS............. If your outstanding notes are held through a
broker, dealer, commercial bank, trust company
or other nominee and you wish to surrender such
outstanding notes, you should contact your
intermediary promptly and instruct it to
surrender your outstanding notes on your
behalf.
GUARANTEED DELIVERY
PROCEDURES.................... If you cannot meet the expiration date
deadline, or you cannot deliver your
outstanding notes, the letter of transmittal or
any other documentation on time, then you must
surrender your outstanding notes according to
the guaranteed delivery
6
<PAGE> 10
procedures appearing in this prospectus under
the heading "The Exchange Offer -- Guaranteed
delivery procedures."
ACCEPTANCE OF YOUR EXISTING
NOTES AND DELIVERY OF THE
EXCHANGE NOTES.............. We will accept for exchange any and all
outstanding notes that are surrendered in the
exchange offer prior to the expiration date if
you comply with the procedures of the exchange
offer. The exchange notes will be delivered as
soon as practicable after the expiration date.
WITHDRAWAL RIGHTS............. You may withdraw the surrender of your
outstanding notes at any time prior to the
expiration date. See "The Exchange
Offer -- Withdrawal of tenders of outstanding
notes."
CERTAIN FEDERAL INCOME TAX
CONSIDERATIONS.............. The exchange of outstanding notes for exchange
notes pursuant to the exchange offer will not
be a taxable event for U.S. federal income tax
purposes. You will not recognize any taxable
gain or loss as a result of such exchange and
will have the same tax basis and holding period
in the exchange notes as you had in the
outstanding notes immediately before the
exchange.
EXCHANGE AGENT................ HSBC Bank USA is serving as the exchange agent
in connection with the exchange offer. HSBC
Bank USA also serves as trustee under the
indenture governing the notes. The mailing
address of the exchange agent is 140 Broadway,
12th Floor, New York, New York 10005, fax
number (212) 658-6425. Deliveries by overnight
courier should be addressed to Issuer Services,
confirm by telephone number at (212) 658-6433.
Deliveries by hand should be addressed to
Issuer Services. For information about the
exchange offer, call the exchange agent at
telephone number: (212) 658-6433.
FAILURE TO EXCHANGE
OUTSTANDING NOTES WILL
ADVERSELY AFFECT YOU........ If you are eligible to participate in this
exchange offer and you do not surrender your
outstanding notes as described in this
prospectus, you will not have any further
registration or exchange rights. In that case
your outstanding notes will continue to be
subject to restrictions on transfer. As a
result of such restrictions and the
availability of registered new notes, the
outstanding notes are likely to be a much less
liquid security than before.
Neither the laws of the State of Nevada, or the
State of Delaware, nor the indenture governing
the notes gives you any appraisal or
dissenters' rights or any other right to seek
monetary damages in court if you do not
participate in the exchange offer.
7
<PAGE> 11
SUMMARY DESCRIPTION OF THE EXCHANGE NOTES
The form and terms of the exchange notes are identical in all respects to
the form and terms of the outstanding notes, except that the exchange notes have
been registered under the Securities Act, and therefore are not subject to the
transfer restrictions applicable to the outstanding notes. Nor are the exchange
notes entitled to the benefits of the registration rights granted under the
registration right agreement, dated as of March 24, 2000, executed in connection
with the initial private offering of the outstanding notes among us and the
initial purchasers.
SECURITIES OFFERED............ $367,063,000 principal amount of 13% Senior
Notes due 2010.
MATURITY...................... April 1, 2010.
INTEREST...................... We will pay interest on the exchange notes at a
fixed annual rate of 13%. We will pay the
interest due on the exchange notes in cash
every six months on April 1 and October 1. We
will make the first payment on October 1, 2000.
RANKING....................... The exchange notes are the senior unsecured
obligations of us (MGC Communications, Inc.)
and our wholly-owned subsidiary, Mpower Holding
Corporation. Mpower Holding Corporation is
currently a shell entity incorporated in
Delaware with minimal assets, no operations, no
subsidiaries and no debt or liabilities other
than the notes. Mpower Holding Corporation was
created for the sole purpose of becoming the
parent holding company if we determine to
restructure our company into a holding company
structure.
- The exchange notes will rank equal in
right of payment to all existing and
future senior unsecured debt of MGC
Communications, Inc. and Mpower Holding
Corporation.
- The exchange notes will rank senior in
right of payment to all future debt of
MGC Communications, Inc. and Mpower
Holding Corporation that expressly
provides that it is subordinated to the
exchange notes.
- In addition, the exchange notes will be
effectively subordinated to:
(a) any existing or future secured
debt of MGC Communications, Inc.
and Mpower Holding Corporation,
including MGC Communications, Inc.
outstanding 13% Senior Secured
Notes due 2004, to the extent of
the value of the assets securing
the debt, and
(b) any existing or future debt or
liabilities (including trade
payables) of MGC Communications,
Inc. subsidiaries, other than
Mpower Holding Corporation.
As discussed, we may restructure our company
into a holding company structure whereby Mpower
Holding Corporation would become the parent
holding company of our corporate
8
<PAGE> 12
operations. MGC Communications, Inc. and our
other subsidiaries, in turn, would become the
wholly-owned subsidiaries, directly or
indirectly, of Mpower Holding Corporation. As a
holding company, Mpower Holding Corporation
would have essentially no assets other than the
capital stock of MGC Communications, Inc., and
our other subsidiaries, and practically all of
Mpower Holding Corporation's revenue generating
operations would be conducted through its
subsidiaries. Under the express terms of the
notes and the indenture governing the notes, if
(a) we do restructure our company into a
holding company structure and (b) at least
66 2/3% of the originally issued $160 million
aggregate principal amount of our 13% Senior
Secured Notes due 2004 are no longer
outstanding, then the notes would become the
exclusive obligations of Mpower Holding
Corporation, and MGC Communications, Inc. would
be automatically released of its obligations
under the notes and the indenture. If this
occurs, the exchange notes would become
effectively subordinated in right of payment to
all debt and other liabilities (including trade
payables) of Mpower Holding Corporation's
subsidiaries.
After the completion of the private exchange
offer in June 2000, only $56.1 million of our
13% Senior Secured Notes due 2004 remain
outstanding. If we repurchase, redeem or
similarly exchange approximately $2.8 million
of additional 13% Senior Secured Notes due
2004, then the provision under the indenture
described above, requiring at least 66 2/3% of
the secured notes to no longer be outstanding,
would be satisfied. See "Description of the
Exchange Notes -- General" and "Risk
Factors -- If we restructure our company into a
holding company structure notes become the
exclusive obligations of Mpower Holding
Corporation. If this happens the notes will be
effectively subordinated to all of the
liabilities of the operating subsidiaries,
including MGC Communications, Inc."
As of March 31, 2000, on a pro forma basis
after giving effect to the issuance of a total
of $117,063,000 aggregate principal amount of
notes in exchange for a total of $103,884,000
aggregate principal amount of our 13% Senior
Secured Notes due 2004 in connection with a
private exchange offer in June 2000, there
would be approximately:
- $56.1 million of outstanding 13% Senior
Secured Notes due 2004, which are secured
by (a) telecommunications assets having a
net book value of approximately $89.0
million (with historical costs of
approximately $108.0 million) and (b) a
pledge of U.S. government securities in
an amount sufficient to cover scheduled
interest payments on these secured notes
through October 1, 2000; and $4.5 million
of
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other secured debt, ranking effectively
senior to the exchange notes to the extent
of the value of the assets securing the
debt.
- No other outstanding debt ranking equally
with the exchange notes.
- No outstanding debt ranking behind the
exchange notes.
OPTIONAL REDEMPTION........... We may redeem some or all of the exchange notes
at our option at any time after April 1, 2005
at the redemption prices described under
"Description of the Notes -- Optional
Redemption" plus any interest that is accrued
and unpaid on the date we redeem the exchange
notes. Until April 1, 2003, we may also redeem
up to 35% of the principal amount of the
exchange notes from the net cash proceeds of an
underwritten public offering of capital stock
at a redemption price equal to 113.0% of the
principal amount of the exchange notes plus any
interest that is accrued and unpaid on the date
we redeem the exchange notes.
CHANGE OF CONTROL............. Following certain changes of control, we must
offer to repurchase the exchange notes at the
prices set forth under "Description of the
Notes -- Offer to Purchase Upon Change of
Control."
CERTAIN COVENANTS............. We will issue the new notes under an indenture
with HSBC Bank USA, as trustee under the
indenture. The indenture governing the new
notes is the same indenture that governs the
existing notes. The indenture will, among other
things, restrict our ability to:
- make restricted payments;
- incur additional debt;
- pay dividends or make other
distributions;
- repurchase equity interests or
subordinated debt;
- engage in sale and leaseback
transactions;
- create liens;
- enter into transactions with affiliates;
- sell our assets or assets of our
subsidiaries;
- conduct other lines of business; and
- enter into mergers and consolidations.
USE OF PROCEEDS............... We will not receive any proceeds from the
exchange offer. See "Use of Proceeds." We have
agreed to bear the expenses of the exchange
offer. No underwriter has been retained to
carry out the exchange offer.
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TRADING....................... We expect that the notes will be eligible for
trading in the PORTAL Market.
RISK FACTORS
You should carefully consider all the information in this prospectus. In
particular, you should evaluate the specific risk factors set forth under "Risk
Factors," beginning on page 12, for a discussion of certain risks involved in
making an investment in the exchange notes.
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RISK FACTORS
You should carefully consider the information below as well as all other
information provided to you in this prospectus before deciding whether to tender
your outstanding notes in exchange for exchange notes pursuant to this exchange
offer. These risks apply to both the outstanding notes and the exchange notes.
WE EXPECT OUR LOSSES TO CONTINUE AND WE MAY NOT BE ABLE TO GENERATE SUFFICIENT
CASH FLOW TO MEET OUR DEBT SERVICE REQUIREMENTS
We recorded net losses of $25.3 million in the first quarter of 2000, and
annual losses of $69.8 million in 1999, $32.1 million in 1998, and $10.8 million
in 1997. In addition, we had positive cash flow from operations of only $2.2
million in the first quarter of 2000 and negative cash flow from operations of
$45.9 million in 1999, $24.2 million in 1998 and $4.5 million in 1997. We do not
generate enough cash flow to cover our operating and investing expenses. Our
historical earnings were insufficient to cover combined fixed charges and
dividends on preferred stock by $76.4 million for the year ended December 31,
1999. Combined fixed charges and dividends include interest and dividends,
whether paid or accrued. We expect to record significant net losses and generate
negative cash flow from operations for the foreseeable future. We cannot assure
you we will achieve or sustain profitability or generate sufficient positive
cash flow from operations to meet our planned capital expenditures, working
capital and debt service requirements.
OUR SUBSTANTIAL DEBT CREATES FINANCIAL AND OPERATING RISK
We have a substantial amount of debt. As of March 31, 2000, we had
approximately $405.2 million of total debt outstanding. The terms of the notes
and our other outstanding debt limit, but do not prohibit, us from incurring
additional debt. For example, the indenture governing the notes allows us to
incur an unlimited amount of debt to finance the cost of acquiring equipment
used in our business. We expect to incur significant amounts of additional debt
in the future to fund our expansion into new markets, develop our network and
expand our customer base. Our level of debt could have important consequences to
you, including the following:
- It could limit our ability to obtain additional financing for working
capital, capital expenditures, acquisitions, joint ventures and general
corporate purposes;
- It could require us to dedicate a substantial portion of our cash flow
from operations to payments on our debt, thereby reducing the funds
available to us for expansion or other purposes, including working
capital, capital expenditures, acquisitions, joint ventures and general
corporate purposes;
- It could make us more vulnerable to changes in general economic
conditions or increases in prevailing interest rates limiting our ability
to withstand competitive pressures and reducing our flexibility in
responding to changing business and economic conditions;
- It could limit our flexibility in planning for, or reacting to, changes
in our business and the industry in which we operate;
- It could place us at a competitive disadvantage compared to our
competitors that have less debt; and
- Our failure to comply with the restrictions contained in any of our
financing agreements could lead to a default which could result in our
being required to repay all of our outstanding debt.
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OUR CASH FLOW MAY NOT BE SUFFICIENT TO PERMIT REPAYMENT OF OUR INDEBTEDNESS WHEN
DUE.
Our ability to make payments on and to refinance our indebtedness will
depend on our ability to generate cash flow in the future. We cannot assure you
that our business will generate sufficient cash flow from operations to meet our
debt service requirements. Our cash flow from operations may be insufficient to
repay our indebtedness at scheduled maturity and some or all of such
indebtedness may have to be refinanced. If we are unable to refinance our debt
or if additional financing is not available on acceptable terms, or at all, we
could be forced to dispose of assets under circumstances that might not be
favorable to realizing the highest price for the assets or to default on our
obligations with respect to our indebtedness.
IF OUR EXPANSION PLANS CHANGE WE MAY NEED SIGNIFICANT ADDITIONAL FUNDS THAT WE
MAY NOT BE ABLE TO OBTAIN
If our expansion plans change we may require significant amounts of capital
to fund the development and expansion of our business and services as well as
operating costs and debt service. If we cannot generate or otherwise obtain
sufficient funds, we may be required to delay or abandon these expansion plans.
This may have a negative impact on our growth and our ability to compete in the
communications industry. We expect to fund our capital requirements through
existing resources, internally generated funds and debt or equity financing,
including the proceeds of this offering. We cannot assure you we will be
successful in raising sufficient debt or equity financing on acceptable terms.
IT IS DIFFICULT TO PREDICT OUR FUTURE OPERATING RESULTS FROM OUR PREVIOUS
PERFORMANCE SINCE OUR BUSINESS MODEL IS STILL EVOLVING AND WE HAVE A LIMITED
OPERATING HISTORY
Our limited operating history makes predicting future results difficult.
Because some of our services are new, we cannot be sure businesses will buy
them. In addition, we have recently hired a new chief executive officer who may
realign our operations into regional service areas to support our expanding
geographic markets or make other changes which could increase the cost of
providing our services.
IF WE RESTRUCTURE OUR COMPANY INTO A HOLDING COMPANY STRUCTURE, THE NOTES MAY
BECOME THE EXCLUSIVE OBLIGATIONS OF MPOWER HOLDING CORPORATION. IF THIS HAPPENS
THE NOTES WILL BE EFFECTIVELY SUBORDINATED TO ALL OF THE LIABILITIES OF THE
OPERATING SUBSIDIARIES, INCLUDING MGC COMMUNICATIONS, INC.
The notes are the senior unsecured obligations of us (MGC Communications,
Inc.) and our wholly-owned subsidiary, Mpower Holding Corporation. Mpower
Holding Corporation is currently a shell entity incorporated in Delaware with
minimal assets, no operations, no subsidiaries and no debt or liabilities other
than the notes. Mpower Holding Corporation was created for the sole purpose of
becoming the parent holding company if we determine to restructure our company
into a holding company structure. If we do restructure our company into a
holding company structure, Mpower Holding Corporation would become the parent
holding company of our corporate operations. In addition, MGC Communications,
Inc. and our other subsidiaries would become the wholly-owned subsidiaries,
directly or indirectly, of Mpower Holding Corporation. As a holding company,
Mpower Holding Corporation would have essentially no assets other than the
capital stock of MGC Communications, Inc., and our other subsidiaries.
Practically all of Mpower Holding Corporation's revenue generating operations
would be conducted through, and all of its assets would be held by, its
subsidiaries. Mpower Holding Corporation's cash flow and ability to service its
indebtedness, including the notes, would depend upon the cash flow of its
subsidiaries and payments of funds by those subsidiaries to Mpower Holding
Corporation in the form of repayment of loans, dividends or otherwise. In
addition, Mpower Holding Corporation's subsidiaries could become parties to
financing
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arrangements which could contain limitations or prohibitions on the ability of
the subsidiaries to pay dividends or to make loans or advances to Mpower Holding
Corporation or otherwise make cash flow available to Mpower Holding Corporation.
Under the express terms of the notes and the indenture governing the notes,
if (a) we do restructure our company into a holding company structure and (b) at
least 66 2/3% of the originally issued $160 million aggregate principal amount
of our 13% Senior Secured Notes due 2004 are no longer outstanding, then the
notes would become the exclusive obligations of Mpower Holding Corporation, and
MGC Communications, Inc. would be automatically released of its obligations
under the notes and the indenture. After the completion of the private exchange
offer in June 2000, only $56.1 million of our 13% Senior Secured Notes due 2004
remain outstanding. If we repurchase, redeem or similarly exchange approximately
$2.8 million of additional 13% Senior Secured Notes due 2004, then the provision
under the indenture described above, requiring at least 66 2/3% of the secured
notes to no longer be outstanding, would be satisfied.
Alternatively, after the date that is the earlier of the date the 13%
Senior Secured Notes due 2004 are no longer outstanding or are defeased, we may
create a holding company structure by transferring substantially all of MGC
Communications, Inc.'s assets to one or more of our subsidiaries. In this case,
MGC Communications, Inc. would become the holding company.
If either of these scenarios occur, the notes would be effectively
subordinated to all debt and liabilities, including trade payables and lease
obligations, of the holding company's subsidiaries. Any right the holding
company would have to receive assets of its subsidiaries upon liquidation or
reorganization would be effectively subordinated to the claims of its
subsidiaries' creditors. The holding company's subsidiaries would have the
ability to incur significant additional debt, all of which would be effectively
senior in right of payment to the notes.
THE NOTES ARE EFFECTIVELY SUBORDINATED TO OUR SECURED DEBT
The notes are senior unsecured obligations and are effectively subordinated
in right of payment to any secured debt to the extent of the value of the assets
securing the secured debt. Currently, our $56.1 million aggregate principal
amount of outstanding 13% Senior Secured Notes due 2004 are secured by certain
telecommunication equipment and government securities. We anticipate that all of
the obligations under any credit facility that we or any of our subsidiaries may
enter into in the future will be secured. In a bankruptcy, liquidation or
reorganization, the assets securing other indebtedness will be available to pay
obligations on the notes only after all indebtedness secured by such assets has
been paid in full, at which point there may not be sufficient proceeds remaining
to pay amounts due on the notes then outstanding. As of March 31, 2000 on a
consolidated and pro forma basis, after giving effect to the private exchange
offer for our 13% Senior Secured Notes due 2004 consummated in June 2000, we had
approximately $60.6 million of outstanding secured debt.
THERE COULD BE ADVERSE CONSEQUENCES OF FAILURE TO EXCHANGE YOUR OUTSTANDING
NOTES FOR EXCHANGE NOTES.
The outstanding notes were not registered under the Securities Act or under
the securities laws of any state and may not be resold, offered for resale or
otherwise transferred unless they are subsequently registered or resold pursuant
to an exemption from the registration requirements of the Securities Act and
applicable state securities laws. Accordingly, if you do not exchange your
outstanding notes for exchange notes pursuant to the exchange offer, you will
not be able to resell, offer to resell or otherwise transfer the outstanding
notes unless they are registered under the Securities Act or unless you resell
them, offer to resell or otherwise transfer them under an exemption from the
registration requirements of, or in a transaction not subject to, the Securities
Act. In addition, we will no longer be under an obligation to register the
outstanding notes under the
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Securities Act except in the limited circumstances provided under the
registration rights agreement. In addition, to the extent that outstanding notes
are tendered for exchange and accepted in the exchange offer, the trading market
for the untendered and tendered but unaccepted outstanding notes could be
adversely affected.
WE WILL FACE ADDITIONAL RISKS IF WE ACQUIRE OTHER BUSINESSES
We have executed a merger agreement in order to acquire Primary Network.
This acquisition is expected to be consummated on June 23, 2000. As part of our
growth strategy, we may acquire other businesses as a means of expanding into
new markets or developing new services. We are currently evaluating various
acquisition opportunities and have engaged in discussions regarding some of
them. One or more of these acquisitions, if consummated, would be material.
However, we have not reached any agreement to effect any transaction, with the
exception of Primary Network. We are unable to predict whether or when any
prospective acquisitions will occur or the likelihood of any acquisition being
completed on favorable terms and conditions. Acquisitions of Primary Network and
other businesses involve risks including:
- difficulties assimilating acquired back-office operations and personnel;
- difficulties integrating different network equipment and systems into our
operations;
- potential disruptions of our ongoing business;
- the diversion of resources and management time;
- the possibility uniform standards, controls, procedures and policies may
not be maintained;
- risks associated with entering new markets in which we have little or no
experience; and
- the potential impairment of relationships with employees or customers as
a result of changes in management.
- The incurrence of integration costs associated with consolidating
corporate headquarters and other administrative functions, terminating
certain leases and severance and facility closing costs associated with
consolidating certain product lines as well as other merger-related
charges such as financial advisory, legal and accounting fees, financial
printing and other related costs.
Primary Network and any other business we might acquire might not perform
as expected. Furthermore, we have never acquired another business. Accordingly,
we have no experience dealing with any of the risks associated with making
acquisitions. Our failure to successfully address these risks could have a
material adverse effect on our business.
WE MAY NOT BE ABLE TO PROVIDE DATA TRANSMISSION SERVICES EFFECTIVELY
We do not have substantial experience in providing data transmission
services and, consequently, we can provide no assurance that we will be
successful in the data transmission business. Our ability to successfully enter
the data transmission business will depend upon, among other things, our ability
to:
- select new equipment and software and integrate these into our network;
- hire and train qualified personnel;
- enhance our billing, back-office and information systems to accommodate
data transmission services; and
- obtain customer acceptance of our service offerings.
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If we are not successful, there may be a material adverse effect on our
business
The data transmission business is also extremely competitive and prices
have declined substantially in recent years and are expected to continue to
decline. In providing these services, we will be dependent upon vendors for
assistance in planning and deploying our data product offerings, as well as
ongoing training and support. Our vendors may not have adequate experience in
providing equipment and configuring data networks in our various markets. We may
also experience technical difficulties in integrating our equipment and handling
differing data transmission protocols in our various markets.
OUR ABILITY TO USE OUR NET OPERATING LOSS CARRYFORWARDS MAY BE LIMITED
As of December 31, 1999, we had federal income tax net operating loss
carryforwards of $133.7 million (which would result in a tax benefit of $48.2
million) which principally begin to expire in 2011. Our ability to use our net
operating loss carryforwards to reduce our future tax payments would be limited
if a 50% ownership change were to occur over a three-year period.
OUR OPERATING RESULTS ARE LIKELY TO FLUCTUATE AND WILL BE DIFFICULT TO PREDICT
Our annual and quarterly operating results are likely to fluctuate
significantly as a result of numerous factors, many of which are outside of our
control. These factors include:
- the timing and willingness of traditional telephone companies to provide
us with central office space and the prices, terms and conditions on
which they make the space available to us;
- the amount and timing of capital expenditures and other costs relating to
the expansion of our networks and the marketing of our services;
- delays in the commencement of operations in new regions and the
generation of revenue because certain network elements have lead times
that are controlled by incumbent carriers and other third parties;
- the ability to develop and commercialize new services by us or our
competitors;
- the ability to deploy on a timely basis our services to adequately
satisfy customer demand;
- our ability to successfully operate our networks;
- the rate at which customers subscribe to our services;
- decreases in the prices for our services due to competition, volume-based
pricing and other factors;
- the mix of line orders between business customers (which typically have
higher margins) and residential customers:
- the development and operation of our billing and collection systems and
other operational systems and processes;
- the rendering of accurate and verifiable bills from the incumbent
carriers from whom we lease transport and resolution of billing disputes;
- the incorporation of enhancements, upgrades and new software and hardware
products into our network and operational processes that may cause
unanticipated disruptions; and
- the interpretation and enforcement of regulatory developments and court
rulings concerning the 1996 Telecommunications Act, interconnection
agreements and the antitrust laws.
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THE TERMS OF OUR DEBT COVENANTS AND PREFERRED STOCK COULD LIMIT HOW WE CONDUCT
OUR BUSINESS AND OUR ABILITY TO RAISE ADDITIONAL FUNDS
The agreements which govern the terms of our debt, including the indentures
governing the notes and our outstanding 13% Senior Secured Notes due 2004,
contain covenants that restrict our ability to:
- incur additional debt;
- pay dividends and make other distributions;
- prepay subordinated debt;
- make investments and other restricted payments;
- create liens;
- sell assets; and
- engage in transactions with affiliates.
In addition, the terms of our outstanding preferred stock require us to
obtain the approval of the holders before we take specified actions. Please see
"Description of Preferred Stock."
Our future financing arrangements will likely contain similar or more
restrictive covenants. As a result of these restrictions, we may be:
- limited in how we conduct our business;
- unable to raise additional debt or equity financing to operate during
general economic or business downturns; and
- unable to compete effectively or to take advantage of new business
opportunities.
These restrictions may affect our ability to grow in accordance with our plans.
OUR SUCCESS DEPENDS ON THE EFFECTIVENESS OF OUR MANAGEMENT. WE HAVE A NEW CHIEF
EXECUTIVE OFFICER AND ARE CONSIDERING OTHER ADDITIONS TO OUR MANAGEMENT TEAM
Our business is managed by a small number of key management personnel, the
loss of some of whom could impair our ability to carry out our planned
expansion. We believe our future success will depend in large part on our
ability to attract and retain highly skilled and qualified personnel. None of
our key executives other than Rolla P. Huff, our new chief executive officer,
and Michael R. Daley, our new chief financial officer, is a party to a long-term
employment agreement and we do not maintain key man insurance on our officers.
Our chief executive officer, chief financial officer and many other
significant members of our senior management team have been with our company for
less than a year. We are considering making further additions to our management
team. We cannot assure you that our new senior officers will be effective in
managing our company or will successfully work with our existing management
team.
IF OUR EQUIPMENT DOES NOT PERFORM AS WE EXPECT, IT COULD DELAY OUR EXPANSION
INTO NEW MARKETS AND OUR INTRODUCTION OF NEW SERVICES
In implementing our strategy, we may use new or existing technologies to
offer additional services. We also plan to use equipment manufactured by
multiple vendors to offer our current services and future services in each of
our new markets. If we cannot successfully install and integrate the technology
and equipment necessary to deliver our current services and any future services
within
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the time frame and with the cost effectiveness we currently contemplate, we
could be forced to delay or abandon a portion of our expansion plans or the
introduction of new services. This could also affect our ability to attract and
retain customers.
THE FAILURE OF OUR OPERATIONS SUPPORT SYSTEM TO PERFORM AS WE EXPECT COULD
IMPAIR OUR ABILITY TO RETAIN CUSTOMERS AND OBTAIN NEW CUSTOMERS OR RESULT IN
INCREASED CAPITAL EXPENDITURES
We employ a proprietary operations support system which is expected to be
an important factor in our success. If the operations support system fails or is
unable to perform as expected, we could suffer customer dissatisfaction, loss of
business or the inability to add customers on a timely basis, any of which would
adversely affect our revenues. Furthermore, problems may arise with higher
processing volumes or with additional automation features, which could
potentially result in system breakdowns and delays and additional, unanticipated
expense to remedy the defect or to replace the defective system with an
alternative system.
OUR FAILURE TO MANAGE GROWTH COULD RESULT IN INCREASED COSTS AND OUR INABILITY
TO ACHIEVE OUR EXPANSION GOALS
We may be unable to manage our growth effectively. This could increase the
costs of expansion and impair our ability to fully implement our expansion
plans. The development and expansion of our business and our entry into new
markets will depend on, among other things, our ability to achieve the following
goals in a timely manner, at reasonable costs and on satisfactory terms and
conditions:
- purchase, install and operate switches and other equipment, including DSL
equipment;
- accurately assess potential new markets;
- negotiate suitable interconnection agreements with, and arrangements for
installing our equipment at the central offices of, incumbent carriers on
satisfactory terms and conditions, including incumbent carriers in
markets we plan to enter;
- hire and retain qualified personnel;
- lease suitable access to transport networks;
- lease or purchase suitable sites; and
- obtain required government authorizations.
We have experienced rapid growth since our inception, and we believe
sustained growth will place a strain on our operational, human and financial
resources. Our growth will also increase our operating complexity as well as the
level of responsibility for both existing and new management personnel. Our
ability to manage our expansion effectively will depend on the continued
development of plans, systems and controls for our operational, financial and
management needs and on our ability to expand, train and manage our employee
base.
OUR SERVICES MAY NOT ACHIEVE SUFFICIENT MARKET ACCEPTANCE TO BECOME PROFITABLE
To be successful, we must develop and market services that are widely
accepted by businesses at profitable prices. Our success will depend upon the
willingness of our target customers to accept us as an alternative provider of
local, long distance, high-speed data and Internet services and developing
additional products and services. Although we are in the process of rolling out
high-speed data and Internet services and developing additional products and
services, we might not be able to provide the range of communication services
our target business customers need or desire. In addition, the lack of
willingness by e-commerce providers to accept us as a marketing, sales and
distribution partner would
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have a negative impact on our ability to deliver additional products and
services to our target customers.
OUR FAILURE TO ACHIEVE OR SUSTAIN MARKET ACCEPTANCE AT DESIRED PRICING LEVELS
COULD IMPAIR OUR ABILITY TO ACHIEVE PROFITABILITY OR POSITIVE CASH FLOW
Prices for data communication services have fallen historically, a trend we
expect will continue. Accordingly, we cannot predict to what extent we may need
to reduce our prices to remain competitive or whether we will be able to sustain
future pricing levels as our competitors introduce competing services or similar
services at lower prices. Our ability to meet price competition may depend on
our ability to operate at costs equal to or lower than our competitors or
potential competitors. There is a risk competitors, perceiving us to lack
capital resources, may undercut our rates or increase their services or take
other actions in an effort to force us out of business. Our failure to achieve
or sustain market acceptance at desired pricing levels could impair our ability
to achieve profitability or positive cash flow.
IF WE ARE UNABLE TO NEGOTIATE AND ENFORCE FAVORABLE INTERCONNECTION AGREEMENTS
AND ARRANGEMENTS FOR INSTALLING OUR EQUIPMENT, WE COULD HAVE DIFFICULTY
OPERATING PROFITABLY IN OUR EXISTING MARKETS AND ENTERING NEW MARKETS
We must negotiate and renew favorable interconnection agreements and
arrangements for installing our equipment with other companies, including
incumbent carriers, in markets we plan to enter. The rates charged to us under
the interconnection agreements might not continue to be low enough for us to
attract a sufficient number of customers and to operate the business on a
profitable basis. In addition, our interconnection agreements provide for our
connection and maintenance orders to receive attention on the same basis as the
incumbent carrier's customers and for the incumbent carriers to provide adequate
capacity to keep blockage within industry standards. However, from time to time,
we have experienced excessive blockage in the delivery of calls to and from the
incumbent carriers due to an insufficient number of phone lines installed by the
incumbent carriers between their switches and our switches. Blocked calls result
in customer dissatisfaction which may result in the loss of business.
DELAYS BY THE INCUMBENT CARRIERS IN CONNECTING OUR CUSTOMERS TO OUR NETWORK
COULD RESULT IN CUSTOMER DISSATISFACTION AND LOSS OF BUSINESS
We rely on the timeliness of incumbent carriers and competitive carriers in
processing our orders for customers switching to our service and in maintaining
the customer's standard telephone lines to assure uninterrupted service. The
incumbent carriers are our competitors and have had little experience leasing
standard telephone lines to other companies. Therefore, the incumbent carriers
might not be able to continue to provide and maintain leased standard telephone
lines in a prompt and efficient manner as the number of standard telephone lines
requested by competitive carriers increases.
WE MAY NOT BE ABLE TO SERVICE OUR CUSTOMERS IF WE CANNOT SECURE SUFFICIENT
TELEPHONE LINES AND CABLE TO MEET OUR FUTURE NEEDS
We may not be able to lease sufficient telephone lines and cable in markets
we want to enter or renew our lease arrangements or obtain comparable
arrangements from other carriers in our existing markets. Because we lease
rather than construct telephone lines and cable in each of our markets, we would
be unable to service our customers if we could obtain sufficient telephone lines
and cable. Our inability to lease sufficient telephone lines and cable could
result in the loss of customers, the inability to add new customers and
limitations on our ability to enter new markets.
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OUR RELIANCE ON A LIMITED NUMBER OF EQUIPMENT SUPPLIERS COULD RESULT IN
ADDITIONAL EXPENSES OR DELAYS IN OUR EXPANSION
We currently rely and expect to continue to rely on a limited number of
third party suppliers to manufacture the equipment we require to implement our
DSL technology. If our suppliers enter into competition with us, or if our
competitors enter into exclusive or restrictive arrangements with our suppliers,
it may materially and adversely affect the availability and pricing of the
equipment we purchase. Our reliance on third-party vendors involves a number of
additional risks, including the absence of guaranteed supply and reduced control
over delivery schedules, quality assurance, production yields and costs.
We cannot assure you that our vendors will be able to meet our needs in a
satisfactory and timely manner in the future or that we will be able to obtain
alternative vendors when and if needed. It could take a significant period of
time to establish relationships with alternative suppliers for critical
technologies and to introduce substitute technologies into our network. As a
result, the use of alternative vendors could delay our expansion plans. In
addition, if we change vendors, we may need to replace all or a portion of the
DSL equipment deployed within our network at significant expense in terms of
equipment costs and loss of revenues in the interim.
THE TELECOMMUNICATIONS INDUSTRY IS HIGHLY COMPETITIVE WITH PARTICIPANTS THAT
HAVE GREATER RESOURCES THAN WE DO, AND WE MAY NOT BE ABLE TO COMPETE
SUCCESSFULLY.
Our success depends upon our ability to compete with other
telecommunications providers in each of our markets, many of which have
substantially greater financial, marketing and other resources than we have. In
addition, competitive alternatives may result in substantial customer turnover
in the future. A growing trend towards consolidation of communications companies
and the formation of strategic alliances within the communications industry, as
well as the development of new technologies, could give rise to significant new
competitors. We cannot assure you that we will be able to compete successfully.
For more information regarding the competitive environment in which we operate,
please see "Business -- MPOWER -- Competition."
IF WE ARE NOT ABLE TO OBTAIN OR IMPLEMENT NEW TECHNOLOGIES, WE MAY LOSE BUSINESS
AND LIMIT OUR ABILITY TO ATTRACT NEW CUSTOMERS
We may be unable to obtain access to new technology on acceptable terms or
at all. We may be unable to adapt to new technologies and offer services in a
competitive manner. If these events occur, we may lose customers to competitors
offering more advanced services and our ability to attract new customers would
be hindered. Rapid and significant changes in technology are expected in the
communications industry. We cannot predict the effect of technological changes
on our business. Our future success will depend, in part, on our ability to
anticipate and adapt to technological changes, evolving industry standards and
changing needs of our current and prospective customers.
A SYSTEM FAILURE OR BREACH OF NETWORK SECURITY COULD CAUSE DELAYS OR
INTERRUPTIONS OF SERVICE TO OUR CUSTOMERS AND RESULT IN CUSTOMER DISSATISFACTION
Interruptions in service, capacity limitations or security breaches could
have a negative effect on customer acceptance and, therefore, on our revenues
and ability to attract new customers. Our networks may be affected by physical
damage, power loss, capacity limitations, software defects, breaches of security
by computer viruses, break-ins or otherwise and other factors which may cause
interruptions in service or reduced capacity for our customers.
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IF WE ARE UNABLE TO EFFECTIVELY DELIVER DSL SERVICES TO A SUBSTANTIAL NUMBER OF
CUSTOMERS, WE MAY NOT ACHIEVE OUR REVENUE GOALS
We cannot guarantee our network will be able to connect and manage a
substantial number of customers at high transmission speeds. If we cannot
achieve and maintain digital transmission speeds that are otherwise available in
the market, we may lose customers to competitors with higher transmission speeds
and we may not be able to attract new customers. While digital transmission
speeds of up to 1.5 Mbps are possible on portions of our network, that speed may
not be available over a majority of our network. Actual transmission speeds on
our network will depend on a variety of factors many of which are beyond our
control, including the distance an end user is located from a central office,
the quality of the telephone lines, the presence of interfering transmissions on
nearby lines and other factors.
WE MAY LOSE CUSTOMERS OR POTENTIAL CUSTOMERS BECAUSE THE TELEPHONE LINES WE
REQUIRE MAY BE UNAVAILABLE OR IN POOR CONDITION
Our ability to provide DSL services to potential customers depends on the
quality, physical condition, availability and maintenance of telephone lines
within the control of the incumbent carriers. If the telephone lines are not
adequate, we may not be able to provide DSL services to many of our target
customers and our expected revenues will be diminished. We believe the current
condition of telephone lines in many cases may be inadequate to permit us to
fully implement our DSL services. In addition, the incumbent carriers may not
maintain the telephone lines in a condition that will allow us to implement our
DSL services effectively or may claim they are not of sufficient quality to
allow us to fully implement or operate our DSL services. Further, some customers
use technologies other than copper lines to provide telephone services, and as a
result, DSL services might not be available to these customers.
INTERFERENCE OR CLAIMS OF INTERFERENCE COULD DELAY OUR ROLLOUT OR RESULT IN
CUSTOMER DISSATISFACTION
Interference, or claims of interference by the incumbent carriers, if
widespread, could adversely affect our speed of deployment, reputation, brand
image, service quality and customer satisfaction and retention. Technologies
deployed on copper telephone lines, such as DSL, have the potential to interfere
with other technologies on the copper telephone lines. Interference could
degrade the performance of our services or make us unable to provide service on
selected lines and the customers served by those lines. Although we believe our
DSL technologies, like other technologies, do not interfere with existing voice
services, incumbent carriers may claim the potential for interference permits
them to restrict or delay our deployment of DSL services. The procedures to
resolve interference issues between competitive carriers and incumbent carriers
are still being developed. We may be unable to successfully resolve interference
issues with incumbent carriers.
OUR SUCCESS WILL DEPEND ON GROWTH IN THE DEMAND FOR INTERNET ACCESS AND
HIGH-SPEED DATA SERVICES
If the markets for the services we offer, including Internet access and
high-speed data services, fail to develop, grow more slowly than anticipated or
become saturated with competitors, we may not be able to achieve our projected
revenues. The markets for business Internet and high-speed data services are in
the early stages of development. Demand for Internet services is highly
uncertain and depends on a number of factors, including the growth in consumer
and business use of new interactive technologies, the development of
technologies that facilitate interactive communication between organizations and
targeted audiences, security concerns and increases in data transport capacity.
In addition, the market for high-speed data transmission via DSL technology
is relatively new and evolving. Various providers of high-speed digital services
are testing products from various
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suppliers for various applications, and no industry standard has been broadly
adopted. Critical issues concerning commercial use of DSL for Internet and
high-speed data access, including security, reliability, ease of use and cost
and quality of service, remain unresolved and may impact the growth of these
services.
THE DESIRABILITY AND MARKETABILITY OF OUR INTERNET SERVICE MAY BE ADVERSELY
AFFECTED IF WE ARE NOT ABLE TO MAINTAIN RECIPROCAL RELATIONSHIPS WITH OTHER
INTERNET SERVICE PROVIDERS
The Internet is comprised of many Internet service providers and underlying
transport providers who operate their own networks and interconnect with other
Internet service providers at various points. As we commence the operation of
Internet services, connections to the Internet will be provided through
wholesale carriers. We anticipate as our volume increases, we will enter into
reciprocal agreements with other Internet service providers. We cannot assure
you other national Internet service providers will maintain reciprocal
relationships with us. If we are unable to maintain these relationships, our
Internet services may not be attractive to our target customers, which would
impair our ability to retain and attract customers. In addition, the
requirements associated with maintaining relationships with the major national
Internet service providers may change. We cannot assure you we will be able to
expand or adapt our network infrastructure to meet any new requirements on a
timely basis, at a reasonable cost, or at all.
WE MAY INCUR LIABILITIES AS A RESULT OF OUR INTERNET SERVICE OFFERINGS
United States law relating to the liability of on-line service providers
and Internet service providers for information carried on, disseminated through,
or hosted on their systems is currently unsettled. If liability is imposed on
Internet service providers, we would likely implement measures to minimize our
liability exposure. These measures could require us to expend substantial
resources or discontinue some of our product or service offerings. In addition,
increased attention to liability issues, as a result of litigation, legislation
or legislative proposals could adversely affect the growth and use of Internet
services.
CHANGES IN THE LEGISLATIVE AND REGULATORY FRAMEWORK COULD RESTRICT THE WAY WE
OPERATE OUR BUSINESS AND NEGATIVELY AFFECT OUR COSTS AND COMPETITIVE POSITION
Our services are regulated at the federal, state and local level. The FCC
exercises jurisdiction over all facilities of, and services offered by,
communication common carriers like us, as long as those facilities are used in
connection with interstate or international communications. State regulatory
commissions have some jurisdiction over most of the same facilities and services
if they are used in connection with communications within states. In recent
years, there has been a dramatic change in regulation of telephone services at
both federal and state levels as both legislative and regulatory bodies seek to
enhance competition in both the local exchange and interexchange service
markets. These efforts are ongoing and many of the legislative measures and
regulations adopted are subject to judicial review. The result of these ongoing
legislative and regulatory efforts or the outcome of any judicial review could
have an adverse effect on our company.
WE MAY NOT BE ABLE TO COLLECT ALL OF THE ACCESS CHARGES WE HAVE BILLED TO LONG
DISTANCE CARRIERS
When our facilities are used to originate a customer's long distance call
and deliver it to the long distance carrier designated by the customer, or to
terminate a long distance call received from a long distance carrier by
delivering it to a telephone number connected to our network, the long distance
carrier is required to pay us for access to our network and the use of our
facilities. These charges are called "access charges." Access charges
represented a significant portion of revenues in 1998 and 1999. While we
recently settled our disputes with AT&T and MCI WorldCom, certain other long
distance carriers responsible for generating a portion of our access charge
revenues continue to refuse
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to pay the full amount of access charges billed to them under our tariffs. For
example, we are currently in litigation with Sprint over the payment of our
tariffed access charges. The law applicable to our disputes with these carriers
is unclear and we may not be able to collect the full amount of the access
charges owed to us. Until these disputes are resolved and access charge
receivables are collected on a timely basis, we cannot rely on these revenues as
a source of cash flow. As a result, we may be required to raise additional
capital sooner than we currently anticipate. See "Business -- Legal
Proceedings."
THE PRICES WE CHARGE FOR OUR SERVICES AND PAY FOR THE USE OF SERVICES OF
INCUMBENT CARRIERS AND OTHER COMPETITIVE CARRIERS MAY BE NEGATIVELY AFFECTED IN
REGULATORY PROCEEDINGS, WHICH COULD RESULT IN DECREASED REVENUES, INCREASED
COSTS AND LOSS OF BUSINESS
If we were required to decrease the prices we charge for our services or to
pay higher prices for services we purchase from incumbent carriers and other
competitive carriers, it would have an adverse effect on our ability to achieve
profitability and offer competitively priced services. We must file tariffs with
state and federal regulators which indicate the prices we charge for our
services. In addition, we purchase some tariffed services from incumbent
carriers and/or competitive carriers. The rate we pay for other services we
purchase from incumbent carriers and other competitive carriers are set by
negotiations between the parties. All of the tariffed prices may be challenged
in regulatory proceedings by customers, including incumbent carriers,
competitive carriers and long distance carriers who purchase these services.
These negotiated rates are also subject to regulatory review. In August 1999,
the FCC initiated a proceeding which is considering the reasonableness of
competitive carrier access charges and is seeking comments on whether the FCC
should regulate the access charges set by competitive carriers. While the
outcome of this proceeding cannot be predicted, if we were required to decrease
our access charges it could have an adverse effect on our expected revenues.
THERE WILL BE NO PUBLIC TRADING MARKET FOR THE NOTES
No active trading market currently exists for the notes. The notes are
currently trading at a discount from their initial offering price in March 2000
and, depending on prevailing interest rates, the market for similar securities
and other factors, including general economic conditions and our financial
condition, performance and prospects, as well as recommendations of securities
analysts, their price could decline further. The initial purchasers in the
private offering in March 2000 have informed us that they intend to make a
market in the notes. They are not obligated to do so, however, and may
discontinue such market making at any time without notice. In addition, any
market making activities will be subject to the limitations imposed by the
Securities Act and Exchange Act and may be limited during the effectiveness of a
registration statement relating to the notes. We cannot assure you that an
active trading market for the notes will develop, or if one does develop, that
it will be sustained.
In addition, to the extent that outstanding notes are surrendered and
accepted in the exchange offer, the trading market for unsurrendered outstanding
notes and for surrendered-but-unaccepted outstanding notes could be adversely
affected due to the limited amount of outstanding notes that are expected to
remain outstanding following this exchange offer. Generally, when there are
fewer outstanding securities of a given issue, there is less demand to purchase
such security, which results in a lower price for such security. See "Plan of
Distribution" and "The Exchange Offer" for further information regarding the
distribution of the exchange notes and the consequences of failure to
participate in the exchange offer.
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OUR FORWARD-LOOKING STATEMENTS MAY MATERIALLY DIFFER FROM ACTUAL EVENTS OR
RESULTS
This prospectus contains "forward-looking statements," which you can
generally identify by our use of forward-looking words including "believe,"
"expect," "intend," "may," "will," "should," "could," "anticipate" or "plan" or
the negative or other variations of these terms or comparable terminology, or by
discussion of strategies that involve risks and uncertainties. We often use
these types of statements when discussing
- our plans and strategies;
- our anticipation of profitability or cash flow from operations;
- the development of our business;
- the expected market for our services and products;
- our anticipated capital expenditures;
- changes in regulatory requirements; and
- other statements contained in this prospectus regarding matters that are
not historical facts.
We caution you these forward-looking statements are only predictions and
estimates regarding future events and circumstances. We cannot assure you we
will achieve the future results reflected in these statements.
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THE EXCHANGE OFFER
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
We sold the outstanding notes on March 24, 2000 to Bear, Stearns & Co.
Inc., Salomon Smith Barney Inc., Goldman, Sachs & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated and Warburg Dillon Read LLC (the "Initial
Purchasers"), pursuant to a purchase agreement. The Initial Purchasers
subsequently sold the outstanding notes to:
- "qualified institutional buyers" ("QIBs"), as defined in Rule 144A under
the Securities Act, in reliance on Rule 144A, and
- certain persons in offshore transactions in reliance on Regulation S
under the Securities Act.
As a condition to the initial sale of the outstanding notes, we and the
Initial Purchasers entered into a registration rights agreement. Pursuant to the
registration rights agreement, unless the exchange offer for the outstanding
notes would not be permitted by applicable law or Securities and Exchange
Commission policy, we agreed to:
(a) file an exchange offer registration statement (the "Exchange Offer
Registration Statement") with the Securities and Exchange Commission on or
before the 90th day after the Issue Date;
(b) use our best efforts to have the Exchange Offer Registration
Statement declared effective by the Securities and Exchange Commission on
or before the 180th day after March 24, 2000 (the "Issue Date");
(c) upon the effectiveness of the Exchange Offer Registration
Statement, commence the exchange offer for the outstanding notes; and
(d) use our best efforts to issue, on or before the 30th business day
after the date on which the Exchange Offer Registration Statement was
declared effective, exchange notes in exchange for all outstanding notes
tendered in the exchange offer.
We agreed to issue and exchange the exchange notes for all outstanding
notes validly tendered and not validly withdrawn prior to the expiration of the
exchange offer. A copy of the registration rights agreement has been filed as an
exhibit to the registration statement, which includes this prospectus. This
registration statement is intended to satisfy some of our obligations under the
registration rights agreement and the purchase agreement.
The term "holder" with respect to the exchange offer means any person in
whose name outstanding notes are registered.
RESALE OF THE EXCHANGE NOTES
We believe that you will be allowed to resell the exchange notes to the
public without registration under the Securities Act, and without delivering a
prospectus that satisfies the requirements of Section 10 of the Securities Act
if you can make the representations set forth above under "Summary of the Terms
of the Exchange Offer -- Procedures for participating in the exchange offer."
However, if you intend to participate in a distribution of the exchange notes,
or you are an "affiliate" of our company as defined under Rule 405 of the
Securities Act, you must comply with the registration requirements of the
Securities Act and deliver a prospectus, unless an exemption from registration
is otherwise available. You have to represent to us in the letter of transmittal
accompanying this prospectus that you meet these conditions exempting you from
the registration requirements.
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We base our view on interpretations by the Staff of the Securities and
Exchange Commission in no-action letters issued to other issuers in exchange
offers like ours. However, we have not asked the Securities and Exchange
Commission to consider this particular exchange offer in the context of a
no-action letter. Therefore, you cannot be sure that the Securities and Exchange
Commission will treat our exchange offer in the same way it has treated other
exchange offers in the past.
A broker-dealer that has bought outstanding notes for market-making or
other trading activities has to deliver a prospectus in order to resell any
outstanding notes it has received for its own account in the exchange. This
prospectus may be used by a broker-dealer to resell any of its outstanding
notes. We have agreed in the registration rights agreement to send this
prospectus to any broker-dealer that requests copies in the letter of
transmittal for a period of up to 365 days after the Securities and Exchange
Commission declares the registration statement relating to this exchange offer
effective. See "Plan of Distribution" for more information regarding
broker-dealers.
The exchange offer is not being made to, nor will we accept surrenders for
exchange from, holders of outstanding notes in any jurisdiction in which this
exchange offer or the acceptance thereof would not be in compliance with the
relevant securities or blue sky laws.
TERMS OF THE EXCHANGE OFFER
Based on the terms and conditions set forth in this prospectus and in the
letter of transmittal, we will accept any and all outstanding notes validly
tendered and not validly withdrawn prior to 5:00 p.m., New York City time, on
the expiration date.
Subject to the minimum denomination requirements of the exchange notes, we
will issue $1,000 principal amount of exchange notes in exchange for each $1,000
principal amount of outstanding notes validly tendered pursuant to the exchange
offer and not validly withdrawn prior to the expiration date. Holders may tender
some or all of their outstanding notes pursuant to the exchange offer. However,
outstanding notes may be tendered only in amounts that are integral multiples of
$1,000 principal amount.
The form and terms of the exchange notes are the same as the form and terms
of the outstanding notes except that:
- the exchange notes will be registered under the Securities Act and,
therefore, the exchange notes will not bear legends restricting the
transfer of the exchange notes;
- the exchange notes shall not contain provisions for additional interest;
and
- holders of the exchange notes will not be entitled to any of the
registration rights of holders of outstanding notes under the
registration rights agreement, which rights will terminate upon the
consummation of the exchange offer.
The exchange notes will evidence the same indebtedness as the outstanding
notes, which they replace. The exchange notes will be issued under, and be
entitled to the benefits of, the same indenture that authorized the issuance of
the outstanding notes. As a result, both the exchange notes and the outstanding
notes will be treated as a single class of debt securities under the indenture.
The exchange offer does not depend upon any minimum aggregate principal amount
of outstanding notes being surrendered for exchange.
As of the date of this prospectus, $367,063,000 in aggregate principal
amount of the outstanding notes are outstanding, all of which is registered in
the name of Cede & Co., as nominee for DTC. Solely for reasons of
administration, we have fixed the close of business on [ ] as the
record date for the exchange offer for purposes of determining the persons to
whom this prospectus and the letter of transmittal will be initially mailed.
There will be no fixed record date for determining holders of the outstanding
notes entitled to participate in this exchange offer.
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As a holder of outstanding notes, you do not have any appraisal or
dissenters' rights, or any other right to seek monetary damages in court under
the law of the State of Nevada, the State of Delaware or the indenture governing
the notes. We intend to conduct the exchange offer in accordance with the
provisions of the registration rights agreement and the applicable requirements
of the Securities Exchange Act of 1934 (the "Exchange Act") and the related
rules and regulations of the Securities and Exchange Commission. Outstanding
notes that are not surrendered for exchange in the exchange offer will remain
outstanding and interest thereon will continue to accrue.
We will be deemed to have accepted validly surrendered outstanding notes if
and when we give oral or written notice of our acceptance to the exchange agent.
The exchange agent will act as agent for the tendering holders of outstanding
notes for the purpose of receiving the exchange notes from us.
If you surrender outstanding notes in the exchange offer, you will not be
required to pay brokerage commissions or fees. No service charge shall be made
to you for the registration of this exchange offer, but we may require from you
payment of a sum sufficient to cover any transfer tax or similar governmental
charge payable in connection with this exchange offer.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The "expiration date" is 5:00 p.m., New York City time, on
[ ], unless we extend the exchange offer, in which case the
expiration date is the latest date and time to which we extend the exchange
offer.
In order to extend the exchange offer, we will:
- notify the exchange agent of any extension by oral or written
communication;
- issue a press release or other public announcement, which will report the
approximate number of outstanding notes deposited; such press release or
announcement would be issued prior to 9:00 a.m., New York City time, on
the next business day after the previously scheduled expiration date.
During any extension of the exchange offer, all outstanding notes
previously surrendered and not withdrawn will remain subject to the exchange
offer.
We reserve the right:
- to delay accepting any outstanding notes;
- to amend the terms of the exchange offer in any manner;
- to extend the exchange offer; or
- if, in the opinion of our counsel, the consummation of the exchange offer
would violate any law or interpretation of the Staff of the Securities
and Exchange Commission, to terminate or amend the exchange offer by
giving oral or written notice to the exchange agent.
Any delay in acceptance, extension, termination or amendment will be
followed as soon as practicable by a press release or other public announcement.
If we amend the exchange offer in a manner that we determine constitutes a
material change, we will promptly disclose that amendment by means of a
prospectus supplement that will be distributed to the holders, and we will
extend the exchange offer for a period of time, depending upon the significance
of the amendment and the manner of disclosure to the holders, if the exchange
offer would otherwise expire during that period.
We will have no obligation to publish, advertise, or otherwise communicate
any public announcement that we may choose to make, other than by making a
timely release to an appropriate news agency.
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In all cases, issuance of the exchange notes for outstanding notes that are
accepted for exchange will be made only after timely receipt by the exchange
agent of a properly completed and duly executed letter of transmittal and all
other required documents. However, we reserve the absolute right to waive any
conditions of the exchange offer or any defects or irregularities in the
surrender of outstanding notes. If we do not accept any surrendered outstanding
notes for any reason set forth in the terms and conditions of the exchange offer
or if you submit outstanding notes for a greater principal amount than you want
to exchange, we will return certificates for the unaccepted or non-exchanged
outstanding notes, or substitute outstanding notes evidencing the unaccepted
portion, as appropriate, to you. See "-- Return of outstanding notes."
INTEREST ON THE EXCHANGE NOTES
The exchange notes will accrue cash interest on the same terms as the
outstanding notes, i.e., at the rate of 13% per annum and payable semi-annually
in cash in arrears on each April 1 and October 1, commencing on October 1, 2000.
We will make each interest payment to the holders of record on the immediately
preceding March 15 and September 15. Outstanding notes accepted for exchange
will not receive any accrued interest on the outstanding notes at the time of
exchange.
However, each new note will bear interest from the most recent date to
which interest has been paid on the outstanding notes or exchange notes, or if
no interest has been paid on the outstanding notes or exchange notes, from
October 1, 2000.
PROCEDURES FOR TENDERING OUTSTANDING NOTES
If you wish to surrender outstanding notes you must:
- complete and sign the letter of transmittal or a facsimile thereof;
- have the signatures thereon guaranteed if required by the letter of
transmittal; and
- mail or deliver the letter of transmittal or facsimile or a properly
transmitted Agent's Message (as defined below), together with any
corresponding certificate or certificates representing the outstanding
notes being surrendered -- or confirmation of a book-entry transfer of
such outstanding notes into the exchange agent's account at DTC pursuant
to the book-entry procedures described below -- to the exchange agent at
its address set forth in the letter of transmittal for receipt prior to
the expiration date. If the certificate representing the outstanding
notes being tendered -- or the confirmation of a book-entry transfer, if
applicable -- is not delivered to the exchange agent with the letter of
transmittal, you must comply with the guaranteed delivery procedures
described below. DELIVERY OF DOCUMENTS TO THE BOOK-ENTRY TRANSFER
FACILITY IN ACCORDANCE WITH ITS PROCEDURE DOES NOT CONSTITUTE DELIVERY TO
THE EXCHANGE AGENT.
If you do not withdraw your surrender of outstanding notes prior to the
expiration date, it will indicate an agreement between you and us that you have
agreed to surrender the outstanding notes, in accordance with the terms and
conditions in the letter of transmittal.
TENDER OF OUTSTANDING NOTES HELD THROUGH DTC
To effectively tender notes that are held through DTC, DTC participants
may, in lieu of physically completing and signing the Letter of Transmittal and
delivering it to the Depositary, electronically transmit their acceptance
through the Automated Tender Offer Program ("ATOP"), and DTC will then edit and
verify the acceptance and send an Agent's Message to the Depositary for its
acceptance. Delivery of tendered outstanding notes must be made to the
Depositary pursuant to
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the book-entry delivery procedures set forth below or the tendering DTC
participant must comply with the guaranteed delivery procedures set forth below.
THE METHOD OF DELIVERY OF OUTSTANDING NOTES, THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS (INCLUDING DELIVERY THROUGH DTC AND ANY ACCEPTANCE
OF AN AGENT'S MESSAGE THROUGH ATOP) TO THE EXCHANGE AGENT IS AT YOUR ELECTION
AND RISK. INSTEAD OF DELIVERY BY MAIL, YOU SHOULD USE AN OVERNIGHT OR HAND
DELIVERY SERVICE, PROPERLY INSURED, WITH RETURN RECEIPT REQUESTED. IN THE CASE
OF DELIVERY THROUGH DTC, DELIVERY WILL BE DEEMED MADE ONLY WHEN ACTUALLY
RECEIVED BY THE DEPOSITARY. IN ALL CASES, YOU SHOULD ALLOW SUFFICIENT TIME TO
ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE. DO NOT SEND
ANY LETTER OF TRANSMITTAL OR OUTSTANDING NOTES TO US. YOU MAY REQUEST THAT YOUR
BROKER, DEALER, COMMERCIAL BANK, TRUST COMPANY OR NOMINEE EFFECT THE ABOVE
TRANSACTIONS FOR YOU.
DTC has authorized DTC participants that hold outstanding notes on behalf
of beneficial owners of outstanding notes through DTC to tender their
outstanding notes as if they were Holders. To effect a tender, DTC participants
may, in lieu of physically completing and signing the Letter of Transmittal,
transmit their acceptance to DTC through ATOP for which the transaction will be
eligible and follow the procedure for book-entry transfer set forth in
"-- Procedures for tendering outstanding notes". A beneficial owner of
outstanding notes that are held of record by a custodian bank, depositary,
broker, trust company or other nominee must instruct such Holder to tender the
outstanding notes on the beneficial owner's behalf.
If you are a beneficial owner of the outstanding notes and you hold those
notes through a broker, dealer, commercial bank, trust company or other nominee
and you want to surrender your outstanding notes, you should contact that
intermediary promptly and instruct it to surrender the outstanding notes on your
behalf.
Generally, an eligible institution must guarantee signatures on a letter of
transmittal or a notice of withdrawal described below under "-- Withdrawal of
tenders of outstanding notes" unless
- you tender your outstanding notes as the registered holder, which term
includes any participant in DTC whose name appears on a security listing
as the owner of outstanding notes;
- you sign the letter of transmittal, and the exchange notes issued in
exchange for your outstanding notes to be issued in your name; or
- you surrender your outstanding notes for the account of an eligible
institution.
In any other case, the surrendered outstanding notes must be endorsed or
accompanied by written instruments of transfer in form satisfactory to us and
duly executed by the registered holder. If the exchange notes or unexchanged
outstanding notes are to be delivered to an address other than that of
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the registered holder appearing on the security register for the outstanding
notes, an eligible institution must guarantee the signature in the letter of
transmittal. In the event that signatures on a letter of transmittal or a notice
of withdrawal are required to be guaranteed, such guarantee must be made by:
- a member firm of a registered national securities exchange or of the
National Association of Securities Dealers, Inc.; or
- a commercial bank or trust company having an office or correspondent in
the United States, or an "eligible guarantor institution" as defined by
Rule 17Ad-15 under the Exchange Act that is a member of one of the
recognized signature guarantee programs identified in the letter of
transmittal.
Your surrender will be deemed to have been received as of the date when:
- the exchange agent receives a properly completed and signed letter of
transmittal accompanied by the outstanding notes, or a confirmation of
book-entry transfer of such outstanding notes into the exchange agent's
account at DTC; or
- the exchange agent receives a notice of guaranteed delivery from an
eligible institution. Issuances of exchange notes in exchange for
outstanding notes surrendered pursuant to a notice of guaranteed delivery
or letter, telegram or facsimile transmission to similar effect by an
eligible institution will be made only against submission of a duly
signed letter of transmittal, and any other required documents, and
deposit of the surrendered outstanding notes, or confirmation of a
book-entry transfer of such outstanding notes into the exchange agent's
account at DTC pursuant to the book-entry procedures described below.
We will make the determination regarding all questions relating to the
validity, form, eligibility, including time of receipt, acceptance and
withdrawal of surrendered outstanding notes, and our determination will be final
and binding on all parties.
We reserve the absolute right to reject any and all outstanding notes
improperly surrendered. We will not accept any outstanding notes if our
acceptance of them would, in the opinion of our counsel, be unlawful. We also
reserve the absolute right to waive any defects, irregularities, or conditions
of surrender as to any particular outstanding notes. Our interpretation of the
terms and conditions of the exchange offer, including the instructions in the
letter of transmittal, will be final and binding on all parties. Unless waived,
you must cure any defects or irregularities in connection with surrenders of
outstanding notes within the time we will determine. Although we intend to
notify holders of defects or irregularities in connection with surrenders of
outstanding notes, neither we, the exchange agent nor anyone else will incur any
liability for failure to give such notice. Surrenders of outstanding notes will
not be deemed to have been made until any defects or irregularities have been
cured or waived.
We have no current plan to acquire any outstanding notes that are not
surrendered in the exchange offer or to file a registration statement to permit
resales of any outstanding notes that are not surrendered pursuant to the
exchange offer. We reserve the right in our sole discretion to purchase or make
offers for any outstanding notes that remain outstanding after the expiration
date. To the extent permitted by law, we also reserve the right to purchase
outstanding notes in the open market, in privately negotiated transactions or
otherwise. The terms of any future purchases or offers could differ from the
terms of the exchange offer.
Pursuant to the letter of transmittal, if you elect to surrender
outstanding notes in exchange for exchange notes, you must exchange, assign and
transfer the outstanding notes to us and irrevocably constitute and appoint the
exchange agent as your true and lawful agent and attorney-in-fact with respect
to such surrendered outstanding notes, with full power of substitution, among
other things, to cause the outstanding notes to be assigned, transferred and
exchanged. By executing the letter of
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transmittal, you make the representations and warranties set forth above under
the heading "Summary of the Terms of the Exchange Offer -- Procedures for
participating in the exchange offer" to us. By executing the letter of
transmittal you also promise to, upon request, execute and deliver any
additional documents that we consider necessary to complete the transactions
described in the letter of transmittal.
By surrendering outstanding notes in the exchange offer, you will be
telling us that, among other things,
- you have full power and authority to tender, sell, assign and transfer
the outstanding notes surrendered;
- we will acquire good title to the outstanding notes being surrendered,
free and clear of all security interests, liens, restrictions, charges,
encumbrances, conditional sale agreements or other obligations relating
to their sale or transfer, and not subject to any adverse claim when we
accept the outstanding notes;
- you are acquiring the exchange notes in the ordinary course of your
business;
- you are not engaging and do not intend to engage in a distribution of the
exchange notes;
- you are not participating, do not intend to participate, and have no
arrangement or understanding with any person to participate in the
distribution of the exchange notes;
- you acknowledge and agree that if you are a broker-dealer registered
under the Exchange Act or you are participating in the exchange offer for
the purpose of distributing the exchange notes, you must comply with the
registration and prospectus delivery requirements of the Securities Act
in connection with a secondary resale of the exchange notes, and that you
cannot rely on the position of the Securities and Exchange Commission's
staff set forth in their no-action letters;
- you understand that a secondary resale transaction described above and
any resales of exchange notes obtained by you in exchange for outstanding
notes acquired by you directly from us should be covered by an effective
registration statement containing the selling security holder information
required by Item 507 or 508, as applicable, of Regulation S-K of the
Securities and Exchange Commission; and
- you are not an "affiliate", as defined in Rule 405 under the Securities
Act, of our company or, if you are an "affiliate," that you will comply
with the registration and prospectus delivery requirements of the
Securities Act to the extent applicable.
If you are a broker-dealer and you will receive exchange notes for your own
account in exchange for outstanding notes that were acquired as a result of
market-making activities or other trading activities, you will be required to
acknowledge in the letter of transmittal that you will deliver a prospectus in
connection with any resale of such outstanding notes.
Participation in the exchange offer is voluntary. You are urged to consult
your financial and tax advisors in making your decision on whether to
participate in the exchange offer.
RETURN OF OUTSTANDING NOTES
If any outstanding notes are not accepted for any reason described here, or
if outstanding notes are withdrawn or are submitted for a greater principal
amount than you want to exchange, the exchange agent will return those
unaccepted or non-exchanged outstanding notes to the surrendering holder, or, in
the case of outstanding notes surrendered by book-entry transfer, into the
exchange agent's account at DTC, unless otherwise provided in the letter of
transmittal. The outstanding notes will be credited to an account maintained
with DTC as promptly as practicable.
31
<PAGE> 35
BOOK ENTRY TRANSFER
The exchange agent will make a request to establish an account with respect
to the outstanding notes at DTC for purposes of the exchange offer promptly
after the date of this prospectus. Any financial institution that is a
participant in DTC's system may make book-entry delivery of outstanding notes by
causing DTC to transfer such outstanding notes into the exchange agent's account
at DTC in accordance with DTC's procedures for transfer. However, although
delivery of outstanding notes may be effected through book-entry transfer at
DTC, you have to deliver the letter of transmittal, or a facsimile thereof, with
any required signature guarantees and any other required documents to the
exchange agent at the address set forth in the letter of transmittal for its
receipt on or prior to the expiration date or pursuant to the guaranteed
delivery procedures described below.
The term "Agent's Message" means a message transmitted by DTC to, and
received by, the Depositary and forming a part of the Book-Entry Confirmation,
which states that DTC has received an express acknowledgment from each
participant in DTC tendering the outstanding notes and that such participants
have received the Letter of Transmittal and agree to be bound by the terms of
the Letter of Transmittal and we may enforce such agreement against such
participants.
GUARANTEED DELIVERY PROCEDURES
If you wish to surrender your outstanding notes and (1) your outstanding
notes are not immediately available so that you can meet the expiration date
deadline, (2) you cannot deliver your outstanding notes or other required
documents to the exchange agent prior to the expiration date or (3) the
procedure for book-entry transfer cannot be completed on a timely basis, you may
nonetheless participate in the exchange offer if:
- you surrender your outstanding notes through an eligible institution;
- prior to the expiration date, the exchange agent receives from the
eligible institution a properly completed and duly executed notice of
guaranteed delivery substantially in the form provided by us, by
telegram, telex, facsimile transmission, mail or hand delivery (or an
Agent's Message with respect to guaranteed delivery that is accepted by
us), showing the name and address of the holder, the name(s) in which the
outstanding notes are registered, the certificate number(s) of the
outstanding notes, if applicable, and the principal amount of outstanding
notes surrendered; the notice of guaranteed delivery must state that the
surrender is being made by the notice of guaranteed delivery and
guaranteeing that, within three Nasdaq National Market trading days after
the expiration date, the letter of transmittal, or facsimile thereof,
together with the certificate(s) representing such outstanding notes, in
proper form for transfer or a book-entry confirmation, and any other
required documents, will be delivered by such eligible institution to the
exchange agent; and
- the properly executed letter of transmittal, as well as the
certificate(s) representing all surrendered outstanding notes, in proper
form for transfer, or a book-entry confirmation, as the case may be, and
all other documents required by the letter of transmittal (or a properly
transmitted Agent's Message) are received by the exchange agent within
three Nasdaq National Market trading days after the expiration date.
Unless outstanding notes are surrendered by the above-described method and
deposited with the exchange agent within the time period set forth above, we
may, at our option, reject the surrender. The exchange agent will send you a
notice of guaranteed delivery upon your request if you want to surrender your
outstanding notes according to the guaranteed delivery procedures described
above.
32
<PAGE> 36
WITHDRAWAL OF TENDERS OF OUTSTANDING NOTES
Except as otherwise provided in this prospectus, you may withdraw your
surrender of outstanding notes at any time prior to 5:00 p.m., New York City
time, on the expiration date.
To withdraw a surrender of outstanding notes in the exchange offer, the
exchange agent must receive a written or facsimile transmission notice of
withdrawal at its address set forth herein prior to 5:00 p.m., New York City
time, on the expiration date. Any notice of withdrawal must:
- specify the name of the person having deposited the outstanding notes to
be withdrawn;
- identify the outstanding notes to be withdrawn, including the certificate
number or numbers, if applicable, and principal amount of the outstanding
notes;
- contain a statement that you are withdrawing your election to have such
outstanding notes exchanged;
- be signed by the holder in the same manner as the original signature on
the letter of transmittal by which the outstanding notes were
surrendered; and
- specify the name in which any outstanding notes are to be registered, if
different from that of the person depositing the outstanding notes. If
outstanding notes have been surrendered pursuant to the procedure for
book-entry transfer, any notice of withdrawal must specify the name and
number of the account at DTC.
We, in our sole discretion, will make the final determination on all
questions regarding the validity, form, eligibility and time of receipt of
notices, and our determination shall bind all parties. Any outstanding notes
withdrawn will be deemed not to have been validly surrendered for purposes of
the exchange offer and no exchange notes will be issued unless the outstanding
notes so withdrawn are validly resurrendered. Properly withdrawn outstanding
notes may be resurrendered by following one of the procedures described above
under "-- Procedures for tendering outstanding notes" at any time prior to the
business day prior to the expiration date. Any outstanding notes that are not
accepted for exchange will be returned at no cost to the holder or, in the case
of outstanding notes surrendered by book-entry transfer, into the exchange
agent's account at DTC pursuant to the book-entry transfer procedures described
above, as soon as practicable after withdrawal, rejection of surrender or
termination of the exchange offer.
TERMINATION OF CERTAIN RIGHTS
All registration rights under the registration rights agreement that
benefit the holders of the outstanding notes will terminate when we consummate
the exchange offer. That includes all rights to receive additional interest in
the event of a registration default under the registration rights agreement. In
any event, we are under a continuing obligation, for a period of up to 180 days
after the Securities and Exchange Commission declares the registration statement
effective, to keep the registration statement effective and to provide copies of
the latest version of the prospectus to any broker-dealer that requests copies
in the letter of transmittal for use in a resale.
CONDITIONS OF THE EXCHANGE OFFER
Notwithstanding any other term of the exchange offer, or any extension of
the exchange offer, we do not have to accept for exchange, or exchange notes
for, any outstanding notes, and we may terminate the exchange offer before
acceptance of the outstanding notes, if:
(1) any statute, rule or regulation has been enacted, or any action
has been taken by any court or governmental authority that, in our
reasonable judgment, seeks to or would prohibit, restrict or otherwise
render consummation of the exchange offer illegal; or
33
<PAGE> 37
(2) any change, or any development that would cause a change, in our
business or financial affairs has occurred that, in our sole judgment,
might materially impair our ability to proceed with the exchange offer or a
change that would materially impair the contemplated benefits to us of the
exchange offer; or
(3) a change occurs in the current interpretations by the Staff of the
Securities and Exchange Commission that, in our reasonable judgment, might
materially impair our ability to proceed with the exchange offer.
If we, in our sole discretion, determine that any of the above conditions
is not satisfied, we may:
- refuse to accept any outstanding notes and return all surrendered
outstanding notes to the surrendering holders;
- extend the exchange offer and retain all outstanding notes surrendered
prior to the expiration date, subject to the holders' right to withdraw
the surrender of the outstanding notes; or
- waive any unsatisfied conditions regarding the exchange offer and accept
all properly surrendered outstanding notes that have not been withdrawn.
If this waiver constitutes a material change to the exchange offer, we
will promptly disclose the waiver by means of a prospectus supplement
that will be distributed to the registered holders, and we will extend
the exchange offer for a period of time that we will determine, depending
upon the significance of the waiver and the manner of disclosure to the
registered holders, if the exchange offer would otherwise expire during
that period of time.
EXCHANGE AGENT
We have appointed HSBC Bank USA as exchange agent for the exchange offer.
Questions and requests for assistance, requests for additional copies of this
prospectus or of the letter of transmittal and requests for notices of
guaranteed delivery should be directed to the exchange agent at the following
address:
<TABLE>
<S> <C>
By Hand or Overnight Courier: By Registered or Certified Mail:
HSBC Bank USA HSBC Bank USA
140 Broadway 140 Broadway
12th Floor 12th Floor
New York, New York 10005 New York, New York 10005
Attention: Issuer Services Attention: Issuer Services
</TABLE>
By Facsimile Transmission (for Eligible Institutions only):
(212) 658-6425
Confirm by Telephone:
(212) 658-6433
For information with respect to the exchange offer, call the Exchange Agent:
(212) 658-6433
FEES AND EXPENSES
We will bear the expenses of soliciting tenders. The principal solicitation
is being made by mail; however, additional solicitation may be made by telecopy,
telephone or in person by our officers and regular employees or by officers and
employees of our affiliates. No additional compensation will be paid to any such
officers and employees who engage in soliciting tenders.
We have not retained any dealer-manager or other soliciting agent for the
exchange offer and will not make any payments to brokers, dealers or others
soliciting acceptance of the exchange offer. We will, however, pay the exchange
agent reasonable and customary fees for its services and will reimburse it for
related, reasonable out-of-pocket expenses. We may also reimburse brokerage
houses
34
<PAGE> 38
and other custodians, nominees and fiduciaries for reasonable out-of-pocket
expenses they incur in forwarding copies of this prospectus, the letter of
transmittal and related documents.
We will pay any expenses you will incur in connection with the exchange
offer, including registration fees, fees and expenses of the exchange agent, the
transfer agent and registrar, accounting and legal fees and printing costs,
among others.
No service charge shall be made to you for the registration of this
exchange offer, but we may require from you payment of a sum sufficient to cover
any transfer tax or similar governmental charge payable in connection with this
exchange offer.
CONSEQUENCES OF FAILURE TO EXCHANGE
Outstanding notes that are not exchanged will remain "restricted
securities" within the meaning of Rule 144(a)(3) of the Securities Act.
Accordingly, they may not be offered, sold, pledged or otherwise transferred
except:
- to us or to any of our subsidiaries;
- inside the United States to a qualified institutional buyer in compliance
with Rule 144A;
- inside the United States to an institutional accredited investor that,
prior to such transfer, furnishes to the trustee a signed letter
containing certain representations and agreements relating to the
restrictions on transfer of the outstanding notes, the form of which you
can obtain from the trustee and, if such transfer is in respect of an
aggregate principal amount of outstanding notes at the time of transfer
of less than $100,000, an opinion of counsel acceptable to us that the
transfer complies with the Securities Act;
- outside the United States in compliance with Rule 904 under the
Securities Act;
- pursuant to the exemption from registration provided by Rule 144 under
the Securities Act, if available; or
- pursuant to an effective registration statement under the Securities Act.
The liquidity of the outstanding notes could be adversely affected by the
exchange offer.
ACCOUNTING TREATMENT
For accounting purposes, we will recognize no gain or loss as a result of
the exchange offer. We will amortize the expenses of the exchange offer and the
unamortized expenses related to the issuance of the outstanding notes over the
remaining term of the notes.
35
<PAGE> 39
USE OF PROCEEDS
The exchange offer is intended to satisfy our obligations under the
registration rights agreement we entered into in connection with the private
offering of the outstanding notes in March 2000. We will not receive any
proceeds from the exchange offer. You will receive, in exchange for outstanding
notes tendered by you in the exchange offer, exchange notes in like principal
amount. The outstanding notes surrendered in exchange for the exchange notes
will be retired and cancelled and cannot be reissued. Accordingly, the issuance
of the exchange notes will not result in any increase of our outstanding debt.
36
<PAGE> 40
CAPITALIZATION
The following table shows our capitalization as of March 31, 2000:
(A) on an actual basis;
(B) as adjusted to reflect the consummation of the private exchange offer
in June 2000 for our 13% Senior Secured Notes due 2004; and
(C) pro forma as adjusted to reflect the consummation of the proposed
merger with Primary Network.
You should read this table with our financial statements and the related
notes appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 2000
--------------------------------------------------
ACTUAL AS ADJUSTED PRO FORMA AS ADJUSTED
---------- ----------- ---------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Cash and cash equivalents and investments
available-for-sale, excluding restricted
investments................................ $ 895,845 $ 893,950 $ 888,778
Restricted investments....................... 20,534 20,534 20,534
---------- ---------- ----------
Total cash and cash equivalents,
investments available-for-sale and
restricted investments.................. $ 916,379 $ 914,484 $ 909,312
========== ========== ==========
13% Senior Notes due 2010.................... $ 243,233 $ 353,272 $ 353,272
13% Senior Secured Notes due 2004............ 157,412 55,151 113,556
Other long-term debt......................... 4,529 4,529 25,390
Series B convertible preferred stock......... -- -- --
Series C convertible preferred stock......... 36,857 36,857 36,857
Series D convertible preferred stock......... 202,359 202,359 202,359
Stockholders' equity:
Common stock, $0.001 par value, 60,000,000
shares authorized, 35,507,596
outstanding and as adjusted and
36,857,596 as further adjusted.......... 35 35 36
Additional paid-in-capital................. 596,240 596,240 663,681
Accumulated deficit........................ (139,505) (150,200) (150,200)
Less: treasury stock....................... (76) (76) (76)
Accumulated other comprehensive income..... (1,972) (1,972) (1,972)
Notes receivable from stockholders for
issuance of common stock................ (5,844) (5,844) (5,844)
---------- ---------- ----------
Total stockholders' equity................. 448,878 438,183 505,625
---------- ---------- ----------
Total capitalization......................... $1,093,268 $1,090,351 $1,237,059
========== ========== ==========
</TABLE>
37
<PAGE> 41
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
You should read the following selected consolidated financial and operating
data with the consolidated financial statements and the related notes for each
of Mpower and Primary Network and with "Management's Discussion and Analysis of
Financial Condition and Results of Operations," for each of Mpower and Primary
Network all of which can be found elsewhere in this prospectus.
SELECTED HISTORICAL FINANCIAL INFORMATION OF MPOWER
The historical data for each of the years in the five-year period ended
December 31, 1999 have been derived from our audited historical consolidated
financial statements. The selected consolidated statement of operations data
presented below for the years ended December 31, 1996, 1997, 1998 and 1999 are
derived from our consolidated financial statements, which have been audited by
KPMG LLP (1996) and Arthur Andersen LLP (1997, 1998 and 1999), independent
auditors. The historical data for the three months ended March 31, 2000 and
March 31, 1999 have been derived from our unaudited consolidated financial
statements. No data is present for periods before 1996 since we commenced our
operations in December 1996, and no revenues or expenses were recognized and no
cash transactions occurred between its inception on October 16, 1995 and
December 31, 1995.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
---------------------------------------- -------------------
1996(1) 1997 1998 1999 1999 2000
------- -------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues................. $ 1 $ 3,791 $ 18,249 $ 55,066 $ 8,401 $ 25,458
Cost of operating revenues,
excluding depreciation........... 305 3,928 17,129 50,012 8,483 23,231
Selling, general and administrative
expenses......................... 841 6,440 17,877 44,836 7,727 23,140
Loss from operations............... (1,554) (7,851) (21,995) (59,417) (11,293) (29,250)
Interest income.................... 63 2,507 8,771 7,702 1,500 8,871
Interest expense................... -- (5,492) (19,064) (18,278) (4,624) (4,965)
Net loss........................... (1,491) (10,836) (32,065) (69,769) (14,212) (25,344)
Basic and diluted loss per common
share............................ $ (2.11) $ (1.30) $ (2.26) $ (7.63) $ (.83) $ (1.18)
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
AS OF DECEMBER 31, MARCH 31,
---------------------------------------- ------------
1996(1) 1997 1998 1999 2000
------- -------- -------- -------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents and investments,
excluding restricted investments.......... $ 7,897 $102,764 $ 84,949 $169,070 $ 895,845
Restricted investments...................... -- 57,574 39,379 20,256 20,534
Property and equipment, net................. 3,250 24,617 116,380 191,612 230,163
Total assets................................ 12,339 191,977 252,119 402,429 1,176,266
Long-term debt.............................. -- 156,637 157,295 161,935 405,174
Series A convertible preferred stock........ -- 16,665 -- -- --
Series B convertible preferred stock........ -- -- -- 55,363 --
Series C convertible preferred stock........ -- -- -- 29,610 36,857
Series D convertible preferred stock........ -- -- -- -- 202,359
Stockholders' equity........................ 10,792 8,976 63,260 103,781 448,878
</TABLE>
38
<PAGE> 42
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------------------ --------------------
1996(1) 1997 1998 1999 1999 2000
------- --------- -------- --------- -------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
EBITDA(2)....................... $(1,145) $ (6,577) $(16,757) $ (39,782) (7,809) (20,913)
Cash flows provided by (used in)
operating activities.......... (942) (4,490) (24,184) (45,913) (611) 2,165
Cash flows used in investing
activities.................... (2,287) (135,491) (77,715) (118,784) (5,390) (496,694)
Cash flows provided by financing
activities.................... 11,126 177,138 68,731 195,790 87 759,319
Capital expenditures............ 3,659 22,641 97,101 94,082 28,134 45,291
Insufficiency of earnings to
cover combined fixed charges
and preferred stock
dividends(3).................. 1,491 11,024 35,376 76,403 15,212 29,251
OPERATING DATA AT END OF PERIOD:
Total access lines in service... 50 15,590 47,744 142,664 65,147 168,786
Central office collocation
sites(4)...................... 9 25 207 322 233 446
Switches in service............. 1 3 7 7 7 7
Number of sales personnel
Field sales................ 7 23 50 142 55 302
Inside sales............... -- -- 31 45 19 54
------- --------- -------- --------- -------- ---------
Total................. 7 23 81 187 74 356
</TABLE>
-------------------------
(1) No data is presented for periods before 1996 since we commenced our
operations in December 1996 and no revenues or expenses were recognized and
no cash transactions occurred between our inception on October 16, 1995 and
December 31, 1995.
(2) EBITDA consists of earnings before interest, income taxes, depreciation and
amortization, and stock-based compensation expense. For the year ended
December 31, 1996, EBITDA excludes a charge of $355,000 related to the
one-time write-off of purchased software. EBITDA does not represent funds
available for management's discretionary use and is not intended to
represent cash flow from operations. EBITDA should not be considered as an
alternative to loss from operations as an indicator of our operating
performance or to cash flows as a measure of liquidity. In addition, EBITDA
is not a term defined by generally accepted accounting principles and, as a
result, the measure of EBITDA may not be comparable to similarly titled
measures used by other companies. We believe that EBITDA is often reported
and widely used by analysts, investors and other interested parties in the
communications industry. Accordingly, we are including this information to
permit a more complete comparison of our operating performance relative to
other companies in the industry.
(3) For purposes of calculating the insufficiency of earnings to cover combined
fixed charges and preferred stock dividends: earning consist of loss before
income taxes plus fixed charges excluding capitalized interest and preferred
stock dividends and fixed charges consist of interest expensed and
capitalized, plus amortization of deferred financing costs, debt discount,
preferred stock dividends and a portion of rent expense under operating
leases deemed by us to represent an interest factor.
(4) The number of central office collocation sites includes only those sites
where we have accepted a cage and installed our equipment. At December 31,
1999, we had a backlog of 60 central office collocation sites where we had
accepted space from the incumbent carrier but not yet completed the
installation of our equipment.
39
<PAGE> 43
SELECTED HISTORICAL FINANCIAL INFORMATION OF PRIMARY NETWORK
The following table sets forth selected consolidated financial information
and other data for Primary Network Holdings, Inc., successor and CDM On-Line,
Inc., predecessor. Please refer to footnotes 1 and 2 in the September 30, 1999
audited financial statements of Primary Network for further explanation of the
organization and basis of presentation and initial formation and capitalization
of Primary Network. The selected consolidated financial information and other
data as of December 31, 1995, 1996, and 1999 and for the year ended December 31,
1995 and 1996 and the six months ended March 31, 1999 and 2000 are unaudited;
however, in the opinion of Primary Network's management, the unaudited data
includes all adjustments (consisting of normal recurring adjustments) necessary
for a fair presentation of the information. The selected consolidated results of
operations and the selected historical consolidated balance sheet data for the
years ended December 31, 1997 and 1998, the five months ended May 31, 1999 and
the four months ended September 30, 1999 have been derived from the audited
consolidated financial statements of Primary Network, successor, and CDM
On-Line, predecessor, which have been audited by Ernst & Young LLP. The results
of operations for the six months ended March 31, 2000 are not necessarily
indicative of the results to be expected for the year ending September 30, 2000
or any other future period. For all periods presented, the related financial
information has been presented using consistent methods of accounting.
<TABLE>
<CAPTION>
FIVE FOUR SIX
MONTHS MONTHS MONTHS
ENDED ENDED ENDED
1995 1996 1997 1998 5/31/99 9/30/99 3/31/99
--------- ---------- ----------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Operating revenue........... $ 350,285 $1,513,619 $ 2,575,552 $ 4,795,571 $2,833,284 $ 4,082,137 $2,878,736
Net loss from continuing
operations................ (158,011) (137,176) (1,590,177) (1,470,010) (681,906) (7,308,703) (988,709)
Total assets................ 174,437 887,431 1,263,561 1,663,929 4,441,030 61,764,417 3,697,866
Long-term debt and capital
lease obligations......... -- -- -- -- 492,346 51,117,562 --
Total Stockholders'
Equity.................... (164,981) (305,746) (783,758) (203,734) 1,746,743 2,812,483 2,090,025
<CAPTION>
SIX
MONTHS
ENDED
3/31/00
------------
<S> <C>
Operating revenue........... $ 9,627,165
Net loss from continuing
operations................ (20,561,141)
Total assets................ 65,019,664
Long-term debt and capital
lease obligations......... 61,763,591
Total Stockholders'
Equity.................... (17,720,326)
</TABLE>
40
<PAGE> 44
UNAUDITED SELECTED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
The following unaudited pro forma condensed combined balance sheet reflects
the combination of the balance sheets of Mpower and Primary Network as of March
31, 2000 as adjusted for the merger as if the merger of Mpower and Primary
Network had been consummated on March 31, 2000. The unaudited pro forma
condensed combined statements of operations reflect the combination of the
statement of operations of Mpower and Primary Network for the three months
ending March 31, 2000 and the twelve months ending December 31, 1999 as adjusted
for the merger as if the merger had been consummated on January 1, 1999. The
unaudited pro forma condensed combined financial information has been prepared
using the purchase method of accounting. This pro forma information does not
give effect to any restructuring costs or to any potential cost savings or other
operating efficiencies that could result from the merger.
The unaudited pro forma statements are based on currently available
information and certain assumptions that Mpower believes are reasonable under
the circumstances. The unaudited pro forma condensed combined financial
information does not purport to represent what the combined company's position
or results of operations would have been had the merger occurred on such date or
at the beginning of the earliest period presented or to project the combined
financial position or results of operations for any future date or period.
The unaudited pro forma statements should be read in conjunction with the
separate historical financial statements of Mpower and Primary Network and its
predecessors and the notes thereto, and with the accompanying notes to the pro
forma statements and sections entitled "Management's Discussion and Analysis of
Financial Conditions and Results of Operations" of each of Mpower and Primary
Network, all of which are contained elsewhere in this prospectus.
41
<PAGE> 45
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
TWELVE MONTHS ENDED DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
MPOWER PRIMARY NETWORK PRO FORMA PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS COMBINED
----------- --------------- ----------- -----------
<S> <C> <C> <C> <C>
Operating revenues.................. $ 55,066 $ 11,169 $ -- $ 66,235
----------- -------- ---------- -----------
Operating expenses:
Cost of operating revenues.......... 50,012 5,722 -- 55,734
Selling, general and
administrative.................... 44,836 13,297 -- 58,133
Stock-based compensation expense.... 714 -- -- 714
Depreciation and amortization....... 18,921 4,750 10,230(1) 33,901
----------- -------- ---------- -----------
114,483 23,769 10,230 148,482
=========== ======== ========== ===========
Loss from operations................ (59,417) (12,600) (10,230) (82,247)
Other income (expense):
Interest income (expense), net...... (10,576) (4,815) -- (15,391)
Other, net........................ 224 1,046 -- 1,270
----------- -------- ---------- -----------
Net loss from continuing
operations........................ (69,769) (16,369) (10,230) (96,368)
Net loss from discontinued
operations........................ -- (82) -- (82)
----------- -------- ---------- -----------
Net loss............................ (69,769) (16,451) (10,230) (96,450)
Value of preferred stock beneficial
conversion feature................ (72,500) -- -- (72,500)
Accretion of preferred to redemption
value............................. (6,133) -- -- (6,133)
Accrued preferred stock dividend.... (2,577) -- -- (2,577)
----------- -------- ---------- -----------
Net loss applicable to common
stockholders...................... $ (150,979) $(16,451) $ (10,230) $ (177,660)
=========== ======== ========== ===========
Basic and diluted weighted average
shares outstanding................ 19,775,410 n/a 1,349,838(2) 21,125,248
=========== ======== ========== ===========
Basic and diluted loss per share of
common stock...................... $ (7.63) n/a n/a $ (8.41)
=========== ======== ========== ===========
</TABLE>
NOTES TO THE 1999 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
(1) Reflects 12 months of amortization of intangibles recorded in connection
with acquisition of Primary Network and includes amortization of goodwill
($10.9 million) and amortization of customer base ($2.4 million) less the
amortization of intangibles in the historical statement of operations of
Primary Network. Amortization periods assumed for goodwill and customer base
were 10 years and 5 years, respectively.
(2) Reflects the estimated number of shares of Mpower stock issued in exchange
for the preferred and common stock of Primary Network.
42
<PAGE> 46
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
AS OF MARCH 31, 2000
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRIMARY
MPOWER NETWORK PRO FORMA PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS COMBINED
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents.................... $ 307,769 $ 4,828 $(10,000)(1) $ 302,597
Investments available-for-sale............... 465,628 -- -- 465,628
Restricted investments....................... 20,534 -- -- 20,534
Accounts receivable, net..................... 14,281 2,546 -- 16,827
Prepaid expenses and other current assets.... 2,553 2,279 -- 4,832
---------- -------- -------- ----------
Total current assets......................... 810,765 9,653 (10,000) 810,418
Property and equipment, net.................... 230,163 32,636 -- 262,799
Investments available-for-sale................. 122,448 -- -- 122,448
Other assets................................... 12,890 5,693 -- 18,583
Intangible assets.............................. -- 17,038 103,481(2) 120,519
---------- -------- -------- ----------
Total assets................................. $1,176,266 $ 65,020 $ 93,481 $1,334,767
========== ======== ======== ==========
Current liabilities:
Current maturities of long-term debt and
capital lease obligations................. $ 670 $ 11,684 $ -- $ 12,354
Accounts payable............................. 59,327 5,134 -- 64,461
Accrued expense and other.................... 23,671 4,159 2,500(3) 30,330
---------- -------- -------- ----------
Total current liabilities.................... 83,668 20,977 2,500 107,145
Senior Secured Notes, net...................... 157,412 52,586 5,819(4) 215,817
Senior Notes, net.............................. 243,233 -- -- 243,233
Other long-term debt and capital lease
obligations.................................. 3,859 9,177 -- 13,036
---------- -------- -------- ----------
Total liabilities............................ 488,172 82,740 8,319 579,231
---------- -------- -------- ----------
Redeemable preferred stock..................... 239,216 -- -- 239,216
Stockholders' equity:
Preferred stock, net of deferred stock
compensation.............................. -- 522 (522)(5) --
Common stock................................. 35 64 (63)(5) 36
Additional paid-in capital................... 596,240 14,497 52,944(5) 663,681
Accumulated deficit.......................... (139,505) (32,803) 32,803(6) (139,505)
Less: Treasury stock......................... (76) -- -- (76)
Notes receivable from stockholders for
issuance of common stock.................. (5,844) -- -- (5,844)
Accumulated other comprehensive loss......... (1,972) -- -- (1,972)
---------- -------- -------- ----------
Total stockholders' equity................ 448,878 (17,720) 85,162 516,320
---------- -------- -------- ----------
Total liabilities, redeemable preferred
stock and stockholders' equity.......... $1,176,266 $ 65,020 $ 93,481 $1,334,767
========== ======== ======== ==========
</TABLE>
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<PAGE> 47
NOTES TO THE UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
(1) Includes $10 million pre-closing cash advance from Mpower to Primary
Network.
(2) Reflects purchase accounting adjustments for the acquisition based on
Mpower's preliminary estimate of the assets and liabilities assumed. For
purchase accounting, Primary Network's assets have been recorded at their
estimated fair market value subject to adjustments based upon the results of
an independent appraisal. Purchase accounting adjustments were recorded to
reflect the estimated fair value of the acquired customer base of $12
million, to decrease the recorded value of intangible assets acquired by $17
million, to record the excess of purchase cost over fair value of net assets
acquired by $108.5 million and to increase the long-term debt by $5.8
million. These adjustments are required to record the assets and liabilities
at their estimated fair market values. The calculation of excess purchase
cost over fair value of net assets acquired is as follows:
<TABLE>
<CAPTION>
(AMOUNTS IN THOUSANDS)
<S> <C>
Common stock issued..................................... $ 66,142
Cash paid............................................... 10,000
Options and warrants issued............................. 2,800
Direct acquisition costs................................ 1,000
--------
Total purchase cost................................... 79,942
Less: Net book value of Primary Network................. (17,720)
Less: Adjustment in net assets to fair value............ (10,857)
--------
Excess of purchase cost over fair value of assets
acquired and liabilities assumed (goodwill)........... $108,519
========
</TABLE>
(3) Includes accruals for estimated direct acquisition and registration costs
including legal, accounting and filing fees.
(4) Reflects purchase accounting adjustment to adjust to fair value of debt.
(5) Reflects the estimated value of the Mpower stock exchanged for the preferred
and common stock of Primary Network, based on the recent market price of
Mpower stock, less registration costs.
(6) Reflects elimination of accumulated deficit of Primary Network as part of
the purchase accounting computation.
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<PAGE> 48
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
PRIMARY
MPOWER NETWORK PRO FORMA PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS COMBINED
----------- --------------- ----------- -----------
<S> <C> <C> <C> <C>
Operating revenues....................... $ 25,458 $ 5,374 $ -- $ 30,832
----------- -------- ---------- -----------
Operating expenses:
Cost of operating revenues............. 23,231 3,554 -- 26,785
Selling, general and administrative.... 23,140 8,523 -- 31,663
Stock-based compensation expense....... 1,576 -- -- 1,576
Depreciation and amortization.......... 6,761 3,450 1,783(1) 11,994
----------- -------- ---------- -----------
54,708 15,527 1,783 72,018
----------- -------- ---------- -----------
Loss from operations..................... (29,250) (10,153) (1,783) (41,186)
Other income (expense):
Interest income (expense), net......... 3,906 (2,204) -- 1,702
Other, net............................. -- 175 -- 175
----------- -------- ---------- -----------
Net loss from continuing operations...... (25,344) (12,182) (1,783) (39,309)
Accretion of preferred to redemption
value.................................. (3,489) -- -- (3,489)
Accrued preferred stock dividend......... (3,007) -- -- (3,007)
----------- -------- ---------- -----------
Net loss applicable to common
stockholders........................... (31,840) (12,182) (1,783) (45,805)
=========== ======== ========== ===========
Basic and diluted weighted average shares
outstanding............................ 26,938,911 n/a 1,349,838(2) 28,288,749
=========== ======== ========== ===========
Basic and diluted loss per share of
common stock........................... $ (1.18) n/a n/a $ (1.62)
=========== ======== ========== ===========
</TABLE>
NOTES TO THE 2000 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
(1) Reflects three months of amortization of intangibles recorded in connection
with the acquisition of Primary Network and includes amortization of
goodwill ($2.7 million) and amortization of customer base ($0.6 million)
less the amortization of intangibles in the historical statement of
operations of Primary Network. Amortization periods assumed for goodwill and
customer base were 10 years and 5 years, respectively.
(2) Reflects the estimated number of shares of Mpower stock issued in exchange
for the preferred and common stock of Primary Network.
45
<PAGE> 49
MPOWER'S MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with Mpower's financial
statements and the notes related to Mpower's financial statements, each of which
can be found elsewhere in this prospectus.
OVERVIEW
We began providing competitive local dialtone services to small business
and residential customers in December 1996, and began offering long distance
services by February 1998. In the third quarter of 1999, we began to offer
high-speed data and Internet services in our Las Vegas market. During the fourth
quarter of 1999, we began offering long distance services in all of our existing
markets. Currently, we have switches fully operational in Las Vegas, Atlanta,
Chicago, southern Florida, and in selected areas of California, including Los
Angeles and San Diego, Sacramento and the San Francisco Bay Area markets.
Our 1997 revenues were generated from sales of communications services
consisting primarily of local phone service, switched access billings and
non-recurring charges, principally installation charges. In 1998 and 1999, long
distance services also contributed to our revenue base. Local services and long
distance services are generally provided and billed as a bundled offering under
which customers pay a fixed amount for a package of combined local and long
distance services. As a result, the portion of our revenues attributable to each
kind of service is not identifiable and, therefore, we do not record or report
these amounts separately.
Our principal operating expenses consist of cost of operating revenues,
selling, general and administrative expenses and depreciation and amortization
expense. Cost of operating revenues consists primarily of access charges, line
installation expenses, transport expenses, compensation expenses of technical
personnel, long distance expenses and lease expenses for our "collocation"
sites, the space we rent from the incumbent carriers for the purpose of
installing our equipment to deliver our services to our customers. Selling,
general and administrative expenses consist primarily of compensation expenses,
advertising, provision for bad debts, professional fees and office rentals.
Depreciation and amortization expense includes depreciation of switching and
collocation equipment as well as general property and equipment.
During 1998, we expanded significantly with the installation of four
additional switches and the build-out of 182 additional collocation sites.
During 1999, we continued this expansion with the addition of 115 collocation
sites for a total of 322 at year end. As expected, both cost of operating
revenues and selling, general and administrative expenses increased as many of
the fixed costs of providing service in new markets are incurred before
significant revenue can be generated from those markets. In addition, we
incurred significant marketing costs to build our initial base of customers in
our new markets.
Building and expanding our business has required and will continue to
require us to make significant capital expenditures primarily consisting of the
costs of purchasing switches and associated equipment and land for switching
sites and constructing buildings or improving leased buildings to house our
switching and collocation facilities. As part of our "smart build" network
growth strategy, we purchased and installed host switches in each of our markets
while leasing the means of transporting voice and data traffic from these
switches to our customers' telephones or other equipment. We believe this
facilities-based strategy, while initially increasing our level of capital
expenditures and operating losses, will enhance our long-term financial
performance in comparison to a resale strategy.
We have experienced operating losses and generated negative cash flow from
operations since inception and expect to continue to generate negative cash flow
from operations for the foreseeable
46
<PAGE> 50
future while we continue to expand our network and develop our product offerings
and customer base. We cannot assure you that our revenue or customer base will
grow or that we will be able to achieve or sustain positive cash flow from
operations. See "Risk Factors -- We expect our losses to continue and we may not
be able to generate sufficient cash flow to meet our debt service requirements."
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 VS. MARCH 31, 1999
Total operating revenues increased to $25.5 million for the quarter ended
March 31, 2000 as compared to $8.4 million for the quarter ended March 31, 1999.
The 204% increase is a result of the increase in the number of lines in service
and increased long distance service revenue. We had 168,786 lines in service at
the end of the first quarter as compared to 65,147 lines in service at March 31,
1999, a 159% increase.
Cost of operating revenues for the quarter ended March 31, 2000 was $23.2
million as compared to $8.5 million for the quarter ended March 31, 1999. The
173% increase is due to the increased number of lines in service and
installation and operational expenses associated with the expansion of our
network.
For the quarter ended March 31, 2000, selling, general and administrative
expenses totaled $23.1 million, a 200% increase over the $7.7 million for the
quarter ended March 31, 1999. The increase is a result of increased costs
attributable to the significant expansion of our sales and marketing efforts;
delivery of customer service and our continued network and market expansion.
For the quarter ended March 31, 2000 depreciation and amortization was $6.8
million as compared to $3.5 million for the quarter ended March 31, 1999. This
increase is a result of placing additional assets in service in accordance with
the planned build-out of our network.
Gross interest expense for the quarters ended March 31, 2000 and March 31,
1999 totaled $5.9 million and $5.6 million, respectively. The 5% increase was a
result of the increased interest expense related to the $250 million debt
offering in late March 2000. Interest capitalized for the quarter ended March
31, 2000 decreased to $.9 million as compared to $1.0 million for the quarter
ended March 31, 1999. Gross interest expense is primarily attributable to the
13% Senior Secured Notes due 2004 we issued in September 1997.
Interest income was $8.9 million during the quarter ended March 31, 2000
compared to $1.5 million for the quarter ended March 31, 1999. The 493% increase
is a result of the increase in cash and investments since March 31, 1999
provided by the debt and equity offerings.
We incurred net losses of $25.3 million during first quarter 2000 compared
to $14.2 million during the first quarter 1999.
YEAR ENDED DECEMBER 31, 1999 VS. 1998
Total operating revenues increased to $55.1 million for the year ended
December 31, 1999 as compared to $18.2 million for the year ended December 31,
1998. The 202% increase was primarily the result of the increase in the number
of lines in service. Total lines in service increased 199% from 47,744 at
December 31, 1998 to 142,664 at December 31, 1999. In addition, long distance
service, which was added to our product offerings in February 1998, contributed
to the revenue base for the full twelve month period in 1999, but only for ten
full months in 1998. Our switched access revenues, which represented 35% of our
total operating revenues for the year ended December 31, 1999, increased $12.1
million or 164% from the year ended December 31, 1998 to the year ended December
31, 1999. As of December 31, 1999, 66% of our switched access receivable
balances were subject to dispute. Until these disputes are resolved and our
access charge receivables are collected, we cannot rely on these revenues as a
source of cash flow.
47
<PAGE> 51
Cost of operating revenues for the year ended December 31, 1999 was $50.0
million as compared to $17.1 million for the year ended December 31, 1998. The
192% increase is due to the increased number of lines in service and
installation and operational expenses associated with the expansion of our
network.
For the year ended December 31, 1999, selling, general and administrative
expenses totaled $44.8 million, a 151% increase over the $17.9 million for the
year ended December 31, 1998. The increase is a result of increased costs
attributable to marketing and delivering our service and supporting our
continued network expansion.
For the year ended December 31, 1999, depreciation and amortization was
$18.9 million as compared to $5.2 million for the year ended December 31, 1998.
This increase is a result of placing additional assets in service in accordance
with the planned build-out of our network.
Gross interest expense for fiscal 1999 totaled $22.3 million, as compared
to $22.2 million for fiscal 1998. Interest capitalized for the year ended
December 31, 1999 increased to $4.1 million as compared to $3.2 million for the
year ended December 31, 1998. The increase in interest capitalized is due to the
increase in switching equipment under construction. Gross interest expense is
primarily attributable to the 13% Senior Secured Notes due 2004 we issued in
September 1997.
Interest income was $7.7 million during the year ended December 31, 1999
compared to $8.8 million for the year ended December 31, 1998. The 12% decrease
is a result of decreases in cash and investments during certain periods of 1999.
Cash and investments have been used to purchase switching equipment, pay
interest on the senior secured notes and fund operating losses.
We incurred net losses of $69.8 million and $32.1 million for the years
ended December 31, 1999 and 1998, respectively.
For the year ended December 31, 1999, we recognized an accrued preferred
stock dividend of $2.6 million, a beneficial conversion feature of $72.5
million, and an accretion of preferred stock to redemption value of $6.1
million, all as a result of the Series B and C preferred stock issued in May and
December 1999, respectively.
YEAR ENDED DECEMBER 31, 1998 VS. 1997
Total operating revenues for the year ended December 31, 1998 were $18.2
million as compared to $3.8 million for the year ended December 31, 1997. The
381% increase is a result of the installation of four additional switches, an
increase in the number of lines in service and the introduction of long distance
service in early 1998. We provided communications services in only Las Vegas
until December 1997 when we initiated service in Atlanta and southern
California. As a result of our network expansion, during 1998 we began to offer
service in Chicago and additional areas of southern California, including Los
Angeles and San Diego. We had 47,744 lines in service as of December 31, 1998 as
compared to 15,590 lines in service as of December 31, 1997, a 206% increase.
Cost of operating revenues for the year ended December 31, 1998 was $17.1
million as compared to $3.9 million for the year ended December 31, 1997. The
336% increase is due to the increased number of lines in service during 1998,
network expenses associated with initiation of long distance service in February
1998, and installation and operational expenses associated with the significant
expansion of our network.
For the year ended December 31, 1998, selling, general and administrative
expenses totaled $17.9 million, a 178% increase over the $6.4 million for the
year ended December 31, 1997. The increase in expenses resulted from increased
costs attributable to marketing of services, delivering our service and
supporting our continued network expansion.
For the year ended December 31, 1998, depreciation and amortization was
$5.2 million as compared to $1.3 million for the year ended December 31, 1997.
This increase is a result of placing
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<PAGE> 52
additional assets in service during the period to support our planned build-out
of our network. As of December 31, 1998 we had seven operational switches and
207 collocation sites built out as compared to three switches and 25 collocation
sites as of December 31, 1997.
Interest expense for fiscal 1998 totaled $19.1 million as compared to $5.5
million for fiscal 1997. The increase is primarily attributable to a full year
of interest incurred on the senior secured notes we issued in September 1997.
Interest income was $8.8 million for the year ended December 31, 1998
compared to $2.5 million for the year ended December 31, 1997. The income is
attributable to earnings on investments made with the proceeds from the issuance
of the senior secured notes and with the proceeds from the sale of our common
and preferred stock.
We incurred net losses of $32.1 million during 1998 and $10.8 million
during 1997.
LIQUIDITY AND CAPITAL RESOURCES
Our operations require substantial capital investment for the purchase of
communications equipment and the development and installation of our network.
Capital expenditures were $94.1 million for the year ended December 31, 1999,
$97.1 million for the year ended December 31, 1998, $22.6 million for the year
ended December 31, 1997 and $45.0 million for the quarter ended March 31, 2000.
We expect we will continue to require substantial amounts of capital to fund the
purchase of the equipment necessary to continue expanding the geographic
coverage of our network in our existing markets and to develop new products and
services. In addition, we expect to enter new markets during 2000.
The substantial capital investment required to initiate services and fund
our operations has exceeded our operating cash flow. This negative cash flow
from operations results from the need to establish our network in anticipation
of connecting revenue-generating customers. We expect to continue recording
negative cash flow from operations because of our network expansion activities.
We cannot assure you we will attain break-even cash flow from operations in
subsequent periods.
We expect that our available cash and the proceeds of the note offering in
March 2000 will be adequate to fund our operating losses and planned capital
expenditures, as currently projected, over the next several years. If these
resources are not sufficient, management intends to consider alternate forms of
financing or to delay or modify some of our expansion plans.
We continually evaluate our capital expenditure plan in light of
developments in the telecommunications industry and market acceptance of our
service offerings. As a result of this evaluation, we may decide to accelerate
or expand our capital expenditure plan. We might also expand through
acquisitions. To fund an accelerated or expanded capital expenditure plan or
acquisitions, we would likely issue additional debt or equity securities. We
cannot assure you we would be successful in raising additional capital on terms
acceptable to us or at all.
Depending on market conditions, we may raise additional capital at any
time, including obtaining a bank facility. However, we cannot assure you that we
will be successful in obtaining additional debt or equity financing or in
obtaining a bank facility on terms acceptable to us, if at all. The indenture
governing the notes and the terms of our preferred stock impose restrictions
upon our ability to incur additional debt or issue preferred stock.
From our inception through September 1997, we raised approximately $17.8
million from private sales of common stock.
In September 1997, we completed a $160.0 million offering of our 13% Senior
Secured Notes due 2004 and warrants to purchase 862,923 shares of common stock
after giving effect to anti-dilution adjustments. At the closing of the sale of
the Senior Secured Notes, we used approximately $56.8 million of the net
proceeds from the sale of the Senior Secured Notes to purchase a portfolio of
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<PAGE> 53
securities that has been pledged as security to cover the first six interest
payments on the Senior Secured Notes. In addition, we have granted the holders
of the Senior Secured Notes a security interest in a significant portion of our
communications equipment.
In November 1997 and January 1998, we issued an aggregate of 6,571,427
shares of Series A convertible preferred stock at $3.50 per share for net
proceeds of $21.6 million.
We completed our initial public offering of common stock on May 15, 1998.
We sold a total of 4,025,000 shares of our common stock to the public and
received net proceeds of $63.0 million. In connection with the initial public
offering of our common stock, we reduced the number of authorized and
outstanding shares of our common stock by 40%. Our outstanding shares of Series
A convertible preferred stock were converted into 3,942,856 shares of common
stock upon our initial public offering.
In May 1999, we issued 5,277,779 shares of Series B convertible preferred
stock at $9.00 per share for net proceeds of approximately $46.7 million.
In July 1999, we issued 5,000,000 shares of common stock and received net
proceeds, after expenses, of approximately $118.1 million. In the offering,
existing stockholders sold an additional 587,695 shares of common stock for
which we did not receive any proceeds.
In December 1999, we sold 1,250,000 shares of Series C convertible
preferred stock at $28.00 per share for a total consideration of $35.0 million.
Of the total consideration, $4.9 million was paid by an interest bearing
promissory note due in March 2000. We received full payment on the note in
February 2000.
In February 2000, we issued 6,163,709 shares of common stock at $54.00 per
share for net proceeds of approximately $316.6 million. We also issued 4,140,000
shares of Series D convertible preferred stock at $50.00 per share for net
proceeds of approximately $200.0 million.
On March 24, 2000, we received approximately $235.6 million in net proceeds
from the issuance of $250.0 million of the outstanding notes.
As of December 31, 1999, we had outstanding receivables of approximately
$10.9 million attributable to access charges billed to AT&T, Sprint and other
long distance carriers. AT&T and Sprint refused to pay the full amount of the
access charges billed to them. We have since settled our dispute with AT&T;
however, our dispute with Sprint has yet to be resolved. Of our outstanding
access charge receivables as of December 31, 1999, 66% remains in dispute. Our
failure to collect from these long distance carriers could have a material
impact on our financial condition. See "Business -- Legal Proceedings" and "Risk
Factors -- We may not be able to collect all of the access charges we have
billed to long distance carriers."
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of our long-term debt bears fixed interest rates. However, the fair
market value of this debt is sensitive to changes in prevailing interest rates.
We run the risk that market rates will decline and the required payments on our
outstanding debt will exceed those based on the current market rate. We do not
use interest rate derivative instruments to manage our exposure to interest rate
changes.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2000, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101, "Revenue Recognition," that will be effective for our
year ending December 31, 2000. The bulletin provides guidance for applying
Generally Accepted Accounting Principles to revenue recognition, presentation,
and disclosure in financial statements filed with the Securities and Exchange
Commission. We believe that the bulletin will not materially impact our revenue
recognition practices.
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<PAGE> 54
PRIMARY NETWORK'S MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion, together with Primary Network's
financial statements and the notes related to Primary Network's financial
statements, each of which can be found elsewhere in this prospectus.
Primary Network is an integrated communications provider offering data and
voice telecommunications services to both business and residential customers.
Primary Network is the successor corporation to CDM On-Line, Inc., and has been
operational since June 1, 1999. A more detailed description of the initial
formation, organization and capitalization of Primary Network can be found in
the footnotes to the September 30, 1999 audited financial statements of Primary
Network found elsewhere in this prospectus. This discussion of the financial
condition of Primary Network will analyze the financial statements of Primary
Network and CDM On-Line for the three year period ended December 31, 1999 and
for the three month period ended March 31, 2000. The following is a discussion
of certain factors affecting the operating results of Primary Network and CDM
On-Line, as predecessor to Primary Network, as well as a description of the
liquidity and capital resources of Primary Network. Based on Primary Network's
initial formation and September 30 fiscal year end, Primary Network has provided
financial comparisons for the following periods:
- The three months ended March 31, 2000 vs. the three months ended March
31, 1999;
- The six months ended March 31, 2000 vs. the six months ended March 31,
1999;
- The four months ended September 30, 1999 vs. the four months ended
September 30, 1998;
- The five months ended May 31, 1999 vs. the five months ended May 31,
1998;
- The twelve months ended December 31, 1999 vs. the twelve months ended
December 31, 1998; and
- The twelve months ended December 31, 1998 vs. the twelve months ended
December 31, 1997.
This discussion should be read along with the financial statements of
Primary Network and their notes, which can be found elsewhere in this
prospectus. These results are not necessarily indicative of any future results.
This discussion contains statements that plan for or anticipate the future.
Because these forward-looking statements include future risks and uncertainties,
there are factors that could cause actual results to differ materially from
those expressed or implied.
OVERVIEW
Primary Network began providing dialup Internet connectivity and web
hosting in August 1995 and began offering ISDN and dedicated connectivity by May
1996. In December 1996, Primary Network began offering cell phone sales and
service on an agency basis. During the fourth quarter of 1999, Primary Network
began offering high-speed DSL service in St. Louis and Kansas City. Currently,
Primary Network provides DSL, high-speed Internet access and dialup modem access
in St. Louis, Kansas City and Springfield, Missouri; Tulsa and Oklahoma City,
Oklahoma; and Metro East, Illinois.
Primary Network's 1997 revenues were generated from sales of communications
services consisting primarily of dialup and dedicated Internet, web hosting and
web design, agency cell phone sales and agency long distance services. In 1998,
these revenue streams grew through added sales and marketing activity. In 1999,
Primary Network discontinued the operation of its web-design services.
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<PAGE> 55
During 1997 and 1998, Primary Network expanded significantly with the
installation of Network Access Points for dialup connectivity within the Kansas
City area and a number of the smaller cities surrounding St. Louis. During 1998
and 1999, Primary Network continued this expansion, adding network access points
in Springfield, Missouri and Tulsa, Oklahoma, and acquiring competing Internet
Service Providers in St. Louis, Kansas City, Springfield and Tulsa. Primary
Network also opened a total of 35 collocation sites for DSL service by the end
of 1999. As expected, both cost of operating revenues and selling, general and
administrative expenses increased as many costs of providing service were
initially duplicated through the acquisitions before efficiencies could be
realized. In addition, Primary Network incurred significant sales and marketing
costs to establish an initial base of customers in new markets.
Building and expanding its business has required and will continue to
require Primary Network to incur significant capital expenditures primarily
consisting of the costs of building out collocations and the purchase of
associated equipment. As part of its network growth strategy, Primary Network
built out and installed DSL collocations in each of the markets Primary Network
does business in while leasing the means of transporting voice and data traffic
from these switches to its customers' telephones or other equipment. Primary
Network believes this facilities-based strategy, while initially increasing its
level of capital expenditures and operating losses, will enhance its long-term
financial performance.
Primary Network has experienced operating losses and generated negative
cash flow from operations since inception and expects to continue to generate
negative cash flow from operations for the foreseeable future while Primary
Network continues to expand its network and develop its product offerings and
customer base. Primary Network cannot ensure that its revenue or customer base
will grow or that Primary Network will be able to achieve or sustain positive
cash flow from operations.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 VS. THREE MONTHS ENDED MARCH 31, 1999
Total Operating Revenues
Total operating revenues increased to $5,373,652 for the three months ended
March 31, 2000 as compared to $1,569,106 for the three months ended March 31,
1999.
Access revenues increased to $3,140,338 for the three months ended March
31, 2000 as compared to $1,141,754 for the three months ended March 31, 1999.
The 275% increase was the result of sales increases through existing channels
and the integration of the ISPs acquired in 1999.
Communications revenues increased to $1,710,966 for the three months ended
March 31, 2000 as compared to $0 for the three months ended March 31, 1999. The
addition of this revenue stream resulted from the purchase of a CLEC in June
1999. The revenue was a combination of sales from resale long distance, local
phone service and the introduction of DSL access services in St. Louis and
Kansas City in late 1999.
Retail revenues decreased to $286,211 for the three months ended March 31,
2000 as compared to $298,054 for the three months ended March 31, 1999. The
decrease was primarily the result of a shift of advertising strategy from
consumer-focused to business-focused marketing.
Other revenues increased to $236,137 for the three months ended March 31,
2000 as compared to $129,298 for the three months ended March 31, 1999. The 83%
increase was primarily the result of increased equipment sales over the prior
year's three month period, as well as increased overall sales and sales of DSL
customer premise equipment from central office collocations completed in late
1999.
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Cost of Operating Revenues
Cost of operating revenues for the three months ended March 31, 2000 was
$3,554,036 as compared to $620,639 for the three months ended March 31, 1999.
Cost of access revenues for the three months ended March 31, 2000 was
$1,320,008 as compared to $351,779 for the three months ended March 31, 1999.
Cost of access revenues as a percentage of access revenues increased to 42.03%
for the three months ended March 31, 2000, from 30.81% for the three months
ended March 31, 1999. The 12% increase was due to inefficiencies in network
operations and redundancies in network infrastructure which mainly resulted from
the 1999 ISP acquisitions.
Cost of communications revenues for the three months ended March 31, 2000
was $1,937,654 as compared to $0 for the three months ended March 31, 1999. Cost
of communications revenues increased due to the purchase of a CLEC in June 1999.
Costs are higher than total communications revenues because of the fixed costs
associated with the DSL collocations relative to the customer base, difficulties
integrating the customer billing systems of Southwestern Bell and Qwest with
that of Primary Network, as well as charges by Southwestern Bell which differ
from both rates quoted in Southwestern Bell's tariff schedule and rates charged
by Primary Network based on Southwestern Bell's tariff schedule.
Cost of retail revenues for the three months ended March 31, 2000 was
$148,438 as compared to $179,293 for the three months ended March 31, 1999. Cost
of retail revenues as a percentage of retail revenues decreased to 51.86% for
the three months ended March 31, 2000, from 60.15% for the three months ended
March 31, 1999. The improvement was the result of increased margins on cellular
equipment sales and shifting the cost of sales tax to the consumer in 2000, as
opposed to absorbing the sales tax as a cost of goods in the prior year period.
Cost of other revenues for the three months ended March 31, 2000 was
$147,936 as compared to $89,567 for the three months ended March 31, 1999. Cost
of other revenues as a percentage of other revenues decreased to 62.65% for the
three months ended March 31, 2000, from 69.27% for the three months ended March
31, 1999. This decrease resulted from increased margins on the sale of DSL
equipment in connection with the new DSL service introduced in the fourth
quarter of 2000.
Operations and Customer Support Expenses
Operations and customer support expenses for the three months ended March
31, 2000 was $3,203,729 as compared to $207,727 for the three months ended March
31, 1999, an increase in percentage of sales to 59.62% for the three months
ended March 31, 2000, from 13.24% for the three months ended March 31, 1999.
This increase was due to the purchase of several ISPs and a CLEC in 1999, as
well as the expansion into multiple new markets during late 1999 and the first
quarter of 2000. Primary Network also continued adding support staff for voice
and DSL products launched in the fourth quarter 2000. Further, in 2000, Primary
Network's technical support center expanded operations to provide service 24
hours a day, seven days a week.
Sales and Marketing Expenses
Sales and marketing expenses for the three months ended March 31, 2000 was
$2,193,308 as compared to $199,310 for the three months ended March 31, 1999.
Sales and marketing expenses as a percentage of total revenues increased to
40.82% for the three months ended March 31, 2000, from 12.7% for the three
months ended March 31, 1999. The increase was due to the re-branding of several
ISP acquisitions and the initial costs associated with building the sales force
and introducing the Primary Network brand into new markets.
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General and Administration Expenses
For the three months ended March 31, 2000, general and administrative
expenses totaled $3,022,429, as compared to $552,020 for the three months ended
March 31, 1999. General and administrative expenses as a percentage of total
revenues increased to 56.25% for the three months ended March 31, 2000, from
35.18% for the three months ended March 31, 1999. This increase was due largely
to costs associated with the expansion into multiple markets, training personnel
to provision and support products in new locations, as well as the continued
development of operational support systems for the new products.
Retail Store Expenses
Retail store expense for the three months ended March 31, 2000 was $103,839
as compared to $305,934 for the three months ended March 31, 1999. The reduction
in retail store expenses was the result of a decrease in the direct sales force
attributable to the selling of retail products, general staff reductions and the
closing of retail locations not used during the 1999 period.
Depreciation and Amortization
Depreciation and amortization for the three months ended March 31, 2000 was
$3,449,800 as compared to $52,649 for the three months ended March 31, 1999.
This increase was due to an increase in the number of fixed assets depreciating.
In addition, Primary Network incurred significant amortization expenses related
to the goodwill recorded in connection with the acquisitions.
Gross Interest Expense
Gross interest expense for three months ended March 31, 2000 totaled
$2,203,765, as compared to $1,219 for the three months ended March 31, 1999. The
increase in interest was due to interest expense accumulated by Primary Network
in connection with the Senior Subordinated Discount Notes, issued on June 1,
1999.
Total Net Loss
Primary Network incurred net losses of $12,182,267 and $406,720 for the
three months ended March 31, 2000 and 1999, respectively.
SIX MONTHS ENDED MARCH 31, 2000 VS. SIX MONTHS ENDED MARCH 31, 1999
Total Operating Revenues
Total operating revenues increased to $9,627,165 for the six months ended
March 31, 2000 as compared to $2,878,736 for the six months ended March 31,
1999.
Access revenues increased to $5,771,959 for the six months ended March 31,
2000 as compared to $2,026,771 for the six months ended March 31, 1999. The 185%
increase was primarily the result of the acquisition of several ISPs during mid
to late 1999 and the growth in the existing customer base.
Communications revenues increased to $2,854,131 for the six months ended
March 31, 2000 as compared to $0 for the six months ended March 31, 1999. The
addition of this revenue stream resulted from the Primary Network's purchase of
a CLEC in June 2000.
Retail revenues increased to $528,388 for the six months ended March 31,
2000 as compared to $518,800 for the six months ended March 31, 1999. The
increase was due to slightly increased sales and pricing over the prior year
six-month period.
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Other revenues increased to $472,687 for the six months ended March 31,
2000 as compared to $333,165 for the six months ended March 31, 1999. The
increase was primarily the result of increased equipment sales over the prior
year six month period, increased overall sales and sales of DSL customer premise
equipment from central office collocations completed in late 1999.
Cost of Operating Revenues
Cost of operating revenues for the six months ended March 31, 2000 was
$6,098,973 as compared to $1,268,707 for the six months ended March 31, 1999.
Cost of access revenues for the six months ended March 31, 2000 was $2,395,394
as compared to $688,995 for the six months ended March 31, 1999. Cost of access
revenues as a percentage of access revenues increased to 41.50% for the three
months ended March 31, 2000, from 33.99% for the three months ended March 31,
1999. The increase in percentage was due to inefficiencies in network operations
and duplicative network elements following the 1999 ISP acquisitions.
Cost of communications revenues for the six months ended March 31, 2000 was
$3,102,857 as compared to $0 for the six months ended March 31, 1999. Cost of
communications revenues increased due to the purchase of a CLEC in June 1999.
Costs are higher than total communications revenues because of the fixed costs
associated with the DSL collocations relative to the customer base, difficulties
integrating the customer billing systems of Southwestern Bell and Qwest with
that of Primary Network, as well as charges by Southwestern Bell which differ
from both rates quoted in Southwestern Bell's tariff schedule and rates charged
by Primary Network based on Southwestern Bell's tariff schedule.
Cost of retail revenues for the six months ended March 31, 2000 was
$245,734 as compared to $326,219 for the six months ended March 31, 1999. Cost
of retail revenues as a percentage of retail revenues decreased to 46.51% for
the six months ended March 31, 2000, from 62.88% for the six months ended March
31, 1999. The improvement was primarily the result of increased margins on
cellular equipment sales. Primary Network also began shifting the cost of sales
tax to customers, as opposed to absorbing the sales tax as a cost of goods in
the prior year period.
Cost of other revenues for the six months ended March 31, 2000 was $354,988
as compared to $253,493 for the six months ended March 31, 1999. Cost of other
revenues as a percentage of other revenues was essentially flat, decreasing to
75.10% for the six months ended March 31, 2000, from 76.09% for the six months
ended March 31, 1999.
Operations and Customer Support Expenses
Operations and customer support expenses for the six months ended March 31,
2000 was $4,799,453 as compared to $400,759 for the six months ended March 31,
1999, an increase in percentage of sales to 49.85% for the six months ended
March 31, 2000, from 13.92% for the six months ended March 31, 1999. This
increase was due to a number of factors related to Primary Network's growth,
including additional costs associated with the ISP acquisitions, increasing
support staff for voice and DSL products in anticipation of a launch of these
products and the expansion into new markets.
Sales and Marketing Expenses
Sales and marketing expenses for the six months ended March 31, 2000 was
$3,535,889 as compared to $436,337 for the six months ended March 31, 1999.
Sales and marketing expenses as a percentage of total revenues increased to
36.73% for the six months ended March 31, 2000, from 15.16% for the six months
ended March 31, 1999. This increase was due to the expansion into several new
markets and increased marketing costs associated with the introduction of the
Primary Network brand to these markets as well as increased spending on brand
building for the DSL Accelerator
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<PAGE> 59
product. Primary Network also began building its direct sales staff, which
includes a three month commission bridge for each new sales representative.
General and Administrative Expenses
General and administrative expenses totaled $5,415,148 for the six months
ended March 31, 2000, as compared to $972,741 for the six months ended March 31,
1999. General and administrative expenses as a percentage of total revenues
increased to 56.25% for the six months ended March 31, 2000, from 33.79% for the
six months ended March 31, 1999. This increase was due largely to the ISP
acquisitions, costs associated with entering new markets, increasing the size of
staff personal, costs associated with developing new software for billing and
provisioning products.
Retail Store Expenses
Retail store expenses for the six months ended March 31, 2000 was $293,700
as compared to $604,242 for the six months ended March 31, 1999. The decrease in
retail store expenses was due to Primary Network's strategy of cost control and
the closing of an unused retail store location during the six months ended March
31, 1999.
Depreciation and Amortization
Depreciation and amortization totaled $6,263,609 for the six months ended
March 31, 2000, as compared to $144,841 for the six months ended March 31, 1999.
This increase was a result of goodwill associated with the ISP acquisitions, as
well as placing additional assets in service in accordance with the planned
build-out of the network.
Gross Interest Expense
Gross interest expense for the six months ended March 31, 2000 totaled
$4,298,552, as compared to $20,550 for the six months ended March 31, 1999. The
increase in interest was primarily due to interest expenses accumulated by
Primary Network in connection with the Senior Subordinated Discount Notes,
issued on June 1, 1999.
Total Net Loss
Primary Network incurred net losses of $20,561,141 and $976,114 for the six
months ended March 31, 2000 and 1999, respectively.
FOUR MONTHS ENDED SEPTEMBER 30, 1999 VS. FOUR MONTHS ENDED SEPTEMBER 30, 1998
Total Operating Revenues
Total operating revenues increased to $4,082,137 for the four months ended
September 30, 1999 as compared to $1,660,685 for the four months ended September
30, 1998.
Access revenues increased to $2,712,058 for the four months ended September
30, 1999 as compared to $1,115,024 for the four months ended September 30, 1998.
The 143% increase was primarily the result of acquisition of three ISPs during
the period, the acquisition of three ISPs during the first 5 months of 1999, and
growth in the existing customer base of Primary Network.
Communications revenues increased to $850,367 for the four months ended
September 30, 1999 as compared to $0 for the four months ended September 30,
1998. The addition of this revenue stream resulted from the Primary Network's
purchase of a CLEC in June 1999.
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Retail revenues increased to $350,715 for the four months ended September
30, 1999 as compared to $314,721 for the four months ended September 30, 1998.
The 11.4% increase was primarily the result of increased sales at four retail
stores.
Other revenues decreased to $168,997 for the four months ended September
30, 1999 as compared to $230,940 for the four months ended September 30, 1998.
The 27% decrease was primarily the result of eliminating certain installation
fees and providing free equipment as an incentive to attract new customers.
Cost of Operating Revenues
Cost of operating revenues for the four months ended September 30, 1999 was
$2,102,573 as compared to $738,126 for the four months ended September 30, 1998.
Cost of access revenues for the four months ended September 30, 1999 was
$947,293 as compared to $417,840 for the four months ended September 30, 1998.
Cost of access revenues as a percentage of access revenues decreased to 34.9%
for the four months ended September 30, 1999, from 37.5% for the four months
ended September 30, 1998. Savings were the result of additional efficiencies of
scale realized from revenue growth.
Cost of communications revenues for the four months ended September 30,
1999 was $903,846 as compared to $0 for the four months ended September 30,
1998. As noted, Primary Network purchased a CLEC on June 1, 1999. Costs are
higher than total communications revenues because of difficulties integrating
the customer billing systems of Southwestern Bell and Qwest with that of Primary
Network and because of installation charges by Southwestern Bell which differed
from rates quoted in Southwestern Bell's tariff schedule.
Cost of retail revenues for the four months ended September 30, 1999 was
$141,734 as compared to $183,358 for the four months ended September 30, 1998.
Cost of retail revenues as a percentage of retail revenues decreased to 40.4%
for the four months ended September 30, 1999, from 58.3% for the four months
ended September 30, 1998. The improvement was the result of increased margins on
cellular equipment sales and shifting the sales tax cost on to customers, as
opposed to absorbing the sales tax as a cost of goods in 1998.
Cost of other revenues for the four months ended September 30, 1999 was
$109,700 as compared to $136,928 for the four months ended September 30, 1998.
Cost of other revenues as a percentage of other revenues increased to 64.9% for
the four months ended September 30, 1999, from 59.3% for the four months ended
September 30, 1998. This increase resulted from offering free or discounted
equipment in order to attract new customers.
Operations and Customer Support Expenses
Operations and customer support expenses for the four months ended
September 30, 1999 was $1,595,725 as compared to $241,295 for the four months
ended September 30, 1998, an increase in percentage of total revenues to 39.1%
for the four months ended September 30, 1999, from 14.5% for the four months
ended September 30, 1998. This increase was due to a number of factors,
including the acquisition of several ISPs, the addition of new employees during
these periods to help launch voice and DSL products, and the expansion of the
technical support center.
Sales and Marketing Expenses
Sales and marketing expenses for the four months ended September 30, 1999
was $1,342,581 as compared to $228,685 for the four months ended September 30,
1998. Sales and marketing expenses as a percentage of total revenues increased
to 32.9% for the four months ended September 30, 1999, from 13.8% for the four
months ended September 30, 1998. This increase was due to Primary
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<PAGE> 61
Network's expansion of communications services into the Kansas City market and
increased marketing costs associated with such expansion, as well as increased
spending on brand building for the DSL Accelerator product in existing markets.
General and Administrative Expenses
General and administrative expenses for the four months ended September 30,
1999 totaled $2,046,290, as compared to $318,537 for the four months ended
September 30, 1998. Cost of general and administrative expenses as a percentage
of total revenues increased to 50.1% for the four months ended September 30,
1999, from 19.2% for the four months ended September 30, 1998. This increase was
due largely to the acquisition of several ISPs and increased costs associated
with entering new markets. In addition, Primary Network increased the management
staff and began developing software for billing and provisioning for new
products.
Retail Store Expenses
Retail store expenses for the four months ended September 30, 1999 was
$275,554 as compared to $298,665 for the four months ended September 30, 1998.
Retail store expenses as a percentage of retail revenues decreased to 78.6% for
the four months ended September 30, 1999, from 94.9% for the four months ended
September 30, 1998. The reduction was the result of a decrease in the direct
sales force responsible for selling cellular products and services.
Depreciation and Amortization
Depreciation and amortization for the four months ended September 30, 1999
was $1,766,901 as compared to $101,857 for the four months ended September 30,
1998. This increase is a result of goodwill associated with the acquisition of
several ISPs, as well as placing additional assets in service in accordance with
the planned build-out of its network.
Gross Interest Expense and Interest Income
Gross interest expense for four months ended September 30, 1999 totaled
$2,701,311, as compared to $91,919 for the four months ended September 30, 1998.
The increase in interest is due almost entirely to interest expense accumulated
from the 12% Senior Subordinated Discount Notes, issued on June 1, 1999.
Interest income was $694,227 during the four months ended September 30, 1999
compared to $22,783 for the four months ended September 30, 1998. The increase
resulted primarily from investment income arising from the investment of
proceeds of the Senior Subordinated Discount Notes financing.
Total Net Loss
Primary Network incurred net losses of $7,308,703 and $270,642 for the four
months ended September 30, 1999 and 1998, respectively.
FIVE MONTHS ENDED MAY 31, 1999 VS. FIVE MONTHS ENDED MAY 31, 1998
Total Operating Revenues
Total operating revenues increased to $2,833,284 for the five months ended
May 31, 1999 as compared to $1,825,257 for the five months ended May 31, 1998.
Total operating revenues consisted of access revenues, retail revenues and other
revenues; there were no communications revenues for five-month period ending May
31, 1999.
Total access revenues increased to $2,070,368 for the five months ended May
31, 1999 as compared to $1,216,422 for the five months ended May 31, 1998. The
70% increase was primarily
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due to an increase in the number of dialup and access customers resulting from
increased marketing and acquisition of three ISPs.
Retail revenues increased to $518,124 for the five months ended May 31,
1999 as compared to $347,913 for the five months ended May 31, 1998. The 49%
increase was primarily the result of increased sales growth at four retail
stores.
Other revenues decreased to $244,792 for the five months ended May 31, 1999
as compared to $260,922 for the five months ended May 31, 1998. The 6% decrease
was primarily the result of a decrease in modem setup fees in order to attract
new customers.
Cost of Operating Revenues
Cost of operating revenues for the five months ended May 31, 1999 was
$1,074,695 as compared to $810,811 for the five months ended May 31, 1998. Cost
of access revenues for the five months ended May 31, 1999 was $614,441 as
compared to $429,378 for the five months ended May 31, 1998. Cost of access
revenues as a percentage of access revenues decreased to 29.7% for the five
months ended May 31, 1999, from 35.3% for the five months ended May 31, 1998.
Savings were realized as a result of increased efficiencies of scale and cost
effective management of both network and telecommunications circuits.
Cost of retail revenues for the five months ended May 31, 1999 was $299,287
as compared to $199,707 for the five months ended May 31, 1998. Cost of retail
revenues as a percentage of retail revenues was essentially unchanged, with cost
of retail revenues marginally increasing to 57.8% for the five months ended May
31, 1999, from 57.4% for the five months ended May 31, 1998.
Cost of other revenues for the five months ended May 31, 1999 was $160,967
as compared to $181,726 for the five months ended May 31, 1998. Cost of other
revenues as a percentage of other revenues decreased to 65.8% for the five
months ended May 31, 1999 from 69.6% for the five months ended May 31, 1998.
Savings resulted from a decrease in the number of promotions designed to attract
new customers.
Operations and Customer Support Expenses
Operations and customer support expenses for the five months ended May 31,
1999 was $387,078 as compared to $237,265 for the five months ended May 31,
1998, an increase in percentage of total revenues to 13.7% for the five months
ended May 31, 1999, from 13% for the five months ended May 31, 1998. The
marginal increase in percentage of total revenues resulted from the need to
increase the customer care organization in anticipation of the acquisition of
several ISPs.
Sales and Marketing Expenses
Sales and marketing expenses for the five months ended May 31, 1999 was
$377,952 as compared to $279,354 for the five months ended May 31, 1998. Sales
and marketing expenses as a percentage of total revenues decreased to 13.3% for
the five months ended May 31, 1999, from 15.3% for the five months ended May 31,
1998. Savings were realized as a result of spreading sales and marketing
management costs over a larger budget.
General and Administrative Expenses
General and administrative expenses for the five months ended May 31, 1999
totaled $978,661, as compared to $449,795 for the five months ended May 31,
1998. Cost of general and administrative expenses as a percentage of total
revenues increased to 34.5% for the five months ended May 31, 1999, from 24.6%
for the five months ended May 31, 1998. This increase was due to an increase in
stock compensation expenses to $391,000 for the five months ended May 31, 1999,
from $0 for the
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five months ended May 31, 1998. This increase in stock compensation resulted
from equity sold or granted to new employees in 1999. Excluding of this increase
in stock compensation expenses, general and administrative expenses as a
percentage of total sales decreased to 20.7% for the five months ended May 31,
1999, from 24.6% for the five months ended May 31, 1998.
Retail Store Expenses
Retail store expenses for the five months ended May 31, 1999 was $518,571
as compared to $416,164 for the five months ended May 31, 1998. Retail store
expenses as a percentage of retail revenues decreased to 100.1% for the five
months ended May 31, 1999, from 119.6% for the five months ended May 31, 1998.
This decrease is the result of management's continued efforts towards improving
operating results for the retail stores.
Depreciation and Amortization
Depreciation and amortization for the five months ended May 31, 1999, was
$168,923 as compared to $69,013 for the five months ended May 31, 1998. This
increase is a result of placing additional assets in service in accordance with
Primary Network's planned build-out of its network.
Gross Interest Expense and Interest Income
Gross interest expense for five months ended May 31, 1999 totaled $19,158,
as compared to $79,731 for the five months ended May 31, 1998. This decrease in
interest expense is attributable to a conversion of a note from an affiliated
party to equity in order to reduce the debt of Primary Network. Interest income
was $8,671 during the five months ended May 31, 1999 compared to $0 for the five
months ended May 31, 1998. The increase resulted from loans made to affiliated
parties and the subsequent interest payments on such loans.
Total Net Loss
Primary Network incurred net losses of $763,691 and $394,081 for the five
months ended May 31, 1999 and 1998, respectively.
YEAR ENDED DECEMBER 31, 1999 VS. 1998
Total Operating Revenues
Total operating revenues increased to $11,168,934 for the twelve-months
ended December 31, 1999 as compared to $4,795,571 for the twelve-months ended
December 31, 1998.
Access revenues increased to $7,414,047 for the twelve-months ended
December 31, 1999 as compared to $3,216,463 for the twelve-months ended December
31, 1998. The 131% increase was the result of sales increases through existing
channels and the acquisition of several ISPs during 1999.
Communications revenues were $1,993,532 for the twelve-months ended
December 31, 1999 as compared to $0 for the twelve-months ended December 31,
1998. The addition of this revenue stream resulted from the Primary Network's
purchase of a CLEC in June 1999. The revenue is attributable to resale long
distance, local phone service and the introduction of DSL access services in St.
Louis and Kansas City.
Retail revenues increased to $1,111,016 for the twelve-months ended
December 31, 1999 as compared to $883,380 for the twelve-months ended December
31, 1998. The 25.8% increase was primarily the result of increased sales at four
retail stores.
Other revenues decreased to $650,339 for the twelve-months ended December
31, 1999 as compared to $695,728 for the twelve-months ended December 31, 1998.
The 6.5% decline was
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<PAGE> 64
primarily the result of initiating certain promotions in 1999 aimed at
attracting new customers in response to market pressure.
Cost of Operating Revenues
Cost of operating revenues for the twelve-months ended December 31, 1999
was $5,722,205 as compared to $2,197,005 for the twelve-months ended December
31, 1998.
Cost of access revenues for the twelve-months ended December 31, 1999 was
$2,637,120 as compared to $1,184,433 for the twelve-months ended December 31,
1998. Cost of access revenues as a percentage of access revenues was essentially
unchanged, at 35.6% for the twelve-months ended December 31, 1999, from 36.8%
for the twelve-months ended December 31, 1998. Cost of access revenues increased
in 1999 in the final quarter due to several acquisitions. However, the aggregate
percentage of cost of access revenues as a percentage of access revenues was
equivalent to the 1998 percentage for that period, primarily because Primary
Network began realizing the economies of scale resulting from the acquisitions
of the ISPs.
Cost of communications revenues for the twelve-months ended December 31,
1999 was $2,069,049 as compared to $0 for the twelve-months ended December 31,
1998. As previously noted, Primary Network purchased a CLEC in June 1999. Costs
are higher than total communications revenues because of difficulties in
reconciling billings from Southwestern Bell and Qwest with the Primary Network's
own customer-billing system.
Cost of retail revenues for the twelve-months ended December 31, 1999 was
$538,317 as compared to $529,992 for the twelve-months ended December 31, 1998.
Cost of retail revenues as a percentage of retail revenues decreased to 48.5%
for the twelve-months ended December 31, 1999, from 60% for the twelve-months
ended December 31, 1998. The improvement was the result of increased margins on
cellular equipment sales and shifting the cost of sales tax to customers in
1999, as opposed to absorbing sales tax as a cost of goods in 1998.
Cost of other revenues for the twelve-months ended December 31, 1999 was
$477,719 as compared to $482,580 for the twelve-months ended December 31, 1998.
Cost of other revenues as a percentage of other revenues increased to 73.5% for
the twelve-months ended December 31, 1999, from 69.4% for the twelve-months
ended December 31, 1998. This increase resulted from waiving certain fees and
providing free equipment in order to attract new customers.
Operations and Customer Support Expenses
Operations and customer support expenses for the twelve-months ended
December 31, 1999 was $3,578,527 as compared to $671,592 for the twelve-months
ended December 31, 1998, an increase in percentage of total revenues to 32.3%
for the twelve-months ended December 31, 1999, from 14.0% for the twelve-months
ended December 31, 1998. This increase is due to a number of factors, including
increases in support staff for voice and DSL products launched in the fourth
quarter of 1999, increased technical support service, the acquisition of several
ISPs in the twelve-month period ending December 31, 1999 and the addition of new
employees to meet the demands of a growing network.
Sales and Marketing Expenses
Sales and marketing expenses for the twelve-months ended December 31, 1999
was $3,063,114 as compared to $745,067 for the twelve-months ended December 31,
1998. Sales and marketing expenses as a percentage of total revenues increased
to 27.7% for the twelve-months ended December 31, 1999, from 15.5% for the
twelve-months ended December 31, 1998. The increase was
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due to increased sales and marketing costs associated with the expansion of
Primary Network into several new markets and the introduction of several new
products during this period.
General and Administrative Expenses
General and administrative expenses for the twelve-months ended December
31, 1999 totaled $5,417,670, as compared to $1,189,052 for the twelve-months
ended December 31, 1998. General and administrative expenses as a percentage of
total revenues increased to 48.5% for the twelve-months ended December 31, 1999,
from 24.8% for the twelve-months ended December 31, 1998. This increase was due
largely to increased costs associated with the acquisition of several ISPs,
continued development of operational support systems for new products, increased
costs associated with the expansion of services into several new states, and
additional costs associated with additional management personnel.
Retail Store Expenses
Retail store expenses for the twelve-months ended December 31, 1999 was
$983,986 as compared to $1,013,136 for the twelve-months ended December 31,
1998. Retail store expenses as a percentage of retail revenues decreased to
88.6% for the twelve-months ended December 31, 1999, from 114.7% for the
twelve-months ended December 31, 1998. The reduction resulted from reductions in
the number of employees and operating efficiencies.
YEAR ENDED DECEMBER 31, 1998 VS. 1997
Total Operating Revenues
Total operating revenues increased to $4,795,571 for the year ended
December 31, 1998 as compared to $2,575,552 for the year ended December 31,
1997. The 86% increase was primarily the result of the increase in access
revenues. Access revenues, which represented 67% of total operating revenues for
the year ended December 31, 1998, increased $1,720,226 or 115% from the year
ended December 31, 1997. In addition, revenues grew at three retail stores
established in 1997, and a fourth retail location was added in the fourth
quarter of 1998.
Cost of Operating Revenues
Cost of operating revenues for the year ended December 31, 1998 was
$2,197,005 as compared to $1,317,947 for the year ended December 31, 1997. The
67% increase is due to an increase in the amount of telephone circuits in
service and other installation and operational expenses associated with the
network expansion.
Sales, General and Administrative Expenses
Sales, general and administrative expenses for the year ended December 31,
1998, totaled $2,605,711, a 45% increase over the $1,801,600 for the year ended
December 31, 1997. The increase is a result of increased costs attributable to
marketing initiatives, increased operational costs associated with providing our
services, and other costs associated with network expansion.
Retail Store Expenses
Retail store expenses for the year ended December 31, 1998 totaled
$1,013,136, a 31% increase over the $773,634 for the year ended December 31,
1997. This increase is attributable to opening a new retail store in 1998 and
increased costs at the other retail stores.
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Depreciation and Amortization
Depreciation and amortization for the year ended December 31, 1998, was
$263,063 as compared to $233,073 for the year ended December 31, 1997. This
increase is a result of placing additional assets in service in accordance with
the planned network development, as well as the addition of the retail stores in
1997 and 1998.
Interest Expense
Interest expense for fiscal 1998 totaled $190,980, as compared to $83,806
for fiscal 1997. Increase in interest expense is primarily attributable to an
increase in the interest rate charged, from the applicable federal rate in 1997
to a rate of 12% in 1998. This interest rate increase was partially offset by a
reduction in notes payables due to a partial debt forgiveness on the part of an
affiliated party. Primary Network had no interest income in either 1997 or 1998.
Total Net Losses
Primary Network incurred net losses of $1,234,118 and $1,442,803 for the
years ended December 31, 1998 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Primary Network's operations require substantial capital investment for the
purchase of communications equipment and the development and installation of its
network. Capital expenditures were $9,137,105 for the year ended December 31,
1999, $193,938 for the year ended December 31, 1998 and $340,899 for the year
ended December 31, 1997. Primary Network expects that it will continue to
require substantial amounts of capital for future expenditures such as
continuing the expansion of central offices into various states, purchasing the
equipment necessary to continue such expansion and constructing a new home
office in St. Louis.
To date, Primary Network has financed its operations primarily through a
private placement of 12% Senior Subordinated Discount Notes due 2006 with an
aggregate principal amount of $84,473,948 in June 1999, which resulted in the
receipt of $53,000,000 by Primary Network. However, the substantial capital
investment required to initiate services and fund its operations has exceeded
Primary Network's operating cash flow. This negative cash flow from operations
results from the need to establish Primary Network's network in anticipation of
connecting revenue-generating customers. Primary Network expects to continue
recording negative cash flow from operations because of its network expansion
activities. Primary Network cannot assure you it will attain break-even cash
flow from operations in subsequent periods.
Because Primary Network expects that its available cash, including the
proceeds of the 12% Senior Subordinated Discount Notes offering in June 1999,
will not be adequate to fund its operating losses and planned capital
expenditures as currently projected, Primary Network will be required to raise
additional capital, the availability, timing and amount of which cannot be
predicted. Primary Network expects that it would be required to raise additional
capital through debt or equity financings, depending on market conditions, to
finance the continued development, commercial deployment and expansion of its
networks and for funding operating losses or to take advantage of unanticipated
opportunities. If Primary Network is unable to obtain required additional
capital or is required to obtain additional capital on terms less satisfactory
than its desire, Primary Network may be required to delay the expansion of its
business or take or forego actions, any or all of which could harm its business.
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BUSINESS
MPOWER
GENERAL
We are a growing communications company currently offering Internet access,
voice over DSL, local dialtone, long distance and other voice and data services
primarily to small and medium size business customers. We have launched bundled
voice and high-speed data services using DSL technology in all of our current
markets. We have one of the broadest geographic service areas of any competitive
carrier providing local, long distance and data services, with 446 incumbent
carrier central office collocation sites providing us access to approximately
17.8 million addressable lines as of March 31, 2000. Over 248 of our central
office collocation sites are DSL capable. We currently deliver our services in
the metropolitan areas of Atlanta, Chicago, Las Vegas, southern Florida and
selected areas of California, including Los Angeles, San Diego, Sacramento and
the San Francisco Bay Area markets. We have established working relationships
with five incumbent local exchange carriers: Ameritech, BellSouth, GTE, PacBell
and Sprint. As of March 31, 2000, we had 194,775 customer lines sold, of which
168,786 lines were in service. To rollout our network and services on a national
basis, during 2000, we plan to aggressively expand our network to include over
900 central office collocation sites providing access to more than 36 million
addressable lines.
We expect to formally change our corporate name to "Mpower Communications
Corp."upon receiving shareholder approval at the next annual meeting on June 22,
2000. We have commenced doing business under the name "Mpower Communications."
We were one of the first competitive carriers to implement a strategy of
building and owning the network equipment that controls how voice and data
transmissions originate and terminate, which we refer to as switches, while
leasing the telephone lines and cable over which the voice and data traffic are
transmitted, which we refer to as transport. We install our network equipment at
the site of the incumbent carrier from whom we rent standard telephone lines.
These sites are referred to as collocation sites within the telecommunications
industry. We believe this strategy has allowed us to serve a broad geographic
area at a comparatively low cost while maintaining control of the access to our
customers. Having executed our strategy in the markets we currently serve, we
are well-positioned to serve the growing demand from small and medium size
business customers for communications services. For an explanation of terms used
in this Offering Memorandum to describe our network and its components, please
read the section entitled "-- Network Architecture and Technology."
The rapid growth of the Internet has fueled demand from small and medium
size businesses for access to high-speed data services. To meet this growing
demand, we are using our current network infrastructure and DSL technology to
offer a bundled voice and high-speed data product over a single standard
telephone line. On average, DSL technology increases the transport capacity of
standard telephone lines by 24 times. By using a single standard telephone line
which we lease from the incumbent carrier to deliver a bundled voice and
high-speed data product, we expect to significantly reduce the per line costs of
providing our services. These savings should allow us to offer a value-priced
package of services to our customers.
MARKET OPPORTUNITY
We believe we have a significant market opportunity as a result of the
following factors:
Impact of the Telecommunications Act of 1996
The Telecommunications Act of 1996 allows competitive carriers to use the
existing infrastructure established by incumbent carriers, as opposed to
building a competing infrastructure at
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significant cost. The Telecommunications Act requires all incumbent carriers to
allow competitive carriers to collocate their equipment in the incumbent
carrier's central offices. This enables competitive carriers to access customers
through existing telephone line connections. The Telecommunications Act creates
an incentive for incumbent carriers that were formerly part of the Bell system
to cooperate with competitive carriers by precluding each of these incumbent
carriers from providing long distance service in its region until regulators
determine there is a significant level of competition in the incumbent carrier's
local market. See "-- Government Regulations."
Needs of Small and Medium Size Businesses for Integrated Communications
Solutions
Many small and medium size businesses have no cost-effective alternative to
dial-up modems for Internet access. As a result, these businesses must contend
with productivity limitations associated with slow transmission speeds. In
addition, to meet their communications needs, small and medium size businesses
are subject to the cost and complexity of using multiple service providers:
local dialtone providers, long distance carriers, Internet service providers and
equipment integrators. We believe these businesses can benefit significantly
from an integrated cost-effective communications solution delivered by a single
provider.
Growing Market Demand for High-Speed Data Services and E-commerce Solutions
The popularity of the Internet with consumers and the development of the
Internet as a commercial medium have driven the demand for high-speed data
services. Businesses are increasingly establishing Web sites and corporate
intranets and extranets to expand their customer reach and improve their
communications efficiency. To remain competitive, small and medium size
businesses increasingly need high-speed data and Internet connections to access
critical business information and communicate more effectively with employees,
customers, vendors and business partners. This is commonly referred to as
"e-commerce." High-speed digital connections are also becoming increasingly
important to businesses and consumers as more information and applications
become available on the Internet.
Emergence of DSL Technology
DSL technology emerged in the early 1990's and is now commercially
available. DSL technology dramatically increases the data, voice and video
carrying capacity of standard copper telephone lines. Because DSL technology
uses existing copper telephone lines, a broad network deployment can be
implemented rapidly and requires a lower initial fixed investment than some
existing alternative technologies. In addition, since a significant portion of
the expense associated with a DSL network is incurred only when a new customer
is added to the network, capital is efficiently deployed.
THE MPOWER SOLUTION
We believe we offer an attractive communications solution to small and
medium size business customers. In developing our solution, we have attempted to
include elements intended to create customer loyalty. Key aspects of our
solution include:
Complete Communications Solutions. We offer a value-priced complete
communications solution, including voice over DSL and high-speed Internet access
services, all on a single bill. We offer this package in all of our markets and
we plan to offer additional Internet-based e-commerce products in 2000. Our
customers have a single point of contact for a complete package of services,
eliminating the need for our customers to manage multiple vendors.
Service Reliability. We are able to offer our customers a high degree of
service reliability through efficient, timely execution of provisioning
telephone lines due to our mature relationships with five incumbent carriers in
the markets we currently serve. We believe our continued rollout of DSL
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technology will enable us to further improve our service reliability by
simplifying the provisioning process. Moreover, our customer service center is
staffed to respond promptly to customer inquiries 24 hours a day, seven days a
week. See "-- Network Architecture and Technology."
BUSINESS STRATEGY
Rapid National Service Rollout. Our strategy is to address the greatest
percentage of our targeted customers as quickly as possible and gain market
share. To create a national presence during 2000, we plan to aggressively expand
our network to include over 900 central office collocation sites. Our central
office collocation build-out program is designed to allow us extensive coverage
in all the markets we enter. By positioning ourselves to be the first provider
of bundled voice and data services targeted to small and medium size business
customers in our markets, we expect to attract many "early adopter" customers
that are interested in high-speed Internet access and data services. See
"-- Markets."
Focused Sales and Marketing Effort. To date, we have demonstrated an
ability to sell and provision our services to small and medium size business
customers. We achieved this through a direct sales force, vendor programs,
telemarketing and targeted advertising. We plan to significantly increase our
direct sales force to provide sales coverage for our expanding geographic
market. We plan to grow our sales force from 187 at December 31, 1999 to over
500 by year end 2000. Additionally, we will continue developing relationships
with third party agents or vendors as a complement to our direct sales channels.
Our simplified, packaged product set enables us to easily train our sales force
and decreases the time required to market and sell our services. With our
bundled voice and data solution, our sales force can target the small and medium
size business market segment with our total communications solution.
Completion of DSL Deployment. We are in the process of deploying our
high-speed data solution within our existing network. We have over 248 central
office collocations equipped to offer DSL services. In addition, all of our new
collocation sites will be equipped with DSL technology upon implementation. Our
physical presence in incumbent carriers' facilities allows us access to
telephone lines which is critical to deploying our DSL product set. The
integration of DSL into our existing network is accomplished by installing
advanced equipment in our host switch sites, collocation sites and customer
sites.
Targeting Small and Medium Size Businesses. Based on telephone lines in
service, we believe the small and medium size business customer base is a large
and rapidly growing segment of the communications market in the United States.
We target suburban areas of large metropolitan markets because these areas have
high concentrations of small and medium size businesses. By introducing a
package of voice and data services and focusing on small and medium size
business sales, we believe we will gain a competitive advantage over the
incumbent carrier, our primary competitor for these customers.
Customer Access Control. By connecting the standard telephone line
originating at our customer's site to our central office collocation, we
effectively place the customer on our network. This connection serves as the
platform for delivering our current and future communications services to our
customers. Any future changes our customers want to make to their services,
including purchasing more services from us, are under our direct control. The
one exception is for repairs, which are infrequent but may require the
participation of the incumbent carrier's network maintenance staff.
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Capital Efficient Network. We were one of the first competitive local
exchange carriers to implement a network strategy of purchasing and installing
switches, collocating in the central offices of the incumbent carrier and
leasing local telephone lines and cable. We believe this network deployment
strategy provides a capital efficient build-out plan and an attractive return on
our invested capital. We have installed DSL technology across a substantial
portion of our existing network which will allow us to reduce significantly the
number of telephone lines we lease. We are currently evaluating alternative
switching devices which are significantly smaller and less expensive than the
switches we have deployed to date. We believe these switches may permit us to
move the intelligence that determines where to route traffic closer to our
customers. We expect this decentralized switching approach will allow us greater
efficiencies in our network.
Sophisticated Operations Support System. We have developed a
comprehensive, proprietary operations support system to manage our business. Our
proprietary system provides integrated features addressing substantially all
aspects of our business, including customer care, billing and collections,
general ledger, payroll, fixed asset tracking, and personnel management. We
believe our system is adaptable to changing circumstances and multiple incumbent
carrier provisioning systems, and can be enhanced to support our operations
throughout our planned growth.
Timely and Accurate Provisioning for Our Customers. We believe one of the
keys to our success is effectively managing the provisioning process for new
customers. Towards this goal, we have committed significant time and resources
to designing more efficient provisioning processes, both internally and with
each of the incumbent carriers. We are in final testing of our internal
automation process whereby all new orders are provisioned through our operations
support system on a real-time basis. Since 1998, we have been developing and
implementing electronic order interfaces with all of the incumbent carriers with
which we work designed to improve provisioning performance by eliminating manual
keying of information and the need to fax paper orders back and forth. As an
illustration, we are currently provisioning the majority of our orders in Las
Vegas through an electronic interface with Sprint. This type of interface, also
known as "electronic bonding," substantially reduces the time, number of steps
and duplication of work typically involved in the provisioning process,
substantially lowering our costs and providing a more attractive solution to our
customers. To speed our implementation of electronic bonding with other
incumbent carriers, including BellSouth, Ameritech, PacBell and US West, we have
recently purchased and begun implementing electronic order interface software
from DSET Corporation.
As we deploy DSL technology throughout our network, we expect the
provisioning process will become easier for us and more transparent for our
customers. With DSL technology in place, one standard telephone line will
provide enough capacity for multiple voice and data connections at the
customer's premises. Therefore, we will be provisioning fewer lines per
customer, making us significantly less dependent on the incumbent carrier for
placing our customers in service.
Co-marketing Arrangements with E-commerce Providers. To expand our product
offerings, we have begun to partner with e-commerce providers. We have entered
into an agreement to co-market PurchasePro.com's e-business solution to our
small and medium size business customers. We believe co-marketing arrangements
will allow us to further solidify our position as a single source provider of
communications services.
Develop E-commerce Data Centers. We believe we will be able to provide an
attractive opportunity for e-commerce providers to use our network facilities to
access our customer base. To exploit this opportunity, we plan to build regional
data centers to host the servers used by e-commerce providers. To support these
data centers, we expect to offer basic security and monitoring services. We
believe by offering these services we will be able to attract e-commerce
partners and enhance the service offerings available to our customers.
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Quality Customer Service. We believe providing quality customer service is
essential to offering a superior product to our customers and creating customer
loyalty. A service representative is assigned to each business customer to
coordinate conversion of service and handle any post-installation issues. In
addition, we have a centralized call service center operating 24 hours a day,
seven days a week which handles general billing, customer care and related
issues for all of our customers. The service representatives use our proprietary
operations support system to gain immediate access to our customers' data,
enabling quick responses to customer requests and needs at any time. This system
allows us to present our customers with one fully integrated monthly billing
statement for all communication services.
PRODUCTS AND SERVICES
To date, we have focused on offering basic telephone and data services to
our small business and residential customers. These services include our
Internet access portal known as MGCi.com, switched local dialtone, long distance
services and custom calling features such as voice mail, call waiting and call
forwarding. To capitalize on the growing demand of small and medium size
business customers for Internet and data services, we have recently introduced
our "Total Solution" package, a bundled offering of voice and high-speed data
access using DSL technology, in all of our markets. The chart below shows the
component features of our "Total Solution" package for small and medium size
business customers:
<TABLE>
<CAPTION>
"TOTAL SOLUTION" PACKAGE
------------------------
<S> <C>
8 voice lines Long Distance
Internet access at speeds up to 1.5 Mbps 500 minute increments
Unlimited custom calling features Free local calling
MGCi.com Customer premise equipment
Web Hosting Single bill and single point of contact
10 e-mail boxes
</TABLE>
MARKETS
We currently operate in Las Vegas, Atlanta, Chicago, southern Florida and
selected areas of California, including Los Angeles, San Diego, Sacramento and
the San Francisco Bay Area markets. As of March 31, 2000, we had 446 incumbent
carrier central office collocation sites providing access to approximately 17.8
million addressable lines in these markets. The table below shows the
distribution of our central office collocation sites within these markets.
<TABLE>
<CAPTION>
MARKET AREA COLLOCATION SITES ADDRESSABLE LINES
----------- ----------------- -----------------
<S> <C> <C>
Southern California.................... 165 6.6 million
Northern California.................... 38 1.52 million
Atlanta................................ 39 1.56 million
Chicago................................ 143 5.72 million
Southern Florida....................... 43 1.72 million
Las Vegas.............................. 18 0.72 million
--- -------------
TOTALS....................... 446 17.84 MILLION
</TABLE>
The number of central office collocation sites includes only those sites
where we have accepted a cage and installed our equipment. As of March 31, 2000,
we had a backlog of 141 central office
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collocation sites where we had accepted space from the incumbent carrier but not
yet completed the installation of our equipment.
To achieve a national presence, we plan to collocate in over 450 additional
incumbent carrier central offices during 2000. All of these collocations will be
located within the 50 largest metropolitan areas of the country, primarily in
the surrounding suburban areas. When evaluating new markets, we consider:
- The importance of the geographic area to our national presence; and
- The demographics of the market, specifically the presence of clusters of
incumbent carrier central offices with high concentrations of small and
medium size business lines.
Based on the criteria outlined above, the table below indicates the number
of collocated central office sites and approximate addressable lines we have
identified for expansion during 2000. The timing of our entering into new
markets will depend on market conditions, incumbent carrier cooperation and
other factors. We cannot assure you we will be able to add collocation sites at
the times indicated below.
<TABLE>
<CAPTION>
NUMBER OF ADDITIONAL ADDRESSABLE PLANNED
COLLOCATION SITES LINES OPERATIONAL DATE
-------------------- ----------- ----------------
<C> <C> <S>
50 2.0 million First Quarter 2000
60 2.4 million Second Quarter 2000
70 2.8 million Third Quarter 2000
270 10.8 million Fourth Quarter 2000
--- ------------
450 18.0 million
</TABLE>
SALES AND MARKETING
Our highly focused marketing efforts seek to generate well-managed,
profitable growth through increased market share with minimal customer turnover.
Our current sales programs include direct sales efforts, programs with agents
and vendors, telemarketing and targeted advertising directed at the small and
medium size business customer. Due to the simplicity of our bundled voice and
data solution, we will not need to incur extensive costs to train our expanding
sales force.
As of December 31, 1999, we employed 142 field sales personnel and 45
inside sales personnel. We expect the size of our sales force to increase
substantially during 2000 as we expand the geographic coverage of our network to
a national scale. During the fourth quarter of 1998, we implemented a "team"
sales approach in our Las Vegas market. We are in the process of implementing
this approach in each of our local markets. Each team consists of two field
sales representatives, one business service representative, one inside sales
representative and one field technician. The field sales representatives work
from lead lists which specifically identify small and medium size business
prospects located within our geographic service area. The inside sales
representative solicits leads and schedule appointments and, when practical,
close sales over the phone. Our business service representative acts as the
liaison between the small business customer and our operational personnel to
effect a coordinated transfer of service from the incumbent carrier's network to
our network. The field technician is responsible for the installation of the
customer premise equipment. These teams report to the city managers and
ultimately the presidents of their respective regions.
To complement our sales force, we use established telephone equipment
vendors to market our services in conjunction with equipment sales to business
customers. We believe this distribution
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channel will become more productive for us in the near future with the continued
rollout of our bundled voice and high-speed data solution.
NETWORK ARCHITECTURE AND TECHNOLOGY
In building our network we have implemented a strategy where we own the
hardware that routes voice calls and data traffic, which we refer to as
switches, while leasing the telephone lines and cable over which the voice calls
and data traffic are actually transmitted, which we refer to as transport. We
use three basic types of transport to transmit our voice calls and data traffic.
First, we lease the standard telephone line from the incumbent carrier. This
allows us to move voice calls and data traffic from a customer's location to the
nearest central office owned by the incumbent carrier. Inside these central
offices, we have installed equipment that allows us to deliver the services we
sell to our customers. Second, we lease cable from other communications
companies which connect the equipment we have installed in the central office of
the incumbent carrier to our switches. Third, we lease additional cable from
other communications companies, which connect our switches to each other and
allow us to complete our customers' long distance calls to national and
international destinations. We believe this network strategy provides us an
efficient capital deployment plan and an attractive return on our invested
capital.
We believe that leasing the standard telephone line from the incumbent
carrier's central office to the end-user provides a cost-efficient solution for
gaining control of access to our customers. Leasing costs are not incurred until
we have acquired a customer and revenue can be generated. It is our experience
that the cable required to connect our collocation equipment located at an
incumbent carriers' central office to our switching hardware and the cable
required to connect our customers' voice calls and data traffic to the Internet
and other telephones is available at reasonable prices in all of our current and
planned markets. Because the cable required to transport voice calls and data
traffic has become a readily available service from numerous other
communications companies, we have focused our efforts on owning and installing
the hardware that determines where to route voice calls and data traffic and on
selling and delivering our services to our customers.
In 1996, we installed our first switch in Las Vegas. By the end of 1998, we
had seven operational switches. All of our current switches are DMS-500 switches
manufactured by Northern Telecom. These switches offer a flexible and cost
efficient way for us to provide local and long distance services to our
customers. We are currently testing smaller and less expensive switches that
would allow us to move the hardware that determines where to route voice calls
and data traffic closer to our customers. This decentralized approach to
determining where to route voice calls and data traffic should allow us to make
more efficient use of the cable we lease to transport voice calls and data
traffic.
Once we have installed equipment in the collocation sites we rent from the
incumbent carrier, we initiate service to a customer by arranging for the
incumbent carrier to physically disconnect a standard telephone line from their
equipment and reconnect the same standard telephone line to our equipment. When
the standard telephone line has been connected to our equipment, we have direct
access to the customer and can deliver our current voice and data services. Any
future changes the customer wishes to make, such as purchasing more services
from us, are under our direct control. The one exception is for certain types of
repairs, which are infrequent, but which may require the participation of the
incumbent carrier's maintenance staff.
We have increased the number of collocation sites where we have installed
our equipment from nine as of December 31, 1996 to 446 as of March 31, 2000. We
believe the expertise we have developed in successfully applying for space in
these central offices, installing our equipment and maintaining the equipment
once it is installed will allow us to efficiently handle our planned expansion.
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Our seven switches are connected to each other by cable which allows us to
transmit voice calls and data traffic using asynchronous transfer mode
technology. Asynchronous transfer mode technology allows both voice calls and
data traffic to be transported in digital form over a single cable connection at
high speeds and reasonable costs. The introduction of DSL technology into our
network will allow us to transport both voice calls and data traffic in digital
form on a single telephone line from a customer's location to one of our
switches.
The diagram below depicts how our network is configured with DSL technology
in our existing markets.
[DSL technology Flow Chart]
We install DSL equipment at our collocation sites, at our switch sites and
at our customers' locations. The DSL equipment we use is manufactured by Copper
Mountain, Turnstone and Tollbridge Technologies. Where installed, this equipment
allows us to deliver multiple voice calls and data traffic over a single,
standard telephone line and is expected to provide us with substantial cost
savings. Using DSL technology, we can increase the amount of information we
carry on a standard telephone line, which we refer to as bandwidth, to up to 1.5
million bits per second or "Mbps". This bandwidth is the equivalent of 24
regular voice telephone lines. Our DSL equipment is programmed to allocate the
available bandwidth. For example, voice calls are carried at 64 thousand bits
per second or "Kbps"; if a customer has eight phone lines and all are in use at
the same time, then 512 Kbps (eight phone lines multiplied by 64 Kbps each) of
the total 1.5 Mbps are allocated for the voice calls. The remaining bandwidth,
988 Kbps, is available to carry the data traffic.
We believe this technology, when fully implemented, will significantly
reduce our customers' potential for service outages when the incumbent carrier
moves the standard telephone line from their equipment to ours. Additionally, we
believe this technology will reduce our costs since we will lease a reduced
number of standard telephone lines per customer from the incumbent carrier. For
example, if a customer today has eight voice lines, we must order from and
provision through the incumbent carrier eight individual standard telephone
lines. If the same customer were to buy our service offering which uses DSL
technology, we would only order and provision one standard telephone line from
the incumbent carrier. Also, we expect that future products and services
designed to take advantage of the increased bandwidth provided by DSL technology
will allow us to generate incremental revenue with attractive margins.
Interconnection Agreements and Competitive Carrier Certifications. We have
interconnection agreements with Sprint for Nevada, BellSouth for Georgia,
Tennessee, North Carolina, Louisiana and Florida, GTE and PacBell for
California, Ameritech for Illinois, Bell Atlantic for Massachusetts, New York
and Pennsylvania and SBC for Texas. These agreements expire on various dates
through October 2000. In some cases, one or both parties may be entitled to
demand renegotiation of particular provisions in an existing interconnection
agreement based on intervening changes in the
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law. We are certified as a competitive carrier in all of our existing markets
and have applied for or obtained competitive carrier certification in 26
additional markets.
SERVICE DEPLOYMENT AND OPERATIONS
Customer Service. We strive to provide high quality customer service
through:
- Personnel. Our customer service representatives and sales personnel are
well trained and attentive to our customers' needs.
- Call Center. Our centralized customer service center in Las Vegas
operates 24 hours a day, seven days a week. Calls from our customers are
answered and responded to with minimal wait time.
- Coordination of Service Provisioning. We coordinate service installation
with our customer and the incumbent carrier to ensure a smooth transition
of services from the incumbent carrier to us.
- Close Customer Contact. We proactively monitor our network and keep our
customers informed of installation or repair problems and allocate the
necessary resources to resolve any problems.
- Billing. We provide our customers with accurate, timely and easily
understood bills.
Process Automation. We have developed a comprehensive, proprietary
operations support system to manage our business. Our proprietary system
provides integrated features addressing substantially all aspects of our
business including customer care, billing and collections, general ledger,
payroll, fixed asset tracking and personnel management. Additionally, customer
service representatives are able to handle all customer service inquiries,
including billing questions and repair calls, with the information available
from our integrated system.
We believe our system is adaptable to changing circumstances and multiple
incumbent carrier provisioning systems and will be able to support our
operations throughout our planned growth. We are in final testing of our
internal automation process whereby all new orders are provisioned through our
operations support system on a real-time basis. Since 1998, we have been
developing and implementing electronic order interfaces with all of the
incumbent carriers with whom we work designed to improve provisioning
performance by eliminating manual keying of information and the need to fax
paper orders back and forth. As an illustration, we are currently provisioning
the majority of our orders in Las Vegas through an electronic interface with
Sprint. This type of interface, also known as "electronic bonding,"
substantially reduces the time, number of steps and duplication of work
typically involved in the provisioning process, substantially lowering our costs
and providing a more attractive solution to our customers. To speed our
implementation of electronic bonding with other incumbent carriers, including
Bellsouth, Ameritech, PacBell and US West, we have recently purchased and begun
implementing electronic order interface software from DSET Corporation.
The billing component of our operations support system is designed to track
and bill all forms of local service, including line and feature charges as well
as long distance charges. We can accommodate business customers desiring a
single bill for many locations, summary bills without detail or a number of
other types of customized bills. We can deliver bills to our customers in a
number of alternative media including electronic files and on-line inquiry
through our Website.
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GOVERNMENT REGULATIONS
Overview
Our services are regulated at the federal, state and local level. The FCC
exercises jurisdiction over all facilities of, and services offered by,
communications common carriers like us, as long as those facilities are used in
connection with interstate or international communications. State regulatory
commissions have some jurisdiction over most of the same facilities and services
if they are used in connection with communications within states. In recent
years, there has been a dramatic change in the regulation of telephone services
at both federal and state levels as both legislative and regulatory bodies seek
to enhance competition in both the local exchange and interexchange services.
These efforts are ongoing and many of the legislative measures and regulations
adopted are subject to judicial review. We cannot predict the impact on us of
the results of these ongoing legislative and regulatory efforts or the outcome
of any judicial review.
Federal Regulation
The FCC regulates interstate and international communications services,
including access to local telephone facilities to place and receive interstate
and international calls. We provide these services as a common carrier. The FCC
also imposes regulations on common carriers that have some degree of market
power, including incumbent carriers. The FCC imposes less regulation on common
carriers without market power including competitive carriers like us. The FCC
grants automatic authority to carriers for interstate long distance service, but
requires common carriers to receive an authorization to construct and operate
communications facilities, and to provide or resell communications services,
between the United States and international points. Both domestic and
international carriers must generally file tariffs for their services. With
respect to our domestic and international service offerings, we have filed
tariffs with the FCC stating the rates, terms and conditions for our interstate
and international services. Our interstate tariffs are subject to "streamlined"
tariff regulations and are generally not reviewed by the FCC before becoming
effective. Our tariffs can be amended on one day's notice. Carriers subject to
the jurisdiction of the FCC must charge just and reasonable rates and must not
discriminate among like customers for like services.
However, the FCC has sought to mandate the detariffing of domestic,
interstate, interexchange services of nondominant carriers. On April 28, 2000,
the U.S. Court of Appeals for the DC Circuit upheld a 1996 FCC order requiring
detariffing of interstate, domestic, interexchange services ("IXC Detariffing
Order"). On May 1, 2000, the stay of the IXC Detariffing Order was lifted and
the rules in the order became effective. After a nine month transition period,
domestic interexchange tariffs may no longer be in effect with the FCC beginning
on January 31, 2001. This means that individual carrier agreements will need to
be entered into with customers who were once provided services under the terms
of a filed tariff. On June 16, 2000, the FCC has also requested renewed comment
on the related subject of mandatory detariffing of interstate access changes.
Mandatory detariffing of interstate access changes could have a material effect
on the amount of switched access charges we collect from long distance carriers
because we will no longer be able to rely on the enforceability of our filed
tariffs to collect access charges from long distance carriers.
The FCC imposes numerous other regulations on carriers subject to its
jurisdiction some of the most important of which are discussed below. It also
hears complaints against carriers filed by customers or other carriers and
levies various charges and fees.
The Telecommunications Act permits virtually any entity, including cable
television companies and electric and gas utilities, to enter any communications
market. The Telecommunications Act takes precedence over inconsistent state
regulation. However, entities that enter communications markets must follow
state regulations relating to safety, quality, consumer protection and other
matters. Implementation of the Telecommunications Act continues to be affected
by numerous
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federal and state policy rulemaking proceedings and review by courts. We are
uncertain as to how our business may be affected by these proceedings.
The Telecommunications Act is intended to promote competition. The
Telecommunications Act opens the local services market to competition by
requiring incumbent carriers to permit interconnection to their networks and by
establishing incumbent carrier and competitive carrier obligations with respect
to:
Reciprocal Compensation. All incumbent carriers and competitive
carriers are currently required to complete calls originated by each other
under reciprocal arrangements at prices based on tariffs or negotiated
prices.
Resale. All incumbent carriers and competitive carriers are required
to permit resale of their communications services without unreasonable
restrictions or conditions. In addition, incumbent carriers are required to
offer wholesale versions of all retail services to other common carriers
for resale at discounted rates, based on the costs avoided by the incumbent
carrier by offering these services at wholesale rates.
Interconnection. All incumbent carriers and competitive carriers are
required to permit their competitors to interconnect with their facilities.
All incumbent carriers are required to permit interconnection at any
feasible point within their networks, on nondiscriminatory terms, at prices
based on cost, which may include a reasonable profit. At the option of the
carrier requesting interconnection, collocation of the requesting carrier's
equipment in the incumbent carriers' premises must be offered.
Unbundled Access. All incumbent carriers are required to provide
access to specified individual components of their networks, which are
sometimes referred to as unbundled network elements, on nondiscriminatory
terms and at prices based on cost, which may include a reasonable profit.
Number Portability. All incumbent carriers and competitive carriers
are required to permit users of communications services to retain their
existing telephone numbers without impairment of quality, reliability or
convenience when switching from one common carrier to another.
Dialing Parity. All incumbent carriers and competitive carriers are
required to provide "l+" equal access to competing providers of long
distance service, and to provide nondiscriminatory access to telephone
numbers, operator services, directory assistance and directory listing,
with no unreasonable dialing delays.
Access to Rights-of-Way. All incumbent carriers and competitive
carriers are required to permit competing carriers access to their poles,
ducts, conduits and rights-of-way at regulated prices.
Incumbent carriers are required to negotiate in good faith with carriers
requesting any or all of the above arrangements. If the negotiating carriers
cannot reach agreement within a predetermined amount of time, either carrier may
request arbitration of the disputed issues by the state regulatory commission.
In August 1996, the FCC established rules to implement the incumbent
carrier interconnection obligations described above. On July 18, 1997, a United
States appeals court overturned portions of these rules and narrowly interpreted
the FCC's power to establish and enforce rules implementing the
Telecommunications Act. On January 25, 1999, the United States Supreme Court
reversed the
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appeals court decision and confirmed the FCC's broad authority to issue rules
implementing the Telecommunications Act. Specifically, the Supreme Court decided
that:
- the FCC has jurisdiction over pricing of unbundled network elements; and
- the FCC has authority to make rules allowing a competitive carrier to
"pick and choose" among the most favorable terms from existing agreements
between an incumbent carrier and other competitive carriers.
On the other hand, the Supreme Court vacated an FCC rule which described
the network elements the incumbent carriers must provide to competitors on an
unbundled basis. This required the FCC to re-examine its rules regarding which
unbundled network elements must be made available to competitors.
On November 5, 1999, the FCC released an order reaffirming and clarifying
the obligation of incumbent carriers to provide those network elements which we
currently lease from incumbent carriers, including standard telephone lines
which are also known as local loops, network interface devices and operations
support systems. Competitive and incumbent local exchange carriers recently have
requested the FCC to reconsider and modify these rules and many of the rules
also require implementing action by state regulatory agencies. We cannot predict
the outcome of any further proceedings.
On March 31, 1999, the FCC issued an order requiring incumbent carriers to
provide alternatives to traditional physical collocation, including providing
carriers with their own dedicated spaces in which to install their equipment. In
addition, the FCC ruled that incumbent carriers must allow competitive carriers
to collocate advanced services equipment and perform their own labor in
connecting their equipment within the incumbent carrier central office. On March
17, 2000, a panel of the U.S. Court of Appeals upheld parts and vacated parts of
the FCC's collocation order and remanded it to the FCC for further
consideration. The Court found that the FCC's order appeared to impermissibly
require the collocation of equipment beyond what was "necessary" for
interconnection or access to unbundled network elements. The Court specifically
questioned any obligation to collocate "multifunction equipment" combining
features that are "necessary" for interconnection or access to unbundled network
elements with features that are not. The Court also found that certain of the
rules relating to the manner of collocation, such as permitting competitors to
select whatever space they desire on the incumbent carrier's premises, were too
expansive. The Court has remanded the order to the FCC for further consideration
of these points. The Company is unable to predict the outcome of any future
proceedings or their impact, if any, on the Company.
On November 18, 1999, the FCC ordered incumbent carriers to share their
telephone lines with providers of high speed Internet access and other data
services. The FCC has indicated that competitive carriers may obtain access to
the high-frequency portion of a standard telephone line from the incumbent
carriers. As a result, competitive carriers will be able to provide DSL-based
services over the same telephone lines simultaneously used by the incumbent
carrier to provide voice services, and will no longer need to purchase a
separate telephone line from the incumbent carrier to provide DSL services. The
ruling could have an unfavorable effect on our business by making it easier for
some of our competitors to provide DSL services.
The Telecommunications Act also contains special provisions that replace
prior antitrust restrictions that prohibited the regional Bell operating
companies from providing long distance services and engaging in communications
equipment manufacturing. Before the passage of the Telecommunications Act, the
regional Bell operating companies and most dominant incumbent carriers were
restricted to providing services within a distinct geographical area known as a
local access and transport area. The Telecommunications Act permits the regional
Bell operating companies to provide long distance service immediately in areas
outside of their market regions and
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within their market region once they have satisfied several procedural and
substantive requirements, including:
- a showing that the regional Bell operating company is subject to
meaningful local competition in the area in which it seeks to offer long
distance service; and
- a determination that the regional Bell operating company's entry into
long distance markets is in the public interest.
In December 1999, the FCC approved Bell Atlantic's request to provide long
distance service to its New York customers. SBC Communications recently filed a
similar request to provide long distance service to its customers in Texas and
additional requests will likely be filed in the near future. One or more of
these requests also may be approved. If regional Bell operating companies are
allowed to offer long distance services in one or more of our markets, our
business will be unfavorably affected.
The FCC has initiated a rulemaking proceeding to consider whether to permit
regional Bell operating companies to eventually offer high-speed data services
between local access and transport areas through a separate subsidiary, without
first having to demonstrate that they have met the FCC procedural and
substantive requirements referred to above. Although the FCC has not acted in
this rulemaking, in approving the merger of SBC Communications and Ameritech, it
authorized the merged entity to provide advanced data services using a separate
subsidiary provided specific conditions relating to the status of competition
are met. A similar condition was accepted by Bell Atlantic in obtaining
authority to provide long distance services in New York.
On November 9, 1999, the FCC released a decision which concluded that
advanced services, such as DSL, sold by incumbent carriers to Internet service
providers and bundled by the Internet service provider with its other services
are not subject to the resale obligations of the Act. This decision will allow
incumbent carriers to provide Internet service providers with special rate
packages for DSL on terms and conditions not available to us.
In two orders released on December 24, l996 and May 16, 1997, the FCC made
major changes in the structure of the access charges incumbent carriers impose
for the use of their facilities to originate or complete interstate and
international calls. The December 24th order permitted incumbent carriers to
lower access charges. The May 16th order granted incumbent carriers subject to
the FCC's price cap rules increased pricing flexibility upon demonstrations of
increased competition or potential competition in their markets. The manner in
which these changes are implemented could have a material effect on the amount
of switched access charges we collect from long distance carriers.
At present we are in litigation with Sprint over the access charges we have
billed to it. In December 1999, we filed a complaint before the FCC to obtain an
order compelling Sprint to pay our tariff rate for access charges. In January
2000, Sprint filed a complaint against us before the FCC seeking a declaration
that Sprint should be entitled to recover any amounts it may be ordered to pay
to us under our complaint on the basis that our charges are unjust and
unreasonable. We recently settled a litigation with AT&T over substantially
similar issues after receiving a favorable decision from the FCC. On June 9,
2000, the FCC released an order denying Sprint's claim that access rates are
unjust and unreasonable. In May, 2000, Sprint filed a second complaint against
us before the FCC alleging that we are discriminating against Sprint by charging
it tariffed access rates while charging other long distance carriers different
contract rates.
In August 1999, the FCC adopted an order providing additional pricing
flexibility to incumbent carriers subject to price cap regulation in their
provision of interstate access services, particularly special access and
dedicated transport. Some of the actions taken by the FCC would immediately
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eliminate rate scrutiny for "new services" and permit the establishment of
additional geographic zones within a market that would have separate rates.
Additional and more substantial pricing flexibility will be given to incumbent
carriers as specified levels of competition in a market are reached through the
collocation of competitive carriers and their use of competitive transport. This
flexibility will include, among other items, customer specific pricing, volume
and term discounts for some services and streamlined tariffing.
As part of the same August 1999 order, the FCC initiated another proceeding
to consider additional pricing flexibility proposals for incumbent carriers.
This proceeding also will consider the reasonableness of competitive carrier
access charges and seeks comment on whether the FCC should adopt rules to
regulate competitive carrier access charges. In addition, the FCC's rulemaking
is examining whether any statutory or regulatory constraints prevent long
distance carriers from declining to accept a competitive carrier's access
services, and if so, under what circumstances. The outcome of the rulemaking is
not possible to predict and may have an unfavorable effect on our business.
In addition, on May 21, 1999, a United States court of appeals reversed an
FCC order that had established the factors that are currently used to set annual
price caps. The court ordered the FCC to further explain the methodology it used
in establishing those factors. This proceeding is ongoing. The outcome of the
proceeding is not possible to predict and may have an unfavorable effect on our
business.
Incumbent carriers have been contesting whether their obligation to pay
reciprocal compensation to competitive carriers should apply to local telephone
calls from an incumbent carrier's customers to Internet service providers served
by competitive carriers. The incumbent carriers claim this traffic is interstate
in nature and should be exempt from reciprocal compensation arrangements
applicable to local and intrastate calls. Competitive carriers have contended
that their interconnection agreements with incumbent carriers provide no
exception for local calls to Internet service providers and reciprocal
compensation is applicable.
On February 26, 1999, the FCC ruled that Internet service provider traffic
is interstate in nature and within the FCC's jurisdiction but that its current
rules neither require nor prohibit the payment of reciprocal compensation for
these calls. The FCC also requested comment on federal rules to govern
compensation for these calls in the future.
Most, but not all, state commissions and several federal and state courts
have ruled that reciprocal compensation arrangements under interconnection
agreements existing prior to the FCC decision apply to calls to Internet service
providers. There are, however, ongoing disputes concerning the appropriate
treatment of Internet service provider traffic under new interconnection
agreements.
Internet service providers may be among our potential customers and adverse
decisions regarding reciprocal compensation could limit our ability to service
this group of customers profitably. While some competitive carriers target
Internet service providers in order to generate additional revenues from
reciprocal compensation charges, at the present time we do not focus our
marketing efforts on Internet service providers. In addition, given the
uncertainty as to whether reciprocal compensation is payable in connection with
calls to Internet service providers, we do not recognize revenue from calls to
Internet service providers. Therefore, the outcome of this dispute in favor of
either the incumbent carrier or competitive carrier will have minimal impact on
us.
On May 8, 1997, the FCC released an order establishing a significantly
expanded federal universal service subsidy program. The FCC's May 8, 1997 order
established new subsidies for telecommunications and information services
provided to qualifying schools and libraries with an annual cap of $2.25 billion
and for services provided to rural health care providers with an annual cap of
$400 million. The FCC also expanded federal subsidies for local dialtone
services provided to low-
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income consumers. Providers of interstate telecommunications service, including
us, must contribute to these programs. On July 30, 1999, the United States
appeals court issued a decision partially upholding the FCC order but precluding
the FCC from basing the amount a carrier must contribute to the subsidy program
on a carrier's intrastate revenues. Currently, the FCC is assessing
contributions to these programs at 5.8% of a provider's interstate and
international revenue for the previous year. We intend to recover our share of
these costs through charges assessed directly to our customers and participation
in federally subsidized programs. On November 2, 1999, the FCC revised its
proposed methodology for subsidizing service provided by non-rural carriers in
high cost areas. This action may result in further substantial increases in the
cost of the subsidy program. The net financial effect of these regulations on us
cannot be determined at this time.
In 1994, Congress adopted the Communications Assistance for Law Enforcement
Act to insure that law enforcement agencies would be able to conduct properly
authorized electronic surveillance over the new digital and wireless media as
well as traditional wireline carriers. An interim technical standard was
released in 1997 and the FCC recently required carriers to have additional
capabilities requested by law enforcement authorities and directed that the
interim standard be revised. Some in the industry believe that the cost of
providing these additional capabilities is unreasonably high and the FCC's
decision has been appealed. We are not able to predict the outcome of this
litigation or the cost of compliance with whatever standards are ultimately
developed.
State Regulation
The implementation of the Telecommunications Act is subject to numerous
state rulemaking proceedings. As a result, it is currently difficult to predict
how quickly full competition for local services, including local dialtone, will
be introduced.
To provide services within a state, we generally must obtain a certificate
of public convenience and necessity from the state regulatory agency and comply
with state requirements for telecommunications utilities, including state
tariffing requirements. To date, we have satisfied state requirements to provide
local and intrastate long distance service in 23 states and the District of
Columbia and have applied for competitive carrier certification in 5 other
states.
State regulatory agencies have jurisdiction over our facilities and
services used to provide intrastate services, including our rates. State
agencies require us to file periodic reports, pay various fees and assessments
and comply with rules governing quality of service, consumer protection and
similar issues. These agencies may also have to approve the transfer of assets
or customers located in the state, a change of control of our company or our
issuance of securities or assumption of debt. The specific requirements vary
from state to state. State regulatory agencies also must approve our
interconnection agreements with incumbent carriers. Price cap or rate of return
regulation does not apply in any of our current or planned expansion markets.
However, we cannot assure you that the imposition of new regulatory burdens in a
particular state will not affect the profitability of our services in that
state.
In those states where we are currently serving customers, certain state
regulatory approvals may be required. Because of time constraints, we will not
have obtained these approvals before closing this offering. We believe these
approvals will be granted and that seeking approval after this offering should
not result in any material adverse consequences to us, although we cannot assure
you of a favorable result.
Local Regulation
Our networks must comply with numerous local regulations such as building
codes, municipal franchise requirements and licensing. These regulations vary on
a city by city and county by county basis. In some of the areas where we provide
service, we may have to comply with municipal
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franchise requirements and may be required to pay license or franchise fees
based on a percentage of gross revenue or other factors. Municipalities that do
not currently impose fees may seek to impose fees in the future. We cannot
assure you fees will remain at their current levels following the expiration of
existing franchises.
COMPETITION
The communications industry is highly competitive. We believe the principal
competitive factors affecting our business will be:
- pricing levels and policies,
- transmission speed,
- customer service,
- breadth of service availability,
- network security,
- ease of access and use,
- bundled service offerings,
- brand recognition,
- operating experience,
- capital availability,
- exclusive contracts,
- accurate billing, and
- variety of services.
To maintain our competitive posture, we believe we must be in a position to
reduce our prices to meet any reductions in rates by our competitors. Any
reductions could adversely affect us. Many of our current and potential
competitors have financial, personnel and other resources, including brand name
recognition, substantially greater than ours, as well as other competitive
advantages over us. In addition, competitive alternatives may result in
substantial customer turnover in the future. Many providers of communications
and networking services experience high rates of customer turnover.
A continuing trend toward consolidation of communications companies and the
formation of strategic alliances within the communications industry, as well as
the development of new technologies, could give rise to significant new
competitors. For example, WorldCom has merged with MCI Communications and now
proposes to merge with Sprint. AT&T has acquired Teleport Communications Group
Inc., a competitive carrier, and Tele-Communications, Inc., a cable,
communications and high-speed Internet services provider, and has announced its
intent to merge with another cable television company, MediaOne. Ameritech
Corporation merged with SBC Communications, Bell Atlantic has agreed to merge
with GTE Corporation and Qwest is seeking to merge with US West. These types of
consolidations and other strategic alliances could put us at a competitive
disadvantage.
LOCAL DIALTONE SERVICES
Incumbent Carriers
In each of the markets we target, we will compete principally with the
incumbent carrier serving that area. We believe the regional Bell operating
companies are aggressively seeking to be able to
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offer long distance service in their service territories. In December 1999, Bell
Atlantic received approval to offer long distance service in New York and
announced that it would offer long distance service beginning in January 2000.
Many experts expect one or more of the other regional Bell operating companies
to be successful in entering the long distance market in early 2000. We believe
the regional Bell operating companies expect to offset losses of market share in
their local markets by attempting to capture a large percentage of the long
distance market in their market areas, especially among residential users where
their strong regional brand names and extensive advertising campaigns may be
very successful. In addition, a continuing trend toward business combinations
and alliances in the communications industry may create significant new
competitors for us.
We have not achieved and do not expect to achieve a significant market
share for any of our services. The incumbent carriers have long-standing
relationships with their customers, have financial, technical and marketing
resources substantially greater than ours and have the potential to subsidize
competitive services with revenues from a variety of businesses. While recent
regulatory initiatives which allow competitive carriers to interconnect with
incumbent carrier facilities provide increased business opportunities for us,
interconnection opportunities have been and likely will continue to be
accompanied by increased pricing flexibility for, and relaxation of regulatory
oversight of, the incumbent carriers.
Incumbent carriers have long-standing relationships with regulatory
authorities at the federal and state levels. The FCC recently proposed a rule
that would provide for increased pricing flexibility for incumbent carriers and
deregulation for competitive access services, either automatically or after
competitive levels are reached. If the incumbent carriers are allowed by
regulators to offer discounts to large customers through contract tariffs,
engage in aggressive volume and term discount pricing practices for their
customers, and/or seek to charge competitors excessive fees for interconnection
to their networks, our operating margins could be materially adversely affected.
Future regulatory decisions which give the incumbent carriers increased pricing
flexibility or other regulatory relief could also have a material adverse effect
on us.
Competitive Carriers/Long Distance Carriers/Other Market Entrants.
We face, and expect to continue to face, competition from long distance
carriers, including AT&T, MCI WorldCom, and Sprint, seeking to enter, reenter or
expand entry into the local exchange market. Qwest Communications International
has a proposed merger with US West Communications, Inc. that will make Qwest the
dominant incumbent carrier in US West's 14 state region if and when that merger
is consummated. We also compete with other competitive carriers, resellers of
local dialtone services, cable television companies, electric utilities,
microwave carriers and wireless telephone system operators.
The Telecommunications Act includes provisions which impose regulatory
requirements on all incumbent carriers and competitive carriers but grants the
FCC expanded authority to reduce the level of regulation applicable to these
common carriers. The manner in which these provisions of the Telecommunications
Act are implemented and enforced could have a material adverse effect on our
ability to successfully compete against incumbent carriers and other
communications service providers.
The Telecommunications Act radically altered the market opportunity for
competitive carriers. Many existing competitive carriers which entered the
market before 1996 had to build a fiber infrastructure before offering services.
With the Telecommunications Act requiring unbundling of the incumbent carrier
networks, competitive carriers are now able to more rapidly enter the market by
installing switches and leasing standard telephone lines and cable.
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A number of competitive carriers have entered or announced their intention
to enter one or more of our markets. We believe that not all competitive
carriers, however, are pursuing the same target customers we pursue. We intend
to keep our prices at levels below those of the incumbent carriers while
providing, in our opinion, a higher level of service and responsiveness to our
customers. Innovative packaging and pricing of basic telephone services is
expected to provide competitive differentiation for us in each of our markets.
LONG DISTANCE SERVICES
The long distance services industry is very competitive and many long
distance providers experience a high average turnover rate as customers
frequently change long distance providers in response to offerings of lower
rates or promotional incentives by competitors. Prices in the long distance
market have declined significantly in recent years and are expected to continue
to decline. We expect to face increasing competition from companies offering
long distance data and voice services over the Internet. Companies offering
these services over the Internet could enjoy a significant cost advantage
because they do not currently pay common carrier access charges or universal
service fees.
DATA AND INTERNET SERVICES
We expect the level of competition with respect to data and Internet
services to intensify in the future. We expect significant competition from:
- Incumbent Carriers. Most incumbent carriers have announced deployment of
commercial DSL services. Some incumbent carriers have announced they
intend to aggressively market these services to their residential
customers at attractive prices. In addition, most incumbent carriers are
combining their DSL service with their own Internet service provider
businesses. We believe incumbent carriers have the potential to quickly
overcome many of the issues that have delayed widespread deployment of
DSL services in the past. The incumbent carriers have an established
brand name in their service areas, possess sufficient capital to deploy
DSL services rapidly and are in a position to offer service from central
offices where we may be unable to secure collocation space. When the
regional Bell operating companies begin providing long distance service,
they may be able to offer "one stop shopping" that would be competitive
with our offerings.
- Traditional Long Distance Carriers. Many of the leading traditional long
distance carriers, including AT&T, MCI WorldCom and Sprint, are expanding
their capabilities to support high-speed, end-to-end networking services.
We expect them to offer combined data, voice and video services over
their networks. These carriers have extensive fiber networks in many
metropolitan areas that primarily provide high-speed data and voice
services to large companies. They could deploy DSL services in
combination with their current fiber networks. They also have
interconnection agreements with many incumbent carriers and have secured
collocation space from which they could begin to offer competitive DSL
services.
- Newer Long Distance Carriers. The newer long distance carriers,
including Williams Communications, Qwest Communications International and
Level 3 Communications, are building and managing high-speed networks
nationwide. They are also building direct sales forces and partnering
with Internet service providers to offer services directly to business
customers. They could extend their existing networks and offer high-speed
services using DSL, either alone or in partnership with others. As
discussed above, Qwest is aggressively seeking to network through its
proposed merger with U.S. West, which is a local and DSL provider in 14
states.
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- Cable Modem Service Providers. Cable modem service providers, like @Home
Networks and its cable partners, are offering, or are preparing to offer,
high-speed Internet access over cable networks to consumers. @Work has
positioned itself to do the same for businesses. These networks provide
high-speed data services similar to our services, and in some cases at
higher speeds. These companies use a variety of new and emerging
technologies, including point-to-point and point-to-multipoint wireless
services, satellite-based networking and high-speed wireless digital
communications.
- Internet Service Providers. Internet service providers, including Yahoo,
Earthlink, PSINet, Concentric and Verio, offer Internet portal services
which compete with our MGCi.com service. We offer basic web hosting and
e-mail services and anticipate offering an enhanced set of Internet
products in the future. The competitive Internet service providers
generally provide more features and functions than our current Internet
portal.
- Wholesale DSL Carriers. Carriers, including Covad Communications Group,
Inc., Rhythms NetConnections Inc. and NorthPoint Communications, Inc.,
have begun offering DSL services and have significant strategic equity
investors, marketing alliances and product development partners.
Many of these competitors are offering, or may soon offer, DSL technologies
and services that will directly compete with us. Please see "Risk
Factors -- Because we compete against established industry competitors with
substantially greater resources, we may not be able to achieve our operating and
financial objectives."
PROPERTY
In Las Vegas, we have a five year lease, expiring in 2001, with a five year
option for the site housing our switch. We also lease space in Las Vegas for our
national customer service operations, national sales personnel, Las Vegas sales
personnel and general administration functions. This lease expires in 2004. This
facility is owned by a limited liability company which is principally owned by
two of our principal stockholders and directors, Maurice J. Gallagher, Jr. and
Timothy P. Flynn.
We have leased office space in the Rochester, New York area and we have
moved our corporate headquarters to the Rochester area.
We also own property housing our switches in Ontario, Long Beach and San
Diego, California, Chicago, Illinois, and Fort Lauderdale, Florida. Our switch
site in Atlanta, Georgia has been leased for a term expiring in 2007 with
renewal options. We have leased facilities to house our local sales and
administration staff in each market.
We place great importance on each switch facility and seek to insure
maximum security and environmental control. We believe this can be achieved most
effectively through stand-alone structures. This approach minimizes the risk of
fire or other hazards from adjacent tenants or properties.
PERSONNEL
As of March 31, 2000, we had approximately 1,209 employees, most of whom
were located in Las Vegas. We expect to substantially increase the number of our
employees over the next two years.
We have non-disclosure and non-compete agreements with all of our executive
employees. None of our employees are represented by a collective bargaining
agreement.
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LEGAL PROCEEDINGS
We are party to numerous state and federal administrative proceedings. In
these proceedings, we are seeking to define and/or enforce incumbent carrier
performance requirements related to:
- the cost and provisioning of those network elements we lease;
- the establishment of customer care and provisioning;
- the allocation of subsidies; and
- collocation costs and procedures.
The outcome of these proceedings will establish the rates and procedures by
which we obtain and provide leased network elements and could have a material
effect on our operating costs.
We are also involved in legal proceedings in which we are seeking to
enforce our tariffed rates for originating and terminating long distance calls.
AT&T, Sprint, MCI WorldCom and other long distance carriers refused to pay the
full amount of the long distance access charges billed to them. Access charges
represented 41% of our operating revenues in 1998 and 35% of our operating
revenues in 1999. Access charge revenues from AT&T, Sprint and MCI WorldCom
represented 81% of our total access charge revenues in 1998. As of December 31,
1999, we had outstanding receivables of approximately $10.9 million attributable
to access charges from AT&T, Sprint and other long distance carriers, of which
approximately 66% was in dispute. As of September 30, 1999, receivables
attributable to access charges were $12.3 million. We settled our dispute with
MCI WorldCom in late 1999 and settled our dispute with AT&T in February 2000;
however, our dispute continues with Sprint.
In December 1999, we filed a complaint before the FCC to obtain an order
compelling Sprint to pay our tariff rate for access charges. In January 2000,
Sprint filed a complaint against us before the FCC seeking a declaration that
Sprint should be entitled to recover any amounts it may be ordered to pay to us
under our complaint on the basis that our charges are unjust and unreasonable.
In May 2000, Sprint filed a second FCC complaint against us alleging that we are
discriminating against it by not making available to it the terms of switched
access agreements that we have entered into with other major long distance
carriers. On June 9, 2000, the FCC denied Sprint's January 2000 complaint
claiming that our switched access rates are unjust and unreasonable.
The final outcome of the dispute with Sprint is uncertain. If we are unable
to collect access charges from long distance carriers it could have a material
impact on our financial condition. See "Risk Factors -- We may not be able to
collect all of the access charges we have billed to long distance carriers."
From time to time, we engage in other litigation and governmental
proceedings in the ordinary course of our business. We do not believe any other
pending litigation or governmental proceeding will have a material adverse
effect on our results of operations or financial condition.
(The remainder of this page intentionally left blank)
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PRIMARY NETWORK
GENERAL
Primary Network is an integrated communications provider offering data and
voice telecommunications services to both business and residential customers in
second-tier and third-tier markets in the Midwestern United States. Primary
Network's advanced network is based on a new generation of DSL platforms and ATM
switches.
Primary Network's voice and data service offerings include:
- High-speed Internet access for residences and small to medium-sized
businesses via both traditional methods and DSL technology;
- Telecommuting network services;
- Local telephone service;
- Long distance telephone service;
- Low cost long distance voice over DSL;
- Web hosting, collocation and other Internet-related services;
- Wide area network solutions for data-intensive businesses; and
- Cellular and paging (as an agent of Southwestern Bell).
Primary Network currently offers these services in four metropolitan areas:
- St. Louis, Missouri;
- Kansas City, Missouri;
- Springfield, Missouri; and
- Tulsa, Oklahoma.
As of March 31, 2000, Primary Network had 43 central offices in service
throughout these four metropolitan areas. As of April 30, 2000, Primary Network
had over 1,000 dedicated access customers, approximately 500 DSL customers in
service, approximately 12,000 other business customers (mainly modem access,
web-hosting and local and long distance) and 30,000 residential customers
(mainly modem access and local and long distance). Current customers include
Boeing, TWA, Arch Coal, Emerson Electric, St. Louis University and Washington
University.
MARKET
Data communications is one of the fastest growing segment of the
telecommunications market. Small and medium-sized businesses increasingly need
high-speed data/Internet connections to remain competitive. Further, the demand
for high-speed digital communications services for remote local area network,
which is referred to as LAN, access has grown rapidly. Many businesses now
desire to allow employees access to their local area networks from home to
improve employee productivity and reduce operating costs.
Primary Network is building a regional presence in the Midwestern United
States as a communications provider by focusing on Tier 2 and Tier 3 cities.
These cities and the surrounding areas accounted for over $29 billion in
telecommunications business in 1998 according to the FCC. The incumbent
telephone companies in these cities have realized almost all of this revenue due
to minimal market penetration by CLECs. In addition, because of the lack of
competition from CLECs, the incumbent phone companies have been slow to roll out
sophisticated data services and new
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platforms such as DSL and have neglected to provide adequate services to smaller
cities and, in particular, small to medium-sized businesses.
PRIMARY NETWORK STRATEGY
Primary Network has pursued an aggressive expansion strategy, rapidly
expanding its network while building a customer base of currently under-served
small and medium-sized businesses and residential customers. In each city in
which Primary Network offers service, Primary Network creates an ATM
Metropolitan Area Network, which is referred as a MAN, of connected central
office collocations. The MANs allow Primary Network to aggregate voice and data
traffic, thus enabling Primary Network to offer a suite of voice and data
services to business customers. Multiple customer offices in a given city may be
linked into a virtual private network carrying both voice and data that includes
remote or at-home workers.
Because of the advantages of its MANs, Primary Network offers services to
businesses, small office or home office workers and residential consumers that
previously had been available only to large enterprises. These services include
broadband access to the Internet or to private networks, remote access to
corporate data networks and low-cost long distance service over DSL. Primary
Network is able to customize its service to the needs of the user -- each
business or consumer is able to choose the configuration that suits its needs
and budget. Primary Network believes that its ability to offer multiple service
options, and to price DSL within the range of consumers, gives it a competitive
advantage over other communications providers.
Primary Network has implemented an aggressive sales and marketing campaign
focused on small and medium-sized businesses, home-based businesses and upscale
residential users in its serviced markets. Primary Network has positioned its
brand name in its serviced markets through direct sales, direct marketing calls
and affinity marketing with print and direct mail advertising. Primary Network's
marketing campaigns focus on educating potential customers on the cost savings
and advantages of Primary Network's converged services. Further, as a means of
growing its customer base, Primary Network has pursued acquisitions of existing
ISPs in the telecommunications market. Such acquisitions give Primary Network
the ability to market its complete services to the acquired customer base.
PRIMARY NETWORK SERVICES
Primary Network has developed a network which utilizes broadband network
services, and has been an industry leader in the Midwest with respect to
advancing broadband technology. Currently, Primary Network's broadband service
offerings are offered via DSL. Primary Network's service offerings are tailored
to meet the specific needs of its target market, specifically small and medium-
sized businesses, with both bundled and individual services.
The Primary Network service offerings are intended to provide customers
with a comprehensive system in order to meet the varying needs of the data and
voice communications market. Primary Network's services include, or will
include: three specific types of DSL services, each with several options,
including ADSL, SDSL and IDSL; long distance Voice over DSL (VoDSL); local and
long distance voice services; T-1 and Fractional T-1; Frame Relay; ISDN (dial-up
and dedicated); and 56k Modem connections (dial-up and dedicated). Primary
Network also offers web hosting, firewalling and other security services and
products, collocation services, hardware for use with many of the Internet
access services, domain name registration and e-mail services.
SALES AND CLIENT CARE
The key aspects of Primary Network's sales efforts are consultative selling
and long-term customer relationships. In order to accomplish this, all Primary
Network sales people go through a
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two-week training period in telecommunications and Internet technology and in
the specific services offered by Primary Network. Further, client development
representatives go beyond the initial sales process to manage Primary Network's
relationship with each client; these representatives focus on identifying the
evolving telecommunications requirements of clients and assisting with
"upselling" a broader array of more comprehensive telecommunications services.
Commission plans and incentive programs are designed to reward and retain top
performers and to encourage strong client relationships.
A local sales force penetrates each of Primary Network's four market
regions. As of March 31, 2000, Primary Network's sales and sales-support staff
consisted of 86 people. In addition to the local direct sales forces, Primary
Network has several third-party agencies which sell Primary Network's services.
All of Primary Network's customers receive the benefit of a single point of
contact for implementation, maintenance and billing. Primary Network's network
operations center provides active and requested maintenance services 24 hours a
day, seven days a week. A trouble-ticket management system, which routes
technical problems to the appropriate service personnel, integrates the network
operations center and the field service organization. The fully staffed 24-hour
operations center enhances Primary Network's ability to provide active
maintenance.
CUSTOMER MANAGEMENT SYSTEM
Primary Network uses a proprietary, internally developed system to manage
all aspects of a customer's account, from initial order throughout the life of
the account. The system was developed over a five-year period and utilizes a
common database that can be accessed by all departments via a web-based browser
interface. Customer orders are provisioned in a highly automated fashion. For
certain types of orders, such as resold local and long distance, secondary
systems are also used for specific tasks, with the relevant information
transmitted back into the centralized database. The system allows customer
service representatives to view the history of each customer account, including
any calls to technical support and all relevant billing history. Technical
support representatives use the system to track calls and initiate trouble
tickets which are transferred to the appropriate service departments for
resolution. Reports are available to management on sales, customer counts and
accounts receivable. The system is also used to bill customers and generate
invoices daily.
NETWORK
Primary Network has developed an infrastructure that is designed to allow
for maximum efficiency on a large scale broadband packet network. Each
metropolitan area occupied by Primary Network is linked through an ATM MAN, and
each of these is connected to Primary Network's regional ATM network. Primary
Network is one of the few communications providers with fully integrated,
end-to-end ATM transmission ability. Primary Network is one of the first
companies in the country using Lucent Technologies' new Stinger platform as the
delivery method for its broadband services. Stinger is the leader in the new
generation of platforms with the density, inter-operability and back-end
connectivity necessary for a cost-effective deployment of all types of DSL,
traditional T1s and advanced services such as voice over DSL. All of these
factors give Primary Network a number of significant advantages over competitors
in the Midwest. Because of this homogeneous network, Primary Network is able to
utilize network management tools which cleanly and effectively touch every
customer and every network component. Primary Network has a level of control
over its network that enables it to quickly identify and correct any service
problem which might arise. Primary Network further benefits from the newness of
its network. Unlike many
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communications providers that still utilize outdated legacy equipment, Primary
Network's network was built from the start to deliver the next generation of
converged services.
COMPETITION
Primary Network faces competition, or potential competition, from companies
with long operating histories, greater name recognition and substantially
greater financial, technical and marketing resources. Many competitors are
offering, or may soon offer, technologies or services that directly compete with
Primary Network's offerings. Competitive offerings may include technologies such
as wireless data systems, cable modems or satellite communication systems that
provide performance advantages in some respects over DSL and other technologies
that use existing copper telephone wires.
Southwestern Bell and Ameritech are currently Primary Network's closest
competitors. It is expected that Southwestern Bell will be the key competitor in
delivering communications services to end users in the Midwest. Southwestern
Bell has existing networks in local areas and across major metropolitan areas in
Primary Network's targeted markets. Southwestern Bell currently serves
substantially all of the customers in these markets and it has established its
own Internet service provider business. Primary Network has succeeded in gaining
customers in Southwestern Bell and Ameritech territory through fair pricing, a
strong focus on customer service, branding efforts and the inherent quality of
its network.
Most cable companies in the Midwest target the residential market with
their cable-based brand of Internet access. To counter this, Primary Network
focuses its marketing efforts on businesses in the region, and will only compete
against the cable companies in the residential arena for telecommuting and
work-at-home applications. Primary Network expects to compete with cable
companies based on the technical advantages of DSL technology over cable modems
and Primary Network's commitment to both service and reliability.
Primary Network believes that its direct sales approach, the depth of
service coverage in all of the targeted markets and Primary Network's ability to
provide additional services will positively impact its ability to compete with
other DSL providers in its covered market. Bundled services provide Primary
Network's customers with comprehensive data transport and networking solutions,
which may make Primary Network a more attractive alternative than many of its
competitors.
REGULATORY APPROVALS
As a competitive local exchange carrier, Primary Network is subject to
regulation at the federal and state levels. Federal and state regulations and
legislation have a direct impact on Primary Network's business and operations.
The FCC exercises jurisdiction over all facilities and services offered by
carriers providing interstate or international communications. The Public
Service Commission in each state oversees the regulation of facilities and
services related to providing intrastate communications. In particular, state
regulatory commissions have substantial oversight over the provision of
interconnection agreements between incumbent phone companies and competitive
phone companies in order to ensure non-discriminatory network access to such
incumbent telephone companies. In addition, both state and federal regulators
share responsibility for implementing and enforcing the policies of the
Telecommunications Act of 1996.
In compliance with these federal and state regulations, Primary Network has
filed tariffs (schedules of rates and terms of service) for authorization by the
FCC. Primary Network also has collocation agreements with the incumbent
telephone companies in Arkansas, Illinois, Kansas, Missouri, Oklahoma and
Tennessee that allow Primary Network access to central offices throughout its
markets. In Indiana, Primary Network has accessed collocation space under the
FCC tariffs. In addition, Primary Network has interconnection agreements with
the incumbent telephone companies
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in each of these states. These interconnection and collocation agreements have
been filed with and approved by the Public Service Commissions in each of these
states, except with respect to Indiana and Kentucky, where the interconnection
agreements are still pending. Primary Network has filed interconnection and
collocation agreements it has made with incumbent telephone companies in
Kentucky, Louisiana, Mississippi, North Carolina and South Carolina, and is
awaiting approval from their Public Service Commissions.
Internet services are not currently subject to direct regulation by the FCC
or any other telecommunications agency.
EMPLOYEES
As of March 31, 2000, Primary Network had 382 employees, employed in
engineering, sales, marketing, customer support and related activities, and
general and administrative functions. This does not include temporary personnel
or consultants that Primary Network retains from time to time. The employees are
not represented by a labor union, and relations with employees are believed to
be good. Primary Network believes that future success will depend in part on a
continued ability to attract, hire and retain qualified personnel, as
competition for such personnel is intense.
FACILITIES
Primary Network is headquartered in St. Louis, Missouri, with personnel in
four buildings with approximately 18,000 square feet of combined office space
and a 1,091 square-foot network operations center. In addition, Primary Network
has secured a lease on a new 95,007 square-foot building near the current
network operations center. All St. Louis operations, except for the network
operations center, will be consolidated to this new building on or about June
15, 2000.
Primary Network has leased premises for local network operations centers in
Kansas City, Missouri; Springfield, Missouri and Tulsa, Oklahoma, and for sales
offices in Overland Park, Kansas; Swansea, Illinois; Tulsa, Oklahoma and
Springfield, Missouri. These facilities are each occupied under separate leases,
which expire over various terms; there are approximately three years remaining
on the term of each such lease. Primary Network leases rack space in a number of
business locations to house equipment needed to serve predominately modem and
Integrated Services Digital Network, which is referred to as ISDN, customers. In
addition, Primary Network leases three small retail stores and owns one other
retail store in the St. Louis metropolitan area. These are located in O'Fallon,
Missouri; Ladue, Missouri; Edwardsville, Illinois and East St. Louis, Illinois,
respectively.
Primary Network also leases space in a number of Southwestern Bell and
Ameritech central offices under specific collocation agreements. While the terms
of these leases are perpetual, the productive use of our facilities in these
central offices are subject to the terms of federal and state tariffs,
regulatory decisions and our interconnection agreements with Southwestern Bell
and Ameritech. Primary Network will increase central office space as the needs
of its expanding network demand.
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MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
Our executive officers and directors, and their respective ages as of May
12, 2000, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Maurice J. Gallagher, Jr....... 49 Chairman of the Board of Directors
Rolla P. Huff.................. 43 Chief Executive Officer, President, Director
Timothy P. Flynn(1)............ 49 Director
Jack L. Hancock(2)............. 69 Director
David Kronfeld................. 52 Director
Mark J. Masiello............... 32 Director
Thomas Neustaetter(1)(2)....... 48 Director
Mark Pelson.................... 38 Director
Robert W. Miller............... 59 Director
James Ball..................... 37 President -- Midwest Region
John Boersma................... 39 Senior Vice President -- Technology Development
David S. Clark................. 39 Senior Vice President -- Investor Relations
S. Gregory Clevenger........... 36 Senior Vice President -- Corporate Development
Michael R. Daley............... 39 Executive Vice President and Chief Financial Officer
Neil Hediger................... 42 Senior Vice President -- Marketing
Kent F. Heyman................. 44 Senior Vice President and General Counsel
George Longyear................ 30 President -- Southwestern Region
Mark D. Magarian............... 33 Senior Vice President -- People Services
James Mitchell................. 39 President -- Eastern Region
Roger J. Pachuta............... 57 Senior Vice President -- Engineering and Operations
Mark W. Peterson............... 45 President -- Western Region
Michele Sadwick................ 33 Vice President -- Corporate Communications
Linda M. Sunbury............... 38 Senior Vice President -- Finance
Russell I. Zuckerman........... 53 Secretary
Frank C. Szabo................. 48 Comptroller
</TABLE>
-------------------------
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
MAURICE J. GALLAGHER, JR. has served as the chairman of our board of
directors since our inception. Mr. Gallagher was a founder of ValuJet Airlines,
Inc. in 1993 and served as a director of ValuJet from 1993 until November 1997
and served as vice chairman from 1994 to 1997.
ROLLA P. HUFF was elected as our chief executive officer and president and
as a member of our board of directors as of November 1, 1999. From March 1999 to
September 1999, Mr. Huff served as president and chief operating officer of
Frontier Corporation and served as executive vice president and chief financial
officer of that corporation from May 1998 to March 1999. From July 1997 to May
1998, Mr. Huff was president of AT&T Wireless for the Central U.S. region and
Mr. Huff served as senior vice president and chief financial officer of that
company from March 1995 to July 1997. From July 1994 to March 1995, Mr. Huff was
financial vice president of mergers and acquisitions for AT&T.
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TIMOTHY P. FLYNN has served as a member of our board of directors since
1996. Mr. Flynn served as a member of the board of directors of ValuJet Airlines
since he participated in its founding in 1993 until November 1997. Mr. Flynn and
Mr. Gallagher are affiliated in a number of other transactions.
JACK L. HANCOCK has served as a member of our board of directors since
1996. Mr. Hancock was vice president of systems technology and executive vice
president, product and technology for PacBell from 1988 to 1993. He has served
as a member of the boards of directors of Union Bank of California and Wittaker
Corporation since 1994. Mr. Hancock will be resigning as a director at the
annual meeting on June 22, 2000.
DAVID KRONFELD was elected to serve as a member of our board of directors
in February 1998. Mr. Kronfeld is the founder of JK&B Management, L.L.C., a
venture capital firm, and has managed its affairs since 1995. Since 1989, Mr.
Kronfeld has also been a partner at Boston Capital Ventures, a venture capital
firm where he specialized in the telecommunications and software industries.
MARK J. MASIELLO was elected to serve as a member of our board of directors
in November 1999. Mr. Masiello is a Managing Director of Providence Equity
Partners, Inc., which provides investment management services to Providence
Equity Partners III L.P. ("PEP") and has since its founding in 1998 served as a
member of Providence Equity Partners III LLC, the general partner of PEP. Mr.
Masiello has been with Providence since 1989 and he currently serves as a
director of VIA NET.WORKS, Inc., Surebridge, Inc. and Global Metro Networks,
Ltd.
THOMAS NEUSTAETTER was elected to serve as a member of our board of
directors in February 1998. Since March 1999, Mr. Neustaetter has been an
executive member of JK&B Capital. From January 1996 to December 1999, Mr.
Neustaetter was a partner of The Chatterjee Group, an investment firm which is
an affiliate of Soros Fund Management. Before joining The Chatterjee Group, he
was the president and founder of Bancroft Capital, a general consulting firm,
from December 1994 to December 1995. Mr. Neustaetter also serves as a director
of Gloss.com, Vertex Holdings, emWare, Inc. and Paragon Networks International.
MARK PELSON was elected to serve as a member of our board of directors in
March 2000. Mr. Pelson is a Managing Director of Providence Equity Partners Inc.
which provides investment management services to Providence Equity Partners III
LLC and has served as a member of Providence Equity Partners III LLC since its
founding in 1998. Before joining Providence, Mr. Pelson was a co-founder and
director of TeleCorp, Inc. a wireless telecommunications company. From 1989 to
1995, Mr. Pelson served in various management positions with AT&T, most recently
as a general manager of strategic planning and mergers and acquisitions. Mr.
Pelson also serves as a director of Carrier1 International S.A., Madison River
Telephone Company, Global Metro Networks, Ltd. and Language Line Holdings, LLC.
RICHARD W. MILLER was elected to serve as a member of our board of
directors in March 2000. From 1993 until 1997, Mr. Miller served as senior
executive vice president and chief financial officer of AT&T and as a member of
AT&T's chairman office. Mr. Miller currently serves as a director of Closure
Medical Corporation and SBA Communications, Inc.
JAMES BALL joined our company as president -- midwest region in November
1999. From September 1998 until November 1999, Mr. Ball served as regional vice
president for a 12-city region with Chicago-based Level 3 Communications. Before
September 1998, Mr. Ball held senior management positions at Epoch Internet from
November 1997 to August 1998 and MFS Telecom from August 1993 to October 1997.
JOHN BOERSMA has served as our vice president -- technology development
since May 1997 and was designated senior vice president -- operations in May
1999. He served as vice president of carrier
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relations for ICG Telecom Group, Inc. from 1996 to 1997. In that capacity, he
was responsible for ICG Telecom's relationship with local exchange carriers and
implementation, purchase agreements and service quality. Mr. Boersma served as
vice president, northern California operations of ICG Telecom from April 1994 to
September 1996.
DAVID S. CLARK has since December 1999 served as our senior vice
president -- investor relations. Mr. Clark served as our vice
president -- marketing from May 1997 until May 1999 when he was designated
senior vice president -- sales and marketing. Mr. Clark has been in the
telecommunications industry for 11 years, with responsibilities including
engineering, purchasing, product development, client acquisition and
maintenance, marketing and advertising. From 1989 to 1997, Mr. Clark was
employed by North American Telecom, his last position being vice president of
communications services.
S. GREGORY CLEVENGER joined our company as senior vice
president -- corporate development in January 2000. From March 1997 to December
1999, Mr. Clevenger was vice president of investment banking at Goldman, Sachs &
Co. in the communications, media and entertainment group in Singapore and New
York. From September 1992 to March 1997, Mr. Clevenger was an associate and vice
president in the investment banking division of Morgan Stanley & Co.
Incorporated in New York, Hong Kong and Singapore in a variety of groups
including the global telecommunications group and the global project finance and
leasing group. From May 1990 to September 1992, Mr. Clevenger was an associate
and vice president at Argent Group Ltd. in New York.
MICHAEL R. DALEY joined our company as executive vice president and chief
financial officer in November 1999. From November 1998 to November 1999, Mr.
Daley served as executive vice president and chief financial officer of
Concentrix Corporation. From 1984 through ACC Corp.'s merger with Teleport
Communications Group, Inc. in 1998, Mr. Daley served in various capacities at
ACC Corp., including as executive vice president and chief financial officer
from March 1994 to October 1998 with responsibilities including operations
support, investor relations, human resources, legal, mergers and acquisitions
and business development.
NEIL HEDIGER joined our company as senior vice president -- marketing in
January 2000. From September 1995 to November 1999, Mr. Hediger served as vice
president of business communications for BellSouth and as vice president of
marketing for BellSouth business systems. From April 1991 to September 1995, he
served as director of marketing for MCI -- business markets.
KENT F. HEYMAN has served as our vice president and general counsel since
June 1996 and was designated senior vice president in December 1999. Mr. Heyman
has 18 years of legal experience, most recently as chairman of the litigation
department and senior trial counsel of the Dowling, Magarian, Aaron & Heyman law
firm. Mr. Heyman has served as a California Superior Court Judge pro tempore
presiding over trial, settlement conference and other proceedings from 1990 to
1996.
GEORGE LONGYEAR has served as our president -- southwestern region since
October 1999. From April 1998 until October, 1999, Mr. Longyear served as branch
director in our Atlanta office. Mr. Longyear has over nine years telephone
industry experience, most recently with MCI Communications from 1991 to 1997
where he held various senior sales and management positions in their local
service group and state government and university segment.
MARK D. MAGARIAN joined our company as senior vice president -- people
services in January 2000. Mr. Magarian practiced law and specialized in labor
and employment law from 1993 until December 1999.
JAMES MITCHELL has served as our president -- eastern region since February
1998. Mr. Mitchell has over nine years of telephone industry experience, serving
from 1990 to 1998 in various sales and
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marketing management roles with MCI, his last position being regional sales and
marketing manager for the southeast region.
ROGER J. PACHUTA joined our company as senior vice president -- engineering
and operations in March of this year. From 1993 through February 2000, Mr.
Pachuta served in various roles for AT&T Wireless, his last position being vice
president of field operations.
MARK W. PETERSON has served as our president -- western region since March
1997. From 1993 to 1996, Mr. Peterson was a marketing and communications
consultant and a law student. He previously served as head of corporate affairs
for WestAir Holding, Inc. from 1988 to 1992.
MICHELE SADWICK joined our company as vice president -- corporate
communications in December 1999. From April 1994 to November 1999, Ms. Sadwick
held various positions in public relations with Frontier Corporation.
LINDA M. SUNBURY has served as our vice president and principal accounting
officer since June 1996 and served as our chief financial officer from January
1998 to November 1999. Ms. Sunbury was designated senior vice president in May
1999 and since December 1999 has served as senior vice president -- finance. Ms.
Sunbury has over 15 years accounting and administrative experience, having held
similar positions in the airline industry. Most recently, Ms. Sunbury was vice
president of administration for Business Express, Inc. dba the Delta Connection
from 1994 to 1996. While Ms. Sunbury was at Business Express, creditors of
Business Express filed an involuntary petition for bankruptcy in January 1996.
Business Express subsequently reorganized and emerged from bankruptcy in April
1997. Before that, Ms. Sunbury served as controller for WestAir Holding, Inc.
from 1988 to 1994.
RUSSELL L. ZUCKERMAN joined us in January, 2000 as Director of National
Legal Affairs. Mr. Zuckerman is a graduate of Columbia College (1968) and Yale
Law School (1971). Before joining us, he had been in private practice since 1973
with Underberg & Kessler, LLP, a Rochester firm. Mr. Zuckerman had served as
Managing Partner and Chairman of the litigation department at Underberg &
Kessler, and specialized in all aspects of litigation, including commercial,
banking and employment.
FRANK C. SZABO has served as our Comptroller since March, 2000. From 1997
to February, 2000, Mr. Szabo served as Vice President and Comptroller of AT&T
Local Services Division (formerly ACC Corp.). From 1981 to 1997, Mr. Szabo
served as Vice President and Comptroller of First Federal Savings and Loan of
Rochester and, in such capacity, served as a member of several management
committees, including Operations, Credit Policy and Information Services
Steering Committee.
Messrs. Kronfeld and Neustaetter were initially selected to serve on our
board of directors by the holders of our Series A convertible preferred stock.
The Series A convertible preferred stock was automatically converted into common
stock upon our initial public offering.
Messrs. Salem and Masiello were selected to serve on our board of directors
by the purchasers of our Series B convertible preferred stock and Series C
convertible preferred stock.
EXECUTIVE COMPENSATION
Summary of Cash and Certain Other Compensation
The following table shows, for the fiscal years ended December 31, 1997,
December 31, 1998, and December 31, 1999, the cash compensation paid by us, as
well as certain other compensation paid or accrued for such year, for our Chief
Executive Officer and four most highly compensated
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executive officers other than the Chief Executive Officer. Such table also
indicates all capacities in which they served.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM ALL OTHER
------------------------- COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) OPTIONS ($) ($)
--------------------------- ---- ---------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Rolla P. Huff............... 1999 77,923 1,000,000(1) 400,000 0
President and Chief
Executive Officer
Nield J. Montgomery......... 1999 137,456 0 0 0
President and Chief 1998 158,707 20,000(3) 45,000 0
Executive Officer(2) 1997 139,424 0 0 0
James Mitchell.............. 1999 114,615 36,125 10,000 0
President -- Eastern 1998 88,275 45,000 48,000 0
Region(4)
James J. Hurley, III........ 1999 120,000 6,676 10,000 0
President -- Midwest 1998 93,991 30,000 48,000 0
Region(5)
John Boersma................ 1999 112,308 0 95,000 0
Senior Vice President 1998 109,442 6,000 15,000 0
1997 53,308 0 60,000 0
David S. Clark.............. 1999 107,115 10,000 95,000 0
Senior Vice President(6) 1998 96,058 6,000 18,000 0
1997 46,750 0 36,000 0
Linda M. Sunbury............ 1999 107,115 10,000 95,000 0
Senior Vice President 1998 90,876 10,000 22,000 0
1997 81,231 0 12,000 0
</TABLE>
---------------
(1) Mr. Huff commenced employment with us in November 1999 and therefore, the
salary shown for him for 1999 is for the period from November 1999 through
December 1999. Mr. Huff received a signing bonus in the amount indicated in
the above table upon his employment as an officer of our company.
(2) Mr. Montgomery served as our President and Chief Executive Officer until
November 1999.
(3) A portion of this bonus was paid in the form of common stock in our company.
(4) Mr. Mitchell commenced employment with us in February 1998 and therefore,
the compensation shown for him for 1998 is for the period from February 1998
through December 1998.
(5) Mr. Hurley commenced employment with us in March 1998 and therefore, the
compensation shown for him for 1998 is for the period from March 1998
through December 1998. Mr. Hurley's employment as an officer of our company
terminated in November 1999.
(6) Mr. Clark commenced employment in May 1997 and therefore, the salary shown
for him for 1997 is for the period from May 1997 through December 1997.
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<PAGE> 97
Option Grants During Year Ended December 31, 1999
The table below sets forth information regarding all stock options granted
in the 1999 fiscal year under the our Stock Option Plan to those executive
officers named in the Summary Compensation Table above.
<TABLE>
<CAPTION>
POTENTIAL REALIZED VALUE AT
% OF TOTAL MARKET ASSUMED ANNUAL RATE OF
NUMBER OF OPTIONS PRICE OR STOCK PRICE APPRECIATION
SECURITIES GRANTED TO FAIR FOR OPTION TERM(1)
UNDERLYING EMPLOYEES VALUE ON ---------------------------
OPTIONS IN FISCAL EXERCISE DATE OF EXPIRATION APPRECIATION APPRECIATION
NAME GRANTED YEAR PRICE GRANT DATE 5% 10%
---- ---------- ---------- -------- -------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Rolla P. Huff................. 400,000 16.4% $20.00 $20.00 10/13/09 $10,773,001 $21,892,882
Nield J Montgomery............ 0 n/a n/a n/a n/a n/a n/a
James Mitchell................ 10,000 .4% 6.09 6.03 3/1/09 37,343 95,535
James J. Hurley, III.......... 10,000 .4% 6.03 6.03 3/1/09 37,942 96,122
John Boersma.................. 20,000 .8% 6.03 6.03 3/1/09 75,885 192,245
John Boersma.................. 75,000 3.1% 27.50 27.50 11/1/09 1,297,095 3,287,094
David S. Clark................ 20,000 .8% 6.03 6.03 3/1/09 75,885 192,245
David S. Clark................ 75,000 3.1% 27.50 27.50 11/1/09 1,297,095 3,287,094
Linda M. Sunbury.............. 20,000 .8% 6.03 6.03 3/1/09 75,885 192,245
Linda M. Sunbury.............. 75,000 3.1% 27.50 27.50 11/1/09 1,297,095 3,287,094
</TABLE>
---------------
(1) The dollar amounts under these columns are the result of calculations at the
5% and 10% rates set by the Securities and Exchange Commission and therefore
are not intended to forecast possible future appreciation, if any, of the
price of our stock.
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<PAGE> 98
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year End Option
Values
The following table shows aggregate exercises of options during 1999 and
the values of options held as of December 31, 1999 by those executive officers
of our company named in the Summary Compensation Table above.
<TABLE>
<CAPTION>
NUMBER OF VALUE OF
UNEXERCISED UNEXERCISED
OPTIONS DECEMBER IN-THE-MONEY
NUMBER OF 31, OPTIONS
SHARES 1999 DECEMBER 31, 1999
ACQUIRED VALUE EXERCISABLE (E)/ EXERCISABLE (E)/
NAME ON EXERCISE REALIZED UNEXERCISABLE (U) UNEXERCISABLE (U)
---- ----------- -------- ----------------- -----------------
<S> <C> <C> <C> <C>
Rolla P. Huff................ -- -- 400,000U $12,300,000U
Nield J. Montgomery.......... -- -- 261,333E 12,726,359E
Nield J. Montgomery.......... -- -- 168,667U 8,283,903U
James Mitchell............... 19,200 $265,800 48,400U 2,171,528U
James J. Hurley, III......... 9,600 232,032 43,409U 1,852,528U
John Boersma................. 34,000 729,080 1,000E 42,750E
John Boersma................. -- -- 135,000U 4,426,270U
David S. Clark............... -- -- 26,000U 646,848E
David S. Clark............... -- -- 123,000U 3,882,022U
Linda M. Sunbury............. -- -- 35,200E 1,629,156E
Linda M. Sunbury............. -- -- 123,800U 3,960,934U
</TABLE>
------------------------
(1) Amounts shown are based upon the closing sale price for our common stock on
December 31, 1999, which was $50.75 per share.
Director Compensation
Our outside directors (Messrs. Flynn, Hancock, Kronfeld, Masiello, Miller,
Neustaetter and Pelson) receive meeting fees of $500 per meeting of the Board of
Directors or Committee attended in person in addition to reimbursement of their
expenses in attending meetings of the Board of Directors.
Employment Agreements
ROLLA P. HUFF. Our employment agreement with Mr. Huff provides for a base
salary of $500,000 per year and an annual bonus of up to 100% of his base salary
based on our achievement of certain annual targets to be established by the
Board of Directors in conjunction with our annual operating budget or in the
discretion of the Board of Directors. Mr. Huff received a $1,000,000 signing
bonus upon his employment with us. The signing bonus is subject to repayment if
Mr. Huff's employment with us is terminated before three years of employment
under certain circumstances. Mr. Huff is required to devote his full time and
efforts to the business of our company during the term of his employment
agreement which expires in October 2002. Mr. Huff's employment may be terminated
by either us or Mr. Huff at any time. Mr. Huff has agreed not to participate in
a competitive business during the term of his employment and for a period of
twelve months following termination. If Mr. Huff's employment is terminated by
us without cause or after a change of control, Mr. Huff will be entitled to
severance pay (not less than $1,000,000) equal to two times the salary and bonus
paid to him during the previous 12 months with payments to be made over the 24
month
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<PAGE> 99
period following his termination of employment. Mr. Huff's initial stock options
will also become immediately vested in the event of a change of control of our
company.
In connection with Mr. Huff's employment with us, we sold to Mr. Huff
150,000 shares of common stock at its value at that time ($20.00 per share). The
purchase price was payable by a non-recourse promissory note secured by the
shares purchased. The promissory note bears interest at 7.5% per annum and is
due in November 2002. We have agreed to forgive all payments due under the
promissory note if there is a change of control, if Mr. Huff is continuously
employed by us until November 2002 or if Mr. Huff's employment is terminated
prior to that time by us without cause or as a result of Mr. Huff's disability.
The shares of stock are subject to repurchase by us if Mr. Huff's employment is
terminated other than by us without cause or as a result of a change of control
or Mr. Huff's death or disability.
MICHAEL R. DALEY. Our employment agreement with Mr. Daley provides for a
base salary of $225,000 per year and an annual bonus of up to 75% of his base
salary based on our achievement of certain annual targets to be established by
the Board of Directors in conjunction with our annual operating budget. Mr.
Daley's employment may be terminated by either us or Mr. Daley at any time. Mr.
Daley has agreed not to participate in a competitive business during the term of
his employment and for a period of twelve months following termination. If Mr.
Daley's employment is terminated by us without cause or after a change of
control, Mr. Daley will be entitled to severance pay equal to two times the
salary and bonus paid to him during the previous 12 months with payments to be
made over the 24 month period following his termination of employment. Mr.
Daley's initial stock options will also become immediately vested in the event
of a change of control of our company.
NIELD J. MONTGOMERY. In November 1999, we entered into an agreement with
Mr. Montgomery superseding Mr. Montgomery's previous employment agreement. Under
the new agreement, Mr. Montgomery is to remain employed by us until April 2001
and Mr. Montgomery will receive a base salary of $5,000 per month during the
period of his employment. In addition, the agreement provided for Mr. Montgomery
to receive a lump sum payment of $360,000 in January 2000 in connection with his
resignation as an executive officer and Director of our company. Under the
agreement, we agreed to accelerate the vesting of a portion of Mr. Montgomery's
stock options.
OTHER EXECUTIVE OFFICERS. We have entered into Employment/Stock Repurchase
Agreements with John Boersma, David S. Clark and Linda M. Sunbury. These
agreements establish base salaries and provide that each employee may earn a
bonus of up to 50% of his or her base salary based on the employee's and our
performance. Each employee's employment may be terminated at any time by either
us or the employee. Each of these executive officers has agreed not to
participate in a business offering local, long distance and related telephone
services in the area of his or her employment during the term of employment and
for a period of six months following termination. Each of these executive
officers has exercised rights to acquire common stock at $5.83 per share. All or
a portion of such shares are subject to repurchase at their cost if the
Executive Officer's employment with us is terminated within a three year period.
We have financed the purchase price of certain of these shares over a period of
three years.
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<PAGE> 100
PRINCIPAL STOCKHOLDERS
SECURITY OWNERSHIP OF MANAGEMENT AND BENEFICIAL OWNERS
The following table sets forth, as of May 10, 2000 (unless otherwise
indicated in the footnotes), certain information with respect to our voting
securities owned beneficially by (1) each director, including the nominees, (2)
our four most highly compensated officers, (3) directors and executive officers
as a group and (4) each person known by us to be a beneficial owner of more than
5% of our outstanding voting securities. Unless otherwise provided, all persons
listed have an address c/o our principal executive offices and have sole voting
and investment power with respect to their shares unless otherwise indicated.
<TABLE>
<CAPTION>
COMMON STOCK SERIES C PREFERRED STOCK
---------------------------- ----------------------------
NUMBER OF NUMBER OF
SHARES PERCENT SHARES PERCENT
BENEFICIALLY OF BENEFICIALLY OF
NAME OF BENEFICIAL OWNER OWNED(1) OWNERSHIP OWNED OWNERSHIP
------------------------ ---------------- --------- ---------------- ---------
<S> <C> <C> <C> <C>
Providence Equity Partners III LLC(2)......... 5,231,488 14.4% 892,857 71.5%
Maurice J. Gallagher, Jr., Chairman of the
Board and director(3)....................... 3,287,608 9.2% -- --
David Kronfeld, director(4)................... 2,091,816 5.8% 357,143 28.5%
Timothy F. Flynn, director(5)................. 900,900 2.5%
Rolla P. Huff, president, Chief Executive
Officer and director........................ 150,000 * -- --
Jack L. Hancock, director(6).................. 39,600 * -- --
Thomas Neustaetter, director.................. 8,800 * -- --
Richard W. Miller, director................... 1,500 * -- --
Mark J. Masiello, director(7)................. -- -- -- --
Mark Pelson, director (7)..................... -- -- -- --
James Mitchell, President -- Eastern
Region(9)................................... 62,200 * -- --
James J. Hurley, III, President -- Midwest
Region(8)................................... 42,200 * -- --
John Boersma, Senior Vice President........... 151,333 * -- --
David S. Clark, Senior Vice President(11)..... 57,753 * -- --
Linda M. Sunbury, Senior Vice President(12)... 126,853 * -- --
All executive officers and directors as a
group (23 persons)(3)(4)(5)(6)(7)(9)(10)(11)
(12)(13).................................... 7,151,239 19.8% 357,143 28.5%
</TABLE>
------------------------
(*) Less than 1% of the total
(1) In accordance with the Securities and Exchange Commission's rules, each
beneficial owner's holdings have been calculated assuming the full exercise
of options and the conversion of all shares of convertible preferred stock
held by the holder which are currently exercisable or convertible or which
will become exercisable or convertible within 60 days after the date
indicated and no exercise of options or conversion of preferred stock held
by any other person.
(2) The common stock ownership indicated includes 892,857 shares of Series C
convertible preferred stock. The shares of Series C convertible preferred
stock are convertible into common
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<PAGE> 101
stock on a one-for one basis. The address of this beneficial owner is 901
Fleet Center, 50 Kennedy Plaza, Providence, Rhode Island 02903.
(3) Include options to purchase 52,000 shares of common stock which are
presently exercisable and 3,190,898 shares of common stock owned by various
partnerships, trusts or corporations with respect to which Mr. Gallagher is
a general partner, beneficiary and/or controlling stockholder. Also
includes 44,730 shares owned by a trust for the benefit of Mr. Gallagher's
minor children with respect to which Mr. Gallagher disclaims any beneficial
ownership interest. Mr. Gallagher's address is 3291 N. Buffalo Drive, Las
Vegas, Nevada 89129.
(4) The common stock ownership indicated includes 1,725,873 shares of common
stock and 357,143 shares of Series C convertible preferred stock owned by
partnerships in which Mr. Kronfeld is a general partner or manager of a
general partner. The shares of Series C convertible preferred stock are
convertible into common stock on a one-for-one basis. Mr. Kronfeld's
address is JK&B Management, L.L.C., 205 North Michigan, Suite 808, Chicago,
Illinois 60601.
(5) Includes options to purchase 9,600 shares which are presently exercisable
or will become exercisable within 60 days after the date indicated above
and 102,000 shares of common stock owned by various partnerships or
corporations with respect to which Mr. Flynn is a general partner and/or
controlling stockholder.
(6) Includes options to purchase 9,600 shares that are presently exercisable or
will become exercisable within 60 days after the date indicated above.
(7) Excludes 4,338,631 shares of common stock and 892,857 shares of Series C
convertible preferred stock owned by Providence Equity Partners III L.P.
and its affiliates. Mr. Masiello and Mr. Pelson disclaim beneficial
ownership of these shares except to the extent of their pecuniary interest
in the general partner of Providence Equity Partners III L.P.
(8) Includes options to purchase 14,600 shares which are presently exercisable.
Mr. Hurley's stock ownership information is as of January 31, 2000. Mr.
Hurley's employment as an officer of our company terminated in November
1999.
(9) Includes 19,600 options that are presently exercisable or will become
exercisable within 60 days after the date indicated above. As of May 12,
2000, Mr. Mitchell is no longer an executive officer of our company but
continues as an officer and employee of our company.
(10) Includes 26,333 options that are presently exercisable or will become
exercisable within 60 days after the date indicated above. As of May 12,
2000, Mr. Boersma is no longer an executive officer of our company but
continues as an officer and employee of our company.
(11) Includes 44,133 options that are presently or will become exercisable
within 60 days after the date indicated above. As of May 12, 2000, Mr.
Clark is no longer an executive officer of our company but continues as an
officer and employee of our company.
(12) Includes 25,953 options that are presently exercisable or will become
exercisable within 60 days after the date indicated above. As of May 12,
2000, Ms. Sunbury is no longer an executive officer of our company but
continues as an officer and employee of our company.
(13) Includes options to purchase 57,267 shares owned by executive officers not
named above which are presently exercisable or which will become
exercisable within 60 days after the date of indicated above.
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<PAGE> 102
DESCRIPTION OF CAPITAL STOCK
GENERAL
The following description is a summary of the material terms of our capital
stock. It is not a complete description of all of the terms of our capital
stock. You should read this description of our capital stock as well as the
Nevada Revised Statutes, which are referred to as the NRS, our articles of
incorporation, our certificates of designation of preferred stock, and our
by-laws. A copy of our articles of incorporation has been filed as an exhibit to
our registration statement on Form S-4, registration number 333-38875, filed
with the Securities and Exchange Commission on October 28, 1997. A copy of our
by-laws has been filed as an exhibit to our registration statement on Form S-1,
registration statement number 333-49085, filed with the Securities and Exchange
Commission on April 1, 1998. A copy of our Amended and Restated Certificate of
Designation of Series B Convertible Preferred Stock has been filed as exhibit
4.7 to the registration statement of which this prospectus is a part. A copy of
our Certificate of Designation of Series C Convertible Preferred Stock has been
filed a exhibit 4.8 to the registration statement of which this prospectus is a
part. A copy of the Certificate of Designation of Series D Convertible Preferred
Stock has been filed as an exhibit to our annual report for fiscal year ended
December 31, 1999 on Form 10-K filed with the Securities and Exchange Commission
on March 30, 2000.
Our authorized capital stock consists of 60,000,000 shares of common stock,
$0.001 par value per share, and 50,000,000 shares of preferred stock, $.001 per
value per share. Of the 50,000,000 shares of authorized preferred stock, we have
designated 5,278,000 shares of Series B convertible preferred stock, 1,250,000
shares of Series C convertible preferred stock and 4,140,000 shares of Series D
convertible preferred stock with the voting, dividend, liquidation and
conversion rights described below. As of April 30, 2000, 35,514,985 shares of
common stock, 1,250,000 shares of Series C convertible preferred stock and
4,140,000 shares of Series D convertible preferred stock were outstanding and
5,345,678 shares of common stock were subject to outstanding options and
warrants. On March 27, 2000, 5,277,779 shares of Series B convertible preferred
stock, issued in May 1999, were converted into 5,277,779 shares of our common
stock. As of the date of this prospectus, there are no shares of Series B
convertible preferred stock outstanding.
If we issue preferred stock in the future, the preferred stock will have
the rights, terms and preferences specified by our board of directors in a
certificate filed with the Secretary of State of Nevada. The issuance of
preferred stock by the board of directors in the future could adversely affect
the rights of holders of our then outstanding classes of capital stock with
preferences over the common stock with voting rights equal to or greater than
those of the common stock. We have no present plan to issue any additional
series of preferred stock.
COMMON STOCK
The holders of our common stock are entitled to receive ratably, from funds
legally available for the payment thereof, dividends when and as declared by
resolution of our board of directors, subject to preferential dividend rights
granted to holders of our preferred stock. In the event of liquidation, each
share of our common stock is entitled to share pro rata in any distribution of
our assets after payment or providing for the payment of liabilities and the
liquidation preferences of our preferred stock. Each holder of our common stock
is entitled to one vote for each share of common stock held of record on the
applicable record date on all matters submitted to a vote of stockholders.
Holders of our common stock have no cumulative voting rights or preemptive
rights to purchase or subscribe for any stock or other securities, and there are
no conversion rights or redemption rights or sinking fund provisions with
respect to our common stock. The outstanding shares of our common
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<PAGE> 103
stock and the shares of our common stock to be issued pursuant to the merger
will be duly authorized, validly issued, fully paid and nonassessable.
SERIES C CONVERTIBLE PREFERRED STOCK
The Series C convertible preferred stock, which was issued in December
1999, has the rights and preferences described in the following paragraphs.
Dividends accrue at the rate of 10% per year, are cumulative and must be
paid before any dividends may be paid on our common stock. Except as described
below, accrued dividends will be paid in common stock at the time the Series C
convertible preferred stock is converted into common stock if the dividends have
not been paid before that time.
On any matter submitted to our stockholders, holders of shares of Series C
convertible preferred stock will be treated as if they hold the number of shares
of our common stock into which their shares of Series C convertible preferred
stock could be converted and will be allowed to vote those shares along with the
holders of our common stock. In addition, the holders of shares of Series C
convertible preferred stock will have the right to approve any action to:
- increase or decrease the total number of authorized shares of or issue
preferred stock ranking equal or senior to the Series C convertible
preferred stock;
- dispose of assets in excess of a fixed dollar amount, merge or
consolidate or sell our company;
- liquidate our company;
- alter the terms of the Series C convertible preferred stock in a manner
adverse to the holders of Series C convertible preferred stock;
- pay dividends on our common stock or other securities junior to the
Series C convertible preferred stock other than dividends payable in our
common stock;
- enter into transactions with our affiliates other than transactions
covered by specified exceptions;
- make acquisitions in excess of a fixed dollar amount;
- incur additional debt in excess of fixed amounts;
- make material changes to our business plan;
- hire a chief executive officer;
- organize subsidiaries or enter into joint venture unless specified
conditions are met; and
- issue additional common stock that would result in an increase in the
number of shares of common stock into which the Series C convertible
preferred stock may be converted.
If we were to take one of these restricted actions without the approval of
the holders of the Series C convertible preferred stock, the holders of the
Series C convertible preferred stock may have the right to require us to seek a
sale of our company. To avoid having to sell our company if one of the
restricted actions described above is not approved by the holders of Series C
convertible preferred stock, we have the right to redeem the Series C
convertible preferred stock at predetermined prices. If we elect not to redeem
the Series C convertible preferred stock and the required sale of our company is
not effected within six months, then the holders of the Series C convertible
preferred stock (along with the holders of Series B convertible preferred stock,
if any, and if they then have similar rights) would be entitled to elect a
majority our board of directors.
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<PAGE> 104
The approval rights described above will terminate if fewer than 416,667
shares of Series C convertible preferred stock remain outstanding.
The holders of Series convertible preferred stock approved the issuance of
our common stock to be exchanged in the merger with Primary Network.
The holders of the Series C convertible preferred stock have the right to
representation on our board of directors as discussed below under "-- Series B
and C Preferred Stock Board Representation."
Upon our liquidation, the holders of the Series C convertible preferred
stock are entitled to receive their liquidation amount on a pro rata basis with
the holders of any series of preferred stock which ranks equally with the Series
C convertible preferred stock and before any amounts may be paid to holders of
our common stock or any other junior securities. The liquidation amount will be
the greater of (a) $28.00 per share plus the greater of $2.80 per share or the
accrued and unpaid dividends or (b) the amount the holders of Series C
convertible preferred stock would have received if the Series C convertible
preferred stock had been converted into common stock. The holders of the Series
C convertible preferred stock have the right to elect that a sale of our company
be treated as a liquidation for these purposes. If the liquidation or sale
occurs before June 30, 2002, the accrued dividends will not be paid to the
extent the holders of Series C convertible preferred stock will receive more
than $58.80 per share.
A holder of shares of Series C convertible preferred stock may convert
those shares into our common stock at any time. Initially, each share of Series
C convertible preferred stock may be converted into one share of our common
stock. The number of shares of our common stock into which each share of Series
C convertible preferred stock can be converted may be adjusted as a result of
stock splits, stock dividends and other issuances of additional stock.
After the earlier of January 19, 2001, or the date on which the holders of
Series B convertible preferred stock, if any, or Series C convertible preferred
stock exercise their demand registration rights, which are discussed below, we
have the right to require the conversion of the Series C convertible preferred
stock if the price of our common stock exceeds $56.00 per share on 20
consecutive trading days. If we require conversion before June 30, 2002, no
accrued dividends in excess of $2.80 per share will be paid.
The holders of Series C convertible preferred stock have the right to
require us to redeem the Series C convertible preferred stock after December 30,
2005 or upon a sale of our company. The redemption price will be equal to the
greater of:
- $28.00 per share plus the greater of $2.80 per share or accrued and
unpaid dividends; or
- the value of our common stock into which the Series C convertible
preferred stock is then convertible.
If we fail to redeem all shares of Series C convertible preferred stock
within six months of the date specified by the holders of the Series C
convertible preferred stock, then the holders of the Series C convertible
preferred stock (along with the holders of Series B convertible preferred stock,
if any, and if they then have similar rights) will have the right to elect a
majority of our board of directors.
SERIES B AND C PREFERRED STOCK BOARD REPRESENTATION
The initial purchasers of the Series B convertible preferred stock, and
Series C convertible preferred stock, voting together, have the right to
nominate two or more directors depending on the size of our board of directors
and the percentage of our stock represented by these initial purchasers, Series
C convertible preferred stock and common stock received upon conversion of the
Series B
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<PAGE> 105
convertible preferred stock or Series C convertible preferred stock. These
initial purchasers also have the right to have one of their board
representatives serve on each committee of our board of directors and on the
board of each of our subsidiaries. Pursuant to this right, these initial
purchasers are entitled to nominate two directors, and Mark Pelson and Mark J.
Masiello have been elected to the board of directors after being designated by
the initial purchasers.
This right to nominate directors will terminate if fewer than 1,759,260
shares of Series B convertible preferred stock remain outstanding, fewer than
416,667 shares of Series C convertible preferred stock remain outstanding and
the shares of Series C convertible preferred stock and our common stock issued
upon conversion of the Series B convertible preferred stock or Series C
convertible preferred stock constitute less than 5% of the outstanding common
stock assuming conversion of all outstanding shares of Series C convertible
preferred stock.
SERIES D CONVERTIBLE PREFERRED STOCK
The Series D convertible preferred stock has the rights and preferences
described in the following paragraphs.
Dividends accrue on the liquidation amount of $50.00 per share at the rate
of 7.25% per year, which is equivalent to $3.625 per year, and are payable
quarterly commencing on May 15, 2000, and must be paid before any dividends may
be paid on our common stock. At our option, dividends may be paid in cash or in
shares of our common stock.
The holders of Series D convertible preferred stock have no voting rights,
except as otherwise required under Nevada law or as provided in the certificate
of designation.
The holders of the outstanding shares of Series D convertible preferred
stock, voting separately, and as a class together with the holders of any stock
that ranks equally with the Series D convertible preferred stock upon which like
rights have been conferred and are exercisable, will be entitled to elect to
serve on our board of directors the lesser of: (a) two additional members to the
board of directors or (b) that number of directors constituting at least 25% of
the members of the board of directors, if:
- dividends on the Series D convertible preferred stock are in arrears and
unpaid for six or more dividend periods, whether or not consecutive;
- we fail to redeem all of the Series D convertible preferred stock in cash
on February 15, 2012, the mandatory redemption date; or
- we fail to offer to repurchase or, if the offer to repurchase is
accepted, to repurchase shares of Series D convertible preferred stock if
a non-stock change of control (as described below) occurs, each referred
to as a voting rights triggering event.
The number of members of the board of directors will be immediately and
automatically increased by that number of directors elected by the Series D
convertible preferred stock. The voting rights of the Series D convertible
preferred stock will be continued until all voting rights triggering events are
cured or waived, at which time, the term of any directors elected pursuant to
the provisions of this paragraph will terminate and the number of directors
constituting the board of directors will be immediately and automatically
decreased by that number.
Without the approval of the holders of at least 66 2/3 of the then
outstanding shares of the Series D convertible preferred stock, we may not amend
the change of control provisions of the Series D convertible preferred stock.
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<PAGE> 106
Without the approval of the holders of at least a majority of the then
outstanding shares of Series D convertible preferred stock, we may not:
- amend the certificate of designation so as to affect adversely the
specified rights, preferences, privileges or voting rights of holders of
shares of the Series D convertible preferred stock;
- increase or decrease the total number of authorized shares of Series D
convertible preferred stock;
- waive any voting rights triggering event or compliance with any
provisions of the Series D convertible preferred stock; or
- enter into specified merger, consolidation or asset sale transactions.
Upon our liquidation, the holders of the Series D convertible preferred
stock are entitled to receive their liquidation amounts plus accumulated and
unpaid dividends, if any, on a pro rata basis with the holders of any series of
preferred stock which ranks equally with the Series D convertible preferred
stock and before any amounts may be paid to holders of our common stock or other
junior securities. The liquidation amount is $50.00 per share.
A holder of shares of Series D convertible preferred stock may convert
those shares into our common stock at any time. Initially, each share of Series
D convertible preferred stock may be converted into 0.7652 shares of our common
stock at a conversion price of $65.34 per share. The conversion price and number
of shares may be adjusted as a result of stock splits, stock dividends, exchange
or tender offers and other issuances of additional stock or non-stock
distributions.
On or after February 15, 2003, we may, at our option, cancel the conversion
rights of the Series D convertible preferred stock. We may only exercise this
option if the closing price of our common stock equals or exceeds 140% of the
conversion price for at least 20 trading days within any 30 trading day period.
On February 15, 2012, we will be required to redeem all of the outstanding
shares of the Series D convertible preferred stock at a redemption price,
payable in cash, equal to the liquidation amount plus accumulated and unpaid
dividends, if any, whether or not declared, to the date of redemption.
On or after February 15, 2002, but before February 15, 2003, if the closing
price of our common stock equals or exceeds 150% of the conversion price for at
least 20 trading days within any 30 day trading period, we may redeem Series D
convertible preferred stock, which is referred to as a provisional redemption.
If we redeem the Series D convertible preferred stock, the redemption price will
be 105.8% of the liquidation amount, plus accumulated and unpaid dividends, if
any, whether or not declared, to the date of the provisional redemption.
If we undertake a provisional redemption, the holders of shares of Series D
convertible preferred stock called for redemption also will receive an
additional payment in an amount equal to the present value of the dividends that
would have been payable on the Series D convertible preferred stock for the
period from the date of the provisional redemption to February 15, 2003.
We may pay the redemption price, including any additional payment in cash
or, at its option, if we satisfy conditions specified in the certificate of
designation for the Series D convertible preferred in shares of our common stock
or a combination thereof.
Upon the occurrence of a non-stock change of control, as described in the
certificate of designation, each holder of Series D convertible preferred stock
will have the right, at the holder's option, to require us to repurchase all of
its shares of Series D preferred stock at a repurchase price specified in the
certificate of designation. We may pay the repurchase price in cash or, at its
option, if we satisfy conditions specified in the certificate of designation for
the series D convertible preferred
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stock in our common stock. If the terms of our outstanding indebtedness restrict
our ability to repurchase the Series D convertible preferred stock following a
non-stock change of control, each holder will have the right to convert its
shares of Series D convertible preferred stock into shares of our common stock
at the conversion price specified in the certificate of designation for the
Series D convertible preferred stock.
Upon the occurrence of a common stock change of control, as defined in the
certificate of designation, each share of Series D convertible preferred stock
will be convertible solely into our common stock of the kind received by the
holders of common stock as the result of the common stock change of control, at
the conversion price specified in the certificate of designation for the Series
D convertible preferred stock.
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DESCRIPTION OF OUTSTANDING INDEBTEDNESS
SENIOR SECURED NOTES DUE 2004
In September 1997, we issued $160.0 million aggregate principal amount of
our 13% Senior Secured Notes due 2004 under an indenture dated September 29,
1997.
EXCHANGE OFFER FOR 13% SENIOR SECURED NOTES DUE 2004 AND CONSENT SOLICITATION
We recently undertook a private exchange offer and consent solicitation
pursuant to the terms and conditions set forth in a private exchange offer and
consent solicitation statement, dated May 23, 2000, as amended and supplemented
by a supplement dated May 31, 2000 (as amended and supplemented, the "Exchange
Offer Statement"). In the exchange offer, we offered to exchange our outstanding
13% Senior Secured Notes due 2004 that were owned by "qualified institutional
buyers" (as defined in Rule 144A under the Securities Act) or institutional
"accredited investors" (as defined in Regulation D under the Securities Act)
(collectively, "Accredited Holders") for our 13% Senior Notes due 2010, which
were the same series as, and were issued under the same indenture governing, our
13% Senior Notes due 2010 issued on March 24, 2000. Concurrently with this
private exchange offer, we solicited consents from the Accredited Holders to the
adoption of certain amendments to the indenture governing the 13% Senior Secured
Notes due 2004 which would eliminate substantially all of the restrictive
covenants under the indenture. Under the terms of the indenture, the adoption of
the amendments and the execution of a supplemental indenture containing the
amendments required the consent of the holders representing a majority of the
outstanding principal amount of 13% Senior Secured Notes due 2004. In June 2000,
the exchange offer and consent solicitation was consummated. We issued
$117,063,000 aggregate principal amount of outstanding notes in exchange for
$103,884,000 aggregate principal amount of 13% Senior Secured Notes due 2004
delivered for exchange by Accredited Holders. Furthermore, as a result of having
received the consents from holders representing more than a majority of the
outstanding principal amount of 13% Senior Secured Notes due 2004 and
consummating the exchange offer, the supplemental indenture containing the
amendments became effective.
The terms of the 13% Senior Secured Notes due 2004 are as follows:
- Principal Amount - $56.1 million currently outstanding
- Maturity - October 1, 2004
- Interest Rate - 13%
- Interest Payments - Every six months on April 1 and October 1
- Optional Redemption - The 13% Senior Secured Notes due 2004 are
redeemable in whole or in part prior to maturity at our option at any
time on or after October 1, 2001, at a premium declining to par in 2003.
Before October 1, 2000, we may also redeem up to 35% of the aggregate
principal amount of the 13% Senior Secured Notes due 2004 with the
proceeds from certain sales of capital stock at a redemption price equal
to 113% of their principal amount.
- Ranking - The 13% Senior Secured Notes due 2004 rank equally with all of
our existing and future senior debt and are senior in right of payment to
all of our existing and future subordinated debt.
- Security - The 13% Senior Secured Notes due 2004 are secured by a
security interest in certain telecommunications equipment having a net
book value of $89.0 million (with historical costs of approximately
$108.0 million). They are also secured by securities purchased with a
portion of the proceeds from the sale of the 13% Senior Secured Notes due
2004 in an amount sufficient to cover the scheduled payment of interest
through October 1, 2000.
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DESCRIPTION OF THE NOTES
GENERAL
The form and terms of the exchange notes and the outstanding notes are
identical in all material respects, except that transfer restrictions and
registration rights applicable to the outstanding notes do not apply to the
exchange notes.
The outstanding notes were, and the exchange notes will be, issued under
the same indenture (the "Indenture") as the outstanding notes, which is dated as
of March 24, 2000, between us and HSBC Bank USA, as trustee. The exchange notes
and the outstanding notes are considered collectively to be a single class of
notes for all purposes under the Indenture and for purposes of this section only
we refer to the exchange notes and the outstanding notes collectively as the
"Notes". The terms of the Notes include those stated in the Indenture and those
made part of the Indenture by reference to the Trust Indenture Act of 1939.
The Notes are the senior unsecured obligations of us (MGC Communications)
and our wholly-owned subsidiary, Mpower Holding Corporation (Mpower Holding).
Mpower Holding is currently a shell entity incorporated in Delaware with minimal
assets, no operations, no subsidiaries and no debt or liabilities other than the
Notes. Mpower Holding was created for the sole purpose of becoming our parent
holding company if we determine to restructure our company into a holding
company structure.
The Notes will rank equal in right of payment to all existing and future
senior unsecured debt of MGC Communications and Mpower Holding. The Notes will
rank senior in right of payment to all future debt of MGC Communications and
Mpower Holding that expressly provides that it is subordinated to the Notes. The
Notes will be effectively subordinated to any existing or future secured debt of
MGC Communications and Mpower Holding to the extent of the value of the assets
securing the debt. As of March 31, 2000, on a pro forma basis after giving
effect to the issuance of a total of $117,063,000 aggregate principal amount of
Notes in exchange for a total of $103,884,000 aggregate principal amount of our
13% Senior Secured Notes due 2004 in connection with a private exchange offer in
June 2000, we had approximately $60.6 million of outstanding secured debt
consisting of:
- $56.1 million aggregate principal amount of 13% Senior Secured Notes due
2004 are secured by (a) certain telecommunications assets having a net
book value of approximately $89.0 million (with historical costs of
approximately $108.0 million) and (b) a pledge of U.S. government
securities in an amount sufficient to cover scheduled interest payments
on these secured notes through October 1, 2000, and
- $4.5 million of other secured debt.
Certain of MGC Communications' operations are, and additional portions of
MGC Communications' operations may in the future be conducted through its
Subsidiaries and, therefore, MGC Communications may become dependent upon the
cash flow of its Subsidiaries to meet its obligations, including its obligations
under the Notes.
The Notes are effectively subordinated to all indebtedness and other
liabilities and commitments, including trade payables and lease obligations of
MGC Communications' Subsidiaries, other than Mpower Holding. Any right of MGC
Communications to receive assets of any of its Subsidiaries upon a Subsidiary's
liquidation or reorganization, and any right of the holders of the Notes to
participate in those assets, will be effectively subordinated to the claims of
that Subsidiary's creditors, in which case, the claims of MGC Communications
would still be subordinate to any security in the assets of the Subsidiary and
any indebtedness of the Subsidiary senior to that held by MGC Communications.
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As discussed, we (MGC Communications) may restructure our company into a
holding structure whereby Mpower Holding would become the parent holding company
of our corporate operations. MGC Communications and out other subsidiaries, in
turn, would become the wholly-owned subsidiaries, directly or indirectly, of
Mpower Holding. As a holding company, Mpower Holding would have essentially no
operating assets other than the capital stock of MGC Communications and our
other subsidiaries, and practically all of Mpower Holding's revenue generating
operations would be conducted through its subsidiaries. To permit us to create a
holding company structure, the Indenture provides that if (a) we do restructure
our company into a holding company structure and (b) at least 66 2/3 of the
originally issued $160 million aggregate principal amount of our 13% Senior
Secured Notes due 2004 are no longer outstanding, then on such date (the
"Release Date") the Notes would become the exclusive obligations of Mpower
Holding, and MGC Communications would be automatically released of all
obligations under the Notes and Indenture. If this occurs, the Notes would
become effectively subordinated in right of payment to all debt and other
liabilities (including trade payables) of Mpower Holding's subsidiaries.
In this Description of Notes, the word "Company" refers only to MGC
Communications, Inc. and not to any of its subsidiaries unless or until the
Release Date after which the word "Company" will mean Mpower Holding
Corporation.
The following description is a summary of the material provisions of the
Indenture and the Registration Rights Agreement. It does not restate those
agreements in their entirety. We urge you to read the Indenture and the
Registration Rights Agreement because they, and not this description, define
your rights as holders of the Notes. Copies of the Indenture and the
Registration Rights Agreement are available as described below under the
subheading "Additional Information."
You can find the definitions of certain terms used in this description
under the subheading "Certain Definitions." Defined terms used in this
description but not defined under the subheading "Certain Definitions" have the
meanings assigned to them in the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The Company issued $250.0 million aggregate principal amount of Notes on
March 24, 2000. In addition, in connection with the consummation of the private
exchange offer in June 2000, the Company issued an additional $117,063,000
aggregate principal amount of Notes in exchange for $103,884,000 aggregate
principal amount of Existing Notes delivered for exchange. The Company will
issue Notes in denominations of $1,000 and integral multiples of $1,000. The
Notes will mature on April 1, 2010.
To the extent permitted by the covenant described below under the
subheading "Certain Covenants -- Incurrence of Indebtedness and Issuance of
Disqualified Stock," the Company may issue additional Notes (the "Additional
Notes") under the Indenture. The outstanding notes already issued, the exchange
notes issued in connection with the exchange offer and any Additional Notes that
the Company subsequently issues under the Indenture, will be treated as a single
class for all purposes under the Indenture.
Interest on the Notes will accrue at the rate of 13% per annum and will be
payable semi-annually in cash in arrears on each April 1 and October 1,
commencing on October 1, 2000. The Company will make each interest payment to
the holders of record on the immediately preceding March 15 and September 15.
Interest on each Note will accrue from the date of original issuance or, if
interest has already been paid, from the date it was most recently paid.
Interest will be computed on the basis of a 360-day year comprised of twelve
30-day months.
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OPTIONAL REDEMPTION
Except as described below, the Notes will not be redeemable before April 1,
2005. After April 1, 2005, the Notes may be redeemed at the option of the
Company, in whole or in part, at the redemption prices (expressed as percentages
of principal amount) described below plus accrued and unpaid interest and
liquidated damages, if any, on the Notes redeemed to the applicable redemption
date, if redeemed during the twelve-month period beginning on April 1 of the
years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2005........................................................ 106.500%
2006........................................................ 104.330%
2007........................................................ 102.166%
2008 and thereafter......................................... 100.000%
</TABLE>
If, before April 1, 2003, the Company sells Capital Stock, other than
Disqualified Stock, in one or more Equity Offerings, up to a maximum of 35% of
the aggregate principal amount of the Notes originally issued, including any
Additional Notes issued under the Indenture, will, at the option of the Company,
be redeemable from the net cash proceeds of one or more Equity Offerings (but
only to the extent the proceeds of the Equity Offering consist of cash or
readily marketable cash equivalents) at a redemption price equal to 113.0% of
the principal amount of the Notes plus accrued and unpaid interest and
liquidated damages, if any, on the Notes redeemed to the redemption date,
provided that:
(1) at least 65% of the aggregate principal amount of the Notes
originally issued, including any Additional Notes issued under the
Indenture, remain outstanding immediately after the redemption; and
(2) the redemption occurs within 90 days of the date of the closing of
the Equity Offering.
MANDATORY REDEMPTION
Except as described below under the subheadings "Offer to Purchase Upon
Change of Control" and "Offer to Purchase with Excess Asset Sale Proceeds," the
Company will not be required to make mandatory redemption or sinking fund
payments with respect to the Notes.
OFFER TO PURCHASE UPON CHANGE OF CONTROL
Upon the occurrence of a Change of Control, the Company will be required to
make an offer (the "Change of Control Offer") to each holder of Notes to
repurchase all or any part of the holder's Notes at a purchase price equal to
101% of the aggregate principal amount of the Notes plus accrued and unpaid
interest and liquidated damages, if any, on the Notes to the date of purchase
(the "Change of Control Payment"). The Change of Control Offer must be commenced
within 30 days following a Change of Control, must remain open for at least 30
and not more than 40 days, unless required by applicable law, and must comply
with the requirements of Rule 14e-1 under the Exchange Act and any other
applicable securities laws and regulations.
Except as described above with respect to a Change of Control, the
Indenture will not contain provisions that permit the holders of the Notes to
require that the Company repurchase or redeem the Notes if a takeover,
recapitalization or similar transaction occurs.
Due to the leveraged structure of the Company and the effective
subordination of the Notes to secured Indebtedness of the Company and
Indebtedness of the Company's Subsidiaries, the Company may not have sufficient
funds available to purchase the Notes tendered in response to a Change of
Control Offer. In addition, other agreements relating to Indebtedness of the
Company's Subsidiaries may contain prohibitions or restrictions on the Company's
ability to effect a Change of Control Payment.
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The definition of Change of Control includes a phrase relating to the sale,
lease, transfer, conveyance or other disposition of "all or substantially all"
of the Company's assets. Although there is a developing body of case law
interpreting the phrase "substantially all," there is no precise established
definition of the phrase under applicable law. Accordingly, the ability of a
holder of Notes to require the Company to repurchase the Notes as a result of a
sale, lease, transfer, conveyance or other disposition of less than all of the
assets of the Company to another Person may be uncertain.
OFFER TO PURCHASE WITH EXCESS ASSET SALE PROCEEDS
When the cumulative amount of Excess Proceeds (as defined below under the
subheading "Certain Covenants -- Asset Sales") exceeds $10.0 million, the
Company will make an offer to all holders of Notes and Pari Passu Notes (an
"Excess Proceeds Offer"), to purchase the maximum principal amount of Notes and
Pari Passu Notes that may be purchased out of the Excess Proceeds, at a price in
cash equal to 100% of the outstanding principal amount of the Notes and 100% of
the accreted value or 100% of the outstanding principal amount, as applicable,
of the Pari Passu Notes, plus accrued and unpaid interest and liquidated
damages, if any, on the Notes and Pari Passu Notes to the date fixed for the
closing of the offer. The Company may also voluntarily use the Net Proceeds of
any Asset Sale to make at any time an Excess Proceeds Offer.
If the aggregate principal amount and/or accreted value, as the case may
be, of Notes and Pari Passu Notes surrendered by holders exceeds the amount of
Excess Proceeds, the Trustee will select the Notes and Pari Passu Notes to be
purchased on a pro rata basis. To the extent that the aggregate amount of Notes
and Pari Passu Notes tendered as a result of an Excess Proceeds Offer is less
than the amount of Excess Proceeds, the Company may use the deficiency for
general purposes. After an Excess Proceeds Offer, the amount of Excess Proceeds
will be reset at zero.
SELECTION OF NOTES FOR REDEMPTION OR OFFERS TO PURCHASE
If less than all of the Notes are to be redeemed or purchased, selection of
Notes for redemption or purchase will be made by the Trustee as follows:
(1) if the Notes are listed, in compliance with the requirements of
the principal national securities exchange on which the Notes are listed;
or
(2) if the Notes are not listed, on a pro rata basis, by lot or by any
other method the Trustee deems fair and appropriate.
No Note with a principal amount of $1,000 or less will be redeemed or
purchased in part. A new Note in principal amount equal to the unredeemed or
unpurchased portion will be issued in the name of the holder upon cancellation
of the original Note. On and after the redemption or purchase date, interest
will cease to accrue on the Notes or portions of them called for redemption or
purchase.
NOTICE OF REDEMPTION
Notice of redemption will be mailed by first class mail at least 30 but not
more than 60 days before the redemption date to each holder of Notes to be
redeemed at its registered address. If any Note is to be redeemed in part only,
the notice of redemption will state the portion of the principal amount to be
redeemed.
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CERTAIN COVENANTS
Restricted Payments
The Company and its Restricted Subsidiaries may not, directly or
indirectly:
(a) declare or pay any dividend or make any distribution on account of
any Equity Interests of the Company or any of its Restricted Subsidiaries
other than dividends or distributions payable:
(A) in Equity Interests of the Company that are not Disqualified
Stock;
(B) to the Company or any Restricted Subsidiary;
(C) on Disqualified Stock permitted to be incurred under the
covenant described below under the subheading "Incurrence of
Indebtedness and Issuance of Disqualified Stock;" or
(D) pro rata on Common Stock of Restricted Subsidiaries held by
minority stockholders;
(b) purchase, redeem, defease, retire or otherwise acquire for value
("Retire" and correlatively, a "Retirement") any Equity Interests of the
Company or any of its Restricted Subsidiaries or other Affiliate of the
Company (other than any Equity Interests owned by the Company or any
Restricted Subsidiary);
(c) Retire for value any Indebtedness of the Company that is
subordinate in right of payment to the Notes, except at final maturity or
in accordance with the mandatory redemption or repayment provisions
specified in the original documentation governing the Indebtedness; or
(d) make any Restricted Investment;
(all the payments and other actions described in clauses (a) through (d) above
being collectively referred to as "Restricted Payments"), unless, at the time of
the Restricted Payment:
(1) no Default or Event of Default has occurred and is continuing or
would occur as a consequence of the Restricted Payment;
(2) after giving effect to the Restricted Payment on a pro forma basis
as if the Restricted Payment had been made at the beginning of the
applicable period, the Company could incur at least $1.00 of additional
Indebtedness under the Consolidated Cash Flow Leverage Ratio test described
under the subheading "Incurrence of Indebtedness and Issuance of
Disqualified Stock;" and
(3) the Restricted Payment, together with the aggregate of all other
Restricted Payments made by the Company and its Restricted Subsidiaries
after January 1, 2000 (including any Restricted Payments made as permitted
by clauses (a), (e) and (f) of the next paragraph), minus any Restricted
Payment Credits, is less than the sum of:
(x) 50% of the Consolidated Net Income of the Company for the
period (taken as one accounting period) from January 1, 2000 to the end
of the Company's most recently ended fiscal quarter for which internal
financial statements are available at the time of the Restricted Payment
(or, if Consolidated Net Income for that period is a deficit, less 100%
of the deficit); plus
(y) 100% of the aggregate net cash proceeds received by the Company
from the issue or sale of Equity Interests of the Company or of debt
securities or Disqualified Stock of the Company that have been converted
into Equity Interests (other than Equity Interests or convertible debt
securities sold to a Restricted Subsidiary and other than Disqualified
Stock
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or debt securities that have been converted into Disqualified Stock)
after January 1, 2000 (other than any Equity Interests, the proceeds of
which were used as described in clause (b) below); plus
(z) For each issuance of Common Stock of the Company after January
1, 2000 as consideration in a transaction which results in either (a) a
Person becoming a Restricted Subsidiary, (b) a Person being merged or
consolidated with or into the Company or a Restricted Subsidiary, or (c)
a Person conveying all or substantially all of its assets to the Company
or a Restricted Subsidiary, 100% of the product of (A) the average
Closing Price of the Common Stock for the 20 consecutive Trading Days
immediately preceding the date of issuance and (B) the number of shares
of Common Stock issued as consideration in the transaction.
The following Restricted Payments will be permitted:
(a) the payment of any dividend within 60 days after the date of
declaration of the dividend, if on the date of declaration the payment
would have complied with the provisions of the Indenture;
(b) the Retirement of:
(A) any Equity Interests of the Company or any Restricted
Subsidiary of the Company; or
(B) Indebtedness of the Company that is subordinate to the Notes;
in exchange for, or out of the proceeds of the substantially concurrent
sale (other than to a Restricted Subsidiary) of, Equity Interests of the
Company, other than Disqualified Stock;
(c) the Retirement of any Indebtedness of the Company subordinated in
right of payment to the Notes in exchange for, or out of the proceeds of,
the substantially concurrent incurrence of Indebtedness of the Company
(other than to a Restricted Subsidiary), but only to the extent that the
new Indebtedness is permitted under the covenant described below under the
subheading "Incurrence of Indebtedness and Issuance of Disqualified Stock"
and:
(A) is subordinated in right of payment to the Notes at least to
the same extent as any equivalent amount of principal under the
Indebtedness so Retired;
(B) has a Weighted Average Life to Maturity at least as long as any
equivalent amount of principal under the Indebtedness so Retired; and
(C) has no scheduled principal payments due in any amount earlier
than any equivalent amount of principal under the Indebtedness so
Retired;
(d) the Retirement of any Indebtedness of the Company in exchange for,
or out of the proceeds of, the substantially concurrent incurrence of
Indebtedness of the Company or any Restricted Subsidiary but only to the
extent that:
(A) the incurrence is permitted under the covenant described below
under the subheading "Incurrence of Indebtedness and Issuance of
Disqualified Stock;" and
(B) the Indebtedness:
(x) is not secured by any assets of the Company to a greater
extent than the Indebtedness so Retired was so secured;
(y) has a Weighted Average Life to Maturity at least as long as
the Indebtedness so Retired; and
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(z) is pari passu or subordinated in right of payment to the
Notes at least to the same extent as the Indebtedness so Retired;
(e) the Retirement of any Equity Interests of the Company or any
Restricted Subsidiary of the Company held by any member of the Company's or
any of its Subsidiaries' management under any management equity
subscription agreement or stock option agreement; provided that the
aggregate price paid for all repurchased, redeemed, acquired or retired
Equity Interests may not exceed $1.0 million in any twelve-month period
plus the aggregate cash proceeds received by the Company during that
twelve-month period from any reissuance of Equity Interests by the Company
to members of management of the Company and its Subsidiaries;
(f) the payment of cash in lieu of fractional shares:
(A) payable as dividends on Equity Interests of the Company; or
(B) issuable upon conversion of or in exchange for securities
convertible into or exchangeable for Equity Interests of the Company; or
(C) issuable as a result of a corporate reorganization;
provided that, in the case of (A) and (B), the issuance of Equity Interests
or securities and, in the case of (C), the corporate reorganization, was
permitted under the terms of the Indenture;
(g) the Retirement of Equity Interests of the Company that may be
deemed to occur upon the exercise of options to acquire Capital Stock of
the Company if options are used to pay all or a portion of the exercise
price of the options;
(h) the Retirement of Equity Interests of a Restricted Subsidiary to
the extent required by applicable law as a result of the exercise of
dissenters' rights by minority shareholders of a Person who becomes a
Restricted Subsidiary; provided that the aggregate amount paid for the
Retirement of Equity Interests pursuant to this clause (h) may not exceed
$25.0 million; and
(i) other Restricted Payments made by the Company or any Restricted
Subsidiary, provided that the aggregate amount of all Restricted Payments
made pursuant to this clause (i) may not exceed $2.0 million;
provided, except in the case of clauses (a), (b), (c), (d) and (g), no Default
or Event of Default will have occurred and be continuing or occur as a
consequence of the actions or payments set forth therein.
A Permitted Investment that ceases to be a Permitted Investment within the
meaning of that term, will become a Restricted Investment and will be deemed to
have been made on the date that it ceases to be a Permitted Investment.
The Board of Directors may designate any Subsidiary as an Unrestricted
Subsidiary if the designation would not cause a Default or an Event of Default,
provided, the Company may not designate any Subsidiary which holds any permit or
license which is material to the operations of the Company and its Restricted
Subsidiaries taken as a whole as an Unrestricted Subsidiary.
For purposes of determining if the designation is permitted, all
outstanding Investments by the Company and its Restricted Subsidiaries in the
Subsidiary to be designated will be deemed to be Restricted Payments at the time
of the designation, except to the extent repaid in cash, and will reduce the
amount available for Restricted Payments under the first paragraph of this
covenant. All
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outstanding Investments will be deemed to constitute Investments in an amount
equal to the greatest of:
(x) the net book value of the Investments at the time of the
designation;
(y) the fair market value of the Investments at the time of the
designation; and
(z) the original fair market value of the Investments at the time they
were made.
The designation will only be permitted if the Restricted Payment would be
permitted at that time.
The Board of Directors of the Company may at any time designate any
Unrestricted Subsidiary as a Restricted Subsidiary; provided that the
designation will be deemed to be an incurrence of Indebtedness by a Restricted
Subsidiary of the Company of any outstanding Indebtedness of the Unrestricted
Subsidiary and the designation will only be permitted if:
(x) the Indebtedness is permitted under the covenant described under
the subheading "Incurrence of Indebtedness and Issuance of Disqualified
Stock;" and
(y) no Default or Event of Default would be in existence following the
designation.
No later than the date any Restricted Payment is made, the Company must
deliver to the Trustee an Officers' Certificate stating that the Restricted
Payment is permitted and setting forth the basis upon which the calculations
required by the covenant described under this subheading were computed, which
calculations may be based upon the Company's latest available financial
statements. The Trustee will have no duty or obligation to confirm or verify the
calculations in the Officers' Certificate.
Incurrence of Indebtedness and Issuance of Disqualified Stock
The Company and its Restricted Subsidiaries may not:
(x) directly or indirectly, create, incur, issue, assume, guarantee or
otherwise become directly or indirectly liable for the payment of
(collectively, "incur" and, correlatively, "incurred" and "incurrence") any
Indebtedness, including Acquired Debt; or
(y) issue any Disqualified Stock;
provided, the Company and/or any of its Restricted Subsidiaries may incur
Indebtedness, including Acquired Debt, or issue shares of Disqualified Stock if,
after giving effect to the incurrence of the Indebtedness or the issuance of the
Disqualified Stock, the Consolidated Cash Flow Leverage Ratio for the Company,
determined on a pro forma basis (including a pro forma application of the net
proceeds therefrom), as if the additional Indebtedness had been incurred, or the
Disqualified Stock had been issued, at the beginning of the period used to
calculate the Consolidated Cash Flow Leverage Ratio, does not exceed 6.0 to 1.
If the Company incurs any Indebtedness or issues or redeems any Preferred
Stock after the beginning of the period for which the ratio is being calculated
but before the event for which the calculation of the ratio is made, then the
ratio will be calculated giving pro forma effect to that incurrence of
Indebtedness, or that issuance or redemption of Preferred Stock, as if the same
had occurred at the beginning of the applicable period. In making the
calculation on a pro forma basis, interest attributable to Indebtedness bearing
a floating interest rate will be computed as if the rate in effect on the date
of computation had been the applicable rate for the entire period.
The foregoing limitation will not apply to (with each exception to be given
independent effect):
(a) the incurrence by the Company and/or any of its Restricted
Subsidiaries of Indebtedness under the Credit Facility in an aggregate
principal amount at any one time
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outstanding (with letters of credit being deemed to have a principal amount
equal to the maximum potential liability of the Company and/or any of its
Restricted Subsidiaries under the letters of credit) not to exceed $150.0
million, less the aggregate amount of all Net Proceeds of Asset Sales
applied to permanently reduce the commitments with respect to the Credit
Facility as specified under the covenant described below under the
subheading "Asset Sales;"
(b) the incurrence by the Company and/or any of its Restricted
Subsidiaries of Vendor Indebtedness, provided that the aggregate amount of
the Vendor Indebtedness incurred does not exceed 100% of the total cost of
the Telecommunications Related Assets financed with the Vendor
Indebtedness;
(c) the incurrence by the Company and/or any of its Subsidiaries of
the Existing Indebtedness;
(d) the incurrence by the Company and/or any of its Restricted
Subsidiaries of Indebtedness in an aggregate amount not to exceed $25.0
million at any one time outstanding;
(e) the incurrence by the Company of Indebtedness, but only to the
extent the Indebtedness has a final maturity no earlier than the final
maturity of the Notes and a Weighted Average Life to Maturity equal to or
greater than the Weighted Average Life to Maturity of the Notes, in an
aggregate principal amount not to exceed 2.0 times the sum of the net cash
proceeds received by the Company after January 1, 2000 from the issuance
and sale of Equity Interests of the Company, other than Disqualified Stock,
or the issuance and sale of debt securities or Disqualified Stock of the
Company that have been converted into Equity Interests, in each case, other
than Equity Interests or convertible debt securities sold to a Restricted
Subsidiary, plus the fair market value of Equity Interests, other than
Disqualified Stock, or the issuance and sale of debt securities or
Disqualified Stock of the Company that have been converted into Equity
Interests, issued after January 1, 2000 in connection with an acquisition
of a Telecommunications Business or Telecommunications Related Assets;
(f) the incurrence (a "Permitted Refinancing") by the Company and/or
any of its Restricted Subsidiaries of Indebtedness issued in exchange for,
or the proceeds of which are used to refinance, replace, refund or defease
("Refinance" and correlatively, "Refinanced" and "Refinancing")
Indebtedness, other than Indebtedness incurred under clause (a) above, but
only to the extent that:
(1) the net proceeds of the Refinancing Indebtedness do not exceed
the principal amount of and premium, if any, and accrued interest on the
Indebtedness so Refinanced (or if the Indebtedness was issued at an
original issue discount, the original issue price plus amortization of
the original issue discount at the time of repayment of the Indebtedness
so Refinanced) plus the fees, expenses and costs of the Refinancing and
prepayment premiums, if any, in connection the Refinancing;
(2) the Refinancing Indebtedness has a final maturity no earlier
than, and a Weighted Average Life to Maturity equal to or greater than,
the final maturity and Weighted Average Life to Maturity of the
Indebtedness being Refinanced; and
(3) if the Indebtedness being Refinanced is subordinated in right
of payment to the Notes, the Refinancing Indebtedness is subordinated in
right of payment to the Notes on terms at least as favorable to the
holders of Notes as those contained in the documentation governing the
Indebtedness being Refinanced;
(g) the incurrence by the Company or any of its Restricted
Subsidiaries of intercompany Indebtedness between or among the Company and
any of its Restricted Subsidiaries;
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(h) the incurrence by the Company or any of its Restricted
Subsidiaries of Hedging Obligations that are incurred for the purpose of
fixing or hedging interest rate or foreign currency risk with respect to
any floating rate Indebtedness that is permitted by the terms of the
Indenture to be outstanding;
(i) the incurrence of Acquired Debt, to the extent that the principal
amount of the Acquired Debt does not exceed the aggregate book value of the
Telecommunications Related Assets acquired concurrently with the incurrence
of the Acquired Debt; and
(j) the incurrence by the Company of Indebtedness to the extent the
net proceeds thereof are promptly:
(1) used to purchase Notes tendered in a Change of Control Offer
made as a result of a Change of Control; or
(2) deposited to defease the Notes as described below under the
subheading "Legal Defeasance and Covenant Defeasance."
For purposes of determining compliance with this covenant, if an item of
Indebtedness meets the criteria of more than one of the categories described in
clauses (a) through (i) above or is entitled to be incurred under the first
paragraph of this covenant, the Company, in its sole discretion, will classify,
and may from time to time reclassify, the item in any manner that complies with
this covenant and the item will be treated as having been incurred under only
one of those clauses or under the first paragraph of this subheading. Accrual of
interest or dividends, the accretion of accreted value or liquidation preference
and the payment of interest or dividends in the form of additional Indebtedness,
Common Stock or Preferred Stock will not be deemed to be an incurrence of
Indebtedness for purposes of this covenant.
Asset Sales
The Company and its Restricted Subsidiaries may not, whether in a single
transaction or a series of related transactions occurring within any
twelve-month period:
(1) sell, lease, convey, dispose or otherwise transfer any assets
(including by way of a Sale and Leaseback Transaction) other than sales,
leases, conveyances, dispositions or other transfers:
(A) in the ordinary course of business;
(B) to the Company by any Restricted Subsidiary or from the Company
to any Restricted Subsidiary;
(C) that constitute a Restricted Payment, Investment or dividend or
distribution permitted under the covenant described above under the
subheading "Restricted Payments;" or
(D) that constitute the disposition of all or substantially all of
the assets of the Company under the covenant described below under the
subheading "Merger, Consolidation or Sale of Assets;" or
(2) issue or sell Equity Interests in any of its Restricted
Subsidiaries (other than an issuance or sale of Equity Interests of any
Restricted Subsidiary to the Company or a Restricted Subsidiary);
if the assets or securities:
(x) have a Fair Market Value in excess of $2.0 million (excluding the
Fair Market Value of Telecommunications Equipment sold to ILECs in
connection with establishing virtual collocation arrangements with the
ILECs); or
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(y) are sold or otherwise disposed of for Net Proceeds in excess of
$2.0 million;
(each of the foregoing, an "Asset Sale"), unless:
(a) no Default or Event of Default exists or would occur as a result
of the Asset Sale;
(b) the Company, or the Restricted Subsidiary, as the case may be,
receives (except in the case of sales of Telecommunications Equipment to
ILECs in connection with establishing virtual collocation arrangements with
the ILECs) consideration at the time of the Asset Sale at least equal to
the Fair Market Value of the assets or securities issued or sold or
otherwise disposed of; evidenced by a resolution of the Board of Directors
of the Company set forth in an Officers' Certificate delivered to the
Trustee; and
(c) at least 75% of the consideration received by the Company or the
Restricted Subsidiary is in the form of cash, provided:
(A) the amount of:
(x) any liabilities (as shown on the Company's or the Restricted
Subsidiary's most recent balance sheet or in the notes thereto) of
the Company or any Restricted Subsidiary, other than liabilities that
are by their terms subordinated to the Notes, that are assumed by the
transferee of any of the assets pursuant to a customary novation
agreement that releases the Company or the Restricted Subsidiary from
further liability; and
(y) any notes, obligations or other securities received by the
Company or any Restricted Subsidiary from the transferee that are
immediately converted by the Company or the Restricted Subsidiary
into cash;
will be deemed to be cash (to the extent of the cash received in the
case of subclause (y)) for purposes of this clause (c); and
(B) an amount equal to the Fair Market Value (determined as
described in clause (b) above) of Telecommunications Related Assets
received by the Company or any Restricted Subsidiary in connection with
the Asset Sale that will be used by the Company or any Restricted
Subsidiary in the operation of a Telecommunications Business in the
United States will be deemed to be cash for purposes of this clause (c).
The foregoing provisions will not apply to a sale, lease, conveyance or
other disposition of all or substantially all of the assets of the Company,
which will be governed by the provisions of the Indenture described below under
the subheading "Merger Consolidation, or Sale of Assets."
Within 365 days after the receipt of Net Proceed of any Asset Sale, the
Company (or the Restricted Subsidiary, as the case may be) may apply the Net
Proceeds from the Asset Sale to:
(a) permanently reduce the amounts permitted to be borrowed by the
Company under the terms of any of its Senior Indebtedness;
(b) the purchase of Telecommunications Related Assets or Voting Stock
of any Person engaged in the Telecommunications Business in the United
States (provided that Person concurrently becomes a Restricted Subsidiary
of the Company);
(c) make a voluntary Excess Proceeds Offer as described under the
subheading "Offer to Purchase with Excess Asset Sale Proceeds."
Any Net Proceeds from any Asset Sales that are not so applied or invested
will constitute "Excess Proceeds." When the aggregate amount of Excess Proceeds
exceeds $10.0 million, the
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Company will be required to make an Excess Proceeds Offer as described under the
subheading "Offer to Purchase with Excess Asset Sale Proceeds."
Liens
The Company and its Restricted Subsidiaries may not, directly or
indirectly, create, incur, assume or suffer to exist any Lien on any asset now
owned or hereafter acquired, or any income or profits therefrom or assign or
convey any right to receive income therefrom, except for Permitted Liens.
Dividend and Other Payment Restrictions Affecting Subsidiaries
The Company and its Restricted Subsidiaries may not, directly or
indirectly, create or otherwise cause to become effective any consensual
encumbrance or restriction on the ability of any Restricted Subsidiary to:
(1) pay dividends or make any other distributions to the Company or
any of its Restricted Subsidiaries on its Capital Stock or with respect to
any other interest or participation in, or measured by, its profits, or pay
any Indebtedness owed to the Company or any of its Restricted Subsidiaries;
(2) make loans or advances to the Company or any of its Restricted
Subsidiaries;
(3) transfer any of its properties or assets to the Company or any of
its Restricted Subsidiaries.
The foregoing shall not restrict any encumbrances or restrictions:
(a) existing as of the Issue Date;
(b) existing under or by reason of applicable law;
(c) existing with respect to any Person or the property or assets of a
Person acquired by the Company or any Restricted Subsidiary, existing at
the time of the acquisition and not incurred in contemplation of the
acquisition, which encumbrances or restrictions are not applicable to any
Person, or the properties or assets of any Person, other than the Person,
or the property or assets of the Person, so acquired;
(d) existing by reason of customary non-assignment provisions in
leases entered into in the normal course of business and consistent with
past practices;
(e) existing under or by reason of Indebtedness in respect of a
Permitted Refinancing, provided that the restrictions contained in the
agreements governing the Refinancing Indebtedness are not materially more
restrictive than those contained in the agreements governing the
Indebtedness being refinanced;
(f) with respect to clause (3) above, existing under or by reason of
performance bonds or similar security for performance which encumbrances or
restrictions do not cover any asset other than the asset associated with
the Company's performance;
(g) existing under or by reason of Indebtedness incurred under clauses
(a) or (b) of the covenant described under the subheading "Incurrence of
Indebtedness and Issuance of Disqualified Stock;"
(h) existing under or by reason of the Indenture or the Notes;
(i) with respect to a Restricted Subsidiary, imposed pursuant to an
agreement that has been entered into for the sale or disposition of all or
substantially all of the Capital Stock of, or
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property and assets of, the Restricted Subsidiary, provided the sale or
disposition is permitted by the terms of the Indenture; or
(j) in the case of clauses (a), (c), (d), (e), (f), (g), (h) and (i)
above, any amendments, modifications, restatements, renewals, increases,
supplements, refundings, replacements or refinancings; provided the
amendments, modifications, restatements, renewals, increases, supplements,
refundings, replacements or refinancings are not materially more
restrictive with respect to dividend and other payment restrictions than
those contained in the instruments as in effect on the date of their
incurrence or, if later, the Issue Date.
Merger, Consolidation or Sale of Assets
The Company may not consolidate or merge with or into (whether or not the
Company is the surviving entity), or sell, assign, transfer, lease, convey or
otherwise dispose of all or substantially all of its properties or assets in one
or more related transactions to, another corporation, Person or entity unless:
(a) the Company is the surviving entity or the entity or Person formed
by or surviving any consolidation or merger, if other than the Company, or
to which the sale, assignment, transfer, lease, conveyance or other
disposition has been made is a corporation organized or existing under the
laws of the United States, any state of the United States or the District
of Columbia;
(b) the entity or Person formed by or surviving any consolidation or
merger, if other than the Company, or the entity or Person to which the
sale, assignment, transfer, lease, conveyance or other disposition has been
made, if other than a wholly owned Restricted Subsidiary, assumes all the
obligations of the Company under the Notes and the Indenture pursuant to a
supplemental indenture in form reasonably satisfactory to the Trustee;
(c) immediately after the transaction no Default or Event of Default
exists;
(d) except in connection with a merger or consolidation with or into a
wholly owned Restricted Subsidiary or a sale, assignment, transfer, lease,
conveyance or other disposition to a wholly owned Restricted Subsidiary,
the Company, or any entity or Person formed by or surviving the
consolidation or merger, or to which the sale, assignment, transfer, lease,
conveyance or other disposition has been made, at the time of the
transaction after giving pro forma effect to the transaction as if the
transaction had occurred at the beginning of the applicable fiscal quarter
(including any Indebtedness incurred or anticipated to be incurred in
connection with or in respect of the transaction) could either:
(A) incur at least $1.00 of additional Indebtedness under the
Consolidated Cash Flow Leverage Ratio test described under the
subheading "Incurrence of Indebtedness and Issuance of Disqualified
Stock;" or
(B) would have (x) Total Market Capitalization of at least $1.0
billion and (y) total Indebtedness (net of cash and cash equivalents
that are not restricted cash or restricted cash equivalents as reflected
on the Company's consolidated balance sheet as of the time of such
event) in an amount not greater than 30% of its Total Market
Capitalization; and
(e) the transaction would not result in the loss, material impairment
or adverse modification or amendment of any authorization or license of the
Company or its Restricted Subsidiaries that would have a material adverse
effect on the business or operations of the Company and its Restricted
Subsidiaries taken as a whole; and
(f) the Company has delivered to the Trustee an Officer's Certificate
and an Opinion of Counsel each to the effect that, with respect to the
transaction, items (a) through (e) as stated above have been satisfied.
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Transactions with Affiliates
The Company and its Restricted Subsidiaries may not sell, lease, transfer
or otherwise dispose of any of their respective properties or assets to, or
purchase any property or assets from, or enter into any contract, agreement,
understanding, loan, advance or guarantee with, or for the benefit of, any
Affiliate (each of the foregoing, an "Affiliate Transaction"), unless:
(a) the Affiliate Transaction is on terms that are no less favorable
to the Company or the relevant Restricted Subsidiary than those that would
have been obtained in a comparable transaction by the Company or the
Restricted Subsidiary with an unrelated Person;
(b) the Affiliate Transaction is approved by a majority of the
disinterested directors on the Board of Directors of the Company;
(c) the Company delivers to the Trustee, with respect to any Affiliate
Transaction involving aggregate payments in excess of $5.0 million, a
resolution of a committee of independent directors of the Company set forth
in an Officers' Certificate certifying that the Affiliate Transaction
complies with clauses (a) and (b) above; and
(d) the Company delivers to the Trustee, with respect to any Affiliate
Transaction involving aggregate payments in excess of $10.0 million, an
opinion of an Independent Appraiser that the terms of the Affiliate
Transaction are fair to the Company or the Restricted Subsidiary, as the
case may be, from a financial point of view;
provided that:
(1) transactions under any employment, stock option or stock purchase
agreement entered into by the Company or any of its Restricted
Subsidiaries, or any grant, issuance or sale of stock, in the normal course
of business that are approved by the Board of Directors of the Company;
(2) transactions between or among the Company and its Restricted
Subsidiaries;
(3) transactions permitted by the provisions of the Indenture
described above under the subheading "Restricted Payments;"
(4) loans and advances to employees and officers of the Company or any
of its Restricted Subsidiaries in the normal course of business in an
aggregate principal amount not to exceed $1.0 million at any one time
outstanding; and
(5) transactions under existing contracts to which the Company is a
party in accordance with the terms of those contracts as they exist on the
Issue Date;
will be deemed not to be Affiliate Transactions.
Business Activities
The Company and its Restricted Subsidiaries may not, directly or
indirectly, engage in any business other than the Telecommunications Business.
Limitations on Sale and Leaseback Transactions
The Company and its Restricted Subsidiaries may not, directly or
indirectly, enter into, assume, Guarantee or otherwise become liable with
respect to any Sale and Leaseback Transaction, unless:
(a) the Company or the Restricted Subsidiary would be permitted under
the covenants described above under the subheadings "Incurrence of
Indebtedness and Issuance of Disqualified Stock" and "Liens" to incur
secured Indebtedness in an amount equal to the Attributable Debt with
respect to the transaction;
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(b) the consideration received by the Company or the Restricted
Subsidiary from the transaction is at least equal to the Fair Market Value
of the property being transferred; and
(c) the Net Proceeds received by the Company or the Restricted
Subsidiary from the transaction are applied as required by the covenant
described above under the subheading "Asset Sales."
Reports
The Company will file with the Trustee within 15 days after it files them
with the SEC copies of the annual and quarterly reports and the information,
documents, and other reports that the Company is required to file with the SEC
pursuant to Section 13(a) or 15(d) of the Exchange Act ("SEC Reports"). If the
Company is not required or ceases to be required to file SEC Reports pursuant to
the Exchange Act, the Company will nevertheless continue to file reports with
the SEC (unless the SEC will not accept the filing) and the Trustee. So long as
any Notes are outstanding, the Company will furnish copies of the SEC Reports to
the holders of Notes at the time the Company is required to file the same with
the Trustee and make the SEC Reports available to investors who request it in
writing. In addition, the Company has agreed that, for so long as any Notes
remain outstanding, it will furnish to the holders and to securities analysts
and prospective investors, upon their request, the information required to be
delivered pursuant to Rule 144A(d)(4) under the Securities Act.
Payments for Consents
Neither the Company nor any of its Affiliates will, directly or indirectly,
pay or cause to be paid any consideration, whether by way of interest, fee or
otherwise, to any holder of Notes for or as an inducement to any consent, waiver
or amendment of any of the terms or provisions of the Indenture or the Notes
unless the consideration is offered to be paid or agreed to be paid to all
holders of Notes that consent, waive or agree to amend in the time frame
specified in the solicitation documents relating to the consent, waiver or
agreement.
EVENTS OF DEFAULT AND REMEDIES
Each of the following constitutes an Event of Default:
(a) default for 30 days in the payment when due of interest, or
liquidated damages, if any, on the Notes;
(b) default in payment when due of principal or premium, if any, on
the Notes at maturity, upon redemption or otherwise;
(c) failure by the Company to perform or comply with the provisions of
the covenants described above under the subheadings "Offer to Purchase Upon
Change of Control," "Asset Sales," "Restricted Payments," "Incurrence of
Indebtedness and Issuance of Disqualified Stock" or "Merger, Consolidation
or Sale of Assets;"
(d) failure by the Company for 30 days after notice from the Trustee
or the holders of at least 25% of the principal amount of Notes then
outstanding to comply with its other agreements in the Indenture or the
Notes;
(e) default under any mortgage, indenture or instrument under which
there may be issued or by which there may be secured or evidenced any
Indebtedness for money borrowed by the Company or any of its Restricted
Subsidiaries (or the payment of which is guaranteed by the
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Company or any of its Restricted Subsidiaries), whether the Indebtedness or
Guarantee now exists, or is created after the Issue Date, which default:
(x) is caused by a failure to pay when due principal, premium, if
any, or interest on the Indebtedness within the grace period provided by
that Indebtedness (a "Payment Default"), and the principal amount of
that Indebtedness, together with the principal amount of any other
Indebtedness of the Company or any Significant Subsidiary under which
there has been a Payment Default or the maturity of which has been
accelerated as provided in clause (y), aggregates $5.0 million or more;
or
(y) results in the acceleration (which acceleration has not been
rescinded) of that Indebtedness before its express maturity and the
principal amount of that Indebtedness, together with the principal
amount of any other Indebtedness under which there has been a Payment
Default or the maturity of which has been so accelerated, aggregates
$5.0 million or more;
(f) failure by the Company or any of its Significant Subsidiaries to
pay final judgments (other than any judgment as to which a reputable
insurance company has accepted full liability in writing) aggregating in
excess of $5.0 million which judgments are not paid, discharged or stayed
within 45 days after their entry; and
(g) certain events of bankruptcy or insolvency with respect to the
Company or any of its Significant Subsidiaries.
If any Event of Default occurs and is continuing under the Indenture, the
Trustee or the holders of at least 25% of the principal amount of Notes then
outstanding may declare all the Notes to be due and payable immediately. Upon
any declaration, the principal of, premium, if any, and accrued and unpaid
interest and liquidated damages, if any, on the Notes will be due and payable
immediately. In the case of an Event of Default arising from certain events of
bankruptcy or insolvency with respect to the Company or any of its Significant
Subsidiaries, the foregoing amount will automatically become due and payable
without further action or notice.
No premium is payable upon acceleration of the Notes except that in the
case of an Event of Default that is the result of an action or inaction by the
Company or any of its Restricted Subsidiaries intended to avoid restrictions on
or premiums related to redemptions of the Notes contained in the Indenture or
the Notes, the amount declared due and payable will include the premium that
would have been applicable on a voluntary prepayment of the Notes or, if
voluntary prepayment is not then permitted, the premium specified in the
Indenture.
Holders of the Notes may not enforce the Indenture or the Notes except as
provided in the Indenture. Generally, holders of a majority of the principal
amount of Notes then outstanding may direct the Trustee in its exercise of any
trust or power. The Trustee may withhold from holders of the Notes notice of any
continuing Default or Event of Default, except a Default or Event of Default
relating to the payments of principal or interest, if it determines that
withholding notice is in the holders' interest.
The holders of a majority of the aggregate principal amount of Notes then
outstanding, by notice to the Trustee, may, on behalf of the holders of all of
the Notes, waive any existing Default or Event of Default and its consequences
under the Indenture, except a continuing Default or Event of Default in the
payment of interest or liquidated damages or premium on, or the principal of,
the Notes.
The Company is required to deliver to the Trustee a statement regarding
compliance with the Indenture annually. The Company is also required, upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying the Default or Event of Default.
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NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company,
in that capacity, will have any liability for any obligations of the Company
under the Notes or the Indenture or for any claim based on, in respect of, or by
reason of those obligations or their creation. Each holder of Notes by accepting
a Note waives and releases all the above described liability. The waiver and
release are part of the consideration for the issuance of the Notes. This waiver
may not be effective to waive liabilities under the federal securities laws and
it is the view of the SEC that a waiver of liabilities under the federal
securities laws is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance"). Legal Defeasance means that the Company will be deemed to have
paid the entire indebtedness represented by the outstanding Notes and discharged
all of its obligations under the Indenture, except for:
(a) the rights of holders of outstanding Notes to receive from the
trust described below payments of the principal of, premium, if any, and
interest on and liquidated damages with respect to the Notes when the
payments are due, or on the redemption date, as the case may be;
(b) the Company's obligations with respect to the Notes concerning
issuing temporary Notes, registration of Notes, mutilated, destroyed, lost
or stolen Notes and the maintenance of an office or agency for payment and
money for security payments held in trust;
(c) the rights, powers, trust, duties and immunities of the Trustee,
and the Company's obligations in connection with the Legal Defeasance; and
(d) the Legal Defeasance provisions of the Indenture.
In addition, the Company may, at its option and at any time, elect to have
the obligations of the Company with respect to certain covenants that are
specified in the Indenture released ("Covenant Defeasance") and thereafter any
omission to comply with those obligations will not constitute a Default or Event
of Default. If Covenant Defeasance occurs, certain events (not including
nonpayment, bankruptcy, receivership, rehabilitation and insolvency events)
described under the subheading "Events of Default" will no longer constitute an
Event of Default.
To exercise either Legal Defeasance or Covenant Defeasance:
(a) the Company must irrevocably deposit with the Trustee, in trust,
for the benefit of the holders of the Notes, cash in U.S. dollars,
non-callable U.S. government obligations, or a combination of cash and
non-callable U.S. government obligations, in an amount as will be
sufficient, in the opinion of a nationally recognized firm of independent
public accountants selected by the Company, to pay the principal of,
premium and liquidated damages, if any, and interest on the outstanding
Notes, on the stated maturity or on the applicable optional redemption
date, as the case may be;
(b) in the case of Legal Defeasance, the Company must deliver to the
Trustee an opinion of counsel in the United States reasonably acceptable to
the Trustee confirming that:
(A) the Company has received from, or there has been published by,
the Internal Revenue Service a ruling; or
(B) since the Issue Date, there has been a change in the applicable
federal income tax law;
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in either case to the effect that, and based thereon the opinion of counsel
will confirm that, the holders of the outstanding Notes will not recognize
income, gain or loss for federal income tax purposes as a result of the
Legal Defeasance and will be subject to federal income tax on the same
amounts, in the same manner and at the same times as would have been the
case if the Legal Defeasance had not occurred;
(c) in the case of Covenant Defeasance, the Company must deliver to
the Trustee an opinion of counsel in the United States reasonably
acceptable to the Trustee confirming that the holders of the outstanding
Notes will not recognize income, gain or loss for federal income tax
purposes as a result of the Covenant Defeasance and will be subject to
federal income tax on the same amounts, in the same manner and at the same
times as would have been the case if the Covenant Defeasance had not
occurred;
(d) no Default or Event of Default will have occurred and be
continuing on the date of the deposit (other than a Default or Event of
Default resulting from the borrowing of funds to be applied to the deposit)
or insofar as Events of Default from bankruptcy or insolvency events are
concerned, at any time in the period ending on the 91st day after the date
of deposit;
(e) the Legal Defeasance or Covenant Defeasance will not result in a
breach or violation of, or constitute a default under any material
agreement or instrument (other than the Indenture) to which the Company or
any of its Subsidiaries is a party or by which the Company or any of its
Subsidiaries is bound;
(f) the Company must have delivered to the Trustee an opinion of
counsel to the effect that after the 91st day (or other applicable date)
following the deposit, the trust funds will not be subject to the effect of
any applicable bankruptcy, insolvency, reorganization or similar laws
affecting creditors' rights generally;
(g) the Company must deliver to the Trustee an Officers' Certificate
stating that the deposit was not made by the Company with the intent of
preferring the holders of Notes over the other creditors of the Company
with the intent of defeating, hindering, delaying or defrauding creditors
of the Company or others; and
(h) the Company must deliver to the Trustee an Officers' Certificate
and an opinion of counsel, each stating that all conditions precedent
provided for in the Indenture relating to the Legal Defeasance or the
Covenant Defeasance have been complied with.
TRANSFER AND EXCHANGE
A holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a holder to pay any taxes and fees required by law or permitted by the
Indenture. The Company is not required to transfer or exchange any Note selected
for redemption. Also, the Company is not required to transfer or exchange any
Note for a period of 15 days before a selection of Notes to be redeemed.
The registered holder of a Note will be treated as the owner of it for all
purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next paragraph, the Indenture or the Notes may be
amended or supplemented and any existing default or compliance with any
provision of the Indenture or the Notes may be waived with the consent of the
holders of at least a majority of the principal amount of Notes then
outstanding, including consents obtained in connection with a tender offer or
exchange offer for Notes.
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Without the consent of each holder affected, an amendment or waiver may not
(with respect to any Note held by a non-consenting holder):
(a) reduce the principal amount of Notes whose holders must consent to
an amendment, supplement or waiver;
(b) reduce the principal or change the fixed maturity of any Note or
alter the provisions with respect to the redemption of the Notes;
(c) reduce the rate of or change the time for payment of interest on
any Notes;
(d) waive a Default or Event of Default in the payment of principal of
or premium, if any, or interest on the Notes (except a rescission of
acceleration of the Notes by the holders of at least a majority in
aggregate principal amount of the Notes and a waiver of the payment default
that resulted from the acceleration);
(e) make any Note payable in money other than that stated in the
Notes;
(f) make any change in the provisions of the Indenture relating to
waivers of past Defaults or the rights of holders of Notes to receive
payments of principal of, premium, if any, or interest on the Notes;
(g) waive a redemption payment with respect to any Note; or
(h) make any change in the foregoing amendment and waiver provisions.
Notwithstanding the foregoing, at any time prior to the occurrence of a
Change of Control or the accumulation by the Company of Excess Proceeds in
excess of $10.0 million, the covenants described under the subheadings "Offer to
Purchase upon Change of Control" and "Offer to Purchase with Excess Asset Sale
Proceeds," as applicable, may be altered and any payment which may be required
to be paid pursuant to these covenants may be waived by the holders of at least
a majority of the principal amount of the Notes then outstanding, including
consents obtained in connection with a tender offer or exchange offer for Notes.
The Company and the Trustee may amend or supplement the Indenture or the
Notes without the consent of any holder of Notes to:
(a) cure any ambiguity, defect or inconsistency;
(b) provide for uncertificated Notes in addition to or in place of
certificated Notes;
(c) provide for the assumption of the Company's obligations in the
case of a merger or consolidation;
(d) make any change that would provide any additional rights or
benefits to the holders of the Notes or that does not, in the opinion of
the Board of Directors of the Company, adversely affect the legal rights of
any holder under the Indenture; or
(e) comply with requirements of the SEC to effect or maintain the
qualification of the Indenture under the Trust Indenture Act.
CONCERNING THE TRUSTEE
If the Trustee should become a creditor of the Company, the Indenture
limits its rights to obtain payment of claims in certain cases, or to realize on
certain property received in respect of any claim as security or otherwise. The
Trustee will be permitted to engage in other transactions with the Company;
however, if the Trustee acquires any conflicting interest, it must eliminate the
conflict within 90 days, apply to the SEC for permission to continue as Trustee
or resign.
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The holders of a majority of the principal amount of Notes then outstanding
will have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy available to the Trustee, with certain
exceptions. The Indenture will provide that if an Event of Default occurs and is
continuing, the Trustee will be required, in the exercise of its powers, to use
the degree of care of a prudent man in the conduct of his own affairs. Subject
to these provisions, the Trustee will be under no obligation to exercise any of
its rights or powers under the Indenture at the request of any holder of Notes,
unless the holder has offered the Trustee security and indemnity satisfactory to
it against any loss, liability or expense.
No holder of any Note will have any right to institute any proceeding with
respect to the Indenture or for any remedy under the Note or the Indenture,
unless:
(a) the holder gives to the Trustee written notice of a continuing
Event of Default;
(b) holders of at least 25% of the principal amount of Notes then
outstanding make a written request to pursue the remedy;
(c) the holders of the Notes provide to the Trustee satisfactory
indemnity; and
(d) the Trustee does not comply within 60 days.
Without complying with the conditions specified in the preceding paragraph,
no holder of any Note will have any right to institute any proceeding with
respect to the Indenture or for any remedy under the Note or the Indenture,
except:
(a) a holder of a Note may institute suit for enforcement of payment
of the principal of, premium, if any, interest on or liquidated damages, if
any, with respect to the Note on or after the respective due dates
expressed in the Note (including upon acceleration of the Note); or
(b) the holders of a majority of the principal amount of Notes then
outstanding may institute any proceeding with respect to the Indenture or
any remedy under the Indenture, including without limitation acceleration,
provided that, upon instituting any proceeding or exercising any remedy the
holders must promptly notify the Trustee.
REGISTRATION RIGHTS; LIQUIDATED DAMAGES
The Company has filed with the SEC a registration statement (the "Exchange
Offer Registration Statement") on the appropriate form under the Securities Act
for an offer to exchange (the "Exchange Offer") the outstanding notes for
Exchange Notes. Upon the effectiveness of the Exchange Offer Registration
Statement, the Company will offer to the holders of Transfer Restricted
Securities who are able to make certain representations the opportunity to
exchange their Transfer Restricted Securities for a new issue of senior notes of
the Company (the "Exchange Notes") registered under the Securities Act, with
terms substantially identical to those of the outstanding notes.
If:
(a) the Company is not required to file the Exchange Offer
Registration Statement or permitted to consummate the Exchange Offer
because the Exchange Offer is not permitted by applicable law or SEC
policy; or
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(b) any holder of Transfer Restricted Securities notifies the Company
within the specified time period that:
(A) it is prohibited by law or SEC policy from participating in the
Exchange Offer;
(B) it may not resell the Exchange Notes acquired by it in the
Exchange Offer to the public without delivering a prospectus and the
prospectus contained in the Exchange Offer Registration Statement is not
appropriate or available for those resales; or
(C) it is a broker-dealer and owns Notes acquired directly from the
Company or an Affiliate of the Company;
the Company will file with the SEC a shelf registration statement (the "Shelf
Registration Statement") to cover resales of the Notes by holders who provide
certain information in connection with the Shelf Registration Statement.
The Company will use its best efforts to cause the applicable registration
statement to be declared effective as promptly as possible by the SEC.
For purposes of the foregoing, "Transfer Restricted Securities" means each
outstanding note until:
(a) the date on which the outstanding note has been exchanged by a
Person other than a broker-dealer for an Exchange Note in the Exchange
Offer;
(b) following the exchange by a broker-dealer in the Exchange Offer of
a outstanding note for an Exchange Note, the date on which the Exchange
Note is sold to a purchaser who receives from the broker-dealer on or
before the date of the sale a copy of the prospectus contained in the
Exchange Offer Registration Statement;
(c) the date on which the outstanding Note has been effectively
registered under the Securities Act and disposed of in accordance with the
Shelf Registration Statement; or
(d) the date on which the outstanding Note may be distributed to the
public pursuant to Rule 144 under the Securities Act.
Unless the Exchange Offer would not be permitted by applicable law or SEC
policy, the Company will:
(a) use its best efforts to have the Exchange Offer Registration
Statement declared effective by the SEC on or before the 180th day after
the Issue Date;
(b) upon the effectiveness of the Exchange Offer Registration
Statement, commence the Exchange Offer; and
(c) use its best efforts to issue, on or before the 30th business day
after the date on which the Exchange Offer Registration Statement was
declared effective, Exchange Notes in exchange for all Notes tendered in
the Exchange Offer.
If the Company is obligated to file the Shelf Registration Statement, the
Company will:
(a) use its best efforts to file the Shelf Registration Statement with
the SEC on or before the 30th day after the filing obligation arises and,
in any event, within 150 days after the Issue Date; and
(b) to cause the Shelf Registration to be declared effective by the
SEC on or before the 90th day after the obligation arises and, in any
event, within 240 days after the Issue Date.
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If:
(a) any required registration statement is not declared effective by
the SEC on or before the latest date specified for effectiveness (the
"Effectiveness Target Date");
(b) the Company fails to consummate the Exchange Offer within 30
business days of the Effectiveness Target Date; or
(c) the Shelf Registration Statement or the Exchange Offer
Registration Statement is declared effective but thereafter ceases to be
effective or usable in connection with resales of Transfer Restricted
Securities during the periods specified in the Registration Rights
Agreement, provided, that the Company will have the option of suspending
the effectiveness of the Shelf Registration Statement without becoming
obligated to pay Liquidated Damages (as defined below) for periods of up to
a total of 60 days in any calendar year if the Board of Directors of the
Company determines that compliance with the disclosure obligations
necessary to maintain the effectiveness of the Shelf Registration Statement
at such time could reasonably be expected to have an adverse effect on the
Company or a pending corporate transaction (each event referred to in
clauses (a) through (d) above, a "Registration Default"),
then the Company will pay liquidated damages to each holder of Transfer
Restricted Securities, with respect to the first 90-day period immediately
following the occurrence of a Registration Default in an amount equal to $.05
per week per $1,000 principal amount of outstanding notes constituting Transfer
Restricted Securities held by a holder.
The amount of the liquidated damages will increase by an additional $.05
per week per $1,000 principal amount of outstanding notes constituting Transfer
Restricted Securities with respect to each subsequent 90-day period until all
Registration Defaults have been cured, up to a maximum amount of liquidated
damages of $.50 per week per $1,000 principal amount of outstanding notes
constituting Transfer Restricted Securities. All accrued liquidated damages will
be paid by the Company on each interest payment date. Following the cure of all
Registration Defaults, the accrual of liquidated damages will cease.
Holders of outstanding notes will be required to make certain
representations to the Company (as specified in the Registration Rights
Agreement) to participate in the Exchange Offer and will be required to deliver
information to be used in connection with the Shelf Registration Statement and
to provide comments on the Shelf Registration Statement within the time periods
specified in the Registration Rights Agreement to have their outstanding notes
included in the Shelf Registration Statement and benefit from the provisions
regarding liquidated damages described above.
BOOK-ENTRY, DELIVERY AND FORM
The Exchange Notes initially will be represented by one or more permanent
global certificates in definitive, fully registered form (the "Global notes").
The Global notes will be deposited upon issuance with DTC and registered in the
name of a nominee of DTC.
THE GLOBAL NOTE
We expect that pursuant to procedures established by DTC (1) upon the
issuance of the Global notes, DTC or its custodian will credit, on its internal
system, the principal amount at maturity of the individual beneficial interests
represented by such Global notes to the respective accounts of persons who have
accounts with such depositary and (2) ownership of beneficial interests in the
Global notes will be shown on, and the transfer of such ownership will be
effected only through, records maintained by DTC or its nominee (with respect to
interests of participants) and the records of participants (with respect to
interests of persons other than participants). Ownership of beneficial interests
in the Global notes will be limited to persons who have accounts with DTC
("participants")
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or persons who hold interests through participants. Holders may hold their
interests in the Global notes directly through DTC if they are participants in
DTC's system, or indirectly through organizations that are participants in such
system.
So long a DTC, or its nominee, is the registered owner or holder of the
exchange notes, DTC or such nominee, as the case may be, will be considered the
sole owner of holder of the exchange notes represented by such Global notes for
all purposes under the indenture. No beneficial owner of an interest in the
Global notes will be able to transfer that interest except in accordance with
DTC's procedures, in addition to those provided for under the indenture with
respect to the exchange notes.
Payments of the principal of, premium, if any, interest, including
additional interest, on, the Global notes will be made to DTC or its nominee as
the registered owner of the Global notes. None of Mpower, the trustee or any
paying agent will have any responsibility or liability for any aspect of the
records relating to or payments made on account of beneficial ownership
interests in the Global notes or for maintaining, supervising or reviewing any
records relating to such beneficial ownership interest.
We expect that DTC or its nominee, upon receipt of any payment of
principal, premium, if any, interest, including additional interest, on the
Global notes, will credit participants' accounts with payments in amounts
proportionate to their respective beneficial interests in the principal amount
of the Global notes as shown on the records of DTC or its nominee. We also
expect that payments by participants to owners of beneficial interests in the
Global notes held through such participants will be governed by standing
instructions and customary practice, as is now the case with securities held for
the accounts of customers registered in the names of nominees for such
customers. Such payments will be the responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
through DTC's same-day funds system in accordance with DTC rules and will be
settled in same-day funds. If a holder requires physical delivery of a
certificated security for any reason, including to sell exchange notes to
persons in states that require physical delivery of the exchange notes, or to
pledge such securities, such holder must transfer its interest in a Global note,
in accordance with the normal procedures of DTC and with the procedure set forth
in the indenture.
DTC has advised us that it will take any action permitted to be taken by a
holder of exchange notes, including the presentation of exchange notes for
exchange as described below, only at the direction of one or more participants
to whose account the DTC interests in the Global notes are credited and only in
respect of such portion of the aggregate principal amount of notes as to which
such participant or participants has or have given such direction. However, if
there is an Event of Default under the indenture, DTC will exchange the Global
notes for certificated securities, which it will distribute to its participants.
DTC has advised us as follows: DTC is a limited purpose trust company
organized under the laws of the State of New York, a member of the Federal
Reserve System, a "clearing corporation" within the meaning of the Uniform
Commercial Code and a "Clearing Agency" registered pursuant to the provisions of
Section 17A of the Exchange Act. DTC was created to hold securities for its
participants and facilitate the clearance and settlement of securities
transactions between participants through electronic book-entry changes in
accounts of its participants, thereby eliminating the need for physical movement
of certificates. Participants include securities brokers and dealers, banks,
trust companies and clearing corporations and certain other organizations.
Indirect access to the DTC system is available to others such as banks, brokers,
dealers and trust companies that clear through or maintain a custodial
relationship with a participant, either directly or indirectly.
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of interests in the Global note among participants of DTC, it is under
no obligation to perform such procedures,
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and such procedures may be discontinued at any time. Neither Mpower nor the
trustee will have any responsibility for the performance by DTC or its
participants or indirect participants of their respective obligations under the
rules and procedures governing their operations.
CERTIFICATED SECURITIES
Certificated securities will be issued in exchange for beneficial interests
in the Global notes (1) if requested by a holder of such interests or (2) if DTC
is at any time unwilling or unable to continue as a depositary for the Global
notes and successor depositary is not appointed by our company within 90 days.
ADDITIONAL INFORMATION
Anyone who receives this prospectus may obtain a copy of the Indenture and
the Registration Rights Agreement without charge by writing to MGC
Communications, Inc., 171 Sully's Trail, Suite 202, Pittsford, New York 14534,
Attention: General Counsel.
CERTAIN DEFINITIONS
Certain defined terms used in the Indenture are listed below. We urge you
to read the Indenture for a full disclosure of the definitions of all those
terms, as well as any other capitalized terms used in this description for which
no definition is provided.
"Acquired Debt" means, with respect to any specified Person, (a)
Indebtedness of any other Person existing at the time the other Person is merged
with or into or became a Restricted Subsidiary of the specified Person,
including Indebtedness incurred in connection with, or in contemplation of, the
other Person merging with or into or becoming a Restricted Subsidiary of the
specified Person, and (b) Indebtedness secured by a Lien encumbering any asset
acquired by the specified Person.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with the specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, means the
possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of that Person, whether through the
ownership of voting securities, by agreement or otherwise, provided, beneficial
ownership of 25% or more of the voting securities of a Person will be deemed to
be control.
"Attributable Debt" means, with respect to any Sale and Leaseback
Transaction, the present value at the time of determination (discounted at a
rate consistent with accounting guidelines, as determined in good faith by the
Company) of the payments during the remaining term of the lease (including any
period for which the lease has been extended or may, at the option of the
lessor, be extended) or until the earliest date on which the lessee may
terminate the lease without penalty or upon payment of a penalty (in which case
the rental payments will include the penalty), after excluding all amounts
required to be paid on account of maintenance and repairs, insurance, taxes,
assessments, water, utilities and similar charges.
"Beneficial Owner" means a beneficial owner as defined in Rules 13d-3 and
13d-5 under the Exchange Act (or any successor rules), including the provision
of those Rules that a Person will be deemed to have beneficial ownership of all
securities that a Person has a right to acquire within 60 days; provided that
the Person will not be deemed a beneficial owner of, or to own beneficially, any
securities if the beneficial ownership:
(a) arises solely as a result of a revocable proxy delivered in
response to a proxy or consent solicitation made pursuant to, and in
accordance with, the Exchange Act; and
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(b) is not also then reportable on Schedule 13D or Schedule 13G (or
any successor schedule) under the Exchange Act.
"Capital Lease Obligation" means, at the time of determination, the amount
of the liability in respect of a capital lease that would be required to be
capitalized on the balance sheet in accordance with GAAP.
"Capital Stock" means:
(a) in the case of a corporation, corporate stock;
(b) in the case of an association or business entity, any and all
shares, interests, participations, rights or other equivalents (however
designated) of corporate stock; and
(c) in the case of a partnership, partnership interests (whether
general or limited) and any other interest or participation that confers on
a Person the right to receive a share of the profits and losses of, or
distributions of assets of, the partnership.
"Change of Control" means the occurrence of any of the following:
(a) the sale, lease, transfer, conveyance or other disposition, in one
or a series of related transactions, of all or substantially all of the
assets of the Company and its Restricted Subsidiaries, taken as a whole, to
any Person or group (as that term is used in Section 13(d)(3) and 14(d)(2)
of the Exchange Act);
(b) the adoption of a plan relating to the liquidation or dissolution
of the Company;
(c) any Person or group (as defined above) other than the Permitted
Holders is or becomes the Beneficial Owner, directly or indirectly, of more
than 50% of the total Voting Stock or Total Common Equity of the Company,
including by way of merger, consolidation or otherwise; or
(d) the first day on which a majority of the members of the Board of
Directors of the Company are not Continuing Directors.
"Closing Price" on any Trading Day with respect to the per share price of
any shares of Capital Stock means the last reported sale price regular way or,
if no reported sale takes place on that day, the average of the reported closing
bid and asked prices regular way:
(a) on the New York Stock Exchange; or
(b) if the shares of Capital Stock are not listed or admitted to
trading on the New York Stock Exchange, on the principal national
securities exchange on which the shares are listed or admitted to trading;
or
(c) if not listed or admitted to trading on any national securities
exchange, on the Nasdaq National Market; or
(d) if the shares are not listed or admitted to trading on any
national securities exchange or quoted on Nasdaq National Market but the
issuer is a Foreign Issuer (as defined in Rule 3b-4(b) under the Exchange
Act) and the principal securities exchange on which the shares are listed
or admitted to trading is a Designated Offshore Securities Market (as
defined in Rule 902(a) under the Securities Act), on that principal
exchange; or
(e) if the shares are not listed or admitted to trading on any
national securities exchange or quoted on Nasdaq National Market and the
issuer is not a Foreign Issuer or the principal securities exchange is not
a Designated Offshore Securities Market, in the over-the-counter market as
furnished by any New York Stock Exchange member firm that is selected from
time to time by the Company for that purpose and is reasonably acceptable
to the Trustee.
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"Common Stock" of any Person means Capital Stock of that Person that does
not rank prior, as to the payment of dividends or as to the distribution of
assets upon any voluntary or involuntary liquidation, dissolution or winding up
of that Person, to shares of any other class of Capital Stock of that Person.
"Consolidated Cash Flow Leverage Ratio" with respect to any Person means
the ratio of the Consolidated Indebtedness of the Person to the Consolidated
EBITDA of the Person, in each case, for the most recently ended full fiscal
quarter for which internal financial statements are available immediately
preceding the transaction requiring this calculation, annualized, provided:
(a) if the Company or any Restricted Subsidiary of the Company has
incurred any Indebtedness (including Acquired Debt) or if the Company has
issued any Disqualified Stock or if any Restricted Subsidiary of the
Company has issued any Preferred Stock since the beginning of the
applicable period that remains outstanding on the date of determination or
if the transaction giving rise to the need to calculate the Consolidated
Cash Flow Leverage Ratio is an incurrence of Indebtedness (including
Acquired Debt) or the issuance of Disqualified Stock by the Company,
Consolidated EBITDA and Consolidated Indebtedness for the applicable period
will be calculated after giving effect on a pro forma basis to:
(x) the Indebtedness, Disqualified Stock or Preferred Stock, as
applicable, as if the Indebtedness had been incurred or the stock had
been issued on the first day of the applicable period;
(y) the discharge of any other Indebtedness repaid, repurchased,
defeased or otherwise discharged with the proceeds of the new
Indebtedness or sale of stock as if the discharge had occurred on the
first day of the applicable period; and
(z) the interest income realized by the Company or its Restricted
Subsidiaries on the proceeds of the Indebtedness or of the stock sale,
to the extent not yet applied at the date of determination, assuming the
proceeds earned interest at the rate in effect on the date of
determination from the first day of the applicable period through the
date of determination;
(b) if since the beginning of the applicable period the Company or any
Restricted Subsidiary has made any sale of assets (including any Asset
Sales or pursuant to any Sale and Leaseback Transaction), Consolidated
EBITDA for the applicable period will be:
(x) reduced by an amount equal to Consolidated EBITDA (if positive)
directly attributable to the assets which are the subject of the sale of
assets for the applicable period; or
(y) increased by an amount equal to Consolidated EBITDA (if
negative) directly attributable to the assets which are the subject of
the sale of assets for the applicable period; and
(c) if since the beginning of that period the Company or any
Restricted Subsidiary (by merger or otherwise) has made an Investment in
any Restricted Subsidiary (or any Person which becomes a Restricted
Subsidiary) or has made an acquisition of assets, including any acquisition
of assets occurring in connection with the transaction causing a
calculation of Consolidated EBITDA to be made, which constitutes all or
substantially all of an operating unit of a business, Consolidated EBITDA
for the applicable period will be calculated after giving pro forma effect
to the Investment of acquisition (including the incurrence of any
Indebtedness (including Acquired Debt)) as if the Investment or acquisition
occurred on the first day of the applicable period.
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For purposes of this definition, whenever pro forma effect is to be given
to an acquisition of assets, the pro forma calculations will be determined in
good faith by a responsible financial or accounting Officer of the Company,
provided, the Officer must assume:
(a) the historical sales and gross profit margins associated with
those assets for any consecutive 12-month period ended before the date of
purchase (provided that the first month of the 12-month period will be no
more than 18 months before the date of purchase) and
(b) other expenses;
as if the assets had been owned by the Company since the first day of the
applicable period.
If any Indebtedness (including Acquired Debt) bears a floating rate of
interest and is being given pro forma effect, the interest on the Indebtedness
will be calculated as if the rate in effect on the date of determination had
been the applicable rate for the entire period.
"Consolidated EBITDA" as of any date of determination means the
Consolidated Net Income for that period (but without giving effect to
adjustments, accruals, deductions or entries resulting from purchase accounting,
extraordinary losses or gains and any gains or losses from any Asset Sales),
plus the following to the extent deducted in calculating Consolidated Net
Income:
(a) provision for taxes based on income or profits of the Person and
its Subsidiaries or, in the case of the Company, its Restricted
Subsidiaries for the applicable period;
(b) Consolidated Interest Expense;
(c) depreciation, amortization (including amortization of goodwill and
other intangibles); and
(d) other non-cash charges (excluding any non-cash charge to the
extent that it represents an accrual of or reserve for cash charges in any
future period or amortization of a prepaid cash expense that was paid in a
prior period and excluding non-cash interest and dividend income) of the
Person and its Subsidiaries or, in the case of the Company, its Restricted
Subsidiaries for the applicable period, in each case, on a consolidated
basis and determined in accordance with GAAP.
Notwithstanding the foregoing, the provision for taxes on the income or
profits of, and the depreciation, amortization, interest expense and other
non-cash charges of, a Subsidiary or, in the case of the Company, a Restricted
Subsidiary of the Person will be added to Consolidated Net Income to compute
Consolidated EBITDA only to the extent (and in same proportion) that the Net
Income of the Subsidiary or, in the case of the Company, the Restricted
Subsidiary was included in calculating the Consolidated Net Income of the Person
and only if a corresponding amount would be permitted at the date of
determination to be dividended to the Company by the Subsidiary, or, in the case
of the Company, the Restricted Subsidiary or loaned to the Company by any the
Subsidiary, or, in the case of the Company any the Restricted Subsidiary without
prior approval (that has not been obtained), pursuant to the terms of its
charter and all agreements, instruments, judgments, decrees, orders, statutes,
rules and governmental regulations applicable to the Subsidiary or, in the case
of the Company, any the Restricted Subsidiary or its stockholders.
"Consolidated Indebtedness" means, with respect to any Person, as of any
date of determination, the aggregate amount of Indebtedness of the Person and
its Subsidiaries or, in the case of the Company, its Restricted Subsidiaries
calculated on a consolidated basis in accordance with GAAP consistently applied.
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"Consolidated Interest Expense" means, for any Person, for any period, the
aggregate of the following for the Person for the period determined on a
consolidated basis in accordance with GAAP:
(a) the amount of interest in respect of Indebtedness (including
amortization of original issue discount, amortization of debt issuance
costs, non-cash interest payments on any Indebtedness and the interest
portion of any deferred payment obligation and after taking into account
the effect of elections made under any Interest Rate Agreement, however
denominated with respect to the Indebtedness);
(b) the amount of Redeemable Dividends (to the extent not already
included in Indebtedness in determining Consolidated Interest Expense for
the relevant period); and
(c) the interest component of rentals in respect of any Capital Lease
Obligation paid, in each case whether accrued or scheduled to be paid or
accrued by the Person during the period to the extent the amounts were
deducted in computing Consolidated Net Income, determined on a consolidated
basis in accordance with GAAP. For purposes of this definition interest on
a Capital Lease Obligation will be deemed to accrue at an interest rate
reasonably determined by the Person to be the rate of interest implicit in
the Capital Lease Obligation in accordance with GAAP consistently applied.
"Consolidated Net Income" means, with respect to any Person for any period,
the aggregate of the Net Income of the Person and its Subsidiaries or, in the
case of the Company, its Restricted Subsidiaries for the period, on a
consolidated basis, determined in accordance with GAAP; provided that:
(a) the Net Income of any Person that is not a Subsidiary or, in the
case of the Company, a Restricted Subsidiary or that is accounted for by
the equity method of accounting will be included only to the extent of the
amount of dividends or distributions paid in cash to the Person or a
Subsidiary or, in the case of the Company, a Restricted Subsidiary thereof,
(b) the Net Income of any Subsidiary or, in the case of the Company,
any Restricted Subsidiary will be excluded to the extent that the
declaration or payment of dividends or other distributions of that Net
Income by that Subsidiary, or Restricted Subsidiary, as the case may be, is
at the date of determination not permitted without any prior governmental
approval (which has not been obtained) or, directly or indirectly, by
operation of the terms of its charter or any agreement, instrument,
judgment, decree, order, statute, rule or governmental regulation
applicable to that Subsidiary or Restricted Subsidiary, as the case may be,
or its stockholders,
(c) the Net Income of any Person acquired in a pooling of interests
transaction for any period before the date of the acquisition will be
excluded,
(d) the cumulative effect of a change in accounting principles will be
excluded, and
(e) the Net Income of any Unrestricted Subsidiary will be excluded,
whether or not distributed to the Company or one of its Restricted
Subsidiaries.
"Contingent Investment" means, with respect to any Person, any guarantee by
the Person of the performance of another Person or any commitment by the Person
to invest in another Person. Any Investment that consists of a Contingent
Investment will be deemed made at the time the guarantee of performance or the
commitment to invest is given, and the amount of the Investment will be the
maximum monetary obligation under the guarantee of performance or commitment to
invest. To the extent that a Contingent Investment is released or lapses without
payment under the guarantee of performance or the commitment to invest, the
Investment will be deemed not made to the extent of the release or lapse. With
respect to any Contingent Investment, the payment of the guarantee of
performance or the payment under the commitment to invest will not be deemed to
be an additional Investment.
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"Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who:
(a) was a member of the Board of Directors on the Issue Date; or
(b) was nominated for election or elected to the Board of Directors
with the affirmative vote of a majority of the Continuing Directors who
were members of the Board at the time of the nomination or election.
"Credit Facility" means any credit facility entered into by and among the
Company or any Restricted Subsidiary and one or more commercial banks or
financial institutions, providing for senior term or revolving credit borrowings
of a type similar to credit facilities typically entered into by commercial
banks and financial institutions, including any related notes, Guarantees,
collateral documents, instruments and agreements executed in connection with the
credit facility, as the credit facility and related agreements may be amended,
extended, refinanced, renewed, restated, replaced or refunded from time to time.
"Default" means any event that is or with the passage of time or the giving
of notice or both would be an Event of Default.
"Disqualified Stock" means any Capital Stock to the extent that, and only
to the extent that, by its terms (or by the terms of any security into which it
is convertible or for which it is exchangeable), or upon the happening of any
event, matures or is mandatorily redeemable, pursuant to a sinking fund
obligation or otherwise, or is redeemable at the option of the holder, in whole
or in part, on or before the date on which the Notes mature, provided that any
Capital Stock which would not constitute Disqualified Stock but for provisions
giving holders the right to require the Company to repurchase or redeem the
Capital Stock upon the occurrence of a Change of Control occurring before the
final maturity of the Notes will not constitute Disqualified Stock if the change
in control provisions applicable to the Capital Stock are no more favorable to
the holders of the Capital Stock than the provisions applicable to the Notes
contained in the covenant described under the subheading "Offer to Purchase Upon
a Change of Control" and the Capital Stock specifically provides that the
Company will not repurchase or redeem any stock pursuant to those provisions
before the Company's repurchase of Notes required to be repurchased pursuant to
the covenant described under the subheading "Offer to Purchase Upon Change of
Control."
"Eligible Institution" means a commercial banking institution that has
combined capital and surplus of not less than $500.0 million or its equivalent
in foreign currency, whose debt is rated "A" (or higher) according to S&P or
Moody's at the time as of which any investment or rollover therein is made.
"Eligible Receivable" means any Receivable not more than 90 days past due
under its scheduled payment terms.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock or that are measured by the value of Capital
Stock (but excluding any debt security that is convertible into or exchangeable
for Capital Stock).
"Equity Offering" means an underwritten offering of Capital Stock (other
than Disqualified Stock) of the Company registered under the Securities Act.
"Exchange Act" means the Securities Exchange Act of 1934, as amended (or
any successor act), and the rules and regulations thereunder.
"Existing Indebtedness" means all Indebtedness of the Company and its
Restricted Subsidiaries in existence on the Issue Date.
"Existing Notes" means the Company's 13% Senior Secured Notes due 2004.
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"Fair Market Value" means with respect to any asset or property, the sale
value that would be obtained in an arm's length transaction between an informed
and willing seller under no compulsion to sell and an informed and willing buyer
under no compulsion to buy.
"GAAP" means generally accepted accounting principles specified in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in other statements by any other
entity as may be approved by a significant segment of the accounting profession
of the United States, which are in effect on the Issue Date.
"Government Securities" means direct obligations of, or obligations
guaranteed by, the United States of America for the payment of which guarantee
or obligations the full faith and credit of the United States is pledged.
"Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including letters of credit and reimbursement
agreements in respect of letters of credit), of all or any part of any
Indebtedness.
"Hedging Obligations" means, with respect to any Person, the obligations of
the Person under Interest Rate Agreements.
"ILEC" means the incumbent local exchange carrier.
"Indebtedness" means, with respect to any Person:
(a) any indebtedness of the Person, whether or not contingent:
(w) in respect of borrowed money;
(x) evidenced by bonds, notes, debentures or similar instruments or
letters of credit (or reimbursement agreements in respect of letters of
credit);
(y) representing the balance deferred and unpaid of the purchase
price of any property (including under capital leases); or
(z) representing any Hedging Obligations;
except any balance that constitutes an accrued expense or trade payable, if
and to the extent any of the foregoing (other than Hedging Obligations or
letters of credit) would appear as a liability upon a balance sheet of the
Person prepared in accordance with GAAP;
(b) all indebtedness of others secured by a Lien on any asset of the
Person (whether or not the indebtedness is assumed by the Person);
(c) all obligations to purchase, redeem, retire, defease or otherwise
acquire for value any Disqualified Stock or any warrants, rights or options
to acquire Disqualified Stock valued, in the case of Disqualified Stock, at
the greatest amount payable in respect of the Disqualified Stock on a
liquidation (whether voluntary or involuntary) plus accrued and unpaid
dividends;
(d) the liquidation value of any Preferred Stock issued by
Subsidiaries of the Person or by Restricted Subsidiaries of the Company, as
the case may be, plus delinquent and unpaid dividends; and
(e) to the extent not otherwise included, the Guarantee of items that
would be included within this definition and any amendment, supplement,
modification, deferral, renewal, extension or refunding of any of the
above.
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Notwithstanding the foregoing, in no event will the following items be
deemed to be Indebtedness:
(A) performance bonds or similar security for performance so long as
the performance bonds or similar security for performance would not appear
as a liability on a balance sheet of the Person prepared in accordance with
GAAP;
(B) letters of credit secured by cash collateral in an amount equal to
the maximum potential liability of the Company or a Restricted Subsidiary
under the letters of credit; and
(C) letters of credit which are terminated and, if applicable, repaid
in full and not replaced by another letter of credit, no later than the
fifth business day following the date of issuance, provided, if a letter of
credit is not terminated and, if applicable, repaid in full and not
replaced by another letter of credit within five business days of its date
of issuance, on the sixth business day following its date of issuance, the
Company or the Restricted Subsidiary, as the case may be, shall be deemed
to have incurred Indebtedness in an amount equal to the maximum potential
liability of the Company or the Restricted Subsidiary under the letter of
credit.
In addition, the amount of any Indebtedness in respect of any Guarantee
will be the maximum principal amount of the Indebtedness so guaranteed.
"Independent Appraiser" means a nationally recognized accounting, appraisal
or investment banking firm experienced in the review of similar types of
transactions which does not have, and whose directors, officers and employees or
Affiliates do not have, a direct or indirect financial interest in the Affiliate
Transaction and which, in the opinion of the Board of Directors, is otherwise
independent and qualified to perform the task for which it is to be engaged.
"Interest Rate Agreements" means (a) interest rate swap agreements,
interest rate cap agreements and interest rate collar agreements; and (b) other
agreements or arrangements designed to protect the Person against fluctuations
in interest rates.
"Investments" means, with respect to any Person, all investments by the
Person in other Persons (including Affiliates) in the forms of loans,
Guarantees, Contingent Investments, advances or capital contributions (excluding
commission, travel and similar advances to officers and employees made in the
ordinary course of business), purchases or other acquisitions for consideration
of Indebtedness, Equity Interests or other securities of any other Person and
all other items that are or would be classified as investments on a balance
sheet prepared in accordance with GAAP; provided, that any investment to the
extent made with Capital Stock of the Company (other than Disqualified Stock)
will not be deemed an "Investment" for purposes of the Indenture.
"Issue Date" means March 24, 2000.
"Joint Venture" means a Person in the Telecommunications Business in which
the Company holds less than a majority of the shares of Voting Stock or an
Unrestricted Subsidiary in the Telecommunications Business.
"Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of the asset,
whether or not filed, recorded or otherwise perfected under applicable law
(including any conditional sale or other title retention agreement, any lease in
the nature thereof, any option or other agreement to sell or give a security
interest in and any filing of or agreement to give any financing statement under
the Uniform Commercial Code (or equivalent statutes) of any jurisdiction).
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"Marketable Securities" means:
(a) Government Securities;
(b) any certificate of deposit maturing not more than 270 days after
the date of acquisition issued by, or time deposit of, an Eligible
Institution;
(c) commercial paper maturing not more than 270 days after the date of
acquisition issued by a corporation (other than an Affiliate of the
Company) with a rating at the time as of which any investment therein is
made, of "A-1" (or higher) according to S&P or "P-1" (or higher) according
to Moody's;
(d) any banker's acceptances or money market deposit accounts issued
or offered by an Eligible Institution; and
(e) any fund investing exclusively in investments of the types
described in clauses (a) through (d) above.
"Moody's" means Moody's Investors Service, Inc. and its successors.
"Net Income" means, with respect to any Person, the net income (loss) of
the Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding:
(a) any gain (but not loss), together with any related provision for
taxes on the gain (but not loss), realized in connection with:
(x) any Asset Sale (including dispositions under Sale and Leaseback
Transactions); or
(y) the disposition of any securities by the Person or any of its
Subsidiaries or, in the case of the Company, any of its Restricted
Subsidiaries or the extinguishment of any Indebtedness of the Person or
any of its Subsidiaries or, in the case of the Company, any of its
Restricted Subsidiaries; and
(b) any extraordinary gain (but not loss), together with any related
provision for taxes on the extraordinary gain (but not loss).
"Net Proceeds" means the aggregate cash proceeds received by the Company or
any of its Restricted Subsidiaries in respect of any Asset Sale, net of the
direct costs relating to the Asset Sale (including legal, accounting and
investment banking fees, and sales commissions) and any relocation expenses
incurred as a result of the Asset Sale, taxes paid or payable as a result of the
Asset Sale (after taking into account any available tax credits or deductions
and any tax sharing arrangements), amounts required to be applied to the
repayment of Indebtedness secured by a Lien on the asset or assets that are the
subject of the Asset Sale and any reserve for adjustment in respect of the sale
price of the asset or assets. Net Proceeds will exclude any non-cash proceeds
received from any Asset Sale, but will include those proceeds when and as
converted by the Company or any Restricted Subsidiary into cash.
"Pari Passu Notes" means any notes issued by the Company which, by their
terms and the terms of any indenture governing the notes, have an obligation to
be repurchased by the Company upon the occurrence of an Asset Sale.
"Permitted Holder" means:
(a) Providence Equity Partners Inc., JK&B Capital, L.P. or any of
their respective Affiliates;
(b) any of Maurice J. Gallagher, Jr., Timothy P. Flynn, Rolla P. Huff
or their respective spouses or lineal descendants and their respective
spouses (collectively, the "Individual Family
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Holders") whether acting in their own name or as a majority of persons
having the power to exercise the voting rights attached to, or having
investment power over, shares held by others;
(c) any Affiliate of any member of the Individual Family Holders;
(d) any trust principally for the benefit of one or more members of
the Individual Family Holders (whether or not any member of the Individual
Family Holders is a trustee of the trust); and
(e) any charitable foundation whose majority of members, trustees or
directors, as the case may be, are persons referred to in (b) above.
"Permitted Investment" means:
(a) any Investments in the Company or any Restricted Subsidiary;
(b) any Investments in Marketable Securities;
(c) any Investments by the Company or any Restricted Subsidiary in a
Person, if as a result of the Investment:
(x) the Person becomes a Restricted Subsidiary; or
(y) the Person is merged, consolidated or amalgamated with or into,
or transfers or conveys substantially all of its assets to, or is
liquidated into, the Company or a Restricted Subsidiary;
(d) with respect to Investments in Joint Ventures at any time
outstanding, an amount not to exceed the greater of:
(x) $35.0 million; or
(y) or 5% of the amount of the Total Common Equity of the Company;
(e) Investments under any agreement or obligation of the Company or a
Restricted Subsidiary to make Investments, in effect on the Issue Date or
on the date a Subsidiary becomes a Restricted Subsidiary (provided that the
agreement was not entered into in contemplation of the Subsidiary becoming
a Restricted Subsidiary);
(f) Investments in prepaid expenses, negotiable instruments held for
collection and lease, utility and workers' compensation, performance and
other similar deposits;
(g) Hedging Obligations permitted to be incurred by the covenant
described under the subheading "Incurrence of Indebtedness and Issuance of
Disqualified Stock;"
(h) bonds, notes, debentures or other securities received as a result
of Asset Sales permitted under the covenant described under the subheading
"Asset Sales;"
(i) Investments received in satisfaction of judgments or in connection
with the settlement of any ordinary course obligations owed to the Company
or any Restricted Subsidiary;
(j) loans and advances to employees and officers of the Company or any
of its Restricted Subsidiaries permitted under the covenant described under
the subheading "Transactions with Affiliates;" and
(k) Investments in any Person that is primarily engaged in the
Telecommunications Business on the date of the Investment, in exchange for,
or out of the proceeds of an offering (that occurred within 90 days of the
time of any such Investment) of, Capital Stock (other than Disqualified
Stock) of the Company (other than to a Restricted Subsidiary), to the
extent that such proceeds have not been used to make a Restricted Payment
pursuant to clause (3) of the
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first paragraph or clause (b) of the second paragraph of the covenant
described under the subheading "Restricted Payments" or used to incur
Indebtedness pursuant to clause (e) of the covenant described under the
subheading "Incurrence of Indebtedness and Issuance of Disqualified Stock."
"Permitted Liens" means:
(a) Liens securing Indebtedness (including Capital Lease Obligations)
permitted to be incurred under clauses (a), (b) or (h) of the third
paragraph of the covenant described under the subheading "Incurrence of
Indebtedness and Issuance of Disqualified Stock;"
(b) Liens in favor of the Company;
(c) Liens on property of a Person existing at the time the Person is
merged into or consolidated with the Company or any Restricted Subsidiary,
provided that the Liens were not incurred in contemplation of the merger or
consolidation and do not extend to any assets other than those of the
Person merged into or consolidated with the Company;
(d) Liens on property existing at the time of acquisition by the
Company or any Restricted Subsidiary, provided that the Liens were in
existence before the contemplation of the acquisition;
(e) Liens to secure the performance of statutory obligations, surety
or appeal bonds, performance bonds or other obligations of a like nature
incurred in the ordinary course of business;
(f) Liens existing, on the Issue Date;
(g) Liens for taxes, assessments or governmental charges or claims
that are not yet delinquent or that are being contested in good faith by
appropriate proceedings timely instituted and diligently concluded,
provided that any reserve or other appropriate provision required in
conformity with GAAP has been made;
(h) Liens incurred in the normal course of business of the Company or
any Restricted Subsidiary with respect to obligations that do not exceed
$3.0 million at any one time outstanding and that:
(x) are not incurred in connection with the borrowing of money or
the obtaining of advances or credit (other than trade credit in the
ordinary course of business); and
(y) do not in the aggregate materially detract from the value of
the property or materially impair the use of the property in the
operation of business by the Company or the Restricted Subsidiary;
(i) Liens on Telecommunications Related Assets existing during the
time of construction;
(j) Liens on Receivables to secure Indebtedness permitted to be
incurred by the covenant described under the subheading "Incurrence of
Indebtedness and Issuance of Disqualified Stock," but only to the extent
that when the Indebtedness is incurred the outstanding amount of the
Indebtedness secured by those Liens would not represent more than 80% of
Eligible Receivables;
(k) Liens on Telecommunications Equipment required to be incurred
under the terms of the Existing Notes;
(l) Liens on the proceeds of Indebtedness to secure the payment of
principal and interest on the Indebtedness;
(m) Liens to secure letters of credit which are deemed not to be
Indebtedness in accordance with clause (B) of the second paragraph of the
definition of Indebtedness; and
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(n) Liens to secure any Permitted Refinancing of any Indebtedness
secured by Liens referred to in the foregoing clauses (a), (c), (d), (e),
(f), (i), (k) or (m); but only to the extent that the Liens do not extend
to any other property or assets and the principal amount of the
Indebtedness secured by the Liens is not increased by more than the fees
and expenses incurred in connection with the refinancing.
"Person" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust, unincorporated organization, government
or any agency or political subdivision or any other entity.
"Preferred Stock" as applied to the Capital Stock of any Person, means
Capital Stock of the Person of any class or classes (however designated) that
ranks prior, as to payment of dividends or as to the distribution of assets upon
any voluntary or involuntary liquidation, dissolution or winding up of the
Person, to shares of any other class of Capital Stock of the Person.
"Receivables" means, with respect to any Person, all of the following
property and interests in property of the person or entity, whether now existing
or existing in the future or hereafter acquired or arising:
(a) accounts;
(b) accounts receivable, including all rights to payment created by or
arising from sales of goods, leases of goods or the rendition of services
no matter how evidenced, whether or not earned by performance;
(c) all unpaid seller's or lessor's rights including rescission,
replevin, reclamation and stoppage in transit, relating to accounts or
accounts receivable after creation of the accounts or accounts receivable
or arising therefrom;
(d) all rights to any goods or merchandise represented by any accounts
or accounts receivable, including returned or repossessed goods;
(e) all reserves and credit balances with respect to any accounts or
accounts receivable;
(f) all letters of credit, security, or Guarantees for any accounts or
accounts receivable;
(g) all insurance policies or reports relating to any accounts or
accounts receivable;
(h) all collection of deposit accounts relating to any accounts or
accounts receivable;
(i) all proceeds of any accounts or accounts receivable; and
(j) all books and records relating to any accounts or accounts
receivable.
"Redeemable Dividend" means, for any dividend with regard to Disqualified
Stock and Preferred Stock, the quotient of the dividend divided by the
difference between one and the maximum statutory federal income tax rate
(expressed as a decimal number between 1 and 0) then applicable to the issuer of
the Disqualified Stock or Preferred Stock.
"Registration Rights Agreement" means the Registration Rights Agreement
between the Company and the Initial Purchasers.
"Restricted Investment" means an Investment other than a Permitted
Investment.
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"Restricted Payment Credit" means the sum of:
(a) any cash received by the Company as repayment of a Restricted
Payment; and
(b) the lesser of:
(x) the net book value of any Restricted Investment at the time it
becomes a Permitted Investment;
(y) the fair market value of any Restricted Investment at the time
it becomes a Permitted Investment; and
(z) the original fair market value of any Restricted Investment at
the time it was made.
"Restricted Subsidiary" means any subsidiary of the Company that is not
designated by the Board of Directors as an Unrestricted Subsidiary. On the Issue
Date, all of the Company's Subsidiaries will be Restricted Subsidiaries.
"Sale and Leaseback Transaction" means, with respect to any Person, any
direct or indirect arrangement under which any property (other than Capital
Stock) is sold by the Person or a Subsidiary, or, in the case of the Company, a
Restricted Subsidiary of the Person and is thereafter leased back from the
purchaser or transferee by the Person or one of its Subsidiaries or, in the case
of the Company, one of its Restricted Subsidiaries.
"Senior Indebtedness" means any Indebtedness permitted to be incurred by
the Company under the terms of the Indenture, unless the instrument under which
the Indebtedness is incurred expressly provides that it is subordinated in right
of payment to the Notes. Notwithstanding anything to the contrary in the
foregoing, Senior Indebtedness will not include:
(a) any liability for federal, state, local or other taxes owed or
owing by the Company;
(b) any Indebtedness of the Company to any of its Subsidiaries or
other Affiliates;
(c) any trade payables; or
(d) any Indebtedness that is incurred in violation of the Indenture.
"Significant Subsidiary" means:
(a) any Restricted Subsidiary that would be a "Significant Subsidiary"
as defined in Article 1, Rule 1-02 of Regulation S-X, promulgated pursuant
to the Securities Act, as that Regulation is in effect on the Issue Date;
and
(b) any Subsidiary which holds any permit or license which is material
to the operations of the Company and its Restricted Subsidiaries taken as a
whole.
"Subsidiary" of any Person means:
(a) any corporation, association or business entity of which more than
50% of the total voting power of shares of Capital Stock entitled (without
regard to the occurrence of any contingency) to vote in the election of
directors, managers or trustees is at the time owned or controlled,
directly or indirectly, by the Person or one or more of the other
Subsidiaries of the Person or a combination thereof; and
(b) any partnership:
(x) the sole general partner or the managing general partner of
which is the Person or a Subsidiary of the Person; or
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(y) the only general partners of which are the Person or one or
more Subsidiaries of the Person or any combination thereof.
"Telecommunications Business" means, when used in reference to any Person,
that the Person is engaged primarily in the business of:
(a) transmitting, or providing services relating to the transmission
of, voice, video or data through owned or leased transmission facilities;
(b) creating, developing or marketing communications related network
equipment, software and other devices for use in a Telecommunications
Business; or
(c) evaluating, participating or engaging in or pursuing any other
activity or opportunity that is related to those identified in (a) or (b)
above; provided that the determination of what constitutes a
Telecommunications Business shall be made in good faith by the Board of
Directors of the Company.
"Telecommunications Equipment" means telecommunications switches and
related equipment and inventory, including all remote switching nodes, modems,
line cards, transport hardware and equipment or hardware necessary in connection
with the Telecommunications Business.
"Telecommunications Related Assets" means all assets, rights (contractual
or otherwise) and properties, whether tangible or intangible, real or personal,
used or to be used, in connection with a Telecommunications Business.
"Total Common Equity" of any Person means, as of any date of determination,
the product of:
(a) the aggregate number of outstanding primary shares of Common Stock
of the Person on the date of determination (which will not include any
options or warrants on, or securities convertible or exchangeable into,
shares of Common Stock of the Person); and
(b) the average Closing Price of the Common Stock over the 20
consecutive Trading Days immediately preceding the date of determination.
If no Closing Price exists with respect to shares of the class of Common
Stock, the value of the shares for purposes of clause (b) of the preceding
sentence will be determined by the Board of Directors of the Company in
good faith and evidenced by a resolution of the Board of Directors filed
with the Trustee.
"Total Market Capitalization" of any Person means, as of any day of
determination, the sum of:
(1) the consolidated Indebtedness of such Person and its Subsidiaries
(except in the case of the Company, in which case of the Company and its
Restricted Subsidiaries) on such day; plus
(2) the product of:
(x) the aggregate number of outstanding primary shares of Common
Stock of such Person on such day (which shall not include any options or
warrants on, or securities convertible or exchangeable into, shares of
Common Stock of such Person); and
(y) the average Closing Price of such Common Stock over the 20
consecutive Trading Days immediately preceding such day; plus
(3) the liquidation value of any outstanding shares of Preferred Stock
of such Person on such day; less
(4) cash and cash equivalents (other than restricted cash and
restricted cash equivalents) as presented on such Person's consolidated
balance sheet on such date.
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If no Closing Price exists with respect to shares of Common Stock, the
value of such shares for purposes of clause (2) of the preceding sentence shall
be determined by the Company's Board of Directors in good faith and evidenced by
a resolution of the Board of Directors filed with the Trustee.
"Trading Day," with respect to a securities exchange or automated quotation
system, means a day on which the exchange or system is open for a full day of
trading.
"Unrestricted Subsidiary" means any Subsidiary that is designated by the
Board of Directors as an Unrestricted Subsidiary by a resolution of the Board of
Directors.
"Vendor Indebtedness" means any Indebtedness of the Company or any
Restricted Subsidiary incurred in connection with the acquisition or
construction of Telecommunications Related Assets.
"Voting Stock" of any Person means Capital Stock of the Person which
ordinarily has voting power for the election of directors (or Persons performing
similar functions) of the Person, whether at all times or only so long as no
senior class of securities has the voting power by reason of any contingency.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing:
(a) the then outstanding principal amount of the Indebtedness; into
(b) the total of the product obtained by multiplying:
(x) the amount of each then remaining installment, sinking fund,
serial maturity or other required payments of principal, including
payment at final maturity, in respect of the Indebtedness, by
(y) the number of years (calculated to the nearest one-twelfth)
that will elapse between that date and the making of the payment;
provided, that with respect to Capital Lease Obligations, that maturity
will be calculated after giving effect to all renewal options by the
lessee.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a summary of the certain United States federal income tax
consequences relevant to the purchase, ownership and disposition of the notes
and to the exchange of outstanding notes for exchange notes. The following
summary is not binding on the U.S. Internal Revenue Service (the "IRS") or the
courts and we cannot assure you that the IRS or any court will take a similar
view with respect to the tax consequences described below. For purposes of this
discussion, the term "U.S. Holder" means a beneficial owner of a note that, for
United States federal income tax purposes, is (i) an individual citizen or
resident of the United States, (ii) a corporation or partnership created or
organized in or under the laws of the United States or of any political
subdivision thereof, (iii) an estate the income of which is subject to United
State federal income taxation regardless of its source, or (iv) a trust if a
court within the United States is able to exercise primary supervision over its
administration, and one or more United States persons have the authority to
control all substantial decisions of the trust. The term "Non-U.S. Holder" means
any person other than a U.S. Holder.
The summary is based on the Internal Revenue Code of 1986, as amended (the
"Code"), its legislative history, existing and proposed regulations, published
rulings and court decisions, all as currently in effect and all of which are
subject to change, possibly on a retroactive basis. This summary applies only to
those persons who purchase notes at the "issue price" (generally, the first
price at which a substantial amount of notes is sold for cash, other than to
bond houses, brokers and other persons acting in the capacity of underwriters),
and who hold the notes as "capital assets" (generally, assets held for
investment). It does not address the tax consequences to special classes of
investors, including:
- financial institutions,
- tax-exempt organizations,
- insurance companies,
- persons holding Notes as part of a straddle, hedge or conversion
transaction; or
- persons whose functional currency is not the United States dollar.
State, local or foreign tax consequences of ownership of the notes are not
summarized. Purchasers of notes should consult their own tax advisors with
respect to the particular consequences to them of the purchase, ownership and
disposition of the notes and the applicability of any state, local or foreign
tax laws, as well as with respect to the possible effects of changes in United
States federal and other tax laws.
EXCHANGE OFFER
Neither the exchange of outstanding notes for exchange notes in the
Exchange Offer nor the registration of the outstanding notes or exchange notes
pursuant to the Shelf Registration Statement will be a taxable event for United
States federal income tax purposes.
HOLDING COMPANY STRUCTURE
If we create a holding company that assumes our obligations under the
notes, we intend to structure the assumption in a manner that should not
constitute a taxable event to the holders of the notes for United States federal
income tax purposes. We also intend to take the position that the assumption has
no other United States federal income tax consequences, such as the creation of
additional OID, or issue premium, on the notes. The IRS, however, might take a
different position, which could affect the timing of both a holder's income and
our deductions with respect to the notes.
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<PAGE> 148
Stated Interest on the Notes. Payments of stated interest on the notes
generally will constitute "qualified stated interest" that is taxable to a
holder as ordinary interest income at the time it is accrued or received in
accordance with the holder's method of accounting for United States federal
income tax purposes.
Original Issue Discount. The notes were issued with original issue
discount ("OID") for U.S. federal income tax purposes to the extent that their
stated redemption price at maturity (that is, the sum of all payments on the
notes, other than payments of qualified stated interest) exceeds their issue
price by more than a de minimis amount. For this purpose, we intend to take the
position that the issue price of the notes is equal to their initial offering
price of 97.288% on March 24, 2000, and that the amount of OID in respect of the
notes (as of March 24, 2000) is equal to $27.12 per $1000 principal amount. As
such, in addition to reporting stated interest in respect of the notes in the
manner described above, a U.S. Holder would be required to continue to accrue
OID into gross income over time (as interest) using a constant yield basis (as
described below), in advance of the receipt of cash attributable to such OID and
without regard to such holder's method of tax accounting.
Because the notes were issued on various dates (March 24, 2000, June 2,
2000 and June 12, 2000), our determination of the amount of OID on the notes is
not entirely certain under existing U.S. federal income tax law and is subject
to challenge by the IRS. If the IRS successfully asserts that the notes have OID
in an amount that is different from our determination, (i) U.S. Holders may be
required to accrue different amounts of OID, and (ii) the notes issued on a
particular date may not be viewed in the public markets as fungible with the
notes issued on other dates. U.S. Holders also should be aware that the IRS
recently issued a proposed regulation (to be effective 60 days after publication
as a final regulation in the Federal Register) that could affect the
determination of the issue price of the notes. No assurance can be made as to
whether or when such regulation might be finalized, or as to whether the issue
price of the notes would change if such regulation were applied as proposed.
U.S. Holders are required to include in gross income an amount equal to the
sum of the "daily portions" of OID attributable to each day during the taxable
year in which the U.S. Holder holds notes, in accordance with a constant yield
to maturity method (based on a compounding of interest). In general, the daily
portions of OID on a note are determined by allocating to each day in any
"accrual period" a ratable portion of the OID on the note allocable to such
accrual period. The amount of OID on a note allocable to an accrual period will
be the excess of (a) the product of the "adjusted issue price" of the note at
the beginning of such accrual period and its yield to maturity (adjusted to
reflect the length of the accrual period) over (b) the amount of any qualified
stated interest on the note allocable to the accrual period. For this purpose,
an "accrual period" means an interval of time of one year or less, provided that
each scheduled payment of principal or interest occurs on either the final day
of an accrual period or the first day of an accrual period, and the "adjusted
issue price" of a note at the beginning of an accrual period will equal the
issue price, plus the amount of OID previously included in the gross income of
any holder less any payments made on such note (other than payments of qualified
stated interest) on or before the first day of the accrual period.
Disposition of the Notes. Generally, any sale, redemption or other taxable
disposition of a note will result in taxable gain or loss equal to the
difference between the sum of the amount of cash and the fair market value of
property received (other than amounts attributable to accrued but unpaid stated
interest on a note) and the holder's adjusted tax basis in the note. For this
purpose, a holder's adjusted tax basis in a note typically would equal the cost
of the note, increased by the amount of accrued OID included in such holder's
gross income, and decreased by all payments previously received by such holder
(other than payments of qualified stated interest), in respect of the note. Any
145
<PAGE> 149
gain or loss upon a sale or other disposition of a note by a U.S. Holder
generally will be U.S. source capital gain or loss, and will be long-term
capital gain or loss if the note has been held by the holder for more than one
year. Certain non-corporate holders (including individuals) are eligible for
preferential rates of United States federal income taxation in respect of
long-term capital gains. The deduction of capital losses is subject to certain
limitations under United States federal income tax laws.
Holders should be aware that the resale of a note may be affected by the
"market discount" rules of the Code, under which a subsequent purchaser
acquiring a note at a market discount generally would be required to include as
ordinary income a portion of gain realized upon the disposition or retirement of
such note to the extent of the market discount that accrued while the note was
held by such purchaser.
NON-U.S. HOLDERS
In general, payments of principal or interest (including OID) on the notes
by us or any paying agent to a beneficial owner of a note that is a Non-U.S.
Holder will not be subject to U.S. withholding tax, provided that, in the case
of interest or accrued OID, (i) such Non-U.S. Holder does not own, actually or
constructively, 10% or more of the total combined voting power of all classes of
our stock entitled to vote, within the meaning of Section 871(h)(3) of the Code,
(ii) such Non-U.S. Holder is not a controlled foreign corporation that is
related, directly or indirectly, to us through stock ownership, (iii) such
Non-U.S. Holder is not a bank receiving interest described in Section
881(c)(3)(A) of the Code, and (iv) the certification requirements under Section
871(h) or Section 881(c) of the Code, and the Treasury regulations thereunder
(summarized below) are satisfied.
A Non-U.S. Holder of a note will not be subject to U.S. federal income tax
on gains realized the sale, exchange or other disposition of a note (other than
amounts attributable to accrued but unpaid OID, which may be subject to the
rules regarding OID described above) unless (i) the Non-U.S. Holder is an
individual who is present in the U.S. for 183 days or more in the taxable year
of the sale, exchange or other disposition, and certain conditions are met, (ii)
the gain is effectively connected with the conduct by the Non-U.S. Holder of a
trade or business in the U.S. and, if certain tax treaties apply, is
attributable to a U.S. permanent establishment maintained by the Non-U.S.
Holder, or (iii) the Non-U.S. Holder is subject to Code provisions applicable to
certain U.S. expatriates.
A note held by an individual who is not a citizen or resident of the U.S.
at the time of his death will not be subject to U.S. estate tax as a result of
the individual's death, provided that, at the time of such individual's death,
the individual does not own, actually or constructively, 10% or more of the
total, combined voting power of all classes of our stock entitled to vote and
payments with respect to such note would not have been effectively connected
with the conduct by such individual of a trade or business in the U.S.
To satisfy the certification requirements noted above, (i) the beneficial
owner of a note must certify, under penalties of perjury, to us or our paying
agent that the owner if a Non-U.S. Holder and must provide the owner's name and
address, and U.S. taxpayer identification number ("TIN"), if any, which
certification may be made on IRS Form W-8BEN, or (ii) a securities clearing
organization, bank or other financial institution that holds customer securities
in the ordinary course of its trade or business and holds the note on behalf of
the beneficial owner must certify, under penalties or perjury, to us or our
paying agent that such certificate has been received from the beneficial owner
and must furnish the payor with a copy thereof.
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<PAGE> 150
For payments made after December 31, 2000, in the case of the notes held by
a foreign partnership that is not a withholding foreign partnership, the
partnership, in addition to providing an IRS Form W-8IMY, must attach an IRS
Form W-8BEN received from each partner.
If a Non-U.S. Holder of a note is engaged in a trade or business in the
U.S., and if interest (including OID) on the note or gain realized on the sale,
exchange or other disposition of the note is effectively connected with the
conduct of the trade or business (or, if a tax treaty applies, it's attributable
to a U.S. permanent establishment maintained by the Non-U.S. Holder), the
Non-U.S. Holder, although exempt from U.S. federal withholding tax (provided
that certification requirements are met), will generally be subject to regular
U.S. federal income tax on the interest (including OID) or gain in the same
manner as if it were a U.S. Holder. In lieu of the certificate described above
(with respect to non-effectively connected interest), the Non-U.S. Holder will
be required to provide us or our paying agent with a properly executed IRS Form
4224 (or, after December 31, 2000, a Form W-8ECI) in order to claim an exemption
from withholding tax. In addition, any such effectively connected interest or
gain received by a foreign corporation may be subject to an additional "branch
profits tax" at a 30% rate or a lower rate specified by an applicable income tax
treaty, subject to certain adjustments.
BACKUP WITHHOLDING
A holder may be subject, under certain circumstances, to backup withholding
at a 31 percent rate with respect to payments of interest (including OID)
received on, and proceeds from the sale (through a broker) of, a Note. Backup
withholding generally applies only if the holder:
- fails to furnish his or her social security or other taxpayer
identification number ("TIN") to us (or to another relevant payor) in the
required manner,
- furnishes an incorrect TIN and the IRS so notifies us (or such other
payor),
- is notified by the IRS that he or she has failed to report properly
payments of interest or dividends and the IRS has notified us (or such
other payor) that he or she is subject to withholding, or
- fails, under certain circumstances, to provide a certified statement,
signed under penalty of perjury, that the TIN provided is his or her
correct number and that he or she is not subject to backup withholding.
Any amount withheld from a payment to a holder under the backup withholding
rules is allowable as a credit against such holder's United States federal
income tax liability, provided that the required information is furnished to the
IRS. Certain holders (including, among others, corporations) are not subject to
backup withholding. Holders should consult their tax advisors as to their
qualification for exemption from backup withholding and the procedure for
obtaining such an exemption.
THE FOREGOING SUMMARY DOES NOT DISCUSS ALL ASPECTS OF UNITED STATES FEDERAL
INCOME TAXATION THAT MAY BE RELEVANT TO THE PARTICULAR CIRCUMSTANCES OF A HOLDER
OF NOTES. HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS AS TO THEIR SPECIFIC TAX
CONSEQUENCES TO THEM, INCLUDING THE APPLICATION AND EFFECT OF STATE, LOCAL,
FOREIGN AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN FEDERAL OR
OTHER TAX LAWS.
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<PAGE> 151
PLAN OF DISTRIBUTION
We are not using any underwriters for this exchange offer. We are also
bearing the expenses of the exchange, which we expect will be approximately [0].
This prospectus, as it may be amended or supplemented from time to time,
may be used by a broker-dealer in connection with resales of any exchange notes
received in exchange for outstanding notes acquired by such broker-dealer as a
result of market-making or other trading activities. Each such broker-dealer
that receives exchange notes for its own account in exchange for such
outstanding notes pursuant to the exchange offer must acknowledge that it will
deliver a prospectus in connection with any resale of such exchange notes. We
have agreed that for a period of up to 180 days after the registration statement
is declared effective, we will make this prospectus, as amended or supplemented,
available to any such broker-dealer that requests copies of this prospectus in
the letter of transmittal for use in connection with any such resale.
We will not receive any proceeds from any sale of exchange notes by
broker-dealers or any other persons. Exchange notes received by broker-dealers
for their own account pursuant to the exchange offer may be sold from time to
time in one or more transactions in the over-the-counter market, in negotiated
transactions or through the writing of options on the exchange notes, or a
combination of such methods of resale, at market prices prevailing at the time
of resale or negotiated prices. Any such resale may be made directly to
purchasers or to or through brokers or dealers who may receive compensation in
the form of commissions or concessions from any such broker-dealer and/or the
purchasers of any such exchange notes. Any broker-dealer that resells exchange
notes that were received by it for its own account pursuant to the exchange
offer in exchange for outstanding notes acquired by such broker-dealer as a
result of market-making or other trading activities and any broker-dealer that
participates in a distribution of such exchange notes may be deemed to be an
"underwriter" within the meaning of the Securities Act. Any profit on these
resales of exchange notes and any commissions or concessions received by any
persons may be deemed to be underwriting compensation under the Securities Act.
The letter of transmittal states that by acknowledging that it will deliver and
by delivering a prospectus, a broker-dealer will not be deemed to admit that it
is an "underwriter" within the meaning of the Securities Act.
We have agreed to pay all expenses incident to our performance of, or
compliance with, the registration rights agreement and will indemnify the
holders of outstanding notes, including any broker-dealers, and certain parties
related to these holders, against various liabilities, including liabilities
under the Securities Act.
LEGAL MATTERS
Various legal matters regarding the validity of the Notes offered by this
prospectus will be passed upon for us by Shearman & Sterling, New York, New
York.
EXPERTS
The audited consolidated financial statements of MGC Communications, Inc.
and its subsidiaries in this prospectus have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.
The financial statements of CDM On-Line, Inc. (the Predecessor) at December
31, 1997, December 31, 1998, and May 31, 1999, and for each of the two years in
the period ended December 31, 1998, and for the period January 1, 1999 to May
31, 1999, as well as the consolidated financial statements of Primary Network
Holdings, Inc. (the Successor), at September 30, 1999, and
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<PAGE> 152
for the period June 1, 1999 to September 30, 1999, included in this prospectus
and registration statement, have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports thereon (of which the May 31, 1999 and
September 30, 1999 reports contain an explanatory paragraph describing
conditions that raise substantial doubt about the Predecessor and Successor
companies' ability to continue as a going concern as described in Note 1 in each
of these respective financial statements) appearing elsewhere herein, and are
included in reliance upon such report given on the authority of such firm as
experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We are subject to the informational requirements of the Exchange Act and,
in accordance therewith, file annual, quarterly and special reports, proxy
statements and other information with the Securities and Exchange Commission.
The reports, proxy statements and other information we file with the Securities
and Exchange Commission can be viewed electronically through the Securities and
Exchange Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR)
system. The Securities and Exchange Commission maintains a World Wide Web site
at http://www.sec.gov that contains reports, proxy and information statements
and other information regarding registrants that file electronically with the
Securities and Exchange Commission. You may read and copy any reports,
statements or other information Mpower files at the Securities and Exchange
Commission's public reference room at 450 Fifth Street, N.W., Washington, D.C.
20549, and at the Securities and Exchange Commission's Regional Offices located
at 7 World Trade Center, 13th floor, New York, New York 10048 and 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. Please call the Securities
and Exchange Commission at 1-800-SEC-0330 for further information on the public
reference rooms.
The Securities and Exchange Commission allows us to "incorporate by
reference" information into this prospectus, which means that we can disclose
important information to you by referring you to another document filed
separately with the Securities and Exchange Commission. The information
incorporated by reference is deemed to be a part of this prospectus, except for
any information superseded by information contained directly in this prospectus.
This prospectus incorporates by reference the documents set forth below that we
have previously filed with the Securities and Exchange Commission. These
documents contain important information about us and our financial condition.
DOCUMENTS INCORPORATED BY REFERENCE ARE AVAILABLE WITHOUT CHARGE UPON
REQUEST TO: GENERAL COUNSEL, MGC COMMUNICATIONS, INC., 171 SULLY'S TRAIL, SUITE
202, PITTSFORD, NY 14534, TELEPHONE: (716) 218-6550.
The following documents filed with the Securities and Exchange Commission
by us are incorporated herein by reference:
(i) Mpower's Annual Report on Form 10-K for the period ended
December 31, 1999;
(ii) Mpower's Quarterly Reports on Form 10-Q for the periods ended
March 31, 2000, March 31, 1999, June 30, 1999 and September 30, 1999;
(iii) Mpower's Current Reports on Form 8-K dated March 13, 2000, March
27, 2000, April 17, 2000 and May 4,2000;
(iv) Registration Statement on Form S-4, dated May 25, 2000; and
(v) Mpower's Definitive Proxy Statement on Schedule 14A dated June 5,
2000.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
FIRST QUARTER FINANCIAL STATEMENTS OF MGC COMMUNICATIONS,
INC. (UNAUDITED)
Consolidated Statements of Operations -- Three months ended
March 31, 2000 and 1999................................... F-3
Consolidated Balance Sheets -- March 31, 2000 and December
31, 1999.................................................. F-4
Consolidated Statements of Redeemable Preferred Stock and
Stockholders' Equity for the period from December 31, 1998
to March 31, 2000......................................... F-5
Consolidated Statements of Cash Flows -- Three months ended
March 31, 2000 and 1999................................... F-6
Condensed Notes to Unaudited Interim Consolidated Financial
Statements................................................ F-7
YEAR END FINANCIAL STATEMENTS OF MGC COMMUNICATIONS, INC.
Report of Independent Public Accountants.................... F-10
Consolidated Balance Sheets as of December 31, 1999 and
1998...................................................... F-11
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997.......................... F-12
Consolidated Statements of Redeemable Preferred Stock and
Stockholders' Equity for the years ended December 31,
1999, 1998 and 1997....................................... F-13
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997.......................... F-14
Notes to Consolidated Financial Statements.................. F-15
PRIMARY NETWORK HOLDINGS, INC. UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 1999 and
March 31, 2000 (unaudited)................................ F-31
Unaudited Consolidated Statements of Operations for the
three months and six months ended March 31, 1999 and March
31, 2000.................................................. F-32
Unaudited Consolidated Statements of Cash Flows for the six
months ended March 31, 1999 and 2000...................... F-33
Notes to Unaudited Consolidated Financial Statements........ F-35
PRIMARY NETWORK HOLDINGS, INC. UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 1999 and
December 31, 1999 (unaudited)............................. F-42
Unaudited Consolidated Statement of Operations for the
quarter ended December 31, 1998 and
1999...................................................... F-43
Unaudited Statements of Cash Flows for the quarter ended
December 31, 1998 and 1999................................ F-44
Notes to Unaudited Consolidated Financial Statements........ F-45
PRIMARY NETWORK HOLDINGS, INC. CONSOLIDATED FINANCIAL
STATEMENTS FOR THE PERIOD JUNE 1, 1999 TO SEPTEMBER 30,
1999
Report of Independent Auditors.............................. F-53
Consolidated Balance Sheet.................................. F-54
Consolidated Statement of Operations........................ F-55
Consolidated Statement of Stockholders' Equity.............. F-56
Consolidated Statement of Cash Flows........................ F-57
Notes to Consolidated Financial Statements.................. F-58
</TABLE>
F-1
<PAGE> 154
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
CDM ON-LINE, INC. CONSOLIDATED FINANCIAL STATEMENTS FOR THE
PERIOD JANUARY 1, 1999 TO MAY 31, 1999
Report of Independent Auditors.............................. F-79
Balance Sheet............................................... F-80
Statement of Operations..................................... F-81
Statement of Stockholders' Equity........................... F-82
Statement of Cash Flows..................................... F-83
Notes to Financial Statements............................... F-84
CDM ON-LINE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS
ENDED DECEMBER 31, 1997 AND 1998
Report of Independent Auditors.............................. F-96
Balance Sheets.............................................. F-97
Statements of Operations.................................... F-98
Statements of Stockholders' Deficit......................... F-99
Statements of Cash Flows.................................... F-100
Notes to Financial Statements............................... F-101
</TABLE>
F-2
<PAGE> 155
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
---------- ----------
<S> <C> <C>
Operating revenues:
Telecommunications services............................... $ 25,458 $ 8,401
Operating expenses:
Cost of operating revenues (excluding depreciation)....... 23,231 8,483
Selling, general and administrative....................... 23,140 7,727
Stock-based compensation expense.......................... 1,576 --
Depreciation and amortization............................. 6,761 3,484
---------- ----------
54,708 19,694
---------- ----------
Loss from operations........................................ (29,250) (11,293)
Other income (expense):
Gain on sale of investments............................... -- 205
Interest income........................................... 8,871 1,500
Interest expense(net of amounts capitalized).............. (4,965) (4,624)
---------- ----------
Net loss.................................................... (25,344) (14,212)
Accretion of preferred stock to redemption value............ (3,489) --
Accrued preferred stock dividend............................ (3,007) --
---------- ----------
Net loss applicable to common stockholders.................. $ (31,840) $ (14,212)
========== ==========
Basic and diluted loss per share of common stock............ $ (1.18) $ (.83)
========== ==========
Basic and diluted weighted average shares outstanding....... 26,938,911 17,204,944
========== ==========
</TABLE>
See accompanying condensed notes to unaudited interim consolidated financial
statements.
F-3
<PAGE> 156
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
---------- ------------
ASSETS (UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 307,769 $ 42,979
Investments available-for-sale............................ 465,628 61,627
Restricted investments.................................... 20,534 20,256
Accounts receivable, less allowance for doubtful accounts
of $936 and $647........................................ 14,281 15,299
Prepaid expenses.......................................... 2,553 1,527
---------- --------
Total current assets............................... 810,765 141,688
Property and equipment, net................................. 230,163 191,612
Investments available-for-sale.............................. 122,448 64,464
Deferred financing costs, net of accumulated amortization of
$2,080 and $1,859......................................... 11,279 3,920
Other assets................................................ 1,611 745
---------- --------
Total assets....................................... $1,176,266 $402,429
========== ========
LIABILITIES, REDEEMABLE PREFERRED
STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt...................... $ 670 $ 623
Accounts payable:
Trade................................................... 22,808 11,788
Property and equipment.................................. 36,519 24,955
Accrued interest.......................................... 10,405 5,200
Accrued sales tax payable................................. 5,447 4,345
Accrued other expenses.................................... 7,819 5,452
---------- --------
Total current liabilities.......................... 83,668 52,363
Senior Secured Notes, net of unamortized discount of $2,588
and $2,732................................................ 157,412 157,268
Senior Notes, net of unamortized discount of $6,767......... 243,233 --
Other long-term debt........................................ 3,859 4,044
---------- --------
Total liabilities.................................. 488,172 213,675
---------- --------
Commitments and contingencies
Redeemable preferred stock:
10% Series B Convertible Preferred Stock, 5,278,000 shares
authorized, 5,277,779 issued and outstanding at December
31, 1999................................................ -- 55,363
10% Series C Convertible Preferred Stock, 1,250,000 shares
authorized, 1,250,000 issued and outstanding............ 36,857 34,510
Note receivable from stockholder for issuance of Series C
convertible preferred stock............................. -- (4,900)
7.25% Series D Convertible Preferred Stock, 4,140,000
shares authorized, 4,140,000 issued and outstanding..... 202,359 --
Stockholders' equity:
Preferred stock, 44,610,000 and 43,472,221 shares
authorized but unissued................................. -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 35,507,596 and 23,244,328 shares issued and
outstanding............................................. 35 23
Additional paid-in capital................................ 596,240 225,300
Accumulated deficit....................................... (139,505) (114,161)
Less: treasury stock...................................... (76) (76)
Accumulated other comprehensive income.................... (1,972) (1,086)
Notes receivable from stockholders for issuance of common
stock................................................... (5,844) (6,219)
---------- --------
Total stockholders' equity......................... 448,878 103,781
---------- --------
Total liabilities, redeemable preferred stock and
stockholders' equity............................. $1,176,266 $402,429
========== ========
</TABLE>
See accompanying condensed notes to unaudited interim consolidated
financial statements.
F-4
<PAGE> 157
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
REDEEMABLE
PREFERRED STOCK COMMON STOCK ADDITIONAL TREASURY STOCK
-------------------- ------------------- PAID-IN ACCUMULATED ---------------
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT
---------- ------- ---------- ------ ---------- ----------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998...... -- $ -- 17,190,428 $17 $108,991 $ (44,392) -- $ --
Unrealized loss on investments
available-for-sale.............. -- -- -- -- -- -- -- --
Common stock issued............... -- -- 5,027,001 5 118,305 -- -- --
Warrants and options exercised for
common stock.................... -- -- 886,039 1 1,678 -- -- --
Common stock issued for note...... -- -- 150,000 -- 4,322 -- -- --
Payment on stockholder's note..... -- -- -- -- -- -- -- --
Repurchase of common stock........ -- -- (9,140) -- -- -- 9,140 (76)
10% Series B Convertible Preferred
Stock issued for cash........... 5,277,779 46,663 -- -- -- -- -- --
10% Series C Convertible Preferred
Stock issued for cash........... 1,250,000 34,500 -- -- -- -- -- --
Preferred stock issued for note... -- (4,900) -- -- -- -- -- --
Stock-based compensation.......... -- -- -- -- 714 -- -- --
Accrued preferred stock
dividend........................ -- 2,577 -- -- (2,577) -- -- --
Value of preferred stock
beneficial conversion
features........................ -- -- -- -- (72,500) -- -- --
Value of preferred stock
beneficial conversion
features........................ -- -- -- -- 72,500 -- -- --
Accretion of preferred stock to
redemption value................ -- 6,133 -- -- (6,133) -- -- --
Net loss.......................... -- -- -- -- -- (69,769) -- --
---------- ------- ---------- --- -------- --------- ----- ----
BALANCE AT DECEMBER 31, 1999...... 6,527,779 $84,973 23,244,328 $23 $225,300 $(114,161) 9,140 $(76)
Unrealized loss on investments
available-for-sale.............. -- -- -- -- -- -- -- --
Warrants and options exercised for
common stock.................... -- -- 529,695 1 1,358 -- -- --
Common stock issued for cash...... -- -- 6,163,709 6 316,728 -- -- --
Payment on stockholder's notes.... -- 4,900 -- -- -- -- -- --
7.25% Series D Convertible
Preferred Stock issued for
cash............................ 4,140,000 200,274 -- -- -- -- -- --
Stock-based compensation.......... -- -- -- -- 1,576 -- -- --
Accrued preferred stock
dividend........................ -- 3,007 -- -- (3,007) -- -- --
Accretion of preferred stock to
redemption value................ -- 3,489 -- -- (3,489) -- -- --
Series B Preferred converted to
Common stock.................... (5,277,779) (55,154) 5,277,779 5 55,148 -- -- --
Preferred dividends paid in Common
stock........................... -- (2,626) 292,085 -- 2,626 -- -- --
Adjustment to estimated issuance
costs of series C preferred
stock........................... -- 353 -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- (25,344) -- --
---------- ------- ---------- --- -------- --------- ----- ----
BALANCE AT MARCH 31, 2000......... 5,390,000 239,216 35,507,596 $35 $596,240 $(139,505) 9,140 $(76)
========== ======= ========== === ======== ========= ===== ====
<CAPTION>
NOTES
RECEIVABLES FROM ACCUMULATED
STOCKHOLDERS FOR OTHER TOTAL
ISSUANCE OF COMPREHENSIVE STOCKHOLDERS'
COMMON STOCK INCOME (LOSS) EQUITY
---------------- ------------- -------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998...... $(2,173) $ 817 $ 63,260
Unrealized loss on investments
available-for-sale.............. -- (1,903) (1,903)
Common stock issued............... -- -- 118,310
Warrants and options exercised for
common stock.................... -- -- 1,679
Common stock issued for note...... (4,322) -- --
Payment on stockholder's note..... 200 -- 200
Repurchase of common stock........ 76 -- --
10% Series B Convertible Preferred
Stock issued for cash........... -- -- --
10% Series C Convertible Preferred
Stock issued for cash........... -- -- --
Preferred stock issued for note... -- -- --
Stock-based compensation.......... -- -- 714
Accrued preferred stock
dividend........................ -- -- (2,577)
Value of preferred stock
beneficial conversion
features........................ -- -- (72,500)
Value of preferred stock
beneficial conversion
features........................ -- -- 72,500
Accretion of preferred stock to
redemption value................ -- -- (6,133)
Net loss.......................... -- -- (69,769)
------- ------- --------
BALANCE AT DECEMBER 31, 1999...... $(6,219) $(1,086) $103,781
Unrealized loss on investments
available-for-sale.............. -- (886) (886)
Warrants and options exercised for
common stock.................... -- -- 1,359
Common stock issued for cash...... -- -- 316,734
Payment on stockholder's notes.... 375 -- 375
7.25% Series D Convertible
Preferred Stock issued for
cash............................ -- -- --
Stock-based compensation.......... -- -- 1,576
Accrued preferred stock
dividend........................ -- -- (3,007)
Accretion of preferred stock to
redemption value................ -- -- (3,489)
Series B Preferred converted to
Common stock.................... -- -- 55,153
Preferred dividends paid in Common
stock........................... -- -- 2,626
Adjustment to estimated issuance
costs of series C preferred
stock........................... -- -- --
Net loss.......................... -- -- (25,344)
------- ------- --------
BALANCE AT MARCH 31, 2000......... $(5,844) $(1,972) $448,878
======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 158
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 1999
--------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (25,344) $(14,212)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 6,761 3,484
Gain on sale of investments............................... -- (205)
Amortization of debt discount............................. 157 144
Amortization of deferred financing costs.................. 216 207
Stock based compensation expense.......................... 1,576 --
Changes in assets and liabilities:
Decrease (increase) in accounts receivable, net......... 1,018 (2,628)
Increase in prepaid expenses............................ (1,026) (42)
Increase in other assets................................ (887) (307)
Increase in accounts payable -- trade................... 11,020 6,819
Increase in sales tax payable........................... 1,102 163
Increase in accrued interest and other expenses......... 7,572 5,966
--------- --------
Net cash provided by (used in) operating activities... 2,165 (611)
--------- --------
Cash flows from investing activities:
Purchase of property and equipment, net of payables....... (33,545) (15,240)
Decrease in accounts payable-property and equipment......... -- (12,894)
Purchase of investments available-for-sale, net............. (785,828) --
Sale of investments available-for-sale.................... 322,957 23,294
Increase in restricted investments........................ (278) (550)
--------- --------
Net cash used in investing activities................. (496,694) (5,390)
--------- --------
Cash flows from financing activities:
Proceeds from issuance of Senior Notes.................... 243,220 --
Costs associated with issuance of Senior Notes............ (7,575) --
Proceeds from issuance of 7.25% Series D Convertible
Preferred Stock, net of issuance costs.................. 200,628 --
Payments on other long term debt.......................... (321) (153)
Proceeds from issuance of common stock.................... 318,092 240
Collection on notes received for preferred and common
stock................................................... 5,275 --
--------- --------
Net cash provided by financing activities............. 759,319 87
--------- --------
Net increase (decrease) in cash....................... 264,790 (5,914)
Cash and cash equivalents at beginning of period............ 42,979 11,886
--------- --------
Cash and cash equivalents at the end of period.............. $ 307,769 $ 5,972
========= ========
Supplemental schedule of non-cash investing and financing
activities:
Increase in property and equipment purchases included in
accounts/notes payable -- property and equipment........ $ 11,746 $ --
========= ========
Series B preferred stock converted to common stock........ 55,153 --
========= ========
Series B preferred stock dividends paid in common stock... 2,578 --
========= ========
Preferred stock dividends accrued......................... 2,957 --
========= ========
Accretion of preferred stock to redemption value.......... 3,489 --
========= ========
</TABLE>
See accompanying condensed notes to unaudited interim consolidated financial
statements.
F-6
<PAGE> 159
MGC COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of MGC
Communications, Inc. doing business as Mpower Communications Corp. (the
"Company"), a Nevada corporation, include the accounts of the Company and its
wholly-owned subsidiaries, MGC Lease Corporation and MGC LJ.Net, Inc. All
significant inter-company balances and transactions have been eliminated.
These consolidated financial statements reflect all normal recurring
adjustments, which management believes are necessary to present fairly the
financial position, results of operations, and cash flows for the Company for
the respective periods presented. Certain information and footnote disclosures
normally included in the annual consolidated financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission for Form 10-Q. These unaudited interim consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's annual report on Form
10-K filed with the Securities and Exchange Commission.
The consolidated balance sheet at December 31, 1999 was derived from the
audited consolidated financial statements, but does not include all disclosures
required under generally accepted accounting principles.
(2) PROPERTY AND EQUIPMENT
Property and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
----------- ------------
(UNAUDITED)
<S> <C> <C>
Building and property....................................... $ 5,579 $ 5,518
Switching equipment......................................... 168,608 137,492
Leasehold improvements...................................... 1,978 870
Computer hardware and software.............................. 5,408 3,780
Office equipment and vehicles............................... 6,889 5,748
-------- --------
188,462 153,408
Less accumulated depreciation and amortization.............. (31,907) (25,237)
-------- --------
156,555 128,171
Switching equipment under construction...................... 73,608 63,441
-------- --------
Net property and equipment.................................. $230,163 $191,612
======== ========
</TABLE>
(3) COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
In the ordinary course of business, the Company enters into purchase
agreements with its vendors of telecommunications equipment and collocation
sites. As of March 31, 2000 and December 31, 1999, the Company had a total of
approximately $127.9 million and $43.3 million, respectively, of remaining
purchase commitments to telecommunication vendors for purchases of switching
equipment and approximately $58.4 million and $11.9 million of commitments to
F-7
<PAGE> 160
MGC COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
collocation site providers for the build-out of collocation sites. In April
2000, the company committed to purchase an aircraft for $10.8 million.
(4) DEBT
On March 24, 2000 the Company received approximately $235.6 million in net
proceeds from the issuance of $250 million of 13% Senior Notes due April 1,
2010. The Notes bear a fixed annual interest rate of 13% which will be paid in
cash every six months on April 1 and October 1, commencing October 1, 2000. The
Notes are senior unsecured obligations and rank equally with all of the
Company's existing and future senior debt and are senior to all of the Company's
existing and future subordinate debt. The Notes contain certain repurchase
requirements if certain assets are sold and the proceeds are not used as
specified in the indenture.
At any time after April 1, 2005, the Company may, at its option, redeem the
Notes, in whole or in part, at a premium declining to par in 2003, plus accrued
and unpaid interest and liquidated damages, if any, through the redemption date
as follows:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2005........................................................ 106.500
2006........................................................ 104.330
2007........................................................ 102.166
2008 and thereafter......................................... 100.000
</TABLE>
At any time prior to April 1, 2003, the Company may redeem up to 35% of the
principal amount of the Notes from the net cash proceeds of an underwritten
public offering of the Company's capital stock at a redemption price equal to
113.0% of the principal amount of the notes plus any unpaid or accrued interest.
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
In February 2000, the Company completed an offering in which 4,140,000
shares of 7.25% Series D Convertible Redeemable Preferred Stock at $50.00 per
share were issued for $207.0 million in gross proceeds. Each share of preferred
stock is convertible at the option of the holder into .7562 shares of common
stock at a conversion price of $65.34 per share, subject to adjustments and
expiration of conversion rights in certain circumstances. Quarterly dividends
are payable at the Company's option in cash or shares of common stock, beginning
May 15, 2000. On April 18, 2000 the Company's board of directors declared a
quarterly dividend of $0.95 per share, payable in shares of the Company's common
stock on May 15, 2000. The record date for the dividend payment was April 28,
2000.
In conjunction with the above offering, the Company issued 6,163,709 shares
of common stock at $54.00 per share for gross proceeds of $332.8 million. In
this offering, existing shareholders sold an additional 29,041 shares of common
stock for which the Company did not receive any proceeds.
(6) SUBSEQUENT EVENT
In April 2000, the Company entered into a merger agreement to purchase
Primary Networks for $145 million. Primary Networks is a provider of
data-centric communications services to business and residential customers in
the Midwest. The Company will issue 1.4 million shares to Primary Network
F-8
<PAGE> 161
MGC COMMUNICATIONS, INC.
CONDENSED NOTES TO UNAUDITED INTERIM CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
shareholders, will assume approximately $76 million of liabilities, a portion of
which will be swapped for additional high-yield bonds to be issued under the
Company's recent high-yield financing indenture discussed above, and will
account for this transaction as a purchase. The Company's board of directors
approved the agreement between both companies and expects to close the merger in
the third quarter.
F-9
<PAGE> 162
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and
Board of Directors of
MGC Communications, Inc.:
We have audited the accompanying consolidated balance sheets of MGC
Communications, Inc. (a Nevada corporation) and subsidiaries (the "Company") as
of December 31, 1999 and 1998, and the related consolidated statements of
operations, redeemable preferred stock and stockholders' equity and cash flows
for each of the three years in the period ended December 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of MGC Communications, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
February 16, 2000
F-10
<PAGE> 163
MGC COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1999 1998
ASSETS --------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 42,979 $ 11,886
Investments available-for-sale............................ 61,627 9,851
Restricted investments.................................... 20,256 20,797
Accounts receivable, less allowance for doubtful accounts
of $647 and $257 at December 31, 1999 and 1998,
respectively............................................ 15,299 6,360
Prepaid expenses.......................................... 1,527 208
--------- --------
Total current assets............................... 141,688 49,102
Property and equipment, net................................. 191,612 116,380
Investments available-for-sale.............................. 64,464 63,212
Restricted investments...................................... -- 18,582
Deferred financing costs, net of accumulated amortization of
$1,859 and $1,065 as of December 31, 1999 and 1998,
respectively.............................................. 3,920 4,714
Other assets................................................ 745 129
--------- --------
Total assets....................................... $ 402,429 $252,119
========= ========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and capital lease
obligations............................................. $ 623 $ 332
Accounts payable:
Trade................................................... 11,788 5,314
Property and equipment.................................. 24,955 18,577
Accrued interest.......................................... 5,200 5,200
Accrued sales taxes payable............................... 4,345 1,400
Accrued other expenses.................................... 5,452 1,073
--------- --------
Total current liabilities.......................... 52,363 31,896
Senior Secured Notes, net of unamortized discount of $2,732
and $3,307 at December 31, 1999 and 1998, respectively.... 157,268 156,693
Other long-term debt and capital lease obligations.......... 4,044 270
--------- --------
Total liabilities.................................. 213,675 188,859
--------- --------
Commitments and contingencies
Redeemable preferred stock:
10% Series B Convertible Preferred Stock, 5,278,000 shares
authorized, 5,277,779 issued and outstanding at December
31, 1999................................................ 55,363 --
10% Series C Convertible Preferred Stock, 1,250,000 shares
authorized, 1,250,000 issued and outstanding at December
31, 1999................................................ 34,510 --
Note receivable from stockholder for issuance of Series C
convertible preferred stock............................. (4,900) --
Stockholders' equity:
Preferred stock, 43,472,221 shares authorized but
unissued................................................ -- --
Common stock, $0.001 par value, 60,000,000 shares
authorized, 23,244,328 and 17,190,428 shares issued and
outstanding............................................. 23 17
Additional paid-in capital................................ 225,300 108,991
Accumulated deficit....................................... (114,161) (44,392)
Less: treasury stock...................................... (76) --
Notes receivable from stockholders for issuance of common
stock................................................... (6,219) (2,173)
Accumulated other comprehensive income (loss)............. (1,086) 817
--------- --------
Total stockholders' equity......................... 103,781 63,260
--------- --------
Total liabilities, redeemable preferred stock and
stockholders' equity.............................. $ 402,429 $252,119
========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-11
<PAGE> 164
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Operating revenues:
Telecommunication services...................... $ 55,066 $ 18,249 $ 3,791
----------- ----------- ----------
Operating expenses:
Cost of operating revenues (excluding
depreciation)................................ 50,012 17,129 3,928
Selling, general and administrative............. 44,836 17,877 6,440
Stock-based compensation expense................ 714 -- --
Depreciation and amortization................... 18,921 5,238 1,274
----------- ----------- ----------
114,483 40,244 11,642
----------- ----------- ----------
Loss from operations......................... (59,417) (21,995) (7,851)
Other income (expense):
Gain on sale of investments..................... 224 223 --
Interest income................................. 7,702 8,771 2,507
Interest expense (net of amount capitalized).... (18,278) (19,064) (5,492)
----------- ----------- ----------
Net loss..................................... (69,769) (32,065) (10,836)
Value of preferred stock beneficial conversion
feature......................................... (72,500) -- --
Accretion of preferred stock to redemption
value........................................... (6,133) -- --
Accrued preferred stock dividend.................. (2,577) -- (136)
----------- ----------- ----------
Net loss applicable to common stockholders........ $ (150,979) $ (32,065) $ (10,972)
=========== =========== ==========
Basic and diluted loss per share of common
stock........................................... $ (7.63) $ (2.26) $ (1.30)
=========== =========== ==========
Basic and diluted weighted average shares
outstanding..................................... 19,775,410 14,178,729 8,458,991
=========== =========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-12
<PAGE> 165
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
REDEEMABLE
PREFERRED STOCK COMMON STOCK ADDITIONAL TREASURY STOCK
-------------------- ------------------- PAID-IN ACCUMULATED ---------------
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT
---------- ------- ---------- ------ ---------- ----------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996...... -- $ -- 7,176,000 $ 7 $ 12,276 $ (1,491) -- $ --
Common stock issued for cash...... -- -- 1,458,600 2 4,860 -- -- --
Common stock issued for notes
receivable...................... -- -- 165,000 -- 688 -- -- --
Proceeds from offering allocated
to warrants..................... -- -- -- -- 3,885 -- -- --
Warrants issued for common stock
commitment...................... -- -- -- -- 409 -- -- --
8% Series A Convertible Preferred
Stock issued for cash........... 5,148,570 16,665 -- -- -- -- -- --
Accrued preferred stock
dividend........................ -- -- -- -- (136) -- -- --
Net loss.......................... -- -- -- -- -- (10,836) -- --
---------- ------- ---------- --- -------- --------- ----- ----
BALANCE AT DECEMBER 31, 1997...... 5,148,570 16,665 8,799,600 9 21,982 (12,327) -- --
Common stock issued for cash...... -- -- 100,680 -- 774 -- -- --
Common stock issued for notes
receivable...................... -- -- 189,000 -- 1,485 -- -- --
Warrants and options exercised for
common stock.................... -- -- 133,309 -- 14 -- -- --
8% Series A Convertible Preferred
Stock issued for cash........... 1,422,857 4,980 -- -- -- -- -- --
Accrued preferred stock
dividend........................ -- -- -- -- (654) -- -- --
Common stock issued for cash
(IPO)........................... -- -- 4,025,000 4 62,959 -- -- --
Conversion of preferred stock to
common stock.................... (6,571,427) (21,645) 3,942,839 4 22,431 -- -- --
Unrealized gain on investments
available-for-sale.............. -- -- -- -- -- -- -- --
Net loss.......................... -- -- -- -- -- (32,065) -- --
---------- ------- ---------- --- -------- --------- ----- ----
BALANCE AT DECEMBER 31, 1998...... -- -- 17,190,428 17 108,991 (44,392) -- --
Unrealized loss on investments
available-for-sale.............. -- -- -- -- -- -- -- --
Common stock issued............... -- -- 5,027,001 5 118,305 -- -- --
Warrants and options exercised for
common stock.................... -- -- 886,039 1 1,678 -- -- --
Common stock issued for note...... -- -- 150,000 -- 4,322 -- -- --
Payment on stockholder's note..... -- -- -- -- -- -- -- --
Repurchase of common stock........ -- -- (9,140) -- -- -- 9,140 (76)
10% Series B Convertible Preferred
Stock issued for cash........... 5,277,779 46,663 -- -- -- -- -- --
10% Series C Convertible Preferred
Stock issued for cash........... 1,250,000 34,500 -- -- -- -- -- --
Preferred stock issued for note... -- (4,900) -- -- -- -- -- --
Stock-based compensation.......... -- -- -- -- 714 -- -- --
Accrued preferred stock
dividend........................ -- 2,577 -- -- (2,577) -- -- --
Value of preferred stock
beneficial conversion
features........................ -- -- -- -- (72,500) -- -- --
Value of preferred stock
beneficial conversion
features........................ -- -- -- -- 72,500 -- -- --
Accretion of preferred stock to
redemption value................ -- 6,133 -- -- (6,133) -- -- --
Net loss.......................... -- -- -- -- -- (69,769) -- --
---------- ------- ---------- --- -------- --------- ----- ----
BALANCE AT DECEMBER 31, 1999...... 6,527,779 $84,973 23,244,328 $23 $225,300 $(114,161) 9,140 $(76)
========== ======= ========== === ======== ========= ===== ====
<CAPTION>
NOTES
RECEIVABLE FROM ACCUMULATED
STOCKHOLDERS FOR OTHER TOTAL
ISSUANCE OF COMPREHENSIVE STOCKHOLDERS'
COMMON STOCK INCOME (LOSS) EQUITY
---------------- ------------- -------------
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996...... $ -- $ -- $ 10,792
Common stock issued for cash...... -- -- 4,862
Common stock issued for notes
receivable...................... (688) -- --
Proceeds from offering allocated
to warrants..................... -- -- 3,885
Warrants issued for common stock
commitment...................... -- -- 409
8% Series A Convertible Preferred
Stock issued for cash........... -- -- --
Accrued preferred stock
dividend........................ -- -- (136)
Net loss.......................... -- -- (10,836)
------- ------- --------
BALANCE AT DECEMBER 31, 1997...... (688) -- 8,976
Common stock issued for cash...... -- -- 774
Common stock issued for notes
receivable...................... (1,485) -- --
Warrants and options exercised for
common stock.................... -- -- 14
8% Series A Convertible Preferred
Stock issued for cash........... -- -- --
Accrued preferred stock
dividend........................ -- -- (654)
Common stock issued for cash
(IPO)........................... -- -- 62,963
Conversion of preferred stock to
common stock.................... -- -- 22,435
Unrealized gain on investments
available-for-sale.............. -- 817 817
Net loss.......................... -- -- (32,065)
------- ------- --------
BALANCE AT DECEMBER 31, 1998...... (2,173) 817 63,260
Unrealized loss on investments
available-for-sale.............. -- (1,903) (1,903)
Common stock issued............... -- -- 118,310
Warrants and options exercised for
common stock.................... -- -- 1,679
Common stock issued for note...... (4,322) -- --
Payment on stockholder's note..... 200 -- 200
Repurchase of common stock........ 76 -- --
10% Series B Convertible Preferred
Stock issued for cash........... -- -- --
10% Series C Convertible Preferred
Stock issued for cash........... -- -- --
Preferred stock issued for note... -- -- --
Stock-based compensation.......... -- -- 714
Accrued preferred stock
dividend........................ -- -- (2,577)
Value of preferred stock
beneficial conversion
features........................ -- -- (72,500)
Value of preferred stock
beneficial conversion
features........................ -- -- 72,500
Accretion of preferred stock to
redemption value................ -- -- (6,133)
Net loss.......................... -- -- (69,769)
------- ------- --------
BALANCE AT DECEMBER 31, 1999...... $(6,219) $(1,086) $103,781
======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-13
<PAGE> 166
MGC COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $ (69,769) $ (32,065) $ (10,836)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 18,921 5,238 1,274
Gain on sale of investments............................... (224) (223) --
Amortization of debt discount............................. 575 575 144
Amortization of deferred debt financing costs............. 794 867 198
Stock-based compensation expense.......................... 714 -- --
Changes in assets and liabilities:
Increase in accounts receivable, net.................... (8,939) (5,160) (1,190)
Decrease (increase) in prepaid expenses................. (1,319) 69 (254)
Increase in other assets................................ (464) (32) (91)
Increase in accounts payable-- trade.................... 6,474 4,852 386
Increase in sales taxes payable......................... 2,945 1,400 --
Increase in accrued interest and other expenses......... 4,379 295 5,879
--------- --------- ---------
Net cash used in operating activities................. (45,913) (24,184) (4,490)
--------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net of payables....... (83,200) (81,597) (20,207)
Purchase of investments held-to-maturity.................. -- (42,622) (57,710)
Sale (purchase) of investments available-for-sale, net.... (54,707) 28,309 --
Sale (purchase) of restricted investments................. 19,123 18,195 (57,574)
--------- --------- ---------
Net cash used in investing activities................. (118,784) (77,715) (135,491)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of Senior Secured Notes net of
discount of $4,026...................................... -- -- 155,974
Costs associated with issuance of Senior Secured Notes and
warrants................................................ -- (133) (5,237)
Proceeds from issuance of warrants........................ -- -- 3,885
Proceeds from issuance of 8% Series A convertible
preferred stock, net of issuance costs.................. -- 4,980 16,665
Proceeds from issuance of 10% Series B convertible
preferred stock, net of issuance costs.................. 46,663 -- --
Proceeds from issuance of 10% Series C convertible
preferred stock, net of issuance costs.................. 29,600 -- --
Proceeds (payments) on other long term debt and capital
lease obligations, net.................................. (439) 133 (164)
Proceeds from issuance of common stock.................... 119,966 63,751 6,015
--------- --------- ---------
Net cash provided by financing activities............. 195,790 68,731 177,138
--------- --------- ---------
Net increase (decrease) in cash....................... 31,093 (33,168) 37,157
Cash and cash equivalents at beginning of period............ 11,886 45,054 7,897
--------- --------- ---------
Cash and cash equivalents at the end of period.............. $ 42,979 $ 11,886 $ 45,054
========= ========= =========
Supplemental schedule of non-cash investing and financing
activities:
Treasury stock acquired in partial settlement of a note... $ 76 $ -- $ --
========= ========= =========
Increase in property and equipment purchases included in
accounts/notes payable -- property and equipment........ $ 10,882 $ 15,504 $ 2,434
========= ========= =========
Stock issued in acquisition of subsidiary................. $ 223 $ -- $ --
========= ========= =========
Preferred stock dividends accrued......................... $ 2,577 $ -- $ 136
========= ========= =========
Accretion of preferred stock to redemption value.......... $ 6,133 $ -- $ --
========= ========= =========
Common stock issued for note receivable................... $ 4,322 $ 1,485 $ 688
========= ========= =========
Preferred stock issued for note receivable................ $ 4,900 $ -- $ --
========= ========= =========
Warrants issued as consideration in debt offering
capitalized as deferred financing costs................. $ -- $ -- $ 409
========= ========= =========
Other disclosures:
Cash paid for interest net of amounts capitalized......... $ 16,915 $ 19,192 $ 164
========= ========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-14
<PAGE> 167
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(1) PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS
The accompanying consolidated financial statements of MGC Communications,
Inc. doing business as Mpower Communications Corp. (the "Company"), a Nevada
corporation, include the accounts of the Company and its wholly owned
subsidiaries, MGC Lease Corporation and MGC LJ.Net, Inc. All significant
inter-company balances have been eliminated.
The Company was organized on October 16, 1995 as a competitive local
exchange carrier to provide low cost alternative communication services to
residential and small business users through the utilization of Company owned
switches and network architecture leased from incumbent local exchange carriers.
During the year ended December 31, 1999, the Company operated in Las Vegas,
Atlanta, Chicago, southern Florida, and selected suburban areas of southern
California including San Diego and Los Angeles with substantially all of its
operating revenues being derived from the Las Vegas, southern California, and
Atlanta operations.
REVENUE RECOGNITION
The Company recognizes operating revenues from the sale of communication
services including local dialtone, long distance, Internet access and data
services. Operating revenues are also recognized from installation charges as
well as from access charges billed to other long distance carriers for utilizing
the Company's network.
Telecommunication revenues and accounts receivable are recognized when
calls are terminated or when the installation services are completed. Accounts
receivable includes both billed and unbilled amounts and is reduced by an
estimate for uncollectible amounts. Due to current disputes, the Company has
recognized switched access revenues based on management's best estimate of the
probable collections from such revenue. AT&T, Sprint, MCI WorldCom and other
long distance carriers have refused to pay the full amount of the long distance
access charges billed to them. For the years ended December 31, 1999, 1998 and
1997, the Company has recognized in operating revenues switched access revenues
of approximately $19.5 million, $7.4 million and $0.7 million, respectively.
These revenue amounts exclude $9.5 million, $3.2 million, and $0.2 million of
billed services which have not been recorded as revenue in the accompanying
consolidated statements of operations for the years ended December 31, 1999,
1998 and 1997, respectively. Switched access revenues from AT&T, Sprint, and MCI
WorldCom represented 71% and 81% of our total access charge revenues in 1999 and
1998, respectively. The Company settled its disputes with MCI WorldCom in
October 1999 and with AT&T in February 2000. Amounts collected approximated the
related switched access revenues estimated by the Company's management.
Included in trade accounts receivable in the accompanying consolidated
balance sheets as of December 31, 1999 and 1998 are net receivables related to
switched access of approximately $10.9 million and $3.6 million, respectively.
CASH AND CASH EQUIVALENTS
The Company considers short-term investments with a remaining maturity of
three months or less at the date of purchase to be cash equivalents.
F-15
<PAGE> 168
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RESTRICTED INVESTMENTS
Restricted investments consist of U.S. Treasury Notes which are restricted
in that they must be used for the repayment of interest on certain debt and are
stated at amortized cost plus accrued interest. Management designated these
investments as held-to-maturity securities in accordance with the provisions of
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities." The carrying value of the
restricted investments approximates the fair value.
ADVERTISING COSTS
The Company expenses advertising costs in the period incurred. As of
December 31, 1999, 1998 and 1997, the Company had expensed advertising costs of
$1,268,000, $810,000 and $125,000, respectively.
INVESTMENTS
Investments classified as available-for-sale at December 31, 1998 were
classified as held-to-maturity as of December 31, 1997. During the fourth
quarter of 1998, the Company sold investments previously classified as
held-to-maturity, prior to their maturity date to fund remaining 1998 capital
expenditures. In accordance with SFAS No. 115, the classification of these
investments has been appropriately changed in the accompanying consolidated
financial statements.
During 1999 and 1998, the Company sold $43.6 million and $28.3 million,
respectively, in investments available-for-sale and recorded a $1.9 million
gross unrealized loss and $0.8 million gross unrealized gain, respectively, as
part of other comprehensive income for the years ended December 31, 1999 and
1998.
Available-for-sale securities represent investments principally in
commercial paper and government securities. The commercial paper matures
periodically through March of 2000 and the government securities mature
periodically through June 2002. The unamortized cost basis of these investments
at December 31, 1999 and 1998 is approximately $128.0 million and $72.2 million,
respectively. The cost basis for which the realized gain was calculated on
available-for-sale securities was $128.2 million and $72.0 million, for 1999 and
1998, respectively, using the specific identification method.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation
and amortization. Direct and indirect costs of construction are capitalized, and
include $4,057,000, $3,175,000 and $188,000 of interest costs related to
construction during 1999, 1998 and 1997, respectively. Depreciation is computed
using the straight-line method over estimated useful lives beginning in the
month an asset is put into service.
F-16
<PAGE> 169
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Estimated useful lives of property and equipment are as follows:
<TABLE>
<S> <C>
Buildings................................ 40 years
Telecommunications and other switching
equipment.............................. 5-10 years
Computer hardware and software........... 3-5 years
Office furniture & equipment............. 3-5 years
Leasehold improvements................... the lesser of the estimated useful lives
or term of lease
</TABLE>
The Company capitalizes costs associated with the design, deployment and
expansion of the Company's network including internally and externally developed
software. Capitalized external software costs include the actual costs to
purchase software from vendors. Capitalized internal software costs generally
include personnel and related costs incurred in the enhancement and
implementation of purchased software packages. Capitalized internal labor costs
for the years ended December 31, 1999, 1998 and 1997 were $1,218,000, $0 and $0,
respectively.
DEFERRED FINANCING COSTS
Deferred financing costs are amortized to interest expense over the life of
the related financing using the effective interest method.
INCOME TAXES
The Company has applied the provisions of SFAS No. 109, "Accounting for
Income Taxes," which requires the recognition of deferred tax assets and
liabilities for the consequences of temporary differences between amounts
reported for financial reporting and income tax purposes. SFAS No. 109 requires
recognition of a future tax benefit of net operating loss carryforwards and
certain other temporary differences to the extent that realization of such
benefit is more likely than not; otherwise, a valuation allowance is applied.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure About Fair Value of Financial Instruments,"
requires all entities to disclose the fair value of financial instruments, both
assets and liabilities recognized and not recognized on the balance sheet, for
which it is practicable to estimate fair value. SFAS No. 107 defines fair value
of a financial instrument as the amount at which the instrument could be
exchanged in a current transaction between willing parties. At December 31, 1999
and 1998, the carrying value of all financial instruments (accounts receivable,
accounts payable and long-term debt) approximates fair value due to the short
term nature of the instruments or interest rates, which are comparable with
current rates.
LONG-LIVED ASSETS
Management periodically evaluates the carrying value of its long-lived
assets, including property, equipment and intangible assets, whenever events or
changes in circumstances indicate that the carrying value may not be
recoverable. To the extent the estimated future cash inflows attributable to the
asset, less estimated future cash outflows, is less than the carrying amount, an
impairment loss is recognized by writing down the asset's carrying value down to
its fair value based on the present
F-17
<PAGE> 170
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value of the discounted cash flows of the asset or other relevant measures.
Management believes no material impairment in the value of long-lived assets
exists at December 31, 1999 or 1998.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 131, "Disclosure About Segments of
an Enterprise and Related Information." SFAS No. 131 establishes additional
standards for segment reporting in financial statements and is effective for
fiscal years beginning after December 15, 1997. The Company currently operates
in only one segment, communication services, and hence, separate segment
reporting is not applicable.
CONCENTRATION OF SUPPLIERS
The Company currently leases its transport capacity from a limited number
of suppliers and is dependent upon the availability of collocation space and
fiber optic transmission facilities owned by the suppliers. The Company is
currently vulnerable to the risk of renewing favorable supplier contracts,
timeliness of the supplier in processing the Company's orders for customers and
is at risk to regulatory agreements that govern the rates to be charged to the
Company.
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 the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
RECLASSIFICATION
Certain reclassifications, which have no effect on net income, have been
made in the prior period financial statements to conform to the current
presentation.
(2) PLAN OF OPERATIONS
In September 1997, the Company completed an offering of 160,000 units
consisting of $160 million of 13% Senior Secured Notes due in 2004 (the "Notes")
and warrants to purchase shares of common stock, as discussed in Note 4. During
May and June 1998, the Company sold an aggregate of 4,025,000 shares of common
stock at $17.00 per share. In May 1999, the Company sold 5,277,779 shares of
preferred stock at $9.00 per share as discussed in Note 5. In July 1999, the
Company sold an additional 5,000,000 shares of common stock at $25.00 per share
as also discussed in Note 5. In December 1999, the Company issued 1,250,000
shares of preferred stock at $28.00 per share as also discussed in Note 5. In
February 2000, the Company sold an additional 6,163,709 shares of common stock
at $54.00 per share and 4,140,000 shares of preferred stock at $50.00 per share
as also discussed in Note 5. The Company expects to continue its expansion and
development of services into new markets. The Company expects to fund any
additional capital requirements through existing resources, debt or equity
financing and internally generated funds.
The Company expects that its available cash and the proceeds from the
common stock and series D preferred stock offerings in February 1999 should be
adequate to fund its operating losses and planned capital expenditures, as
currently projected, over the next several years. If these
F-18
<PAGE> 171
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
resources are not sufficient, management intends to consider alternate forms of
financing or to delay or modify some of our expansion plans.
The Company continually evaluates the capital expenditure plan in light of
developments in the telecommunications industry and market acceptance of the
Company's service offerings. As a result of this evaluation, the Company may
decide to accelerate or expand its capital expenditure plan. The Company might
also expand through acquisitions. To fund an accelerated or expanded capital
expenditure plan or acquisitions, the Company would likely issue additional debt
or equity securities. The Company cannot predict that it would be successful in
raising additional capital on terms acceptable to it or at all.
Management also recognizes that certain risks are inherent to the industry.
Such risks and assumptions include, but are not limited to, the Company's
ability to successfully market its existing and proposed services to current and
new customers in existing and planned markets, successfully develop commercially
viable data and Internet offerings, access markets, install switches and obtain
suitable locations for its switches, negotiate suitable interconnect agreements
with the ILECs, obtain an acceptable level of cooperation from the ILECs, all in
a timely manner, at reasonable cost and on satisfactory terms and conditions, as
well as competitive, regulatory, legislative and judicial developments that
could materially affect the Company's future results.
(3) PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Building and property....................................... $ 5,518 $ 2,653
Switching equipment......................................... 137,492 57,045
Leasehold improvements...................................... 870 740
Computer hardware and software.............................. 3,780 2,218
Office equipment and vehicles............................... 5,748 901
-------- --------
153,408 63,557
Less accumulated depreciation and amortization.............. (25,237) (6,555)
-------- --------
128,171 57,002
Switching equipment under construction...................... 63,441 59,378
-------- --------
Net property and equipment............................. $191,612 $116,380
======== ========
</TABLE>
F-19
<PAGE> 172
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) DEBT
Long-term borrowings at December 31, 1999 and 1998 consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1999 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
13% Senior Secured Notes, due October 1, 2004, net of
unamortized discount of $2,732 and $3,307................. $157,268 $156,693
Other long-term debt and capital lease obligations.......... 4,667 602
-------- --------
161,935 157,295
Less current portion........................................ (623) (332)
-------- --------
$161,312 $156,963
======== ========
</TABLE>
Maturities of long-term debt and capital lease obligations for each of the
next five years and thereafter ending December 31, consist of the following:
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
2000........................................................ $ 623
2001........................................................ 696
2002........................................................ 508
2003........................................................ 274
2004 and thereafter......................................... 159,834
--------
$161,935
========
</TABLE>
In September 1997, the Company completed an offering of units consisting of
in the aggregate of $160 million of 13% Senior Secured Notes due in 2004 and
warrants to purchase 774,720 shares of common stock (collectively the "1997
Offering").
The Notes bear interest at the rate of 13% per annum, payable semi-annually
in arrears on April 1 and October 1, commencing April 1, 1998. As set forth in
the Indenture pursuant to which the Notes were issued the Company is required to
hold in a trust account sufficient funds to provide for payment in full of
interest on the Notes through October 1, 2000. The accompanying consolidated
financial statements reflect approximately $20.3 million as restricted
investments as security for the interest payments on the Notes. In addition, the
Notes are secured by a security interest in certain telecommunications equipment
owned by the Company or which may be acquired in the future. As of December 31,
1999, the Notes were secured by a security interest in telecommunications
equipment with a net book value of $105.4 million.
In conjunction with the 1997 Offering, the Company engaged an
investment-banking firm that determined a value for each warrant and share of
common stock. Consistent with this determination, the Company has allocated a
portion of the 1997 Offering proceeds to the warrants based on a value of $4.68
per share of common stock less the exercise price of $.02 per share for the
warrant.
The warrants are currently exercisable and expire on October 1, 2004. The
agreement pursuant to which the warrants were issued required an anti-dilution
adjustment if the November 1997 preferred stock offering was consummated at a
price less than $5.00 per share. As further discussed in Note 5, the Company
completed the preferred stock offering for $3.50 per share. Accordingly, the
warrants issued in connection with the 1997 Offering were increased from 774,200
to 862,923 and
F-20
<PAGE> 173
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
have been reflected in the accompanying consolidated financial statements as of
December 31, 1999 and 1998. Expenses allocated to the warrants in connection
with the 1997 Offering were $141,000.
In conjunction with the 1997 Offering, certain persons deposited an
aggregate of $15.0 million in escrow (the "Common Stock Commitment"), which
funds were to have been applied to the purchase of shares of Common Stock in the
event the Company failed to sell at least $15.0 million of preferred stock
within a certain period of time. Since sufficient preferred stock was issued
within the time period, the investors received a return of their funds
contributed to escrow. As a commitment fee for the Common Stock Commitment, the
Company issued to all such persons contributing to the escrow funds warrants to
purchase an aggregate of 90,000 shares of Common Stock at $.02 per share.
The Company has recorded the commitment fee as non-cash consideration in
connection with the 1997 Offering. The value of the warrants issued as a
commitment fee was determined based on a value of the Company's common stock at
$4.68 per share less the exercise price of $.02 per share for the warrant. All
such warrants were exercised in January and February 1998.
The Notes may be redeemed at the option of the Company, in whole or in
part, on or after October 1, 2001, at a premium declining to par in 2003, plus
accrued and unpaid interest and liquidated damages, if any, through the
redemption date as follows:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2001........................................................ 106.50
2002........................................................ 103.25
2003 and thereafter......................................... 100.00
</TABLE>
In the event of a sale by the Company prior to October 1, 2000 of its
capital stock in one or more equity offerings, up to a maximum of 35% of the
aggregate principal amount of the Notes originally issued will, at the option of
the Company, be redeemed from the net cash proceeds at a redemption price equal
to 113% of the principal amount, plus accrued and unpaid interest and liquidated
damages, if any, to the redemption date, provided at least 65% of the aggregate
principal amount of Notes originally issued remain outstanding immediately after
the occurrence of such redemption.
The Indenture contains certain covenants that among other things, limit the
ability of the Company and its restricted subsidiaries to incur additional
indebtedness and issue preferred stock, pay dividends or make other
distributions, repurchase equity interests or subordinated indebtedness, engage
in sale and lease back transactions, create certain liens, enter into certain
transactions with affiliates, sell assets of the Company or its restricted
subsidiaries, conduct certain lines of business, issue or sell equity interests
of the Company's restricted subsidiaries or enter into certain mergers and
consolidations. As of December 31, 1999, management believes it is in compliance
with all debt covenants.
In conjunction with the 1997 Offering, the authorized capital stock of the
Company was increased to 60,000,000 shares of common stock, $.001 par value per
share, and 50,000,000 shares of preferred stock, $.001 par value per share.
In January 1998, the Company filed a registration statement offering to
exchange the Notes for 13% Series B Senior Secured Notes due 2004 under the
Securities Act of 1933, as amended. Terms of the 13% Series B Senior Secured
Notes due 2004 are substantially the same as the Notes. The exchange was
consummated in March 1998.
F-21
<PAGE> 174
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1999, the Company entered into a capital lease agreement for an
aircraft, the owners of which are directors of the Company. All assets under
capital leases are capitalized using interest rates appropriate at the inception
of each lease. Capital leases are recorded at cost and depreciated over the
lesser of the estimated life or lease term. Total related lease payments in 1999
were $97,500.
(5) REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
COMMON STOCK
In 1997, the Company approved agreements with two key members of management
granting them rights to purchase a total of 150,000 shares at $3.33 per share
and 165,000 shares at $4.17 per share. In both cases, the Company retains the
right to repurchase these shares at their cost in the event of termination of
employment for any reason and has agreed to finance the purchase price of the
shares purchased at $4.17 per share over a period of three years. During
September 1997, the members of management exercised their rights and the
respective aforementioned shares were issued. The Company received $500,000 for
the 150,000 shares issued at $3.33 per share. The $688,000 owed to the Company
for the 165,000 shares issued at $4.17 per share has been classified in the
accompanying consolidated statements of redeemable preferred stock and
stockholders' equity as notes receivable from stockholders for issuance of
common stock.
During 1998, the Company issued 100,680 shares of $.001 par value common
stock at prices ranging from $5.83 to $8.33 per share, for total proceeds to the
Company of $774,000.
During 1998, the Company approved agreements with 11 key members of
management to purchase a total of 189,000 shares of common stock. The purchase
price of these shares ranged from $5.83 to $8.33 per share. In each case, the
Company retains the right to repurchase these shares at their cost in the event
of termination of employment for any reason and has agreed to finance a portion
of the purchase price of the shares over a period of three years. The $1,485,000
owed to the Company is classified in the accompanying statements of redeemable
preferred stock and stockholders' equity as notes receivable from stockholders
for issuance of common stock.
During May and June 1998, the Company sold 4,025,000 shares of common stock
at $17.00 per share pursuant to the registration statement filed on Form S-1,
which was declared effective by the Securities and Exchange Commission on May
11, 1998. In connection with the initial public offering of the Company's common
stock, the Company effected a six for ten reverse stock split, which has been
reflected in the accompanying consolidated financial statements. In addition to
the reverse stock split, the Company's 6,571,427 outstanding shares of Series A
Preferred Stock (as defined below) were converted to 3,942,839 shares of the
Company's common stock upon completion of the initial public offering. The
conversion of the Preferred Stock has been reflected in the accompanying
consolidated financial statements.
In July 1999, the Company issued 5,000,000 shares of common stock at $25.00
per share and received proceeds, after expenses, of $118.1 million. In this
offering, existing shareholders sold an additional 587,695 shares of common
stock for which the Company did not receive any proceeds.
In September 1999, the Company reacquired 9,140 shares of its common stock
at an aggregate purchase price of $76,136 in partial cancellation of a note
receivable from stockholder for issuance of common stock and is classified as
treasury stock in the accompanying consolidated financial statements.
F-22
<PAGE> 175
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In October 1999, the Company approved an agreement with a newly hired key
member of management to purchase a total of 150,000 shares of common stock at
$28.81 per share. The Company retains the right to repurchase these shares at
their cost in the event of termination of employment for any reason and has
agreed to finance the purchase price of the shares purchased. The agreement
provides for the forgiveness of the note at the end of a three year term of
employment. The $4,321,875 owed to the Company is classified in the accompanying
statements of redeemable preferred stock and stockholders' equity as notes
receivable from stockholders for issuance of common stock.
In February 2000, the Company issued 6,163,709 shares of common stock at
$54.00 per share for gross proceeds of $332.8 million. In this offering,
existing shareholders sold an additional 29,041 shares of common stock for which
the Company did not receive any proceeds.
REDEEMABLE PREFERRED STOCK
The Company has authorized the issuance of up to 50,000,000 shares of
preferred stock. In November 1997, the Company designated 6,571,450 shares as 8%
Series A Convertible Preferred Stock ("Series A Preferred Stock").
In November 1997, the Company completed a private placement offering in
which 5,148,570 shares of the Series A Preferred Stock were issued at $3.50 per
share, for total proceeds to the Company of approximately $16.7 million, net of
expenses.
In January 1998, the Company completed an additional private placement
offering in which 1,422,857 shares of Series A Preferred Stock were issued at
$3.50 per share for total proceeds to the Company of approximately $5.0 million,
net of expenses. The terms of the offering were substantially identical to those
of the previous preferred stock offering.
Each share of Series A Preferred Stock was automatically converted into
common stock on a six for ten basis upon the consummation of the Company's IPO.
In accordance with the terms of the Series A Preferred Stock, the accrued
dividends were reversed at the time of conversion.
On April 5, 1999, the Company entered into a Security Purchase Agreement
with Providence Equity Partners III L.P. ("Providence"), JK&B Capital III L.P.
("JK&B III") and Wind Point Partners III L.P. ("Wind Point") under which
Providence, JK&B III and Wind Point and their affiliates ("the Purchasers")
agreed to purchase 5,277,779 shares of newly issued Series B Convertible
Preferred Stock ("Series B Preferred Stock") at $9.00 per share (the
"Transaction") for a total consideration of $47.5 million. The Transaction was
consummated on May 4, 1999. Net Proceeds to the Company were approximately $46.7
million.
Dividends accrued on the Series B Preferred Stock at the rate of 10% per
annum from the issue date until November 21, 1999 and are payable in preference
to any dividends that may be paid with respect to the Company's Common Stock.
Effective November 22, 1999, the Company elected to terminate the accrual of
dividends since the Company's stock price exceeded $27.00 per share for 20
consecutive trading days (the "Market Threshold").
The Series B Preferred Stock is convertible into Common Stock at any time
at the option of the holder. Initially, the conversion price is $9.00 per share
and each share of Series B Preferred Stock is convertible into one share of
Common Stock. The conversion price is subject to adjustment as a result of stock
splits, stock dividends and certain other issuances of additional stock.
F-23
<PAGE> 176
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Series B Preferred Stock was issued in May 1999 with a beneficial
conversion feature totaling $47.5 million measured as the difference between the
conversion price of $9.00 per share and the fair value of the underlying common
stock at the time of issuance, limited by the total amount of the proceeds of
the preferred stock issued. The beneficial conversion feature has been
recognized as an increase in additional paid-in capital, with an offsetting
decrease in additional paid-in capital.
After the earlier of May 24, 2000 or the date on which the holders of
Series B Preferred Stock exercise their demand registration rights, the Company
has the right to require the conversion of the Series B Preferred Stock if the
Company's stock price exceeds the Market Threshold referenced above. If the
Company requires conversion within three years after closing, no accrued
dividends will be paid.
At each balance sheet date, the Company records a pro rata accretion of the
Series B Preferred Stock to its anticipated redemption value. Such accretion is
based on the market value of the common stock at the balance sheet date, not to
exceed $27.00 per share based on the Market Threshold. For the year ended
December 31, 1999, the Company recorded accretion of $6,123,395 related to the
Series B Preferred Stock which has been recorded as an increase in redeemable
preferred stock with a corresponding decrease in additional paid-in capital.
The holders of the Series B Preferred Stock have the right to require us to
redeem the Series B Preferred Stock after May 4, 2005 or upon sale of the
Company. The redemption price will be equal to the greater of (x) $9.00 per
share plus accrued and unpaid dividends, or (y) the value of the common stock
into which the Series B Preferred Stock is then convertible. If the Company
fails to redeem all shares of Series B Preferred Stock, then the holders of the
Series B Preferred Stock, along with the holders of the Series C Preferred Stock
(as defined below) will have the right to elect a majority of the Company's
Board of Directors.
In November 1999, the Company entered into an agreement with Providence,
JK&B III L.P. and their affiliates (the "Purchasers") under which the Purchasers
purchased 1,250,000 shares of newly issued Series C Convertible Preferred Stock
("Series C Preferred Stock") at $28.00 per share for a total consideration of
$35.0 million. Of the total consideration, $4.9 million was paid by an
interest-bearing promissory note which was paid in February 2000. The
transaction was consummated on December 30, 1999.
Dividends accrue on the Series C Preferred Stock at the rate of 10% per
annum, are cumulative and are payable in preference to any dividends that may be
paid with respect to the Company's Common Stock. No accrued dividends in excess
of $2.80 per share will be paid if the Company requires conversion of the Series
C Preferred Stock within 30 months of issuance. The Company may require
conversion if the Company's stock price exceeds $56.00 for 20 consecutive
trading days.
The Series C Preferred Stock is convertible into Common Stock at any time
at the option of the holder. Initially, the conversion price is $28.00 per share
and each share of Series C Preferred Stock is convertible into one share of
Common Stock. The conversion price is subject to adjustment as a result of stock
splits, stock dividends and certain other issuances of additional stock.
The Series C Preferred Stock was issued in December 1999 with a beneficial
conversion feature totaling $25.0 million measured as the difference between the
conversion price of $28.00 per share and the fair value of the underlying common
stock at the time of issuance. The beneficial conversion feature has been
recognized as an increase in addition paid-in capital, with an offsetting
decrease in additional paid-in capital.
F-24
<PAGE> 177
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At each balance sheet date, the Company records a pro rata accretion of the
Series C Preferred Stock to its anticipated redemption value. Such accretion is
based on the market value of the common stock at the balance sheet date, not to
exceed $56.00 per share based on the Market Threshold. For the year ended
December 31, 1999, the Company recorded accretion of $9,623 related to the
Series C Preferred Stock which has been recorded as an increase in redeemable
preferred stock with a corresponding decrease in additional paid-in capital.
The holders of the Series C Preferred Stock have the right to require the
Company to redeem the Series C Preferred Stock after six years from issuance or
upon a sale of the Company. The redemption price will be equal to the greater of
(x) $28.00 per share plus the greater of $2.80 per share or accrued and unpaid
dividends, or (y) the value of the Common Stock into which the Series C
Preferred Stock is then convertible.
If the Company fails to redeem all shares of Series C Preferred Stock
within six months of the date specified by the holders of the Series C Preferred
Stock, then the holders of the Series C Preferred Stock, along with the holders
of the Preferred B Stock will have the right to elect a majority of the
Company's Board of Directors.
The Series B Preferred Stock and Series C Preferred Stock will vote along
with the Common Stock on an as-converted basis. The holders of the Series B
Preferred Stock and Series C Preferred Stock have the right to nominate two or
more of the directors depending on the size of the Company's Board of Directors
and the percentage of the Company's stock represented by the outstanding Series
B Preferred Stock and Series C Preferred Stock. The Series B Preferred Stock and
the Series C Preferred Stock also have the right to have their Board
representative serve on each committee of the Company's Board and on the Board
of each of the Company's subsidiaries.
On February 11, 2000, the Company completed an additional offering in which
4,140,000 shares of 7.25% Series D Convertible Redeemable Preferred Stock at
$50.00 per share were issued for $207.0 million in gross proceeds. Each share of
preferred stock is convertible at the option of the holder into .7652 shares of
common stock at a conversion price of $65.34 per share, subject to adjustments
and expiration of conversion rights in certain circumstances. Quarterly
dividends are payable at the Company's option in cash or shares of common stock,
beginning May 15, 2000.
(6) STOCK OPTION PLAN
In June 1996, the Company adopted a stock option plan which allows the
Board of Directors to grant incentives to employees in the form of incentive
stock options and non-qualified stock options. As of December 31, 1997, the
Company had reserved 1,440,000 shares of common stock to be issued under the
plan. In March 1998, the Board of Directors approved an additional 1,200,000
shares of common stock to be issued under the plan. In July 1998, the Company
filed a registration statement on Form S-8 to register these reserved shares of
the Company's common stock under the MGC Communications, Inc. Stock Option Plan
(the "Plan").
In May 1999, the Company's stockholders approved an amendment to the
Company's stock option plan under which an additional 2,240,000 shares of common
stock were approved to be issued under the plan. In September 1999, the Company
filed a registration statement on Form S-8 to register these reserved shares of
the Company's common stock under the Plan.
Under the Plan, substantially all options have been granted to employees at
a price equal to the then-current market price, as estimated by management, and
vest primarily over a 5-year period with
F-25
<PAGE> 178
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
an acceleration provision for certain events or qualified changes in control.
All options expire within ten years of the date of grant.
Stock option transactions during 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
NUMBER EXERCISE
OF SHARES PRICE
--------- --------
<S> <C> <C>
Outstanding at December 31, 1996............................ 781,860 $ 1.35
Granted..................................................... 274,560 $ 5.78
Canceled.................................................... (3,300) $ 5.08
---------
Outstanding at December 31, 1997............................ 1,053,120 $ 2.50
Granted..................................................... 865,700 $ 8.48
Exercised................................................... (7,380) $ 1.77
Canceled.................................................... (85,240) $ 5.84
---------
Outstanding at December 31, 1998............................ 1,826,200 $ 5.18
Granted..................................................... 2,436,240 $15.58
Exercised................................................... (345,700) $ 4.88
Canceled.................................................... (364,800) $13.92
---------
Outstanding at December 31, 1999............................ 3,551,940 $16.87
---------
Exercisable at December 31, 1997............................ 165,720 $ 1.47
=========
Exercisable at December 31, 1998............................ 378,660 $ 2.07
=========
Exercisable at December 31, 1999............................ 815,073 $ 4.09
=========
</TABLE>
For options granted during the years ended December 31, 1999 and 1998, the
weighted average fair value of options, on the date of grant, estimated using
the Black-Scholes option pricing model, was $23.80 and $6.70, respectively,
using the following assumptions: dividend yield of 0%; expected option life of
6.5 years; and risk free interest rate at December 31, 1999 and 1998 of 6.54%
and 5.06% and an expected volatility of 153.7% and 80.5%, respectively.
The weighted average fair value of each of the options issued during the
year ended December 31, 1997, substantially all of which have been granted at a
price equal to the then current market price as estimated by management, was
estimated to be $4.03, using an option pricing model with the following
assumptions: dividend yield of 0%; expected option life of 6.5 years; and risk
free interest rate of 5.06%.
F-26
<PAGE> 179
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
at December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
AT DEC. 31, CONTRACTUAL EXERCISE AT DEC. 31, EXERCISE
RANGE OF EXERCISE PRICE 1999 LIFE PRICE 1999 PRICE
----------------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ 0.83 to $ 5.83 747,930 8.77 years $ 2.24 559,260 $ 2.23
$ 6.03 to $10.00 947,680 9.00 years $ 7.42 241,273 $ 7.82
$12.50 to $26.00 853,180 9.63 years $21.23 14,540 $25.17
$27.44 to $40.06 1,003,150 9.83 years $33.00 -- $ --
--------- -------
$ 0.83 to $40.06 3,551,940 9.44 years $16.87 815,073 $ 4.09
========= =======
</TABLE>
The Company applied Accounting Principles Board (APB) Opinion No. 25 in
accounting for its plan. No compensation expense was recognized for the years
ended December 31, 1999, 1998 and 1997. Had the Company determined compensation
cost using the fair value based method defined in SFAS No. 123, the Company's
loss for the years then ended would have increased by $3,778,000, $565,000 and
$7,000, respectively.
(7) LOSS PER SHARE
SFAS No. 128, "Earnings Per Share," requires the Company to calculate its
earnings per share based on basic and diluted earnings per share, as defined.
Basic and diluted loss per share for the years ended December 31, 1999, 1998 and
1997 were computed by dividing net loss applicable to common stockholders by the
weighted average number of shares of common stock.
The Company's warrants, preferred stock and stock options granted and
issued during 1999, 1998 and 1997, and outstanding as of December 31, 1999, 1998
and 1997, are antidilutive and have been excluded from the diluted loss per
share calculation for the years ended December 31, 1999, 1998 and 1997. Had the
Company shown the effects of dilution, the warrants, preferred stock and options
would have added an additional 5.4 million, 1.8 million and 1.6 million shares
to the weighted average shares outstanding for the years ended December 31,
1999, 1998 and 1997, respectively.
F-27
<PAGE> 180
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) INCOME TAXES
The net deferred tax asset as of December 31, 1999 and 1998 is as follows
(in thousands):
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Deferred Tax Asset
Net operating loss carry-forward.......................... $ 48,152 $ 17,804
Start-up expenditures..................................... 173 164
Other..................................................... 928 534
-------- --------
49,253 18,502
Less: valuation allowance................................. (39,906) (15,517)
-------- --------
Net deferred tax asset.................................... 9,347 2,985
-------- --------
Deferred Tax Liability
Property and equipment.................................... 6,405 2,769
Other..................................................... 2,942 216
-------- --------
Net deferred tax liability................................ 9,347 2,985
-------- --------
Net......................................................... $ -- $ --
======== ========
</TABLE>
SFAS No. 109 requires recognition of the future tax benefit of these assets
to the extent realization of such benefits is more likely than not; otherwise, a
valuation allowance is applied. At December 31, 1999 and 1998, the Company
determined that $39,906,000 and $15,517,000, respectively, of tax benefits did
not meet the realization criteria because of the Company's historical operating
results. Accordingly, a valuation allowance was applied to reserve against the
applicable deferred tax asset.
At December 31, 1999 and 1998, the Company had net operating loss
carry-forwards available for income tax purposes of approximately $133,701,000
and $50,869,000, respectively, which expire principally from 2011 to 2019.
(9) COMMITMENTS AND CONTINGENCIES
LEASE OBLIGATIONS
The Company has entered into various leasing agreements for its switching
facilities, offices, and office equipment. The facilities which house the
Company's headquarters in Las Vegas are owned by an entity principally owned by
two of the Company's principal stockholders and directors. Management believes
the terms and conditions of this agreement are equal to the terms which would be
available from an unaffiliated lessor.
F-28
<PAGE> 181
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease obligations in effect as of December 31, 1999 are as
follows (in thousands):
<TABLE>
<S> <C>
Payments during the year ending December 31:
2000...................................................... $2,353
2001...................................................... 2,291
2002...................................................... 2,150
2003...................................................... 1,588
2004...................................................... 1,101
Thereafter................................................ 248
------
$9,731
======
</TABLE>
Rent expense was $1,609,000, $850,000 and $207,000 for the years ended
December 31, 1999, 1998 and 1997, respectively, of which $806,000 was paid to a
related party during 1999.
PURCHASE COMMITMENTS
In the ordinary course of business, the Company enters into purchase
agreements with its vendors of telecommunications equipment and colocation
sites. As of December 31, 1999, the Company had a total for telecommunication
vendors of approximately $43.3 million of remaining purchase commitments for
purchases of switching equipment and to colocation site providers of
approximately $11.9 million of remaining commitments for the build-out of
colocation sites.
LITIGATION
The Company is party to various legal proceedings, most of which relate to
routine matters incidental to its business. Management does not believe that the
outcome of such proceedings will have a material adverse effect on the Company's
financial position or results of operations.
INTERCONNECTION AGREEMENTS
The Company has interconnection agreements with five incumbent local
exchange carriers. These agreements expire on various dates through July 2000.
The Company is dependent on the cooperation of the incumbent local exchange
carriers to provide access service for the origination and termination of its
local and long distance traffic. Historically, charges for these services have
made up a significant percentage of the overall cost of providing these
services. To the extent the access services of the local exchange carriers are
used, the Company and its customers are subject to the quality of service,
equipment failures and service interruptions of the local exchange carriers.
(10) RISKS AND UNCERTAINTIES
Certain rates in the interconnection agreements have been established by
the Federal Communications Commission (FCC) and are subject to adjustment upon
final negotiations. For the years ended December 31, 1999 and 1998, the Company
has recorded costs of sales related to the Sprint (Nevada) interconnection
agreement at amounts which are management's best estimates of the probable
outcome of the final negotiated charges to our accounts. The difference, which
totaled approximately $1.1 million and $1.7 million at December 31, 1999 and
1998, respectively has not been recorded in the accompanying consolidated
financial statements. Management believes that the
F-29
<PAGE> 182
MGC COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
resolution of this matter will not have a material adverse effect on the
Company's consolidated financial position, results of operations or liquidity.
(11) RELATED PARTY TRANSACTION
In May 1997, the Company entered into an agreement with a company, the
owner of which is a former officer and current stockholder of the Company, for
the purchase of certain computer software pursuant to which the Company paid the
contract price of $600,000 in six equal monthly installments beginning July 1,
1997. In addition, the Company has paid $541,000 and $656,000 during 1999 and
1998, respectively, under such agreement to support and maintain the Company's
proprietary management information computer system. Management believes the
terms and conditions of this agreement are equal to the terms which would be
available from an unaffiliated party.
F-30
<PAGE> 183
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 2000
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 26,712,416 $ 4,828,306
Investments............................................... 5,076,212 --
Accounts receivable, less allowance for doubtful accounts
of $630,920 at September 30, 1999 and $959,169 at March
31, 2000................................................ 963,512 2,545,798
Due from affiliates....................................... 1,052,505 --
Inventory................................................. 105,886 220,577
Other current assets...................................... 923,385 2,058,240
------------ ------------
Total current assets........................................ 34,833,916 9,652,921
Restricted cash............................................. 1,000,000 2,000,000
Property and equipment, net................................. 8,900,931 32,636,059
Refundable capital lease deposit with affiliate............. 707,660 707,660
Debt issuance costs, net of accumulated amortization of
$160,582 at September 30, 1999 and $401,457 at March 31,
2000...................................................... 3,211,658 2,984,988
Intangible assets, net...................................... 13,110,252 17,038,036
------------ ------------
$ 61,764,417 $ 65,019,664
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable.......................................... $ 2,322,537 $ 5,134,293
Accrued expenses.......................................... 3,130,130 2,851,502
Unearned revenues......................................... 1,069,696 1,307,104
Current maturities of capital lease obligations........... 1,137,019 11,205,758
Note payable.............................................. 16,614 477,742
Due to affiliates......................................... 158,376 --
------------ ------------
Total current liabilities................................... 7,834,372 20,976,399
Capital lease obligations, less current maturities........ 1,280,252 7,427,490
Convertible note payable.................................. 1,000,000 1,750,000
Senior subordinated discount note......................... 48,837,310 52,586,101
Stockholders' equity (deficit):
Preferred stock, $.001 par value, 20,000,000 shares
authorized
Series A preferred stock, 2,306,765 shares issued and
outstanding............................................ 494,375 494,375
Series B preferred stock, 1,500,000 shares designated,
850,000 shares issued and outstanding at March 31,
2000................................................... -- 170,000
Deferred stock compensation............................... -- (141,668)
Common stock, $.001 par value, 80,000,000 shares
authorized, 63,600,815 shares issued.................... 63,601 63,601
Additional paid-in capital................................ 14,496,596.. 14,496,596
Accumulated deficit....................................... (12,242,089) (32,803,230)
------------ ------------
2,812,483 (17,720,326)
------------ ------------
$ 61,764,417 $ 65,019,664
============ ============
</TABLE>
See notes to unaudited consolidated financial statements.
F-31
<PAGE> 184
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- -----------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
1999 2000 1999 2000
(PREDECESSOR) (SUCCESSOR) (PREDECESSOR) (SUCCESSOR)
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Revenues:
Access revenues.............. $1,141,754 $ 3,140,338 $2,026,771 $ 5,771,959
Communication revenues....... -- 1,710,966 -- 2,854,131
Retail revenues.............. 298,054 286,211 518,800 528,388
Other revenues............... 129,298 236,137 333,165 472,687
---------- ------------ ---------- ------------
1,569,106 5,373,652 2,878,736 9,627,165
Costs and expenses:
Costs of access revenues..... 351,779 1,320,008 688,995 2,395,394
Cost of communication
revenues.................. -- 1,937,654 -- 3,102,857
Cost of retail revenues...... 179,293 148,438 326,219 245,734
Costs of other revenues...... 89,567 147,936 253,493 354,988
Operations and customer
support................... 207,727 3,203,729 400,759 4,799,453
Sales and marketing.......... 199,310 2,193,308 436,337 3,535,889
General and administrative... 552,020 3,022,429 972,741 5,415,148
Retail store expenses........ 305,934 103,839 604,242 293,700
Depreciation and
amortization.............. 52,649 3,449,800 144,841 6,263,609
---------- ------------ ---------- ------------
1,938,279 15,527,141 3,827,627 26,406,772
---------- ------------ ---------- ------------
Loss from operations........... (369,173) (10,153,489) (948,891) (16,779,607)
Other income (expense):
Interest
expense -- affiliates..... -- (72,438) (18,909) (151,395)
Interest expense............. (1,219) (2,131,327) (1,641) (4,147,157)
Other, net................... 8,184 174,987 (19,268) 517,018
---------- ------------ ---------- ------------
Loss from continuing
operations................... (362,208) (12,182,267) (988,709) (20,561,141)
Income (loss) from operations
of discontinued Web
development division......... (44,512) -- 12,595 --
---------- ------------ ---------- ------------
Loss before income taxes....... (406,720) (12,182,267) (976,114) (20,561,141)
Provision for income taxes..... -- -- -- --
---------- ------------ ---------- ------------
Net loss....................... $ (406,720) $(12,182,267) $ (976,114) $(20,561,141)
========== ============ ========== ============
</TABLE>
See notes to unaudited consolidated financial statements
F-32
<PAGE> 185
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------
MARCH 31, MARCH 31,
1999 2000
(PREDECESSOR) (SUCCESSOR)
------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (976,114) $(20,561,141)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 144,841 6,263,609
Amortization of debt issuance costs....................... -- 240,875
Allowance for doubtful accounts........................... 201,427 332,630
Accretion of discount on senior subordinated Debt......... -- 3,748,791
Amortization of discount on investment.................... -- (48,788)
Stock based compensation expense.......................... 436,772 28,332
Changes in operating assets and liabilities:.............. -- --
Accounts receivable.................................... (382,063) (1,762,628)
Due from affiliates.................................... (1,870,826) 1,052,505
Inventory.............................................. 37,821 (114,691)
Other current assets................................... 128,104 262,370
Accounts payable....................................... 510,309 2,655,489
Accrued expenses....................................... 211,366 (320,826)
Unearned revenues...................................... 70,006 16,821
----------- ------------
Net cash used in operating activities....................... (1,488,357) (8,206,652)
INVESTING ACTIVITIES
Increase in restricted cash................................. -- (1,000,000)
Sale of held to maturity security........................... -- 5,125,000
Purchases of property and equipment,
net of capital lease obligations.......................... (110,677) (10,213,120)
Acquisition of Information Services Technologies, Inc. ..... -- (591,006)
Acquisition of Business Product Systems Internet, Inc. ..... -- (700,112)
Acquisition of UNI Networking, Inc. ........................ -- (345,301)
Acquisition of GlobalVision Systems, Inc., net of cash
acquired.................................................. -- (3,102,445)
Acquisition of Digital Internet Access Inc., net of cash
acquired.................................................. -- (1,417,771)
Acquisition of Harvest Telecom, Inc. ....................... -- (50,000)
Business acquisition costs.................................. (454,783) --
----------- ------------
Net cash used in investing activities....................... (565,460) (12,294,755)
</TABLE>
F-33
<PAGE> 186
<TABLE>
<CAPTION>
SIX MONTHS ENDED
-----------------------------
MARCH 31, MARCH 31,
1999 2000
(PREDECESSOR) (SUCCESSOR)
------------- ------------
<S> <C> <C>
FINANCING ACTIVITIES
Principal payments of obligations under capital leases...... -- (1,222,826)
Principal payments under notes payable...................... -- (1,501)
Purchase of common stock held in treasury................... (73,086) --
Due to affiliates........................................... (153,270) (158,376)
Proceeds from issuance of common stock...................... 2,535,487 --
----------- ------------
Net cash provided by (used in) financing activities......... 2,309,131 (1,382,703)
----------- ------------
Net increase (decrease) in cash and cash equivalents........ 255,314 (21,884,110)
Cash and cash equivalents at beginning of period............ 689 26,712,416
----------- ------------
Cash and cash equivalents at end of period.................. $ 256,003 $ 4,828,306
=========== ============
Noncash investing and financing transactions:
Capital leases entered into................................. $ -- $ 17,438,803
=========== ============
</TABLE>
See notes to unaudited consolidated financial statements.
F-34
<PAGE> 187
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
NATURE OF BUSINESS
Primary Network Holdings, Inc. (the Company) is headquartered in St. Louis,
Missouri and provides full-service access to the Internet for corporate and
residential users primarily in Missouri, Kansas, and Oklahoma. The Company also
is a reseller of basic local telecommunications services, dedicated non-switched
local exchange telecommunications services, and intrastate interexchange
telecommunications services in Missouri. The basic local service is classified
as competitive by the State of Missouri Public Service Commission (PSC) and is
provided in portions of Missouri that are currently served primarily by
Southwestern Bell Telephone Company (SWBT). Furthermore, the Company also serves
as an authorized agent of Southwestern Bell Mobile Systems and operates cellular
and other wireless communication products retail stores in the St. Louis
metropolitan area. Billings are due upon receipt.
BASIS OF PRESENTATION
The unaudited consolidated financial statements of Primary Network
Holdings, Inc., the successor company, and CDM On-Line, Inc., the predecessor
company, have been prepared in accordance with generally accepted accounting
principles for interim financial information (refer to footnotes 1 and 2 in the
September 30, 1999 audited financial statements of the Company for further
explanation of the organization and basis of presentation and initial formation
and capitalization of the Company). Accordingly, these interim financial
statements do not include all of the information and notes required by generally
accepted accounting principles for complete financial statements, and,
therefore, should be read in conjunction with the Company's audited financial
statements for the four months ended September 30, 1999, contained in this
Prospectus. In the opinion of management, all adjustments (consisting only of
normal recurring items) considered necessary for a fair presentation have been
included. The results of operations for the three and six months ended March 31,
2000 are not necessarily indicative of the results that may be expected for the
year ended September 30, 2000.
2. INVENTORY
Inventory consists of cellular and other wireless communication products
and accessories and is stated at the lower of cost (specific identification
basis) or market.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at September 30, 1999 and
March 31, 2000:
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 2000
------------- -----------
<S> <C> <C>
Computer equipment................................... $ 4,465,458 $21,120,968
Software............................................. 478,574 890,576
Furniture, fixtures, and office equipment............ 680,884 971,060
Capitalized collocation costs........................ 150,236 7,992,275
</TABLE>
F-35
<PAGE> 188
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 2000
------------- -----------
<S> <C> <C>
Land, building, and leasehold improvements........... 285,552 535,447
Vehicles............................................. 71,348 71,348
----------- -----------
6,132,052 31,581,674
Less accumulated depreciation and amortization....... (1,881,830) (4,323,645)
----------- -----------
4,250,222 27,258,029
Construction in progress............................. 4,650,709 5,378,030
----------- -----------
$ 8,900,931 $32,636,059
=========== ===========
</TABLE>
4. OTHER ASSETS
Other assets consist of the following at September 30, 1999 and March 31,
2000:
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 2000
------------- ----------
<S> <C> <C>
Prepaid maintenance agreements............................ $ -- $1,484,806
Other non-current assets.................................. 923,385 573,434
-------- ----------
$923,385 $2,058,240
======== ==========
</TABLE>
5. INTANGIBLE ASSETS
Intangible assets consist of the following at September 30, 1999 and March
31, 2000:
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 2000
------------- -----------
<S> <C> <C>
Acquired customer list............................... $ 2,771,783 $ 5,460,083
Goodwill............................................. 11,631,661 16,213,676
----------- -----------
14,403,444 21,673,759
Less accumulated amortization........................ (1,293,192) (4,635,723)
----------- -----------
$13,110,252 $17,038,036
=========== ===========
</TABLE>
6. ACCRUED LIABILITIES
Accrued liabilities consist of the following at September 30, 1999 and
March 31, 2000:
<TABLE>
<CAPTION>
SEPTEMBER 30, MARCH 31,
1999 2000
------------- ----------
<S> <C> <C>
Accrual for equipment acquired............................ $1,836,572 $ --
Accrued payroll and related expenses...................... 366,933 661,704
Acquisition related holdback accrual...................... 130,000 621,675
Deferred gain on sale leaseback........................... -- 468,037
Other accrued liabilities................................. 796,625 1,100,086
---------- ----------
$3,130,130 $2,851,502
========== ==========
</TABLE>
F-36
<PAGE> 189
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. SEGMENT INFORMATION
The Company has three reportable segments, Internet, Retail, and
Communications, which are separate operating units that offer different products
and services and are managed accordingly. Performance of each segment is
evaluated by management based on income (loss) before income taxes. The
corporate and eliminations segment includes corporate assets, principally
consisting of cash and cash equivalents, investments and debt issuance costs,
corporate activities and the elimination of intersegment transactions. In
addition, as a result of the initial formation and capitalization of the Company
as of June 1, 1999, the Company adjusted its segment reporting structure whereby
interest expense is no longer allocated to its three reportable segments.
The Internet segment provides full service access to the Internet for
corporate and residential customers including dial-up and dedicated services and
activities related to setup and installation, selling equipment, and software.
The Retail segment sells cellular and other wireless communication products,
including phones, pagers, and related accessories. The Communications segment,
which was established June 1, 1999, provides facilities-based and resold basic
local telecommunications service, including dedicated/non-switched local
exchange services, and intrastate interexchange services.
The following segment information is as of March 31 or for the three months
and six months then ended:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999
(PREDECESSOR)
------------------------------------
INTERNET RETAIL TOTAL
---------- -------- ----------
<S> <C> <C> <C>
Revenues from external customers........................ $1,271,052 $298,054 $1,569,106
Intersegment revenues................................... -- -- --
Depreciation and amortization........................... 48,929 3,720 52,649
Interest expense........................................ 988 231 1,219
Stock based compensation................................ 390,615 -- 390,615
Loss from continuing operations......................... (171,084) (191,124) (362,208)
Income from discontinued operation -- Web Development... (44,512) -- (44,512)
Loss before income taxes................................ (215,596) (191,124) (406,720)
Segment assets.......................................... 3,211,201 486,666 3,697,866
Capital expenditures, net of capital lease
obligations........................................... 15,240 4,552 19,792
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 2000 (SUCCESSOR)
--------------------------------------------------------------------
CORPORATE
AND
INTERNET RETAIL COMMUNICATIONS ELIMINATIONS TOTAL
---------- -------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues from external
customers.................... $3,376,475 $286,211 $1,710,966 -- $ 5,373,652
Intersegment revenues.......... 415 30,847 291,650 (322,912) --
Depreciation and
amortization................. 1,442,521 9,158 1,936,122 61,999 3,449,800
Interest expense............... -- -- -- 2,203,765 2,203,765
Loss before income taxes....... (1,427,120) 24,771 (4,709,975) (6,069,943) (12,182,267)
Segment assets................. 18,330,068 463,406 34,760,916 11,465,274 65,019,664
Capital expenditures, net of
capital lease obligations.... 238,556 547 2,862,114 493,813 3,595,030
</TABLE>
F-37
<PAGE> 190
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED MARCH 31, 1999
(PREDECESSOR)
------------------------------------
INTERNET RETAIL TOTAL
---------- -------- ----------
<S> <C> <C> <C>
Revenues from external customers........................ $2,359,936 $518,800 $2,878,736
Intersegment revenues................................... -- -- --
Depreciation and amortization........................... 137,396 7,445 144,841
Interest expense........................................ 17,061 3,489 20,550
Stock based compensation................................ 436,772 -- 436,772
Loss from continuing operations......................... (566,114) (422,595) (988,709)
Income from discontinued operation -- Web Development... 12,595 -- 12,595
Loss before income taxes................................ (553,519) (422,595) (976,114)
Segment assets.......................................... 3,211,201 486,665 3,697,866
Capital expenditures, net of capital lease
obligations........................................... 101,875 8,802 110,677
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED MARCH 31, 2000 (SUCCESSOR)
--------------------------------------------------------------------
CORPORATE
AND
INTERNET RETAIL COMMUNICATIONS ELIMINATIONS TOTAL
---------- -------- -------------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Revenues from external
customers.................... $6,244,646 $528,388 $2,854,131 -- $ 9,627,165
Intersegment revenues.......... 1,180 75,496 535,768 (612,444) --
Depreciation and
amortization................. 3,308,659 18,105 2,826,331 110,514 6,263,609
Interest expense............... -- -- -- 4,298,552 4,298,552
Loss before income taxes....... (3,325,208) (27,543) (7,407,792) (9,800,598) (20,561,141)
Segment assets................. 18,330,068 463,406 34,760,916 11,465,274 65,019,664
Capital expenditures, net of
capital lease obligations.... 278,495 1,083 7,393,116 1,140,426 8,813,120
</TABLE>
8. ACQUISITIONS
In the six month period ended March 31, 2000, the Company made the
following acquisitions:
On October 1, 1999, the Company purchased substantially all of the assets
of Information Systems Technologies, Inc. for approximately $591,000, net of
liabilities assumed.
On October 6, 1999, the Company purchased substantially all of the assets
of Business Products Systems Internet, Inc. for approximately $700,000, net of
liabilities assumed.
On October 13, 1999, the Company purchased substantially all of the assets
of UNI Networking Inc. for approximately $345,000, net of liabilities assumed.
On October 20, 1999, the Company purchased all of the outstanding common
stock of GlobalVision Systems, Inc. for approximately $3,102,000, net of cash
acquired and liabilities assumed.
On November 1, 1999, the Company purchased all of the outstanding common
stock of Harvest Telecom, Inc. for approximately $50,000.
On November 10, 1999, the Company purchased all of the outstanding common
stock of Digital Internet Access, Inc. for approximately $1,418,000, net of cash
acquired and liabilities assumed.
The above acquisitions were accounted for under the purchase method of
accounting, and accordingly, the purchase prices were allocated to assets
acquired and liabilities assumed based upon their estimated fair values at the
dates of acquisition. The customer lists were valued at $200 per
F-38
<PAGE> 191
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subscriber acquired, which represents the estimated fair value of such
subscribers based upon recent transactions in the ISP industry. Included in the
purchase prices listed above are legal and acquisition costs of approximately
$32,600. For those businesses acquired, the results of operations are included
in the Company's consolidated statement of operations from the dates of
acquisition.
The combined historical results for the acquisitions listed above were not
deemed to be material and thus, pro forma financial information was not
presented for the periods disclosed.
9. SECONDMENT AGREEMENT
On November 23, 1999, the Company entered into a Secondment Agreement with
an investor to obtain certain services to be provided by an employee of the
investor. Under the terms of the agreement, the Company is required to pay
$17,500 per month for the services, including out-of-pocket expenses.
Furthermore, the seconded employee was issued 680,000 shares of Series B
preferred stock which vests in eight equal quarterly installments over a
two-year period and warrants with an exercise price of $1.52 per share to
purchase an additional 520,000 shares of Series B preferred stock which vest in
three equal annual installments. Furthermore, the investor was issued 170,000
shares of Series B preferred stock and was granted warrants with an exercise
price of $1.52 to purchase an additional 130,000 shares of Series B preferred
stock, both with the same vesting terms as the seconded employee described
above. All of the above issuances and grants vest immediately upon the
occurrence of certain events described in the agreement, including a change in
control. The Company will recognize the compensation expense related to these
transactions ratably over the vesting period. Finally, the investor is entitled
to receive a fee, payable immediately, in the event the Company consummates
certain transactions outlined in the agreement prior to June 1, 2000, including
a change in control, obtaining senior debt from a financial institution, or
issuing additional subordinated debt or equity securities.
10. LEASE TRANSACTIONS
On February 23, 2000, the Company entered into an equipment capital lease
to finance its continued build out of collocations. Under the terms of the
lease, the Company is required to make thirty-six equal monthly payments of
approximately $122,000 and has the guaranteed option to purchase the equipment
at 10% of original purchase price or approximately $3,700,000. The assets under
the capital lease are recorded at the lower of the present value of the minimum
lease payments or the fair value of the equipment. The lease is secured by the
equipment financed.
On March 31, 2000, the Company entered into a sale leaseback agreement,
whereby the Company sold collocation equipment with a book value of
approximately $8,000,000 and subsequently entered into a capital lease for
approximately $9,400,000, including the financing of approximately $900,000 in
equipment maintenance agreements. The assets under the capital lease are
recorded at the lower of the present value of the minimum lease payments or the
fair value of the equipment. The gain resulting from this transaction of
approximately $500,000 is being amortized over the term of the lease. Under the
terms of the lease, the Company is required to make six monthly payments of
approximately $106,000 and then thirty monthly payments of approximately
$340,000. In addition to the equipment being financed under the lease, the
Company granted the lessor an additional security interest in substantially all
tangible and intangible assets of the Company. The lessor has provided a
contingent clause in the agreement for the release of the additional security
upon the Company obtaining unrestricted cash equity proceeds in the amount of
$50,000,000 or greater. The lease agreement also contains covenants requiring
the Company to maintain certain debt to total
F-39
<PAGE> 192
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
contributed capital ratios as well as requiring the Company to secure future
minimum commitments of either secured bridge debt or unrestricted equity by
various dates. The Company was in violation of its senior debt to contributed
capital ratio covenant at April 30, 2000. Accordingly, the entire amount
outstanding under this capital lease agreement has been classified as a current
liability in the March 31, 2000 balance sheet.
11. SUBSEQUENT EVENTS
LEASE COMMITMENT
On April 15, 2000 the Company entered into an agreement for the lease of a
new office building. The term of the agreement is five years with total annual
rent of approximately $1,200,000. In addition, the Company has committed
$3,900,000 for leasehold improvements and certain equipment purchases related to
this property.
PENDING TRANSACTION
On April 17, 2000, the Company signed an agreement and plan of merger
(merger agreement) with Mpower Communications Corp. (A/K/A MGC Communications,
Inc.).
In connection with the consummation of the merger agreement, the following
will occur:
(i) The Company's stockholders will exchange their shares in the Company
for 1,350,000 shares of common stock of Mpower Communications Corp.
(Mpower). Each outstanding share of the Company's common stock and
preferred stock will be converted into .02022 shares of Mpower common
stock.
(ii) All of the Company's stock options outstanding under the Company's
stock option plan shall continue to have, and be subject to, the same
terms and conditions as set forth in the Company's stock option plan
and the agreements pursuant to which such Company stock options were
issued, except that each Company stock option shall be exercisable
for .02022 shares of Mpower common stock and the price per share will
be adjusted accordingly.
(iii) The Company's 4,476,423 detachable non-callable warrants to the
Investors that entitle the holders to purchase common shares of the
Company at a price of $3.385 per share shall continue to be subject
to the same terms and conditions, except that each warrant shall be
exercisable for .02022 shares of Mpower common stock and the price
per share will be adjusted accordingly.
(iv) Mpower will assume approximately $80,000,000 of net liabilities of
the Company, a portion of which will be swapped for additional
high-yield bonds to be issued under Mpower's recent high-yield
financing indenture. The holders of the swapped debt will also
receive 50,000 shares of Mpower common stock.
(v) Mpower will become the sole stockholder of the Company.
NOTE PAYABLE
On April 27, 2000 the Company issued a $10,000,000 senior promissory note
(senior note) to Mpower due the earliest of April 17, 2001, upon a change of
control of the Company other than the pending transaction discussed above, or
upon the event of default, as defined. Interest accrues at 15 percent per annum
until the maturity date. After the maturity date, interest accrues at 18 percent
F-40
<PAGE> 193
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
per annum until the senior note is paid in full. At any time prior to maturity
of the senior note, the unpaid principal amount of the senior note together with
any accrued but unpaid interest may be prepaid in whole or in part as long as
the Company has provided at least 15 business days notice to Mpower.
Due to the issuance of this senior note, the Company was in violation of a
covenant included in the Note and Purchase Agreement dated June 1, 1999 related
primarily to limitations of indebtedness. The holders of Notes waived their
right to call the debt as well as this covenant violation as of April 27, 2000.
F-41
<PAGE> 194
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1999
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 26,712,416 $ 15,644,224
Investments.............................................. 5,076,212 --
Accounts receivable, less allowance for doubtful accounts
of $630,920 at September 30, 1999 and $1,014,009 at
December 31, 1999..................................... 963,512 2,238,733
Due from affiliates...................................... 1,052,505 995,807
Inventory................................................ 105,886 129,610
Other current assets..................................... 923,385 1,603,446
------------ ------------
Total current assets............................. 34,833,916 20,611,820
Restricted cash............................................ 1,000,000 1,000,000
Property and equipment, net................................ 8,900,931 20,361,875
Refundable capital lease deposit with affiliate............ 707,660 707,660
Debt issuance costs, net of accumulated amortization of
$160,582 at September 30, 1999 and $281,020 at December
31, 1999................................................. 3,211,658 3,091,221
Intangible assets, net..................................... 13,110,252 18,628,241
------------ ------------
$ 61,764,417 $ 64,400,817
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable......................................... $ 2,322,537 $ 4,112,501
Accrued expenses......................................... 3,130,130 8,243,755
Unearned revenues........................................ 1,069,696 1,171,315
Current maturities of capital lease obligations.......... 1,137,019 1,626,112
Note payable............................................. 16,614 462,928
Due to affiliates........................................ 158,376 --
------------ ------------
Total current liabilities........................ 7,834,372 15,616,611
Capital lease obligations, less current maturities....... 1,280,252 1,906,408
Convertible note payable................................. 1,000,000 1,750,000
Senior subordinated discount note........................ 48,837,310 50,687,106
Stockholders' equity (deficit):
Preferred Stock, $.001 par value, 20,000,000 shares
authorized Series A preferred stock, 2,306,765 shares
issued and outstanding................................ 494,375 494,375
Series B preferred stock, 1,500,000 shares designated,
850,000 shares issued and outstanding................. -- 170,000
Deferred stock compensation.............................. -- (162,917)
Common stock, $.001 par value, 80,000,000 shares
authorized, 63,600,815 shares issued.................. 63,601 63,601
Additional paid-in capital............................... 14,496,596 14,496,596
Accumulated deficit...................................... (12,242,089) (20,620,963)
------------ ------------
2,812,483 (5,559,308)
------------ ------------
$ 61,764,417 $ 64,400,817
============ ============
</TABLE>
See notes to unaudited consolidated financial statements.
F-42
<PAGE> 195
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------
DECEMBER 31, DECEMBER 31,
1998 1999
(PREDECESSOR) (SUCCESSOR)
----------------- -----------------
<S> <C> <C>
Revenues:
Access revenues..................................... $ 885,017 $ 2,631,621
Communication revenues.............................. -- 1,143,165
Retail revenues..................................... 220,746 242,177
Other revenues...................................... 203,866 236,550
---------- -----------
1,309,629 4,253,513
Costs and expenses:
Costs of access revenues............................ 337,216 1,075,386
Cost of communication revenues...................... -- 1,165,203
Cost of retail revenues............................. 146,925 97,296
Costs of other revenues............................. 163,925 207,052
Operations and customer support..................... 193,032 1,595,724
Sales and marketing................................. 237,028 1,342,581
General and administrative.......................... 420,720 2,392,719
Retail store expenses............................... 298,308 189,861
Depreciation and amortization....................... 92,192 2,813,809
---------- -----------
1,889,346 10,879,631
---------- -----------
Loss from operations.................................. (579,717) (6,626,118)
Other income (expense):
Interest expense -- affiliates...................... (18,909) --
Interest expense.................................... (422) (2,094,787)
Other, net.......................................... (27,453) 342,031
---------- -----------
Loss from continuing operations....................... (626,501) (8,378,874)
Income from operations of discontinued Web development
division............................................ 57,106 --
---------- -----------
Loss before income taxes.............................. (569,395) (8,378,874)
Provision for income taxes............................ -- --
---------- -----------
Net loss.............................................. $ (569,395) $(8,378,874)
========== ===========
</TABLE>
See notes to unaudited consolidated financial statements.
F-43
<PAGE> 196
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
-----------------------------
DECEMBER 31, DECEMBER 31,
1998 1999
(PREDECESSOR) (SUCCESSOR)
------------- ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $(569,395) $ (8,378,874)
Adjustments to reconcile net loss to net cash used in
operating activities: -- --
Depreciation and amortization............................. 92,192 2,813,809
Amortization of debt issuance costs....................... -- 120,438
Allowance for doubtful accounts........................... 14,692 387,471
Accretion of discount on senior subordinated debt......... -- 1,849,796
Amortization of discount on investment.................... -- (48,788)
Stock based compensation expense.......................... 46,157 7,083
Changes in operating assets and liabilities:
Accounts receivable.................................... 75,189 (1,510,404)
Due from affiliates.................................... (203,164) 56,698
Inventory.............................................. 14,041 (23,724)
Other current assets................................... (38,226) (668,631)
Accounts payable....................................... 66,531 1,635,906
Accrued expenses....................................... 102,697 (86,704)
Unearned revenues...................................... 42,205 (118,969)
--------- ------------
Net cash used in operating activities....................... (357,081) (3,964,893)
INVESTING ACTIVITIES
Sale of held to maturity security........................... -- 5,125,000
Advances to affiliates...................................... (152,172) --
Purchases of property and equipment, net of accrued
expenses.................................................. (90,885) (5,218,090)
Acquisition of Information Services Technologies, Inc. ..... -- (591,006)
Acquisition of Business Product Systems Internet, Inc. ..... -- (700,112)
Acquisition of UNI Networking, Inc. ........................ -- (345,301)
Acquisition of Global Vision Systems, Inc., net of cash
acquired.................................................. -- (3,102,445)
Acquisition of Digital Internet Access Inc., net of cash
acquired.................................................. -- (1,417,771)
Acquisition of Harvest Communications, Inc. ................ -- (50,000)
--------- ------------
Net cash used in investing activities....................... (243,057) (6,299,725)
FINANCING ACTIVITIES
Principal payments of obligations under capital lease....... -- (645,198)
Net proceeds under line of credit........................... 20,000 --
Purchase of common stock held in treasury................... (33,255) --
Due to affiliates........................................... 634,226 (158,376)
Proceeds from issuance of common stock...................... 279,058 --
--------- ------------
Net cash provided by (used in) financing activities......... 900,029 (803,574)
--------- ------------
Net increase (decrease) in cash and cash equivalents........ 299,891 (11,068,192)
Cash and cash equivalents at beginning of period............ 689 26,712,416
--------- ------------
Cash and cash equivalents at end of period.................. $ 300,580 $ 15,644,224
========= ============
</TABLE>
F-44
<PAGE> 197
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
NATURE OF BUSINESS
Primary Network Holdings, Inc. (the Company) is headquartered in St. Louis,
Missouri, and provides full-service access to the Internet for corporate and
residential users primarily in Missouri and Kansas. The Company also is a
reseller of basic local telecommunications services, dedicated non-switched
local exchange telecommunications services, and intrastate interexchange
telecommunications services in Missouri. The basic local service is classified
as competitive by the State of Missouri Public Service Commission (PSC) and is
provided in portions of Missouri that are currently served primarily by
Southwestern Bell Telephone Company (SWBT). Furthermore, the Company also serves
as an authorized agent of Southwestern Bell Mobile Systems and operates cellular
and other wireless communication products retail stores in the St. Louis
metropolitan area. Billings are due upon receipt.
BASIS OF PRESENTATION
The unaudited consolidated financial statements of Primary Network
Holdings, Inc., the successor company, and CDM On-Line, Inc., the predecessor
company, have been prepared in accordance with generally accepted accounting
principles for interim financial information (refer to footnotes 1 and 2 in the
September 30, 1999 audited financial statements of the Company for further
explanation of the organization and basis of presentation and initial formation
and capitalization of the Company). Accordingly, these interim financial
statements do not include all of the information and notes required by generally
accepted accounting principles for complete financial statements, and,
therefore, should be read in conjunction with the Company's audited financial
statements for the four months ended September 30, 1999, contained in this
Prospectus. In the opinion of management, all adjustments (consisting only of
normal recurring items) considered necessary for a fair presentation have been
included. The results of operations for the three months ended December 31, 1999
are not necessarily indicative of the results that may be expected for the year
ended September 30, 2000.
2. INVENTORY
Inventory consists of cellular and other wireless communication products
and accessories and is stated at the lower of cost (specific identification
basis) or market.
F-45
<PAGE> 198
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at September 30, 1999 and
December 31, 1999:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1999
------------- ------------
<S> <C> <C>
Computer equipment................................... $ 4,465,458 $ 6,441,308
Software............................................. 478,574 698,167
Furniture, fixtures, and office equipment............ 680,884 793,849
Capitalized collocation costs........................ 150,236 4,342,291
Land, building, and leasehold improvements........... 285,552 480,219
Vehicles............................................. 71,348 71,348
----------- -----------
6,132,052 12,827,182
Less accumulated depreciation and amortization....... (1,881,830) (2,459,256)
----------- -----------
4,250,222 10,367,926
Construction in progress............................. 4,650,709 9,993,949
----------- -----------
$ 8,900,931 $20,361,875
=========== ===========
</TABLE>
4. INTANGIBLE ASSETS
Intangible assets consist of the following at September 30, 1999 and
December 31, 1999:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1999
------------- ------------
<S> <C> <C>
Acquired customer list............................... $ 2,771,783 $ 5,460,083
Goodwill............................................. 11,631,661 16,733,735
----------- -----------
14,403,444 22,193,818
Less accumulated amortization........................ (1,293,192) (3,565,577)
----------- -----------
$13,110,252 $18,628,241
=========== ===========
</TABLE>
5. ACCRUED LIABILITIES
Accrued liabilities consist of the following at September 30, 1999 and
December 31, 1999:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1999
------------- ------------
<S> <C> <C>
Accrual for equipment acquired....................... $1,836,572 $6,369,305
Accrued payroll and related expenses................. 366,933 550,076
Acquisition related holdback accrual................. 130,000 751,355
Other accrued liabilities............................ 796,625 573,019
---------- ----------
$3,130,130 $8,243,755
========== ==========
</TABLE>
F-46
<PAGE> 199
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. SEGMENT INFORMATION
The Company has three reportable segments, Internet, Retail, and
Communications, which are separate operating units that offer different products
and services and are managed accordingly. Performance of each segment is
evaluated by management based on income (loss) before income taxes. The
corporate and eliminations segment includes corporate assets, principally
consisting of cash and cash equivalents, investments and debt issuance costs,
corporate activities and the elimination of intersegment transactions. In
addition, as a result of the initial formation and capitalization of the Company
as of June 1, 1999, the Company adjusted its segment reporting structure whereby
interest expense is no longer allocated to its three reportable segments.
The Internet segment provides full service access to the Internet for
corporate and residential customers including dial-up and dedicated services and
activities related to setup and installation, selling equipment, and software.
The Retail segment sells cellular and other wireless communication products,
including phones, pagers, and related accessories. The Communications segment,
which was established June 1, 1999, provides facilities-based and resold basic
local telecommunications service, including dedicated/non-switched local
exchange services, and intrastate interexchange services.
The following segment information is as of December 31 or for the three
months then ended:
<TABLE>
<CAPTION>
1998 (PREDECESSOR)
-------------------------------------
INTERNET RETAIL TOTAL
---------- --------- ----------
<S> <C> <C> <C>
Revenues from external customers................... $1,088,883 $ 220,746 $1,309,629
Intersegment revenues.............................. -- -- --
Depreciation and amortization...................... 88,467 3,725 92,192
Interest expense................................... 16,073 3,258 19,331
Loss from continuing operations.................... (395,028) (231,473) (626,501)
Income from discontinued operation -- Web
Development...................................... 57,106 -- 57,106
Loss before income taxes........................... (337,922) (231,473) (569,395)
Segment assets..................................... 1,123,687 540,241 1,663,928
Capital expenditures, net of accrued expenses...... 86,635 4,250 90,885
</TABLE>
<TABLE>
<CAPTION>
1999 (SUCCESSOR)
--------------------------------------------------------------------
CORPORATE
AND
INTERNET RETAIL COMMUNICATIONS ELIMINATIONS TOTAL
----------- -------- -------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues from external
customers................. $ 2,868,171 $242,177 $ 1,143,165 -- $ 4,253,513
Intersegment Revenues....... 765 44,649 244,118 (289,532) --
Depreciation and
amortization.............. 1,866,138 8,947 890,209 48,515 2,813,809
Interest expense............ -- -- -- 2,094,787 2,094,787
Loss before income taxes.... (1,898,088) (52,314) (2,697,817) (3,730,655) (8,378,874)
Segment assets.............. 20,192,172 360,552 22,502,260 21,345,833 64,400,817
Capital expenditures, net of
accrued expenses.......... 39,939 536 4,531,002 646,613 5,218,090
</TABLE>
F-47
<PAGE> 200
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. ACQUISITIONS
In the three month period ended December 31, 1999, the Company made the
following acquisitions:
On October 1, 1999, the Company purchased substantially all of the assets
of Information Systems Technologies, Inc. for approximately $591,000, net of
liabilities assumed.
On October 6, 1999, the Company purchased substantially all of the assets
of Business Products Systems Internet, Inc. for approximately $700,000, net of
liabilities assumed.
On October 13, 1999, the Company purchased substantially all of the assets
of UNI Networking Inc. for approximately $345,000, net of liabilities assumed.
On October 20, 1999, the Company purchased all of the outstanding common
stock of GlobalVision Systems, Inc. for approximately $3,102,000, net of cash
acquired and liabilities assumed.
On November 1, 1999, the Company purchased all of the outstanding common
stock of Harvest Telecom, Inc. for approximately $50,000.
On November 10, 1999, the Company purchased all of the outstanding common
stock of Digital Internet Access, Inc. for approximately $1,418,000, net of cash
acquired and liabilities assumed.
The above acquisitions were accounted for under the purchase method of
accounting, and accordingly, the purchase prices were allocated to assets
acquired and liabilities assumed based upon their estimated fair values at the
dates of acquisition. The customer lists were valued at $200 per subscriber
acquired, which represents the estimated fair value of such subscribers based
upon recent transactions in the ISP industry. Included in the purchase prices
listed above are legal and acquisition costs of approximately $32,600. For those
businesses acquired, the results of operations are included in the Company's
consolidated statement of operations from the dates of acquisition.
The combined historical results for the acquisitions listed above were not
deemed to be material and thus, pro-forma financial information was not
presented for the periods disclosed.
8. SECONDMENT AGREEMENT
On November 23, 1999, the Company entered into a Secondment Agreement with
an investor to obtain certain services to be provided by an employee of the
investor. Under the terms of the agreement, the Company is required to pay
$17,500 per month for the services, including out-of-pocket expenses.
Furthermore, the seconded employee was issued 680,000 shares of Series B
preferred stock which vests in eight equal quarterly installments over a
two-year period and warrants with an exercise price of $1.52 per share to
purchase an additional 520,000 shares of Series B preferred stock which vest in
three equal annual installments. Furthermore, the investor was issued 170,000
shares of Series B preferred stock and was granted warrants with an exercise
price of $1.52 to purchase an additional 130,000 shares of Series B preferred
stock, both with the same vesting terms as the seconded employee described
above. All of the above issuances and grants vest immediately upon the
occurrence of certain events described in the agreement, including a change in
control. The Company will recognize the compensation expense related to these
transactions ratably over the vesting period. Finally, the investor is entitled
to receive a fee, payable immediately, in the event the Company consummates
certain transactions outlined in the agreement prior to June 1, 2000, including
a change in control, obtaining senior debt from a financial institution, or
issuing additional subordinated debt or equity securities.
F-48
<PAGE> 201
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. SUBSEQUENT EVENTS
LEASE TRANSACTIONS
On February 23, 2000, the Company entered into an equipment capital lease
to finance its continued build out of collocations. Under the terms of the
lease, the Company is required to make thirty-six equal monthly payments of
approximately $122,000 and has the guaranteed option to purchase the equipment
at 10% of original purchase price or approximately $3,700,000. The assets under
the capital lease are recorded at the lower of the present value of the minimum
lease payments or the fair value of the equipment. The lease is secured by the
equipment financed.
On March 31, 2000, the Company entered into a sale leaseback agreement,
whereby the Company sold collocation equipment with a book value of
approximately $8,000,000 and subsequently entered into a capital lease for
approximately $9,400,000, including the financing of approximately $900,000 in
equipment maintenance agreements. The assets under the capital lease are
recorded at the lower of the present value of the minimum lease payments or the
fair value of the equipment. The gain resulting from this transaction of
approximately $500,000 is being amortized over the term of the lease. Under the
terms of the lease, the Company is required to make six monthly payments of
approximately $106,000 and then thirty monthly payments of approximately
$340,000.
In addition to the equipment being financed under the lease, the Company
granted the lessor an additional security interest in substantially all tangible
and intangible assets of the Company. The lessor has provided a contingent
clause in the agreement for the release of the additional security upon the
Company obtaining unrestricted cash equity proceeds in the amount of $50,000,000
or greater. The lease agreement also contains covenants requiring the Company to
maintain certain debt to total contributed capital ratios as well as requiring
the Company to secure future minimum commitments of either secured bridge debt
or unrestricted by various dates.
LEASE COMMITMENT
On April 15, 2000 the Company entered into an agreement for the lease of a
new office building. The term of the agreement is five years with total annual
rent of approximately $1,200,000. In addition, the Company has committed
$3,900,000 for leasehold improvements and certain equipment purchases related to
this property.
PENDING TRANSACTION
On April 17, 2000, the Company signed an agreement and plan of merger
(merger agreement) with Mpower Communications Corp. (A/K/A MGC Communications,
Inc.).
In connection with the consummation of the merger agreement, the following
will occur:
(i) The Company's stockholders will exchange their shares in the Company
for 1,350,000 shares of common stock of Mpower Communications Corp.
(Mpower). Each outstanding share of the Company's common stock and
preferred stock will be converted into .02022 shares of Mpower common
stock.
(ii) All of the Company's stock options outstanding under the Company's
stock option plan shall continue to have, and be subject to, the same
terms and conditions as set forth in the Company's stock option plan
and the agreements pursuant to which such Company stock options were
issued, except that each Company stock option shall be exercisable
for .02022 shares of Mpower common stock and the price per share will
be adjusted accordingly.
F-49
<PAGE> 202
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(iii) The Company's 4,476,423 detachable non-callable warrants to the
Investors that entitle the holders to purchase common shares of the
Company at a price of $3.385 per share shall continue to be subject
to the same terms and conditions, except that each warrant shall be
exercisable for .02022 shares of Mpower common stock and the price
per share will be adjusted accordingly.
(iv) Mpower will assume approximately $80,000,000 of net liabilities of
the Company, a portion of which will be swapped for additional
high-yield bonds to be issued under Mpower's recent high-yield
financing indenture. The holders of the swapped debt will also
receive 50,000 shares of Mpower common stock.
(v) Mpower will become the sole stockholder of the Company.
NOTE PAYABLE
On April 27, 2000 the Company issued a $10,000,000 senior promissory note
(senior note) to Mpower due the earliest of April 17, 2001, upon a change of
control of the Company other than the pending transaction discussed above, or
upon the event of default, as defined. Interest accrues at 15 percent per annum
until the maturity date. After the maturity date, interest accrues at 18 percent
per annum until the senior note is paid in full. At any time prior to maturity
of the senior note, the unpaid principal amount of the senior note together with
any accrued but unpaid interest may be prepaid in whole or in part as long as
the Company has provided at least 15 business days notice to Mpower.
Due to the issuance of this senior note, the Company was in violation of a
covenant included in the Note and Purchase Agreement dated June 1, 1999 related
primarily to limitations of indebtedness. The holders of Notes waived their
right to call the debt as well as this covenant violation as of April 27, 2000.
F-50
<PAGE> 203
CONSOLIDATED FINANCIAL STATEMENTS
PRIMARY NETWORK HOLDINGS, INC.
FOR THE PERIOD JUNE 1, 1999 TO SEPTEMBER 30, 1999
WITH REPORT OF INDEPENDENT AUDITORS
F-51
<PAGE> 204
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD JUNE 1, 1999 TO SEPTEMBER 30, 1999
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors.............................. F-53
Consolidated Financial Statements
Consolidated Balance Sheet.................................. F-54
Consolidated Statement of Operations........................ F-55
Consolidated Statement of Stockholders' Equity.............. F-56
Consolidated Statement of Cash Flows........................ F-57
Notes to Consolidated Financial Statements.................. F-58
</TABLE>
F-52
<PAGE> 205
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Primary Network Holdings, Inc.
We have audited the accompanying consolidated balance sheet of Primary
Network Holdings, Inc. as of September 30, 1999 and the related consolidated
statements of operations, stockholders' equity, and cash flows for the period
June 1, 1999 to September 30, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Primary Network Holdings, Inc. at September 30, 1999 and the consolidated
results of its operations and its cash flows for the period June 1, 1999 to
September 30, 1999, in conformity with accounting principles generally accepted
in the United States.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As more fully
described in Note 1, the Company has incurred significant operating losses and
negative cash flows from operations. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 1. The September 30, 1999
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
ERNST & YOUNG LLP
February 11, 2000, except for
Note 16, as to which the date is April 27, 2000
St. Louis, Missouri
F-53
<PAGE> 206
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1999
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 26,712,416
Investments............................................... 5,076,212
Accounts receivable, less allowance for doubtful accounts
of $630,920............................................ 963,512
Due from affiliates....................................... 1,052,505
Inventory................................................. 105,886
Prepaid expenses and other current assets................. 923,385
------------
Total current assets.............................. 34,833,916
Restricted cash............................................. 1,000,000
Property and equipment, net................................. 8,900,931
Refundable capital lease deposit with affiliate............. 707,660
Debt issuance costs, net of accumulated amortization of
$160,582.................................................. 3,211,658
Intangible assets, net...................................... 13,110,252
------------
$ 61,764,417
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,322,537
Accrued expenses.......................................... 3,130,130
Unearned revenues......................................... 1,069,696
Current maturities of capital lease obligations........... 1,137,019
Note payable.............................................. 16,614
Due to affiliates......................................... 158,376
------------
Total current liabilities......................... 7,834,372
Capital lease obligations, less current maturities.......... 1,280,252
Convertible note payable.................................... 1,000,000
Senior subordinated discount notes.......................... 48,837,310
Stockholders' equity:
Preferred stock, $.001 par value, 20,000,000 shares
authorized Series A, 2,306,765 shares issued and
outstanding............................................ 494,375
Common stock, $.001 par value, 80,000,000 shares
authorized, 63,600,815 shares issued and outstanding... 63,601
Additional paid-in capital................................ 14,496,596
Accumulated deficit....................................... (12,242,089)
------------
2,812,483
------------
$ 61,764,417
============
</TABLE>
See accompanying notes.
F-54
<PAGE> 207
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE PERIOD JUNE 1, 1999 TO SEPTEMBER 30, 1999
<TABLE>
<S> <C>
Revenues:
Access revenues........................................... $ 2,712,058
Communications revenues................................... 850,367
Retail revenues........................................... 350,715
Other revenues............................................ 168,997
-----------
4,082,137
Costs and expenses:
Costs of access revenues.................................. 947,293
Costs of communications revenues.......................... 903,846
Costs of retail revenues.................................. 141,734
Costs of other revenues................................... 109,700
Operations and customer support........................... 1,595,725
Sales and marketing....................................... 1,342,581
General and administrative................................ 2,046,290
Retail store expenses..................................... 275,554
Depreciation and amortization............................. 1,766,901
Impairment charge......................................... 254,132
-----------
9,383,756
-----------
Loss from operations........................................ (5,301,619)
Other income (expense):
Interest expense -- affiliates............................ (118,507)
Interest expense.......................................... (2,582,804)
Interest income -- affiliates............................. 30,301
Other income, net......................................... 663,926
-----------
(2,007,084)
-----------
Loss before income taxes.................................... (7,308,703)
Provision for income taxes.................................. --
-----------
Net loss.................................................... $(7,308,703)
===========
</TABLE>
See accompanying notes.
F-55
<PAGE> 208
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
SERIES A PREFERRED
STOCK COMMON STOCK ADDITIONAL
-------------------- -------------------- PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT
--------- -------- ---------- ------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at June 1, 1999... -- $ -- -- $ -- $ -- $ --
Issuance of stock in
connection with the
acquisition of CDM
Online, Inc.......... -- -- 24,632,359 24,632 6,655,497 (4,933,386)
Issuance of stock in
connection with the
acquisition of
BroadSpan
Communications,
Inc.................. -- -- 7,085,664 7,086 1,511,480 --
Issuance of stock in
initial
capitalization (See
Note 2).............. 2,306,765 494,375 31,882,792 31,883 6,329,619 --
Net loss................ -- -- -- -- -- (7,308,703)
--------- -------- ---------- ------- ----------- ------------
Balance at September 30,
1999.................... 2,306,765 $494,375 63,600,815 $63,601 $14,496,596 $(12,242,089)
========= ======== ========== ======= =========== ============
</TABLE>
See accompanying notes.
F-56
<PAGE> 209
PRIMARY NETWORK HOLDINGS, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE PERIOD JUNE 1, 1999 TO SEPTEMBER 30, 1999
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (7,308,703)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 1,766,901
Amortization of debt issue costs.......................... 160,582
Allowance for doubtful accounts........................... 305,692
Accretion of discount on senior subordinated debt......... 2,392,255
Amortization of discount on investment.................... (76,667)
Impairment charge......................................... 254,132
Gain on disposal of fixed assets.......................... (75,000)
Changes in operating assets and liabilities:
Accounts receivable.................................... (178,375)
Due from affiliates.................................... (1,126,900)
Inventory.............................................. (9,560)
Prepaid expenses and other current assets.............. (532,987)
Accounts payable....................................... (209,308)
Accrued expenses....................................... 825,371
Due to affiliates...................................... (348,488)
Unearned revenues...................................... 105,706
------------
Net cash used in operating activities....................... (4,055,349)
INVESTING ACTIVITIES
Increase in restricted cash................................. (1,000,000)
Purchase of held-to-maturity security....................... (4,999,545)
Cash acquired in acquisition of CDM On-Line, Inc............ 73,938
Cash acquired in acquisition of BroadSpan Communications,
Inc....................................................... 109,762
Acquisition of InLink Communications Company................ (4,738,848)
Acquisition of Q-Networks Inc., net of cash acquired........ (3,980,795)
Acquisition of CySource, Inc................................ (593,502)
Additional costs incurred in acquisitions made by
predecessor in prior periods.............................. (34,726)
Purchase of property and equipment, net of accounts
payable................................................... (3,772,056)
------------
Net cash used in investing activities....................... (18,935,772)
FINANCING ACTIVITIES
Payments of equity and debt issuance costs.................. (3,071,307)
Principal payments of obligations under capital leases...... (222,350)
Proceeds from issuance of senior subordinated discount
notes..................................................... 46,445,055
Proceeds from issuance of common stock...................... 6,554,945
Principal payments under note payable....................... (2,806)
------------
Net cash provided by financing activities................... 49,703,537
------------
Net increase in cash and cash equivalents................... 26,712,416
Cash and cash equivalents at June 1, 1999................... --
------------
Cash and cash equivalents at September 30, 1999............. $ 26,712,416
============
Noncash investing and financing transactions:
Note payable issued to seller in acquisition of Q-Networks
Inc.................................................... $ 1,000,000
============
Capital leases entered into............................... $ 119,311
============
</TABLE>
See accompanying notes.
F-57
<PAGE> 210
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
1. ORGANIZATION AND BASIS OF PRESENTATION
Primary Network Holdings, Inc., a Delaware corporation (PNH or the
Company), was incorporated on March 3, 1999 for the purpose of combining two
affiliated entities, CDM On-Line, Inc., d/b/a/ Primary Network Internet, Inc.
(PNI), an Internet service provider (ISP), and BroadSpan Communications, Inc.,
d/b/a/ Primary Network Communication, Inc. (PNC), a competitive local exchange
carrier (CLEC). In an April 1999 joint stockholders meeting, the stockholders of
PNI and PNC voted to approve an Agreement & Plan of Reorganization, pursuant to
which the respective stockholders of each company would exchange their current
ownership interests for shares of common stock in the Company effective the
close of business on May 31, 1999 (the Exchange) (see Note 3). Subsequent to the
Exchange, PNI and PNC continued as wholly owned subsidiaries of the Company.
The Company was in the development stage for the period from March 3, 1999
(date of inception) to June 1, 1999. Accordingly, the Company had no assets,
liabilities, or financial activity prior to June 1, 1999.
Pursuant to the requirements of the Securities and Exchange Commission's
Staff Accounting Bulletin No. 97, which was issued and became effective July 31,
1996, although the Company is the legal acquiror of both entities, PNI has been
designated as the acquirer of PNC and the predecessor of PNH for financial
reporting purposes. This designation was the result of the PNI stockholders
receiving the largest ownership interests in the combined corporation subsequent
to the Exchange. In addition, because PNI was treated as the acquirer in the
Exchange for financial accounting purposes, the Company's financial position on
June 1, 1999 reflected the historical cost basis of PNI. Furthermore, the
acquisition of PNC was accounted for as a purchase transaction, and accordingly,
purchase accounting adjustments, including the recognition of goodwill, were
recorded based on the fair value of the Company's common stock issued in the
Exchange at that date.
The accompanying consolidated financial statements of the Company for the
period June 1, 1999 to September 30, 1999 have been prepared on a going-concern
basis which contemplates the realization of assets and the settlement of
liabilities and commitments in the normal course of business. The Company
incurred a net loss of $7,308,703 and had negative cash flows from operations of
$4,055,349 for the period June 1, 1999 to September 30, 1999. Additionally, the
Company continues to incur substantial capital expenditures as it relates to the
collocation build-out for its Digital Subscriber Line (DSL) service, which is
necessary for the Company to be able to offer its future core services, and has
continued to incur operating losses through the first four months of fiscal
2000. These two factors have resulted in a significant decrease in the Company's
cash position subsequent to year-end. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Furthermore, the
online services, Internet, and telecommunications markets are highly
competitive. The Company believes that existing competitors, Internet-based
services, other ISPs, Internet directory services, incumbent local exchange
carriers, other CLECs, and other telecommunications companies are likely to
enhance their service offerings, resulting in greater competition for the
Company. The competitive conditions could have the following effects: require
additional pricing programs, increase spending on marketing, limit the Company's
ability to expand its subscriber base, and result in increased attrition in the
existing subscriber base. The Company's viability as a going concern is
dependent upon management's operational and financing plans to address these
conditions which include, but are not limited to, obtaining additional equity
and debt financing, continuing investments in its infrastructure to increase its
efficiency and capacity to serve
F-58
<PAGE> 211
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
existing and additional customers, and employing marketing and sales strategies
to increase its customer base. Although there can be no assurance that growth in
the Company's revenues or subscriber base will continue or that the Company will
be able to achieve or sustain profitability or positive cash flow, the Company
believes that these steps are appropriate and will enable the Company to
effectively reorganize its operations. Under current circumstances, the
Company's ability to continue as a going concern depends upon the successful
implementation of its plan. If the Company is unsuccessful in its efforts, it
may be necessary to undertake such other actions as may be appropriate to
preserve asset values. The accompanying consolidated financial statements do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
2. INITIAL FORMATION AND CAPITALIZATION
As described in Note 1, effective the close of business on May 31, 1999,
the Company legally acquired PNI through the execution of an Agreement & Plan of
Reorganization, whereby all common stockholders of PNI exchanged each of their
shares for 16.67 shares of common stock in the Company. This transaction
resulted in the issuance of 24,632,359 common shares of the Company and occurred
simultaneously with the acquisition of PNC discussed below and, as mentioned
previously, resulted in PNI being designated as the accounting acquirer of PNC
and PNI being deemed to be the predecessor of PNH. Accordingly, the Company's
acquisition of PNI was accounted for using the carryover basis of PNI's assets,
liabilities, and retained earnings. As a result, no goodwill was recorded in
this acquisition. The net carrying value of PNI's assets as of the acquisition
date was $1,746,743.
Also in connection with the Agreement & Plan of Reorganization, the Company
legally acquired PNC, whereby all common stockholders of PNC exchanged each of
their shares for 13.227 shares of common stock in the Company. This transaction
resulted in the issuance of 7,085,664 common shares of the Company and was
accounted for under the purchase method of accounting, based on the fair value
of the Company's common stock issued in the Exchange at the acquisition date of
$1,518,566, plus net liabilities assumed of $1,702,547 and acquisition costs of
$100,420. The purchase price allocation resulted in the Company recording total
goodwill associated with this transaction of $3,321,533.
The acquisitions of PNI and PNC have been structured as tax-free exchanges
of stock; therefore, the difference between the recognized fair value of the
acquired assets, including intangible assets, and their historical tax bases is
not deductible for income tax purposes.
On June 1, 1999, the Company entered into a Purchase Agreement with a
syndicate of investors (Investors) to obtain additional financing. Under this
agreement, the Company received cash proceeds of $53,000,000 and issued the
following debt and equity securities to the Investors: senior subordinated
discount notes with a face value of $84,473,948, 30,564,640 shares of common
stock, and detachable non-callable warrants to purchase 4,476,423 shares of
common stock. The Company determined the fair value of the common stock based
upon an independent valuation as of June 1, 1999. Accordingly, the Company
allocated the proceeds received among the debt, common stock, and warrants based
on their respective fair values at the time of issuance. The value attributable
to the common stock of approximately $6,550,000 was recorded as a debt discount
to be charged to interest expense over the life of the notes. The fair value of
the warrants was deemed insignificant on the date of grant, and thus only a
nominal amount was recorded as additional paid-in capital. This nominal
F-59
<PAGE> 212
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value was also recorded as a debt discount to be charged to interest expense
over the life of the notes. The balance of the proceeds of approximately
$46,445,000 was allocated to the notes.
Offering costs incurred in connection with the Purchase Agreement of
approximately $3,500,000, including legal costs, accounting fees, and financial
advisor fees, were recorded as debt issuance costs or as a reduction to
additional paid-in capital, based on the proportional allocation of proceeds
described above. Included in these offering costs were amounts equaling the fair
value at the transaction date of 2,306,765 shares of the Company's Series A
preferred stock and 1,318,152 shares of the Company's common stock which were
granted to certain investors who also acted as financial advisors and exclusive
placement agents in this transaction.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Company, which is headquartered in St. Louis, Missouri, provides
full-service access to the Internet for corporate and residential users
primarily in Missouri and Kansas. The Company also is a reseller of basic local
telecommunications services, dedicated non-switched local exchange
telecommunications services, and intrastate interexchange telecommunications
services in Missouri. The basic local service is classified as competitive by
the State of Missouri Public Service Commission (PSC) and is provided in
portions of Missouri that are currently served primarily by Southwestern Bell
Telephone Company (SWBT). Furthermore, the Company also serves as an authorized
agent of Southwestern Bell Mobile Systems and operates cellular and other
wireless communication products retail stores in the St. Louis metropolitan
area.
CONSOLIDATION
The consolidated financial statements of the Company include the accounts
of all of its wholly owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
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 in the financial statements and
accompanying notes. Actual results could differ from those estimates.
ACCOUNTING PERIOD
Effective June 1, 1999, the Company changed its fiscal year-end from
December 31, which was used by its predecessor, to September 30.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid financial instruments with a
maturity of three months or less at the time of purchase to be cash equivalents.
INVESTMENTS
Debt securities are classified as held-to-maturity when the Company has the
positive intent and ability to hold the securities to maturity. Held-to-maturity
securities are stated at amortized cost, adjusted for amortization of premiums
and discounts to maturity. Such amortization and the interest on securities are
included in other income.
F-60
<PAGE> 213
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment, including leasehold improvements, are stated at
cost. Costs related to software developed for internal use are capitalized in
accordance with AcSEC Statement of Position 98-1, Accounting for the Costs of
Computer Software Developed For or Obtained For Internal Use. Depreciation is
calculated using the straight-line method over the estimated useful lives
ranging from 18 months to 15 years. Leasehold improvements are amortized over
the lesser of the related lease term or the useful life of the assets.
Capitalized collocation costs represent application fees, equipment costs,
and leasehold improvement costs related to the leasing of collocation space at
SWBT. These costs are necessary for the delivery of certain communication
services, primarily DSL service, to the Company's customers. The Company
depreciates these costs using a straight-line method over a three-year period
beginning on the date the service becomes available. At September 30, 1999, the
Company has incurred $4,650,709 of collocation costs which are under
construction and classified in construction in progress.
Equipment under capital leases is amortized over its related lease terms or
its estimated productive useful lives, depending on the criteria met in
determining a lease's qualification as a capital lease. Costs of repair and
maintenance are charged to expense as incurred.
INVENTORY
Inventory consists of cellular and other wireless communication products
and accessories and is stated at the lower of cost (specific identification
basis) or market.
CUSTOMER LISTS
The cost of customer lists acquired is being amortized over three years
using the straight-line method.
GOODWILL
Goodwill, which represents the cost in excess of the fair market value of
identifiable net assets acquired, is being amortized using the straight-line
method over three years.
IMPAIRMENT OF LONG-LIVED ASSETS
Periodically, management determines whether any property or equipment or
any other assets have been impaired based on the criteria established in
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of. Based
on these criteria, customer lists and goodwill associated with assets acquired
in a business combination are included in impairment evaluations when events or
circumstances exist that indicate the carrying amount of those assets may not be
recoverable. During the four-month period ended September 30, 1999, the Company
recorded a $254,000 noncash charge to earnings related to the impairment
associated with the acquisition of the customer list and goodwill of CySource,
Inc. (see Note 4).
STOCK COMPENSATION
The Financial Accounting Standards Board's SFAS No. 123, Accounting for
Stock-Based Compensation, establishes the use of the fair value-based method of
accounting for stock-based
F-61
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PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
employee compensation arrangements, under which compensation cost is determined
using the fair value of stock-based compensation determined as of the grant date
and is recognized over the periods in which the related services are rendered.
SFAS No. 123 also permits companies to elect to continue using the intrinsic
value accounting method specified in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, (APB 25) and related interpretations
to account for stock-based compensation. The Company has elected to retain the
intrinsic value-based method and will disclose in its financial statements the
pro forma effect of using the fair value-based method to account for its
stock-based compensation.
REVENUE RECOGNITION
Access revenues: Internet customers are billed in advance for the periods
for which Internet services are provided. Internet access service plans range
from one month to one year. The Company defers recognition of revenue on these
advance billings and amortizes the amounts to revenue on a straight-line basis
as the services are provided.
Communications revenues services: Revenues from communications services are
recognized when customers use the services. Revenues billed in advance are
deferred and are recognized in the period in which the related services are
provided.
Retail revenues: These revenues consist primarily of retail product sales
of cellular and other wireless products, such as phones, pagers, and related
accessories. Such sales are recorded upon customer purchase. The Company also
generates revenues from activation commissions from cellular carriers for each
new cellular phone subscription sold by the Company. Revenue from such
commissions is recorded upon customer subscription. New subscription activation
commissions are fully refundable if the subscriber cancels service within a
certain minimum period of continuous active service (generally 180 days).
Customers generally sign a service agreement that requires a customer deposit
which is forfeited in case of early cancellation. At September 30, 1999, the
Company's allowance for accounts receivable includes an amount for estimated
cancellation losses, net of deposit forfeitures.
The Company generally receives monthly residual income from the cellular
service providers based on a percentage of actual phone usage by subscribers.
Revenue from residual income is recorded as the cellular service is provided.
Revenue from prepaid pager service is deferred and recognized over the period
service is provided, usually annually. Revenue from monthly installment pager
service contracts is recorded as earned.
Other revenues: Other revenues consist of setup and installation fees and
selling equipment and software. These revenues are recognized in the period in
which the service has been provided.
COSTS OF REVENUES
Costs of access revenues primarily consist of telecommunications expenses
inherent in the network infrastructure, including fees paid for the lease of the
Company's backbone. Costs of communications revenues include local and long
distance services purchased from SWBT and Qwest Communications Corporation
(Qwest), respectively. Costs of retail revenues consist of the costs of cellular
and other wireless communication products and accessories purchased for resale.
Costs of other revenues primarily consist of the costs of equipment and software
purchased for resale.
F-62
<PAGE> 215
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING COSTS
All advertising and promotion costs are expensed as incurred and totaled
$508,000 for the period June 1, 1999 to September 30, 1999.
INCOME TAXES
The provision for income taxes is computed using the liability method.
Deferred income taxes are provided to reflect the tax effects of temporary
differences between the book and tax basis of assets and liabilities. The
primary difference between the reported loss and taxable loss results from
financial statement accruals and reserves. The Company reported book and tax
losses for the period June 1, 1999 to September 30, 1999 and, therefore, has not
recorded income tax expense for the period then ended. Valuation allowances are
established, when appropriate, to reduce any deferred tax assets to the amount
that will more likely than not be realized.
For tax years prior to June 1, 1999, PNI was taxed under the provisions of
Subchapter S of the Internal Revenue Code (the Code). Under the Subchapter S
provisions of the Code, the stockholders of PNI included the Company's income or
loss in their personal income tax returns. Effective June 1, 1999, pursuant to
the Exchange, PNI's status as an S Corporation under the Code terminated, and it
became subject to state and federal corporate income taxes. Accordingly, the
Company established deferred tax assets and liabilities for PNI effective June
1, 1999. This calculation resulted in a net deferred tax asset position which
was fully reserved for by a valuation allowance.
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents,
investments, accounts receivable, accounts payable, and senior subordinated
discount notes. The cash and cash equivalents and investments are held by a
high-credit-quality financial institution. For accounts receivable, the Company
performs ongoing credit evaluations of the financial condition of its customers
and does not require collateral. The Company maintains reserves for credit
losses, and such losses have been within management's expectations. The
concentration of credit risk is mitigated by the large customer base. The net
carrying amount of all of these financial instruments, excluding the senior
subordinated discount notes, approximates their fair value at September 30,
1999. The fair value of the senior subordinated discount notes approximates the
liquidation value (see Note 9).
SOURCES OF SUPPLIES/SIGNIFICANT SUPPLIERS
The Company relies on local telephone companies and other companies to
provide data communications for its Internet access services. Furthermore, the
Company relies on SWBT and Qwest to provide the services that the Company
resells to its customers. Although management believes alternative
telecommunication facilities and providers could be found in a timely manner,
any disruption of these services could have an adverse effect on operating
results.
Although the Company attempts to maintain numerous vendors for required
products, its modems, terminal servers, and high-performance routers, which are
important components of its network, are each currently acquired from a limited
number of sources. In addition, some of the Company's suppliers have limited
resources and production capacity. If the suppliers are unable to meet the
Company's needs as its network infrastructure grows, then delays and increased
costs in the
F-63
<PAGE> 216
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
expansion of the Company's network infrastructure could result, having an
adverse effect on operating results.
4. ACQUISITIONS
In the period June 1, 1999 to September 30, 1999, the Company completed the
three acquisitions described below:
On June 17, 1999, the Company acquired all outstanding stock of Q-Networks
Inc. (Qnet), an ISP located in Kansas City, Missouri, from the sole stockholder
for $5,630,000, including the assumption of liabilities of approximately
$649,000. The purchase price was funded with $3,981,000 cash and $1,000,000 of
financing in the form of a convertible note payable issued to the seller. The
note was issued with an interest rate of 6 percent and is due in full or
convertible no later than June 2001. This note allows the seller to convert the
note into shares of the Company at the initial public offering price should the
Company complete an initial public offering any time prior to June 2001. The
Company may make prepayments at any time during the note term; however, should
the note be prepaid in full, the seller continues to have an option to acquire
up to $1,000,000 of the Company's stock in an initial public offering should it
occur at any time prior to June 2001. Interest under the convertible note is due
quarterly. In connection with the issuance of the convertible note, the Company
was required to place $1,000,000 in escrow at the time of acquisition. The funds
in escrow cannot be accessed by the Company without the consent of the seller
and thus are reflected as restricted cash in the accompanying consolidated
balance sheet at September 30, 1999. Approximately $1,056,000 and $4,264,000
were allocated to the acquired customer list and goodwill, respectively, as a
result of this transaction.
On June 22, 1999, the Company entered into an asset purchase agreement to
acquire the Internet access customer base of CySource, Inc. (CySource) for
approximately $602,000, including the assumption of liabilities of approximately
$8,000. The acquisition was funded with cash, and as of September 30, 1999, the
Company had made all required payments to the former stockholders of CySource.
Approximately $362,000 and $240,000 were allocated to the acquired customer list
and goodwill, respectively, as a result of this transaction.
As of September 30, 1999, the Company reviewed the carrying value of the
customer list as well as the goodwill associated with the CySource acquisition
and determined the following conditions:
i) The customer database used to determine the acquisition price was
corrupted, resulting in the actual number of customers receiving
Internet access from CySource at the date of acquisition being
significantly less than was expected.
ii) Subsequent to the acquisition date, the Company experienced
significant difficulties in merging the former CySource customers into
the Company's operations, which resulted in lost subscribers well in
excess of the Company's traditional customer attrition or churn rate.
iii) Additionally, as the Company continued to review the customer service
and reputation of CySource, the Company identified that the expected
internal growth rate resulting from the acquisition of the CySource
customer base was significantly impacted in a negative manner.
The foregoing factors have resulted in a material and permanent reduction
in both the forecasted cash flows for the operation and the results for the
four-month period ended September 30, 1999. Accordingly, the Company recorded a
$254,000 charge to earnings to reflect the impairment of the customer list and
goodwill associated with this acquisition. This charge was recorded ratably
among
F-64
<PAGE> 217
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
these assets, and the remaining $298,000 will be amortized over the estimated
remaining useful life of the customer list and goodwill.
On August 5, 1999, the Company entered into an asset purchase agreement to
acquire substantially all of the assets of InLink Communications Company
(Inlink), an ISP located in St. Louis, Missouri, for approximately $5,217,000,
including the assumption of liabilities of approximately $478,000. The
acquisition was funded with cash, and as of September 30, 1999, the Company had
made all required payments to the former stockholders of Inlink except for
$85,000 which is included in accounts payable at September 30, 1999.
Approximately $1,301,000 and $3,678,000 were allocated to the acquired customer
base and goodwill, respectively, as a result of this transaction.
The above acquisitions were accounted for under the purchase method of
accounting, and accordingly, the purchase prices were allocated to assets
acquired and liabilities assumed based upon their estimated fair values at the
dates of acquisition. The customer lists were valued at $200 per subscriber
acquired, which represents the estimated fair value of such subscribers based
upon recent transactions in the ISP industry. Included in the purchase prices
listed above are legal and acquisition costs of approximately $224,000. For
those businesses acquired, the results of operations are included in the
Company's consolidated statement of operations from the dates of acquisition.
The unaudited pro forma combined historical results of the Company and PNI,
its predecessor, as if PNC, Qnet, Cysoure and Inlink had been acquired by the
predecessor at the beginning of the respective periods, are included in the
table below. The pro forma combined historical results for KC One Internet
Services, Inc., Web World Services, Inc., and LidaNet, Inc. were not deemed
material and are not included in the table below.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1998 SEPTEMBER 30, 1999
----------------- ------------------
<S> <C> <C>
Total revenues............................... $ 9,350,099 $ 9,532,064
Net loss..................................... (7,447,087) (12,613,676)
</TABLE>
The pro forma results above include amortization of intangibles and are not
necessarily indicative of what actually would have occurred if the acquisitions
had been completed as of the beginning of each of the periods presented, nor are
they necessarily indicative of future consolidated results.
5. INVESTMENTS
At September 30, 1999, the Company held one U.S. government agency security
that is classified as held-to-maturity and is due in less than one year. This
investment's amortized cost, unrealized loss, and estimated fair value at
September 30, 1999 are $5,076,212, $1,437, and $5,074,775, respectively.
F-65
<PAGE> 218
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at September 30, 1999:
<TABLE>
<S> <C>
Computer equipment......................................... $ 4,465,458
Software................................................... 478,574
Furniture, fixtures, and office equipment.................. 680,884
Capitalized collocation costs.............................. 150,236
Land, building, and leasehold improvements................. 285,552
Vehicles................................................... 71,348
-----------
6,132,052
Less accumulated depreciation and amortization............. (1,881,830)
-----------
4,250,222
Construction in progress................................... 4,650,709
===========
$ 8,900,931
===========
</TABLE>
7. INTANGIBLE ASSETS
Intangible assets consist of the following at September 30, 1999:
<TABLE>
<S> <C>
Acquired customer list..................................... $ 2,771,783
Goodwill................................................... 11,631,661
-----------
14,403,444
Less accumulated amortization.............................. (1,293,192)
-----------
$13,110,252
===========
</TABLE>
8. ACCRUED LIABILITIES
Accrued liabilities consist of the following at September 30, 1999:
<TABLE>
<S> <C>
Accrual for equipment acquired.............................. $1,836,572
Accrued payroll and related expenses........................ 366,933
Other accrued liabilities................................... 926,625
----------
$3,130,130
==========
</TABLE>
9. RELATED PARTY TRANSACTIONS
Affiliates include officers, employees, and other corporations and
partnerships that are substantially or partially owned by officers and
stockholders of the Company. The significant affiliates include CBC Distribution
and Marketing, Inc., CDM Fantasy Sports, Inc., and CDM Properties Management,
L.L.C.
F-66
<PAGE> 219
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of September 30, 1999, amounts due from affiliates consist of the
following:
<TABLE>
<S> <C>
Advances to affiliates...................................... $1,020,090
Accounts receivable -- trade affiliates..................... 32,415
----------
$1,052,505
==========
</TABLE>
The advances to affiliates are unsecured, due on demand, and bear interest
at 12 percent per annum, which is payable upon repayment of the advances.
As of September 30, 1999, the amount due to affiliates was $158,375 and
consisted primarily of borrowings from affiliates. Such advances are unsecured,
due on demand, and bear interest at 12 percent per annum, which is payable upon
demand.
Revenues derived from affiliates for the period June 1, 1999 to September
30, 1999 were approximately $162,000. Expenses and costs incurred to affiliates
related to purchasing advertising, insurance, and other services for the period
June 1, 1999 to September 30, 1999 were approximately $872,000.
The Company leases office space under noncancelable operating leases from
an affiliate. The leases expire in August 2008, contain an option to renew for a
five-year term, and provide for additional rent related to the Company's share
of certain taxes and operating expenses. Rent expense associated with these
leases was approximately $57,000 for the period June 1, 1999 to September 30,
1999.
The Company leases certain computer equipment under capital leases with an
affiliate. These lease agreements required the Company to make a refundable
deposit equal to approximately 25 percent of the fair market value of the
equipment at the lease inception date, or $707,660. The assets under capital
leases are recorded at the lower of the present value of the minimum lease
payments or the fair value of the asset. The related computer equipment had a
cost and accumulated amortization of $2,565,764 and $566,902, respectively, at
September 30, 1999. Amortization of leased equipment is included in depreciation
and amortization.
F-67
<PAGE> 220
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum lease payments under capital leases and noncancelable
operating leases with the affiliate at September 30, 1999 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
2000................................................... $1,259,470 $ 170,764
2001................................................... 1,054,596 172,423
2002................................................... 260,356 181,663
2003................................................... -- 181,663
2004................................................... -- 183,710
Thereafter............................................. -- 748,610
---------- ----------
Total minimum lease payments........................... 2,574,422 $1,638,833
==========
Less amount representing interest...................... (378,302)
----------
Present value of minimum lease payments (including
current portion of $998,188)......................... $2,196,120
==========
</TABLE>
10. SENIOR SUBORDINATED DISCOUNT NOTES
The senior subordinated discount notes (the Notes), issued in connection
with the Purchase Agreement described in Note 2, mature on June 1, 2006 and were
issued at a substantial discount from their principal amount on the closing
date. Accordingly, the Notes will accrete semiannually at a rate of 12 percent
from $53,000,000 on June 1, 1999 to $84,473,948 (the Principal Amount) at June
1, 2003. Subsequently, interest will accrue on the Principal Amount at a rate of
12 percent. This interest will be due and payable on a semiannual basis
commencing on December 1, 2003 and thereafter on June 1 and December 1 of each
year until maturity. On June 1, 2006, all principal and accrued but unpaid
interest on the Notes will be due and payable. The discounted value (see Note 2)
and the liquidation value of the Notes at September 30, 1999 are $48,837,310 and
$55,100,000, respectively.
At any time prior to maturity of the Notes, the accreted value, together
with any accrued but unpaid interest, may be redeemed or prepaid in whole or in
part as long as the Company is not in default on any senior indebtedness, as
defined in the agreement. In the event of a change in control, as defined in the
agreement, the Company must offer to repay these notes for an amount equal to
101 percent of the accreted value plus any accrued but unpaid interest.
If either (a) the Notes are redeemed in whole within 9 months of closing or
(b) the Notes are redeemed in whole within 15 months of the closing date through
a qualified public offering, as defined in the agreement, the Company may
repurchase the number of shares of common stock representing one-seventh of the
total common shares issued to the investors at June 1, 1999 for $0.01.
In the event of default, as defined in the note agreement, holders of at
least a 25 percent interest in the principal amount of Notes outstanding may
declare the entire accreted value plus any accrued but unpaid interest
immediately due and payable by written notice to the Company. In addition,
holders of a 50 percent interest may (1) waive the Company's compliance with its
covenants and obligations under the Note and Purchase Agreement, (2) waive a
breach or default by the Company, or (3) rescind an acceleration of the Notes
subject to certain restrictions defined in the agreements.
F-68
<PAGE> 221
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For the period June 1, 1999 to September 30, 1999, the Company was in violation
of certain covenants included in the Note and Purchase Agreement related
primarily to transactions with affiliates. The holders of Notes waived their
right to call the debt as well as these violations as of September 30, 1999.
11. EMPLOYEE BENEFIT PLAN
The Company sponsors a defined contribution 401(k) profit sharing plan
covering substantially all eligible employees. Under this plan, the Company
matches 100 percent of the first 6 percent of compensation that employees
contribute into the plan. Additional contributions may be made to the plan at
the discretion of Company management. The Company made contributions of $22,110
to the plan for the period June 1, 1999 to September 30, 1999.
12. COMMITMENTS, CONTINGENCIES, AND UNCERTAINTIES
LEASE COMMITMENTS
The Company leases vehicles and office and retail space under noncancelable
operating lease agreements with unaffiliated vendors. The leases for office and
retail space generally include renewal options and require the Company to pay a
portion of the expenses for common areas, including maintenance, real estate
taxes, and other expenses. Rent expense under these operating leases for the
period June 1, 1999 to September 30, 1999 was approximately $130,000.
The Company leases certain computer equipment under capital leases with
unaffiliated vendors. The assets under capital leases are recorded at the lower
of the present value of the minimum lease payments or the fair value of the
asset. The related computer equipment had a cost and accumulated amortization of
$611,817 and $383,489, respectively, at September 30, 1999. Amortization of
leased equipment is included in depreciation and amortization.
Future minimum lease payments under capital leases and noncancelable
operating leases with unaffiliated vendors with initial or remaining lease terms
in excess of one year are as follows at September 30, 1999:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
2000..................................................... $146,499 $ 411,848
2001..................................................... 53,963 303,287
2002..................................................... 41,502 199,627
2003..................................................... -- 121,548
2004..................................................... -- 50,701
-------- ----------
Total minimum lease payments............................. 241,964 $1,087,011
==========
Less amount representing interest........................ (20,813)
--------
Present value of minimum lease payments (including
current portion of $138,831)........................... $221,151
========
</TABLE>
F-69
<PAGE> 222
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
BACKBONE AGREEMENT
The Company has agreements with its principal ISP which require payment of
minimum monthly Internet access and other charges totaling $33,520. These
agreements automatically renew unless the ISP or Company terminates them, as
described in the agreements. The Company has additional agreements with two
other ISPs related to the acquisition of Inlink (see Note 4). These agreements
require the Company to make minimum monthly payments of $6,800 and $1,300,
respectively, for a specified period ending in January 2001. The total minimum
purchase requirements under these agreements for the years ending September 30,
2000, 2001, and 2002, are $95,100, $81,600, and $20,200, respectively. Under all
agreements, additional monthly charges are incurred for the use of capacity
above the amounts contracted in the agreements. Expenses incurred under all
backbone agreements were $154,645 for the period June 1, 1999 to September 30,
1999.
LOCAL SERVICES
In August 1998, the Company's wholly owned subsidiary, PNC, entered into an
Interconnection Agreement with SWBT. The agreement establishes the terms and
conditions by which the Company and SWBT interconnect their local networks and
by which the Company gains access to unbundled elements of SWBT's network
pursuant to the Telecommunications Act of 1996. This access allows the Company
to compete effectively with SWBT in reselling local telephone service. SWBT has
appealed the PSC orders which established the agreement. While the Company has
negotiated an amendment to its Agreement with SWBT precluding an interruption of
service in the event of an adverse court ruling, the appeal leaves various
aspects of the Agreement uncertain as to duration. Furthermore, there is the
possibility that the current rates charged to the Company by SWBT could change
significantly. The Company's management and its legal counsel are unable to
estimate the probability of outcome or the potential economic impact on the
Company.
LONG DISTANCE SERVICES
The Company has a $5 million three-year supply agreement, which has been
amended subsequent to September 30, 1999 to have an effective date of February
1, 2000, with Qwest. The agreement provides for a cancellation charge to be
assessed in the event of early termination by the Company and a deficiency
charge to be assessed if the Company does not meet the minimum purchase levels
each year of the agreement. Expenses incurred with its long distance service
provider were $154,099 for the period June 1, 1999 to September 30, 1999. The
minimum purchase requirements under this agreement for the years ending
September 30, 2000, 2001, 2002, and 2003, are $830,000, $1,416,000, $2,002,000,
and $752,000, respectively.
BILLING SERVICES
The Company has a three-year agreement, effective August 7, 1998, with its
service processor that requires minimum annual purchases by the Company for
billing services. The agreement provides for a cancellation charge to be
assessed in the event of early termination by the Company and a deficiency
charge to be assessed if the Company does not meet the minimum purchase levels
each year of the agreement. Expenses incurred under this agreement were $61,642
for the period June 1, 1999 to September 30, 1999. The minimum purchase
requirements under this agreement for the years ending September 30, 2000 and
2001, are $360,000 and $300,000, respectively.
F-70
<PAGE> 223
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
GUARANTEES
Letters of credit issued as prerequisites for entering agreements with the
Company's significant suppliers of $117,000 were outstanding at September 30,
1999.
13. INCOME TAXES
The difference between the effective income tax rate and the U.S. federal
income tax rate is explained as follows for the period June 1, 1999 to September
30, 1999:
<TABLE>
<S> <C>
Tax at U.S. statutory tax rate............................. $(2,558,000)
State income taxes, net of federal benefit................. (228,000)
Interest on senior subordinated discount notes............. 205,000
Intangibles................................................ 333,000
Other...................................................... 9,000
Valuation allowance........................................ 2,239,000
-----------
Provision for income taxes................................. $ --
===========
</TABLE>
The components of the deferred tax asset are as follows as of September 30,
1999:
<TABLE>
<S> <C>
Vacation accruals.......................................... $ 41,000
Organizational costs....................................... 54,000
Allowance for doubtful accounts............................ 239,000
Reserve for inventory obsolescence......................... 9,000
Intangibles................................................ 237,000
Capital leases............................................. 72,000
Interest on senior subordinated discount notes............. 707,000
Property and equipment..................................... 18,000
Net operating loss carryforward............................ 2,255,000
-----------
3,632,000
Valuation allowance........................................ (3,632,000)
-----------
Total deferred taxes....................................... $ --
===========
</TABLE>
The Company's net operating loss carryforwards were approximately
$5,914,000 at September 30, 1999 and expire on various dates through 2019. The
Company has recorded a valuation allowance for the entire deferred tax asset
balance as of September 30, 1999 due to the uncertainty of its realization.
14. STOCKHOLDER EQUITY
SERIES A PREFERRED STOCK
Pursuant to the Purchase Agreement discussed in Note 2, one investor, who
also acted as a financial advisor and exclusive placement agent in the
transaction, received 2,306,765 shares of
F-71
<PAGE> 224
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Series A preferred stock. These preferred shares have no liquidation preference
and are not entitled to vote on matters submitted for stockholder approval.
Each preferred stockholder has the right at any time to convert any or all
shares into an equal number of common shares subject to the following:
(i) The total number of shares held by a Series A stockholder, aggregated
with any common shares held by an affiliate of such holder, and after
giving effect to the proposed conversion, shall be less than 5 percent
of the total shares of common stock outstanding immediately after such
conversion.
(ii) Upon the occurrence of a change in federal law that permits a
registered bank holding company to acquire in excess of 5 percent of
the voting shares of the Company, a Series A stockholder may convert
its shares to common stock to the maximum extent permitted by
then-current federal law.
(iii) In the event the Company (a) subdivides its outstanding shares of
common stock into a larger number of shares or (b) combines its
outstanding shares of common stock into a smaller number of shares,
then the number of shares of common stock into which the Series A
preferred stockholder are convertible shall also be adjusted
proportionally.
WARRANTS
Also in connection with the Purchase Agreement discussed in Note 2, the
Company issued 4,476,423 detachable non-callable warrants to the Investors. The
warrants entitle the holders to purchase common shares of the Company at a price
of $3.385 per share. The warrants may be exercised by a cash payment or a
cashless exercise following either (i) the occurrence of a qualified public
offering or (ii) upon delivery of the subordinated notes for cancellation in an
accreted principal amount, along with any interest, equal to the exercise price.
The warrants are also subject to certain anti-dilution adjustments, as defined
in the Purchase Agreement, for any changes in the Company's outstanding shares
during the period the warrants are outstanding. The warrants expire on June 1,
2006 and can be exercised at any time.
STOCK OPTION PLAN
In July 1999, the Company established a stock option plan under which both
qualified and nonqualified options to purchase up to 3,468,820 shares of common
stock are available to be granted to employees, directors, and consultants. At
September 30, 1999, 753,579 shares are available for grant under the plan. The
plan is administered by the Board of Directors. No option can be for a term of
more that ten years from the date of grant. The option price and the vesting
provisions are determined by the Board of Directors at the date of grant.
F-72
<PAGE> 225
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock option activity under the plan during the period June 1, 1999 to
September 30, 1999 is as follows:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
OPTIONS EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Outstanding at June 1, 1999........................... -- $ --
Granted............................................... 2,715,241 1.52
Exercised, forfeited, and expired..................... -- --
--------- -----
Outstanding at September 30, 1999..................... 2,715,241 $1.52
========= =====
Exercisable at September 30, 1999..................... 366,295 $1.52
========= =====
</TABLE>
Pro forma information regarding results of operations is required by SFAS
No. 123 as if the Company had accounted for its stock-based awards under the
fair value method of SFAS No. 123. The fair value of the Company's stock-based
awards to employees has been estimated using the minimum value option pricing
model which does not consider stock price volatility.
Because the Company does not have actively traded equity securities,
volatility is not considered in determining the fair value of the stock-based
awards.
For the period June 1, 1999 to September 30, 1999, the fair value of the
Company's stock-based awards was estimated using the following weighted average
assumptions:
<TABLE>
<S> <C>
Expected life of options in years........................... 3
Risk-free interest rate..................................... 5.5 percent
Expected dividend yield..................................... 0.0 percent
</TABLE>
The weighted average remaining contractual life of the stock options
outstanding at September 30, 1999 is approximately ten years. The per share
weighted average fair value of stock options granted during the period June 1,
1999 to September 30, 1999 was zero. Accordingly, for pro forma purposes, the
estimated fair value of the Company's stock-based awards which is to be
amortized over the options' vesting period would have resulted in no change in
the Company's reported net loss for the period June 1, 1999 to September 30,
1999.
The effect of applying SFAS No. 123 to pro forma net income (loss) as
stated above is not necessarily representative of the effects on reported net
income (loss) for future periods due to, among other things, the vesting period
of the stock options and the fair value of additional stock options granted in
future years.
SHARES RESERVED FOR FUTURE ISSUANCE
Common stock shares reserved for future issuance as of September 30, 1999
are as follows:
<TABLE>
<S> <C>
Warrants.................................................... 4,476,423
Convertible Series A preferred stock........................ 2,306,765
Stock options............................................... 3,468,820
----------
10,252,008
==========
</TABLE>
F-73
<PAGE> 226
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
15. SEGMENT INFORMATION
The Company has three reportable segments, Internet, Retail, and
Communications, which are separate operating units that offer different products
and services and are managed accordingly. Performance of each segment is
evaluated by management based on income (loss) before income taxes. Transactions
between segments are reported at fair value and the accounting policies of the
segments are the same as those in Note 1. The corporate and eliminations segment
includes corporate assets, principally consisting of cash and cash equivalents,
investments and debt issuance costs, corporate activities and the elimination of
intersegment transactions. In addition, as a result of the transactions
described in Notes 1 and 2, the Company adjusted its segment reporting structure
whereby interest expense is no longer allocated to its three reportable
segments.
The Internet segment provides full service access to the Internet for
corporate and residential customers including dial-up and dedicated services and
activities related to set up and installation, selling equipment and software.
The Retail segment sells cellular and other wireless communication products,
including phones, pagers, and related accessories. The Communications segment
provides facilities-based and resold basic local telecommunications service,
including dedicated/non-switched local exchange services, and intrastate
interexchange services.
The following segment information is as of September 30, 1999 or for the
four months then ended:
<TABLE>
<CAPTION>
CORPORATE
AND
INTERNET RETAIL COMMUNICATIONS ELIMINATIONS TOTAL
----------- -------- -------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Revenues from external
customers................... $ 2,881,055 $350,715 $ 850,367 $ -- $ 4,082,137
Intersegment revenues......... 4,554 73,792 86,434 (164,780) --
Depreciation and
amortization................ 1,145,516 9,848 593,897 17,640 1,766,901
Impairment charge (Note 4).... 254,132 -- -- -- 254,132
Interest expense.............. -- -- -- 2,701,311 2,701,311
Loss before income taxes...... (1,081,229) (77,424) (2,198,581) (3,951,469) (7,308,703)
Segment assets................ 14,466,339 234,800 10,075,595 36,987,683 61,764,417
Capital expenditures, net of
accounts payable............ 431,129 -- 3,092,593 248,334 3,772,056
</TABLE>
16. SUBSEQUENT EVENTS
ACQUISITIONS
Subsequent to year-end, the Company made the following acquisitions:
On October 1, 1999, the Company purchased substantially all of the assets
of Information Systems Technologies, Inc. for approximately $591,000, net of
liabilities assumed.
On October 6, 1999, the Company purchased substantially all of the assets
of Business Products Systems Internet, Inc. for approximately $700,000, net of
liabilities assumed.
On October 13, 1999, the Company purchased substantially all of the assets
of UNI Networking Inc. for approximately $345,000, net of liabilities assumed.
On October 20, 1999, the Company purchased all of the outstanding common
stock of GlobalVision Systems, Inc. for approximately $3,102,000, net of cash
acquired and liabilities assumed.
F-74
<PAGE> 227
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
On November 1, 1999, the Company purchased all of the outstanding common
stock of Harvest Telecom, Inc. for approximately $50,000.
On November 10, 1999, the Company purchased all of the outstanding common
stock of Digital Internet Access, Inc. for approximately $1,418,000, net of cash
acquired and liabilities assumed.
SECONDMENT AGREEMENT
On November 23, 1999, the Company entered into a Secondment Agreement with
an investor to obtain certain services to be provided by an employee of the
investor. Under the terms of the agreement, the Company is required to pay
$17,500 per month for the services, including out-of-pocket expenses.
Furthermore, the seconded employee was issued 680,000 shares of Series B
preferred stock which vests in eight equal quarterly installments over a
two-year period and warrants with an exercise price of $1.52 per share to
purchase an additional 520,000 shares of Series B preferred stock which vest in
three equal annual installments. Furthermore, the investor was issued 170,000
shares of Series B preferred stock and was granted warrants with an exercise
price of $1.52 to purchase an additional 130,000 shares of Series B preferred
stock, both with the same vesting terms as the seconded employee described
above. All of the above issuances and grants vest immediately upon the
occurrence of certain events described in the agreement, including a change in
control. The Company will recognize the applicable compensation expense related
to these transactions ratably over the vesting period. Finally, the investor is
entitled to receive a fee, payable immediately, in the event the Company
consummates certain transactions outlined in the agreement prior to June 1,
2000, including a change in control, obtaining senior debt from a financial
institution, or issuing additional subordinated debt or equity securities.
LEASE TRANSACTIONS
On February 23, 2000, the Company entered into an equipment capital lease
to finance its continued build out of collocations. Under the terms of the
lease, the Company is required to make thirty-six equal monthly payments of
approximately $122,000 and has the guaranteed option to purchase the equipment
at 10% of original purchase price or approximately $3,700,000. The assets under
the capital lease are recorded at the lower of the present value of the minimum
lease payments or the fair value of the equipment. The lease is secured by the
equipment financed.
On March 31, 2000, the Company entered into a sale leaseback agreement,
whereby the Company sold collocation equipment with a book value of
approximately $8,000,000 and subsequently entered into a capital lease for
approximately $9,400,000, including the financing of approximately $900,000 in
equipment maintenance agreements. The assets under the capital lease are
recorded at the lower of the present value of the minimum lease payments or the
fair value of the equipment. The gain resulting from this transaction of
approximately $500,000 is being amortized over the term of the lease. Under the
terms of the lease, the Company is required to make six monthly payments of
approximately $106,000 and then thirty monthly payments of approximately
$340,000. In addition to the equipment being financed under the lease, the
Company granted the lessor an additional security interest in substantially all
tangible and intangible assets of the Company. The lessor has provided a
contingent clause in the agreement for the release of the additional security
upon the Company obtaining unrestricted cash equity proceeds in the amount of
$50,000,000 or greater. The lease agreement also contains covenants requiring
the Company to maintain certain debt to total contributed capital ratios as well
as requiring the Company to secure future minimum commitments of either secured
bridge debt or unrestricted equity by various dates.
F-75
<PAGE> 228
PRIMARY NETWORK HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LEASE COMMITMENT
On April 15, 2000 the Company entered into an agreement for the lease of a
new office building. The term of the agreement is five years with total annual
rent of approximately $1,200,000. In addition, the Company has committed
$3,900,000 for leasehold improvements and certain equipment purchases related to
this property.
PENDING TRANSACTION
On April 17, 2000, the Company signed an agreement and plan of merger
(merger agreement) with Mpower Communications Corp. (A/K/A MGC Communications,
Inc.).
In connection with the consummation of the merger agreement, the following
will occur:
(i) The Company's stockholders will exchange their shares in the Company
for 1,350,000 shares of common stock of Mpower Communications Corp.
(Mpower). Each outstanding share of the Company's common stock and
preferred stock will be converted into .02022 shares of Mpower
common stock.
(ii) All of the Company's stock options outstanding under the Company's
stock option plan shall continue to have, and be subject to, the
same terms and conditions as set forth in the Company's stock option
plan and the agreements pursuant to which such Company stock options
were issued, except that each Company stock option shall be
exercisable for .02022 shares of Mpower common stock and the price
per share will be adjusted accordingly.
(iii) The Company's 4,476,423 detachable non-callable warrants to the
Investors that entitle the holders to purchase common shares of the
Company at a price of $3.385 per share shall continue to be subject
to the same terms and conditions, except that each warrant shall be
exercisable for .02022 shares of Mpower common stock and the price
per share will be adjusted accordingly.
(iv) Mpower will assume approximately $80,000,000 of net liabilities of
the Company, a portion of which will be swapped for additional
high-yield bonds to be issued under Mpower's recent high-yield
financing indenture. The holders of the swapped debt will also
receive 50,000 shares of Mpower common stock.
(v) Mpower will become the sole stockholder of the Company.
NOTE PAYABLE
On April 27, 2000 the Company issued a $10,000,000 senior promissory note
(senior note) to Mpower due the earliest of April 17, 2001, upon a change of
control of the Company other than the pending transaction discussed above, or
upon the event of default, as defined. Interest accrues at 15 percent per annum
until the maturity date. After the maturity date, interest accrues at 18 percent
per annum until the senior note is paid in full. At any time prior to maturity
of the senior note, the unpaid principal amount of the senior note together with
any accrued but unpaid interest may be prepaid in whole or in part as long as
the Company has provided at least 15 business days notice to Mpower.
Due to the issuance of this senior note, the Company was in violation of a
covenant included in the Note and Purchase Agreement (See Note 10) related
primarily to limitations of indebtedness. The holders of Notes waived their
right to call the debt as well as this violation as of April 27, 2000.
F-76
<PAGE> 229
FINANCIAL STATEMENTS
CDM ON-LINE, INC.
FOR THE PERIOD JANUARY 1, 1999 TO MAY 31, 1999
WITH REPORT OF INDEPENDENT AUDITORS
F-77
<PAGE> 230
CDM ON-LINE, INC.
FINANCIAL STATEMENTS
FOR THE PERIOD JANUARY 1, 1999 TO MAY 31, 1999
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors.............................. F-79
Financial Statements
Balance Sheet............................................... F-80
Statement of Operations..................................... F-81
Statement of Stockholders' Equity........................... F-82
Statement of Cash Flows..................................... F-83
Notes to Financial Statements............................... F-84
</TABLE>
F-78
<PAGE> 231
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
CDM On-Line, Inc.
We have audited the accompanying balance sheet of CDM On-Line, Inc. as of
May 31, 1999 and the related statements of operations, stockholders' equity, and
cash flows for the period January 1, 1999 to May 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CDM On-Line, Inc. at May 31,
1999 and the results of its operations and its cash flows for the period January
1, 1999 to May 31, 1999, in conformity with accounting principles generally
accepted in the United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 1, the
Company has incurred significant operating losses and has an accumulated
deficit. These conditions raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
also described in Note 1. The May 31, 1999 financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
ERNST & YOUNG LLP
November 19, 1999
St. Louis, Missouri
F-79
<PAGE> 232
CDM ON-LINE, INC.
BALANCE SHEET
MAY 31, 1999
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 73,938
Accounts receivable, less allowance for doubtful accounts
of $126,845............................................ 558,980
Due from affiliates....................................... 1,624,811
Inventory, less reserve for obsolescence of $23,450....... 96,326
Other current assets...................................... 24,105
-----------
Total current assets........................................ 2,378,160
Property and equipment, net................................. 1,397,284
Refundable capital lease deposit with affiliate............. 295,739
Intangible assets, net...................................... 369,847
-----------
$ 4,441,030
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 845,452
Accrued expenses.......................................... 336,555
Unearned revenues......................................... 471,443
Current maturities of capital lease obligations........... 388,473
Due to affiliates......................................... 160,018
-----------
Total current liabilities................................... 2,201,941
Capital lease obligations, less current maturities.......... 492,346
Stockholders' equity:
Common stock, $.15 par value; 2,000,000 shares
authorized............................................. 224,519
Additional paid-in capital................................ 6,680,887
Accumulated deficit....................................... (4,933,386)
-----------
1,972,020
Treasury stock at cost.................................... (225,277)
-----------
1,746,743
-----------
$ 4,441,030
===========
</TABLE>
See accompanying notes.
F-80
<PAGE> 233
CDM ON-LINE, INC.
STATEMENT OF OPERATIONS
FOR THE PERIOD JANUARY 1, 1999 TO MAY 31, 1999
<TABLE>
<S> <C>
Revenues:
Access revenues........................................... $2,070,368
Retail revenues........................................... 518,124
Other revenues............................................ 244,792
----------
2,833,284
Costs and expenses:
Costs of access revenues.................................. 614,441
Costs of retail revenues.................................. 299,287
Costs of other revenues................................... 160,967
Operations and customer support........................... 387,078
Sales and marketing....................................... 377,952
General and administrative................................ 978,661
Retail store expenses..................................... 518,571
Depreciation and amortization............................. 168,923
----------
3,505,880
----------
Loss from operations........................................ (672,596)
Other income (expense):
Interest expense -- affiliates............................ (18,009)
Interest expense.......................................... (1,149)
Interest income -- affiliates............................. 8,671
Other income, net......................................... 1,177
----------
Loss from continuing operations............................. (681,906)
Loss from disposal of discontinued Web development division
(Note 12)................................................. (81,785)
----------
Net loss.................................................... $ (763,691)
==========
</TABLE>
See accompanying notes.
F-81
<PAGE> 234
CDM ON-LINE, INC.
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE PERIOD JANUARY 1, 1999 TO MAY 31, 1999
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TREASURY STOCK
-------------------- PAID-IN ACCUMULATED ------------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT
--------- -------- ---------- ----------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1998..................... 1,222,406 $183,361 $3,841,839 $(4,169,695) 5,393 $ (59,239)
Net loss................... -- -- -- (763,691) -- --
Contribution of services... -- -- 233,162 -- -- --
Sale of stock.............. 214,298 32,145 2,214,027 -- -- --
Sale of stock to employees
under employee stock
purchase plan............ 850 127 10,130 -- -- --
Stock awards to
employees................ 59,241 8,886 381,729 -- -- --
Common stock purchased for
treasury................. -- -- -- -- 13,756 (166,038)
--------- -------- ---------- ----------- ------ ---------
Balance at May 31, 1999.... 1,496,795 $224,519 $6,680,887 $(4,933,386) 19,149 $(225,277)
========= ======== ========== =========== ====== =========
</TABLE>
See accompanying notes.
F-82
<PAGE> 235
CDM ON-LINE, INC.
STATEMENT OF CASH FLOWS
FOR THE PERIOD JANUARY 1, 1999 TO MAY 31, 1999
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net loss.................................................... $ (763,691)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization............................. 185,939
Stock-based compensation expense.......................... 390,615
Allowance for doubtful accounts........................... 37,760
Changes in operating assets and liabilities:
Accounts receivable.................................... (280,550)
Due from affiliates.................................... (53,896)
Inventory.............................................. 34,208
Other current assets................................... 17,013
Refundable capital lease deposit with affiliate........ (295,739)
Other assets........................................... 174,105
Accounts payable....................................... 472,888
Accrued expenses....................................... 151,513
Unearned revenues...................................... 80,895
-----------
Net cash provided by operating activities................... 151,060
INVESTING ACTIVITIES
Advances to affiliates...................................... (1,302,159)
Business acquisition costs.................................. (454,783)
Purchases of property and equipment......................... (147,559)
-----------
Net cash used in investing activities....................... (1,904,501)
FINANCING ACTIVITIES
Principal payments of obligations under capital leases...... (37,263)
Net payments under line of credit........................... (20,000)
Purchase of common stock held in treasury................... (166,038)
Due to affiliates........................................... (506,329)
Proceeds from issuance of common stock...................... 2,256,429
-----------
Net cash provided by financing activities................... 1,526,799
-----------
Net decrease in cash and cash equivalents................... (226,642)
Cash and cash equivalents at beginning of period............ 300,580
-----------
Cash and cash equivalents at end of period.................. $ 73,938
===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during period for:
Interest.................................................. $ 19,158
===========
Noncash investing and financing transaction:
Capital lease obligations incurred........................ $ 918,082
===========
</TABLE>
See accompanying notes.
F-83
<PAGE> 236
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS
MAY 31, 1999
1. ORGANIZATION/BASIS OF PRESENTATION
CDM On-Line, Inc. (the Company) is a local provider of Internet access and
other Internet-related services in St. Louis and Kansas City, Missouri. In
addition, the Company serves as an authorized agent of Southwestern Bell Mobile
Systems and operates cellular and other wireless communication products retail
stores in the St. Louis metropolitan area. The Company was organized on
September 23, 1994 (Inception) and began providing Internet services in July
1995. The Company commenced its retail operations in November 1996. The
Company's targeted markets include residential and business customers in
Missouri.
The financial statements of the Company for the period January 1, 1999 to
May 31, 1999 have been prepared on a going-concern basis, which contemplates the
realization of assets and the settlement of liabilities and commitments in the
normal course of business. The Company incurred a net loss of $763,691 for the
five-month period ended May 31, 1999 and as of May 31, 1999 had an accumulated
deficit of $4,933,386. Additionally, the Company continues to commit substantial
capital expenditures as it relates to improvements and upgrades to its
infrastructure, which are necessary for the Company to be able to offer its
future core services. These conditions raise substantial doubt about the
Company's ability to continue as a going concern. Furthermore, the online
services and Internet markets are highly competitive. The Company believes that
existing competitors, Internet-based services, Internet services providers
(ISPs), Internet directory services, and telecommunications companies are likely
to enhance their service offerings, resulting in greater competition for the
Company. The competitive conditions could have the following effects: require
additional pricing programs, increase spending on marketing, limit the Company's
ability to expand its subscriber base, and result in increased attrition in the
existing subscriber base. The Company's viability as a going concern is
dependent upon management's operational and financing plans to address these
conditions which include, but are not limited to, obtaining additional equity
and debt financing, continuing investments in its infrastructure to increase its
efficiency and capacity to serve additional customers, and employing marketing
strategies to increase its customer base. Although there can be no assurance
that growth in the Company's revenues or subscriber base will continue or that
the Company will be able to achieve or sustain profitability or positive cash
flow, the Company believes that these steps are appropriate and will enable the
Company to effectively reorganize its operations. Under current circumstances,
the Company's ability to continue as a going concern depends upon the successful
implementation of its plan. If the Company is unsuccessful in its efforts, it
may be necessary to undertake such other actions as may be appropriate to
preserve asset values. The financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and classification
of assets or the amounts and classification of liabilities that may result from
the outcome of this uncertainty.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 in the financial statements and
accompanying notes. Actual results could differ from those estimates.
F-84
<PAGE> 237
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid financial instruments with maturity
of three months or less at the time of purchase to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment, including leasehold improvements, are stated at
cost. Costs related to software developed for internal use are capitalized in
accordance with AcSEC Statement of Position 98-1, Accounting for the Costs of
Computer Software Developed For or Obtained For Internal Use. Depreciation is
calculated using the straight-line method over the estimated useful lives
ranging from 18 months to 15 years. Leasehold improvements are amortized over
the lesser of the related lease term or the useful life of the assets.
Equipment acquired under capital leases is amortized over its related lease
terms or its estimated productive useful lives, depending on the criteria met in
determining the lease's qualification as a capital lease. Costs of repairs and
maintenance are charged to expense as incurred.
INVENTORY
Inventory consists of cellular and other wireless communication products
and accessories and is stated at the lower of cost (specific identification
basis) or market.
CUSTOMER LISTS
The cost of customer lists acquired is being amortized over three years
using the straight-line method.
GOODWILL
Goodwill, which represents the cost in excess of the fair market value of
identifiable net assets acquired, is being amortized using the straight-line
method over three years.
IMPAIRMENT OF LONG-LIVED ASSETS
At each balance sheet date, management determines whether any property or
equipment or any other assets have been impaired based on the criteria
established in Statement of Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of. The Company made no adjustments to the carrying values of its
assets during the period January 1, 1999 to May 31, 1999.
STOCK COMPENSATION
The Financial Accounting Standards Board's SFAS No. 123, Accounting for
Stock-Based Compensation, establishes the use of the fair value-based method of
accounting for stock-based employee compensation arrangements, under which
compensation cost is determined using the fair value of stock-based compensation
determined as of the grant date and is recognized over the periods in which the
related services are rendered. SFAS No. 123 also permits companies to elect to
continue using the intrinsic value accounting method specified in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25), and related interpretations to account for stock-based compensation. The
Company has elected to retain the intrinsic value-based method and will
F-85
<PAGE> 238
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
disclose in its financial statements the pro forma effect of using the fair
value-based method to account for its stock-based compensation.
REVENUE RECOGNITION
Access revenues: Internet customers are billed in advance for the periods
for which Internet services are provided. Internet access service plans range
from one month to one year. The Company defers recognition of revenue on these
advance billings and amortizes the amounts to revenue on a straight-line basis
as the services are provided.
Retail revenues: These revenues consist primarily of retail product sales
of cellular and other wireless products, such as phones, pagers, and related
accessories. Such sales are recorded upon customer purchase. The Company also
generates revenues from activation commissions from cellular carriers for each
new cellular phone subscription sold by the Company. Revenue from such
commissions is recorded upon customer subscription. New subscription activation
commissions are fully refundable if the subscriber cancels service within a
certain minimum period of continuous active service (generally 180 days).
Customers generally sign a service agreement that requires a customer deposit,
which is forfeited in case of early cancellation. At May 31, 1999, the Company's
allowance for accounts receivable includes an amount for estimated cancellation
losses, net of deposit forfeitures.
The Company generally receives monthly residual income from the cellular
service providers based on a percentage of actual phone usage by subscribers.
Revenue from residual income is recorded as the cellular service is provided.
Revenue from prepaid pager service is deferred and recognized over the period
service is provided, usually annually. Revenue from monthly installment pager
service contracts is recorded as received.
Other revenues: Other revenues consist of setup and installation fees and
selling equipment and software.
COSTS OF REVENUES
Costs of access revenues primarily consist of telecommunications expenses
inherent in the network infrastructure, including fees paid for the lease of the
Company's backbone. Costs of retail revenues consist of the costs of cellular
and other wireless communication products and accessories purchased for resale.
Costs of other revenues primarily consist of the costs of equipment and software
purchased for resale.
ADVERTISING COSTS
All advertising and promotion costs are expensed as incurred and totaled
$77,567 for the period January 1, 1999 to May 31, 1999.
INCOME TAXES
The Company is treated as an S Corporation under the provisions of the
Internal Revenue Code, whereby the Company's income or loss is allocated to the
individual stockholders for federal income tax purposes. While the Company is
not subject to federal income taxes, it is subject to certain state and local
taxes, which were not significant for the period presented.
F-86
<PAGE> 239
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
If the Company had been subject to federal and certain state income taxes
for the period ended May 31, 1999, the Company would have been in a net deferred
tax asset position, which would have been fully offset by a valuation allowance.
Any tax benefit or provision for the period ended also would have been fully
offset by changes in the deferred tax asset valuation allowance. Therefore,
unaudited pro forma income tax information is not presented in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," as if the Company had been subject to federal and certain state income
taxes.
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and accounts receivable.
The cash is held by a high-credit-quality financial institution. For accounts
receivable, the Company performs ongoing credit evaluations of the financial
condition of its customers and does not require collateral. The Company
maintains reserves for credit losses, and such losses have been within
management's expectations. The concentration of credit risk is mitigated by the
large customer base. The net carrying amount of the receivables approximates
their fair value.
SOURCES OF SUPPLIES
The Company relies on local telephone companies and other companies to
provide data communications. Although management feels alternative
telecommunication facilities could be found in a timely manner, any disruption
of these services could have an adverse effect on operating results.
Although the Company attempts to maintain numerous vendors for required
products, its modems, terminal servers, and high-performance routers, which are
important components of its network, are each currently acquired from three
sources. In addition, some of the Company's suppliers have limited resources and
production capacity. If the suppliers are unable to meet the Company's needs as
its network infrastructure grows, then delays and increased costs in the
expansion of the Company's network infrastructure could result, having an
adverse effect on operating results.
3. BUSINESS COMBINATIONS
During the period January 1, 1999 to May 31, 1999, the Company acquired
certain assets from three Internet access service providers as described below:
On February 17, 1999, the Company purchased the customer list of KC One
Internet Services, Inc. for approximately $75,000. Approximately $37,000 was
allocated to the acquired customer list, and approximately $38,000 was allocated
to goodwill.
On March 31, 1999, the Company entered into an asset purchase agreement to
acquire the customer base and certain computer equipment of Web World Services,
Inc. for approximately $167,000, including approximately $19,000 for the payment
of a liability related to terminating a lease agreement. Approximately $65,000
was allocated to the acquired customer list, and approximately $89,000 was
allocated to goodwill.
On April 9, 1999, the Company entered into an asset purchase agreement to
acquire the customer base and certain networking equipment of Leaned, Inc. for
approximately $213,000, including approximately $72,000 for the payment of
certain liabilities related to terminating certain lease agreements.
Approximately $103,000 was allocated to the acquired customer list, and
approximately $68,000 was allocated to goodwill.
F-87
<PAGE> 240
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The above acquisitions were accounted for under the purchase method, and
accordingly, the purchase prices were allocated to assets acquired and
liabilities assumed based upon their estimated fair values at the dates of
acquisition. The customer lists were valued at $200 per subscriber acquired,
which represents the estimated fair value of such subscribers based upon recent
transactions in the ISP industry. Included in the purchase prices listed above
are legal and acquisition costs of $30,000. For those businesses acquired, the
results of operations are included in the Company's statement of operations from
the dates of acquisition.
The combined historical results for KC One Internet Services, Inc., Web
World Services, Inc., and LidaNet, Inc. were not deemed to be material and thus
the unaudited proforma combined historical results are not presented.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at May 31, 1999:
<TABLE>
<S> <C>
Computer equipment.......................................... $1,801,319
Software.................................................... 170,512
Furniture, fixtures, and office equipment................... 33,864
Land, building, and leasehold improvements.................. 109,930
Vehicles.................................................... 44,913
----------
2,160,538
Less accumulated depreciation and amortization.............. (763,254)
----------
$1,397,284
==========
</TABLE>
5. RELATED PARTY TRANSACTIONS
Affiliates include officers, employees, and other corporations and
partnerships that are substantially or partially owned by officers and
stockholders of the Company. The significant affiliates include CBC Distribution
and Marketing, Inc., CDM Fantasy Sports, Inc., CDM Properties Management, L.L.C.
(CDM Properties), and BroadSpan Communications, Inc. (BroadSpan).
As of May 31, 1999, amounts due from affiliates consist of the following:
<TABLE>
<S> <C>
Advances to affiliates...................................... $1,454,331
Accounts receivable -- trade affiliates..................... 170,480
----------
$1,624,811
==========
</TABLE>
The advances to affiliates are unsecured, due on demand, and bear interest
at 12 percent per annum, which is payable upon repayment of the advances.
As of May 31, 1999, the advances due to affiliates was $160,018 and
consisted primarily of borrowings from affiliates. Such advances are unsecured,
due on demand, and bear interest at 12 percent.
Revenues derived from affiliates related to providing Internet access and
other services for the period January 1, 1999 to May 31, 1999 were approximately
$126,172. Expenses and costs incurred to affiliates related to purchasing
advertising and insurance for the period January 1, 1999 to May 31, 1999 were
approximately $23,332.
F-88
<PAGE> 241
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company leases office space under noncancelable operating leases from
an affiliate. The leases expire in August 2008, contain an option to renew for a
five-year term, and provide for additional rent related to the Company's share
of certain taxes and operating expenses. Rent expense associated with these
leases was approximately $36,000 from January 1, 1999 to May 31, 1999, and such
amounts and the future minimum lease payment are included in the disclosure in
Note 10.
The Company leases certain network-related equipment on a month-to-month
basis from an affiliate. Rent expense for the equipment for the period January
1, 1999 to May 31, 1999 was approximately $29,000. Total future minimum lease
payments under these month-to-month leasing arrangements are expected to
approximate $35,000 and will be paid within one year.
An affiliate provides the Company the use of its programmers, certain
equipment, payroll services and the administration of the 401(k) defined
contribution plan. All labor and administrative costs provided by the affiliate
were expensed and were $233,162 during the five months ended May 31, 1999.
In May 1999, the Company sold its investment in Interchange Technologies,
Inc., which was an investment in a private company that provided educational
courses over the Internet, to CDM Properties for $160,000. This purchase price
represented the net book value of that investment on the date of sale, and
accordingly, no gain or loss occurred as a result of this transaction.
6. INTANGIBLE ASSETS
Intangible assets consisted of the following at May 31, 1999:
<TABLE>
<S> <C>
Acquired customer list...................................... $206,000
Goodwill.................................................... 195,083
--------
401,083
Less accumulated amortization............................... (31,236)
--------
$369,847
========
</TABLE>
7. ACCRUED LIABILITIES
Accrued liabilities consisted of the following at May 31, 1999:
<TABLE>
<S> <C>
Due to employee from treasury stock transaction............. $125,000
Other....................................................... 211,555
--------
$336,555
========
</TABLE>
8. EMPLOYEE BENEFIT PLAN
Employees of the Company are eligible to participate in a defined
contribution 401(k) profit sharing plan, sponsored by an affiliate, covering
substantially all eligible employees. The Company matches 100 percent of the
first 6 percent of compensation that employees contribute into the plan.
Additional contributions may be made to the plan at the discretion of Company
management. The Company made contributions of $20,310 to the plan for the period
January 1, 1999 to May 31, 1999.
F-89
<PAGE> 242
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
9. LINE OF CREDIT
The Company has a line of credit with a bank allowing borrowings of up to
$25,000. Interest is payable monthly at the bank's prime rate plus .5 percent
(9.00 percent at May 31, 1999). The principal balance and any unpaid accrued
interest are payable on November 20, 1999. The line is secured by accounts
receivable, inventory, and property and equipment and is personally guaranteed
by certain stockholders. No borrowings were outstanding against the line at May
31, 1999.
10. COMMITMENTS
LEASE COMMITMENTS
The Company leases vehicles and office and retail space under noncancelable
operating lease agreements. The leases for office and retail space generally
include renewal options and require the Company to pay a portion of the expenses
for common areas, including maintenance, real estate taxes, and other expenses.
Rent expense under all operating leases for the period January 1, 1999 to May
31, 1999 was $123,894.
The Company leases certain computer equipment under capital leases with an
affiliate. These lease agreements require the Company to make a refundable
deposit equal to approximately 25 percent of the fair market value of the
equipment at the lease inception date. The total amount deposited to this
affiliate under these leases was $295,739. The assets under capital leases are
recorded at the lower of the present value of the minimum lease payments or the
fair value of the asset. The related computer equipment had a cost and
accumulated amortization of $918,082 and $53,830, respectively, at May 31, 1999.
Amortization of leased equipment is included in depreciation and amortization.
Future minimum lease payments under capital leases and noncancelable
operating leases with initial or remaining lease terms in excess of one year
(including operating lease commitments to affiliates disclosed in Note 5) are as
follows at May 31, 1999:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
2000................................................... $ 488,049 $ 349,451
2001................................................... 399,001 338,982
2002................................................... 147,694 316,531
2003................................................... -- 211,748
2004................................................... -- 198,590
Thereafter............................................. -- 433,971
---------- ----------
Total minimum lease payments........................... 1,034,744 $1,849,273
==========
Less amount representing interest...................... 153,925
----------
Present value of minimum lease payments (including
current portion of $388,473)......................... $ 880,819
==========
</TABLE>
BACKBONE AGREEMENT
At May 31, 1999, the Company has three agreements with its principal ISP
which require payment of minimum monthly Internet access and other charges
totaling $19,185 per month.
F-90
<PAGE> 243
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Additional monthly charges are incurred for the use of capacity above the
amounts contracted in the agreements. The agreements automatically renew on a
month-to-month basis unless the ISP or Company terminates them, as described in
the agreements. Expenses incurred under these agreements were $120,405 for the
period January 1, 1999 to May 31, 1999.
11. STOCKHOLDER EQUITY
Restrictive Stock Agreement
Under the terms of the 1994 restrictive stock agreement, as subsequently
amended in November 1996, certain employees/stockholders are restricted in their
ability to sell common stock of the Company. Specifically, if a stockholder
desires to sell Company common stock, written consent of the sale must be
obtained from the Company. In the absence of written consent, the Company
possesses a "right of first refusal" under which the employees/stockholders must
first offer the stock for sale to the Company before it may be sold to another
party. The purchase price for common stock purchased under the right of first
refusal is based on book value. The Company also has the right to purchase
common stock from an employee under voluntary or involuntary termination, as
defined. The purchase price for a voluntary termination is the book value, while
for involuntary termination the purchase price is a formula price defined in the
agreement. If the Company decides not to exercise its right of first refusal or
right to purchase stock in the event of termination, each stockholder has the
right for a certain period of time to purchase such common stock at the same
price and terms as the Company's rights. The restrictive stock agreement also
obligates the Company to repurchase, at a formula price, all of the stock owned
by an employee/stockholder in the event of death.
Common Stock
In December 1997, the Board of Directors approved the implementation of an
employee stock purchase program whereby employees eligible for the 401(k)
defined contribution plan are also eligible to purchase Company stock through
payroll withholdings. Purchases of Company stock are made at the end of each
quarter at a price determined by a formula, essentially based on multiples of
sales and certain other factors. During the period January 1, 1999 to May 31,
1999, employees purchased 850 shares of stock through the stock purchase program
for $10,257. Employees may sell and the Company is obligated to buy common stock
purchased under the program at the formula price in the quarter in which the
common stock is sold. Repurchased shares are carried as treasury stock, at cost.
In December 1997, the Company granted an officer an option to purchase
10,000 shares of common stock at an exercise price of $15 per share. The option
vested immediately and expires five years from the grant date.
In January 1998, the Board of Directors awarded 9,000 shares of common
stock to certain employees, of which 1,100 vested immediately. The remaining
7,900 shares of common stock were to vest after the completion of two years of
service ending December 1999, at which time the earned shares of common stock
would be issued. In January 1999, one employee was terminated by the Company,
and the related 500 shares were forfeited and canceled. Compensation cost was
measured at the date of the award based on the formula price, which the Company
believed approximated fair value, used in the restrictive stock agreement and
the employee stock purchase program. This cost was to be amortized to expense
over the applicable vesting period in which the award was earned. In connection
with the exchange of shares with Primary Network Holdings, Inc. (PNH) (Note 14),
all
F-91
<PAGE> 244
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7,400 remaining shares became fully vested on March 31, 1999. Also in March
1999, the Company awarded 51,841 shares of common stock to certain employees,
all of which vested immediately. Compensation expense for these awards is
measured based on estimated fair value at the date of the award. For the period
January 1, 1999 to May 31, 1999, the Company recognized compensation expense of
$390,615, which includes $31,533 related to the amortization of the 7,400 shares
of common stock. Finally in March 1999, the Company issued 422,693 options to
employees at an exercise price of $15 per share. As the exercise price of the
options was above fair value at the grant date, no compensation expense was
recorded by the Company related to these options. Effective May 31, 1999, all of
these options, as well as the option to purchase 10,000 shares granted in
December 1997, were canceled. No other options were granted, forfeited, or
expired during 1999, and no options were outstanding at May 31, 1999.
Under SFAS No. 123, the Minimum Value method may be used by nonpublic
companies to value an option. This includes estimating the risk-free interest
rate, the expected dividend yield, and the life of the options. Based on this
option valuation model, the weighted average fair value of options granted and
the total pro forma compensation expense to be disclosed as prescribed under
SFAS No. 123 for the period January 1, 1999 to May 31, 1999 are immaterial.
During the period January 1, 1999 to May 31, 1999, the Company sold 214,298
shares of common stock for $2,246,172. These stockholders are subject to the
restrictive stock agreement disclosed above.
Contributions to Capital
During the five months ended May 31, 1999, an affiliate provided $233,162
of services to the Company at no cost. The Company recorded these transactions
as additional capital contributions.
12. DISCONTINUED OPERATIONS
On January 1, 1999, the Board of Directors approved a decision to
discontinue the Company's Web development division. On May 19, 1999, the Company
sold that line of business to an affiliate. Sales of the Web development
division for the period January 1, 1999 to May 19, 1999 were $172,414. The
Company sold all assets of the division, with the exception of accounts
receivable totaling $125,020 as of May 31, 1999, for an amount equaling their
net book value of approximately $7,000 as of the disposal date and a 3 percent
royalty of future Web development gross revenues of the affiliate for two years.
13. SEGMENT INFORMATION
The Company has two reportable segments, Internet and Retail, which are
separate operating units that offer different products and services and are
managed accordingly. Performance of each segment is evaluated by management
based on income (loss) from continuing operations. Transactions between segments
are reported at fair value and the accounting polices of the segments are the
same as those in Note 1.
The Internet segment provides full service access to the Internet for
corporate and residential customers including dial-up and dedicated services and
activities related to setup and installation, selling equipment, and software.
The Retail segment sells cellular and other wireless communication products,
including phones, pagers, and related accessories.
F-92
<PAGE> 245
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following segment information is as of May 31, 1999 or for the five
months then ended:
<TABLE>
<CAPTION>
INTERNET RETAIL TOTAL
---------- --------- ----------
<S> <C> <C> <C>
Revenues from external customers........... $2,315,160 $ 518,124 $2,833,284
Depreciation and amortization.............. 168,923 17,016 185,939
Stock-based compensation expense........... 390,615 -- 390,615
Interest expense........................... 15,655 3,503 19,158
Loss from continuing operations............ (329,157) (352,749) (681,906)
Loss from disposal of discontinued Web
development division (Note 12)........... (81,785) -- (81,785)
Loss before income taxes................... (410,942) (352,749) (763,691)
Segment assets............................. 4,093,931 347,099 4,441,030
Capital expenditures....................... 145,672 1,887 147,559
</TABLE>
14. SUBSEQUENT EVENTS
Effective the close of business on May 31, 1999, the Company executed a
plan of reorganization whereby all common stockholders of the Company exchanged
each of their shares for 16.67 shares in PNH, a newly formed holding company.
This transaction terminated the restrictive stock agreement (see Note 11) as of
that date. In addition, all of the common stockholders of BroadSpan (see Note
5), a Competitive Local Exchange Carrier, exchanged each of their shares for
13.227 shares in PNH. This reorganization will allow PNH, of which the Company
and BroadSpan will be wholly owned subsidiaries, to cross-sell Internet access
and cellular services to its local and long distance telephone customers.
Additionally, on June 1, 1999, PNH raised a combination of debt and equity
proceeds approximating $53,000,000 from various investors. The proceeds are
expected to be used to acquire ISPs, develop and offer DSL technology, and grow
revenues through aggressive marketing.
On June 17, 1999, the Company purchased all outstanding common stock of Q
Networks, Inc. for approximately $5,000,000.
On June 21, 1999, the Company purchased the Internet dial-up customer base
and certain assets of CySource Inc. for approximately $650,000.
On August 6, 1999, the Company purchased substantially all of the assets of
Inlink Communications Company for approximately $4,700,000.
F-93
<PAGE> 246
FINANCIAL STATEMENTS
CDM ON-LINE, INC.
YEARS ENDED DECEMBER 31, 1997 AND 1998
WITH REPORT OF INDEPENDENT AUDITORS
F-94
<PAGE> 247
CDM ON-LINE, INC.
FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997 AND 1998
CONTENTS
<TABLE>
<S> <C>
Report of Independent Auditors.............................. F-96
Financial Statements
Balance Sheets.............................................. F-97
Statements of Operations.................................... F-98
Statements of Stockholders' Deficit......................... F-99
Statements of Cash Flows.................................... F-100
Notes to Financial Statements............................... F-101
</TABLE>
F-95
<PAGE> 248
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
CDM On-Line, Inc.
We have audited the accompanying balance sheets of CDM On-Line, Inc. as of
December 31, 1997 and 1998, and the related statements of operations,
stockholders' deficit, and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of CDM On-Line, Inc. at
December 31, 1997 and 1998, and the results of its operations and its cash flows
for the years then ended, in conformity with accounting principles generally
accepted in the United States.
ERNST & YOUNG LLP
March 22, 1999
St. Louis, Missouri
F-96
<PAGE> 249
CDM ON-LINE, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 148,527 $ 300,580
Accounts receivable, less allowance for doubtful accounts
of $27,604 in 1997 and $89,085 in 1998................. 279,934 296,190
Due from affiliates....................................... 29,172 268,756
Inventory................................................. 109,335 130,534
Other current assets...................................... 3,442 41,118
----------- -----------
Total current assets........................................ 570,410 1,037,178
Property and equipment, net................................. 521,771 452,646
Other assets................................................ 171,380 174,105
----------- -----------
$ 1,263,561 $ 1,663,929
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Line of credit............................................ $ -- $ 20,000
Accounts payable.......................................... 204,568 372,564
Accrued expenses.......................................... 166,815 185,042
Unearned revenues......................................... 213,938 390,548
Due to affiliates......................................... 1,461,998 899,509
----------- -----------
Total current liabilities................................... 2,047,319 1,867,663
Stockholders' deficit:
Common stock, $.15 par value, 2,000,000 shares authorized,
1,197,745 and 1,222,406 shares issued in 1997 and 1998,
respectively........................................... 179,662 183,361
Additional paid-in capital................................ 1,972,157 3,841,839
Accumulated deficit....................................... (2,935,577) (4,169,695)
----------- -----------
(783,758) (144,495)
Treasury stock at cost.................................... -- (59,239)
----------- -----------
(783,758) (203,734)
----------- -----------
$ 1,263,561 $ 1,663,929
=========== ===========
</TABLE>
See accompanying notes.
F-97
<PAGE> 250
CDM ON-LINE, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
Revenues:
Access revenues........................................... $ 1,496,237 $ 3,216,463
Retail revenues........................................... 549,997 883,380
Other revenues............................................ 529,318 695,728
----------- -----------
2,575,552 4,795,571
Costs and expenses:
Costs of access revenues.................................. 701,439 1,184,433
Costs of retail revenues.................................. 371,235 529,992
Costs of other revenues................................... 245,273 482,580
Operations and customer support........................... 494,292 671,592
Sales and marketing....................................... 645,827 745,067
General and administrative................................ 661,481 1,189,052
Retail store expenses..................................... 773,634 1,013,136
Depreciation and amortization............................. 233,073 263,063
----------- -----------
4,126,254 6,078,915
----------- -----------
Loss from operations........................................ (1,550,702) (1,283,344)
Other income (expense):
Interest expense -- affiliates............................ (83,131) (189,175)
Interest expense.......................................... (675) (1,805)
Other income, net......................................... 44,331 4,314
----------- -----------
Loss from continuing operations............................. (1,590,177) (1,470,010)
Income from operations of discontinued Web development
division (Note 12)........................................ 147,374 235,892
----------- -----------
Net loss.................................................... $(1,442,803) $(1,234,118)
=========== ===========
</TABLE>
See accompanying notes.
F-98
<PAGE> 251
CDM ON-LINE, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TREASURY STOCK
--------------------- PAID-IN ACCUMULATED ------------------
SHARES AMOUNT CAPITAL DEFICIT SHARES AMOUNT
--------- -------- ---------- ----------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996..... 1,197,745 $179,662 $ 916,063 $(1,492,774) -- $ --
Net loss....................... -- -- -- (1,442,803) -- --
Forgiveness of advances by
stockholders and contribution
of services.................. -- -- 1,056,094 -- -- --
--------- -------- ---------- ----------- ----- --------
Balance at December 31, 1997..... 1,197,745 179,662 1,972,157 (2,935,577) -- --
Net loss....................... -- -- -- (1,234,118) -- --
Forgiveness of advances by
stockholders and contribution
of services.................. -- -- 1,548,166 -- -- --
Sale of stock to employees..... 19,967 2,995 238,007 -- -- --
Sale of stock to employees
under employee stock purchase
arrangement.................. 3,594 539 37,517 -- -- --
Stock awards to employees...... 1,100 165 9,889 -- -- --
Amortization of vested stock... -- -- 36,103 -- -- --
Common stock purchased for
treasury..................... -- -- -- -- 5,393 (59,239)
--------- -------- ---------- ----------- ----- --------
Balance at December 31, 1998..... 1,222,406 $183,361 $3,841,839 $(4,169,695) 5,393 $(59,239)
========= ======== ========== =========== ===== ========
</TABLE>
See accompanying notes.
F-99
<PAGE> 252
CDM ON-LINE, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
OPERATING ACTIVITIES
Net loss.................................................... $(1,442,803) $(1,234,118)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 233,073 263,063
Stock-based compensation expense.......................... -- 46,157
Allowance for doubtful accounts........................... 1,274 61,481
Gain on disposal of equipment to affiliates............... (29,539) --
Changes in operating assets and liabilities:
Accounts receivable.................................... (57,782) (77,737)
Due from affiliates.................................... (23,958) (87,412)
Inventory.............................................. (91,605) (21,199)
Other current assets................................... 9,477 (37,676)
Other assets........................................... (7,095) (2,725)
Accounts payable....................................... 114,399 167,996
Accrued expenses....................................... 68,241 18,227
Unearned revenues...................................... 143,518 176,610
----------- -----------
Net cash used in operating activities....................... (1,082,800) (727,333)
INVESTING ACTIVITIES
Advances to affiliates...................................... -- (152,172)
Purchases of property and equipment......................... (340,899) (193,938)
Proceeds from disposal of equipment to affiliates........... 81,718 --
Investments in and advances to unconsolidated
subsidiaries.............................................. (60,000) --
----------- -----------
Net cash used in investing activities....................... (319,181) (346,110)
FINANCING ACTIVITIES
Bank overdraft.............................................. (4,437) --
Net proceeds under line of credit........................... -- 20,000
Purchase of common stock held in treasury................... -- (59,239)
Due to affiliates........................................... 1,554,945 985,677
Proceeds from issuance of common stock...................... -- 279,058
----------- -----------
Net cash provided by financing activities................... 1,550,508 1,225,496
----------- -----------
Net increase in cash and cash equivalents................... 148,527 152,053
Cash and cash equivalents at beginning of year.............. -- 148,527
----------- -----------
Cash and cash equivalents at end of year.................... $ 148,527 $ 300,580
=========== ===========
</TABLE>
See accompanying notes.
F-100
<PAGE> 253
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ORGANIZATION
CDM On-Line, Inc. (the "Company") is a local provider of Internet access
and other Internet-related services in St. Louis and Kansas City, Missouri. In
addition, the Company serves as an authorized agent of Southwestern Bell Mobile
Systems and operates cellular and other wireless communication products retail
stores in the St. Louis metropolitan area. The Company was organized on
September 23, 1994 (Inception) and began providing Internet services in July
1995. The Company commenced its retail operations in November 1996. The
Company's targeted markets include residential and business customers in
Missouri.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The Company has incurred losses since its inception, has had negative cash
flows from operations in all periods, and has working capital and stockholders'
equity deficiencies. Management's operational and financing plans to address
these conditions include but are not limited to obtaining additional equity and
debt financing, continuing investments in its network infrastructure to increase
its network efficiency and capacity to serve additional subscribers, and
employing marketing strategies to increase its subscriber base. Subsequent to
December 31, 1998, the Company raised approximately $2,300,000 in cash from the
sale of common stock. Further, the Company's stockholders have agreed to provide
the Company with the necessary funds to meet all of its working capital needs
during 1999.
The online services and Internet markets are highly competitive. The
Company believes that existing competitors, Internet-based services, Internet
service providers, Internet directory services, and telecommunications companies
are likely to enhance their service offerings, resulting in greater competition
for the Company. The competitive conditions could have the following effects:
require additional pricing programs, increase spending on marketing, limit the
Company's ability to expand its subscriber base, and result in increased
attrition in the existing subscriber base. The accompanying financial statements
have been prepared on a basis which contemplates the realization of the assets
and satisfaction of liabilities in the normal course of business.
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 in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid financial instruments with a
maturity of three months or less at the time of purchase to be cash equivalents.
PROPERTY AND EQUIPMENT
Property and equipment, including leasehold improvements, are stated at
cost. Depreciation is calculated using the straight-line method over the
estimated useful lives ranging from 18 months to 15 years. Leasehold
improvements are amortized over the lesser of the related lease term or the
useful life of the assets.
F-101
<PAGE> 254
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
INVENTORY
Inventory consists of cellular and other wireless communication products
and accessories and is stated at the lower of cost (specific identification
basis) or market.
IMPAIRMENT OF LONG-LIVED ASSETS
At each balance sheet date, management determines whether any property or
equipment or any other assets have been impaired based on the criteria
established in Statement of Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of. The Company made no adjustments to the carrying values of its
assets during the years ended December 31, 1997 and 1998.
STOCK COMPENSATION
The Company accounts for its stock-based compensation plans and
arrangements using the intrinsic value method prescribed by Accounting
Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees.
SFAS No. 123, Accounting for Stock-Based Compensation, requires that
companies electing to continue using the intrinsic value method make pro forma
disclosures of net income as if the fair value-based method of accounting had
been applied. The pro forma effect of using the fair value-based method to
account for its stock-based compensation would have resulted in no difference to
the net loss reported by the Company in 1997 and 1998.
REVENUE RECOGNITION
Access revenues: Internet customers are billed in advance for the periods
for which Internet services are provided. The Company defers recognition of
revenue on these advance billings and amortizes the amounts to revenue on a
straight-line basis as the services are provided.
Retail revenues: These revenues consist primarily of retail product sales
of cellular and other wireless products, such as phones, pagers, and related
accessories. Such sales are recorded upon customer purchase. The Company also
generates revenues from activation commissions from cellular carriers for each
new cellular phone subscription sold by the Company. Revenue from such
commissions is recorded upon customer subscription. New subscription activation
commissions are fully refundable if the subscriber cancels service within a
certain minimum period of continuous active service (generally 180 days).
Customers generally sign a service agreement that requires a customer deposit
which is forfeited in case of early cancellation. At December 31, 1997 and 1998,
the Company's allowance for accounts receivable includes an amount for estimated
cancellation losses, net of deposit forfeitures.
The Company generally receives monthly residual income from the cellular
service providers based on a percentage of actual phone usage by subscribers.
Revenue from residual income is recorded as the cellular service is provided.
Revenue from prepaid pager service is deferred and recognized over the period
service is provided, usually annually. Revenue from monthly installment pager
service contracts is recorded as received.
Other revenues: Other revenues consist of setup and installation fees and
selling equipment and software.
F-102
<PAGE> 255
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
COSTS OF REVENUES
Costs of access revenues primarily consist of telecommunications expenses
inherent in the network infrastructure, including fees paid for the lease of the
Company's backbone. Costs of retail revenues consist of the costs of cellular
and other wireless communication products and accessories purchased for resale.
Costs of other revenues primarily consist of the costs of equipment and software
purchased for resale.
ADVERTISING COSTS
All advertising and promotion costs are expensed as incurred. During the
years ended December 31, 1997 and 1998, the Company incurred advertising costs
of approximately $330,900 and $200,300, respectively.
INCOME TAXES
The Company is treated as an S Corporation under the provisions of the
Internal Revenue Code, whereby the Company's income or loss is allocated to the
individual stockholders for federal income tax purposes. While the Company is
not subject to federal income taxes, it is subject to certain state and local
taxes, which were not significant for the periods presented.
If the Company had been subject to federal and certain state income taxes
for the two year period ended December 31, 1998, the Company would have been in
a net deferred tax asset position which would have been fully offset by a
valuation allowance. Any tax benefit or provision for those years also would
have been fully offset by changes in the deferred tax asset valuation allowance.
Therefore, unaudited pro-forma income tax information is not presented in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes," as if the Company had been subject to federal and certain
state income taxes.
FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash and accounts receivable.
The cash is held by a high-credit-quality financial institution. For accounts
receivable, the Company performs ongoing credit evaluations of the financial
condition of its customers and does not require collateral. The Company
maintains reserves for credit losses, and such losses have been within
management's expectations. The concentration of credit risk is mitigated by the
large customer base. The net carrying amount of the receivables approximates
their fair value.
F-103
<PAGE> 256
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1997 1998
--------- ----------
<S> <C> <C>
Computer equipment...................................... $ 732,455 $ 777,521
Software................................................ 22,004 49,721
Furniture, fixtures, and office equipment............... 21,166 26,213
Land, building, and leasehold improvements.............. 55,919 169,529
Vehicles................................................ 42,413 44,913
--------- ----------
873,957 1,067,897
Less accumulated depreciation and amortization.......... (352,186) (615,251)
--------- ----------
$ 521,771 $ 452,646
========= ==========
</TABLE>
4. OTHER ASSETS
Other assets consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
-------- --------
<S> <C> <C>
Investment in Interchange Technologies, Inc............... $160,000 $160,000
Other non-current assets.................................. 11,380 14,105
-------- --------
$171,380 $174,105
======== ========
</TABLE>
5. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
-------- --------
<S> <C> <C>
Accrued payroll and related expenses...................... $124,849 $150,358
Other accrued expenses.................................... 41,966 34,684
-------- --------
$166,815 $185,042
======== ========
</TABLE>
6. RELATED PARTY TRANSACTIONS
Affiliates include officers, employees, and other corporations and
partnerships that are substantially or partially owned by officers and
stockholders of the Company. The significant affiliates include CBC Distribution
and Marketing, Inc., CDM Fantasy Sports, Inc., CDM Properties Management,
L.L.C., and Primary Communications, Inc.
F-104
<PAGE> 257
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1997 and 1998, amounts due from affiliates consist of
the following:
<TABLE>
<CAPTION>
DECEMBER 31
-------------------
1997 1998
------- --------
<S> <C> <C>
Advances to affiliates..................................... $ -- $152,172
Accounts receivable -- trade affiliates.................... 29,172 116,584
------- --------
$29,172 $268,756
======= ========
</TABLE>
The advances to affiliates are unsecured, are due on demand, and bear
interest at 12 percent per annum, which is payable upon repayment of the
advances.
As of December 31, 1997 and 1998, the due to affiliates was $1,461,998 and
$899,509, respectively, and consisted solely of borrowings from affiliates. Such
advances are unsecured, are due on demand, and bear interest in 1997 at rates
ranging from 5.63 percent to 6.07 percent and at 12 percent in 1998 as published
by the Internal Revenue Service.
Revenues derived from affiliates related to providing Internet access and
other services were approximately $217,000 and $378,000 in 1997 and 1998,
respectively. Expenses and costs incurred to affiliates related to purchasing
advertising and insurance were approximately $51,000 and $53,000 in 1997 and
1998, respectively.
The Company leases office space under noncancelable operating leases from
an affiliate. The leases expire in August 2008, contain an option to renew for a
five-year term, and provide for additional rent related to the Company's share
of certain taxes and operating expenses. Rent expense associated with these
leases was $37,000 and $76,000 in 1997 and 1998, respectively, and such amounts
are included in the total rent expense disclosed in Note 9.
Future minimum lease payments under the noncancelable operating leases with
the affiliate at December 31, 1998 are as follows:
<TABLE>
<S> <C>
1999........................................................ $ 91,845
2000........................................................ 91,847
2001........................................................ 94,379
2002........................................................ 97,189
2003........................................................ 97,189
Thereafter.................................................. 466,016
--------
$938,465
========
</TABLE>
The Company leases certain network-related equipment on a month-to-month
basis from an affiliate. Rent expense for the equipment was approximately
$157,000 in 1997 and $276,000 in 1998. Future minimum lease payments under the
month-to-month leasing arrangements are expected to be as follows: $279,656 in
1999, $214,310 in 2000, and $38,701 in 2001.
An affiliate provides the Company the use of its programmers, certain
equipment, payroll services and the administration of the 401(k) defined
contribution plan. All labor and administrative costs provided by the affiliate
were expensed and were $374,973 and $491,511 during the years ended December 31,
1997 and 1998, respectively.
F-105
<PAGE> 258
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. LINE OF CREDIT
The Company has a line of credit with a bank allowing borrowings of up to
$25,000. Interest is payable monthly at the bank's prime rate plus .5 percent
(8.25 percent at December 31, 1998). The principal balance and any unpaid
accrued interest are payable on November 20, 1999. The line is secured by
accounts receivable, inventory, and property and equipment and is personally
guaranteed by certain stockholders. Borrowings of $20,000 were outstanding
against the line at December 31, 1998.
8. EMPLOYEE BENEFIT PLAN
Employees of the Company are eligible to participate in a defined
contribution 401(k) profit sharing plan, sponsored by an affiliate, covering
substantially all eligible employees. The Company matches 100 percent of the
first 6 percent of compensation that employees contribute into the plan.
Additional contributions may be made to the plan at the discretion of Company
management. Company matching amounts of employee contributions for the years
ended December 31, 1997 and 1998, were $39,324 and $50,603, respectively.
9. COMMITMENTS
LEASE COMMITMENTS
The Company leases vehicles and office and retail space under noncancelable
operating lease agreements. The leases for office and retail space generally
include renewal options and require the Company to pay a portion of the expenses
for common areas, including maintenance, real estate taxes, and other expenses.
Rent expense under these operating leases for the years ended December 31, 1997
and 1998, was $140,556 and $216,719, respectively.
Future minimum lease payments under noncancelable operating leases with
initial or remaining lease terms in excess of one year (including lease
commitments to affiliates disclosed in Note 6) are as follows at December 31,
1998:
<TABLE>
<S> <C>
1999........................................................ $ 240,366
2000........................................................ 232,304
2001........................................................ 230,518
2002........................................................ 134,305
2003........................................................ 97,189
Thereafter.................................................. 466,016
----------
$1,400,698
==========
</TABLE>
BACKBONE AGREEMENT
The Company has agreements with its principal Internet service provider
(ISP) which require payment of minimum monthly Internet access and other charges
of $7,350 under one agreement through April 1999 and $6,300 under another
agreement through March 1999. Additional monthly charges are incurred for the
use of capacity above the amounts contracted in the agreements. The agreements
automatically renew unless the ISP or Company terminates them, as described in
the agreements. Expenses incurred under these agreements were $154,051 in 1997
and $218,689 in 1998.
F-106
<PAGE> 259
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
10. STOCKHOLDER EQUITY
RESTRICTIVE STOCK AGREEMENT
Under the terms of the 1994 restrictive stock agreement, as subsequently
amended in November 1996, certain employees/stockholders are restricted in their
ability to sell common stock of the Company. Specifically, if a stockholder
desires to sell Company common stock, written consent of the sale must be
obtained from the Company. In the absence of written consent, the Company
possesses a "right of first refusal" under which the employees/stockholders must
first offer the stock for sale to the Company before it may be sold to another
party. The purchase price for common stock purchased under the right of first
refusal is based on book value. The Company also has the right to purchase
common stock from an employee under voluntary or involuntary termination, as
defined. The purchase price for a voluntary termination is the book value, while
for involuntary termination the purchase price is. If the Company decides not to
exercise its right of first refusal or right to purchase stock in the event of
termination, each stockholder has the right for a certain period of time to
purchase such common stock at the same price and terms as the Company's rights.
The restrictive stock agreement also obligates the Company to repurchase, at a
formula price, all of the stock owned by an employee/stockholder in the event of
death.
COMMON STOCK
In December 1997, the Board of Directors approved the implementation of an
employee stock purchase program whereby employees eligible for the 401(k)
defined contribution plan are also eligible to purchase Company stock through
payroll withholdings. Purchases of Company stock are made at the end of each
quarter at a price determined by a formula, essentially based on multiples of
sales and certain other factors. In 1998, employees purchased 3,594 shares of
stock through the stock purchase program for $38,056. Employees may sell and the
Company is obligated to buy common stock purchased under the program at the
formula price in the quarter in which the common stock is sold. Repurchased
shares are carried as treasury stock, at cost.
In December 1997, the Company granted an officer an option to purchase
10,000 shares of common stock at an exercise price of $15 per share. The option
vested immediately and expires five years from the grant date.
In January 1998, the Board of Directors awarded 9,000 shares of common
stock to certain employees, of which 1,100 vested immediately. The remaining
7,900 shares of common stock vest after the completion of two years of service
in December 1999, at which time the earned shares of common stock will be
issued. Compensation cost is measured at the date of the award based on the
formula price, which approximates fair value, used in the restrictive stock
agreement and the employee stock purchase program, and such cost is amortized as
expense over the period in which the award is earned over the applicable vesting
period. In 1998, the Company recognized compensation expense of $46,157, which
includes $36,103 related to the amortization of 7,900 shares of common stock.
CONTRIBUTIONS TO CAPITAL
In 1997 and 1998, an affiliate distributed to its stockholders, as a
tax-free distribution of its previously taxed earnings as an S Corporation, a
portion of its amount due from the Company. The affiliate's stockholders, who
are also stockholders of the Company, simultaneously made capital contributions
to the Company for the amount distributed to them. The effect of these
transactions is
F-107
<PAGE> 260
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
to reduce the amount due to the affiliate and increase additional paid-in
capital by $681,121 in 1997 and $1,056,655 in 1998. In addition the affiliate
provided $374,973 and $491,511 of services to the Company at no cost in 1997 and
1998, respectively. The Company recorded these transactions as additional
capital contributions.
11. SEGMENT INFORMATION
The Company has two reportable segments, Internet and Retail, which are
separate operating units that offer different products and services and are
managed accordingly. Performance of each segment is evaluated by management
based on income (loss) from continuing operations. Transactions between segments
are reported at fair value and the accounting polices of the segments are the
same as those in Note 1.
The Internet segment provides full service access to the Internet for
corporate and residential customers including dial-up and dedicated services and
activities related to setup and installation, selling equipment, and software.
The Retail segment sells cellular and other wireless communication products,
including phones, pagers, and related accessories.
The following segment information is as of December 31, or for the year
then ended:
<TABLE>
<CAPTION>
1997
--------------------------------------
INTERNET RETAIL TOTAL
---------- --------- -----------
<S> <C> <C> <C>
Revenues from external customers.......... $2,025,555 $ 549,997 $ 2,575,552
Depreciation and amortization............. 221,879 11,194 233,073
Stock-based compensation.................. -- -- --
Interest expense.......................... 65,910 17,896 83,806
Loss from continuing operations........... (915,232) (674,945) (1,590,177)
Income from discontinued operations -- Web
development (Note 12)................... 147,374 -- 147,374
Net loss.................................. (767,858) (674,945) (1,442,803)
Segment assets............................ 906,145 357,416 1,263,561
Capital expenditures...................... 218,953 121,946 340,899
</TABLE>
<TABLE>
<CAPTION>
1998
--------------------------------------
INTERNET RETAIL TOTAL
---------- --------- -----------
<S> <C> <C> <C>
Revenues from external customers.......... $3,912,191 $ 883,380 $ 4,795,571
Depreciation and amortization............. 224,598 38,465 263,063
Stock-based compensation.................. 46,157 -- 46,157
Interest expense.......................... 155,799 35,181 190,980
Loss from continuing operations........... (611,808) (858,202) (1,470,010)
Income from discontinued operations -- Web
development (Note 12)................... 235,892 -- 235,892
Net loss.................................. (375,916) (858,202) (1,234,118)
Segment assets............................ 1,170,156 493,773 1,663,929
Capital expenditures...................... 34,033 159,905 193,938
</TABLE>
F-108
<PAGE> 261
CDM ON-LINE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
12. SUBSEQUENT EVENTS
On January 1, 1999, the Board of Directors approved a decision to
discontinue the Company's Web development division. The results of the Web
development division have been reported separately as discontinued operations in
the statement of operations. Sales for the Web development division for the
years ended December 31, 1997 and 1998 were $477,311 and $651,350, respectively.
Management expects the disposal to occur in the second quarter of 1999 and that
the gain or loss on disposal of this division will not be material.
Since January 1, 1999 through March 22, 1999, the Company has granted
51,841 shares of common stock to certain employees and sold 214,298 shares of
common stock, raising proceeds of $2,246,172.
F-109
<PAGE> 262
------------------------------------------------------
------------------------------------------------------
NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS EXCHANGE
OFFER OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THOSE TO WHICH IT
RELATES, NOR DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER
TO BUY THE NOTES IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS
UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Summary............................... 1
Risk Factors.......................... 12
The Exchange Offer.................... 25
Use of Proceeds....................... 36
Capitalization........................ 37
Selected Consolidated Financial and
Operating Data...................... 38
Unaudited Selected Pro Forma Condensed
Combined Financial Information...... 41
Mpower's Management's Discussion and
Analysis of Financial Condition and
Results of Operations............... 46
Primary Network's Management's
Discussion and Analysis of Financial
Condition and Results of
Operations.......................... 51
Business.............................. 64
Management............................ 89
Principal Stockholders................ 97
Description of Capital Stock.......... 99
Description of Outstanding
Indebtedness........................ 105
Description of the Notes.............. 106
Certain United States Federal Income
Tax Considerations.................. 144
Plan of Distribution.................. 148
Legal Matters......................... 148
Experts............................... 148
Where You Can Find More Information... 149
Index to Consolidated Financial
Statements.......................... F-1
</TABLE>
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
OFFER TO EXCHANGE
[MGC COMMUNICATIONS LOGO]
MGC COMMUNICATIONS, INC.
MPOWER HOLDING CORPORATION
13% SENIOR NOTES DUE 2010
THAT HAVE BEEN
REGISTERED UNDER THE
SECURITIES ACT OF 1933
FOR ANY AND ALL
OUTSTANDING UNREGISTERED
13% SENIOR NOTES DUE 2010
------------------------
PROSPECTUS
------------------------
------------------------------------------------------
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<PAGE> 263
PART II
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The articles of incorporation of Mpower provides that Mpower shall
indemnify any director or officer for any liability and legal expenses,
including attorney's fees, judgments, fines and amounts paid in settlement
actually and reasonably incurred by him arising out of his status or actions as
a director or officer if he acted in good faith and in a manner which he
reasonably believed to be in or not opposed to the best interests of Mpower, and
had no reasonable cause to believe his conduct was unlawful.
The by-laws of Mpower state that, except as otherwise provided in the
Mpower by-laws, Mpower shall indemnify any officer or director in the event he
is made a party to a proceeding because he is or was a director or officer
against liability incurred by him in the proceeding if he acted in good faith
and in a manner he believed to be in or not opposed to the best interests of
Mpower and, in the case of any criminal proceeding, he had no reasonable cause
to believe his conduct was unlawful. The Mpower by-laws further state that
Mpower shall not indemnify any officer or director in connection with a
proceeding in which such officer or director was adjudged liable to Mower,
unless and only to the extent the court in which the proceeding was brought or
other court of competent jurisdiction determines that the officer or director is
fairly and reasonably entitled to indemnify for such expenses as the court deems
proper.
The Mpower by-laws further provide that Mpower shall not indemnify any
officer or director unless a separate determination has been made that
indemnification of such officer or director is permissible because he has met
the standard of conduct set forth in the Mpower by-laws, unless ordered by a
court or advanced pursuant to the section of the Mpower by-laws concerning
advancement of expenses; provided, however, that regardless of the result or
absence of such determination, to the extent that such officer or director has
been successful on the merits or otherwise, in the defense to an proceeding by
or in right of Mpower to which he as a party, Mpower shall indemnify such
officer or director against any liability incurred by him in connection with
such proceeding.
The determination required to be made by the Mpower by-laws shall be made,
at the election of the board of directors of Mpower:
1. by the board of directors of Mpower by majority vote of a quorum
consisting of directors not at the time parties to the proceeding;
2. by special independent legal counsel:
a. selected by the board of directors in the manner prescribed in
subpararaph 1 immediately above; or
b. if a quorum of the board of directors cannot be obtained under
subparagraph 1 immediately above, selected by a majority vote of the
full board of directors (in which selection directors who are parties
may participate); or
3. by the shareholders of Mpower, provided that shares owned by or
voted under the control of directors or officers who are at the time
parties to the proceeding may not be voted on the determination.
The Mpower by-laws further provide that Mpower shall pay for or reimburse
the reasonable expenses incurred by an officer or director as a party to a
proceeding in advance of final disposition of the proceeding if the officer or
director furnishes to Mpower a written undertaking to repay any advances if it
is ultimately determined that he is not entitled to any indemnification under
the Mpower by-laws or otherwise.
II-1
<PAGE> 264
The Mpower by-laws also provide that the rights of an officer or director
to indemnification set forth in the Mpower by-laws shall be in addition to any
other rights with respect to indemnification, advancement of expenses or
otherwise that such officer or director may be entitled to under Nevada law.
Both the Mpower articles of incorporation and by-laws provide that it is
the intention of Mpower to provide the indemnification of officers and directors
to the fullest extent provided by Nevada law.
With certain limitations, Section 78.7502(1) and (2) of the Nevada Revised
Statutes permit a corporation to indemnify a director or officer who is a party
or is threatened to be made a party to any threatened, pending or completed
action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that he is or was a director, officer,
employee or agent of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses,
including attorneys fees, judgments, fines and amounts paid in settlement
actually and reasonably incurred by him in connection with the action, suit or
proceeding if he acted in good faith and in a manner which he reasonably
believed to be in or not opposed to the interest of the corporation, and, with
respect to any criminal action or proceeding, had no reasonable cause to believe
his conduct was unlawful.
The Mpower articles of incorporation provide that the personal liability of
all directors and officers of Mpower to any person shall be eliminated or
limited to the maximum extent allowed by Nevada law except that directors and
officers shall be liable for any acts or omissions which involve intentional
misconduct, fraud or a knowing violation of law, or the payment of dividends in
violation of Section 78.300 of the Nevada Revised Statutes.
As permitted by Section 78.752 of the Nevada Revised Statutes, Mpower
maintains liability insurance covering directors and officers.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) The following documents are exhibits to the Registration Statement.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
1.1 Purchase Agreement, dated March 17, 2000, by and between MGC
Communications, Inc., a Nevada corporation (the "Company"),
Mpower Holding Corporation, a Delaware corporation
("Mpower"), Bear, Stearns & Co. Inc. ("Bear Stearns"),
Salomon Smith Barney Inc. ("Salomon"), Goldman, Sachs & Co.
("Goldman Sachs), Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") and Warburg Dillon Read LLC
("Warburg")
3.1 Articles of Incorporation and Amendments of the Company
(Incorporated by reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-4 (file No. 333-38875)
previously filed with the Commission on October 28, 1997)
3.2 Certificate of Change in Authorized Capital of MGC
Communications, Inc. (Incorporated by reference to Exhibit
4.9 to the Company's Registration Statement on Form S-3
(file No. 333-79863) previously filed with the Commission on
June 10, 1999)
3.3 By-laws of the Company (Incorporated by reference to Exhibit
3.2 to the Company's Registration Statement on Form S-1
(file No. 333-49085) previously filed with the Commission on
April 21, 1998)
3.4 Certificate of Incorporation of Mpower
3.5 By-laws of Mpower
4.1 Indenture, dated as of March 24, 2000, between the Company,
Mpower and HSBC Bank USA, as trustee (Incorporated by
reference to Exhibit 4.3 to the Company's Registration
Statement on Form S-4 (file No. 333-36672) previously filed
with the Commission on May 10, 2000)
</TABLE>
II-2
<PAGE> 265
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
4.2 Registration Rights Agreement, dated March 24, 2000, by and
between the Company, Mpower, Bear Stearns, Salomon, Goldman
Sachs, Merrill Lynch, and Warburg
4.3 Form of Outstanding Note for the registrants' unregistered
13% Senior Notes due 2010 (contained in Indenture
incorporated by reference to Exhibit 4.3 to the Company's
Registration Statement on Form S-4 (file No. 333-36672)
previously filed with the Commission on May 10, 2000)
4.4 Form of Exchange Note for the registrants' registered 13%
Senior Notes due 2010 (contained in Indenture incorporated
by reference to Exhibit 4.3 to the Company's Registration
Statement on Form S-4 (file No. 333-36672) previously filed
with the Commission on May 10, 2000)
4.5 Shareholders Agreement among Mpower Communications Corp. and
Brian Matthews, Carol Matthews, Charles Wiegert, Welton
Brison, Tom Hesterman, Richard Phillips, John Alden, EC
Primary LLC, Quantum Emerging Growth Partners, C.V. and TGV
Partners, dated as of April 17, 2000 (Incorporated by
reference to Annex C to the Company's Registration Statement
on Form S-4 (file No. 333-36672) previously filed with the
Commission on May 10, 2000)
4.6 Letter Agreement among Mpower Communications Corp. and EC
Primary, L.P., Quantum Emerging Growth Partners C.V., Ravich
Revocable Trust of 1989, The Ravich Children Permanent
Trust, U.S. Bancorp Libra, and TGV/Primary Investors LLC,
dated as of April 17, 2000 (Incorporated by reference to
Annex D to the Company's Registration Statement on Form S-4
(file No. 333-36672) previously filed with the Commission on
May 10, 2000)
4.7 Amended and Restated Certificate of Designation of Series B
Convertible Preferred Stock of the Company
4.8 Certificate of Designation of Series C Convertible Preferred
Stock of the Company
4.9 Certificate of Designation of Series D Convertible Preferred
Stock (Incorporated by reference to Exhibit 4.12 to the
Company's Annual Report for the fiscal year ended December
31, 1999 on Form 10-K previously filed with the Commission
on March 30, 2000)
*5.1 Opinion of Shearman & Sterling regarding the legality of the
securities being registered
*8.1 Opinion of Shearman & Sterling regarding tax matters
10.1 Agreement and Plan of Merger, dated as of April 17, 2000,
among Primary Network Holdings, Inc., Mpower Communications
Corp. and Mpower Merger Sub, Inc. (Incorporated by reference
to Annex A to the Company's Registration Statement on Form
S-4 (file No. 333-36672) previously filed with the
Commission on May 10, 2000)
12.1 Statement re Computation of Deficiency of Earnings to Fixed
Charges
13.1 Annual Report to security holders (Incorporated by reference
to the Company's Annual Report for the fiscal year ended
December 31, 1999 on Form 10-K previously filed with the
Commission on March 30, 2000)
13.2 Quarterly Report to security holders (Incorporated by
reference to the Company's Quarterly Report for the
quarterly period ended March 31, 2000 on Form 10-Q
previously filed with the Commission on May 15, 2000)
21.1 Subsidiaries of the Company
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Ernst & Young LLP
23.3 Consent of Shearman & Sterling (included in Exhibit 5.1 to
this Registration Statement)
23.4 Consent of Shearman & Sterling (included in Exhibit 8.1 to
this Registration Statement)
24.1 Powers of Attorney (included on the signature pages of this
Registration Statement)
25.1 Statement of Eligibility of HSBC Bank USA, Trustee
99.1 Form of Letter of Transmittal
99.2 Form of Notice of Guaranteed Delivery
*99.3 Form of Exchange Agent Agreement
</TABLE>
---------------
* To be filed by amendment.
II-3
<PAGE> 266
ITEM 22. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1993 may be permitted to directors, officers and controlling persons of the
registrants pursuant to the foregoing provisions, or otherwise, the registrants
have been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrants of expenses incurred
or paid by a director, officer or controlling person of the registrants in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrants will, unless in the opinion of their counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
II-4
<PAGE> 267
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Pittsford, State of New
York, on June 22, 2000.
MGC COMMUNICATIONS, INC.
By: /s/ ROLLA P. HUFF
------------------------------------
Rolla P. Huff
Chief Executive Officer, President
and Director
POWER OF ATTORNEY
The undersigned Directors and Officers of MGC Communications, Inc. hereby
constitute and appoint Rolla P. Huff, Michael R. Daley, Kent F. Heyman, and
Russell I. Zuckerman as true and lawful attorney-in-fact for the undersigned,
with full power of substitution and resubstitution, for and in the name, place
and stead of the undersigned, to sign and file with the Securities and Exchange
Commission under the Securities Act of 1933, as amended, any and all amendments
(including post-effective amendments) and exhibits to this Registration
Statement, any related registration statement and its amendments and exhibits
filed pursuant to Rule 462(b) under the Securities Act and any and all
applications and other documents to be filed with the Securities and Exchange
Commission pertaining to the registration of the securities covered hereby or
under any related registration statement or any amendment hereto or thereto,
with full power and authority to do and perform each and every act and thing
requisite and necessary or desirable, hereby ratifying and confirming all that
such attorney-in-fact or its substitute shall lawfully do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ MAURICE J. GALLAGHER, JR. Chairman of the Board of Directors June 22, 2000
---------------------------------------------------
Maurice J. Gallagher, Jr.
/s/ ROLLA P. HUFF Chief Executive Officer, President June 22, 2000
--------------------------------------------------- and Director (Principal Executive
Rolla P. Huff Officer)
/s/ TIMOTHY P. FLYNN Director June 22, 2000
---------------------------------------------------
Timothy P. Flynn
/s/ DAVID KRONFELD Director June 22, 2000
---------------------------------------------------
David Kronfeld
/s/ MARK J. MASIELLO Director June 22, 2000
---------------------------------------------------
Mark J. Masiello
</TABLE>
II-5
<PAGE> 268
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ RICHARD W. MILLER Director June 22, 2000
---------------------------------------------------
Richard W. Miller
/s/ THOMAS NEUSTAETTER Director June 22, 2000
---------------------------------------------------
Thomas Neustaetter
/s/ MARK PELSON Director June 22, 2000
---------------------------------------------------
Mark Pelson
/s/ MICHAEL R. DALEY Executive Vice President and Chief June 22, 2000
--------------------------------------------------- Financial Officer (Principal
Michael R. Daley Financial Officer)
/s/ KENT F. HEYMAN Senior Vice President and General June 22, 2000
--------------------------------------------------- Counsel
Kent F. Heyman
/s/ FRANK C. SZABO Controller (Principal Accounting June 22, 2000
--------------------------------------------------- Officer)
Frank C. Szabo
/s/ RUSSELL I. ZUCKERMAN Secretary June 22, 2000
---------------------------------------------------
Russell I. Zuckerman
</TABLE>
II-6
<PAGE> 269
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Pittsford, State of New
York, on June 22, 2000.
MPOWER HOLDING CORPORATION
By: /s/ ROLLA P. HUFF
------------------------------------
Rolla P. Huff
President and Director
POWER OF ATTORNEY
The undersigned Directors and Officers of Mpower Holding Corporation hereby
constitute and appoint Kent F. Heyman and Russell I. Zuckerman as true and
lawful attorney-in-fact for the undersigned, with full power of substitution and
resubstitution, for and in the name, place and stead of the undersigned, to sign
and file with the Securities and Exchange Commission under the Securities Act of
1933, as amended, any and all amendments (including post-effective amendments)
and exhibits to this Registration Statement, any related registration statement
and its amendments and exhibits filed pursuant to Rule 462(b) under the
Securities Act and any and all applications and other documents to be filed with
the Securities and Exchange Commission pertaining to the registration of the
securities covered hereby or under any related registration statement or any
amendment hereto or thereto, with full power and authority to do and perform
each and every act and thing requisite and necessary or desirable, hereby
ratifying and confirming all that such attorney-in-fact or its substitute shall
lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ ROLLA P. HUFF President and Director (Principal June 22, 2000
--------------------------------------------------- Executive Officer)
Rolla P. Huff
/s/ MICHAEL R. DALEY Vice President, Treasurer and June 22, 2000
--------------------------------------------------- Director (Principal Financial
Michael R. Daley Officer and Principal
Accounting Officer)
/s/ KENT F. HEYMAN Vice President and General June 22, 2000
--------------------------------------------------- Counsel
Kent F. Heyman
/s/ RUSSELL I. ZUCKERMAN Secretary June 22, 2000
---------------------------------------------------
Russell I. Zuckerman
</TABLE>
II-7
<PAGE> 270
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE
------- ----------------------- ----
<C> <S> <C>
1.1 Purchase Agreement, dated March 17, 2000, by and between MGC
Communications, Inc., a Nevada corporation (the "Company"),
Mpower Holding Corporation, a Delaware corporation
("Mpower"), Bear, Stearns & Co. Inc. ("Bear Stearns"),
Salomon Smith Barney Inc. ("Salomon"), Goldman, Sachs & Co.
("Goldman Sachs), Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") and Warburg Dillon Read LLC
("Warburg").................................................
3.1 Articles of Incorporation and Amendments of the Company
(Incorporated by reference to Exhibit 3.1 to the Company's
Registration Statement on Form S-4 (file No. 333-38875)
previously filed with the Commission on October 28, 1997)...
3.2 Certificate of Change in Authorized Capital of MGC
Communications, Inc. (Incorporated by reference to Exhibit
4.9 to the Company's Registration Statement on Form S-3
(file No. 333-79863) previously filed with the Commission on
June 10, 1999)..............................................
3.3 By-laws of the Company (Incorporated by reference to Exhibit
3.2 to the Company's Registration Statement on Form S-1
(file No. 333-49085) previously filed with the Commission on
April 21, 1998).............................................
3.4 Certificate of Incorporation of Mpower......................
3.5 By-laws of Mpower...........................................
4.1 Indenture, dated as of March 24, 2000, between the Company,
Mpower and HSBC Bank USA, as trustee (Incorporated by
reference to Exhibit 4.3 to the Company's Registration
Statement on Form S-4 (file No. 333-36672) previously filed
with the Commission on May 10, 2000)........................
4.2 Registration Rights Agreement, dated March 24, 2000, by and
between the Company, Mpower, Bear Stearns, Salomon, Goldman
Sachs, Merrill Lynch, and Warburg...........................
4.3 Form of Outstanding Note for the registrants' unregistered
13% Senior Notes due 2010 (contained in Indenture
incorporated by reference to Exhibit 4.3 to the Company's
Registration Statement on Form S-4 (file No. 333-36672)
previously filed with the Commission on May 10, 2000).......
4.4 Form of Exchange Note for the registrants' registered 13%
Senior Notes due 2010 (contained in Indenture incorporated
by reference to Exhibit 4.3 to the Company's Registration
Statement on Form S-4 (file No. 333-36672) previously filed
with the Commission on May 10, 2000)........................
4.5 Shareholders Agreement among Mpower Communications Corp. and
Brian Matthews, Carol Matthews, Charles Wiegert, Welton
Brison, Tom Hesterman, Richard Phillips, John Alden, EC
Primary LLC, Quantum Emerging Growth Partners, C.V. and TGV
Partners, dated as of April 17, 2000 (Incorporated by
reference to Annex C to the Company's Registration Statement
on Form S-4 (file No. 333-36672) previously filed with the
Commission on May 10, 2000).................................
4.6 Letter Agreement among Mpower Communications Corp. and EC
Primary, L.P., Quantum Emerging Growth Partners C.V., Ravich
Revocable Trust of 1989, The Ravich Children Permanent
Trust, U.S. Bancorp Libra, and TGV/Primary Investors LLC,
dated as of April 17, 2000 (Incorporated by reference to
Annex D to the Company's Registration Statement on Form S-4
(file No. 333-36672) previously filed with the Commission on
May 10, 2000)...............................................
4.7 Amended and Restated Certificate of Designation of Series B
Convertible Preferred Stock of the Company..................
4.8 Certificate of Designation of Series C Convertible Preferred
Stock of the Company........................................
</TABLE>
<PAGE> 271
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT PAGE
------- ----------------------- ----
<C> <S> <C>
4.9 Certificate of Designation of Series D Convertible Preferred
Stock (Incorporated by reference to Exhibit 4.12 to the
Company's Annual Report for the fiscal year ended December
31, 1999 on Form 10-K previously filed with the Commission
on March 30, 2000)..........................................
*5.1 Opinion of Shearman & Sterling regarding the legality of the
securities being registered.................................
*8.1 Opinion of Shearman & Sterling regarding tax matters........
10.1 Agreement and Plan of Merger, dated as of April 17, 2000,
among Primary Network Holdings, Inc., Mpower Communications
Corp. and Mpower Merger Sub, Inc. (Incorporated by reference
to Annex A to the Company's Registration Statement on Form
S-4 (file No. 333-36672) previously filed with the
Commission on May 10, 2000).................................
12.1 Statement re Computation of Deficiency of Earnings to Fixed
Charges
13.1 Annual Report to security holders (Incorporated by reference
to the Company's Annual Report for the fiscal year ended
December 31, 1999 on Form 10-K previously filed with the
Commission on March 30, 2000)...............................
13.2 Quarterly Report to security holders (Incorporated by
reference to the Company's Quarterly Report for the
quarterly period ended March 31, 2000 on Form 10-Q
previously filed with the Commission on May 15, 2000).......
21.1 Subsidiaries of the Company
23.1 Consent of Arthur Andersen LLP..............................
23.2 Consent of Ernst & Young LLP................................
23.3 Consent of Shearman & Sterling (included in Exhibit 5.1 to
this Registration Statement)................................
23.4 Consent of Shearman & Sterling (included in Exhibit 8.1 to
this Registration Statement)................................
24.1 Powers of Attorney (included on the signature pages of this
Registration Statement).....................................
25.1 Statement of Eligibility of HSBC Bank USA, Trustee..........
99.1 Form of Letter of Transmittal...............................
99.2 Form of Notice of Guaranteed Delivery.......................
*99.3 Form of Exchange Agent Agreement............................
</TABLE>
---------------
* To be filed by amendment.
