<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 1998
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
Commission File Number: _______
21ST CENTURY TELECOM GROUP, INC.
(Exact Name of Registrant as specified in its charter)
ILLINOIS 36-4076758
(State or other jurisdiction of (IRS employer
incorporation or organization) identification No.)
WORLD TRADE CENTER
350 NORTH ORLEANS
SUITE 600
CHICAGO, ILLINOIS 60654
(Address of principal executive office) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (312) 470-2100
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such
Page 1
<PAGE>
shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes __No X
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K [ ]
The aggregate market value of the voting stock held by
non-affiliates is not applicable as no established public trading market
exists for the voting stock of the Registrant.
The number of shares outstanding of the Registrant's Common Stock,
as of June 15, 1998 was 3,489,467.9 shares of Common Stock.
Page 2
<PAGE>
21ST CENTURY TELECOM GROUP, INC. 1998 FORM 10-K
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PART I
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ITEM 1. BUSINESS 4
ITEM 2. PROPERTIES 14
ITEM 3. LEGAL PROCEEDINGS 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS 14
ITEM 6. SELECTED FINANCIAL DATA 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 19
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 21
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING FINANCIAL DISCLOSURE 22
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 22
ITEM 11. EXECUTIVE COMPENSATION 26
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT 29
ITEM 13. CERTAIN RELATIONSHIPS 32
PART IV
ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 34
</TABLE>
Page 3
<PAGE>
FORWARD-LOOKING STATEMENTS
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K
CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED
IN THE SECTION ENTITLED "BUSINESS" AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS." READERS SHOULD CAREFULLY REVIEW
THE RISKS DESCRIBED IN OTHER DOCUMENTS THE COMPANY HAS FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION, INCLUDING A REGISTRATION STATEMENT ON A FORM S-4.
READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING
STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL REPORT ON FORM 10-K.
THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE ANY REVISIONS TO THE
FORWARD-LOOKING STATEMENTS OR REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF
THIS DOCUMENT.
PART I
ITEM 1. BUSINESS
21st Century Telecom Group, Inc. ("21st Century" or the "Company")
originally known as "21st Century Cable TV, Inc.", is a Chicago-based company
incorporated in October, 1992.
21st Century is an integrated, facilities-based communications
company, which seeks to be the first provider of bundled voice, video and
high-speed Internet and data services in selected midwestern markets
beginning with Chicago's Area 1. The City of Chicago has awarded the Company
a 15-year renewable franchise for Area 1. Area 1 stretches more than 16
miles along Chicago's densely populated lakefront skyline and includes the
affluent residential neighborhoods of the Gold Coast, Lincoln Park and
Dearborn Park and the nation's second largest business and financial
district. The Company has developed and has begun to install and activate an
advanced fiber optic network that employs a Distributed Ring-Star
architecture characterized by fiber-richness, two-way interactivity and
SONET-based redundancy and self-healing attributes (the "DRS Network"). The
DRS Network accommodates not only traditional voice and video applications,
but also the rapidly growing demand for high-speed data services. The
Company believes that its DRS Network provides the Company with significant
strategic advantages that differentiate 21st Century from its competitors,
such as improved time-to-market, multiple revenue streams, enhanced service
quality and reliability, and the provisioning of competitively-priced bundled
services.
The Company has secured a 15-year renewable attachment agreement with
the Chicago Transit Authority (the "CTA"), which reduces costly and
time-consuming "make-ready" and underground construction for the DRS Network
and enables the Company to install and activate the DRS Network rapidly and
efficiently by taking advantage of access to the CTA's rail systems. The
Company also has secured pole attachment agreements with Commonwealth Edison
Company ("Commonwealth Edison") and a subsidiary of Ameritech Corporation
("Ameritech") which provide 21st Century access to scarce pole space within
Area 1 to further facilitate deployment of its DRS Network. The
decentralized configuration of the DRS Network, which includes distributed
hubs and nodes that act "intelligently" to route network traffic efficiently,
together with the CTA and the pole attachment agreements, enables
Page 4
<PAGE>
network construction to be driven in large part by market demand and revenue
potential in contrast to the conventional approach of building a system from
the headend outward on a block-by-block basis. To fully exploit this
advantage, the Company's sales and marketing strategy is coordinated with
ongoing network construction and focused on securing bulk contracts with
125-unit or larger multiple dwelling units ("MDUs"). The Company believes
that this strategy will help to identify the optimal sequence of node
activation on the DRS Network and tie capital expenditures directly to
revenue-producing subscribers.
21st Century's DRS Network currently provides video, audio and data
services. These services include 111 analog video channels, 59 interactive
information channels with local content (e.g., train and airline schedules,
restaurant menus, local news and sports scores, stock quotes and expressway
traffic updates) and 24 specialty audio channels (e.g., international and
foreign language programming, BBC radio broadcasts, reading services for the
blind, commercial-free music categories and select distant-market FM
stations), with significant capacity for additional broadband and narrowband
products and services. The Company's residential and small business data
product is its shared-four Mbps (Megabits per second) cable modem Internet
access service (high speed cable modem), which is delivered at symmetrical
speeds more than 125 times faster than the prevalent 28.8 Kbps (Kilobits per
second) telephone modem and 25 times faster than an integrated services
digital network ("ISDN") modem. The Company is also hosting websites for
commercial customers. The Company will also provide switched,
facilities-based competitive local exchange carrier ("CLEC") services with
last mile connectivity and local dial tone to both commercial accounts and
selected residential subscribers. The Company currently provides telephony
service on a test basis and plans to begin offering, in the third quarter of
1998, a broad range of competitive telephony services (e.g., local, long
distance and enhanced services) to both commercial accounts and selected
residential subscribers, most of whom currently have no facilities-based
alternative to the service provided over the network of the incumbent local
exchange carrier ("ILEC"). The Company will offer high-speed, flexible
bandwidth access services concurrent with its build-out of the commercial
district.
21st Century has taken significant steps to implement its business plan
and service offerings in Chicago's Area 1. In addition to securing the Area 1
franchise, the CTA attachment agreement and the Commonwealth Edison and
Ameritech pole attachment agreements, the Company has (i) constructed and
activated its network operations center ("NOC"), which includes a video
headend and a data operations center ("DOC"), (ii) completed the northern
fiber transport ring of the DRS Network, extending from the downtown business
district to the northern portions of the city bordering Evanston, (iii)
completed tunnel construction under the Chicago River and begun its
southbound fiber transport ring of the DRS network which will extend to 51st
street, (iv) secured programming content for approximately 170 channels of
video and interactive information programming, (v) constructed and activated
portions of the outside fiber distribution network to reach selected MDUs,
(vi) initiated installation processes, billing, call center and customer care
services, (vii) secured contracts for more than 4,800 residential subscribers
(which includes more than 3,000 new subscribers under 5-year bulk MDU
agreements as well as subscribers acquired in early 1997 from an affiliated
company) and (viii) passed with its initial distribution facilities more than
11,900 additional potential subscribers. The Company has also entered into a
letter of intent for the acquisition and installation of the switching and
other ancillary equipment necessary for it to provide telephony services.
BUSINESS STRATEGY AND COMPETITIVE ADVANTAGES
The Company believes that it can utilize its innovative DRS Network,
superior product offerings and other strategic assets to compete strongly in
Chicago's Area 1 and other selected markets. 21st Century's strategy and
competitive advantages include the following:
HIGH-CAPACITY, FULL-SERVICE DRS NETWORK. 21st Century intends to
utilize the advantages of its innovative, internally-developed DRS Network
architecture to provide fully integrated voice, video and high-speed data
services. Key attributes of the DRS Network include (i) an advanced
integrated network
Page 5
<PAGE>
design built to the rigorous Bellcore standards, (ii) the distribution of
switching and traffic routing mechanics at specific locations out on the DRS
Network (rather than being concentrated at one point as in conventional
networks), allowing the Company to efficiently and economically route traffic
regardless of penetration and usage levels, (iii) a SONET-based redundancy
and self-healing architecture with both circuit and route diversity, (iv)
multiple layers of power redundancy to ensure network reliability and (v) a
large fiber capacity permitting delivery of advanced two-way,
fully-interactive broadband services, as well as significant unutilized
capacity to allow the Company to upgrade services, add applications and
develop new product offerings without service interruption or interference.
COST-EFFECTIVENESS OF THE DRS NETWORK ON A REVENUE-DRIVEN BASIS. The
decentralized configuration of the DRS Network, combined with the CTA and
pole attachment agreements, allows the Company to rapidly and efficiently
deploy the DRS Network to accommodate market demand on a revenue-driven
basis. This strategy contrasts sharply with the typical approach of building
a conventional coaxial cable system from the headend outward on a
block-by-block basis. This DRS Network advantage will also allow the Company
to efficiently utilize its capital resources to secure larger MDU bulk video
contracts which will be used as the basis for node activation; thus, more
significant revenue streams should be realized earlier in the planned 3-4
year construction buildout than would be realized by a conventional coaxial
cable system buildout. After a large MDU is activated within a node, the
Company will then market its premium cable and pay-per-view video services,
as well as its high-speed Internet data and, when available, telephony
services, to its cable subscribers in order to leverage MDU subscriber
relationships. In addition, 21st Century will market its full range of voice,
video and high-speed data services to adjacent homes passed. For commercial
subscribers, the Company will seek initially to deploy the DRS Network in
Chicago's dense central downtown area to (i) small to mid-sized commercial
accounts and communications-intensive businesses that have an interest in the
Company's high-speed data and Internet services and (ii) organizations such
as the Building Owners Management Association and other facilities management
companies that influence the selection of communications facilities at
multiple buildings, as well as industry associations which the Company
believes will encourage member companies to use the Company's services.
SUPERIOR PRODUCT OFFERINGS ON A BUNDLED BASIS. The Company believes
that its voice, video, high-speed Internet and data offering will be superior
to competitive products currently available in Area 1 in terms of (i) the
breadth and quality of the individual product offerings, (ii) the extent of
the enhanced service features offered to the customer and (iii) the ability
to bundle such product offerings into a simple, convenient and
attractively-priced packages. The Company's current video offering includes
111 analog video channels, 59 interactive information channels and 24
specialty audio channels, with significant capacity for additional broadband
and narrowband products and services. 21st Century's fiber-rich DRS Network
is designed with only one to four amplifiers in cascade between its NOC and
the subscriber (compared to up to 40 amplifiers used by conventional
networks). This reduction in amplifiers significantly reduces signal
degradation and results in higher video quality, increased reliability,
superior audio, and greater data transmission accuracy. The Company's
interactive information channels, which provide useful local content and
information, are currently not available from any other single source in Area
1. The Company's high-speed data offering includes cable modems that provide
access to the Internet at 4 Mbps, which is approximately 125 times faster
than the prevalent 28.8 Kbps telephone modem and 25 times faster than an ISDN
modem. Beginning in the third quarter of 1998, the Company expects to begin
marketing a broad range of telephony services (e.g., local, long distance,
call waiting, call forwarding, caller ID and three-way calling) to both
commercial accounts and selected residential subscribers, most of whom
currently have no facilities-based alternative to the service provided over
the ILEC's network. The Company's bundled service offering will provide
customers with convenient "one-stop shopping," attractive pricing through
significant package discounts, a single source for installation and service,
and the ease of a single monthly bill.
STRATEGIC ASSETS. The Company's core strategic assets include (i) the
15-year renewable franchise granted by the City of Chicago, which permits the
construction and installation of a network serving the
Page 6
<PAGE>
entirety of Chicago's Area 1 and (ii) the attachment agreement negotiated
with the CTA and the pole attachment arrangements negotiated with
Commonwealth Edison and Ameritech, which facilitate the timely and efficient
buildout of the DRS Network through the utilization of scarce pole space and
city infrastructure rights-of-way. Each of these assets is a valuable and
important component of the Company's facilities-based business strategy and
together would be difficult for another entrant to replicate.
FIRST-TO-MARKET ADVANTAGES. The Company seeks to be the
first-to-market in offering bundled voice, video and high-speed data services
in Chicago's Area 1 and other selected markets. The Company believes that the
rapid buildout of the DRS Network will enable it to acquire a significant
customer base and will give it a competitive advantage over other prospective
bundled and single-service providers.
EXPERIENCED MANAGEMENT. The Company's management team has extensive
and diverse experience in the cable television, Internet, data and
telecommunications industries. During the past year, the Company's senior
management has demonstrated its expertise by constructing and activating the
NOC, completing the northern fiber transport ring of the DRS Network,
securing necessary programming content, and initiating services. The Company
intends to continue to attract qualified senior-level management with
demonstrated expertise from the various industries comprising the Company's
service offering.
SUPERIOR CUSTOMER CARE. The Company is committed to providing superior
customer care to differentiate 21st Century from its competitors. To
accomplish this, the Company has (i) contracted with a third party to provide
a single billing statement for its voice, video, Internet and data services
(which will facilitate bundled discounting for multiple services, permit
customized billing statements and enable monthly, transactional and metered
billing to support the Company's planned product lines) and (ii) established
a relationship with a leading call center service provider to staff and
operate a 24-hour call center. The Company has provided a dedicated toll-free
number to the call center for all subscriber needs and has established call
center performance parameters. The Company believes that the quality and
reliability of its services will result in fewer in-bound subscriber
complaints, service requests and other non-revenue producing calls. In
addition, the Company has installed sophisticated status monitoring equipment
in the NOC and throughout its DRS Network, which should allow the Company to
become aware of and remedy many potential problems before they are detectable
by subscribers.
MARKET EXPANSION. The Company intends to expand its operations to
selected midwestern markets which have the size, demographics and
geographical location suitable for its business strategy. Although the
Company may consider stand-alone systems, the Company expects to focus on
markets in which it can use its Chicago DRS Network and NOC to achieve
synergies and economies of scale. In March 1998, the Company was awarded a
franchise to provide cable service to the Village of Skokie, a Chicago suburb
northwest of the Company's existing Area 1 franchise. Skokie's 23,000 homes
will be served by an extension of the Company's DRS Network. In addition,
the Company has applied for franchises in a number of cities in suburban
Chicago, central, south central and southwestern Michigan, and northern
Indiana.
MARKET OVERVIEW
The City of Chicago is the third largest urban market in the United
States and Area 1 is the densest section of the city, characterized by a high
concentration of MDUs and commercial office buildings. Area 1 has several
significant and attractive attributes, including a relatively high density of
12,000 housing units per square mile (compared with a density for the entire
City of Chicago of 5,000 housing units per square mile); more than 300,000
homes (many of which are located in upscale, demographically attractive
lakefront neighborhoods); existing cable penetration that the Company
believes is significantly below the national average for urban areas and
approximately 51,000 employers in the City's prominent business and financial
districts, which include such businesses and landmarks as the Chicago
Mercantile Exchange, Sears Tower,
Page 7
<PAGE>
Chicago Board of Trade, Chicago Board of Options Exchange, Federal Reserve,
Hancock Building, Merchandise Mart, Amoco Tower, major banks and other
premier businesses.
INTERACTIVE BROADBAND DRS NETWORK
DRS NETWORK COMPONENTS. The DRS Network consists of six main components:
the NOC, the Transport Ring, Transport Hubs, Campus Rings, Campus Hubs and
Nodes.
The NOC processes voice, video and data signals before they are
transported to the rest of the system. The DOC and a video headend are
located at the NOC and, when the Company begins to offer telephony service, a
telephone switch will also be located at the NOC. The NOC also functions as a
gateway to other networks outside the DRS Network. The NOC monitors DRS
Network activity and receives real-time information regarding DRS Network
performance and power supply status. When the Company begins to offer
telephony service, the NOC will monitor the activation of equipment at the
premises of the Company's telephony subscribers.
The Transport Ring, a group of fiber-optic cables that run along the CTA
right-of-way, carries voice, video, high-speed Internet and data signals
between the NOC and the Transport Hubs. Transport Hubs connect the Transport
Ring and the Campus Rings and also provide a diagnostic function by
trouble-shooting potential problems on the DRS Network. The Campus Rings are
groups of fiber-optic cables that carry voice, video, Internet and high-speed
data signals between the Transport Hubs and the Campus Hubs. The Campus Hubs
connect the Campus Rings and the lines that feed the Nodes and provide a
diagnostic function similar to the Transport Hubs. The Nodes connect the
subscribers to the Campus Hubs via coaxial cable. The Nodes represent the
point in the DRS Network where light sent over the DRS Network via
fiber-optic cable is translated into radio frequencies for delivery to the
subscriber. The Nodes also monitor the DRS Network and detect potential
problems. The "star distribution" of the DRS Network refers to the
star-shaped DRS Network components branching off each Node to the
subscribers.
Delivery of telephony services over the DRS Network will require the
installation of switching and other ancillary equipment at the NOC and at the
Nodes, where the existing twisted-pair telephone wire will connect to the DRS
Network. The Company has executed an agreement for the acquisition and
installation of such equipment.
DESIGN ATTRIBUTES. The Company's DRS Network was conceived and
designed by the Company's engineers and incorporates SONET, Ring and Star
architectures as well as wave-division multi-plexing elements, and includes
certain attributes of Hybrid Fiber Coax ("HFC"). Key attributes of the DRS
Network include (i) an advanced integrated network design built to the
rigorous Bellcore standards, (ii) the distribution of switching and traffic
routing mechanics at specific locations out on the DRS Network (rather than
being concentrated at one point as in conventional networks), allowing the
Company to efficiently and economically route traffic regardless of
penetration and usage levels, (iii) a SONET-based redundancy and self-healing
architecture with both circuit and route diversity, (iv) multiple layers of
power redundancy to ensure network reliability and (v) a large fiber capacity
permitting delivery of advanced two-way, fully-interactive broadband
services, as well as significant unutilized capacity to allow the Company to
upgrade services, add applications and develop new product offerings without
service interruption or interference. In addition, the DRS Network is
designed with only one to four amplifiers in cascade between its NOC and the
subscriber (compared to up to 40 amplifiers used by conventional networks).
This reduction in amplifiers significantly reduces signal degradation and
results in higher video quality and telephony reliability, a superior audio
component and greater data transmission accuracy.
The DRS Network uses signal processing techniques to deliver
communication services such as Internet access and high-speed data, Shared
Tenant Services ("STS"), Small Business Services and Plain Telephone
Services, which the Company intends to provide directly or in conjunction
with strategic
Page 8
<PAGE>
business partners. The DRS Network is able to separate data and voice signals
from the video signals, which will enable it to provide higher reliability
and the advanced network management necessary for residential and commercial
data communications and telephony services.
DRS NETWORK ADVANTAGES. The DRS Network has several advantages
including (i) intelligent routing of network traffic, (ii) advanced
functionality at subscribers' premises, (iii) efficient introduction of new
switched and broadband services and (iv) dedicated, two-way, high-speed data
connectivity.
INTELLIGENT ROUTING OF TRAFFIC. The DRS Network routes traffic
intelligently using grooming and hairpinning techniques. Grooming is a
technique by which voice, video and data signals are kept on the DRS
Network, thereby decreasing the reliance on and the costs incurred by using
other companies' communications networks. Hairpinning, a type of grooming,
is a technique that allows voice, video and data signals to be diverted
away from the Company's NOC, where network traffic is likely to be heavy,
and routed by Campus Hubs or Transport Hubs.
ADVANCED FUNCTIONALITY AT SUBSCRIBERS' PREMISES. The Company uses an
advanced analog set-top box with 512K RAM and flash memory, which will
allow it to provide subscribers additional functions and features. Among
such functions and features are interactive data channel capability,
impulse pay-per-view, fully computerized addressability, forward and return
path capability, bit-mapped graphics, downloadable software capability,
fully interactive seven-day electronic program guide, enhanced signal theft
protection and dataport connectivity to printers, faxes and personal
computers. The Company believes this terminal is designed to readily
convert to digital technology at a cost that is competitive with analog
industry standards.
EFFICIENT INTRODUCTION OF NEW SWITCHED AND BROADBAND TECHNOLOGIES.
21st Century should be able to introduce most new switched and broadband
technologies to its subscribers without causing service interruption or
interference. The DRS Network's architecture has reserved bandwidth from
750MHz to 860MHz. This bandwidth has been allocated for future digital
video services representing approximately 90 to 100 channels. While the
Company does not anticipate conversion to digital in the near future given
the DRS Network's initial 111 analog video channel offering, the DRS
Network's large fiber capacity will allow the Company to upgrade services,
add applications and develop new product offerings without service
interruption or interference.
DEDICATED, TWO-WAY, HIGH-SPEED DATA CONNECTIVITY. The DOC allows
true two-way (duplex), high-speed interactivity. At the DOC a redundant
series of routers, servers and switches are installed, from which typical
internet service provider ("ISP") functionalities (Domain Naming System,
Mail, News, Proxy, etc.) are administered and dual connections to national
ISPs are maintained. 21st Century will store the most popular Web pages,
along with local content, in servers located in the DOC. By storing these
Web pages and local content within the DOC and providing cable modem access
to these resources, subscribers can receive any of this information at up
to four Mbps, or approximately 125 times faster than the prevalent 28.8
Kbps telephone modem. As a further benefit, since the cable modem is
connected directly from the subscriber's PC to the coaxial portion of the
DRS Network, there is no need for a second telephone line to access the
Internet, no delay associated with dialing into and signing onto a typical
ISP's modem service, and no surcharge for making a call into the DOC (as
is typically the case with 128 Kbps ISDN service).
As an integral part of the DRS Network design, the Company has reserved
fiber-optic capacity dedicated for providing a wide variety of high-speed
data services, including high-speed (up to OC-12) private line quality access
to the Internet. The use of multi-protocol switching platforms in both the
Campus and Transport hubs and the DRS Network's high fiber count will allow
the Company to offer private virtual networks to link offices, buildings and
campuses located in Area 1. Further, the high-speed data network will extend
to both commercial and residential areas and will support a host of other
Page 9
<PAGE>
applications, including telecommuting, distance-learning, software
distribution, site mirroring, bulk data transfer and teleconferencing.
BROADBAND SERVICES
The Company's service offering will include a wide range of voice, video
and high-speed data services that the Company expects to provide on a bundled
basis. The Company's bundled service offering will provide customers with
convenient "one-stop shopping," attractive pricing through significant
bundled discounts, a single source for installation and service, and the ease
of a single monthly bill.
VIDEO AND AUDIO. The Company currently offers 111 analog video
channels, 59 interactive information channels with local content and 24
specialty audio channels, with significant capacity for additional broadband
and narrowband products and services. The 111 analog video channels include a
basic package of 88 channels, one of the largest basic packages in the United
States, designed to appeal to Chicago's ethnic and cultural diversity. Basic
video channels for business customers also include specialized business
programming such as Bloomberg, CNN, CNN Financial, and Knowledge TV. This
specialized business programming will be combined with downlink
teleconferencing from the NOC. Programming for the Company's video offering
comes from national and local networks, including most major networks such as
ESPN, HBO, Showtime, Disney, CourtTV, and local Chicago affiliates of ABC,
CBS, NBC and Fox. The video offering includes an on-screen, 7-day interactive
program guide, one-button VCR recording and near-video-on-demand pay-per-view
movies, with start times every 30 minutes, 24 hours per day. The Company also
plans to offer a custom camera-monitored security channel for apartment and
condominium buildings that execute master agreements with the Company.
Also included in the Company's basic video package are 59 interactive
information channels, which include local bus and train schedules, airline
schedules, employment ads, restaurant menus, local news and sports scores,
stock quotes, expressway traffic updates, personal ads, and other relevant
local content (including building-specific information for large MDU
accounts). The Company plans to expand its interactive information offering
to 100 channels during 1998. This server-delivered information is accessed on
the customer's television via a specialized universal remote control.
The Company's 24 specialty audio channels include international and
foreign language broadcasts (selected to appeal to concentrations of
nationalities residing in Chicago's Area 1), BBC radio broadcasts, reading
services for the blind, commercial-free music categories, and select
distant-market FM stations.
HIGH-SPEED INTERNET AND DATA SERVICES. The Company provides high-speed
Internet access services using a high-speed cable modem in much the same way
customers currently receive Internet services over a modem linked to the
local telephone network. The cable modems presently being used with the
Company's DRS Network will operate at 4 Mbps, which is approximately 25 times
faster than ISDN modems, and more than 125 times faster than the prevalent
28.8 Kbps analog modems. The customer's cable line (with cable modem) will be
connected directly into the Internet. Because the cable modem connects
through a cable line rather than through a telephone line, the Internet
connection will always be active and there will be no need to dial up for
access to the Internet or wait to connect through a port leased by an ISP.
The Company is also hosting websites for commercial customers and expects to
offer private virtual networks to link offices, buildings or campuses located
throughout the franchise area. In addition to supporting cable modem services
for Internet access, the DRS Network is capable of connecting computers or
computer networks via a separate fiber connection. By connecting computers or
computer networks at multiple locations, subscribers can establish virtual
local area networks, over which they can transport data. The Company expects
to offer such connections, which will enable subscribers to conduct video
conferences, provide Internet-protocol telephony services, conduct electronic
commerce, connect hospitals and universities for tele-medicine and
distance-learning applications and access office networks with the same speed
and functionality as office desktop computers.
Page 10
<PAGE>
TELEPHONY. The DRS Network will allow the Company, after installation
of the requisite telephony equipment and completion of a network
interconnection with Ameritech, to act as a facilities-based CLEC offering
telecommunications services with last mile connectivity and local dial tone.
The Company anticipates that the necessary equipment and installation will
cost approximately $40 million over five years, and that the installation
necessary for the Company to begin providing telephony service will take
approximately five to six months. The Company plans to begin offering, in the
third quarter of 1998, a broad range of competitive telephony services (e.g.,
local, long distance and enhanced services) to both commercial accounts and
selected residential subscribers, most of whom currently have no
facilities-based alternative to the service provided over the ILEC's network.
The selected residential customers to which the Company will offer telephony
services initially will be limited to those residing in, or in close
proximity to, MDUs containing 24 or more residences, but the Company expects
that the threshold number of residences in MDUs to which this service can be
viably offered will be reduced over time. The Company anticipates that its
telecommunications service offerings will include local service,
long-distance and enhanced service packages. Enhanced services will include
custom calling features such as call waiting, call forwarding and three-way
calling. The Company also expects to offer more advanced custom local area
signaling services ("CLASS") features, such as caller ID and caller masking
and plans to offer voice mail as an optional service. The Company expects to
provide long-distance service on a resale basis from one or more national
interexchange carriers. The Company also plans to make available to
businesses Centrex services and PBX trunk provisioning. The Company
anticipates that it will establish wireless and paging services on a resale
basis.
The Company will be required to rely on local exchange carriers ("LECs")
and interexchange carriers to provide communications capacity or
interconnection for its local and long-distance telephone service. On April
20, 1998, the Company executed an interconnection agreement with Ameritech,
pursuant to the 1996 Telecom Act. The Company expects to obtain access to
Ameritech's telephone network under this interconnection agreement which
requires the approval of the Illinois Commerce Commission. The terms of its
interconnection agreement are similar to those contained in interconnection
agreements between Ameritech and other telephony providers previously
approved by the Illinois Commerce Commission. In addition, the 1996 Telecom
Act established certain requirements and standards for interconnection
arrangements, and the Company's interconnection agreement with Ameritech is
based, in part, on such requirements. However, these requirements and
standards are still being developed and implemented by the FCC in conjunction
with the states through a process of negotiation and arbitration.
The DRS Network is capable of providing telephony services, but will
require the installation of switching and other ancillary equipment at the
NOC and at the nodes, where the customer's existing twisted-pair telephone
wire will connect to the DRS Network. The Company has entered into an
agreement with Northern Telecom Inc. ("Nortel") for the acquisition and
installation of such equipment.
FUTURE BROADBAND SERVICES. The Company believes that the DRS Network
will enable it to provide additional broadband services in the future,
including (i) high-speed data transmission connecting homes and offices
("extranets"), (ii) wholesale transport and interconnection (local loop)
services to connect long-distance carriers to their customers, (iii) security
services, including closed-circuit television security monitoring and alarm
systems, and (iv) interactive energy management services, which involve
active monitoring by the customer of energy usage and cost. The Company
plans to seek strategic partnerships and alliances to provide a number of
these services.
Page 11
<PAGE>
SALES AND MARKETING
21st Century seeks to capitalize on its position as a new communications
company that brings competition, choice and innovative bundling of
communications products to the residential and commercial markets covered by
its DRS Network.
RESIDENTIAL MARKETING. The Company's marketing plan for residential
customers is initially focused on establishing relationships with the
managers of residential rental properties, developers, and presidents of
condominium associations which the Company expects will lead to long-term
bulk bundled service contracts with the residents of targeted MDUs. Once the
Company has entered into bulk MDU contracts and has connected its DRS Network
to the buildings, the Company will then market its premium cable and
pay-per-view video services, as well as its high-speed data and, when
available, telephony services, to its cable subscribers in order to leverage
its existing MDU subscriber relationships. In addition, the Company will
utilize direct mail and personal sales calls to market its full range of
voice, video, Internet and data services to homes passed.
COMMERCIAL MARKETING. The Company's commercial marketing plan is
initially focused on Chicago's central downtown "Loop"area due to the heavy
concentration of potential commercial accounts. Further, the Company expects
to focus on small to mid-sized commercial accounts (under 50 employees), a
market the Company believes has been underserved by the incumbent providers
and which has the potential for higher margins and greater interest in
switching carriers for better pricing and customer care. Because the Company
is not yet widely known, it will seek to acquire visibility and recognition
by selling to well-known, communications-intensive accounts that have an
interest in the Company's high-speed Internet and data services. At the same
time, the Company's sales staff will seek to develop relationships with
organizations such as the Building Owners Management Association and other
facilities management companies that influence the selection of
communications facilities installed at multiple buildings, as well as
industry associations which the Company believes will encourage member
companies to use the Company's services.
The Company will also focus its marketing efforts on the commercial
market outside of Chicago's central downtown area, which is made up primarily
of small businesses operating in strip malls, commercial boulevards or
small-office/home-office environments. This market has an expanding diversity
of communications needs which 21st Century believes are well-suited to the
bundled products offered by the Company. The Company plans to focus its
marketing efforts to these subscribers on its high-speed data service
capabilities, which the Company believes will be an attractive alternative to
data connectivity via the lower-speed, twisted-pair copper lines that are
currently available.
SALES AND MARKETING STAFF. The Company's sales and marketing staff
currently consists of 28 professionals. The Company expects to increase this
staff to approximately 36 by the first quarter of 1999. The sales and
marketing staff is comprised of a commercial division and a residential
division, each headed by a manager who supervises various account executives.
In addition, the Company has contracted with a third-party organization for
sales support on an interim basis to assist the Company in marketing and
selling its services to certain homes passed. The Company has selected its
account executives for the collective diversity of their industry experience
across cable television, telephony and data communications sectors.
CUSTOMER CARE
The Company believes that customer care is an essential element of its
operations and is committed to providing superior customer care to
differentiate it from its competitors. The Company believes the quality and
reliability of its services will result in fewer in-bound subscriber
complaints, service requests and other
Page 12
<PAGE>
non-revenue producing calls. In addition, the Company has installed
sophisticated status-monitoring and diagnostic equipment on both the NOC and
its DRS Network, which should allow the Company to become aware of and remedy
many potential problems before they are detectable by subscribers.
BILLING. The Company has contracted with a third party to provide a
single billing statement for its voice, video, Internet and data services.
This technology will facilitate bundled discounting for multiple services,
permit customized billing statements and permit monthly, transactional and
metered billing to support the Company's planned product lines. The third
party's billing and information management system is currently integrated for
video, internet and data services, and is in the beta testing phase for
integrated voice, video and Internet and data services. If an integrated
billing and information management system for all services is not
commercially available when the Company begins providing telephony service,
the Company's customers will still receive a single billing statement, but
such statement will be generated from two separate billing and information
management systems.
CUSTOMER SERVICE REPRESENTATIVES. The Company has established a
relationship with a leading call-center services provider to outsource its
customer service operations. The call center is currently staffed with six
full-time customer service representatives ("CSRs") trained to handle calls
24 hours per day, 365 days per year. An additional 20 CSRs have been trained
and will be available to the Company as demand requires. Each CSR is required
to have a thorough understanding of the Company's service offerings. The
Company has provided a dedicated toll-free number to the call center for all
subscriber needs and has established call center performance parameters.
COMPETITION
All of the Company's principal business activities are highly
competitive. The Company's competitors include some of the nation's largest
regional and independent local exchange carriers as well as cable television
providers, Internet service providers, satellite-based companies, and
long-distance carriers. Many of these carriers have substantially greater
access to capital than 21st Century, and significantly greater experience
than the Company in providing voice, video, Internet and data services.
CHICAGO FRANCHISE
21st Century was awarded a 15-year renewable franchise effective June
1996 by the City of Chicago for the construction of a fiber cable network in
Chicago's Area 1, representing one of the first second-provider franchise
awards for a large urban area. Under this 15-year renewable franchise, the
Company has been granted unrestricted access to the public right-of-way to
construct, operate and maintain its DRS Network to all residential and
commercial subscribers in the franchise area. The franchise requires that the
Company provide ubiquitous service to all residential subscribers in the
franchise area in accordance with a specified time schedule, and allows the
Company to selectively provide service to the franchise area's business and
financial districts.
SKOKIE FRANCHISE
In March of 1998, 21st Century was awarded a 15-year renewable franchise
by the Village of Skokie. The City boundaries of Skokie are contiguous with
a portion of the Chicago Area 1 franchise (at the NW corner). The Skokie
franchise area consists of 23,000 homes, 2,800 businesses, and 38,000
employees.
Franchises typically contain many conditions, such as time limitations
on commencement and completion of system construction, customer service
standards, minimum number of channels and the provision of free service to
schools and certain other public institutions. The Company believes that the
Page 13
<PAGE>
conditions in its franchises in Chicago's Area 1 and Skokie are fairly
typical. The franchises obligate the Company to meet a number of local
regulatory requirements, including (i) notices to subscribers of service and
fee changes, (ii) system design, construction, maintenance and technical
criteria that, among other things, require that the system be fully
constructed within specified times, (iii) interconnection with other cable
operators serving the municipalities for purposes of public, educational and
governmental ("PEG") and leased access, (iv) various payments to the Chicago
Access Corporation ("CAC") for PEG local access obligations, including an
annual payment of one percent of annual gross revenues for PEG/I-Net, (v)
preservation of channel capacity for PEG local access, (vi) equal employment
and affirmative action requirements and (vii) development and fulfillment of
standards for customer service and consumer complaints. The Company is
required to pay a fee for both the Chicago and Skokie franchise to the
issuing authority equal to 5% of gross revenues received from the operation
of its cable television system.
EMPLOYEES
At March 31, 1998, the Company had 127 full-time employees. The Company
considers its relations with its employees to be satisfactory. The Company
recruits from several major industries for employees with skills in voice,
video, Internet, and data technologies.
ITEM 2. PROPERTIES
The Company entered into a 15-year lease, dated January 31, 1997 (the
"Apparel Lease") for its headquarters and NOC, located at 350 N. Orleans,
Suite 600, Chicago, IL 60654. The Apparel Lease which covers 32,422 square
feet, will be increased on July 1, 1998 to cover 40,397 square feet.
The Company's principal physical assets consist of fiber optic network
and equipment, located either at the equipment site or along the DRS Network.
The Company's distribution equipment along the DRS Network is generally
attached to utility poles under pole rental agreements with local public
utilities, although in some areas the distribution cable is buried in
underground ducts or trenches. The Company's franchise from the City of
Chicago gives the Company rights of way for its DRS Network. The physical
components of the DRS Network require maintenance and periodic upgrading to
keep pace with technology advances. The Company believes its properties,
taken as a whole, are in good operating condition and are suitable for the
Company's business operations.
ITEM 3. LEGAL PROCEEDINGS
The Company is not aware of any pending or threatened litigation that
could have a material adverse effect on the Company's financial condition,
results of operation, or cash flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Common Stock
Page 14
<PAGE>
There is no established public trading market for the Company's Common
Stock, and accordingly, no high and low bid information or quotations are
available with respect to the Company's Common Stock. At March 31, 1998,
there were 3,489,467.9 shares of Common Stock outstanding and held of record
by approximately 60 shareholders. At March 31, 1998, options and warrants to
purchase an aggregate of 3,298,563.5 shares of Common Stock were outstanding.
All outstanding options and warrants provide for antidilution adjustments in
the event of certain mergers, consolidations, reorganizations,
recapitalizations, stock dividends, stock splits or other changes in the
corporate structure of the Company.
The Company has filed with the Securities and Exchange Commission (the
"Commission"), a Registration Statement on Form S-4 (including all amendments
thereto the "Registration Statement") under the Securities Act of 1933, with
respect to the New Notes and the New Exchangeable Preferred Stock (as defined
in the Registration Statement) offered in connection with the exchange offer.
For further information with respect to the Company, the New Notes and New
Exchangeable Preferred Stock offered in connection with the exchange offer,
reference is made to the Registration Statement and the exhibits and
schedules filed therewith. The Registration Statement, including exhibits
and schedules thereto, may be inspected without charge at the Commission's
principal office in Washington, D.C., and copies of all or any part thereof
may be obtained from such office after payment of fees prescribed by the
Commission. The Commission also maintains a Web site that contains such
information. The address of the Commission's Web site is http://www.sec.gov.
RIGHTS OF CLASS A CONVERTIBLE 8% CUMULATIVE PREFERRED STOCK SHAREHOLDERS
The Class A Convertible 8% Cumulative Preferred Stock (the "Class A
Preferred Stock") shareholders possess the right to require the sale of the
Company. This provision provides that at any time and from time to time
after the fourth anniversary of the date of issuance of the senior discount
notes and senior cumulative exchangeable preferred stock and ending on the
earlier of the consummation of a qualified public offering and the seventh
anniversary of the date of issuance of the senior discount notes, the Class A
Preferred Stock shareholders have the right to require the sale of the
Company.
In addition, the holders of the Class A Preferred Stock are collectively
in a position to control the taking of many significant corporate actions by
the Company, including the making of any significant capital commitments, the
incurrence of any significant indebtedness, merger and the payment of
dividends on the common stock, pursuant to agreements which provide that
prior to taking such actions, the Company will need to obtain the approval of
the nominees to the Board of Directors of the holders of the Class A
Preferred Stock. These rights have been modified by the covenants related to
the 12 1/4% Senior Discount Notes.
DIVIDEND POLICY
The Company has never declared or paid any cash dividends on its capital
stock and does not anticipate paying cash dividends on its capital stock in
the foreseeable future. It is the current policy of the Company's Board of
Directors to retain earnings to finance the expansion of the Company's
operations. Future declaration and payment of dividends, if any, will be
determined in light of the then-current conditions, including the Company's
earnings, operations, capital requirements, financial condition and other
factors deemed relevant by the Board of Directors. In addition, the Company's
ability to pay dividends is limited by the terms of the Indenture governing
the New Notes, the Amended Articles and the terms of the Company's existing
preferred stock.
RECENT SALES OF UNREGISTERED SECURITIES
In September 1997, pursuant to a Purchase, Joinder and Waiver Agreement
(the "Purchase Agreement"), the Company issued 63.3 shares of Class A
Convertible 8% Cumulative Preferred Stock at a price of $15,793.84 per share,
and warrants to purchase up to 53,271 shares of Common Stock at a price of
$.000001 per share to Consolidated Communications, whose President and Chief
Executive Officer at such time was Mr. Currey, a Director of the Company at
that time and currently the Company's President and Chief Operating Officer.
In November 1997, pursuant to a Purchase, Joinder and Waiver Agreement,
the Company issued 9.5 shares of Class A Convertible 8% Cumulative Preferred
Stock at a price of $15,793.84 per share, and warrants to purchase up to
7,990.6 shares of Common Stock at a price of $.000001 per share to Mr.
Webster, the Company's Chief Financial Officer.
In January 1998, the Company agreed to issue an aggregate of 550,362.2
shares of Common Stock and an equal number of shares of non-voting Common
Stock, for a total of 1,100,724.3 shares. These shares are issuable in
exchange for the initial and debt warrants, which arose from the purchase of
Class A Convertible 8% Cumulative Preferred Stock and were assigned a value
of $2,343,746. The beneficial holders of such shares include Purnendu
Chatterjee, JK&B Capital, William Farley, Boston Capital Ventures III, L.P.,
Thomas Neustaetter, Edward T. Joyce, David Kronfeld, Glenn W. Milligan and
Charles E. Kaegi, M.D.
Page 15
<PAGE>
Also in January 1998, certain shareholders, including Messrs. Milligan,
Joyce and Kaegi, purchased an additional 95.4 shares of Class A Convertible
8% Cumulative Preferred Stock at a price of $15,793.84 per share.
In February 1998, the Company sold in a private placement $200 million
of 12-1/4% Senior Discount Notes Due 2008 ("the Senior Discount Notes"), and
$50 million of Units, consisting of 13-3/4% Senior Cumulative Exchangeable
Preferred Stock Due 2010 (the "Exchangeable Preferred Stock") and Warrants to
purchase 438,870 shares of Common Stock.
In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company agreed to issue 6.3316 shares of Class A Convertible 8% Cumulative
Preferred Stock at a price of $15,793.84 per share and warrants to purchase
5,327.1 shares of Common Stock at a price of $.000001 per share to Wendy
Dietze, Managing Director of Credit Suisse First Boston Corporation. In
addition 2,248.9 shares of voting common stock and 2,248.9 shares of
non-voting common stock will be issued in conjunction with this sale.
Page 16
<PAGE>
PART II
ITEM 6. SELECTED FINANCIAL DATA (1994 - 1998)
The following table sets forth selected financial and operating data for
the Company. The selected financial and operating data as of and for the
periods ended March 31, 1998, 1997, 1996, and 1995 have been derived from the
audited financial statements of the Company. The selected financial and
operating data as of and for the period ended March 31, 1994, has been
derived from the unaudited financial statements of the Company and, in the
opinion of the Company, include all adjustments, consisting of normal
recurring accruals, necessary for a fair presentation of such information.
The selected financial and operating data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Financial Statements included elsewhere in
this Form 10-K.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
STATEMENT OF OPERATIONS DATA: 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C>
Subscriber revenues $ 189,023 $ 27,480 $ -- $ -- $ --
Operating expenses 2,023,310 200,911 9,617 -- --
Selling, general and
administrative expenses 10,216,919 2,337,534 694,122 624,963 253,205
Depreciation and
amortization 1,411,847 170,108 108,182 38,923 11,770
--------------- --------------- --------------- ------------- -------------
Operating loss (13,463,053) (2,681,073) (811,921) (663,886) (264,975)
Amortization of issuance costs on
senior discount notes (218,411) -- -- -- --
Interest income 2,373,867 301,624 -- -- --
Interest expense (3,722,947) (437,843) (214,688) (115,428) ( 38,055)
--------------- --------------- --------------- ------------- -------------
Net loss (15,030,544) (2,817,292) (1,026,609) (779,314) (303,030)
Preferred stock requirements (4,234,463) (478,981) -- -- --
--------------- --------------- --------------- ------------- -------------
Net loss attributable to
common shares $ (19,265,007) $ (3,296,273) $ (1,026,609) $ (779,314) $ (303,030)
--------------- --------------- --------------- ------------- -------------
--------------- --------------- --------------- ------------- -------------
Weighted average common
shares outstanding 2,615,061 1,988,365 1,609,129 1,508,000 1,470,288
Basic and diluted
net loss per common share $ (7.37) $ (1.66) $ (.64) $ (.52) $ (.21)
--------------- --------------- --------------- ------------- -------------
--------------- --------------- --------------- ------------- -------------
OTHER DATA:
Capital expenditures $ 15,665,047 $ 246,863 $ -- $ -- $ --
Number of subscribers
(end of period) 4,814 1,734 -- -- --
Deficiency in earnings to cover
combined fixed charges 19,265,007 3,296,273 1,026,609 779,314 303,030
Deficiency in earnings to cover
interest charge 15,030,544 2,817,292 1,026,609 779,314 303,030
Deficiency in earnings to cover
preferred stock requirements 15,102,731 2,840,046 N/A N/A N/A
BALANCE SHEET DATA
(END OF PERIOD):
Total assets $ 262,732,604 $14,396,708 $ 1,664,877 $ 847,659 $ 428,914
</TABLE>
Page 17
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Total liabilities 212,301,162 562,082 3,409,433 1,910,781 726,450
Total redeemable preferred
stock 46,492,812 16,794,963 -- -- --
Total shareholders' equity 3,938,630 (2,960,337) (1,744,556) (1,063,122) (297,536)
</TABLE>
Page 18
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
21st Century was awarded a franchise in 1996 by the City of Chicago that
allows for the construction of the DRS Network in Chicago's Area 1. Under
this 15-year renewable license, the Company is granted unrestricted access to
the public right-of-way to construct, operate and maintain its DRS Network to
all residential and commercial subscribers. Since inception, the Company's
principal focus has been the development of its communications business in
Chicago's Area 1.
The Company has incurred net losses in each year since its inception,
and as of March 31, 1998, the Company had an accumulated deficit of
$24,787,871. As the Company anticipates that it will continue to expand its
operations, it anticipates that it will continue to incur net losses during
the next several years as a result of (i) substantially increased
depreciation and amortization from the construction of networks, (ii)
significantly increased operating expenses as it builds its subscriber base
and (iii) interest charges associated with the Senior Discount Notes. There
can be no assurance that growth in the Company's revenues or subscriber base
will occur or that the Company will be able to achieve or sustain
profitability or positive cash flow.
RESULTS OF OPERATIONS
TWELVE MONTHS ENDED MARCH 31, 1998 COMPARED TO TWELVE MONTHS ENDED
MARCH 31, 1997.
REVENUES. The Company generated subscriber revenues of $189,023 for
the twelve months ended March 31, 1998. Subscriber revenues for the twelve
months ended March 31, 1997 were $27,480. The commencement and ramp up of
subscriber revenues resulted principally from the purchase of 1,734 bulk
subscribers from an affiliated entity during January 1997. By the end of
March 31, 1998, the Company was providing service to 3,052 subscribers in 14
bulk MDUs and pursuant to certain right of entry ("ROE") contracts. As of
March 31, 1998, there were 1,762 backlogged connection orders for both bulk
MDU and ROE customers.
EXPENSES. The Company incurred operating expenses of $2,023,310 and
$200,911 for the twelve months ended March 31, 1998 and 1997, respectively.
The increase in operating expenses resulted from activities required to
accelerate the network build-out, operate the franchise and deliver services.
The component of operating expenses that represents network operating costs
related to the delivery of cable and telecommunications services increased
from $12,653 for the twelve months ended March 31, 1997 to $1,345,921 for the
twelve months ended March 31, 1998. This increase is directly related to the
continued ramp-up in the design and construction of the network as well as
the addition of employees. The component of operating expenses that
represents local access, origination programming fees and franchise fees
increased from $188,258 for the twelve months ended March 31, 1997 to
$677,389 for the twelve months ended March 31, 1998. Programming fees for
the upgraded channel lineup made possible by the fiber enriched network
increased from zero dollars to more than $195,000. Public Educational and
Government (PEG) access programming fees which are payable to the Chicago
Access Corporation (CAC) amounted to over $250,000 as annual installment
payments of $100,000 for 1997 and 1998 were paid in fiscal 1998. Access costs
required to offer Internet services paid to both wholesale ISPs and exchange
carriers that lease transport to the wholesale ISPs added $125,000 to 1998
expenses. Depreciation and amortization costs were $1,411,847 and $170,108
for the twelve months ended March 31, 1998 and March 31, 1997, respectively.
The increase in depreciation and amortization costs is primarily attributable
to the amortization of leasehold improvements upon the occupation of the
space in the Apparel Center and the depreciation of the network equipment as
it is placed into service. Selling, general and administrative
Page 19
<PAGE>
expenses were $10,216,919 and $2,337,534 for the twelve months ended March
31, 1998 and March 31, 1997, respectively. The increase in selling, general
and administrative expenses reflects the Company's acquisition of
subscribers, promotion costs, the addition of employees, and compensation
expense related to stock options granted to certain officers and employees in
October 1997. Interest expense increased from $437,843 to $3,722,947 due
primarily to the interest associated with the Senior Discount Notes issued in
February 1998. Interest income increased from $301,624 to $2,373,867 due
primarily to interest earned on the increased level of cash held by the
Company as a result of the issuance of the Senior Discount Notes and
Exchangeable Preferred Stock in February 1998. Amortization of issuance
costs on Senior Discount Notes of $218,411 for the year ended March 31, 1998
resulted from the issuance costs associated with the Senior Discount Notes
issued in February 1998 and their subsequent amortization.
NET LOSS. For the twelve months ended March 31, 1998 and 1997, the
Company incurred net losses amounting to $15,030,544 and $2,817,292,
respectively. The Company expects its net losses to continue to increase as
it introduces new services and as the Company continues to build-out the DRS
Network and seeks to expand its business.
YEAR ENDED MARCH 31, 1997 COMPARED TO THE YEAR ENDED MARCH 31, 1996.
The Company's net loss of $2,817,292 in fiscal 1997 was an increase over
the net loss of $1,026,609 in 1996. The higher losses reflect primarily the
additional activities undertaken to prepare for the initiation of services in
1997. These activities accelerated in February 1997 with the close of the
Company's initial private preferred stock offering. Operating expenses
increased to $200,911 in fiscal 1997 from $9,617 in fiscal 1996 primarily due
to local access and origination programming support as required by the
franchise agreement. Selling, general and administrative expenses increased
to $2,337,534 in fiscal 1997 from $694,122 in fiscal 1996. This increase was
primarily due to higher payroll-related costs of $675,574, increased legal
and professional fees of $561,167, higher bank fees of $130,706 and increased
occupancy costs of $122,991. Interest expense increased by $223,155 due to
the additional interest on the revolving credit note outstanding for most of
fiscal 1997. Depreciation and amortization increased due to higher balances
subject thereto. Interest income was $301,624 for the year ended March 31,
1997. There was no interest income for the year ended March 31, 1996. The
increase in the interest income is the result primarily of two factors. The
first factor relates to the accrued interest associated with prepayment of
the franchise fees in June and July 1996. This factor accounts for
approximately $217,000 of the increase. The second factor is the higher
overall cash balance created by the infusion of cash associated with the
preferred equity offering in January 1997. This factor accounts for
approximately $84,000 of the increase.
LIQUIDITY AND CAPITAL RESOURCES
The cost of development, construction and start-up activities of the
Company will require substantial capital. As of March 31, 1998, the Company
had expended more than $3,800,000 related to the acquisition of the franchise
for Chicago's Area 1, including $3,000,000 to the City of Chicago for prepaid
franchise fees. The Company also purchased 1,734 bulk video subscribers from
an affiliated entity in January 1997 for $3,381,300.
Net cash used in operating activities was $8,080,516 for the twelve
months ended March 31, 1998, $6,910,766 for the year ended March 31, 1997,
and $611,227 for the year ended March 31, 1996. Net cash used in operating
activities for the twelve months ended March 31, 1998 resulted principally
from the Company's net loss from operations and purchases of inventory,
offset by increases in accounts payable, amortization of the discount on the
Senior Discount Notes, depreciation expense and the compensation expense
recognized related to the stock option plan. Net cash used in operating
activities for the year ended March 31, 1997 resulted from the net loss from
operations and increases in prepayments consisting primarily of the
$3,000,000 prepayment of franchise fees to the City of Chicago and decreases
in various payables made
Page 20
<PAGE>
possible by the equity infusion of approximately $20 million. Net cash
required for operations in 1996 resulted primarily from net losses and
increases in deferred legal costs offset by increases in various payables
incurred during the acquisition of the Area 1 franchise.
Cash flow used in investing activities totaled $25,665,047 in the twelve
months ended March 31, 1998 and $3,628,163 in the year ended March 31, 1997.
Cash requirements in the twelve months ended March 31, 1998 consisted of the
cost of building and equipping the NOC, facilitating the corporate
headquarters and network construction. In addition, $10 million was invested
in a security which matures on December 7, 1998. Cash requirements in the
year ended March 31, 1997 consisted primarily of the purchase of 1,734 Area 1
bulk subscribers for $3,381,300.
Cash flow from financing activities was $243,154,859 in the twelve
months ended March 31, 1998, $18,768,915 in the year ended March 31, 1997,
and $608,765 in the year ended March 31, 1996. In the twelve months ended
March 31, 1998, the private sale of $200 million in Senior Discount Notes;
the sale of $50 million in Exchangeable Preferred Stock; and the sale of
Class A Preferred Stock; generated a net of $192,113,175, $48,025,236, and
$2,597,380, respectively. For the year ended March 31, 1997 approximately
$20,000,000 of cash flow was generated through the private sale of preferred
equity. In fiscal 1996, cash flow from financing activities was generated by
the private sale of $342,000 in common stock to a small group of Chicago
investors and the sale of $266,765 in convertible debentures to existing
shareholders.
The Company estimates that its aggregate capital expenditure
requirements related to DRS Network construction in Area 1 for the period
ended March 31, 1998 and for the fiscal years 1999, 2000 and 2001, the time
frame in which construction of the DRS Network in Area 1 is expected to be
completed, will total approximately $270 million, of which between
approximately $90 million to $120 million is expected to be spent during
calendar year 1998. The Company will fund these expenditures from the net
proceeds of the Senior Discount Notes and the Exchangeable Preferred Stock.
In order to retain funds available to support its operations, the Company has
no expectation of paying cash interest on the Notes or cash dividends on the
Exchangeable Preferred Stock prior to February 15, 2003. The Company may
require additional financing in the future if it begins to develop additional
franchise areas or if the development of Area 1 in Chicago is delayed or
requires costs in excess of current expectations. The Company has entered
into a commitment letter with BankBoston, N.A. and Bank of America NT&SA for
a $50 million bank revolving credit facility to provide supplemental
financing. There can be no assurance that the Company will be able to obtain
such proposed bank financing or any such additional debt or equity financing,
or that the terms thereof will not be unfavorable to the Company or its
existing creditors or investors.
While the Year 2000 considerations are not expected to materially impact
the Company's internal operations, they may have an effect on some of its
customers and suppliers, and thus indirectly affect the Company. The Company
is in contact with its major suppliers regarding this issue. However, it is
not possible to quantify the aggregate cost to the Company with respect to
customers and suppliers with Year 2000 problems, although the Company does
not anticipate it will have a material adverse affect on its business.
ITEM 7A. QUANTITATIVE & QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and supplementary data required
under Item 8 of Part II are set forth in Part IV, Items 14(a)(1) of this Form
10-K.
Page 21
<PAGE>
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
During the two years preceding March 31, 1998, there has been neither a
change of accountants of the Registrant nor any disagreement on any matter of
accounting principles, practices, or financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The current directors and executive officers of the Company are listed
below. Directors and executive officers of the Company are elected to serve
until they resign or are removed, are otherwise disqualified to serve or until
their successors are elected and qualified.
<TABLE>
<CAPTION>
NAME AGE POSITION(s) WITH COMPANY
----------------------- --- -----------------------------------------
<S> <C> <C>
Glenn W. Milligan .... 50 Chairman of the Board and Chief Executive
Officer
Robert J. Currey ..... 52 President, Chief Operating Officer and
Director
Ronald D. Webster .... 48 Chief Financial Officer
Jay E. Carlson ....... 36 Chief Technical Officer
Stephen M. Lee ....... 42 Senior Vice President of Internet and Data
Services
Susan R. Quandt ...... 43 Senior Vice President of Corporate
Marketing/Sales
John Brouse .......... 49 Vice President of Network Operations
Roxanne Jackson ...... 33 Vice President of Human Resources
Eric D. Kurtz ........ 34 Vice President of Corporate Development
and Regulatory Affairs
Edward T. Joyce ...... 56 Director
Dr. Charles E. Kaegi . 48 Director
David Kronfeld ....... 50 Director
James H. Lowry ....... 58 Director
Thomas M. Neustaetter 46 Director
</TABLE>
GLENN W. MILLIGAN, the Company's founder, has been Chairman of the Board
and Chief Executive Officer of the Company since its inception in October 1992.
Prior to founding the Company, Mr. Milligan was President and Chief Executive
Officer of 21st Century Technology Group, Inc. from April 1986 to October 1992.
From July 1985 until March 1986, Mr. Milligan served as Regional Director for
the Walt Disney Company, where he was responsible for sales and marketing in
eight midwestern states. From March 1984 to March 1985, Mr. Milligan served as
Area Manager of the Midwest offices of Showtime Networks, Inc. and Regional
Sales Director of their North Central offices from March 1985 to June 1985. From
July 1979 to November 1983, Mr. Milligan was the Chief Executive Officer of
DAEOC, Inc., a diversified government contractor.
ROBERT J. CURREY has served as a Director of the Company since February
1997 and was named President and Chief Operating Officer on March 1, 1998. Mr.
Currey served as Group President of Telecommunications Services for McLeod USA,
a wholly owned subsidiary of McLeod, Inc., from September 1997 through February
1998. Mr. Currey continues to serve on the board of directors of McLeod USA.
From March 1990 until September 1997, he served as President and Chief Executive
Officer of Consolidated Communications. From 1988 to 1990, Mr. Currey served as
Senior Vice President
Page 22
<PAGE>
of Operations and Engineering at Citizens Utilities Company in Stanford,
Connecticut. From 1987 to 1988, Mr. Currey served as Executive Vice President at
US Sprint in Kansas City, Missouri.
RONALD D. WEBSTER joined the Company as Chief Financial Officer in
September 1997. He was previously Vice President and Treasurer at Telephone Data
Systems, Inc., where he served from April 1988 until August 1997. Prior thereto,
he held executive positions with Ideal School Supply Corp. and Trans Union
Corporation.
JAY E. CARLSON has served as the Company's Chief Technical Officer since
March 1997. From October 1989 to March 1997, Mr. Carlson was the Fund
Engineering Director for Jones Intercable, Inc. where he was responsible for
engineering operations in the Western region. He was also instrumental in the
design and construction of Jones Intercable's Alexandria, Virginia HFC broadband
network, which was one of the first platforms to simultaneously carry
residential and commercial telephony, video and data.
STEPHEN M. LEE joined the Company in January 1997 as Senior Vice President
of Internet and Data Services. Mr. Lee was the Director of the Central Region
Sales for MFS Datanet, Inc. from October 1993 to April 1996. From April 1996 to
January 1997, Mr. Lee served as a technical consultant to the Company. From
October 1983 until October 1993, Mr. Lee held various managerial positions at
Graphnet, Inc. From January 1979 to October 1983, Mr. Lee was the Major Account
Manager/Systems Sales Engineer for ITT World Communications, Inc.
SUSAN R. QUANDT has served as the Company's Senior Vice President of
Corporate Marketing/Sales since December 1997. From December 1994 to December
1997, Ms. Quandt served as Executive Vice President of Taylor-Winfield, an
information technology market consulting and executive recruiting firm. From
January 1992 to September 1994, Ms. Quandt served as Vice President of Marketing
and Product Development of Call-Net Enterprises Inc., a national long-distance
telephone company owned by Sprint Canada. From January 1989 to December 1991,
Ms. Quandt served as Vice President of Marketing for Schneider Communications,
Inc., a regional long-distance telephone company.
JOHN BROUSE has served as the Company's Vice President of Network
Operations since April 1997. Prior to that time, Mr. Brouse was Operations
Engineering Director for Jones Intercable, Inc. from June 1988 to April 1997.
Mr. Brouse received the cable industry's prestigious Polaris Award in 1996.
ROXANNE JACKSON has served as the Company's Vice President of Human
Resources since May 1996. Prior to that time, from January 1994 to May 1996, Ms.
Jackson was the Human Resources Director for Metz Baking Group. From August 1992
until January 1994, Ms. Jackson served as the Director of Human Resources for
Fox Television Stations, Inc.
ERIC D. KURTZ has served as the Company's Vice President of Corporate
Development and Regulatory Affairs since March 1997. From April 1989 until July
1996, Mr. Kurtz was a General Manager with Time Warner's Milwaukee & Chicago
Divisions. During this time span he also served as a board member of the
Wisconsin Cable Communications Association and as its President from September
1994 to September 1996.
EDWARD T. JOYCE has served as a Director of the Company since the Company's
inception in October 1992. Mr. Joyce founded his own firm in 1971, now known as
Edward T. Joyce and Associates, P.C., a law firm dealing with commercial
litigation.
DR. CHARLES E. KAEGI has served as a Director of the Company since the
Company's inception in October 1992. Dr. Kaegi has been in private practice of
medicine since July 1979. From November 1979 to present, Dr. Kaegi has held the
following positions at Ravenswood Hospital Medical Center: Attending Physician
(November 1979 to present); Medical Director, Alcohol & Drug Abuse Program (July
1994 to present); Medical Director, Community Mental Health Center (November
1994 to present); Medical
Page 23
<PAGE>
Education (January 1980 to present); Secretary of the Department of Psychiatry
(January 1993-present); and Consultant to Community Mental Health Center (March
1980 to August 1985). Dr. Kaegi is the cousin of Mr. Glenn Milligan.
DAVID KRONFELD has served as a Director of the Company since February 1997.
Mr. Kronfield founded JK&B Capital in January 1996 and has been its general
partner since that time. Before founding JK&B Capital, Mr. Kronfield was a
General Partner at Boston Capital Ventures from August 1989 to October 1995,
where he specialized in the telecommunications and software industries. From
October 1984 to August 1989, Mr. Kronfield served as Vice President of
Acquisitions and Venture Investments at Ameritech.
JAMES H. LOWRY has served as a Director of the Company since February 1997.
Mr. Lowry serves as President and Chief Executive Officer of James H. Lowry &
Associates ("JHLA"), a consulting company established in 1975. Prior to
establishing JHLA, Mr. Lowry served as the Director of Public Service Practice
for McKinsey & Company from 1967 to 1975.
THOMAS M. NEUSTAETTER has served as a Director of the Company since
February 1997. Mr. Neustaetter has been an officer of the Chatterjee Management
Group, a division of Chatterjee Management Company, since January 1996. From
January 1995 to January 1996, Mr. Neustaetter was the Managing Director for
Bancroft Capital Corporation in New York City, a company he founded. From August
1986 to December 1994, Mr. Neustaetter was employed at Chemical Banking
Corporation in New York City.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board currently has two committees, the Executive Committee and the
Compensation Committee. The Executive Committee makes recommendations to the
Board of Directors regarding issues such as finance, strategic planning and
long-range goals for the Company. The current members of the Executive Committee
are Glenn Milligan, Edward Joyce and David Kronfeld.
The Compensation Committee reviews and recommends the compensation and
bonus arrangements for executive level management of the Company and administers
the Company's stock option plans. The current members of the Compensation
Committee are Glenn Milligan, Edward Joyce and Thomas Neustaetter.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
As stated above, the current members of the Compensation Committee are
Messrs. Milligan, Joyce and Neustaetter. Mr. Milligan is also the Chief
Executive Officer of the Company.
In January 1998, the Company issued to Messrs. Milligan, Kaegi and Joyce
4.7, 6.3 and 31.7 shares of Class A Convertible 8% Cumulative Preferred Stock,
respectively, at a price of $15,793.84 per share, and warrants to purchase up to
3,995.3, 5,327.1 and 26,635.5 shares of Common Stock, respectively, at a price
of $.000001 per share.
DIRECTOR COMPENSATION
Directors of the Company receive no directors' fees. Directors are
reimbursed for their reasonable out-of-pocket travel expenditures incurred in
connection with their service as directors.
Page 24
<PAGE>
COMPENSATION PLAN
1997 STOCK OPTION PLAN. The Company's Stock Option Plan (the "Stock
Option Plan") provides for the grant of options that are not intended to qualify
as "incentive stock options" under Section 422 of the Internal Revenue Code of
1986, as amended (the "Code"), to key employees. The Compensation Committee of
the Board of Directors administers the Stock Option Plan and grants options to
purchase Common Stock thereunder.
The aggregate number of shares of Common Stock that may be issued under
options under the Stock Option Plan may not exceed 728,667.7 shares. Reserved
shares may be either authorized but unissued shares or treasury shares, and will
be distributed at the discretion of the Board of Directors.
The Compensation Committee has the exclusive authority to establish, amend
and rescind appropriate rules and regulations relating to the Stock Option Plan.
Each participant's option will expire as of the earliest of : (i) the date on
which it is forfeited under the provisions of the Stock Option Plan; (ii) ten
years from the option date; and (iii) the date on which it expires pursuant to
the relevant option agreement. The option price may be greater than, less than
or equal to the fair market value on the option date as determined in the sole
discretion of the Compensation Committee.
An option participant may not exercise an option or any portion thereof
until such option or such portion thereof has become fully vested. Pursuant to
the Stock Option Plan, options generally vest 1/48th each month and are fully
vested after four years. All options become 100% vested and immediately
exercisable prior to a Change in Control (as such term is defined in the Stock
Option Plan).
During October and December 1997, the compensation committee granted
options to acquire an aggregate of 728,667.8 shares of common stock to
executive officers of the company. Messers Milligan, Wiegand-Moss, Webster
and Carlson were awarded 131,160.3, 109,300.2, 109,300.2 and 91,083.5 shares
respectively. In March 1998 the options granted to Mr. Wiegand-Moss were
reduced from 109,300.2 to 72,866.8 shares when he ceased to be the Chief
Operating Officer and became Senior Vice President of Customer Operations.
Each of such options vests at a rate of 1/48th per month from the optionee's
date of employment with the company, even if such employment precedes the
date of the grant.
As of March 31, 1998, options to acquire 692,234.6 shares of Common Stock
were outstanding pursuant to the Stock Option Plan.
Page 25
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth information concerning compensation of (i)
the Company's Chief Executive Officer during the fiscal year ended March 31,
1998 and (ii) executive officer of the Company whose total annual salary and
bonus equaled or exceeded $100,000 in the fiscal year ended March 31, 1998
(collectively, the "Named Executive Officers"):
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
AWARDS
------
ANNUAL COMPENSATION NUMBER
OF
SECURITIES
UNDERLYING
NAMED OFFICERS AND PRINCIPAL
POSITION YEAR SALARY ($) BONUS ($) OTHER($)(1) OPTIONS
- -------- ---- ---------- --------- ------------ -------
<S> <C> <C> <C> <C> <C>
Glenn W. Milligan 1998 188,648 48,089 29,169 131,160.3
Chairman of the Board, 1997 170,833 6,875 4,000
President and Chief
Executive Officer
Richard Wiegand-Moss (2) 1998 150,566 6,990 36,232 72,866.8 (3)
Former Chief Operating
Officer 1997 117,709 5,729 13,750
Ronald D. Webster 1998 92,308 (4) 50,000 3,462 109,300.2
Chief Financial Officer 1997
Jay E. Carlson 1998 120,800 3,625 40,196 91,083.5
Chief Technical Officer 1997
Daniel O. Day 1998 126,748 (5) 5,730 16,011 0.0
Former Vice President of
Finance 1997 116,041 5,208 2,500
</TABLE>
(1) Includes automobile allowances and amounts reimbursed for relocation
expenses and premiums on life insurance. In the case of Mr. Milligan, the
amount also includes an annual membership fee to a private club.
(2) Mr. Wiegand-Moss was the Company's Chief Operating Officer from August 1996
to March 1998. Effective March 4, 1998, he ceased to be the Chief
Operating Officer and became Senior Vice President of Customer Operations.
Mr. Wiegand-Moss left the Company in May 1998.
(3) In March 1998, the options granted to Mr. Wiegand-Moss were reduced from
109,300.2 shares to 72,866.8 shares when he ceased to be the Chief
Operating Officer and became Senior Vice President of Customer Operations.
His options to purchase 36,433 shares of the Company's Common Stock were
forfeited.
(4) Mr. Webster joined the Company in September 1997. His annual salary for
fiscal 1998 would have been $160,000 if he were with the Company for the
entire year.
(5) Mr. Day was the Company's Chief Financial Officer from August 1996.
Effective September 1997, Mr. Day ceased to be the Chief Financial Officer
and became Vice President of Finance. Mr. Day left the Company in February
1998. His annual salary for fiscal 1998 would have been $131,346 if he
were with the Company for the entire year.
Page 26
<PAGE>
The following table contains certain information concerning the stock option
grants made to each of the Named Executive Officers during the fiscal year ended
March 31, 1998.
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
--------------------------------------------------------------------
% OF TOTAL POTENTIAL REALIZABLE VALUE AT
NUMBER OF OPTIONS ASSUMED ANNUAL RATES OF STOCK
SECURITIES GRANTED TO EXERCISE OR PRICE APPRECIATION FOR OPTION TERM (3)
UNDERLYING EMPLOYEES IN BASE PRICE -------------------------------------
OPTIONS GRANTED (1) FISCAL YEAR ($/Sh) EXPIRATION DATE 5% 10%
------------------- --------------- ----------- --------------- -- ---
<S> <C> <C> <C> <C> <C> <C>
NAME
Glenn W. Milligan 131,160.3 18.0 1.12 11/01/02 $814,509 $ 1,383,983
Richard Wiegand-Moss 72,866.8(2) 10.0 1.12 05/15/06 $452,500 $ 768,870
Ronald D. Webster 109,300.2 15.0 1.12 09/01/07 $678,757 $ 1,153,318
Jay E. Carlson 91,083.5 12.5 1.12 02/17/07 $565,631 $ 961,099
Daniel O. Day 0 0 0 0 0 0
</TABLE>
- --------------------
* Less than 1%.
(1) Stock options vest 1/48th each month and are fully vested after four years;
provided that such officer remains continuously employed by the Company.
(2) In March 1998 the options granted to Mr. Wiegand-Moss were reduced from
109,300.2 shares to 72,866.8 shares.
(3) These amounts are based on compounded annual rates of stock price
appreciation of five and ten percent over the 10-year term of the options,
are mandated by rules of the Securities and Exchange Commission and are not
indicative of expected stock performance. Actual gains, if any, on stock
option exercises are dependent on future performance of the Common Stock,
overall market conditions, as well as the option holders' continued
employment throughout the vesting period. The amounts reflected in this
table may not necessarily be achieved or may be exceeded. The indicated
amounts are net of the option exercise price but before taxes that may be
payable upon exercise.
The following table sets forth certain information regarding options to
purchase Common Stock held as of March 31, 1998 by each of the Named Executive
Officers. None of such Named Executive Officers exercised any options during
the year ended March 31, 1998
<TABLE>
<CAPTION>
AGGREGATED FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED IN-THE-
UNEXERCISED OPTIONS AT FISCAL MONEY OPTIONS AT
YEAR END FISCAL YEAR END (1)
--------------------------------- -------------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Glenn W. Milligan 131,160.3 0 $ 443,322 0
Richard Wiegand-Moss 44,543.2 28,323.6(2) $ 150,556 $ 95,733(2)
Ronald D. Webster 15,796.2 93,504.0 $ 53,391 $316,043
Jay E. Carlson 25,982.8 65,100.7 $ 87,822 $220,104
Daniel O. Day 0 0 0 0
</TABLE>
Page 27
<PAGE>
______________
(1) There was no public trading market for the Common Stock as of March 31,
1998. Accordingly, these values have been calculated by determining the
difference between the estimated fair market value of the Company's Common Stock
underlying the option as of March 31, 1998 ($4.50 per share) and the exercise
price per share payable upon exercise of such options. In determining the fair
market value of the Company's Common Stock, the Board of Directors considered
various factors, including the Company's financial condition and business
prospects, its operating results, and the absence of a market for its Common
Stock.
(2) These options were forfeited in May 1998.
EMPLOYMENT AGREEMENTS
GLENN W. MILLIGAN. Mr. Milligan entered into an employment agreement with
the Company as of August 1996 for a five-year term, which will be automatically
renewed for consecutive five-year terms unless either party elects not to renew
the agreement. Pursuant to the employment agreement, Mr. Milligan is entitled to
an initial annual base salary of $165,000 which was increased to $200,000 on
February 1, 1997 upon the consummation of the Company's initial private
preferred stock offering and will increase by ten percent annually. In addition,
if the Company obtains a new franchise and finances its construction, Mr.
Milligan's annual base salary will be increased in an amount equal to $.20 times
the number of new homes passed by the Company in the new franchise area. Mr.
Milligan is entitled to an annual bonus, based upon a bonus plan approved by the
Board of Directors, in a minimum amount of 1/24th of his annual base salary.
Mr. Milligan is also entitled annually to receive shares of the Company's common
stock in an amount equal to 5,000 shares or such other number of shares as is
necessary to provide him with .261% of the outstanding shares of common stock
and to receive stock options covering such number of shares pursuant to a
separate agreement. Upon a termination of the employment agreement, Mr. Milligan
is generally entitled to severance benefits and stock options to which he would
have been entitled during the remaining contract term had the employment
agreement not been terminated and a lump-sum payment, the amount of which is
dependent upon the reason for termination. In addition, upon a termination of
the employment agreement for any reason, Mr. Milligan has the right to require
the Company to repurchase all shares of the Company's capital stock then
beneficially owned by him for their fair market value. Certain elements of Mr.
Milligan's employment agreement are in the process of being renegotiated.
RICHARD WIEGAND-MOSS. Mr. Wiegand-Moss was employed by the Company as its
Chief Operating Officer pursuant to an employment agreement in August 1996 . In
March 1998, he entered into another employment agreement with the Company,
pursuant to which he ceased to be the Chief Operating Officer and became Senior
Vice President of Customer Operations effective March 4, 1998. Pusuant to the
employment agreement in 1998, he was entittled to an initial annual base salary
of $150,000. In May 1998, Mr. Wiegand-Moss resigned from the Company. On May
5, 1998, Mr. Wiegand entered into a Seperation Agreement and General Release
with the Company. Pursuant to the Separation Agreement, Mr. Wiegand-Moss
received a lump sum payment in the amount of $150,000, representing his base
salary for the most recent 12-month period. He was also entitled to continue to
receive his base salary bi-monthly through September 8, 1998. Other severance
benefits include continuation of health benefits for him and his dependents for
18 months and outplacement services. All unvested options were forfeited.
RONALD D. WEBSTER. Mr. Webster entered into an employment agreement with
the Company as of November 3, 1997. The employment agreement will expire on
January 1, 2000. Pursuant to the employment agreement, Mr. Webster is entitled
to an initial annual base salary of $160,000 and a minimum annual bonus of
$50,000 on each of December 31, 1997, 1998, and 1999. In addition, he is
entitled to receive stock options covering such number of shares pursuant to a
separate agreement. Upon a termination of his employment agreement, Mr.
Webster is generally entitled to severance benefits, and depending on the reason
for termination, he may be entitled to an amount equal to two times the annual
salary and bonus he would have received for the year during which such
termination occurs.
Page 28
<PAGE>
JAY E. CARLSON. Mr. Carlson entered into an employment agreement with the
Company as of November 3, 1997, for a term of three years. Pursuant to the
employment agreement, Mr. Carlson is entitled to an initial annual base salary
of $128,400. In addition, he is entitled to receive stock options covering such
number of shares pursuant to a separate agreement. Upon a termination of his
employment agreement, Mr. Carlson is generally entitled to severance benefits,
and depending on the reason for termination, he may be entitled to an amount
equal to the annual salary he would have received for the year during which such
termination occurs.
DANIEL O. DAY. Mr. Day was employed by the Company as its Chief Financial
Officer pursuant to an employment agreement in August 1996. Effective September
1997, Mr. Day ceased to be the Chief Financial Officer and became Vice President
of Finance. Mr. Day resigned from the Company as of February 1998. Terms of
his severance agreement are still being negotiated.
All employment agreements contain confidentiality provisions and
non-compete provisions.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth certain information at June 15, 1998,
regarding beneficial ownership of the capital stock of the Company by (i) each
person known by the Company to beneficially own more than 5% of the outstanding
capital stock of the Company, (ii) each director of the Company, (iii) each
Named Executive Officer of the Company and (iv) all directors and executive
officers as a group.
<TABLE>
<CAPTION>
NUMBER OF SHARES
OF
NUMBER OF SHARES CLASS A
OF CONVERTIBLE PERCENT OF
NAME OF BENEFICIAL OWNER COMMON STOCK 8% CUMULATIVE AGGREGATE
------------------------ BENEFICIALLY PREFERRED STOCK VOTING RIGHTS(3)
OWNED(1) BENEFICIALLY ----------------
-------- OWNED(2)
--------
<S> <C> <C> <C>
Purnendu Chatterjee(4) ......................... 757,600.3 633.2 27.7%
JK&B Capital(5) ................................ 378,800.2 316.6 14.6
William Farley(6) .............................. 303,040.0 249.3 11.7
Myron M. Cherry(7) ............................. 269,625.3 12.7 6.2
Boston Capital Ventures III, L.P.(8) ........... 151,520.1 126.6 6.1
Elske Bolitho(9) ............................... 305,000.0 -- 6.8
Thomas Neustaetter(4)(10) ...................... 757,600.3 633.2 27.7
Charles E. Kaegi, M.D.(11)(19) ................. 932,480.0 6.3 19.3
Edward T. Joyce(12)(19) ........................ 758,496.7 50.8 16.7
David Kronfeld(13) ............................. 530,320.3 443.2 20.0
Glenn W. Milligan(14)(19) ...................... 660,259.6 4.7 13.7
James H. Lowry(19) ............................. 19,000.0 -- *
Robert Currey(19) .............................. -- -- *
Ronald Webster(15)(19) ......................... 48,557.6 9.5 1.0
Richard Weigand-Moss(16)(19) ................... 56,842.3 -- 1.3
Daniel O. Day(17)(19) .......................... 16,673.6 -- *
Jay E. Carlson(18)(19) ......................... 34,156.3 -- *
All executive officers and directors as a group
(16 persons)(20) .......................... 3,892,414.5 1,147.8 74.8
</TABLE>
* Less than 1%.
Page 29
<PAGE>
(1) The persons named in this table have sole voting power with respect to
all shares of Common Stock shown as beneficially owned by them,
subject to community property laws where applicable and except as
indicated in the other footnotes to this table. Beneficial ownership
is determined in accordance with the rules of the SEC. In computing
the number of shares beneficially owned by a person and the percentage
ownership of that person, shares of Common Stock subject to options
and warrants held by that person that are currently exercisable or
exercisable within 60 days after January 15, 1998, are deemed
outstanding. Such shares, however, are not deemed outstanding for the
purpose of computing the percentage ownership of any other person.
(2) Each share of Class A Convertible 8% Cumulative Preferred Stock
converts into one thousand shares of Common Stock at the option of the
shareholder.
(3) Percent of Aggregate Voting Rights, for each beneficial owner, was
determined based upon a fraction. The numerator of such fraction is
the sum of (a) the number of outstanding shares of Common Stock
beneficially owned by such owner, plus (b) the number of shares of
Common Stock into which the number of shares of Class A Convertible 8%
Cumulative Preferred Stock beneficially owned by such owner are
convertible, plus (c) the number of shares of Common Stock issuable
upon exercise of options and warrants beneficially owned by such owner
and which are exercisable within 60 days of January 15, 1998. The
denominator of such fraction is the sum of (a) the aggregate number of
shares of Common Stock outstanding on January 15, 1998, plus (b) the
number of shares of Common Stock into which the aggregate number of
shares of Class A Convertible 8% Cumulative Preferred Stock
outstanding on January 15, 1998 are convertible, plus (c) the
aggregate number of shares of Common Stock issuable upon exercise of
options and warrants beneficially owned by such owner and which are
exercisable within 60 days of January 15, 1998.
(4) Represents 112,445.2 shares of Common Stock, 266,354.9 shares of
Common Stock issuable upon exercise of warrants and 316.6 shares of
Class A Convertible 8% Cumulative Preferred Stock held by Quantum
Industrial Partners LDC ("QIP"). The address of QIP is c/o Curacao
Corporation Company, Kaya Flamboyan 9, Willemstad, Curacao,
Netherlands Antilles. Also includes 65,218.2 shares of Common Stock,
154,485.9 shares of Common Stock issuable upon exercise of warrants
and 183.6 shares of Class A Convertible 8% Cumulative Preferred Stock
held by S-C Phoenix Holdings, L.L.C. ("S-C Phoenix"). The address of
S-C Phoenix is c/o Chatterjee Management Company, 888 Seventh Avenue,
New York, New York 10106. This total also includes 45.2 shares of
Class A Convertible 8% Cumulative Preferred Stock, 16,069.8 shares of
Common Stock and 38,035.5 shares of Common Stock issuable upon
exercise of warrants held by Winston Partners II, LLC and 87.8 shares
of Class A Convertible 8% Cumulative Preferred Stock, 31,157.2 shares
of Common Stock and 73,833.6 shares of Common Stock issuable upon
exercise of warrants held by Winston Partners II, LDC (Winston
Partners II, LLC and Winston Partners II, LDC, collectively "Winston
Partners"). The address of Winston Partners II, LLC is c/o Chatterjee
Management Company, 888 Seventh Avenue, New York, New York 10106. The
address of Winston Partners II, LDC is c/o Curacao Corporation
Company, Kaya Flamboyan 9, Willemstad, Curacao, Netherlands Antilles.
QIP, S-C Phoenix and Winston Partners are associated with Chatterjee
Management Company. Chatterjee Management Company is managed and
controlled by Purnendu Chatterjee. Dr. Chatterjee may be deemed to
have the power to direct the voting and disposition of the shares
owned by QIP, S-C Phoenix and Winston Partners. Dr. Chatterjee and Mr.
George Soros may each be deemed to have the power to direct the voting
and disposition of the shares owned by S-C Phoenix. In addition, Mr.
Soros, Mr. Stanley F. Druckenmiller and Soros Fund Management LLC may
be deemed to have the power to direct the voting and disposition of
the shares owned by QIP. The Percent of Aggregate Voting Rights
excludes 224,890.4 shares of non-voting Common Stock beneficially
owned by Purnendu Chatterjee which the Company has agreed to issue.
Page 30
<PAGE>
(5) Represents 221.6 shares of Class A Convertible 8% Cumulative Preferred
Stock, 78,711.6 shares of Common Stock and 186,448.5 shares of Common
Stock issuable upon exercise of warrants held by JK&B Capital, L.P.
and 95.0 shares of Class A Convertible 8% Cumulative Preferred Stock,
33,733.6 shares of Common Stock and 79,906.5 shares of Common Stock
issuable upon exercise of warrants held by JK&B Capital II, L.P. (JK&B
Capital, L.P. and JK&B Capital II, L.P., collectively "JK&B Capital").
The address of JK&B Capital is 205 North Michigan, Suite 800, Chicago,
IL 60601. The Percent of Aggregate Voting Rights excludes up to
112,445.2 shares of non-voting Common Stock beneficially owned by JK&B
Capital which the Company has agreed to issue.
(6) Represents the following securities held by the following entities,
all of which are beneficially owned by Mr. Farley: 73.9 shares of
Class A Convertible 8% Cumulative Preferred Stock, 26,237.2 shares of
Common Stock and 62,149.4 shares of Common Stock issuable upon
exercise of warrants held by Farley, Inc. of which Mr. Farley is the
sole owner, and 101.5 shares of Class A Convertible 8% Cumulative
Preferred Stock, 37,481.7 shares of Common Stock and 88,785.0 shares
of Common Stock issuable upon exercise of warrants held by The
Retirement Program of Farley, Inc. of which Mr. Farley is the sole
member of the Pension Investment Committee of the Retirement Program
of Farley, Inc. Also includes 42.2 shares of Class A Convertible 8%
Cumulative Preferred Stock, 14,992.7 shares of Common Stock and 35,514
shares of Common Stock issuable upon exercise of warrants held by FTL
Investments Inc. of which Mr. Farley is Chairman and Chief Executive
Officer, and 31.7 shares of Class A Convertible 8% Cumulative
Preferred Stock, 11,244.5 shares of Common Stock and 26,635.5 shares
of Common Stock issuable upon exercise of warrants held by Union
Underwear Pension Plan of which Mr. Farley is the sole member of the
Pension Investment Committee of the Fruit of the Loom Board of
Directors. The address of Mr. Farley is 233 South Wacker Drive,
Chicago, Illinois, 60606. The Percent of Aggregate Voting Rights
excludes 89,956.1 shares of non-voting Common Stock beneficially owned
by Mr. Farley which the Company has agreed to issue.
(7) Includes 72,223.3 shares of Common Stock issuable upon exercise of
options. The address of Mr. Cherry is 30 North LaSalle, #2300,
Chicago, Illinois 60602. The Percent of Aggregate Voting Rights
excludes 4,497.8 shares of non-voting Common Stock beneficially owned
by Mr. Cherry which the Company has agreed to issue.
(8) Includes 106,542.0 shares of Common Stock issuable upon exercise of
warrants. The address of Boston Capital Ventures III, L.P. is Old City
Hall, 45 School Street, Boston, MA 02108. The Percent of Aggregate
Voting Rights excludes 44,978.1 shares of non-voting Common Stock
beneficially owned by Boston Capital Ventures III, L.P. which the
Company has agreed to issue.
(9) Represents 153,000 shares of Common Stock held by Elske Bolitho,
Trustee of Robert W. Bolitho Trust, and 152,000 shares of Common Stock
held by Elske Bolitho, Trustee of Elske Bolitho Trust. The address of
Ms. Bolitho is 13376 185th Place N, Jupiter, Florida 33478.
(10) All of such shares are beneficially owned by Purnendu Chatterjee. Mr.
Neustaetter is an officer of the Chatterjee Management Group, a
division of Chatterjee Management Company. Mr. Neustaetter is an
officer of Chatterjee Management Company. Mr. Neustaetter disclaims
beneficial ownership of these shares, over which he does not have
dispositive or voting control. The business address of Mr. Neustaetter
is c/o Chatterjee Management Company, 888 Seventh Avenue, New York, NY
10106.
(11) Includes 172,202.2 shares of Common Stock and 376,721.8 shares of
Common Stock issuable upon exercise of options held by Charles E.
Kaegi, M.D., S.C., Defined Contribution Pension Plan and Trust,
26,990.0 shares of Common Stock held by Charles E. Kaegi, M.D., S.C.,
Defined Benefit Pension Plan and Trust, 1,700.0 shares of Common Stock
held by Charles E. Kaegi, M.D., S.C. Profit Sharing Pension Plan and
Trust, 321,240.0 shares of Common Stock held jointly with Mr. Kaegi's
wife, and 17,470.0 shares of non-voting Common Stock owned by Mr.
Kaegi's wife. The
Page 31
<PAGE>
Percent of Aggregate Voting Rights excludes 2,248.9 shares of
non-voting Common Stock held by Mr. Kaegi which the Company has agreed
to issue.
(12) Includes 269,516.5 shares of Common Stock issuable upon exercise of
options held by Mr. Joyce, 96,620.0 shares of Common Stock and
52,291.5 shares of Common Stock issuable upon exercise of options held
by Mr. Joyce's wife, 28,500 shares of Common Stock issuable upon
exercise of warrants held by Mr. Joyce, 12.9 shares of Class A
Convertible 8% Cumulative Preferred Stock and 10,867.3 shares of
Common Stock issuable upon exercise of warrants held by Edward T.
Joyce, as Trustee of the Edward T. Joyce Ltd. Employees' Profit
Sharing Plan, and 4.1 shares of Convertible Class A Preferred Stock
and 3,409.3 shares of Common Stock issuable upon exercise of warrants
held by Edward T. Joyce, as Trustee of the Individual Retirement
Account for Edward T. Joyce. The Percent of Aggregate Voting Rights
excludes 18,058.7 shares of non-voting Common Stock beneficially owned
by Mr. Joyce which the Company has agreed to issue.
(13) All such shares are held of record by JK&B Capital and Boston Capital
Ventures III, L.P. Mr. Kronfeld is a Manager of JK&B Management,
L.L.C. and General Partner of JK&B Capital, L.P. and JK&B Capital II,
L.P. The business address of Mr. Kronfeld is c/o JK&B Capital, 205
North Michigan, Suite 800, Chicago, IL 60601.
(14) Includes 316,060.3 shares of Common Stock issuable upon exercise of
options held by Mr. Milligan, and 93,750.0 shares of Common Stock and
61,225.5 shares of Common Stock issuable upon exercise of options held
by Mr. Milligan's wife. The Percent of Aggregate Voting Rights
excludes 1,686.7 shares of non-voting Common Stock beneficially owned
by Mr. Milligan which the Company has agreed to issue.
(15) Includes 37,193.7 shares of Common Stock issuable upon exercise of
options and 7,990.6 shares of Common Stock issuable upon exercise of
Warrants. Also includes 3,165.5 shares of Common Stock and 8.9 shares
of Class A Convertivle 8% Cumulative Preferred Stock held by LaSalle
National Bank, as custodian for Ron Webster IRA Rollover. The Percent
of Aggregate Voting Rights excludes 3,165.5 shares of non-voting
Common Stock which the compnay has agreed to issue.
(16) Includes 51,847.4 shares of Common Stock issuable upon exercise of
options.
(17) Includes 3,527.2 shares of Common Stock issuable upon exercise of
options.
(18) Includes 34,156.3 shares of Common Stock issuable upon exercise of
options.
(19) The address of each such person is c/o the Company, 350 N. Orleans
Street, Suite 600, Chicago, IL 60654.
(20) Includes the aggregate of 1,280,567.9 shares of Common Stock issuable
upon exercise of options and 965,696.5 shares of Common Stock issuable
upon exercise of warrants. See notes 10, 11, 12, 13, 14, 15, 16, 17
and 18 above. The Percent of Aggregate Voting Rights excludes
407,682.6 shares of non-voting Common Stock which the Company has
agreed to issue.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTION WITH JAMES LOWRY & ASSOCIATES
On December 9, 1997 the Board of Directors of the Company authorized the
Company to enter into a contract whereby James Lowry & Associates would assist
the Company in the development of a plan to
Page 32
<PAGE>
meet Chicago's Minority Business Enterprise/Women Business Enterprise
certification requirements. The contract calls for payment for services rendered
on an hourly basis, but not to exceed $200,000 per annum. Mr. Lowry, who became
a Director of the Company in February 1997, is the President and Chief Executive
Officer and the sole beneficial owner of James Lowry & Associates.
SALE OF CAPITAL STOCK
In September 1997, pursuant to a Purchase, Joinder and Waiver Agreement
(the "Purchase Agreement"), the Company issued 63.3 shares of Class A
Convertible 8% Cumulative Preferred Stock at a price of $15,793.84 per share,
and warrants to purchase up to 53,271 shares of Common Stock at a price of
$.000001 per share to Consolidated Communications, whose President and Chief
Executive Officer at such time was Mr. Currey, a Director of the Company at that
time and currently the Company's President and Chief Operating Officer.
In November 1997, pursuant to a Purchase, Joinder and Waiver Agreement, the
Company issued 9.5 shares of Class A Convertible 8% Cumulative Preferred Stock
at a price of $15,793.84 per share, and warrants to purchase up to 7,990.6
shares of Common Stock at a price of $.000001 per share to Mr. Webster, the
Company's Chief Financial Officer.
In January 1998, the Company agreed to issue an aggregate of 550,362.2
shares of Common Stock and an equal number of shares of non-voting Common
Stock, for a total of 1,100,724.3 shares. These shares are issuable in
exchange for the initial and debt warrants, which arose from the purchase of
Class A Convertible 8% Cumulative Preferred Stock and have an assigned value
of $2,343,746. The beneficial holder of such shares include Purnendu
Chatterjee, JK&B Capital, William Farley, Boston Capital Ventures III, L.P.,
Thomas Neustaetter, Edward T. Joyce, David Kronfeld, Glenn W. Milligan and
Charles E. Kaegi, M.D.
Also in January 1998, certain shareholders, including Messrs. Milligan,
Joyce and Kaegi purchased an additional 95.4 shares of Class A Convertible 8%
Cumulative Preferred Stock at a price of $15,793.84 per share.
The Company believes that all transactions set forth above were made on
terms no less favorable to the Company than would have been obtained from
unaffiliated third parties. The Company has adopted a policy whereby all future
transactions between the Company and its officers, directors and affiliates will
be on terms no less favorable to the Company than could be obtained from
unrelated third parties and will be approved by a majority of the disinterested
members of the Board of Directors.
Page 33
<PAGE>
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 10-K
<TABLE>
<CAPTION>
PAGE
<S> <C>
14. (a)(1) AUDITED FINANCIAL STATEMENTS
Report of Independent Public Accountants..................................................................... 35
Consolidated Balance Sheets as of March 31, 1998 and 1997.................................................... 36
Consolidated Statements of Income for the years ended March 31, 1998, 1997, and 1996......................... 38
Consolidated Statements of Changes in Shareholders' Equity for the years ended March 31, 1998, 1997 and
1996 ..................................................................................................... 39
Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996...................... 40
Notes to Consolidated Financial Statements for the years ended March 31, 1998, 1997 and 1996................. 41
</TABLE>
Page 34
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
21st Century Telecom Group, Inc.:
We have audited the accompanying consolidated balance sheets of 21st
Century Telecom Group, Inc. (an Illinois corporation) and subsidiaries as of
March 31, 1998 and 1997, and the related consolidated statements of income,
shareholders' equity and cash flows for each of the three years in the period
ended March 31, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of 21st Century
Telecom Group, Inc. and subsidiaries as of March 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended March 31, 1998, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Chicago, Illinois
May 15, 1998
Page 35
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------------- -------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................................................... $ 217,640,238 $ 8,230,942
Accounts receivable from shareholders........................................... -- 86,000
Accounts receivable from subscribers............................................ 10,359 27,480
Short term investments.......................................................... 10,000,000 --
Prepayments..................................................................... 168,152 149,250
Inventory....................................................................... 1,991,690 --
-------------- -------------
Total current assets.................................................. 229,810,439 8,493,672
PROPERTY, PLANT AND EQUIPMENT:
Leasehold improvements......................................................... 4,010,868 177,526
Other property, plant and equipment............................................ 16,588,094 69,337
Less--Accumulated depreciation................................................. (1,193,236) (6,934)
-------------- -------------
Net property, plant and equipment.................................... 19,405,726 239,929
OTHER ASSETS:
Restricted cash collateral reserve............................................. 1,796,880 1,796,880
Prepaid franchise fees......................................................... 3,505,706 3,216,575
Debt issuance costs, net of amortization of $218,411........................... 7,668,414 --
Deferred franchise costs, net of amortization of $489,093 and $309,641,
respectively.............................................................. 463,989 587,615
Deferred mapping and design, net of amortization of $58,501 and $12,407,
respectively.............................................................. 79,450 62,037
Other deferred costs........................................................... 2,000 --
-------------- -------------
Total other assets................................................... 13,516,439 5,663,107
-------------- -------------
Total Assets........................................................ $ 262,732,604 $ 14,396,708
-------------- -------------
-------------- -------------
LIABILITIES AND PREFERRED AND COMMON EQUITY
CURRENT LIABILITIES:
Accounts payable............................................................... $ 6,691,683 $ 238,775
Other current liabilities...................................................... 1,756,916 --
Debentures payable............................................................. 52,702 --
Interest payable............................................................... 112,712 --
Accounts payable to associated company......................................... 138,080 138,080
-------------- -------------
Total current liabilities............................................ 8,752,093 376,855
NONCURRENT LIABILITIES:
Debentures payable............................................................. 28,849 81,551
Interest payable............................................................... 42,203 103,676
Senior discount notes, net of discount of $159,656,983......................... 203,478,017 --
-------------- -------------
Total noncurrent liabilities......................................... 203,549,069 185,227
-------------- -------------
Total Liabilities.................................................... 212,301,162 562,082
REDEEMABLE PREFERRED STOCK:
Class A convertible 8% cumulative preferred stock, no par value,
1,380.3 shares outstanding ................................................ -- 16,794,963
13 3/4% senior cumulative exchangeable preferred stock, .01 par value,
50,000 shares outstanding................................................... 46,492,812 --
-------------- -------------
Total................................................................ 46,492,812 16,794,963
SHAREHOLDERS' EQUITY:
Page 36
<PAGE>
Class A convertible 8% cumulative preferred stock, no par value,
1,548.5 shares outstanding................................................ 21,751,665 --
Voting common stock, no par value, 2,939,105.7, issued and outstanding,
550,362.2 shares of non-voting common stock issued and outstanding
and 1,741,738.9 secondary common share warrants outstanding at
March 31, 1998 and 2,374,343.6 shares of voting common stock outstanding,
1,161,307.6 secondary common share warrants outstanding and 1,000,966.8
initial and debt common share warrants (converted to voting and non-voting
common stock in 1998) at March 31, 1997 ................................... 10,356,136 5,946,904
Deficit........................................................................ (24,787,871) (5,522,830)
Related party purchase, in excess of cost...................................... (3,381,300) (3,381,300)
Unearned compensation.......................................................... -- (3,111)
-------------- -------------
Total Shareholders' Equity............................................ 3,938,630 (2,960,337)
-------------- -------------
Total Liabilities and Equity.......................................... $ 262,732,604 $ 14,396,708
-------------- -------------
-------------- -------------
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
Page 37
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Subscriber revenues..................... $ 189,023 $ 27,480 $ --
Operating expenses...................... 2,023,310 200,911 9,617
Selling, general and administrative
expenses.............................. 10,216,919 2,337,534 694,122
Depreciation and amortization........... 1,411,847 170,108 108,182
-------------- -------------- --------------
Operating loss..................... (13,463,053) (2,681,073) (811,921)
Amortization of issuance costs on senior
discount notes....................... (218,411) -- --
Interest income......................... 2,373,867 301,624 --
Interest expense........................ (3,722,947) (437,843) (214,688)
-------------- -------------- --------------
NET LOSS................................ (15,030,544) (2,817,292) (1,026,609)
Preferred stock requirements............ (4,234,463) (478,981) --
-------------- -------------- --------------
NET LOSS ATTRIBUTABLE to COMMON
SHARES............................. $(19,265,007) $(3,296,273) $(1,026,609)
-------------- -------------- --------------
-------------- -------------- --------------
Weighted average common shares
outstanding........................... 2,615,061 1,988,365 1,609,129
BASIC AND DILUTED LOSS PER WEIGHTED
AVERAGE SHARE...................... $ (7.37) $ (1.66) $ (.64)
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
Page 38
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED MARCH 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
CLASS A RELATED
COMMON PREFERRED PARTY
TOTAL STOCK STOCK DEFICIT PURCHASE
----------- ------ ----- ------- --------
<S> <C> <C> <C> <C> <C>
BALANCES, MARCH 31, 1995.... $(1,063,121) $ 138,001 $ -- $(1,199,948) $ --
Net loss.................... (1,026,609) -- -- (1,026,609) --
Stock issuances............. 350,000 350,000 -- -- --
Unearned compensation....... (8,000) -- -- -- --
Amortization of unearned
compensation............. 3,174 -- -- -- --
----------- ------ ----- ------- --------
BALANCES, MARCH 31, 1996.... (1,744,556) 488,001 -- (2,226,557) --
Net loss.................... (2,817,292) -- -- (2,817,292) --
Stock issuances............. 1,421,281 1,421,281 -- -- --
Accrued preferred stock
dividends................. (280,795) -- -- (280,795) --
Class A preferred stock
proceeds allocated to
related common share
warrants.................. 4,324,549 4,324,549 -- -- --
Class A preferred stock
issuance costs allocated
to related common shares
warrants.................. (286,927) (286,927) -- -- --
Preferred stock accretion... (198,186) -- -- (198,186) --
Amortization of unearned
compensation.............. 2,889 -- -- -- --
Related party purchase, in
excess of cost............ (3,381,300) -- -- -- (3,381,300)
----------- ------------ ------------ ------------ ------------
BALANCES, MARCH 31, 1997.... (2,960,337) 5,946,904 -- (5,522,830) (3,381,300)
Net loss (15,030,544) -- -- (15,030,544) --
Reclassification of
Class A preferred stock
to permanent equity....... 16,794,963 -- 16,794,963 -- --
Stock issuances............. 2,597,380 -- 2,597,380 -- --
Exchange of initial and
debt warrants for voting
and non-voting common
shares.................... -- -- -- -- --
Accrued preferred stock
dividends................. (973,958) -- 1,872,892 (2,846,850) --
Preferrred stock
accretion................. (87,014) -- 1,300,633 (1,387,647) --
Class A preferred stock
proceeds allocated to
related common share
warrants.................. -- 825,037 (825,037) -- --
Class A preferred stock
issuance costs allocated
to related common share
warrants.................. -- (10,834) 10,834 -- --
Exchangeable preferred
stock proceeds allocated
to related common shares
warrants.................. 2,700,000 2,700,000 -- -- --
Exchangeable preferred
stock issuance costs
allocated to related
common share Warrants..... (106,636) (106,636) -- -- --
Stock option accrual........ 972,865 972,865 -- -- --
Stock compensation.......... 28,800 28,800 -- -- --
Amortization of unearned
compensation.............. 3,111 -- -- -- --
----------- ------------ ------------ ------------ ------------
BALANCES, MARCH 31, 1998.... $ 3,938,630 $ 10,356,136 $ 21,751,665 $(24,787,871) $ (3,381,300)
----------- ------------ ------------ ------------ ------------
----------- ------------ ------------ ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
COMMON
UNEARNED COMMON SHARE PREFERRED
COMPENSATION SHARES WARRANTS SHARES
------------ ------ -------- ------
<S> <C> <C> <C> <C>
BALANCES, MARCH 31, 1995.... $(1,174) 1,508,000 -- --
Net loss.................... -- -- -- --
Stock issuances............. -- 175,000 -- --
Unearned compensation....... (8,000) -- -- --
Amortization of unearned
compensation............. 3,174 -- -- --
------------ ------ -------- ------
BALANCES, MARCH 31, 1996.... (6,000) 1,683,000 -- --
Net loss.................... -- -- -- --
Stock issuances............. -- 691,343.6 -- --
Accrued preferred stock
dividends................. -- -- -- --
Class A preferred stock
proceeds allocated to
related common share
warrants.................. -- -- 1,161,307.6 --
Class A preferred stock
issuance costs allocated
to related common shares
warrants.................. -- -- -- --
Preferred stock accretion... -- -- -- --
Amortization of unearned
compensation.............. 2,889 -- -- --
Related party purchase, in
excess of cost............ -- -- -- --
------ ----------- ----------- -------
BALANCES, MARCH 31, 1997.... (3,111) 2,374,343.6 1,161,307.6 --
Net loss -- -- -- --
Reclassification of
Class A preferred stock
to permanent equity....... -- -- -- 1,380.3
Stock issuances............. -- -- -- 168.2
Exchange of initial and
debt warrants for voting
and non-voting common
shares.................... -- 1,100,724.4 -- --
Accrued preferred stock
dividends................. -- -- -- --
Preferrred stock
accretion................. -- -- -- --
Class A preferred stock
proceeds allocated to
related common share
warrants.................. -- -- 141,561.3 --
Class A preferred stock
issuance costs allocated
to related common share
warrants.................. -- -- -- --
Exchangeable preferred
stock proceeds allocated
to related common shares
warrants.................. -- -- 438,870 --
Exchangeable preferred
stock issuance costs
allocated to related
common share Warrants..... -- -- -- --
Stock option accrual........ -- -- -- --
Stock compensation.......... -- 14,399.9 -- --
Amortization of unearned
compensation.............. 3,111 -- -- --
------ ----------- ----------- -------
BALANCES, MARCH 31, 1998.... -- 3,489,467.9 1,741,738.9 1,548.5
------ ----------- ----------- -------
------ ----------- ----------- -------
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
Page 39
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Net loss ................................................................. $ (15,030,544) $ (2,817,292) $ (1,026,609)
Adjustments to reconcile net loss to net cash
Provided by operating activities--
Depreciation and amortization ......................................... 1,411,847 170,108 108,182
Amortization of debt discount ......................................... 3,478,017 -- --
Amortization of issuance costs on senior discount notes................ 218,411 -- --
Stock compensation .................................................... 1,004,776 44,190 --
Interest expense related to debenture
conversions.......................................................... -- 147,533 168,762
Decrease/(Increase) in accounts receivable ............................ 103,121 (27,480) --
Decrease/(Increase) in prepayments .................................... (18,902) (149,250) --
Decrease/(Increase) in inventory, ..................................... (1,991,690) -- --
(Increase) in prepaid franchise fees .................................. (289,131) (3,216,575) --
(Increase) in deferred charges......................................... (121,333) (361,287) (338,887)
Change in intercompany receivable and
payable,net ......................................................... -- (372,819) 114,964
Increase in interest payable .......................................... 51,240 15,612 45,926
(Decrease)/Increase in accounts payable and other accrued liabilities.. 3,103,672 (119,707) 201,926
(Decrease)/Increase in notes payable .................................. -- (226,930) 111,961
Other ................................................................. -- 3,131 2,548
-------------- -------------- --------------
Net cash used in operating activities .................................... (8,080,516) (6,910,766) (611,227)
Cash flows from investing activities--
Purchase of held-to-maturity securities ............................... (10,000,000) -- --
Purchase of subscribers from affiliate ................................ -- (3,381,300) --
Capital expenditures .................................................. (15,665,047) (246,863) --
-------------- -------------- --------------
Net cash used by investing activities .................................. (25,665,047) (3,628,163) --
Cash flows from financing activities--
Payable to bank ..................................................... 419,068 -- --
Proceeds from senior discount notes ................................. 200,000,000 -- --
Issuance costs related to senior discount notes ..................... (7,886,825) -- --
Proceeds from issuance of exchangeable preferred stock, net of
issuance costs .................................................... 48,025,236 -- --
Cash paid for letters of credit ..................................... -- (1,796,880) --
Proceeds from issuance of debentures ................................ -- 153,660 266,765
Proceeds from issuance of Class A preferred stock,
net of issuance costs ............................................. 2,597,380 20,267,604 --
Proceeds from issuance of common stock............................... -- 144,531 342,000
-------------- -------------- --------------
Net cash provided by financing activities............................... 243,154,859 18,768,915 608,765
-------------- -------------- --------------
Net increase/(decrease) in cash ........................................ 209,409,296 8,229,986 (2,462)
Cash at beginning of period ............................................ 8,230,942 956 3,418
-------------- -------------- --------------
Cash at end of period .................................................. $217,640,238 $ 8,230,942 $ 956
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>
The accompanying notes to financial statements are an integral part of these
statements.
Page 40
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MARCH 31, 1998, 1997 AND 1996
1. DESCRIPTION OF BUSINESS:
21st Century Telecom Group, Inc. ("21st Century" or the "Company")
originally known as "21st Century Cable TV, Inc.", is a Chicago-based company
incorporated in October 1992. For the year ended March 31, 1998 the Company
is no longer considered to be in the development stage.
21st Century is an integrated, facilities-based communications company,
which seeks to be the first provider of bundled voice, video and high-speed
Internet and data services in selected midwestern markets beginning with
Chicago's Area 1. The City of Chicago has awarded the Company a 15-year
renewable franchise for Area 1. Area 1 stretches more than 16 miles along
Chicago's densely populated lakefront skyline and includes the affluent
residential neighborhoods of the Gold Coast, Lincoln Park and Dearborn Park and
the nation's second largest business and financial district. The Company has
developed (and has begun to install and activate) an advanced fiber optic
network that employs a Distributed Ring-Star architecture characterized by
fiber-richness, two-way interactivity and SONET-based redundancy and
self-healing attributes (the "DRS Network"). The DRS Network accommodates not
only traditional voice and video applications, but also the rapidly growing
demand for high-speed data services. The Company believes that its DRS Network
provides the Company with significant strategic advantages that differentiate
21st Century from its competitors, such as improved time-to-market, multiple
revenue streams, enhanced service quality and reliability, and the provisioning
of competitively-priced bundled services.
The Company has secured a 15-year renewable attachment agreement with the
Chicago Transit Authority (the "CTA"), which reduces costly and time-consuming
"make-ready" and underground construction for the DRS Network and enables the
Company to install and activate the DRS Network rapidly and efficiently by
taking advantage of access to the CTA's rail systems. The Company also has
secured pole attachment agreements with Commonwealth Edison Company (the
"Commonwealth Edison") and a subsidiary of Ameritech Corporation ("Ameritech")
which provide 21st Century access to scarce pole space within Area 1 to further
facilitate deployment of its DRS Network. The decentralized configuration of
the DRS Network, which includes distributed hubs and nodes that act
"intelligently" to route network traffic efficiently, together with the CTA and
the pole attachment agreements, enables network construction to be driven in
large part by market demand and revenue potential in contrast to the
conventional approach of building a system from the headend outward on a
block-by-block basis. To fully exploit this advantage, the Company's sales and
marketing strategy is coordinated with ongoing network construction and focused
on securing bulk contracts with 125-unit or larger multiple dwelling units
("MDUs"). The Company believes that this strategy will help to identify the
optimal sequence of node activation on the DRS Network and tie capital
expenditures directly to revenue-producing subscribers.
21st Century has taken significant steps to implement its business plan and
service offerings in Chicago's Area 1. In addition to securing the Area 1
franchise, the CTA attachment agreement and the Commonwealth Edison and
Ameritech pole attachment agreements, the Company has (i) constructed and
activated its network operations center ("NOC"), which includes a video headend
and a data operations center ("DOC"), (ii) completed the northern fiber
transport ring of the DRS Network, extending from the downtown business district
to the northern portions of the city bordering Evanston, (iii) completed tunnel
construction under the Chicago River and begun its southbound fiber transport
ring of the DRS network which will extend to 51st street, (iv) secured
programming content for approximately 170 channels of video and interactive
information programming, (v) constructed and activated portions of the outside
fiber distribution network to reach selected MDUs, (vi) initiated installation
processes, billing, call center and customer care services, (vii) secured
contracts for more than 4,800 residential subscribers (which includes
Page 41
<PAGE>
more than 3,000 new subscribers under 5-year bulk MDU agreements as well as
subscribers acquired in early 1997 from an affiliated company) and (viii)
passed with its initial distribution facilities more than 11,900 additional
potential subscribers. The Company has also entered into a letter of intent
for the acquisition and installation of the switching and other ancillary
equipment necessary for it to provide telephony services.
The company has been awarded a fifteen year renewable franchise by the
Village of Skokie, Illinois. The city boundaries of Skokie are contiguous with
a portion of the Chicago area 1 franchise and includes 23,000 homes, 2,800
businesses with 38,000 employees.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company's accounting and reporting principles conform to generally
accepted accounting principles.
CONSOLIDATION
The consolidated financial statements include two wholly-owned
subsidiaries. There have been no significant intercompany transactions or
activities within or between these subsidiaries through March 31, 1998.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents at March 31,1998 and March 31, 1997, consist of
cash on hand at certain banks as well as investments with maturities of 90
days or less. The investments are stated at cost, which approximates market
value. All investments were purchased in accordance with debt restrictions.
RECEIVABLES
Receivables are reflected at their net realizable value.
SHORT TERM INVESTMENTS
Short term investments are held to maturity and are stated at cost which
approximates market value. At March 31, 1998, short term investments consist
of a bank note with a fixed rate of interest that matures in December 1998.
This investment was purchased in accordance with debt restrictions.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined using the first-in, first-out method. Inventory consists
primarily of converters and modems.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at original cost of acquisition or
construction. Costs capitalized for constructed assets consist of direct
materials and labor. Interest incurred during construction has not been
capitalized, due to the short term nature of the construction projects.
Repairs of all property, plant and equipment and minor replacements and
renewals are charged to expense as incurred. Major replacements and
betterments are capitalized.
Page 42
<PAGE>
Property, plant and equipment depreciation is computed on a straight
line basis using estimated useful lives of three to seven years.
During fiscal 1998, leasehold improvements were depreciated on a
straight-line basis over the term of the lease, fifteen years. The Company began
to depreciate leasehold improvements in September 1997.
DEFERRED FRANCHISE COSTS
The Company has deferred franchise costs, including legal costs, associated
with the organization of its business and obtaining the franchises from the City
of Chicago and the Village of Skokie. Deferred franchise costs are being
amortized over five years.
DEFERRED MAPPING AND DESIGN COSTS
The Company has deferred certain mapping and design costs associated with
strand mapping the Area 1 region within the City of Chicago. Deferred mapping
and design costs are being amortized over three years.
DEBT ISSUANCE COSTS
Costs associated with the issuance of the Company's debt securities (see
Note 6) have been capitalized and are being amortized over five years, using the
effective interest rate method.
REVENUE RECOGNITION
The Company recognizes cable television revenues as services are provided
to subscribers.
OPERATING EXPENSES OTHER THAN INTEREST AND AMORTIZATION
From inception to March 31, 1996, operating expenses, except interest
and amortization, had been allocated from a related party through some common
ownership and common management, based on estimates of time spent by management
and employees of the related party on Company activities. The Company's Board of
Directors approved these allocations. The related party's Board of Directors
did not formally approve these allocations. However, at the time the allocations
were made, the Company's and the related company's Boards contained
substantially the same individuals. For the year ended March 31, 1996, the
Company also recognized 100% of expenses paid by the related party on behalf of
the Company, as well as 100% of expenses incurred by the Company. Effective
April 1, 1996, the Company began recognizing and paying substantially all of its
own expenses. Therefore, for the years ended March 31, 1998 and 1997, there were
no allocations.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company adopted Statement of Financial Accounting Standard (SFAS)
No. 123, "Accounting for Stock-Based Compensation," for disclosure purposes.
However, it continues to recognize compensation cost based on Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees."
The fair value disclosures required by SFAS No.123 are shown in Note 11.
Page 43
<PAGE>
EARNINGS PER SHARE
For the twelve months ended March 31, 1998, 1997 and 1996, per share
amounts were based on weighted average common shares outstanding of 2,615,061,
1,988,365 and 1,609,129 shares, respectively.
Effective for the twelve months ended March 31, 1998, the Company adopted
FAS No. 128, "Earnings per Share". The retroactive adoption of this standard
for March 31, 1998, 1997 and 1996 did not have an impact on the denominator of
the basic loss per common share given the anti-dilutive effects of including
potential common shares in the denominator of the diluted earnings per share
calculation. At March 31, 1998, these potential common shares included the
following: (1) 1,302,868.9 common share warrants related to the Class A
Convertible 8% Cumulative Preferred Stock, (2) 438,870 common share warrants
related to 13 3/4% Senior Cumulative Exchangeable Preferred Stock, (3)
1,250,000 options issued in connection with certain Directors' guarantee of a
loan, (4) 287,829.9 employee vested stock options, (see Note 11), and (5)
18,994.7 common share warrants issued to a financial advisor. The net loss
attributable to common shares on which the basic earnings per share calculation
is based, reflects the net loss increased by the amount of preferred dividends
and accretion related to the Class A Convertible 8% Cumulative Preferred Stock
and 13 3/4% Senior Cumulative Exchangeable Preferred Stock.
At March 31, 1997, these potential common shares included the following:
(1) 1,161,307.6 common share warrants related to the Class A Convertible 8%
Cumulative Preferred Stock, (2) 1,000,966.8 shares of voting and non-voting
common stock which replaced the initial and debt warrants associated with the
Class A Convertible 8% Cumulative Preferred Stock as discussed in Note 4, (3)
1,250,000 options issued in connection with certain Directors' guarantee of a
loan, and (4) 18,994.7 stock warrants issued to a financial advisor. At
March 31, 1996, these potential common shares included 627,199.5 shares
related to convertible debentures. The net loss attributabe to common shares
on which the basic earnngs per share calculation is based for the year ended
March 31, 1997, reflects the net loss increased by the amount of preferred
dividends and accretion related to the Class A Convertible 8% Cumulative
Preferred Stock.
CASH FLOW INFORMATION
For the periods ending March 31, 1998, 1997 and 1996, the Company has not
paid any income taxes. For the years ending March 31, 1998 and 1997, the Company
paid $193,922 and $274,993, respectively, in interest. For the period ending
March 31, 1996, no interest was paid.
USE OF ESTIMATES
The preparation of 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 expenses during the reporting period.
Actual results could differ from those estimates.
LONG-LIVED ASSETS
The Company periodically reviews the values assigned to long-lived
assets such as property, plant and equipment and identifiable intangibles to
determine whether any impairments are other than temporary. If the impairment
is permanent, a loss is recognized. No impairment losses have been recognized
by the Company.
Page 44
<PAGE>
DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount reported in the balance sheets for cash and cash
equivalents, accounts receivable, short term investments, accounts payable
and other current liabilities approximates fair value because of the
short-term maturity of these financial instruments. The carrying amounts
reported in the balance sheet for the 12 1/4% Senior Discount Notes and 13
3/4% Senior Cumulative Exchangeable Preferred Stock approximate fair value
given the issuance of the debt and preferred stock in close proximity to the
balance sheet date.
RECLASSIFICATIONS
Certain prior year balances have been reclassified to conform with the
current year presentation.
3. PROPERTY PLANT AND EQUIPMENT
The components of property, plant and equipment follow:
<TABLE>
<CAPTION>
ESTIMATED LIFE
1998 1997 (YEARS)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Transmission and Distribution Systems $14,994,770 $ - 3 - 7
Leasehold Improvements 4,010,868 177,526 15
Other Equipment 641,825 69,337 3 - 5
Furniture and Fixtures 403,702 - 3 - 5
Construction in Progress 547,797 - N/A
----------- --------
Property, Plant and Equipment, at cost 20,598,962 246,863
Less Accumulated Depreciation (1,193,236) (6,934)
----------- --------
Net Property Plant and Equipment $19,405,726 $239,929
----------- --------
----------- --------
</TABLE>
Depreciation and amortization expense related to property, plant and
equipment for March 31, 1998, 1997 and 1996 was $1,186,302, $6,934, and zero,
respectively.
4. PREPAID FRANCHISE FEES:
The Company was required to prepay $3,000,000 of franchise fees within
120 days of being awarded the franchise by the City of Chicago. In accordance
with the franchise agreement, the prepaid franchise fees earn interest for the
period outstanding at a rate equal to the Company's cost of borrowed funds. The
borrowing rate of the Company, at the time of the prepayment, was 10%. The
interest accrued on the prepaid franchise fees for the years ended March 31,
1998 and 1997, amounted to $299,994 and $216,575, respectively. These prepaid
franchise fees are reduced as revenues are billed to customers.
5. RELATED-PARTY TRANSACTIONS:
Page 45
<PAGE>
The Company is related through some common ownership and common
management to 21st Century Technology Group, Inc. (Technology).
Activities pertaining to the Company's development from its inception
date to March 31, 1996, have, for the most part, been intermingled with the
activities of Technology. As discussed in Note 2, from inception to March 31,
1996, operating expenses, except interest and amortization, have been allocated
to the Company based on estimates of time spent on the Company's activities by
employees of Technology. The net related affiliate payable to Technology was
$138,080 at March 31, 1998 and 1997.
In January 1997, the Company purchased Technology's Area 1 subscriber
base and related equipment for $3,381,300. As this is considered to be a related
party transaction, the Company could only capitalize Technology's book value of
the purchased subscribers and the related equipment. As Technology's book value
was zero at the time of purchase, the entire purchase price is shown as a
reduction to shareholders' equity.
In January 1997, the Company paid approximately $459,000 of accrued legal
fees to one of its directors, either individually or to entities controlled by
him, for legal services rendered by him to the Company in connection with the
Company's cable service offering and its obtaining the Chicago franchise.
6. DEBT:
A summary of debt outstanding at March 31, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
1998 1997
------------- -----------
<S> <C> <C>
Convertible Subordinated Debentures, Series 1, 25%, due 1998 ............ $ 52,702 $ 52,702
Convertible Subordinated Debentures, Series 2, 25%, due 1999 ............ 28,849 28,849
12 1/4% Senior Discount Notes Due 2008 .................................. 203,478,017 --
------------- -----------
Total................................................................. $ 203,559,568 $ 81,551
------------- -----------
------------- -----------
</TABLE>
CONVERTIBLE SUBORDINATED DEBENTURES
Prior to February 1,1997, all subordinated debentures were convertible
to common stock based on a conversion ratio of $2 to 1 share of common stock.
Conversion of $147,298 of the Series 1 convertible debentures occurred
on May 17, 1996. Conversion of $111,151 of the Series 2 convertible
debentures occurred on April 28, 1996. Conversion of $150,000 of the Series 3
convertible debentures occurred on November 14, 1996. Conversion of $200,000
of the Series 4 convertible debentures and $196,854 of the Series 5
convertible debentures occurred on January 31, 1997.
Total debenture conversions to common stock for Series 1 through 5
convertible debentures resulted in the issuance of 616,280 additional shares
of common stock between April 1996 and January 1997. (See "Common Shares"
footnote for conversion effects on common shares outstanding.) Subsequent to
January 31,1997, these debentures are no longer convertible.
12 1/4% SENIOR DISCOUNT NOTES DUE 2008
Page 46
<PAGE>
On February 9, 1998, the Company issued $363,135,000 of 12 1/4% Senior
Discount Notes due 2008. The proceeds from the issue were $200,000,000 which
represent a yield to maturity on the Notes of 12 1/4% (computed on a
semi-annual bond equivalent basis). The discount and issuance costs are
being amortized through February 15, 2003, using the effective interest rate
method. Thereafter, cash interest accrues until the notes mature in 2008.
For the year ending March 31, 1998, the amortized discount totalled
$3,478,017. Issuance costs for the transaction totalled $7,886,825. The
amount of amortization recognized in the year ended March 31, 1998 was
$218,411. The notes are unsecured obligations.
The notes are redeemable at the Company's option in whole or part, on
February 15, 2003, 2004 and 2005, at a redemption price of 106.1250, 104.0833
and 102.0417, respectively and at the principal amount thereafter. The
redemption price would also include accrued interest earned through the date
of redemption.
Upon a Change of Control, each holder of Notes may require the Company
to purchase all or any portion of such holder's Notes at a purchase price
equal to 101% of the Accreted Value thereof plus accrued and unpaid interest,
if any, to the date of purchase. Accreted value means, as of any date, the
amount for each $1,000 principal amount at maturity of the Senior Discount
Notes as specified in the terms of the Notes.
The notes include certain restrictive covenants relating to, among
other things, limitations on additional indebtedness, payment of dividends,
investment options, asset sales, liens on assets and mergers and
consolidations. The Company is in compliance with the covenants at March 31,
1998.
OTHER
During the period August 1994 to March 1996, the Company signed a
series of promissory notes aggregating $226,930 at March 31, 1996, with
Kubasiak, Cremieux, Flystra & Reigers, P.C. (Kubasiak). These notes accrued
interest at a rate of 9% and were due between February 1, 1995, and September
1, 1996. On July 1, 1996, Kubasiak canceled its notes that were outstanding
as of March 31, 1996, along with additional notes issued through June 1996,
and consolidated them into a single note, due January 2, 1997. This new note
was paid in full on December 31, 1996.
7. CLASS A CONVERTIBLE 8% CUMULATIVE PREFERRED STOCK:
<TABLE>
<CAPTION>
PREFERRED
SHARES AMOUNT
----------- -----------
<S> <C> <C>
March 31, 1996..................... -- --
January 30, 1997
Proceeds................. 1,380.3 $17,475,451
Issuance costs........... -- (1,159,469)
Accrued dividends........ -- 280,795
Accretion................ -- 198,186
----------- -----------
March 31, 1997..................... 1,380.3 16,794,963
September 23, 1997
Proceeds................. 63.3 819,439
Issuance costs........... -- (49,166)
November 20, 1997
Proceeds................. 9.5 121,842
January 20, 1998
Page 47
<PAGE>
Proceeds................. 95.4 891,062
Accrued dividends.................. -- 1,872,892
Accretion.......................... -- 1,300,633
----------- -----------
March 31, 1998..................... 1,548.5 $21,751,665
----------- -----------
----------- -----------
</TABLE>
On January 30, 1997 several investors contracted with the Company to purchase
1,380.3 shares of the Company's Class A Convertible 8% Cumulative Preferred
Stock and initial, secondary and debt warrants for a purchase price of
$15,793.84 per share, totaling $21.8 million. A portion of the initial purchase
price was allocated to the common share warrants. The allocation was based on
the market value of the common stock at the date of the sale of the Class A
Convertible 8% Cumulative Preferred Stock and the number of related secondary
warrants, initial warrants and debt warrants associated with such preferred
stock. The fair market value of the common stock at the date of the sale was
estimated to be $2 per share. The number of secondary warrants associated with
the initial purchase amounted to 1,161,307.6. The number of initial and debt
warrants associated with the initial purchase was based on the number of voting
and non-voting common shares that these warrants were replaced with as a result
of a subsequent amendment to the related stock purchase agreement as discussed
below. These initial and debt warrants were replaced with 1,000,966.8 shares of
voting and non-voting common stock. This allocation resulted in $4,324,549 and
$17,475,451 being recorded as common stock and redeemable preferred stock,
respectively, at March 31, 1997. Issuance costs of $1,446,396 were incurred in
conjunction with the sale of the Class A Convertible 8% Cumulative Preferred
Stock. These issuance costs were allocated between the Class A Convertible 8%
Cumulative Preferred Stock and the related warrants based on the relative
portions of the proceeds allocated to each. The carrying value of the Class A
Convertible 8% Cumulative Preferred Stock is being accreted to its redemption
value (using the effective interest method) over the four year period from the
date of the original preferred stock purchase agreement to the date the stock
became mandatorily redeemable under the original agreement or the date at which
the Class A preferred shareholders can compel sale of the Company under the
amended agreement, both dates being January 30, 2001. The Class A convertible
8% Cumulative Preferred Stock is recorded on the balance sheet at the allocated
portion of the purchase price paid by investors, less the allocated portion of
the issuance costs, plus accrued and unpaid preferred stock dividends, plus
accretion. At March 31, 1997, certain of the provisions of the agreement were
as follows:
- Each preferred share is convertible into one thousand common shares.
- Dividends accrue daily on the aggregate amount paid at an
annual rate of 8%. Unpaid dividends compound on a semi-annual basis
on June 30 and December 31. At the consummation of a qualified
public offering, all accrued and unpaid dividends would be
converted into common stock without the issuance of additional
shares. A qualified public offering is one in which (1) the public
purchases at least $25 million of common stock, (2) the price per
share paid is at least twice the liquidation value per share of the
Class A Convertible 8% Cumulative Preferred Stock, (3) the common
stock is traded on a national exchange or The Nasdaq Stock Market,
and (4) the shares issued and sold represent at least 20% of the
common stock outstanding after the public offering.
- Upon consummation of a qualified public offering, all
preferred shares are required to be converted into common shares.
- At any time after the fourth anniversary of the date of the
purchase and before the earlier of the date of the consummation of
a qualified public offering or the seventh anniversary of the date
of the purchase, each holder of the stock has the right from time
to time to require the Company to repurchase all, but not less than
all, of their shares held (the put arrangement). The shares would
be repurchased by the Company for the greater of: (1) the purchase
price paid by the holder of the stock, plus all accrued and unpaid
dividends, or (2) the market value of the shares.
Page 48
<PAGE>
- "Initial Warrants" were granted to the investors who may
increase their ownership percentage up to another 12%.
These warrants expire on May 31, 2008. The warrants are exercisable at
$.000001 per share of common stock only if the Company does not
meet certain pre-established performance indicators. The Company
has until May 31, 1998 to meet these performance indicators.
- "Secondary Warrants" to purchase up to 1,331,774.8 shares
of common stock at $.000001 per share of common stock were also
granted to the investors. These secondary warrants expire on
January 30, 2007.
- "Debt Warrants", in addition to the initial and secondary
warrants discussed above, will vest to the new investors if the
Company does not receive Board of Director approval by July 31,
1997, for a $50 million senior debt financing arrangement. Under
this provision the Company is to issue warrants to purchase shares
representing 2% of the outstanding common stock on the first day of
each month until the definitive document with respect to such debt
is in place. Any such warrants issued would expire ten years from
the date of issue. Any debt warrants would also be exercisable at
$.000001 per share of common stock.
During December 1997, the Company and its Class A Convertible 8%
Cumulative Preferred Stock shareholders negotiated a number of changes to the
original Stock Purchase Agreement. These changes were formally ratified on
January 8 and 14, 1998. The original put arrangement as discussed above was
removed and was replaced by the right of the Class A preferred shareholders to
require the sale of the Company. The new provision provides that at any time and
from time to time after the fourth anniversary of the date of issuance of the
senior discount notes and senior cumulative exchangeable preferred stock and
ending on the earlier to occur of the consummation of a qualified public
offering and the seventh anniversary of the date of issuance of the senior
discount notes, the Class A preferred shareholders have the right to require the
sale of the Company. The liquidation value of the preferred stock is the sum of
the original cost plus any accrued and unpaid dividends. The right to obtain
additional common shares under the initial warrant and debt warrant provisions
as discussed above was removed and was replaced by an agreement to increase the
Class A preferred shareholders ownership on a fully diluted basis by an
additional 8% by issuing additional common stock. One-half of this additional
stock is voting and the other half is non-voting. A portion of the proceeds
and issuance costs associated with the sale of the Class A Convertible 8%
Cumulative Preferred stock were allocated to the initial and debt warrants and
reflected in common stock at March 31, 1997.
In addition, the holders of the Class A preferred stock are collectively
in a position to control the taking of many significant corporate actions by the
Company, including the making of any significant capital commitments, the
incurrence of any significant indebtedness, merger and the payment of dividends
on the common stock, pursuant to agreements which provide that prior to taking
such actions, the Company will need to obtain the approval of the nominees to
the Board of Directors of the holders of the Class A preferred stock. These
rights have been modified by the covenants related to the 12 1/4% Senior
Discount Notes (see Note 6).
Of the $21.8 million for the related January 30, 1997 sale, $21.7 million
was received by March 31, 1997, with the remainder received by April 22, 1997.
The purchase resulted in the preferred shareholders having an approximate 37%
ownership interest in the Company on a fully diluted basis excluding the
contingently issuable common shares from the exercise of the initial warrants
and the debt warrants. The proceeds from this preferred stock offering were used
to (1) repay a $5 million revolving credit note to LaSalle Northwest National
Bank, (2) purchase the subscriber base of a related party located in the Chicago
franchise area for $3,381,300, (3) retire existing Company debt and accounts
payable in the amount of $541,166, and (4) pay transaction costs of $1,446,396.
The balance of the proceeds were used
Page 49
<PAGE>
for working capital and capital expenditures to build the network, operating
center and network infrastructure.
On September 23 and November 20, 1997 and January 20, 1998, several
investors contracted with the Company to purchase 63.3, 9.5 and 95.4 shares,
respectively, of the Company's Class A Convertible 8% Cumulative Preferred
Stock and initial, secondary and debt warrants for a purchase price of
$15,793.84 per share, totaling approximately $2.6 million. A portion of the
initial purchase price was allocated to the common share warrants. The
allocation was based on the market value of the common stock at the date of
the sale of the Class A Convertible 8% Cumulative Preferred Stock and the
number of related secondary initial and debt warrants associated with such
preferred stock. The fair market value of the common stock at the date of the
sale was estimated to be $2 per share for the September 23 and November 20,
1997 sales and $4.50 per share for the January 20, 1998 sale. The number of
secondary warrants associated with the three purchases amounted to 53,271,
7,990, and 80,300 respectively. The number of initial and debt warrants
associated with the three purchases was based on the number of voting and
non-voting common shares that these warrants were replaced with as a result
of the amendment to the related stock purchase agreement as discussed above.
These initial and debt warrants were replaced with 37,009, 6,089 and 56,660
shares of voting and non-voting common stock respectively. This allocation
resulted in $180,561, $28,158 and $616,318 being recorded as common stock on
the three sales dates respectively and $819,439, $121,842 and $891,062 being
recorded as class A preferred stock on the three sales dates, respectively.
Issuance costs of $60,000 were incurred in conjunction with the sale of the
Class A Convertible 8% Cumulative Preferred Stock on September 23, 1997.
These issuance costs were allocated between the Class A Convertible 8%
Cumulative Preferred Stock and the related warrants based on the relative
portions of the proceeds allocated each. The purchases were based on the
same terms as those previously mentoned for the $21.8 million preferred stock
issuance.
8. 13 3/4% SENIOR CUMULATIVE EXCHANGEABLE PREFERRED STOCK
<TABLE>
<CAPTION>
PREFERRED
SHARES AMOUNT
--------- -----------
<S> <C> <C>
February 9, 1998
Proceeds ........................... 50,000 $47,300,000
Issuance costs ..................... -- (1,868,126)
Accrued dividends ........................ -- 973,924
Accretion ................................ -- 87,014
--------- -----------
March 31, 1998 ........................... 50,000 $46,492,812
--------- -----------
--------- -----------
</TABLE>
On February 9, 1998, 50,000 shares of 13 3/4% Senior Cumulative Exchangeable
Preferred Stock Due 2010 and related common share warrants were issued. The net
proceeds received were $48,025,236. The Exchangeable Preferred Stock will rank
senior to all other classes of equity securities of the Company.
The value of the 438,870 common stock warrants issued, $2,605,000, has been
allocated to common shareholders' equity (see Note 9).
The carrying value of the 13 3/4% Senior Cumulative Exchangeable
Preferred Stock is being accreted to its redemption value (using the
effective interest method) over the five year period from the date of issue
to the date the stock first becomes redeemable, February 15, 2003. The 13
3/4% Senior Cumulative Exchangeable Preferred Stock is recorded on the
balance sheet at the allocated portion of the purchase price paid by
investors, less the allocated portion of the issuance costs, plus accrued and
unpaid dividends, plus accretion.
On or prior to February 15, 2001, the Company may redeem in whole but not
in part, the outstanding Exchangeable Preferred Stock at a redemption price
of 113 3/4% of the liquidation preference ($1,000 per share) plus accumulated
unpaid dividends to date of redemption with the net proceeds of an Equity
Offering. An equity offering means either (a) an underwritten primary public
offering of common stock of the Company pursuant to an effective registration
statement under the Securities Act or (b) a primary
Page 50
<PAGE>
offering of capital stock (other than disqualified stock) of the Company to
one or more persons primarily engaged in related business. On February 15,
2003, 2004, 2005 and 2006 (and thereafter), at a redemption price of
106.8750%, 104.5833%,102.2917% and 100%, respectively, of the liquidation
preference ($1,000 per share) plus accumulated unpaid dividends, the
Exchangeable Preferred Stock may be redeemed in whole, or in part, at the
Company's option. On February 15, 2010, the Exchangeable Preferred Stock is
mandatorily redeemable.
In the event of a change of control, the Company shall offer to
purchase all outstanding shares of Exchangeable Preferred Stock, in whole or in
part, at a purchase price equal to 101% of the aggregate liquidation preference
($1,000 per share) thereof, plus accumulated and unpaid dividends, if any to the
date of purchase.
Dividends are payable quarterly on February 15, May 15, August 15 and
November 15. Dividends are payable in cash except that on or prior to February
15, 2003, dividends may be paid by the issuance of additional shares of
Exchangeable Preferred Stock at the Company's option.
The restrictive covenants are similar to those indicated for the 12 1/4%
Senior Debenture Notes in Note 6 apply to the Exchangeable Preferred Stock. The
Company is in compliance with these covenants at March 31, 1998.
9. COMMON SHARES
On January 9, 1998, the common shareholders approved an amendment to the
Articles of Incorporation to increase the number of authorized common shares to
50,000,000 from 1,000,000. On the same date, the directors of the Company
declared a 1,000 for 1 share split of the Company's issued and outstanding
common shares. All common share amounts and per share amounts have been restated
to reflect this amendment and related split.
On January 9, 1998, the Company obtained the approval of the common
shareholders for an amendment to the Articles of Incorporation to authorize
1,000,000 shares of non-voting common stock.
At March 31, 1998 and 1997, the Company had 50,000,000 shares of no par
common stock authorized, of which 3,489,467.9 and 2,374,343.6 are issued and
outstanding, respectively.
Changes in the Company's common shares and related amounts during the
three years ended March 31, 1998, are as follows:
<TABLE>
<CAPTION>
COMMON
SHARES AMOUNT
-------- -----------
<S> <C> <C>
March 31, 1995....... 1,508,000.0 $ 138,001
September 20, 1995............. 171,000.0 342,000
October 17, 1995............... 4,000.0 8,000
-------- -----------
March 31, 1996....... 1,683,000.0 488,001
April 28, 1996................. 84,490.0 168,980
May 17, 1996................... 146,540.0 293,080
November 14, 1996.............. 115,410.0 230,820
January 28, 1997............... 75,063.6 188,721
January 30, 1997............... -- 4,037,622
Page 51
<PAGE>
January 31, 1997............... 269,840.0 539,680
----------- -----------
March 31, 1997............. 2,374,343.6 5,946,904
September 23, 1997............. -- 169,727
November 20, 1997.............. -- 28,158
January 20, 1997............... 1,100,724.4 --
January 20, 1998............... -- 616,318
February 9, 1998............... -- 2,593,364
February 9, 1998............... 14,399.9 28,800
Compensation expense related
to stock option plan -- 972,865
----------- -----------
March 31, 1998.............. 3,489,467.9 $10,356,136
----------- -----------
----------- -----------
</TABLE>
On September 20, 1995, the Company sold 171,000 shares of common stock to
various third-party investors for $342,000 at an estimated fair value of $2 per
share. On October 17, 1995, the Company issued 4,000 shares of restricted stock,
to an officer of the Company, at an estimated fair value of $2 per share.
As discussed earlier, Series 1 through 5 of the Company's convertible
debentures were converted to common stock throughout the year ended March 31,
1997. On April 28, 1996, debenture conversions of $111,151 in principal and
$57,829 in related interest resulted in the issuance of 84,490 shares of common
stock. On May 17, 1996, debenture conversions of $147,298 in principal and
$145,782 in related interest resulted in the issuance of 146,540 shares of
common stock. On November 14, 1996, debenture conversions of $150,000 in
principal and $80,820 in related interest resulted in the issuance of 115,410
shares of common stock. On January 31, 1997, debenture conversions of $396,854
in principal and $142,826 in related interest resulted in the issuance of
269,840 shares of common stock. The impacts of these noncash financing
activities are not included in the net cash provided or used by operating or
financing activities in the statements of cash flows.
The Company also had an arrangement with a law firm to compensate it for
its professional services by issuing 2,797.9 shares of common stock to it at a
per share price of $15.79, which was based upon the offering price of the
Company's preferred stock offering discussed below. The shares were issued on
January 28, 1997.
Also on January 28, 1997, certain shareholders of a related party were
allowed to purchase shares of the Company's common stock with the proceeds from
their loan repayment from the related party. This transaction resulted in the
issuance of 72,265.7 shares of additional common stock, at $2 per share.
As discussed in Note 7, portions of the proceeds and issuance costs
associated with the January 30, 1997 sale of Class A Convertible 8% Cumulative
Preferred Stock were allocated to the related common share warrants. This
allocation resulted in a net amount of $4,037,622 being recorded as common
equity at March 31, 1997 (see Note 7 for additional discussion related to the
allocation of the proceeds and issuance costs). Certain of the common stock
warrants were replaced with voting and non-voting common stock. These shares
were reflected as outstanding on January 20, 1998.
In order to prepay the City's franchise fees, mentioned above, the
Company requested and received a $5 million Loan and Security Agreement on June
21, 1996, with LaSalle Northwest National Bank which expired on January 1, 1997.
The Company paid the loan including interest on January 31, 1997. Certain
members of the Company's Board of Directors had individually guaranteed the full
line of credit. The Company, in return for the Directors' guarantees, issued to
the Directors options to acquire 1,250,000
Page 52
<PAGE>
additional common shares of the Company, at a price of $4 per share,
exercisable until the expiration date of June 30, 2006. As of March 31, 1998,
all options are outstanding.
In February 1997, the Company issued stock warrants representing
18,994.7 shares to its financial advisor at an exercise price of $15.79,
aggregating $300,000. The exercise price was based upon the offering price of
the Company's preferred stock offering previously discussed. As of March 31,
1997, all warrants are outstanding.
Also discussed in Note 7, portions of the proceeds and issuance costs
associated with the September 23 and November 20, 1997 and January 20, 1998
sales of Class A Convertible 8% Cumulative Preferred Stock were allocated to
the related common share warrants. These allocations resulted in net amounts
of $169,727, $28,158 and $616,318 being recorded as common equity on
September 23 and November 20, 1997 and January 20, 1998 respectively (see
Note 7 for additional discussion related to the allocation of the proceeds
and issuance costs). Certain of the common stock warrants were replaced with
voting and non-voting commom stock. These shares were reflected as outstanding
on January 20, 1998.
On January 20, 1998, as a result of the amended Class A Convertible 8%
Cumulative Preferred Stock purchase agreement (formally ratified in January
1998 and discussed in Note 7) 550,362.2 voting and 550,362.2 non-voting
shares were effectively issued. These shares replaced the initial and debt
warrants associated with the Class A Preferred Stock. The value associated
with these warrants was recorded on the related purchase dates of the
Preferred Stock: January 30, September 23, and November 20, 1997, and January
20, 1998.
On February 9, 1998, certain Company officers received common shares as
part of their compensation. Total shares issued were 14,399.9 at $2 per
share. Also on February 9, 1998, as discussed in Note 8, portions of the
proceeds and issuance costs from the sale of 13 3/4% Exchangeable Preferred
Stock were allocated to the related common share warrants.
During 1998, as a result of the stock based compensation plan (see Note
11) 287,829.9 shares were vested to certain officers. Compensation expense
recognized per option was $3.38.
10. RESTRICTED STOCK AWARDS:
The Company awarded restricted stock to certain officers. The restricted
shares vest over a 33-month period. Vested shares were subject to certain
transfer restrictions and forfeiture under certain circumstances. Unearned
compensation, representing the fair value of the stock on the date of award
(estimated at $2 by management), was amortized to salary expense over the
vesting period. During the period from inception to March 31, 1994, 8,000 shares
of restricted stock were issued and were fully vested on March 31, 1996. In
October 1995, an additional 4,000 shares of restricted stock were awarded.
During year ended March 31, 1998, the awarded unvested shares were forfeited.
Page 53
<PAGE>
11. STOCK BASED COMPENSATION PLANS
Effective January 30, 1997, the Company established a common stock option
plan. No options were granted under the plan until October 14, 1997. 728,667.8
options were originally granted under the terms of the plan. The options vest
over 48 months and expire after ten years. The vesting period starts from the
date of employment with the beginning vesting dates ranging from November 11,
1992 to December 26, 1997. The Company accounts for the plans under APB Opinion
No. 25, under which $972,865 of compensation expense was recognized in the year
ended March 31, 1998 relating to stock option awards to employees. Had
compensation cost for such stock option awards under the plan been determined
consistent with SFAS No. 123, the Company's net loss, net loss attributable to
common shares and basic and diluted loss per share would have been increased to
the following pro forma amounts:
<TABLE>
<CAPTION>
1998
-----
<S> <C> <C>
Net Loss: As Reported ($15,030,544)
Pro Forma ($15,102,676)
Net Loss Attributable to As Reported ($19,265,007)
Common Shares: Pro Forma ($19,337,139)
Basic and Diluted As Reported ($7.37)
Loss per Share: Pro Forma ($7.39)
</TABLE>
A summary of the status of the Company's stock option plan at March 31,
1998 and changes during the year is presented below:
<TABLE>
<CAPTION>
1998
------
Wtd Avg. Wtd Avg
Shares Ex Price Fair Value
--------- --------- ----------
<S> <C> <C> <C>
Outstanding at beginning of year -- -- --
Granted 728,667.8 1.12 4.50
Exercised -- -- --
Forfeited 36,433.2 1.12 4.50
Expired -- -- --
Canceled -- -- --
---------
Outstanding at end of year 692,234.6
---------
Exercisable end of year 287,829.9
</TABLE>
Page 54
<PAGE>
The 728,667.8 options granted in fiscal year 1998 have an exercise price
of $1.12, with a weighted average remaining contractual life of 9.6 years. At
March 31, 1998, 287,829.9 options were exercisable.
The fair value of each option grant is estimated at the beginning of the
vesting period (date of employment) using the Minimum Value option pricing
model with the following weighted-average assumptions used for the option
grants in 1998: risk-free interest rate of 6.4 percent; expected dividend
yields of zero percent; expected life of ten years; expected volatility of
zero percent. Zero percent volatility is used as the company's common stock
is not publicly traded.
12. INCOME TAXES:
The Company uses an asset and liability approach to account for income
taxes. Deferred income taxes (credit) reflect the impact of temporary
differences between amounts of assets and liabilities for financial reporting
purposes and such amounts as measured by tax laws. These temporary
differences are determined in accordance with Statement of Financial
Accounting Standards (FAS) No. 109, "Accounting for Income Taxes." The
temporary differences and net operating loss carryforward, which give rise to
deferred tax assets at March 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
MARCH 31, 1998 MARCH 31, 1997
DEFERRED TAX DEFERRED TAX
ASSET/(LIABILITY) ASSET/(LIABILITY)
----------------- ---------------
<S> <C> <C>
Accrued vacation...................... $ 77,357 $ --
Stock option expense.................. 386,227 --
Property, plant and equipment
depreciation expense................ (588,411) --
Accretion of discount on senior
discount notes...................... 1,374,974 --
Amortization of debt issuance costs
related to senior discount
notes............................... 43,297 --
Net operating loss carryforward ...... 6,619,846 1,969,962
Valuation allowance .................. (7,913,290) (1,969,962)
----------------- ---------------
$ -- $ --
----------------- ---------------
----------------- ---------------
</TABLE>
The provision (credit) for income taxes is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
-------------- -------------- ---------------
<S> <C> <C> <C>
Current--
Federal ...... $ -- $ -- $ --
State ........ -- -- --
Deferred--
Federal ...... (4,850,473) (896,666) (327,033)
State ........ (1,092,854) (202,026) (73,683)
-------------- -------------- ---------------
(5,943,327) (1,098,692) (400,716)
Valuation allowance .... 5,943,327 1,098,692 400,716
-------------- -------------- ---------------
$ -- $ -- $ --
-------------- -------------- ---------------
-------------- -------------- ---------------
</TABLE>
Page 55
<PAGE>
The income tax provision (credit) differs from amounts at the statutory
federal income tax rate as follows:
<TABLE>
YEAR ENDED YEAR ENDED YEAR ENDED
MARCH 31, 1998 MARCH 31, 1997 MARCH 31, 1996
-------------- -------------- ----------------
<S> <C> <C> <C>
Income tax provision (credit) at
statutory rate .............. $ (5,260,690) $ (986,052) $ (359,313)
Meals and entertainment ........ 14,993 19,210 6,642
Disallowed portion of original
issue discount on senior
discount notes................. 5,799 -- --
State income taxes ............. (703,429) (131,850) (48,045)
Valuation allowance ............ 5,943,327 1,098,692 400,716
-------------- -------------- ----------------
Income tax provision (credit) as
reported .................... $ -- $ -- $ --
-------------- -------------- ----------------
-------------- -------------- ----------------
</TABLE>
At March 31, 1998, the Company had cumulative tax net operating loss
carryforwards aggregating $19,835,995 expiring between 2009 and 2013. At March
31, 1998, the Company had recorded a valuation allowance related to its net
deferred tax assets aggregating $7,913,289.
13. COMMITMENTS AND CONTINGENCIES:
The Company obtained two letters of credit totaling $1,796,880. The
first letter, for $500,000, was obtained as part of the Chicago franchise
agreement mentioned earlier. The second letter is for the benefit of the
Merchandise Mart totaling $1,296,880 and was obtained in place of a security
deposit related to the Merchandise Mart lease. These letters of credit are
fully collateralized by cash, which is reflected as a restricted cash
collateral reserve on the balance sheet. The Company invests the cash in
commercial paper which matures daily. As of March 31, 1998 and 1997, the
commercial paper investments had earned $95,505 and $11,411, respectively, in
interest income.
The Company entered into a 15-year lease, dated January 31, 1997 (the
"Apparel Lease") for its headquarters and NOC. The Apparel Lease which covers
32,422 square feet, will be increased on July 1, 1998 to cover 40,397 square
feet.
As of March 31, 1998, the aggregate minimum rental commitments under
this and other lease agreements were as follows:
<TABLE>
<CAPTION>
TOTAL
DESCRIPTION OF LEASE 1999 2000 2001 2002 2003 THEREAFTER COMMITMENTS
<S> <C> <C> <C> <C> <C> <C>
Facilities Lease $626,729 $676,662 $735,152 $789,388 $870,454 $9,763,046 $13,461,431
Equipment Leases 172,397 172,397 114,604 - - - 459,398
Hub Site Leases 22,898 23,552 24,268 17,603 10,272 70,805 169,398
Pole Leases 21,040 21,040 21,040 21,040 21,040 21,040 126,240
Office Equipment 16,615 15,829 9,443 - - - 41,887
-------- -------- -------- -------- -------- ---------- -----------
Totals $859,679 $909,480 $904,507 $828,031 $901,766 $9,854,891 $14,258,354
-------- -------- -------- -------- -------- ---------- -----------
-------- -------- -------- -------- -------- ---------- -----------
</TABLE>
Page 56
<PAGE>
Rent expense under operating leases was $662,753, $55,152 and $34,266
for the years ended March 31 1998, 1997 and 1996 respectively.
In March 1998, the Company signed a purchase agreement with Nortel for
telecommunication equipment. This agreement covers three years and the
purchase of a minimum of $25,000,000 of equipment during the three year
period.
14. SUBSEQUENT EVENTS:
After March 31, 1998, certain officers of the Company forfeited
48,489.1 common shares options.
On April 14, 1998, the Company's Board of Directors approved a stock
option plan for a total of 531,200 shares of common stock. The plan
specifies 331,200 shares for two named executive officers, 150,000 shares to
be awared to key management employees and 50,000 shares for all employees.
On April 16, 1998, the Company paid an initial fee of $500,000 as part
of the negotiation for a $50,000,000 revolving credit facility.
In April 1998, pursuant to a Purchase, Joinder & Waiver Agreement, the
Company agreed to issue 6.3316 shares of Class A Convertible 8% Cumulative
Preferred Stock at a price of $15,793.84 per share and warrants to purchase
5,327.1 shares of Common Stock at a price of $.000001 per share to Wendy
Dietze, Managing Director of Credit Suisse First Boston Corporation. In
addition, 2,248.9 shares of voting common stock and 2,248.9 shares of
non-voting common stock will be issued in conjunction with this sale.
On May 15, 1998, the Company issued 1,833.33 additional shares of
Exchangeable Preferred Stock as the quarterly dividends on the 13 3/4% Senior
Cumulative Exchangeable Preferred Stock Due 2010.
Page 57
<PAGE>
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31, 1998
---------------------------
1ST QTR 2ND QTR 3RD QTR 4TH QTR
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Subscriber Revenues $ 42,497 $ 37,158 $ 43,877 $ 65,491
Operating Loss $(1,203,601) $(2,190,282) $(4,816,430) $(5,252,740)
Net Loss Attributable
to Common Shares $(1,920,941) $(2,638,655) $(5,573,193) $(9,132,218)
Basic and Diluted Net Loss
per Weighted
Average Share $ (0.81) $ (1.11) $ (2.33) $ (2.74)
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDING MARCH 31, 1997
--------------------------
1ST QTR 2ND QTR 3RD QTR 4TH QTR
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Subscriber Revenues $ - $ - $ - $ 27,480
Operating Loss (336,403) (485,593) (1,056,491) (802,586)
Net Loss Attributable
to Common Shares $ (424,169) $( 530,115) $(1,158,428) $(1,183,561)
Basic and Diluted Net Loss
per Weighted
Average Share $ (0.23) $ (0.28) $ (0.59) $ (0.52)
</TABLE>
Quarterly EPS figures may not total EPS for the year due to the changes
in the number of shares outstanding.
Page 58
<PAGE>
16. NEW ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT YET EFFECTIVE:
In June 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
effective for periods beginnng after December 15, 1997. These statements do
not affect the accounting recognition or measurement of transactions, but
rather require expanded disclosures regarding financial results. The
Company will adopt these standards in 1998 as required by FASB.
Page 59
<PAGE>
ITEM 14(a)(3) EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
Exhibit No. Document
- -------------------------------------------------------------------------------
<S> <C>
3.1* Amended Articles of Incorporation
- -------------------------------------------------------------------------------
3.2* By-laws
- -------------------------------------------------------------------------------
4.1* Indenture dated February 15, 1998 between
the Company, as Issuer, and State Street
Bank and Trust, as Trustee, with respect to
the 12 1/4 Senior Discount Notes Due 2008
- -------------------------------------------------------------------------------
4.2* Form of the 12 1/4 Senior Discount Notes Due
2008
- -------------------------------------------------------------------------------
4.3* Indenture dated as of February 15, 1998
between the Company and IBJ Stirred Bank &
Trust Company, as Trustee, with respect to
the Exchange Debenture
- -------------------------------------------------------------------------------
4.4* Form of the 13 3/4 Senior Cumulative
Exchangeable Preferred Stock Due 2010
- -------------------------------------------------------------------------------
4.5* Registration Rights Agreement dated as of
February 2, 1998 by and among the Company
and Credit Suisse First Boston Corporation,
BancAmerica Robertson Stephens and
BancBoston Securities, Inc., as Initial
Purchasers*
- -------------------------------------------------------------------------------
10.1* Franchise Agreement dated as of June 24,
1996 by and among the City of Chicago and
the Company
- -------------------------------------------------------------------------------
10.2* License Agreement dated as of October 27,
1994 by and among the Chicago Transit
Authority and the Company
- -------------------------------------------------------------------------------
10.3* CSG Master Subscriber Management System
Agreement dated as of May 28, 1997 by and
among CSG Systems, Inc. and the Company
- -------------------------------------------------------------------------------
10.4* Telemarketing Consultation Agreement dated
as of August 5, 1997 by and among the
Company and ITI Marketing Services, Inc.
- -------------------------------------------------------------------------------
10.5* Pole Attachment Agreement dated as of April
3, 1996 by and among the Company and
Commonwealth Edison Company
- -------------------------------------------------------------------------------
10.6* Pole Attachment Agreement dated as of
November 14, 1998 by and among the Company
and Ameritech--Illinois
- -------------------------------------------------------------------------------
10.7* Office Lease dated January 31, 1997 by and
among the Company and LaSalle National Bank
- -------------------------------------------------------------------------------
10.8* Franchise Agreement dated as of March 16,
1998 by and between the Village of Skokie,
Illinois and 21st Century Cable TV of
Illinois, Inc.
- -------------------------------------------------------------------------------
10.9* Interconnection Agreement dated as if May
5, 1997 by and between Ameritech
Information Industry Services and 21st
Century Telecom of Illinois, Inc.
- -------------------------------------------------------------------------------
10.10* Network Products Purchase Agreement by and
between Northern Telecom Inc. and the
Company
- -------------------------------------------------------------------------------
12.1 Statement regarding Computation of Earnings
Ratio to Fixed Charges
- -------------------------------------------------------------------------------
21.1* Subsidiaries of the Company
- -------------------------------------------------------------------------------
Page 60
<PAGE>
- -------------------------------------------------------------------------------
23.1 Consent of Arthur Andersen with Respect to
the Company
- -------------------------------------------------------------------------------
27.1 Financial Data Schedule
- -------------------------------------------------------------------------------
</TABLE>
* Incorporated herein by reference to the Company's S-4 Registration
Statement, filed on March 3, 1998, (Commission File No. 333-47235)
Page 61
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS FULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
21st CENTURY TELECOM GROUP, INC.
/s/ Ronald D. Webster
----------------------------------------------
By: Ronald D. Webster, Chief Financial Officer
/s/ Byron E. Hill
----------------------------------------------
By: Byron E. Hill, Corporate Controller
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
PRINCIPAL EXECUTIVES AND ACCOUNTING OFFICERS
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ------ ----
<S> <C> <C>
Chief Executive Officer and
Chairman of the Board of June 29, 1998
/s/ Glenn W. Milligan Directors (Principal
----------------------- Executive Officer)
Glenn W. Milligan
President, Chief Operating
/s/ Robert J. Currey Officer and Director June 29, 1998
-----------------------
Robert J. Currey
/s/ Ronald D. Webster Chief Financial Officer June 29, 1998
-----------------------
Ronald D. Webster
/s/ Jay E. Carlson Chief Technical Officer June 29, 1998
-----------------------
Jay E. Carlson
/s/ Edward T. Joyce Director June 29, 1998
----------------------
Edward T. Joyce
Page 62
<PAGE>
/s/ Dr. Charles E. Kaegi Director June 29, 1998
------------------------
Dr. Charles E. Kaegi
/s/ James H. Lowry Director June 29, 1998
------------------------
James H. Lowry
/s/ David Kronfeld Director June 29, 1998
------------------------
David Kronfeld
/s/ Thomas Neustaetter Director June 29, 1998
------------------------
Thomas Neustaetter
/s/ Byron E. Hill Controller June 29, 1998
------------------------
Byron Hill
</TABLE>
Page 63
<PAGE>
FORM 10K
INDEX TO EXHIBITS
Certain exhibits to this report on Form 10-K have been
incorporated by reference. For a list of these and all exhibits, see Item
14(a)(3) hereof. The following exhibits are being filed herewith.
<TABLE>
<CAPTION>
Exhibit No. Document
- -------------------------------------------------------------------------------
<S> <C>
3.1* Amended Articles of Incorporation
- -------------------------------------------------------------------------------
3.2* By-laws
- -------------------------------------------------------------------------------
4.1* Indenture dated February 15, 1998 between
the Company, as Issuer, and State Street
Bank and Trust, as Trustee, with respect to
the 12 1/4 Senior Discount Notes Due 2008
- -------------------------------------------------------------------------------
4.2* Form of the 12 1/4 Senior Discount Notes Due
2008
- -------------------------------------------------------------------------------
4.3* Indenture dated as of February 15, 1998
between the Company and IBJ Stirred Bank &
Trust Company, as Trustee, with respect to
the Exchange Debenture
- -------------------------------------------------------------------------------
4.4* Form of the 13 3/4 Senior Cumulative
Exchangeable Preferred Stock Due 2010
- -------------------------------------------------------------------------------
4.5* Registration Rights Agreement dated as of
February 2, 1998 by and among the Company
and Credit Suisse First Boston Corporation,
BancAmerica Robertson Stephens and
BancBoston Securities, Inc., as Initial
Purchasers
- -------------------------------------------------------------------------------
10.1* Franchise Agreement dated as of June 24,
1996 by and among the City of Chicago and
the Company
- -------------------------------------------------------------------------------
10.2* License Agreement dated as of October 27,
1994 by and among the Chicago Transit
Authority and the Company
- -------------------------------------------------------------------------------
10.3* CSG Master Subscriber Management System
Agreement dated as of May 28, 1997 by and
among CSG Systems, Inc. and the Company
- -------------------------------------------------------------------------------
10.4* Telemarketing Consultation Agreement dated
as of August 5, 1997 by and among the
Company and ITI Marketing Services, Inc.
- -------------------------------------------------------------------------------
10.5* Pole Attachment Agreement dated as of April
3, 1996 by and among the Company and
Commonwealth Edison Company
- -------------------------------------------------------------------------------
10.6* Pole Attachment Agreement dated as of
November 14, 1998 by and among the Company
and Ameritech--Illinois
- -------------------------------------------------------------------------------
10.7* Office Lease dated January 31, 1997 by and
among the Company and LaSalle National Bank
- -------------------------------------------------------------------------------
10.8* Franchise Agreement dated as of March 16,
1998 by and between the Village of Skokie,
Illinois and 21st Century Cable TV of
Illinois, Inc.
- -------------------------------------------------------------------------------
Page 64
<PAGE>
- -------------------------------------------------------------------------------
10.9* Interconnection Agreement dated as if May
5, 1997 by and between Ameritech
Information Industry Services and 21st
Century Telecom of Illinois, Inc.
- -------------------------------------------------------------------------------
10.10* Network Products Purchase Agreement by and
between Northern Telecom Inc. and the
Company
- -------------------------------------------------------------------------------
12.1 Statement regarding Computation of Earnings
Ratio to Fixed Charges
- -------------------------------------------------------------------------------
21.1* Subsidiaries of the Company
- -------------------------------------------------------------------------------
23.1 Consent of Arthur Andersen with Respect to
the Company
- -------------------------------------------------------------------------------
27.1 Financial Data Schedule
- -------------------------------------------------------------------------------
</TABLE>
* Incorporated herein by reference to the Company's S-4 Registration
Statement, filed on March 3, 1998, (Commission File No. 333-47235)
Page 65
<PAGE>
21ST CENTURY TELECOM GROUP, INC.
COMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES, INTEREST
CHARGES AND PREFERRED STOCK REQUIREMENTS
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
-----------------------------------------------------------
1998 1997 1996 1995
-----------------------------------------------------------
<S> <C> <C> <C> <C>
1. EARNINGS
(a) Loss before interest expense and income taxes $ (11,089,186) $ (2,379,449) $ (811,921) $ (663,886)
(b) Portion of rental expense representative of
the interest factor (1) (220,918) (18,384) (11,422) (8,855)
-----------------------------------------------------------
Total of 1(a) and 1(b) $ (10,868,268) $ (2,361,065) $ (800,499) $ (655,031)
2. COMBINED FIXED CHARGES
(a) Total interest expense $ 3,941,358 $ 437,843 $ 214,688 $ 115,428
(b) Portion of rental expense representative of the
interest factor (1) 220,918 18,384 11,422 8,855
(c) Dividends and accretion on Class A Convertible 8%
Cumulative preferred stock 3,173,525 478,981 - -
(d) Dividends and accretion on 13 3/4% Senior Cumulative
Exchangeable preferred stock due 2010 1,060,938 - - -
-----------------------------------------------------------
Total Combined Fixed Charges (2(a) through 2(c))
Combined Fixed Charges (2(a) through 2(d) 8,396,739 935,208 226,110 124,283
-----------------------------------------------------------
Total Interest Charges (2(a) through 2(b)) 4,162,276 456,227 226,110 124,283
-----------------------------------------------------------
Total Preferred Stock Requirements (2(c)
Preferred Stock Requirements (2 (c) through 2(d)) $ 4,234,463 $ 478,981 $ - $ -
-----------------------------------------------------------
3. RATIO OF EARNINGS TO COMBINED FIXED CHARGES (1.29) (2.52) (3.54) (5.27)
-----------------------------------------------------------
-----------------------------------------------------------
RATIO OF EARNINGS TO INTEREST CHARGES (2.61) (5.18) (3.54) (5.27)
-----------------------------------------------------------
-----------------------------------------------------------
RATIO OF EARNINGS TO PREFERRED STOCK REQUIREMENTS (2.57) (4.93) N/A N/A
-----------------------------------------------------------
-----------------------------------------------------------
4. DEFICIENCY RELATED TO LESS THAN ONE-TO-ONE COVERAGE:
Ratio of Earnings to Combined Fixed Charges 19,265,007 3,296,273 1,026,609 779,314
-----------------------------------------------------------
-----------------------------------------------------------
Ratio of Earnings to Interest Charges 15,030,544 2,817,292 1,026,609 779,314
-----------------------------------------------------------
-----------------------------------------------------------
Ratio of Earnings to Preferred Stock Requirements 15,102,731 2,840,046 N/A N/A
-----------------------------------------------------------
-----------------------------------------------------------
</TABLE>
(1) We consider one-third of total rental expense to represent return on
capital.
Page 66
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report dated May 15, 1998 included in this Form 10-K for the
year ended March 31, 1998, into 21st Century Telecom Group, Inc.'s previously
filed Registration Statement on Form S-4 No. 333-47235.
Arthur Andersen LLP
Chicago, Illinois
June 29, 1998
67
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 217,640,238
<SECURITIES> 10,000,000
<RECEIVABLES> 10,359
<ALLOWANCES> 0
<INVENTORY> 1,991,690
<CURRENT-ASSETS> 229,810,439
<PP&E> 20,598,962
<DEPRECIATION> 1,193,236
<TOTAL-ASSETS> 262,732,604
<CURRENT-LIABILITIES> 8,752,093
<BONDS> 203,506,866
46,492,812
21,751,665
<COMMON> 10,356,136
<OTHER-SE> (28,169,171)
<TOTAL-LIABILITY-AND-EQUITY> 262,732,604
<SALES> 189,023
<TOTAL-REVENUES> 189,023
<CGS> 2,023,310
<TOTAL-COSTS> 4,237,033
<OTHER-EXPENSES> 9,851,865
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (3,722,947)
<INCOME-PRETAX> (15,030,544)
<INCOME-TAX> 0
<INCOME-CONTINUING> (15,030,544)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,030,544)
<EPS-PRIMARY> (7.37)
<EPS-DILUTED> (7.37)
</TABLE>