<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 10, 1998
REGISTRATION NO. 333-62797
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 4
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
BIRCH TELECOM, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 4813 43-1766929
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) NO.)
</TABLE>
1004 BALTIMORE AVE., SUITE 900
KANSAS CITY, MISSOURI 64105
(816) 842-7560
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
GREGORY C. LAWHON
SENIOR VICE PRESIDENT OF
PUBLIC POLICY AND GENERAL COUNSEL
BIRCH TELECOM, INC.
1004 BALTIMORE AVE., SUITE 900
KANSAS CITY, MISSOURI 64105
(816) 842-7560
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
------------------------
Copy to:
KIRK A. DAVENPORT, ESQ.
LATHAM & WATKINS
885 THIRD AVENUE.
NEW YORK, NEW YORK 10022
(212) 906-1267
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
IF ANY OF THE SECURITIES BEING REGISTERED ON THIS FORM ARE BEING OFFERED IN
CONNECTION WITH THE FORMATION OF A HOLDING COMPANY AND THERE IS COMPLIANCE WITH
GENERAL INSTRUCTION G, CHECK THE FOLLOWING BOX. [ ]
IF THIS FORM IS FILED TO REGISTER ADDITIONAL SECURITIES FOR AN OFFERING
PURSUANT TO RULE 462(b) UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND
LIST THE SECURITIES ACT REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE
REGISTRATION STATEMENT FOR THE SAME OFFERING. [ ]
IF THIS FORM IS A POST-EFFECTIVE AMENDMENT FILED PURSUANT TO RULE 462(d)
UNDER THE SECURITIES ACT, CHECK THE FOLLOWING BOX AND LIST THE SECURITIES ACT
REGISTRATION STATEMENT NUMBER OF THE EARLIER EFFECTIVE REGISTRATION STATEMENT
FOR THE SAME OFFERING. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
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TITLE OF EACH PROPOSED PROPOSED AMOUNT OF
CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE REGISTRATION
TO BE REGISTERED REGISTERED PER NOTES(1) OFFERING PRICE(1) FEE(2)
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<S> <C> <C> <C> <C>
14% Senior Notes due 2008..... $115,000,000 100% $115,000,000 $33,925
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</TABLE>
(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457.
(2) Paid with the initial filing of the Registration Statement.
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED NOVEMBER 10, 1998
PROSPECTUS
$115,000,000
BIRCH TELECOM, INC.
OFFER TO EXCHANGE ITS 14% SENIOR NOTES DUE 2008
FOR ALL OUTSTANDING 14% SENIOR NOTES DUE 2008
------------------------
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME ON
, 1998 UNLESS EXTENDED.
Birch Telecom, Inc., a Delaware corporation (the "Company" or "Birch"), is
hereby offering (the "Exchange Offer"), upon the terms and subject to the
conditions set forth in this Prospectus and the accompanying Letter of
Transmittal (the "Letter of Transmittal"), to exchange $1,000 principal amount
of its 14% Senior Notes due 2008 (the "Exchange Notes"), which exchange has been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
pursuant to a registration statement of which this Prospectus is a part (the
"Registration Statement"), for each $1,000 principal amount of its outstanding
14% Senior Notes due 2008 (the "Private Notes"), of which $115,000,000 in
aggregate principal amount was issued on June 23, 1998 and is outstanding as of
the date hereof. The Private Notes were originally issued (the "Private
Offering") as part of units (the "Units") consisting in the aggregate of
$115,000,000 in aggregate principal amount of Private Notes and 115,000 warrants
(the "Warrants") to purchase 1,409,734 shares of the Company's Common Stock, par
value $.001 per share. The form and terms of the Exchange Notes are the same as
the form and terms of the Private Notes except that (i) the exchange will have
been registered under the Securities Act, and, therefore, the Exchange Notes
will not bear legends restricting the transfer thereof and (ii) holders of the
Exchange Notes will not be entitled to certain rights of holders of the Private
Notes under the Registration Rights Agreement (as defined herein), which rights
will terminate upon the consummation of the Exchange Offer. The Exchange Notes
will evidence the same indebtedness as the Private Notes (which they replace)
and will be entitled to the benefits of an indenture dated as of June 23, 1998
governing the Private Notes and the Exchange Notes (the "Indenture"). The
Private Notes and the Exchange Notes are sometimes referred to herein
collectively as the "Notes." See "The Exchange Offer" and "Description of
Exchange Notes."
The Exchange Notes will bear interest at the same rate and on the same
terms as the Private Notes. Consequently, interest on the Notes will be payable
semi-annually in arrears on June 15th and December 15th, commencing December 15,
1998. The Notes will be redeemable at the option of the Company, in whole or in
part, at any time on or after June 15, 2003, at the redemption prices set forth
herein, plus accrued and unpaid interest and Liquidated Damages (as defined), if
any, thereon to the date of redemption. In addition, at any time prior to June
15, 2001, the Company may redeem up to 35% of the originally issued aggregate
principal amount of Notes at the redemption price set forth herein, plus accrued
and unpaid interest and Liquidated Damages, if any, to the date of redemption
with the net cash proceeds of one or more Equity Offerings (as defined);
provided that at least 65% of the originally issued aggregate principal amount
of Notes remains outstanding immediately after the occurrence of each such
redemption. In the event of a Change of Control (as defined), each holder of
Notes will have the right to require the Company to purchase all or any part of
such holder's Notes at a purchase price equal to 101% of the principal amount
thereof, plus accrued and unpaid interest and Liquidated Damages, if any, to the
date of purchase. See "Description of the Exchange Notes."
(Continued on next page)
SEE "RISK FACTORS" BEGINNING ON PAGE 15 FOR A DISCUSSION OF CERTAIN FACTORS
THAT INVESTORS SHOULD CONSIDER IN CONNECTION WITH THE EXCHANGE OFFER AND AN
INVESTMENT IN THE EXCHANGE NOTES.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
<PAGE> 3
(Continued from previous page)
On the Closing Date (as defined), the Company used a portion of the
proceeds of the Private Offering to purchase a portfolio of U.S. Government
Obligations (as defined), which will be pledged as security for the first six
scheduled interest payments on the Notes and other obligations thereunder (the
"Pledged Securities"). See "Description of the Exchange Notes -- Security."
The Notes will be general obligations of the Company, will be unsecured
(except as described above) and will rank senior in right of payment to all
future unsecured subordinated Indebtedness (as defined) of the Company and will
rank pari passu in right of payment with all future unsecured senior
Indebtedness (as defined) of the Company. All of the operations of the Company
are conducted through its subsidiaries, and the Company's subsidiaries will not
be guarantors of the Notes. Accordingly, the Notes will be effectively
subordinated to all current and future Indebtedness and all other liabilities or
obligations of such subsidiaries. As of September 30, 1998, the Company had
approximately $114.7 million of Indebtedness outstanding and the Company's
subsidiaries had approximately $764,000 of Indebtedness outstanding. The
Indebtedness of the Company includes the amount represented by the Notes.
Currently, no Indebtedness of the Company ranks senior in right of payment to
the Notes and $764,000 of Indebtedness of the Company's subsidiaries effectively
ranks senior in right of payment to the Notes. In addition, no Indebtedness of
the Company ranks pari passu in right of payment to the Notes. See
"Capitalization." The Indenture governing the Notes permits the incurrence of
substantial additional Indebtedness, including secured Indebtedness, by the
Company and its subsidiaries. See "Description of the Exchange Notes."
The Company will accept for exchange any and all validly tendered Private
Notes not withdrawn prior to 5:00 p.m., New York City time, on ,
1998, unless the Exchange Offer is extended by the Company in its exercise of
reasonable discretion (the "Expiration Date"). Tenders of Private Notes may be
withdrawn at any time prior to the Expiration Date. Private Notes may be
tendered only in integral multiples of $1,000. The Exchange Offer is subject to
certain customary conditions. See "The Exchange Offer -- Conditions."
Based on an interpretation by the staff of the Securities and Exchange
Commission (the "Commission") set forth in no-action letters issued to third
parties (See e.g., Exxon Capital Holdings Corp., SEC No-Action Letter (available
April 13, 1989) and Morgan Stanley & Co. Inc., SEC No-Action Letter (available
June 5, 1991), collectively, the "No-Action Letters"), the Company believes that
the Exchange Notes issued pursuant to the Exchange Offer in exchange for Private
Notes may be offered for resale, resold and otherwise transferred by a holder
thereof (other than (i) a broker-dealer who purchases such Exchange Notes
directly from the Company to resell pursuant to Rule 144A or any other available
exemption under the Securities Act or (ii) a person that is an affiliate of the
Company within the meaning of Rule 405 under the Securities Act), without
compliance with the registration and prospectus delivery provisions of the
Securities Act; provided that the holder is acquiring the Exchange Notes in the
ordinary course of its business and is not participating, and had no arrangement
or understanding with any person to participate, in the distribution of the
Exchange Notes. Holders who tender their Private Notes in the Exchange Offer
with the intention of participating in a distribution of the Exchange Notes will
not be able to rely on the No-Action Letters or similar no-action letters.
Holders of Private Notes wishing to accept the Exchange Offer must represent to
the Company, as required by the Registration Rights Agreement, that such
conditions have been met. Each broker-dealer that receives Exchange Notes for
its own account in exchange for Private Notes, where such Private Notes were
acquired by such broker-dealer as a result of market-making activities or other
trading activities, must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. The Company believes that
none of the registered holders of the Private Notes is an affiliate (as such
term is defined in Rule 405 under the Securities Act) of the Company.
Prior to the Exchange Offer, there has been no public market for the Notes.
The Company does not intend to list the Exchange Notes on any securities
exchange, but the Private Notes are eligible for trading in the National
Association of Securities Dealers, Inc.'s Private Offerings, Resales and Trading
through Automatic Linkages ("PORTAL") market. There can be no assurance that an
active market for the Notes
(Continued on next page)
ii
<PAGE> 4
(Continued from previous page)
will develop. To the extent that a market for the Notes does develop, the market
value of the Notes will depend on market conditions (such as yields on
alternative investments), general economic conditions, the Company's financial
condition and certain other factors. Such conditions might cause the Notes, to
the extent that they are traded, to trade at a significant discount from face
value. See "Risk Factors -- Absence of Public Market for the Notes; Restrictions
on Transfer."
Each broker-dealer that receives Exchange Notes for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes. The Letter of
Transmittal states that by so acknowledging and by delivering a prospectus, a
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of Exchange Notes received in exchange for Private Notes where such
Private Notes were acquired by such broker-dealer as a result of market-making
activities or other trading activities. The Company has indicated its intention
to make this Prospectus (as it may be amended or supplemented) available to any
broker-dealer for use in connection with any such resale for a period of 180
days after the Expiration Date. See "Plan of Distribution."
The Company will not receive any proceeds from, and has agreed to bear the
expenses of, the Exchange Offer. No underwriter is being used in connection with
this Exchange Offer. See "The Exchange Offer."
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE COMPANY ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF PRIVATE NOTES IN ANY JURISDICTION IN
WHICH THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE
WITH THE SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
NO PERSON IS AUTHORIZED IN CONNECTION WITH THE EXCHANGE OFFER TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS OR
THE ACCOMPANYING LETTER OF TRANSMITTAL, AND, IF GIVEN OR MADE, SUCH INFORMATION
OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE
COMPANY. NEITHER THE DELIVERY OF THIS PROSPECTUS OR THE ACCOMPANYING LETTER OF
TRANSMITTAL, NOR ANY EXCHANGE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES
CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY DATE SUBSEQUENT TO THE DATE HEREOF.
UNTIL , 1998 (90 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS OFFERING TRANSACTIONS IN THE EXCHANGE NOTES, WHETHER OR NOT
PARTICIPATING IN THE EXCHANGE OFFER, MAY BE REQUIRED TO DELIVER A PROSPECTUS IN
CONNECTION THEREWITH. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
The Exchange Notes will be available initially only in book-entry form. The
Company expects that the Exchange Notes issued pursuant to the Exchange Offer
will be issued in the form of one or more fully registered global notes that
will be deposited with, or on behalf of, the Depository Trust Company ("DTC" or
the "Depository") and registered in its name or in the name of Cede & Co., as
its nominee. Beneficial interests in the global note representing the Exchange
Notes will be shown on, and transfers thereof will be effected only through,
records maintained by the Depository and its participants. After the initial
issuance of such global note, Exchange Notes in certificated form will be issued
in exchange for the global note only in accordance with the terms and conditions
set forth in the Indenture. See "The Exchange Offer -- Book-Entry Transfer" and
"Book Entry; Delivery and Form."
THE INFORMATION CONTAINED IN THIS PROSPECTUS HAS BEEN FURNISHED BY BIRCH
AND OTHER SOURCES BELIEVED BY BIRCH TO BE RELIABLE. THIS PROSPECTUS CONTAINS
SUMMARIES, BELIEVED TO BE ACCURATE, OF MATERIAL TERMS OF ALL DOCUMENTS AND
AGREEMENTS INCORPORATED BY REFERENCE. REFERENCE IS MADE TO THE ACTUAL DOCUMENTS,
COPIES OF WHICH WILL BE MADE AVAILABLE
(Continued on next page)
iii
<PAGE> 5
(Continued from previous page)
UPON REQUEST, FOR THE COMPLETE INFORMATION CONTAINED THEREIN. ALL SUCH
SUMMARIES ARE QUALIFIED IN THEIR ENTIRETY BY THIS REFERENCE.
PROSPECTIVE INVESTORS ARE NOT TO CONSTRUE THE CONTENTS OF THIS PROSPECTUS
AS INVESTMENT OR TAX ADVICE. EACH INVESTOR SHOULD CONSULT ITS OWN COUNSEL,
ACCOUNTANT AND OTHER ADVISERS AS TO TAX, BUSINESS, FINANCIAL AND RELATED ASPECTS
OF A PURCHASE OF THE NOTES. BIRCH MAKES NO REPRESENTATION TO ANY OFFEREE OR
PURCHASER OF THE NOTES REGARDING THE LEGALITY OF AN INVESTMENT THEREIN BY SUCH
OFFEREE OR PURCHASER UNDER APPROPRIATE LEGAL INVESTMENT OR SIMILAR LAWS.
EACH PROSPECTIVE PURCHASER OF THE NOTES MUST COMPLY WITH ALL APPLICABLE
LAWS AND REGULATIONS IN FORCE IN ANY JURISDICTION IN WHICH IT PURCHASES, OFFERS
OR SELLS THE NOTES OR POSSESSES OR DISTRIBUTES THIS PROSPECTUS AND MUST OBTAIN
ANY CONSENT, APPROVAL OR PERMISSION REQUIRED BY IT FOR THE PURCHASE, OFFER OR
SALE BY IT OF THE NOTES UNDER THE LAWS AND REGULATIONS IN FORCE IN ANY
JURISDICTION TO WHICH IT IS SUBJECT OR IN WHICH IT MAKES SUCH PURCHASES, OFFERS
OR SALES, AND BIRCH SHALL HAVE NO RESPONSIBILITY THEREFOR.
THE NOTES DESCRIBED HEREIN HAVE NOT BEEN RECOMMENDED BY OR APPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION") OR ANY OTHER FEDERAL OR
STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY, NOR HAS THE COMMISSION OR
ANY STATE SECURITIES COMMISSION OR REGULATORY AUTHORITY PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
IN MAKING AN INVESTMENT DECISION REGARDING THE EXCHANGE NOTES OFFERED
HEREBY, PROSPECTIVE INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF BIRCH AND
THE TERMS OF THE EXCHANGE OFFER, INCLUDING THE MERITS AND RISKS INVOLVED. THE
EXCHANGE OFFER IS BEING MADE ON THE BASIS OF THIS PROSPECTUS. ANY DECISION TO
PURCHASE EXCHANGE NOTES IN THE EXCHANGE OFFER MUST BE BASED ON THE INFORMATION
CONTAINED HEREIN.
This Prospectus includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities and Exchange
Act of 1934, as amended (the "Exchange Act"). All statements other than
statements of historical facts included in this Prospectus, including, without
limitation, the statements under "Prospectus Summary," "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and "Business"
and located elsewhere herein regarding industry prospects, Birch's prospects and
Birch's financial position are forward-looking statements. Although Birch
believes that the expectations reflected in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove to have
been correct. Important factors that could cause actual results to differ
materially from Birch's expectations ("Cautionary Statements") are disclosed in
this Prospectus, including, without limitation, in conjunction with the
forward-looking statements included in this Prospectus under "Risk Factors." All
subsequent written and oral forward-looking statements attributable to Birch or
persons acting on its behalf are expressly qualified in their entirety by the
Cautionary Statements.
iv
<PAGE> 6
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the more
detailed information and consolidated financial statements appearing elsewhere
in this Prospectus. Unless the context requires otherwise, "Birch" or the
"Company" means Birch Telecom, Inc. and its subsidiaries after giving effect to
the Merger (as defined). For all periods presented, except where otherwise
indicated, the discussions on a pro forma basis give effect to the Transactions
(as defined) and the Private Offering as if they had occurred on January 1, 1997
with respect to statement of operations data and as if they had occurred on
September 30, 1998 with respect to balance sheet data. Industry data used
throughout this Prospectus was obtained from industry publications and is
believed by Birch to be reliable but has not been independently verified by
Birch.
THE COMPANY
Birch is a rapidly growing competitive local exchange carrier ("CLEC")
serving small to mid-sized business and, to a lesser extent, residential
customers in selected markets in Missouri and Kansas. As of September 30, 1998,
Birch had over 20,000 customers. The Company provides its customers with a full
range of telecommunications services, including local and long distance service,
customer premises equipment ("CPE") and, in selected markets, Internet access
service. Since it began offering local service in March 1997, Birch has
increased aggregate local access lines to over 30,000, making it one of the
largest CLECs in the territory served by Southwestern Bell Telephone Company
("SWBT"). On a pro forma basis, the Company's revenue for the nine months ended
September 30, 1998 would have been $20.3 million and the Company's net losses
for the nine months ended September 30, 1998 would have been $20.6 million.
Birch currently provides local, long distance and CPE services in Missouri
and Kansas, including Kansas City, St. Louis and St. Joseph, Missouri and
Wichita, Topeka, Manhattan, Lawrence, Emporia, Salina and Dodge City, Kansas,
and Internet access in selected markets in Kansas. The Company intends to
provide service in 12 markets in Texas by the end of 1999. Birch currently
operates a long distance switch in Wichita, Kansas and is in the process of
installing and testing a Lucent Technologies, Inc. ("Lucent") Series 5ESS(R)-
2000 digital switch in Kansas City, Missouri. The Company also intends to deploy
switches in St. Louis, Missouri and Wichita and Topeka, Kansas, during the next
six to nine months, and, subject to obtaining additional financing, anticipates
deploying additional switches in other markets in Missouri, Kansas and Texas
commencing in 1999.
The Company believes that deregulation of the telecommunications industry
has created opportunities for providers who deliver simple, integrated services
at a price lower than the incumbent local exchange carriers ("ILECs"). Birch
believes that other CLECs have concentrated primarily on the largest cities and
largest customers and have focused primarily on the construction of fiber-optic
networks in concentrated business districts. This concentration has created an
opportunity for CLECs that focus on underserved customers, such as small and
mid-sized businesses in larger cities and all customers in smaller metropolitan
areas. Birch provides services to these customers through a combination of owned
and leased network facilities and resold services. Management believes that the
Company's comprehensive portfolio of telecommunications services, competitive
pricing, local market expertise and superior customer service provide it with a
competitive advantage over the ILECs, CLECs, interexchange carriers ("IXCs"),
and other telecommunications providers against which the Company competes.
MARKET OPPORTUNITY
The Company plans to concentrate its activity in the five-state region of
Missouri, Kansas, Texas, Arkansas and Oklahoma which is dominated by SWBT and
GTE Corp. ("GTE") for local services and IXCs such as AT&T Corp. ("AT&T"), MCI
Telecommunications Corporation ("MCI"), Sprint Corporation ("Sprint") and
WorldCom, Inc. ("WorldCom") for long distance services. Based on data provided
by the Federal Communications Commission (the "FCC"), Birch estimates its
addressable telecommunications services market opportunity (defined as total
wireline intrastate and interstate telephone revenue in Birch's targeted
five-state region) to be approximately $21.4 billion, or 11.6% of the U.S. total
of $184.0 billion, in
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<PAGE> 7
1996. As of December 31, 1996, there were approximately 18.3 million access
lines in Birch's targeted five-state region, representing 11.6% of the U.S.
total of 157.4 million access lines. The FCC data on which Birch's estimate of
addressable telecommunications services market opportunity is based do not
include the Internet access and CPE markets in which Birch competes.
BUSINESS STRATEGY
Birch's objective is to be a leading provider of telecommunications
services to small and mid-sized businesses in its target markets. The key
components of Birch's strategy are: (i) to provide a broad set of services, (ii)
to target underserved customers, (iii) own strategic network assets, (iv) employ
a direct sales force with extensive local market experience, (v) build
regionally clustered operations and (vi) leverage its experience with SWBT.
The Company expects to grow through the development of new markets and
through increased sales and marketing efforts in its current markets. The
Company will also have opportunities to expand its reach through acquisitions or
joint ventures that bring Birch an existing customer base, a new target market
or business and technological capabilities that complement its business
objectives. The Company intends to pursue acquisition candidates that offer one
or more of these benefits as opportunities arise. Birch currently has no
definitive agreement with respect to any acquisition or joint venture, although
from time to time it has discussions with other companies and continuously
assesses such opportunities. See "-- Recent Developments" and "Risk
Factors -- Risks Associated with Acquisitions."
MANAGEMENT
Senior members of the Birch management team combine extensive industry
experience with an in-depth knowledge of the local telecommunications market in
the regions targeted by Birch. The eight most senior ranking members of Birch's
management team have an average of 13 years of telecommunications industry
experience ranging from senior positions with major telecommunications companies
such as SWBT, Sprint and Time Warner Inc. ("Time Warner") to successful
entrepreneurial ventures such as Kansas City Fiber Network, L.P. ("Kansas City
FiberNet") and the Valu-Line Companies, Inc. ("Valu-Line"). Prior to co-
founding Birch, David E. Scott and Jeffrey D. Shackelford directed the
development of Kansas City FiberNet as President and Director of Sales and
Marketing, respectively. Prior to joining Kansas City FiberNet, David E. Scott
was Vice President of Strategic Development with Sprint, responsible for
Sprint's investment plans in competitive local exchange, wireless (PCS) and
international marketplaces. Stephen L. Sauder, Vice President of Birch, founded
Valu-Line, Birch's predecessor, in 1982 and built it into a successful
telecommunications provider. Birch has entered into employment agreements with
Mr. Scott and other members of senior management. As of September 30, 1998, the
eight most senior members of Birch's management team owned 44.7% of Birch's
outstanding common stock (the "Common Stock"), on a fully diluted basis. See
"Risk Factors -- Dependence on Key Personnel," "Management" and "Security
Ownership of Certain Beneficial Owners and Management."
RECENT DEVELOPMENTS
In February 1998, Birch Telecom, Inc. merged with Valu-Line (the "Merger").
Since 1982, Valu-Line has provided customers in Kansas with switched long
distance service, CPE and related service and, since March 1997, has resold
local service. As of December 31, 1997, Valu-Line had 15,810 customers and, for
the year ended December 31, 1997, revenue and EBITDA of $16.8 million and
$892,000, respectively. Prior to the Merger, Birch Telecom, Inc. was a
development stage company. In May 1998, Birch acquired Dunn & Associates, Inc.,
which does business as Boulevard Phone Company ("Boulevard"), a shared tenant
service provider serving approximately 52 customers as of December 31, 1997 in
the Kansas City metropolitan area (the "Boulevard Acquisition"). Boulevard's
revenue and EBITDA for the year ended December 31, 1997 were $339,000 and
$4,000, respectively. In May 1998, Birch acquired Telesource Communications,
Inc. ("Telesource"), a CPE provider serving approximately 1,200 CPE customers as
of December 31, 1997 in the
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<PAGE> 8
Kansas City metropolitan area (the "Telesource Acquisition"). Telesource's
revenue and EBITDA for the year ended December 31, 1997 were $911,000 and
$(75,000), respectively. Birch financed the Merger, the Boulevard Acquisition
and the Telesource Acquisition with a combination of cash and preferred stock.
In September 1998, the Company acquired TFSnet, Inc., an Internet Service
Provider based in the Kansas City Area, (the "TFSnet Acquisition") in exchange
for $2.65 million. TFSnet's revenue and EBITDA for the year ended December 31,
1997 were $796,000 and $210,000, respectively. On June 23, 1998, the Company
consummated the Private Offering. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Birch used a portion of the proceeds of the Private Offering to repurchase
all of the outstanding shares of Birch's Series A Preferred Stock (the "Series A
Preferred Stock"), which were issued in connection with the Merger. In
connection with the Private Offering, Birch amended the terms of its Series B
Preferred Stock (the "Series B Preferred Stock") to, among other things, suspend
certain redemption provisions contained therein, exchanged $3.5 million in
aggregate principal amount of its outstanding Convertible Discount Notes due
2005 (the "Convertible Notes") for shares of its Series B Preferred Stock and
paid a dividend in kind to the holders of the Series B Preferred Stock, the
Company's Series C Preferred Stock (the "Series C Preferred Stock") and the
Common Stock (the "Stock Dividend"). The Merger, the repurchase of the Series A
Preferred Stock, the amendment of the terms of the Series B Preferred Stock, the
exchange of the Convertible Notes, the Boulevard Acquisition, the Telesource
Acquisition, the TFSnet Acquisition and the Stock Dividend are collectively
referred to herein as the "Transactions." See "Use of Proceeds" and "Description
of Capital Stock."
------------------------
The Company's principal executive offices are located at 1004 Baltimore
Ave., Suite 900, Kansas City, Missouri 64105.
RISK FACTORS
For a discussion of certain material factors that should be considered in
connection with an investment in the Notes, see "Risk Factors."
3
<PAGE> 9
THE EXCHANGE OFFER
THE EXCHANGE OFFER............ The Company is hereby offering to exchange
$1,000 principal amount of Exchange Notes for
each $1,000 principal amount of Private Notes
that are properly tendered and accepted. The
Company will issue Exchange Notes on or
promptly after the Expiration Date. As of the
date hereof, there is $115,000,000 aggregate
principal amount of Private Notes outstanding.
See "The Exchange Offer."
Based on an interpretation by the staff of the
Commission set forth in no-action letters
issued to third parties, the Company believes
that the Exchange Notes issued pursuant to the
Exchange Offer in exchange for Private Notes
may be offered for resale, resold and otherwise
transferred by a holder thereof (other than (i)
a broker-dealer who purchases such Exchange
Notes directly from the Company to resell
pursuant to Rule 144A or any other available
exemption under the Securities Act or (ii) a
person that is an affiliate of the Company
within the meaning of Rule 405 under the
Securities Act), without compliance with the
registration and prospectus delivery provisions
of the Securities Act; provided that the holder
is acquiring Exchange Notes in the ordinary
course of its business and is not
participating, and had no arrangement or
understanding with any person to participate,
in the distribution of the Exchange Notes. (See
e.g. Exxon Capital Holdings Corp., SEC
No-Action Letter (available April 13, 1989) and
Morgan Stanley & Co. Inc., SEC No-Action Letter
(available June 5, 1991), collectively, the
"No-Action Letters"). Holders who tender their
Private Notes in the Exchange Offer with the
intention of participating in a distribution of
the Exchange Notes will not be able to rely on
the No-Action Letters or similar no-action
letters. Each broker-dealer that receives
Exchange Notes for its own account in exchange
for Private Notes, where such Private Notes
were acquired by such broker-dealer as a result
of market-making activities or other trading
activities, must acknowledge that it will
deliver a prospectus in connection with any
resale of such Exchange Notes. See "The
Exchange Offer -- Resale of the Exchange
Notes."
REGISTRATION RIGHTS
AGREEMENT..................... The Private Notes were sold by the Company on
June 23, 1998 to Lehman Brothers Inc. and BT
Alex. Brown Incorporated (the "Initial
Purchasers") pursuant to a Purchase Agreement,
dated June 18, 1998, by and among the Company
and the Initial Purchasers (the "Purchase
Agreement") as part of Units consisting in the
aggregate of $115,000,000 in aggregate
principal amount of Private Notes and 115,000
Warrants to purchase 1,409,734 shares of the
Company's Common Stock, par value $.001 per
share. Pursuant to the Purchase Agreement, the
Company and the Initial Purchasers entered into
a Registration Rights Agreement, dated as of
June 23, 1998 (the "Registration Rights
Agreement"), which grants the holders of the
Private Notes certain exchange and registration
rights. The Exchange Offer is intended to
satisfy such rights, which will terminate upon
the consummation of the Exchange Offer. The
holders of the Exchange Notes will not be
4
<PAGE> 10
entitled to any exchange or registration rights
with respect to the Exchange Notes. See "The
Exchange Offer -- Termination of Certain
Rights."
EXPIRATION DATE............... The Exchange Offer will expire at 5:00 p.m.,
New York City time, on , 1998,
unless the Exchange Offer is extended by the
Company in its exercise of reasonable
discretion, in which case the term "Expiration
Date" shall mean the latest date and time to
which the Exchange Offer is extended. See "The
Exchange Offer -- Expiration Date; Extensions;
Amendments."
ACCRUED INTEREST ON THE
EXCHANGE NOTES AND THE PRIVATE
NOTES....................... The Exchange Notes will bear interest from and
including the date of issuance of the Private
Notes (June 23, 1998). Holders whose Private
Notes are accepted for exchange will be deemed
to have waived the right to receive any
interest accrued on the Private Notes. See "The
Exchange Offer -- Interest on the Exchange
Notes."
CONDITIONS TO THE EXCHANGE
OFFER......................... The Exchange Offer is subject to certain
customary conditions that may be waived by the
Company. The Exchange Offer is not conditioned
upon any minimum aggregate principal amount of
Private Notes being tendered for exchange. See
"The Exchange Offer -- Conditions."
PROCEDURES FOR TENDERING
PRIVATE NOTES................. Each holder of Private Notes wishing to accept
the Exchange Offer must complete, sign and date
the Letter of Transmittal, or a facsimile
thereof, in accordance with the instructions
contained herein and therein, and mail or
otherwise deliver such Letter of Transmittal,
or such facsimile, together with such Private
Notes and any other required documentation to
Norwest Bank Minnesota, National Association,
as exchange agent (the "Exchange Agent"), at
the address set forth herein. By executing the
Letter of Transmittal, the holder will
represent to and agree with the Company that,
among other things, (i) the Exchange Notes to
be acquired by such holder of Private Notes in
connection with the Exchange Offer are being
acquired by such holder in the ordinary course
of its business, (ii) such holder has no
arrangement or understanding with any person to
participate in a distribution of the Exchange
Notes, (iii) that if such holder is a
broker-dealer registered under the Exchange Act
or is participating in the Exchange Offer for
the purposes of distributing the Exchange
Notes, such holder will comply with the
registration and prospectus delivery
requirements of the Securities Act in
connection with a secondary resale transaction
of the Exchange Notes acquired by such person
and cannot rely on the position of the staff of
the Commission set forth in no-action letters
(see "The Exchange Offer -- Resale of Exchange
Notes"), (iv) such holder understands that a
secondary resale transaction described in
clause (iii) above and any resales of Exchange
Notes obtained by such holder in exchange for
Private Notes acquired by such holder directly
from the Company should be covered by an
effective registration statement containing the
selling securityholder information required by
Item 507 or Item 508, as applicable, of
5
<PAGE> 11
Regulation S-K of the Commission and (v) such
holder is not an "affiliate," as defined in
Rule 405 under the Securities Act, of the
Company. (See e.g., SEC No-Action Letter
(available April 13, 1989) and Morgan Stanley &
Co. Inc., SEC No-Action Letter (available June
5, 1991), collectively, the "No-Action
Letters"). Holders who tender their Private
Notes in the Exchange Offer with the intention
of participating in a distribution of the
Exchange Notes will not be able to rely on the
No-Action Letters or similar no-action letters.
If the holder is a broker-dealer that will
receive Exchange Notes for its own account in
exchange for Private Notes that were acquired
as a result of market-making activities or
other trading activities, such holder will be
required to acknowledge in the Letter of
Transmittal that such holder will deliver a
prospectus in connection with any resale of
such Exchange Notes; however, by so
acknowledging and by delivering a prospectus,
such holder will not be deemed to admit that it
is an "underwriter" within the meaning of the
Securities Act. See "The Exchange Offer --
Procedures for Tendering."
SPECIAL PROCEDURES FOR
BENEFICIAL OWNERS............. Any beneficial owner whose Private Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
and who wishes to tender such Private Notes in
the Exchange Offer should contact such
registered holder promptly and instruct such
registered holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes
to tender on such owner's own behalf, such
owner must, prior to completing and executing
the Letter of Transmittal and delivering such
owner's Private Notes, either make appropriate
arrangements to register ownership of the
Private Notes in such owner's name or obtain a
properly completed bond power from the
registered holder. The transfer of registered
ownership may take considerable time and may
not be able to be completed prior to the
Expiration Date. See "The Exchange
Offer -- Procedures for Tendering."
GUARANTEED DELIVERY
PROCEDURES.................... Holders of Private Notes who wish to tender
their Private Notes and whose Private Notes are
not immediately available or who cannot deliver
their Private Notes, the Letter of Transmittal
or any other documentation required by the
Letter of Transmittal to the Exchange Agent
prior to the Expiration Date must tender their
Private Notes according to the guaranteed
delivery procedures set forth under "The
Exchange Offer -- Guaranteed Delivery
Procedures."
ACCEPTANCE OF THE PRIVATE
NOTES AND DELIVERY OF THE
EXCHANGE NOTES.............. Subject to the satisfaction or waiver of the
conditions to the Exchange Offer, the Company
will accept for exchange any and all Private
Notes that are properly tendered in the
Exchange Offer prior to the Expiration Date.
The Exchange Notes issued pursuant to the
Exchange Offer will be delivered on the
earliest practicable date following the
Expiration Date. See "The Exchange Offer --
Terms of the Exchange Offer."
6
<PAGE> 12
WITHDRAWAL RIGHTS............. Tenders of Private Notes may be withdrawn at
any time prior to the Expiration Date. See "The
Exchange Offer -- Withdrawal of Tenders."
CERTAIN FEDERAL INCOME TAX
CONSIDERATIONS.............. For a discussion of certain material federal
income tax considerations relating to the
exchange of the Exchange Notes for the Private
Notes, see "Certain Federal Income Tax
Considerations."
7
<PAGE> 13
THE EXCHANGE NOTES
The Exchange Offer applies to $115,000,000 in aggregate principal amount of
the Private Notes. The form and terms of the Exchange Notes are the same as the
form and terms of the Private Notes except that (i) the exchange will have been
registered under the Securities Act and, therefore, the Exchange Notes will not
bear legends restricting the transfer thereof and (ii) holders of the Exchange
Notes will not be entitled to certain rights of holders of the Private Notes
under the Registration Rights Agreement, which rights will terminate upon
consummation of the Exchange Offer. The Exchange Notes will evidence the same
indebtedness as the Private Notes (which they replace) and will be issued under,
and be entitled to the benefits of, the Indenture. For further information and
for definitions of certain capitalized terms used below, see "Description of
Exchange Notes."
NOTES OFFERED................. $115,000,000 in aggregate principal amount of
14% Senior Notes due 2008.
MATURITY...................... June 15, 2008.
INTEREST PAYMENT DATES........ June 15th and December 15th, commencing
December 15, 1998.
RANKING....................... The Notes will be general obligations of Birch,
will be unsecured (except as described below)
and will rank senior in right of payment to all
future unsecured subordinated Indebtedness (as
defined) of Birch and will rank pari passu in
right of payment with all future unsecured
senior Indebtedness of Birch. However, the
Notes will be effectively junior to all future
secured Indebtedness of Birch to the extent of
the assets securing such Indebtedness. All of
the operations of Birch are conducted through
its subsidiaries and Birch's subsidiaries will
not be guarantors of the Notes. Accordingly,
the Notes will be effectively subordinated to
all current and future Indebtedness and all
other liabilities or obligations of such
subsidiaries. As of September 30, 1998, Birch
had approximately $114.7 million of
Indebtedness outstanding and Birch's
subsidiaries had approximately $764,000 of
Indebtedness outstanding. The Indebtedness of
the Company includes the amount represented by
the Notes. See "Capitalization." The Indenture
governing the Notes permits the incurrence of
substantial additional Indebtedness, including
secured Indebtedness, by Birch and its
subsidiaries. See "Description of the Exchange
Notes."
SECURITY...................... The Indenture required the Company to purchase
and pledge to the Trustee, as security for the
benefit of the holders of the Notes, U.S.
Government Obligations in such amount as will
be sufficient upon receipt of scheduled
interest and/or principal payments of such
securities to provide for the payment in full
of the first six scheduled interest payments
due on the Notes. The Company used
approximately $44.2 million of the net proceeds
of the Private Offering to acquire the Pledged
Securities. Under the Pledge Agreement (as
defined), assuming that the Company makes the
first six scheduled interest payments on the
Notes when due, any remaining Pledged
Securities will be released to the Company and
the Notes will be unsecured. See "Description
of the Exchange Notes -- Security."
OPTIONAL REDEMPTION........... Except as described below, the Notes will not
be redeemable at Birch's option prior to June
15, 2003. Thereafter, the Notes will be
8
<PAGE> 14
subject to redemption at any time at the option
of Birch, in whole or in part, at the
redemption prices set forth herein plus accrued
and unpaid interest and Liquidated Damages (as
defined) thereon, if any, to the applicable
redemption date. In addition, at any time prior
to June 15, 2001, Birch may on any one or more
occasions redeem up to 35% of the originally
issued aggregate principal amount of the Notes
at a redemption price of 114% of the principal
amount thereof, plus accrued and unpaid
interest and Liquidated Damages thereon, if
any, to the redemption date, with the net cash
proceeds from one or more Equity Offerings;
provided that at least 65% of the originally
issued aggregate principal amount of the Notes
remains outstanding immediately after the
occurrence of such redemption. See "Description
of the Exchange Notes -- Optional Redemption."
CHANGE OF CONTROL............. Upon the occurrence of a Change of Control, the
holders of the Notes will have the right to
require Birch to repurchase such holders'
Notes, in whole or in part, at a price equal to
101% of the principal amount thereof, plus
accrued and unpaid interest and Liquidated
Damages thereon, if any, to the date of
purchase. There can be no assurance that Birch
will be able to raise sufficient funds to meet
this obligation should it arise. See
"Description of the Exchange
Notes -- Repurchase at the Option of Holders --
Change of Control."
CERTAIN COVENANTS............. The indenture pursuant to which the Notes were
issued (the "Indenture") contains certain
covenants that, among other things, limit the
ability of Birch and its Restricted
Subsidiaries (as defined) to (i) incur
additional indebtedness and issue preferred
stock, (ii) pay dividends or make certain other
restricted payments, (iii) enter into
transactions with affiliates, (iv) make certain
asset dispositions, (v) merge or consolidate
with, or transfer substantially all its assets
to, another Person (as defined), (vi) create
Liens (as defined), (vii) permit restrictions
on the ability of Birch's Restricted
Subsidiaries to make certain payments to Birch,
(viii) engage in sale and leaseback
transactions, (ix) issue or sell certain Equity
Interests (as defined) of Birch's Restricted
Subsidiaries or (x) engage in certain business
activities. See "Description of the Exchange
Notes -- Certain Covenants." In addition, under
certain circumstances, Birch will be required
to offer to purchase the Notes at a price equal
to 100% of the principal amount thereof, plus
accrued and unpaid interest and Liquidated
Damages thereon, if any, to the date of
purchase, with the proceeds of certain Asset
Sales (as defined). See "Description of the
Exchange Notes -- Repurchase at the Option of
Holders -- Asset Sales."
9
<PAGE> 15
SUMMARY UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION AND
OTHER DATA
The following table sets forth pro forma statements of operations data and
other data of Birch for the year ended December 31, 1997 and the nine months
ended September 30, 1998. These pro forma data have been derived from, and are
qualified by reference to, the pro forma condensed consolidated financial
statements of Birch included elsewhere in this Prospectus. The pro forma
statement of operations data and other data give effect to the Transactions and
the Private Offering as if they had occurred on January 1, 1997. The information
set forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Pro Forma
Financial Statements (as defined) and related notes thereto included elsewhere
in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1997 SEPTEMBER 30, 1998
----------------- ------------------
(IN THOUSANDS EXCEPT PER SHARE
AND OPERATING DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue.................................................... $ 18,847 $ 20,348
Cost of services........................................... 12,861 14,055
-------- --------
Gross margin............................................... 5,986 6,293
Selling, general and administrative........................ 6,731 9,710
Depreciation and amortization.............................. 2,333 2,064
-------- --------
Loss from operations....................................... (3,078) (5,481)
Interest expense........................................... 16,247 15,089
-------- --------
Net loss................................................... (19,325) (20,570)
Preferred stock dividends(a)............................... -- 1,204
Amortization of preferred stock issuance costs............. -- 21
-------- --------
Loss applicable to Common Stock............................ $(19,325) $(21,795)
======== ========
Loss per common share -- basic and diluted................. $ (15.65) $ (6.45)
======== ========
Weighted average number of common shares
outstanding -- basic and diluted......................... 1,235 3,381
OTHER FINANCIAL DATA:
EBITDA(b).................................................. $ (745) $ 3,417
Capital expenditures....................................... 534 10,023
OPERATING DATA:
Customers served at end of period.......................... 17,060 22,696
Access lines at end of period.............................. 14,817 30,871
Employees at end of period................................. 108 283
</TABLE>
- ---------------
(a) Includes accretion of mandatorily redeemable preferred shares to redemption
value.
(b) "EBITDA" is defined as earnings before interest, taxes, depreciation and
amortization. Although EBITDA is not a measure of performance calculated in
accordance with generally accepted accounting principles ("GAAP"), Birch's
management believes that EBITDA is accepted as a generally recognized
measure of performance in the telecommunications industry. Nevertheless,
this measure should not be considered in isolation or as a substitute for
operating income (as determined in accordance with GAAP) as an indicator of
Birch's operating performance, or to cash flows from operating activities
(as determined in accordance with GAAP) as a measure of liquidity. In
addition, it should be noted that companies calculate EBITDA differently
and, therefore, EBITDA as presented for the Company may not be comparable to
EBITDA reported by other companies. See the consolidated financial
statements of Valu-Line and Birch and related notes thereto (collectively,
the "Consolidated Financial Statements") included elsewhere in this
Prospectus for a review of the cash used in and provided by operating and
investing activities. Furthermore, there are legal and functional
requirements that limit management's discretionary use of funds depicted by
EBITDA. See "Risk Factors -- Substantial Future Operating Losses; Negative
Cash Flow from Operations, Risk Factors -- Substantial Leverage; Ability to
Service Indebtedness and Risk Factors -- Discretionary Use of Funds."
10
<PAGE> 16
SUMMARY HISTORICAL FINANCIAL INFORMATION AND OTHER DATA
The following table sets forth summary historical financial information and
other data of (i) Valu-Line, Birch's predecessor (the "Predecessor"), for the
years ended December 31, 1993, 1994, 1995, 1996 and 1997 and (ii) Birch for the
year ended December 31, 1997 and the nine months ended September 30, 1997 and
1998. The financial data for the years ended December 31, 1995, 1996 and 1997
for the Predecessor have been derived from, and are qualified by reference to,
the audited consolidated financial statements of Valu-Line included elsewhere in
this Prospectus. The financial data for the year ended December 31, 1997 for the
Company have been derived from, and are qualified by reference to, the audited
consolidated financial statements of Birch included elsewhere in this
Prospectus. The summary historical financial information of Birch for the nine
months ended September 30, 1997 and 1998 has been derived from, and is qualified
by reference to, the unaudited financial statements of Birch included elsewhere
herein. The unaudited condensed consolidated financial statements have been
prepared on the same basis as the audited consolidated financial statements and,
in the opinion of management, include all adjustments (consisting only of normal
recurring adjustments) necessary to present fairly the information included
therein. Operating results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the entire year
ended December 31, 1998. The information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements included
elsewhere in this Prospectus.
11
<PAGE> 17
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
------------------------------------------------------------- ---------------------------------
NINE MONTHS
PERIOD ENDED
YEARS ENDED DECEMBER 31, ENDED YEAR ENDED SEPTEMBER 30,
---------------------------------------------- FEBRUARY 10, DECEMBER 31, ------------------
1993 1994 1995 1996 1997 1998 1997(a) 1997 1998(b)
------ ------- ------- ------- ------- ------------ ------------ -------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Revenue.................. $8,321 $10,741 $12,226 $13,217 $16,801 $1,675 $ -- $ -- $17,243
Cost of services......... 5,504 6,713 8,284 8,749 11,842 1,194 -- -- 12,247
------ ------- ------- ------- ------- ------ ------- -------- -------
Gross margin............. 2,817 4,028 3,942 4,468 4,959 481 -- -- 4,996
Selling, general and
administrative......... 2,085 3,022 3,520 3,561 4,067 315 1,776 1,214 8,816
Depreciation and
amortization........... 161 199 189 311 341 31 27 19 1,229
------ ------- ------- ------- ------- ------ ------- -------- -------
Income (loss) from
operations............. 571 807 233 596 551 135 (1,803) (1,233) (5,049)
Interest (income)
expense................ 49 48 58 102 97 5 (14) (8) 2,808
------ ------- ------- ------- ------- ------ ------- -------- -------
Income (loss) before
taxes.................. 522 759 175 494 454 130 (1,789) (1,225) (7,857)
Income taxes............. 191 319 81 205 186 52 -- -- --
------ ------- ------- ------- ------- ------ ------- -------- -------
Net income (loss)........ $ 331 $ 440 $ 94 $ 289 $ 268 $ 78 (1,789) (1,225) (7,857)
====== ======= ======= ======= ======= ======
Preferred stock
dividends(c)........... -- -- 1,204
Amortization of preferred
stock issuance costs... -- -- 21
------- -------- -------
Income (loss) applicable
to Common Stock........ $(1,789) $ (1,225) $(9,082)
======= ======== =======
Earnings (loss) per
common share -- basic
and diluted............ $ (1.45) $ (1.15) $ (2.69)
======= ======== =======
Weighted average number
of common shares
outstanding -- basic
and diluted............ 1,235 1,064 3,381
</TABLE>
12
<PAGE> 18
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
------------------------------------------------------------- --------------------------------
NINE MONTHS
PERIOD ENDED
YEARS ENDED DECEMBER 31, ENDED YEAR ENDED SEPTEMBER 30,
---------------------------------------------- FEBRUARY 10, DECEMBER 31, -----------------
1993 1994 1995 1996 1997 1998 1997(a) 1997 1998(b)
------ ------- ------- ------- ------- ------------ ------------ ------ --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Customers served at end
of period............... * * 12,002 12,733 15,810 * -- -- 22,696
Access lines at end of
period.................. -- -- -- -- 14,700 15,650 -- -- 30,871
Employees at end of
period.................. 40 51 58 61 84 84 14 13 283
</TABLE>
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
--------------------------------------------------------- ----------------------------
PERIOD
AS OF DECEMBER 31, ENDED AS OF AS OF
------------------------------------------ FEBRUARY 10, DECEMBER 31, SEPTEMBER 30,
1993 1994 1995 1996 1997 1998 1997 1998
------ ------ ------ ------ ------ ------------ ------------ -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents....... $ 123 $ 333 $ 96 $ 158 $ 258 $ -- $210 $ 53,378
Pledged Securities.............. -- -- -- -- -- -- -- 44,917
Property and equipment.......... 1,342 2,063 2,265 2,721 2,964 3,182 128 16,638
Total assets.................... 2,760 3,748 3,971 3,868 4,802 5,287 534 145,624
Long-term debt and capital lease
obligations................... 587 1,188 1,431 792 681 650 -- 115,320
Redeemable preferred
stock......................... -- -- -- -- -- -- -- 13,572
Total stockholders' equity...... 574 1,014 1,108 1,397 1,665 1,743 29 1,752
</TABLE>
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
------------------------------------------------------ ---------------------------------
NINE MONTHS
PERIOD ENDED
YEARS ENDED DECEMBER 31, ENDED YEAR ENDED SEPTEMBER 30,
--------------------------------------- FEBRUARY 10, DECEMBER 31, ------------------
1993 1994 1995 1996 1997 1998 1997(a) 1997 1998(b)
------ ------ ----- ----- ----- ------------ ------------ ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA:
Cash flows from operating
activities..................... $ 515 $ 568 $(267) $ 834 $ 488 $ (215) $(1,464) $(1,133) $ (1,353)
Cash flows from investing
activities..................... (371) (753) (230) (513) (243) (30) (215) (111) (62,616)
Cash flows from financing
activities..................... 27 395 259 (257) (145) (13) 1,889 1,818 117,137
EBITDA(d)........................ 732 1,006 422 907 892 166 (1,776) (1,214) (3,820)
Capital expenditures............. 371 753 230 513 243 30 128 111 9,959
Ratio of earnings to fixed
charges(e)..................... 10.00x 14.09x 3.46x 5.19x 4.91x 11.12x -- -- --
Deficiency of earnings to fixed
charges........................ -- -- -- -- -- -- $(1,789) $(1,225) $ (7,857)
</TABLE>
- ---------------
(a) Birch, which was formed on December 23, 1996, had no assets, liabilities, or
financial activity prior to January 1, 1997.
(b) Includes the results of operations of Valu-Line, Telesource, Boulevard and
TFSnet for the period from the date of the closing of the transactions
through September 30, 1998.
(c) Includes accretion of mandatorily redeemable preferred shares to redemption
value.
(d) "EBITDA" is defined as earnings before interest, taxes, depreciation and
amortization. Although EBITDA is not a measure of performance calculated in
accordance with generally accepted accounting principles ("GAAP"), Birch's
management believes that EBITDA is accepted as a generally recognized
measure of performance in the telecommunications industry. Nevertheless,
this measure should not be considered in isolation or as a substitute for
operating income (as determined in accordance with GAAP) as an indicator of
Birch's operating performance, or to cash flows from operating activities
(as determined in accordance with GAAP) as a measure of liquidity. In
addition, it should be noted that
13
<PAGE> 19
companies calculate EBITDA differently and, therefore, EBITDA as presented
for the Company may not be comparable to EBITDA reported by other companies.
See the consolidated financial statements of Valu-Line and Birch and related
notes thereto (collectively, the "Consolidated Financial Statements")
included elsewhere in this Prospectus for a review of the cash used in and
provided by operating and investing activities. Furthermore, there are legal
and functional requirements that limit management's discretionary use of
funds depicted by EBITDA. See "Risk Factors -- Substantial Future Operating
Losses; Negative Cash Flow from Operations, Risk Factors -- Substantial
Leverage; Ability to Service Indebtedness and Risk Factors -- Discretionary
Use of Funds."
(e) For purposes of calculating the ratio of earnings to fixed charges, earnings
are defined as loss before income taxes plus fixed charges. Fixed charges
consist of interest expense and a reasonable approximation of the interest
factor included in rental payments on operating leases. Earnings were
insufficient to cover fixed charges for the year ended December 31, 1997 and
for the nine months ended September 30, 1997 and 1998.
* Information not available.
14
<PAGE> 20
RISK FACTORS
This Prospectus includes "forward looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. Although
Birch believes that its plans, intentions and expectations reflected in such
forward looking statements are reasonable, it can give no assurance that such
plans, intentions or expectations will be achieved. Important factors that could
cause actual results to differ materially from Birch's forward looking
statements are set forth below and elsewhere in this Prospectus. All forward
looking statements attributable to Birch or persons acting on its behalf are
expressly qualified in their entirety by the cautionary statements set forth
below.
FAILURE TO EXCHANGE PRIVATE NOTES
Exchange Notes will be issued in exchange for Private Notes only after
timely receipt by the Exchange Agent of such Private Notes, a properly completed
and duly executed Letter of Transmittal and all other required documentation.
Therefore, holders of Private Notes desiring to tender such Private Notes in
exchange for Exchange Notes should allow sufficient time to ensure timely
delivery. Neither the Exchange Agent nor the Company is under any duty to give
notification of defects or irregularities with respect to tenders of Private
Notes for exchange. Private Notes that are not tendered or are tendered but not
accepted will, following consummation of the Exchange Offer, continue to be
subject to the existing restrictions upon transfer thereof. In addition, any
holder of Private Notes who tenders in the Exchange Offer for the purpose of
participating in a distribution of the Exchange Notes will be required to comply
with the registration and prospectus delivery requirements of the Securities Act
in connection with any resale transaction. Each broker-dealer that receives
Exchange Notes for its own account in exchange for Private Notes, where such
Private Notes were acquired by such broker-dealer as a result of market-making
activities or any other trading activities, must acknowledge that it will
deliver a prospectus in connection with any resale of such Exchange Notes. To
the extent that Private Notes are tendered and accepted in the Exchange Offer,
the trading market for untendered and tendered but unaccepted Private Notes
could be adversely affected due to the limited amount, or "float," of the
Private Notes that are expected to remain outstanding following the Exchange
Offer. Generally, a lower "float" of a security could result in less demand to
purchase such security and could, therefore, result in lower prices for such
security. For the same reason, to the extent that a large amount of Private
Notes are not tendered or are tendered and not accepted in the Exchange offer,
the trading market for the Exchange Notes could be adversely affected. See "Plan
of Distribution" and "The Exchange Offer."
SUBSTANTIAL FUTURE OPERATING LOSSES; NEGATIVE CASH FLOW FROM OPERATIONS
The expansion of Birch's business and the deployment of its services and
systems will require significant capital expenditures, a substantial portion of
which will need to be incurred before the realization of significant revenue.
Birch expects to generate negative earnings before interest, income taxes,
depreciation and amortization ("EBITDA") while it emphasizes deployment of its
switches and further development of its telecommunications services business and
until it establishes a sufficient revenue-generating customer base. There can be
no assurance that an adequate revenue base will be established. For the nine
months ended September 30, 1998, the Company had an operating loss of $5.0
million, net loss of $7.9 million and EBITDA of $(3.8) million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." Birch expects to experience increasing operating losses and
negative EBITDA as it expands its operations. There can be no assurance that
Birch will achieve or sustain profitability or generate sufficient EBITDA to
meet its working capital, capital expenditures and debt service requirements,
which could have a material adverse effect on Birch's business, operating
results and financial condition and its ability to achieve sufficient cash flow
to service the Notes. See "-- Substantial Leverage; Ability to Service
Indebtedness;" "-- Need for Additional Financing" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE INDEBTEDNESS
The Company is highly leveraged. On September 30, 1998, Birch had total
indebtedness of approximately $115.4 million (most of which consisted of the
Notes) and total stockholders' equity (excluding $13.6 million in aggregate
liquidation preference of Series B Preferred Stock) of approximately $1.8
million. For the fiscal
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year ended December 31, 1997 and for the nine months ended September 30, 1998,
earnings were insufficient to cover fixed charges by approximately $1.8 million
and $7.9 million, respectively. In addition, commencing December 15, 1998, the
Company will make semi-annual interest payments on the Notes of approximately
$8.1 million. The Company and its subsidiaries are permitted to incur
substantial additional indebtedness in the future. See "Capitalization,"
"Selected Historical Consolidated Financial and Other Data" and "Description of
the Exchange Notes."
The ability of the Company to fund the capital expenditures and other costs
contemplated by its business plan and to make scheduled payments with respect to
the Notes will depend upon, among other things, its ability to seek and obtain
additional financing within the next nine months, to implement its business
plan, to deploy its network and expand its operations and to obtain and retain a
significant number of customers in its target markets, and the future operating
performance of Birch and its subsidiaries. Each of these factors is, to a large
extent, subject to economic, financial, competitive, political, regulatory and
other factors, many of which are beyond Birch's control. Birch expects that it
will generate operating losses for the foreseeable future and that its business
will not generate positive cash flow for the foreseeable future. In addition,
the Company will require significant amounts of additional financing, which may
not be available, before it will be able to generate positive cash flow. No
assurance can be given that Birch will be successful in developing and
maintaining a level of cash flow from operations sufficient to permit it to pay
the principal of, and interest and Liquidated Damages, if any, on the Notes. If
Birch is unable to generate sufficient cash flow from operations to service its
indebtedness, including the Notes, it may have to modify its growth plans, limit
its capital expenditures, restructure or refinance its indebtedness, seek
additional capital or liquidate its assets. There can be no assurance (i) that
any of these strategies could be effected on satisfactory terms, if at all, in
light of Birch's high leverage or (ii) that any such strategy would yield
sufficient proceeds to service the Notes. Any failure by Birch to satisfy its
obligations with respect to the Notes at maturity or prior thereto would
constitute a default under the Indenture and could cause a default under
agreements governing other indebtedness of Birch. See "-- Limited History of
Operations as a Combined Organization," "-- Need for Additional Financing" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
The degree to which Birch is leveraged could have important consequences to
holders of the Notes, including (i) making it more difficult for Birch to
satisfy its obligations with respect to the Notes; (ii) increasing Birch's
vulnerability to general adverse economic and industry conditions; (iii)
limiting Birch's ability to obtain additional financing to fund its expected
capital expenditures for the next two years, future working capital (including
anticipated future operating losses), or other general corporate requirements;
(iv) requiring the dedication of a substantial portion of Birch's cash flow from
operations (if any) to the payment of principal of, and interest on, its
indebtedness, thereby reducing the availability of such cash flow to fund
working capital, capital expenditures or other general corporate purposes; (v)
limiting Birch's flexibility in planning for, or reacting to, changes in its
business and the telecommunications industry; (vi) limiting Birch's ability to
expand into new markets; and (vii) placing Birch at a competitive disadvantage
relative to less leveraged competitors. In addition, Birch's operating and
financial flexibility will be limited by covenants contained in agreements
governing the indebtedness of Birch, including the Indenture. Among other
things, the covenants in the Indenture limit, and covenants in agreements
governing other indebtedness will likely limit, the ability of Birch and its
subsidiaries to incur additional indebtedness, issue preferred stock, pay
dividends or make distributions to its stockholders or to make certain other
restricted payments, create certain liens upon assets, apply the proceeds from
the disposition of certain assets or enter into certain transactions with
affiliates. Restrictions on the ability of the Company to incur additional
indebtedness may be waived, however, with the consent of the holders of a
majority in principal amount of the Notes outstanding. The Indenture also allows
the Company to designate current or future subsidiaries as Unrestricted
Subsidiaries. There can be no assurance that such covenants will not adversely
affect Birch's ability to finance its future operations or capital needs or to
engage in other business activities which may be in the interests of Birch. See
"Description of the Exchange Notes -- Certain Covenants."
The Company currently anticipates that, in order to pay the principal of
the Notes or to redeem or repurchase the Notes upon a Change of Control, Birch
may be required to adopt one or more alternatives, such as refinancing its
indebtedness or selling its equity securities or the equity securities or assets
of its
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subsidiaries. There can be no assurance that any of the foregoing actions could
be effected on satisfactory terms, that any of the foregoing actions would
enable the Company to pay the principal amount of the Notes or that any of such
actions would be permitted by the terms of the Indenture or any of the debt
instruments of Birch or Birch's subsidiaries then in effect.
NEED FOR ADDITIONAL FINANCING
Birch expects to make significant capital outlays for the foreseeable
future in order to continue the development activities called for in its current
business plan for 1999 and thereafter and to fund expected operating losses. In
order for the Company to implement its current business plan and finance its
projected capital expenditures for 1999 and thereafter, Birch will be required
to seek and obtain significant amounts of additional financing (debt and/or
equity) -- perhaps as much as $60 million or more -- within the next nine
months. The Company's expansion into Texas is dependent upon raising substantial
additional financing in the near term. If Birch's plans or assumptions change,
if its assumptions prove to be inaccurate, or if it experiences unanticipated
costs or competitive pressures, Birch will be required to seek additional
capital sooner than currently anticipated, possibly within the next six months.
In particular, if Birch elects to pursue significant additional acquisition
opportunities or to deploy more switches than currently planned, its cash needs
may be increased substantially. There can be no assurance that Birch's current
projection of cash flow (and losses) from operations (which will depend upon
numerous future factors and conditions, many of which are outside of Birch's
control) will be accurate. Because Birch's cost of developing new networks and
services, funding other strategic initiatives and operating its business will
depend on a variety of factors (including the number of subscribers and the
service for which they subscribe, the nature and penetration of services that
may be offered by Birch, regulatory changes, changes in technology and actions
taken by competitors in response to Birch's strategic initiatives), it is almost
certain that actual costs and revenue will vary from expected amounts, very
likely to a material degree, and such variations are likely to affect Birch's
future capital requirements. The proceeds from the Private Offering will not be
sufficient to fund Birch's current business plan beyond the next nine months. As
a consequence, Birch intends to seek additional debt and/or equity financing
necessary to fund Birch's liquidity needs after the use of proceeds from the
Private Offering. There can be no assurance that Birch will be able to raise
additional capital on satisfactory terms or at all. If Birch decides to raise
additional funds through the incurrence of debt, its interest obligations will
increase and it may become subject to additional or more restrictive financial
covenants. For example, Birch's ability to access the cash flow of its
subsidiaries may be restricted by such future debt covenants. See "-- Holding
Company Structure; Effective Subordination and Ranking." If Birch decides to
raise additional funds through the issuance of equity, the ownership interests
represented by the Warrant Shares will be diluted. See "-- Shares Eligible for
Future Sale" and "Dilution." In the event that Birch is unable to obtain such
additional capital or to obtain it on acceptable terms or in sufficient amounts,
Birch will be required to delay the development of its network or take other
actions that could have a material adverse effect on Birch's business, operating
results and financial condition and its ability to achieve sufficient cash flow
to service the Notes. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
LIMITED HISTORY OF OPERATIONS AS A COMBINED ORGANIZATION
Birch Telecom, Inc. commenced operations on January 1, 1997 and merged with
Valu-Line in February 1998. Prior to the Merger, Birch Telecom, Inc. had been a
development stage company with no revenue. While Valu-Line has a 15-year
operating history, it has been under the guidance of Birch management for less
than four months. In May 1998, Birch acquired Boulevard and Telesource.
Prospective investors, therefore, have limited financial or operating
information about Birch as a combined organization. Birch's viability,
profitability and growth depend upon its ability to successfully integrate
Valu-Line, Boulevard and Telesource. The implementation of Birch's business plan
will be subject to numerous risks, many of which are outside of its control and
any of which could require substantial changes to proposed plans or otherwise
alter the time frames or budgets currently contemplated. Such risks include (i)
risks related to the integration of Birch, Valu-Line, Boulevard, Telesource and
TFSnet into a cohesive and efficient enterprise; (ii) the risks of unfavorable
regulatory changes; (iii) the need to obtain required governmental and local
regulatory approvals; (iv) the need to negotiate acceptable purchase, lease,
joint venture and other
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agreements, including interconnection agreements with SWBT, other ILECs and long
distance service providers; (v) identifying, financing and completing suitable
acquisitions; (vi) risks associated with developing its operational support and
back office systems; (vii) risks associated with entry into new markets; (viii)
risks associated with recruiting and training new employees; and (ix) risks
typically associated with any business venture, such as unanticipated cost
increases. There can be no assurance that the implementation of Birch's current
business plan will be successful, and the failure to integrate Birch, Valu-Line,
Boulevard and Telesource successfully would have a material adverse effect on
Birch's business, operating results and financial condition and its ability to
achieve sufficient cash flow to service the Notes.
RISKS ASSOCIATED WITH ACQUISITIONS
Birch's current business plan contemplates future acquisitions and may
result in acquisitions of companies that are larger than Birch. Future
acquisitions by Birch could result in the incurrence of debt or contingent
liabilities, which could have a material adverse effect on Birch's business,
financial condition and results of operations. Such transactions commonly
involve certain risks, including, among others: the difficulty of assimilating
the acquired operations and personnel; the potential disruption of Birch's
ongoing business and diversion of resources and management time; the possible
inability of management to maintain uniform standards, controls, procedures and
policies; the risks of entering markets in which Birch has little or no direct
prior experience; and the potential impairment of relationships with employees
or customers as a result of changes in management. There can be no assurance
that any future acquisition will be made, that Birch will be able to obtain
additional financing needed to finance such acquisitions and, if any
acquisitions are so made, that the acquired business will be successfully
integrated into Birch's operations or that the acquired business will perform as
expected. The failure to integrate any such future acquisition successfully
would have a material adverse effect on Birch's business, operating results and
financial condition and its ability to achieve sufficient cash flow to service
the Notes.
HOLDING COMPANY STRUCTURE; EFFECTIVE SUBORDINATION AND RANKING
Birch is a holding company with no business operations of its own. Birch's
only significant asset is and will be the outstanding capital stock of its
subsidiaries. Birch conducts, and will conduct, all of its business operations
through its subsidiaries. Accordingly, Birch's only source of cash to pay
interest on and principal of the Notes will be distributions by its subsidiaries
from the net earnings and cash flow generated by such subsidiaries. Birch
currently expects that the earnings and cash flow of its subsidiaries will be
retained and used by such subsidiaries in their operations, including to service
their future debt obligations. Even if Birch determined to pay a dividend on or
make a distribution in respect of the capital stock of its subsidiaries, there
can be no assurance that Birch's subsidiaries will generate sufficient cash flow
to pay such a dividend or distribute such funds to Birch or that applicable
state law and contractual restrictions will permit such dividends or
distributions.
The Notes will be general obligations of Birch secured only by the Pledged
Securities (approximately $44.2 million) and will rank senior in right of
payment to all future unsecured subordinated Indebtedness of Birch and will rank
pari passu in right of payment with all future unsecured senior Indebtedness of
Birch. Birch's subsidiaries will not be guarantors of the Notes. Accordingly,
the Notes will be effectively subordinated to all current and future
Indebtedness and all other liabilities or obligations of such subsidiaries. The
Indenture permits Birch's subsidiaries to incur substantial indebtedness, the
terms of which may contain restrictions or prohibitions on the payment of
dividends or the making of loans by such subsidiaries to Birch. Accordingly,
there can be no assurance that sufficient amounts will be available to service
interest on the Notes. See "Description of the Exchange Notes."
In the event of any distribution or payment of the assets of Birch in any
foreclosure, dissolution, winding-up, liquidation, reorganization, or other
bankruptcy proceeding, holders of secured Indebtedness will have a prior claim
to the assets of Birch that constitute their collateral. Holders of the Notes
will participate ratably with all holders of unsecured Indebtedness of Birch
that is deemed to be of the same class as the Notes, and potentially with all
other general creditors of Birch, based upon the respective amounts owed to each
holder or creditor, in the remaining assets of Birch. The Indenture permits the
incurrence of substantial amounts of secured Indebtedness by Birch in the
future, and the holders of such secured Indebtedness would have a prior
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claim over the holders of the Notes to the assets of Birch that secure such
Indebtedness. In any of the foregoing events, there can be no assurance that
there would be sufficient assets to pay amounts due on the Notes.
BUSINESS EXPANSION RISKS; POSSIBLE INABILITY TO MANAGE GROWTH
Birch's business strategy contemplates expanding its operations rapidly
into new markets. For example, Birch intends to provide service in 12 markets in
Texas by the end of 1999. Birch's success will depend, among other things, upon
Birch's ability to secure significant amounts of additional financing, assess
potential markets, obtain required governmental authorizations and permits,
provision new customers, implement interconnection and collocation with ILEC
facilities, lease adequate trunking capacity from ILECs or other CLECs, purchase
and install switches in additional markets, implement efficient operations
support systems and other back office systems, and develop a sufficient customer
base. The successful implementation of Birch's business plan will result in
rapid expansion of its operations. Rapid expansion of Birch's operations may
place a significant strain on Birch's management, financial and other resources.
See "-- Need for Additional Financing."
The Company's ability to manage future growth, should it occur, will depend
upon its ability to develop efficient operations support systems and other back
office systems, monitor operations, control costs, maintain regulatory
compliance, maintain effective quality controls and significantly expand Birch's
internal management, technical, information and accounting systems and to
attract, assimilate, train and retain additional qualified personnel, including
sales, marketing and technical personnel. See "-- Dependence on New Employees."
Birch intends to deploy switches in several markets in Missouri, Kansas and
Texas over the next 18 months, which will result in a significant amount of
capital expenditures. Failure of Birch to manage its future growth effectively
could adversely affect the expansion of Birch's customer base and service
offerings. There can be no assurance that the Company will successfully
implement and maintain such operational and financial systems or successfully
obtain, integrate and utilize the employees and management, operational and
financial resources necessary to manage a developing and expanding business in
an evolving, highly regulated and increasingly competitive industry. Any failure
to expand these areas and to implement and improve such systems, procedures and
controls in an efficient manner at a pace consistent with the growth of Birch's
business could have a material adverse effect on Birch's business, operating
results and financial condition and its ability to achieve sufficient cash flow
to service the Notes.
If Birch were unable to hire sufficient qualified personnel or develop,
acquire and integrate successfully its operational, customer service and other
information systems, customers could experience delays in connection of service
and/or lower levels of customer service. Failure by Birch to meet the demands of
customers and to manage the expansion of its business and operations could have
a material adverse effect on Birch's business, operating results and financial
condition and its ability to achieve sufficient cash flow to service the Notes.
REGULATION
Birch is subject to, and benefits from, varying degrees of federal, state,
and local regulation of its business and the businesses of its competitors. On
the federal level, Birch is not currently subject to rate regulation, nor is it
currently required to obtain FCC authorization for the installation,
acquisition, or operation of its network facilities. Birch's subsidiaries that
provide intrastate services are generally subject to certification and tariff-
filing requirements by state regulators. Challenges to these tariffs by third
parties could cause Birch to incur substantial legal and administrative
expenses. In addition, Birch must comply with various state and federal
obligations, such as the duty to contribute to universal service subsidies, the
impact of which cannot yet be fully assessed. Failure to comply with federal and
state reporting and regulatory requirements may result in fines or other
penalties, including loss of certification to provide services.
The Telecommunications Act of 1996 (the "Telecommunications Act") and the
interconnection decisions of the FCC may provide ILECs with increased pricing
flexibility for their services and other regulatory relief, which could have a
material adverse effect on CLECs, including Birch. There can be no assurance
that future regulatory provisions will not be less favorable to CLECs and more
favorable to their competitors. If ILECs like SWBT are allowed by regulators to
lower the rates for their services, to engage in substantial volume and term
discount pricing practices for their customers, or to charge CLECs fees for
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interconnection to the ILECs' networks, Birch's business, operating results and
financial condition could be materially adversely affected. ILECs may also seek
to delay competitors through legal or regulatory challenges, or by recalcitrant
responses to requirements that they open their markets through interconnection
and unbundling of network elements. For example, SWBT has refused to pay
reciprocal compensation to Birch for calls to Internet Service Providers
("ISPs"). See "-- Reciprocal Compensation for Internet Access" and
"Business -- Regulation -- Interconnection with ILEC Facilities." Increased
local exchange competition resulting from various legislative initiatives,
including the Telecommunications Act, may allow Bell Operating Companies
("BOCs") such as SWBT to provide long distance services under provisions of the
Telecommunications Act more quickly than had earlier been anticipated. When SWBT
is permitted to provide such services, it will be in a position to offer
integrated local and long distance service, subject to certain regulatory
constraints, and Birch will no longer enjoy the competitive advantage of being
one of the only companies in its markets to offer integrated local and long
distance service and billing. See "Business -- Regulation -- BOC Entry into New
Markets."
There are currently many regulatory actions under way and being
contemplated by federal and state authorities regarding interconnection pricing
and other issues that could result in significant changes to the business
conditions in the telecommunications industry. State utility commissions
determine the size of the wholesale discount at which ILECs must offer local
exchange services to resellers. Prices set forth in interconnection agreements
or through proceedings before state utility commissions may be subject to
changes mandated by state commission as they develop permanent rules governing
interconnection. No assurance can be given that changes in current or future
regulations adopted by the FCC or state regulators, or other legislative,
administrative, or judicial initiatives relating to the telecommunications
industry, would not have a material adverse effect on Birch's business,
operating results and financial condition. In particular, Birch's belief that
the entire local exchange market will open to CLEC competition depends upon
continued favorable pro-competitive regulatory changes, and the ability of Birch
to compete in these new market segments may be adversely affected by the greater
pricing flexibility and other regulatory relief granted to ILECs under the
Telecommunications Act and under changes in state regulatory policy. In
addition, Birch may need to register or obtain certification before entering the
market in many states, and delays in obtaining the required regulatory approvals
may have a material adverse effect on Birch. A federal court's partial stay of
FCC rules that set forth the amounts that ILECs can charge CLECs for access to
the ILEC's networks may slow the pace of open competition initiatives and result
in individual states having a more prominent role in the opening of local
exchange markets to competition. See "Business -- Regulation."
COMPETITION
The telecommunications industry is highly competitive. Birch expects it
will face substantial and increasing competition from a variety of service
providers due to regulatory changes and a trend toward business combinations and
alliances in the market. Birch faces competition from integrated service
providers as well as entities that serve individual market segments targeted by
Birch. In each of the cities served by Birch's networks, the services offered by
Birch compete principally with the services offered by the ILEC serving that
area. ILECs, like SWBT, have established networks, long-standing relationships
with their customers, strong political and regulatory influence, the potential
to subsidize competitive services from monopoly service revenue, and the benefit
of state and federal regulations that, until recently, have favored ILECs. In
the local exchange market, the ILECs continue to hold near-monopoly positions.
The BOCs are currently prohibited from entering the in-region long distance
business but industry analysts believe that some may be permitted to enter as
early as the fourth quarter of 1998. Other ILECs are already offering in-region
long distance services.
Birch also expects to face competition from other current and potential
market entrants, including other CLECs, IXCs, cable television companies,
electric utilities, microwave carriers, wireless telephone system operators, and
private networks built by large end users. The Telecommunications Act
facilitates such entry by requiring ILECs to allow new entrants to acquire local
services at wholesale prices for resale and to purchase unbundled network
elements at cost-based prices. A continuing trend toward combinations and
strategic alliances in the telecommunications industry, including potential
consolidation among ILECs, or among CLECs in smaller markets, or transactions
between telephone companies and cable companies outside of the
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telephone company's service area, or between IXCs and CLECs, could give rise to
significant new competitors. Many of Birch's current and potential competitors
have financial, personnel, and other resources, including broad name
recognition, substantially greater than those of Birch, as well as other
competitive advantages over Birch.
The recent World Trade Organization ("WTO") agreement on basic
telecommunications services could increase the level of competition faced by
Birch. Under this agreement, the United States and 68 other members of the WTO
committed themselves to opening their respective telecommunications markets,
including permitting foreign entry into basic telecommunications services
markets and adopting regulatory measures to protect competitors against
anticompetitive behavior by dominant telecommunications companies, effective in
some cases as early as January 1998. The FCC has introduced streamlined
processing of applications to facilitate entry into the U.S. market by entities
of WTO-member origin. There can be no assurance that the pro-competitive effects
of the WTO agreement will not have a material adverse effect on Birch's
business, operating results and financial condition and its ability to achieve
sufficient cash flow to service the Notes.
Birch currently purchases all of its resold local services from SWBT and is
therefore heavily dependent on the availability of the network of SWBT. To the
extent Birch interconnects with and uses the networks of other ILECs, CLECs, and
fiber optic transport providers to service its customers, Birch is and will be
dependent upon the technology and capabilities of those carriers to meet certain
telecommunications needs of Birch's customers and to maintain its service
standards. Birch must interface with the ILEC's operations support systems in
order to properly provision new customers. There can be no assurance that Birch
will be able to obtain the interconnection it requires at rates and on terms and
conditions that permit Birch to offer switched services that are both
competitive and profitable. See "-- Reliance on Leased Transport Facilities and
ILEC Interconnection; Relationship with SWBT." In the event that Birch
experiences difficulties in obtaining high quality, reliable and reasonably
priced services from SWBT and other carriers, the attractiveness of Birch's
services to its customers would be significantly impaired.
The long distance telecommunications market has numerous entities competing
for the same customers and a high average churn rate, as customers frequently
change long distance providers in response to the offering of lower rates or
promotional incentives. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline. The
Company will face competition from large carriers such as AT&T, MCI, Sprint, and
WorldCom. Other competitors are likely to include BOCs providing out-of-region
(and, with the removal of regulatory barriers, in-region) long distance
services, other ILECs, other CLECs, microwave and satellite carriers and private
networks owned by large end users. See "-- Regulation."
The FCC may authorize a BOC to provide interLATA (Local Access and
Transport Area) services in a state when the BOC satisfies 14 specified
interconnection requirements and receives approval from the FCC. In evaluating a
BOC application for interLATA entry, the FCC must consult with the U.S.
Department of Justice and the state regulatory commission. If and when SWBT
obtains authority to provide interLATA services, it will be able to offer
customers local and long distance telephone services. This will permit SWBT to
offer a full range of services to potential customers in a new region and thus
eliminate an existing competitive advantage of Birch. Given the resources and
experience that SWBT currently possess in the local exchange market, the ability
to provide both local and long distance services could make SWBT a very strong
competitor. See "Business -- Regulation -- BOC Entry into New Markets."
The Company competes with equipment vendors and installers, and
telecommunications management companies with respect to certain portions of its
business.
The Internet services market is also highly competitive and the Company
expects that competition will continue to intensify. Birch's competitors in this
market will include other Internet service providers, other telecommunications
companies, on-line services providers and Internet software providers. Many of
these competitors have substantially greater financial, technological,
marketing, personnel and other resources than those available to Birch.
The Company believes that the principal competitive factors affecting its
business operations are service quality, network reliability, reliable customer
service, accurate billing and variety of services, to a lesser extent, pricing
levels and clear pricing policies. The ability of Birch to compete effectively
will depend upon its ability
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to maintain high quality, market-driven services at prices generally equal to or
below those charged by its competitors. To maintain its competitive posture, the
Company believes that it must be in a position to reduce its prices in order to
meet reductions in rates, if any, offered by others. Any such reductions could
adversely affect Birch's business, operating results and financial condition.
See "Business -- Competition."
RELIANCE ON LEASED TRANSPORT FACILITIES AND ILEC INTERCONNECTION; RELATIONSHIP
WITH SWBT
Because Birch has elected to lease transport capacity, it is dependent upon
the availability of fiber optic transmission facilities owned by ILECs (such as
SWBT), CLECs and other fiber optic transport providers whose fiber optic
networks are being or will be leased by Birch. The risks inherent in this
approach include, but are not limited to, negotiating and renewing favorable
supply agreements, and the timeliness of the ILECs, CLECs or other fiber optic
transport providers in processing Birch's orders for customers who seek to
utilize Birch's service. Alternatively, if and when Birch seeks to install its
own fiber, Birch must obtain permits, access to rights-of-way, and permission to
utilize underground conduit and aerial pole space from entities such as ILECs
and other utilities, railroads, long distance companies, state highway
authorities, local governments and transit authorities, and may be required to
obtain franchises from municipal governments. There can be no assurance that
Birch will be able to obtain and maintain the franchises, permits and rights
needed to implement its network buildout on acceptable terms. The failure to
enter into and maintain any such required arrangements for a particular network
may affect Birch's ability to develop that network and may have a material
adverse effect on Birch's business, operating results and financial condition
and its ability to achieve sufficient cash flow to service the Notes.
In addition to transport providers, the Company is reliant on executing
interconnection agreements with the ILECs, in particular SWBT, operating in its
target markets. Birch's interconnection agreements with SWBT in Kansas and
Missouri currently provide that Birch's connection and maintenance orders will
receive attention at parity with SWBT's customers and that SWBT will provide
adequate trunking capacity to keep call blockage within industry standards.
Accordingly, Birch and its customers are currently dependent on SWBT and will in
the future be dependent on other ILECs to assure uninterrupted service. Blocked
calls result in customer dissatisfaction and risk the loss of business.
ILEC-CLEC interconnection agreements, such as the agreements between SWBT and
certain operating subsidiaries of Birch, typically may have short terms,
requiring Birch to renegotiate the agreements continually. ILECs may not provide
timely provisioning or adequate service quality, thereby impairing Birch's
reputation with customers who can easily switch back to the ILEC. In addition,
the prices set in the agreements may be subject to significant rate increases at
the discretion of the states. There can be no assurance that ILECs like SWBT
will comply with their network provisioning requirements, or that Birch will be
able to procure interconnections in other markets on terms comparable to the
interconnection agreements Birch currently has in place. For example, Birch's
ability to enter successfully 12 new markets in Texas by the end of 1999 could
be dependent on Birch's ability to negotiate an interconnection agreement with
SWBT, GTE and other ILECs on substantially similar terms as those currently in
place with SWBT in Kansas and Missouri. In addition, there can be no assurance
that the rates charged to Birch under such interconnection agreements will allow
Birch to offer low enough usage rates to attract a sufficient number of
customers and to operate its business profitably. See "Business -- Regulation --
Terms of Birch Interconnection Agreements."
As described above, Birch is reliant on the continued cooperation of and
the continued lack of competition from SWBT. Any extended interruption in SWBT's
cooperation could disrupt Birch's operations and have a material adverse effect
on Birch's business, operating results and financial condition and its ability
to achieve sufficient cash flow to service the Notes. It is also possible that
SWBT may expand and refocus its product offerings and networks to compete
directly with Birch. Accordingly, there can be no assurance that SWBT will
continue to lease transport capacity to Birch or that SWBT will continue to
renew the interconnection agreements it has with Birch, which would have a
material adverse effect on Birch's business, financial condition and results of
operations.
RISKS RELATING TO LONG DISTANCE BUSINESS
As part of its offering of bundled telecommunications services to its
customers, Birch offers long distance services to its customers. The long
distance business is extremely competitive and prices have declined
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substantially in recent years and are expected to continue to decline. In
addition, the long distance industry has historically had a high average churn
rate, as customers frequently change long distance providers in response to the
offering of lower rates or promotional incentives by competitors. Birch will
initially rely on other carriers to provide transmission and termination
services for all of its long distance traffic. Birch will need resale agreements
with long distance carriers to provide it with transmission services. Such
agreements typically provide for the resale of long distance services on a
per-minute basis and may contain minimum volume commitments. Negotiation of
these agreements involves estimates of future supply and demand for transmission
capacity as well as estimates of the calling patterns and traffic levels of
Birch's future customers. In the event Birch fails to meet its minimum volume
commitments, it may be obligated to pay underutilization charges and in the
event it underestimates its need for transmission capacity, Birch may be
required to obtain capacity through more expensive means. The incurrence of any
underutilization charges, rate increases or termination charges could have a
material adverse effect on Birch's business, operating results and financial
condition and its ability to achieve sufficient cash flow to service the Notes.
DEPENDENCE ON BILLING, CUSTOMER SERVICE AND INFORMATION SYSTEMS
Sophisticated back office information and processing systems are vital to
Birch's growth and its ability to monitor costs, bill customers, provision
customer orders, provide customer service and achieve operating efficiencies.
Birch's plans for the development and implementation of these operations support
systems rely, for the most part, on choosing products and services offered by
third party vendors and integrating such products and services in-house to
produce efficient operational solutions. There can be no assurance that these
systems will be successfully implemented on a timely basis or that they will
perform as expected. Failure of these vendors to deliver proposed products and
services in a timely and effective manner and at acceptable costs, failure by
Birch to adequately identify all of its information and processing needs,
failure of Birch's related processing or information systems, failure by Birch
to integrate effectively such products or services, or the failure by Birch to
upgrade systems as necessary could have a material adverse effect on Birch and
its ability to meet its obligations on the Notes. In addition, Birch's right to
use these systems is dependent upon license agreements with third party vendors.
Certain of such agreements may be cancelable by the vendor and the cancellation
or nonrenewal of these agreements may have an adverse effect on Birch's
business, operating results and financial condition and its ability to achieve
sufficient cash flow to service the Notes.
RISK OF NEW SERVICE ACCEPTANCE BY CUSTOMERS
The success of Birch's service offerings will be dependent upon, among
other things, the willingness of customers to accept Birch as a new provider of
telecommunications services. There can be no assurance that Birch will be
successful in overcoming the resistance of customers or that customers will be
willing to contract for Birch's services. The lack of such acceptance could have
a material adverse effect on Birch's business, operating results and financial
condition and its ability to achieve sufficient cash flow to service the Notes.
RAPID TECHNOLOGICAL CHANGE
The telecommunications industry is subject to rapid and significant changes
in technology. Birch will be subject to competitive threats from new technology
that becomes available before and after its networks are built. The effect of
technological changes on the businesses of Birch, however, cannot be predicted.
Birch believes its future success will depend, in part, on its ability to
anticipate and adapt to such changes and to offer, on a timely basis, services
that meet customer demands. Thus, there can be no assurance that technological
developments will not have a material adverse effect on Birch's business,
operating results and financial condition and its ability to achieve sufficient
cash flow to service the Notes.
RISK OF LOSS OR REDUCTION OF ACCESS CHARGE REVENUES
A portion of Birch's revenue comes from access charges, which are paid to
Birch by long distance carriers for originating and terminating calls to
customers served by Birch. The amount of access charge revenue that Birch
receives is calculated based on guidelines set by federal and state regulatory
bodies, and such guidelines could change at any time. The FCC has indicated that
it intends to begin a rulemaking proceeding during 1998 to reform the federal
access charge system. States often mirror these federal rules in establishing
intrastate access charges. It is unknown at this time what changes, if any, the
FCC may eventually adopt. The
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FCC did adopt some changes to the federal access charge rules in May 1997. These
rules are currently the subject of review by courts, the outcome of which cannot
be predicted. The above circumstances could have a material adverse effect on
Birch's business, operating results and financial condition and its ability to
achieve sufficient cash flow to service the Notes. See "Business -- Products and
Services" and "Business -- Regulation -- Universal Service and Access Charge
Reform."
RECIPROCAL COMPENSATION FOR INTERNET ACCESS
Birch expects to receive a portion of its revenue in a given market from
the ILEC in the form of reciprocal compensation payments for local traffic
terminated on the Company's network. Birch anticipates that the balance of
reciprocal compensation payments between Birch and other LECs would be in
Birch's favor because Birch's target customers are expected to receive more
calls than they make due to the initial mix of services typically sold. Certain
ILECs (including SWBT) have refused to pay that portion of reciprocal
compensation that they estimate is the result of inbound ISP traffic since they
believe such traffic to be interstate in nature and not covered under the
interconnection agreements. While some states in which Birch is providing, or
proposes to provide, such service have ordered ILECs to pay reciprocal
compensation for such calls, most states have not considered the issue. States
which have not considered the issue could determine that no reciprocal
compensation is due with respect to calls made to ISPs. In addition, the FCC is
considering this matter in response to a request for a declaratory ruling. There
can be no assurance that the payment of reciprocal compensation for ISP or other
traffic types will be maintained. A change in the type of traffic eligible for
reciprocal compensation payments would reduce Birch's ability to be compensated
for the termination of ISP destined traffic, and therefore could have a material
adverse effect on Birch's business, operating results and financial condition
and its ability to achieve sufficient cash flow to service the Notes.
On June 9, 1997, SWBT notified Birch and other CLECs that it would not pay
or collect reciprocal compensation under interconnection agreements for ISP
traffic originated or terminated on Birch's network in Missouri. On December 31,
1997, Birch filed a petition with the Public Service Commission of the State of
Missouri (the "Missouri Public Service Commission") to arbitrate the terms of an
interconnection agreement between Birch and SWBT. In its petition, Birch
claimed, among other things, that ISP traffic is local in nature, and that the
rate of reciprocal compensation payments for traffic to an ISP should be the
same as the rate for other local calls. On April 23, 1998, the Missouri Public
Service Commission ordered the parties, pending final resolution of these issues
by the FCC, to compensate each other for ISP traffic at the same rate as is
applicable to other local calls. If a decision adverse to Birch is issued on any
appeal or review of the order of the Missouri Public Service Commission or by
the FCC, the ability of Birch to serve existing and future ISP customers
profitably would be limited, which could have a material adverse effect on
Birch's business, operating results and financial condition and its ability to
achieve sufficient cash flow to service the Notes. See
"Business -- Regulation -- Interconnection with ILEC Facilities."
DIFFICULTIES IN IMPLEMENTING ENHANCED SERVICE FEATURES
Birch has begun, and plans to continue, to deploy switches in the cities in
which it will operate networks and plans initially to rely on ILEC or CLEC
facilities for certain aspects of interconnection. Subject to obtaining
interconnection with SWBT, Birch will be able to offer a variety of enhanced
service features (such as voicemail, call waiting, caller ID and call
forwarding). Although under the Telecommunications Act the ILECs will be
required to unbundle network elements and permit Birch to purchase only the
origination and termination services it needs, there can be no assurance that
such unbundling will be effected in a timely manner and result in prices
favorable to Birch. In addition, Birch's ability to implement successfully its
enhanced service features will require the negotiation of resale agreements with
ILECs and other CLECs and the negotiation of interconnection and collocation
agreements with ILECs, which can take considerable time, effort and expense and
are subject to federal, state and local regulation.
Birch's enhanced service features may not be profitable due to, among other
factors, lack of customer demand, inability to secure access to ILEC facilities
on acceptable terms, and competition and pricing pressure from the ILECs and
other CLECs. There can be no assurance that Birch will be able to successfully
implement its switched and enhanced service features strategy.
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<PAGE> 30
CONTROL OF COMPANY BY CURRENT STOCKHOLDERS
As of September 30, 1998, on a fully-diluted basis, the executive officers
and Directors of the Company beneficially owned 14.1 million shares of Common
Stock, representing approximately 60.2% of the fully-diluted ownership. The
Company's executive officers and directors as a group will be able to exercise
significant influence over such matters as the election of the Directors of the
Company and other fundamental corporate transactions such as mergers, assets
sales and the sale of the Company. In addition, the Purchasers Rights Agreement
(as defined) provides that each of the parties thereto will vote in favor of the
election of certain designees to the Company's Board of Directors. See "Security
Ownership of Certain Beneficial Owners and Management," "Certain Relationships
and Related Transactions -- Purchasers Rights Agreement" and "Description of
Capital Stock."
In addition, the Company may adopt certain procedural and other
requirements or amend its Certificate of Incorporation or By-laws in a manner
that could have the effect of delaying, deterring or preventing a change in
control of the Company or make it more difficult for stockholders to effect
certain corporate actions, including the ability to replace incumbent directors
and to accomplish transactions opposed by the incumbent Board of Directors. See
"Description of Capital Stock."
DEPENDENCE ON KEY PERSONNEL
Birch's business is managed by a small number of key executive officers,
particularly David E. Scott, Birch's President and Chief Executive Officer,
Jeffrey D. Shackelford, Birch's Senior Vice President of Sales and Marketing,
Gary L. Chesser, Birch's Senior Vice President of Engineering and Operations,
David W. Vranicar, Birch's Senior Vice President of Business Development,
Bradley A. Moline, Birch's Senior Vice President of Finance and Chief Financial
Officer, Gregory C. Lawhon, Birch's Senior Vice President of Public Policy and
General Counsel and Stephen L. Sauder, Vice President of Birch, the loss of any
of whom could have a material adverse effect on Birch's business, operating
results and financial condition. Birch believes that its future success will
depend in large part on its continued ability to attract and retain highly
skilled and qualified executive personnel. See "Management."
DEPENDENCE ON NEW EMPLOYEES
Birch's future success will depend in large part on its ability to obtain
the services of motivated technical, information systems, marketing, and sales
personnel. Birch is particularly dependent on its ability to identify, hire,
train, retain, and manage highly skilled and experienced network engineers to
execute the installation, development, and operation of Birch's networks, as
well as sales and marketing personnel to create and expand Birch's customer
base. The pace of growth of the CLEC industry may make it difficult to recruit
qualified labor for key functions, particularly general managers, sales
representatives, sales management, public policy experts, technicians,
engineers, and operations management. Because Birch's markets will generally be
smaller, finding the right employees who are willing to relocate may be more
difficult. There can be no assurance that Birch will be able to obtain or retain
the services of additional personnel necessary for Birch's growth.
RISK OF SYSTEM FAILURE
Birch's operations are dependent upon its ability to protect its network
infrastructure against damage from fire, earthquakes, floods, power loss, and
similar events and to construct networks that are not vulnerable to the effects
of such events. The occurrence of a natural disaster or other unanticipated
problem at Birch's facilities or at the sites of its switches could cause
interruptions in the services provided by Birch. The failure of a switch would
result in interruption of service to the customers served by such switch until
necessary repairs were effected or replacement equipment were installed.
Additionally, failure of the other telecommunications providers to provide the
data communications capacity required by Birch as a result of natural disaster,
operational disruption or for any other reason could cause interruptions in the
services provided by Birch. Any damage or failure that causes interruptions in
Birch's operations could have a material adverse effect on Birch's business,
financial condition and results of operations.
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<PAGE> 31
YEAR 2000 ISSUE
An issue exists for all companies that rely on computers as the year 2000
approaches. The "year 2000" problem is the result of the past practice in the
computer industry of computer programs using two digits rather than four to
define the applicable year. This practice will result in incorrect results when
computers perform arithmetic operations, comparisons or data field sorting
involving years later than 1999. Any of Birch's computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a system failure or miscalculations
causing disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities. Based on ongoing assessments, the Company has determined
that it will be required to modify or replace portions of its software so that
its computer systems will function properly with respect to dates in the year
2000 and thereafter. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000 Issue."
There can be no assurance until the year 2000 that Birch's systems will be
year 2000 compliant. In addition, Birch uses SWBT's facilities to service its
customers, and such facilities currently utilize numerous date-sensitive
computer applications. If SWBT's facilities are not year 2000 compliant, or if
the systems of other ILECs, long-distance carriers and others upon which Birch
relies are not year 2000 compliant, it would have a material adverse effect on
Birch's business, operating results and financial condition and its ability to
achieve sufficient cash flow to service the Notes.
DISCRETIONARY USE OF FUNDS
Birch intends to use the proceeds of the Private Offering to fund ongoing
operations, to fund possible future acquisitions and to fund the costs of
deploying networks in Birch's target markets, as well as for general corporate
and working capital purposes. Birch cannot predict in which, if any, of its
existing or future opportunities it will ultimately invest. While Birch
currently expects to use the proceeds of the Private Offering as set forth
above, if Birch's plans change, Birch would use any remaining cash to fund other
development projects or acquisitions and for general corporate and working
capital purposes. See "Use of Proceeds."
REPURCHASE OF THE NOTES UPON A CHANGE OF CONTROL
Upon a Change of Control, the holders of the Notes will have the right to
require Birch to repurchase such holders' Notes, in whole or in part, at a price
equal to 101% of the principal amount thereof, plus accrued and unpaid interest
and Liquidated Damages thereon, if any, to the date of purchase. If a Change of
Control were to occur, Birch may not have the financial resources to repurchase
all of the Notes and repay any other indebtedness that would become payable upon
the occurrence of such Change of Control. The Change of Control purchase feature
of the Notes may in certain circumstances discourage or make more difficult a
sale or takeover of Birch. It should be noted, however, that certain highly
leveraged transactions may be consummated without triggering the Change of
Control purchase feature of the Notes, and that under such circumstances, the
Change of Control purchase feature would not provide any protection to holders
of Notes. See "Description of the Exchange Notes -- Repurchase at the Option of
Holders -- Change of Control."
ORIGINAL ISSUE DISCOUNT
Since the Private Notes were issued as part of an investment unit and a
portion of the issue price of the Units was allocated to the Warrants, the
Private Notes will likely be considered to be issued with original issue
discount in excess of a de minimis amount for U.S. federal income tax purposes.
If so, purchasers of the Units generally will be required to include amounts in
gross income for U.S. federal income tax purposes attributable to the value of
the Warrants attached to the Private Notes, in advance of receipt of the cash
payments to which the income is attributable. As the Exchange Notes are being
offered in exchange for the Private Notes, the Exchange Notes may also be
considered to be issued with original issue discount in excess of a de minimis
amount for U.S. federal income tax purposes. Furthermore, the Notes may be
subject to the high yield discount obligation rules, which will defer and may,
in part, eliminate the Company's ability to deduct for U.S. federal income tax
purposes the original issue discount attributable to the Notes. Accordingly, the
Company's
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<PAGE> 32
after-tax cash flow might be less than if the original issue discount on the
Notes was deductible when it accrued. See "Certain United States Federal Income
Tax Considerations" for a more detailed discussion of the U.S. federal income
tax consequences for the Company and the beneficial owner resulting from the
purchase, ownership and disposition of the Notes and Warrants.
If a bankruptcy case were commenced by or against the Company under the
Bankruptcy Code of 1978, as amended (the "Bankruptcy Code") after the issuance
of the Notes, the claims of a holder with respect to the principal amount
thereof may be limited to an amount equal to the sum of (i) the initial offering
price and (ii) that portion of the original issue discount that is not deemed to
constitute "unmatured interest" for purposes of the Bankruptcy Code. Any
original issue discount that was not amortized as of the date of any such
bankruptcy filing would constitute "unmatured interest." In addition, the
enforceability of the Notes may be subject to (i) the effect of bankruptcy,
insolvency, reorganization, moratorium or other similar laws now or hereafter in
effect relating to or affecting the rights and remedies of creditors and (ii)
the effect of general principles of equity, including, without limitation,
whether acceleration of the Notes may affect the collectibility of that portion
of the stated principal amount thereof which might be determined to constitute
unearned interest thereon, whether enforcement is considered in a proceeding at
equity or at law, and the discretion of the court before which any proceeding
therefor may be brought.
ABSENCE OF PUBLIC MARKET; RESTRICTIONS ON TRANSFER
As of the date hereof, the only registered holder of Private Notes is Cede
& Co., as the nominee of DTC. The Company believes that, as of the date hereof,
such holder is not an "affiliate" (as such term is defined in Rule 405 under the
Securities Act) of the Company. Prior to the Private Offering, there had been no
market for the Notes and there can be no assurance that such a market will
develop or, if such a market develops, as to the liquidity of such market. The
Exchange Notes will not be listed on any securities exchange. The Exchange Notes
are new securities for which there is currently no market. The Exchange Notes
may trade at a discount from their initial offering price, depending upon
prevailing interest rates, the market for similar securities, the performance of
the Company and other factors. The Company has been advised by the Initial
Purchasers that they intend to make a market in the Exchange Notes, as well as
the Private Notes, as permitted by applicable laws and regulations; however, the
Initial Purchasers are not obligated to do so and any such market making
activities may be discontinued at any time without notice. In addition, such
market making activities may be limited during the Exchange Offer and the
pendency of the Shelf Registration Statement (as defined in the Registration
Rights Agreement). Therefore, there can be no assurance that an active market
for the Notes will develop. See "The Exchange Offer" and "Plan of Distribution."
FORWARD LOOKING STATEMENTS
The statements contained in this Prospectus that are not historical facts
are "forward looking statements" (as such term is defined in the Private
Securities Litigation Reform Act of 1995), which statements can be identified by
the use of forward looking terminology such as "believes," "expects," "may,"
"will," "should," "intends" or "anticipates" or the negative thereof or other
variations thereon or comparable terminology, or by discussions of strategy that
involve risks and uncertainties. Management cautions the reader that these
forward looking statements, and statements regarding the development of Birch's
business and markets, the estimates of market sizes and addressable markets for
Birch's services and products, Birch's anticipated capital expenditures and
future financing requirements and other statements contained in this Prospectus
regarding matters that are not historical facts, are only predictions. No
assurance can be given that the future results will be achieved; actual events
or results may differ materially as a result of risks facing Birch. Such risks
include, but are not limited to, Birch's ability to implement its business plan,
market its services to current and new customers, integrate Valu-Line, Boulevard
and Telesource with Birch, access markets, identify, finance and complete
suitable acquisitions, install switching facilities, and obtain any required
governmental authorizations, franchise and permits, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions, as well as
regulatory, legislative and judicial developments that could cause actual
results to vary materially from the future results indicated, expressed or
implied, in such forward looking statements.
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THE EXCHANGE OFFER
PURPOSE OF THE EXCHANGE OFFER
The Private Notes were sold by the Company on June 23, 1998 (the "Closing
Date") to the Initial Purchasers pursuant to the Purchase Agreement as part of
Units consisting of the Private Notes and 115,000 Warrants to purchase in the
aggregate 1,409,734 shares of the Company's Common Stock, $.001 par value. The
Initial Purchasers subsequently sold the Units (including the Private Notes) (i)
to "qualified institutional buyers" ("QIBs"), as defined in Rule 144A under the
Securities Act ("Rule 144A"), in reliance on Rule 144A and (ii) in offshore
transactions pursuant to Regulation S under the Securities Act to purchasers
that executed a letter of representations to the Initial Purchasers and the
Company. As a condition to the sale of the Units (including the Private Notes),
the Company and the Initial Purchasers entered into the Registration Rights
Agreement on June 23, 1998. Pursuant to the Registration Rights Agreement, the
Company agreed that, unless the Exchange Offer is not permitted by applicable
law or Commission policy, it would (i) file with the Commission a Registration
Statement under the Securities Act with respect to the Exchange Notes on or
prior to 90 days after the Closing Date, (ii) use all commercially reasonable
efforts to cause such Registration Statement to become effective under the
Securities Act on or prior to 150 days after the Closing Date and (iii) use its
best efforts to consummate the Exchange Offer within 30 business after the date
on which the Registration Statement was declared effective by the Commission. A
copy of the Registration Rights Agreement has been filed as an exhibit to the
Registration Statement. The Registration Statement is intended to satisfy
certain of the Company's obligations under the Registration Rights Agreement and
the Purchase Agreement.
RESALE OF THE EXCHANGE NOTES
With respect to the Exchange Notes, based upon an interpretation by the
staff of the Commission set forth in certain no-action letters issued to third
parties, the Company believes that a holder (other than (i) a broker-dealer who
purchases such Exchange Notes directly from the Company to resell pursuant to
Rule 144A or any other available exemption under the Securities Act or (ii) any
such holder that is an "affiliate" of the Company within the meaning of Rule 405
under the Securities Act) who exchanges Private Notes for Exchange Notes in the
ordinary course of business and who is not participating, does not intend to
participate, and has no arrangement with any person to participate, in a
distribution of the Exchange Notes, will be allowed to resell Exchange Notes to
the public without further registration under the Securities Act and without
delivering to the purchasers of the Exchange Notes a prospectus that satisfies
the requirements of Section 10 of the Securities Act. See e.g. Exxon Capital
Holdings Corp., SEC No-Action Letter (available April 13, 1989) and Morgan
Stanley & Co. Inc., SEC No-Action Letter (available June 5, 1991). However, if
any holder acquires Exchange Notes in the Exchange Offer for the purpose of
distributing or participating in the distribution of the Exchange Notes or is a
broker-dealer, such holder cannot rely on the position of the staff of the
Commission enumerated in certain no-action letters issued to third parties and
must comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any resale transaction, unless an exemption
from registration is otherwise available. Each broker-dealer that receives
Exchange Notes for its own account in exchange for Private Notes, where such
Private Notes were acquired by such broker-dealer as a result of market-making
activities or other trading activities, must acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes. The Letter of
Transmittal states that by so acknowledging and by delivering a prospectus, a
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a broker-dealer in connection
with resales of Exchange Notes received in exchange for Private Notes where such
Private Notes were acquired by such broker-dealer as a result of market-making
or other trading activities. Pursuant to the Registration Rights Agreement, the
Company has agreed to make this Prospectus, as it may be amended or supplemented
from time to time, available to broker-dealers for use in connection with any
resale for a period of 180 days after the Expiration Date. See "Plan of
Distribution."
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TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Private
Notes validly tendered and not withdrawn prior to the Expiration Date. The
Company will issue $1,000 principal amount of Exchange Notes in exchange for
each $1,000 principal amount of outstanding Private Notes surrendered pursuant
to the Exchange Offer. Private Notes may be tendered only in integral multiples
of $1,000.
The form and terms of the Exchange Notes are the same as the form and terms
of the Private Notes except that (i) the exchange will be registered under the
Securities Act and, therefore, the Exchange Notes will not bear legends
restricting the transfer thereof and (ii) holders of the Exchange Notes will not
be entitled to any of the rights of holders of Private Notes under the
Registration Rights Agreement, which rights will terminate upon the consummation
of the Exchange Offer. The Exchange Notes will evidence the same indebtedness as
the Private Notes (which they replace) and will be issued under, and be entitled
to the benefits of, the Indenture, which also authorized the issuance of the
Private Notes, such that both series of Notes will be treated as a single class
of debt securities under the Indenture.
As of the date of this Prospectus, $115,000,000 in aggregate principal
amount of the Private Notes are outstanding and registered in the name of Cede &
Co., as nominee for DTC. Only a registered holder of the Private Notes (or such
holder's legal representative or attorney-in-fact) as reflected on the records
of the Trustee under the Indenture may participate in the Exchange Offer. There
will be no fixed record date for determining registered holders of the Private
Notes entitled to participate in the Exchange Offer.
Holders of the Private Notes do not have any appraisal or dissenters'
rights under the Indenture in connection with the Exchange Offer. The Company
intends to conduct the Exchange Offer in accordance with the provisions of the
Registration Rights Agreement and the applicable requirements of the Securities
Act, the Exchange Act and the rules and regulations of the Commission
thereunder.
The Company shall be deemed to have accepted validly tendered Private Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering holders
of Private Notes for the purposes of receiving the Exchange Notes from the
Company.
Holders who tender Private Notes in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Private
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than certain applicable taxes described below, in connection
with the Exchange Offer. See "-- Fees and Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 5:00 p.m., New York City time on
, 1998, unless the Company, in its exercise of reasonable
discretion, extends the Exchange Offer, in which case the term "Expiration Date"
shall mean the latest date and time to which the Exchange Offer is extended.
In order to extend the Exchange Offer, the Company will (i) notify the
Exchange Agent of any extension by oral or written notice, (ii) mail to the
registered holders an announcement thereof and (iii) issue a press release or
other public announcement which shall include disclosure of the approximate
number of Private Notes deposited to date, each prior to 9:00 a.m., New York
City time, on the next business day after the previously scheduled Expiration
Date. Without limiting the manner in which the Company may choose to make a
public announcement of any delay, extension, amendment or termination of the
Exchange Offer, the Company shall have no obligation to publish, advertise, or
otherwise communicate any such public announcement, other than by making a
timely release to an appropriate news agency.
The Company reserves the right, in its exercise of reasonable discretion,
(i) to delay accepting any Private Notes, (ii) to extend the Exchange Offer or
(iii) if any conditions set forth below under "-- Conditions" shall not have
been satisfied, to terminate the Exchange Offer by giving oral or written notice
29
<PAGE> 35
of such delay, extension or termination to the Exchange Agent. Any such delay in
acceptance, extension, termination or amendment will be followed as promptly as
practicable by oral or written notice thereof to the registered holders. If the
Exchange Offer is amended in a manner determined by the Company to constitute a
material change, the Company will promptly disclose such amendment by means of a
prospectus supplement that will be distributed to the registered holders, and
the Company will extend the Exchange Offer for a period of five to ten business
days, depending upon the significance of the amendment and the manner of
disclosure to the registered holders, if the Exchange Offer would otherwise
expire during such five to ten business day period.
INTEREST ON THE EXCHANGE NOTES
The Exchange Notes will bear interest at a rate equal to 14% per annum.
Interest on the Exchange Notes will be payable semi-annually in arrears on each
June 15 and December 15, commencing December 15, 1998. Holders of Exchange Notes
will receive interest on December 15, 1998 from the date of initial issuance of
the Exchange Notes, plus an amount equal to the accrued interest on the Private
Notes from the date of initial delivery to the date of exchange thereof for
Exchange Notes. Holders of Private Notes that are accepted for exchange will be
deemed to have waived the right to receive any interest accrued on the Private
Notes.
PROCEDURES FOR TENDERING
Only a registered holder of Private Notes may tender such Private Notes in
the Exchange Offer. To tender in the Exchange Offer, a holder of Private Notes
must complete, sign and date the Letter of Transmittal, or a facsimile thereof,
have the signatures thereon guaranteed if required by the Letter of Transmittal,
and mail or otherwise deliver such Letter of Transmittal or such facsimile to
the Exchange Agent at the address set forth below under "-- Exchange Agent" for
receipt prior to the Expiration Date. In addition, either (i) certificates for
such Private Notes must be received by the Exchange Agent along with the Letter
of Transmittal, (ii) a timely confirmation of a book-entry transfer (a
"Book-Entry Confirmation") of such Private Notes, if such procedure is
available, into the Exchange Agent's account at the Depository pursuant to the
procedure for book-entry transfer described below, must be received by the
Exchange Agent prior to the Expiration Date or (iii) the holder must comply with
the guaranteed delivery procedures described below.
The tender by a holder that is not withdrawn prior to the Expiration Date
will constitute an agreement between such holder and the Company in accordance
with the terms and subject to the conditions set forth herein and in the Letter
of Transmittal.
THE METHOD OF DELIVERY OF PRIVATE NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE, PROPERLY INSURED. IN ALL CASES,
SUFFICIENT TIME SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT
BEFORE THE EXPIRATION DATE. NO LETTER OF TRANSMITTAL OR PRIVATE NOTES SHOULD BE
SENT TO THE COMPANY. HOLDERS MAY REQUEST THEIR RESPECTIVE BROKERS, DEALERS,
COMMERCIAL BANKS, TRUST COMPANIES OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS
FOR SUCH HOLDERS.
Any beneficial owner(s) of the Private Notes whose Private Notes are
registered in the name of a broker, dealer, commercial bank, trust company or
other nominee and who wishes to tender should contact the registered holder
promptly and instruct such registered holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes to tender on such owner's own
behalf, such owner must, prior to completing and executing the Letter of
Transmittal and delivering such owner's Private Notes, either make appropriate
arrangements to register ownership of the Private Notes in such owner's name or
obtain a properly completed bond power from the registered holder. The transfer
of registered ownership may take considerable time.
Signatures on a Letter of Transmittal or a notice of withdrawal described
below (see "-- Withdrawal of Tenders"), as the case may be, must be guaranteed
by an Eligible Institution (as defined below) unless the Private Notes tendered
pursuant thereto are tendered (i) by a registered holder who has not completed
the
30
<PAGE> 36
box titled "Special Delivery Instructions" on the Letter of Transmittal or (ii)
for the account of an Eligible Institution. In the event that signatures on a
Letter of Transmittal or a notice of withdrawal, as the case may be, are
required to be guaranteed, such guarantee must be made by a member firm of a
registered national securities exchange or of the National Association of
Securities Dealers, Inc., a commercial bank or trust company having an office or
correspondent in the United States or an "eligible guarantor institution" within
the meaning of Rule 17Ad-15 under the Exchange Act which is a member of one of
the recognized signature guarantee programs identified in the Letter of
Transmittal (an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the
registered holder of any Private Notes listed therein, such Private Notes must
be endorsed or accompanied by a properly completed bond power, signed by such
registered holder as such registered holder's name appears on such Private
Notes.
If the Letter of Transmittal or any Private Notes or bond powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
The Exchange Agent and the Depository have confirmed that any financial
institution that is a participant in the Depository's system may utilize the
Depository's Automated Tender Offer Program to tender Private Notes.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Private Notes will be determined
by the Company in its exercise of reasonable discretion, which determination
will be final and binding. The Company reserves the absolute right to reject any
and all Private Notes not properly tendered or any Private Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the right to waive any defects,
irregularities or conditions of tender as to particular Private Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Private Notes must be cured within such time as the
Company shall determine. Although the Company intends to notify holders of
defects or irregularities with respect to tenders of Private Notes, neither the
Company, the Exchange Agent nor any other person shall incur any liability for
failure to give such notification. Tenders of Private Notes will not be deemed
to have been made until such defects or irregularities have been cured or
waived.
While the Company has no present plan to acquire any Private Notes that are
not tendered in the Exchange Offer or to file a registration statement to permit
resales of any Private Notes that are not tendered pursuant to the Exchange
Offer, the Company reserves the right in its exercise of reasonable discretion
to purchase or make offers for any Private Notes that remain outstanding
subsequent to the Expiration Date or, as set forth below under "-- Conditions,"
to terminate the Exchange Offer and, to the extent permitted by applicable law,
purchase Private Notes in the open market, in privately negotiated transactions
or otherwise. The terms of any such purchases or offers could differ from the
terms of the Exchange Offer.
By tendering, each holder of Private Notes will represent to the Company
that, among other things, (i) Exchange Notes to be acquired by such holder of
Private Notes in connection with the Exchange Offer are being acquired by such
holder in the ordinary course of business of such holder, (ii) such holder has
no arrangement or understanding with any person to participate in the
distribution of the Exchange Notes, (iii) if such Holder is a resident of the
State of California, it falls under the self-executing institutional investor
exemption set forth under Section 25102(i) of the Corporate Securities Law of
1968 and Rules 260.102.10 and 260.105.14 of the California Blue Sky Regulations,
(iv) if such Holder is a resident of the Commonwealth of Pennsylvania, it falls
under the self-executing institutional investor exemption set forth under
Sections 203(c), 102(d) and (k) of the Pennsylvania Securities Act of 1972,
Section 102.111 of the Pennsylvania Blue Sky Regulations and an interpretive
opinion dated November 16, 1985, (v) such holder acknowledges and agrees that
any person who is a broker-dealer registered under the Exchange Act or is
participating in the Exchange Offer for the purposes of distributing the
Exchange Notes must comply with the registration and
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<PAGE> 37
prospectus delivery requirements of the Securities Act in connection with a
secondary resale transaction of the Exchange Notes acquired by such person and
cannot rely on the position of the staff of the Commission set forth in certain
no-action letters, (vi) such holder understands that a secondary resale
transaction described in clause (v) above and any resales of Exchange Notes
obtained by such holder in exchange for Private Notes acquired by such holder
directly from the Company should be covered by an effective registration
statement containing the selling securityholder information required by Item 507
or Item 508, as applicable, of Regulation S-K of the Commission and (vii) such
holder is not an "affiliate," as defined in Rule 405 under the Securities Act,
of the Company. If the holder is a broker-dealer that will receive Exchange
Notes for such holder's own account in exchange for Private Notes that were
acquired as a result of market-making activities or other trading activities,
such holder will be required to acknowledge in the Letter of Transmittal that
such holder will deliver a prospectus in connection with any resale of such
Exchange Notes; however, by so acknowledging and by delivering a prospectus,
such holder will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act.
RETURN OF PRIVATE NOTES
If any tendered Private Notes are not accepted for any reason set forth in
the terms and conditions of the Exchange Offer or if Private Notes are withdrawn
or are submitted for a greater principal amount than the holders desire to
exchange, such unaccepted, withdrawn or non-exchanged Private Notes will be
returned without expense to the tendering holder thereof (or, in the case of
Private Notes tendered by book-entry transfer into the Exchange Agent's account
at the Depository pursuant to the book-entry transfer procedures described
below, such Private Notes will be credited to an account maintained with the
Depository) as promptly as practicable.
BOOK-ENTRY TRANSFER
The Exchange Agent will make a request to establish an account with respect
to the Private Notes at the Depository for purposes of the Exchange Offer within
two business days after the date of this Prospectus, and any financial
institution that is a participant in the Depository's systems may make
book-entry delivery of Private Notes by causing the Depository to transfer such
Private Notes into the Exchange Agent's account at the Depository in accordance
with the Depository's procedures for transfer. However, although delivery of
Private Notes may be effected through book-entry transfer at the Depository, the
Letter of Transmittal or facsimile thereof, with any required signature
guarantees and any other required documents, must, in any case, be transmitted
to and received by the Exchange Agent at the address set forth below under
"-- Exchange Agent" on or prior to the Expiration Date or pursuant to the
guaranteed delivery procedures described below.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Private Notes and (i) whose Private Notes
are not immediately available or (ii) who cannot deliver their Private Notes,
the Letter of Transmittal or any other required documents to the Exchange Agent
prior to the Expiration Date, may effect a tender if:
(a) The tender is made through an Eligible Institution;
(b) Prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery substantially in the form provided by the Company (by
facsimile transmission, mail or hand delivery) setting forth the name and
address of the holder, the certificate number(s) of such Private Notes and
the principal amount of Private Notes tendered, stating that the tender is
being made thereby and guaranteeing that, within five New York Stock
Exchange trading days after the Expiration Date, the Letter of Transmittal
(or a facsimile thereof), together with the certificate(s) representing the
Private Notes in proper form for transfer or a Book-Entry Confirmation, as
the case may be, and any other documents required by the Letter of
Transmittal, will be deposited by the Eligible Institution with the
Exchange Agent; and
(c) Such properly executed Letter of Transmittal (or facsimile
thereof), as well as the certificate(s) representing all tendered Private
Notes in proper form for transfer and all other documents
32
<PAGE> 38
required by the Letter of Transmittal are received by the Exchange Agent
within five New York Stock Exchange trading days after the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to holders who wish to tender their Private Notes according to the
guaranteed delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Private Notes may be
withdrawn at any time prior to the Expiration Date.
To withdraw a tender of Private Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to the Expiration Date. Any such
notice of withdrawal must (i) specify the name of the person having deposited
the Private Notes to be withdrawn (the "Depositor"), (ii) identify the Private
Notes to be withdrawn (including the certificate number or numbers and principal
amount of such Private Notes) and (iii) be signed by the holder in the same
manner as the original signature on the Letter of Transmittal by which such
Private Notes were tendered (including any required signature guarantees). All
questions as to the validity, form and eligibility (including time of receipt)
of such notices will be determined by the Company in its exercise of reasonable
discretion, whose determination shall be final and binding on all parties. Any
Private Notes so withdrawn will be deemed not to have been validly tendered for
purposes of the Exchange Offer and no Exchange Notes will be issued with respect
thereto unless the Private Notes so withdrawn are validly retendered. Properly
withdrawn Private Notes may be retendered by following one of the procedures
described above under "The Exchange Offer-Procedures for Tendering" at any time
prior to the Expiration Date.
CONDITIONS
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or exchange the Exchange Notes for, any
Private Notes, and may terminate the Exchange Offer as provided herein prior to
the Expiration Date, if the Exchange Offer violates applicable law, rules or
regulations or an applicable interpretation of the staff of the Commission.
If the Company determines in its exercise of reasonable discretion that any
of these conditions are not satisfied, the Company may (i) refuse to accept any
Private Notes and return all tendered Private Notes to the tendering holders,
(ii) extend the Exchange Offer and retain all Private Notes tendered prior to
the expiration of the Exchange Offer, subject, however, to the rights of holders
to withdraw such Private Notes (see "-- Withdrawal of Tenders") or (iii) waive
such unsatisfied conditions with respect to the Exchange Offer and accept all
properly tendered Private Notes that have not been withdrawn. If such waiver
constitutes a material change to the Exchange Offer, the Company will promptly
disclose such waiver by means of a prospectus supplement that will be
distributed to the registered holders of the Private Notes, and the Company will
extend the Exchange Offer for a period of five to ten business days, depending
upon the significance of the waiver and the manner of disclosure to the
registered holders, if the Exchange Offer would otherwise expire during such
five to ten business day period.
TERMINATION OF CERTAIN RIGHTS
All rights under the Registration Rights Agreement (including registration
rights) of holders of the Private Notes eligible to participate in the Exchange
Offer will terminate upon consummation of the Exchange Offer except with respect
to the Company's continuing obligations (i) to indemnify such holders (including
any broker-dealers) and certain parties related to such holders against certain
liabilities (including liabilities under the Securities Act), (ii) to provide,
upon the request of any holder of a transfer-restricted Private Note, the
information required by Rule 144A(d)(4) under the Securities Act in order to
permit resales of such Private Notes pursuant to Rule 144A, (iii) to use its
best efforts to keep the Registration Statement effective to the extent
necessary to ensure that it is available for resales of transfer-restricted
Private Notes by broker-dealers for a period of up to 180 days from the
Expiration Date and (iv) to provide
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<PAGE> 39
copies of the latest version of the Prospectus to broker-dealers upon their
request for a period of up to 180 days after the Expiration Date.
ADDITIONAL INTEREST
In the event of a Registration Default (as defined in the Registration
Rights Agreement), the Company is required to pay as liquidated damages to each
holder of Transfer Restricted Securities (as defined below), during the first
90-day period immediately following the occurrence of such Registration Default
in an amount equal to $.05 per week per $1,000 of the principal amount of
Private Notes constituting Transfer Restricted Securities held by such holder.
Transfer Restricted Securities shall mean each Private Note until the earlier to
occur of (i) the date on which such Private Note has been exchanged by a person
other than a Broker-Dealer for an Exchange Note in the Exchange Offer, (ii)
following the exchange by a Broker-Dealer in the Exchange Offer of a Private
Note for an Exchange Note, the date on which such Exchange Note is sold to a
purchaser who receives from such Broker-Dealer on or prior to the date of such
sale a copy of the Prospectus, (iii) the date on which such Private Note has
been effectively registered under the Securities Act and disposed of in
accordance with the Shelf Registration Statement (as defined in the Registration
Rights Agreement) or (iv) the date on which such Private Note is distributed to
the public pursuant to Rule 144 under the Securities Act or is eligible for
resale pursuant to Rule 144(k) under the Securities Act. The amount of the
liquidated damages will increase by an additional $.05 per week per $1,000 of
the principal amount of Private Notes constituting Transfer Restricted
Securities for each subsequent 90-day period until all Registration Defaults
have been cured, up to a maximum amount of $.50 per week per $1,000 in principal
amount of Private Notes constituting Transfer Restricted Securities. Following
the cure of all Registration Defaults, the payment of liquidated damages will
cease. The filing and effectiveness of the Registration Statement of which this
Prospectus is a part and the consummation of the Exchange Offer will eliminate
all rights of the holders of Private Notes eligible to participate in the
Exchange Offer to receive damages that would have been payable if such actions
had not occurred.
EXCHANGE AGENT
Norwest Bank Minnesota, National Association has been appointed as Exchange
Agent of the Exchange Offer. Questions and requests for assistance, requests for
additional copies of this Prospectus or of the Letter of Transmittal and
requests for Notice of Guaranteed Delivery should be directed to the Exchange
Agent addressed as follows:
<TABLE>
<S> <C>
By Registered or Certified Mail: In Person:
Norwest Bank Minnesota, Northstar East Bldg.
National Association 608 2nd Ave. S.
Corporate Trust Operations 12th Floor
P.O. Box 1517 Corporate Trust Services
Minneapolis, MN 55480-1517 Minneapolis, MN 55479-0113
By Hand or Overnight Courier: By Facsimile (for Eligible Institutions only):
Norwest Bank Minnesota, (612) 667-4927
National Association
Corporate Trust Operations Confirm Receipt of Notice of
Norwest Center Guaranteed Delivery by Telephone:
Sixth and Marquette (612) 667-9764
Minneapolis, MN 55479-0113
</TABLE>
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, telephone or in person by officers and regular
employees of the Company and its affiliates.
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<PAGE> 40
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
it for its reasonable out-of-pocket expenses in connection therewith.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company and are estimated in the aggregate to be approximately
$200,000. Such expenses include registration fees, fees and expenses of the
Exchange Agent and the Trustee, accounting and legal fees and printing costs,
among others.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Private Notes pursuant to the Exchange Offer. If, however, a transfer tax is
imposed for any reason other than the exchange of the Private Notes pursuant to
the Exchange Offer, then the amount of any such transfer taxes (whether imposed
on the registered holder or any other persons) will be payable by the tendering
holder. If satisfactory evidence of payment of such taxes or exemption therefrom
is not submitted with the Letter of Transmittal, the amount of such transfer
taxes will be billed directly to such tendering holder.
CONSEQUENCE OF FAILURES TO EXCHANGE
Participation in the Exchange Offer is voluntary. Holders of the Private
Notes are urged to consult their financial and tax advisors in making their own
decisions on what action to take.
The Private Notes that are not exchanged for the Exchange Notes pursuant to
the Exchange Offer will remain restricted securities. Accordingly, such Private
Notes may be offered, resold, pledged or otherwise transferred only (1) to a
person who the seller reasonably believes is a QIB in a transaction meeting the
requirements of Rule 144A, in a transaction meeting the requirements of Rule 144
under the Securities Act, outside the United States to a foreign person in a
transaction meeting the requirements of Rule 904 under the Securities Act, or in
accordance with another exemption from the registration requirements of the
Securities Act (and based upon an opinion of counsel if the Company so
requests), (2) to the Company or (3) pursuant to an effective registration
statement, and, in each case, in accordance with any applicable securities laws
of any State of the United States or any other applicable jurisdiction.
ACCOUNTING TREATMENT
For accounting purposes, the Company will recognize no gain or loss as a
result of the Exchange Offer. The expenses of the Exchange Offer will be
amortized over the term of the Exchange Notes.
USE OF PROCEEDS
The Company will not receive proceeds from the Exchange Offer. The net
proceeds received by Birch from the Private Offering were approximately $110.2
million, after deducting estimated discounts and commissions and other fees and
expenses related to the Private Offering payable by Birch.
With a portion of the net proceeds from the Private Offering, Birch
acquired the Pledged Securities for approximately $44.2 million, which will
provide funds for the first six interest payments on the Notes. Birch redeemed
all of its outstanding Series A Preferred Stock for an aggregate redemption
price of $4.9 million and intends to use the remaining net proceeds from the
Private Offering to fund capital expenditures in its target markets and to fund
working capital requirements and operating losses. Birch also intends to use the
remaining net proceeds from the Private Offering for general corporate purposes,
including acquisitions. The outstanding shares of Series A Preferred Stock were
issued to Stephen L. Sauder, Vice President of Birch and Valu-Line's founder,
President and Chief Executive Officer, in connection with the Merger. Birch
currently estimates that capital expenditures will be approximately $25.0
million in 1998 and $80.0 million in 1999, respectively, although actual
expenditures may vary materially from Birch's current estimates. The proceeds
from the Private Offering will not be sufficient to fund Birch's projected
capital expenditures beyond the next nine months and the Company will be
required to seek additional financing to implement its current business plan.
Birch's principal capital expenditure requirements include the purchase and
installation of switches,
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<PAGE> 41
transmission equipment collocated in ILEC central offices, CPE, and the further
development of operations support systems and other automated back office
systems. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
As part of its strategy, Birch may make acquisitions and enter into joint
ventures. Birch will be required to obtain additional financing within the next
nine months to complete its network buildout. There can be no assurance that
such additional financing will be available on terms acceptable to Birch or at
all. See "Risk Factors -- Risks Associated with Acquisitions," "Risk
Factors -- Need for Additional Financing," "Risk Factors -- Discretionary Use of
Funds" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
DIVIDEND POLICY
Through September 30, 1998, the Company paid dividends totaling $168,000 to
Stephen L. Sauder, the holder of all of the Company's Series A Preferred Stock.
On June 23, 1998, the Company paid a dividend in kind, in the amount of 0.055
shares per share, to the holders of the Company's Series B Preferred Stock,
Series C Preferred Stock and Common Stock as of June 15, 1998. Accumulated
Series B Preferred Stock dividends totaling $527,000 were satisfied with the
dividend in kind. The Company redeemed all of its Series A Preferred Stock in
connection with the Private Offering for an aggregate redemption price of $4.9
million (including $104,000 in accrued cash dividends). See "Use of Proceeds."
The Company has never paid cash dividends on its Common Stock and has no plans
to do so in the foreseeable future. The declaration and payment of any dividends
in the future will be determined by the Board of Directors, in its discretion,
and will depend on a number of factors, including the Company's earnings,
capital requirements and overall financial condition. In addition, the Company's
ability to declare and pay dividends will be substantially restricted under the
terms of the Indenture. See "Description of the Exchange Notes -- Certain
Covenants."
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<PAGE> 42
CAPITALIZATION
The following table sets forth, as of September 30, 1998, the cash and
capitalization of Birch. The Private Notes surrendered in exchange for the
Exchange Notes will be retired and cancelled and cannot be reissued.
Accordingly, issuance of the Exchange Notes will not result in any increase or
decrease in the indebtedness of the Company. As such no effect has been given to
the exchange offer in this capitalization table. The information set forth below
should be read in conjunction with "Unaudited Pro Forma Condensed Consolidated
Financial Statements," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the consolidated financial statements
and other financial data included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998
------------------
(UNAUDITED)
(IN THOUSANDS
EXCEPT SHARE DATA)
<S> <C>
Cash and cash equivalents................................... $ 53,378
Pledged Securities(a)....................................... 44,917
--------
Cash, cash equivalents and Pledged Securities............. $ 98,295
========
LONG-TERM DEBT AND CAPITAL LEASE (LESS CURRENT MATURITIES):
14% Senior Notes due 2008(b).............................. $114,671
Other..................................................... 649
--------
Total long-term debt and capital lease................. 115,320
Series B Preferred Stock, 8,572,039 shares issued and
outstanding(c)............................................ 13,572
STOCKHOLDERS' EQUITY:
Series C Preferred Stock, 8,492,749 shares issued and
outstanding, liquidation value $12,880................. 8
Common Stock, $.001 par value, 27,000,000 shares
authorized; 5,016,889 issued and outstanding(d)........ 5
Warrants.................................................. 337
Additional paid-in capital................................ 12,273
Accumulated deficit....................................... (10,871)
--------
Total stockholders' equity............................. 1,752
--------
Total capitalization.............................. $130,644
========
</TABLE>
- ---------------
(a) Investment in the Pledged Securities, using a portion of the net proceeds of
the Private Offering, which will be held as security for the first six
scheduled interest payments on the Notes and certain other obligations
thereunder. See "Description of the Exchange Notes -- Security."
(b) Reflects the aggregate principal amount of the Notes after allocating that
portion of the Private Offering proceeds that is attributable to the value
of the Warrants.
(c) Of the 25,000,000 shares of Preferred Stock, $.001 par value, that are
authorized, 2,968,750 shares are designated Series A Preferred Stock,
8,750,000 shares are designated Series B Preferred Stock, and 8,500,000
shares are designated Series C Preferred Stock.
(d) Does not include the Warrant Shares or options to purchase 523,845 shares of
the Common Stock issued to employees that have not been exercised. Includes
options to purchase 4,546,359 shares of the Common Stock which were issued
to employees of the Company pursuant to the 1998 Stock Option Plan and were
subsequently early exercised in connection with the provisions of the 1998
Stock Option Plan. Such options were exercisable immediately upon grant at
an exercise price of $.001 per share, and vest over a four-year period, at a
rate of 6.25% per quarter. Holders of exercised options have voting power
with respect to all shares of Common Stock underlying the options. Upon
termination of employment with the Company, Birch has the right to purchase
all options which have not vested as of that date, subject to certain
exceptions. See "Security Ownership of Certain Beneficial Owners and
Management" and "Management -- 1998 Stock Option Plan -- Early Exercise."
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<PAGE> 43
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma condensed consolidated financial
statements are based on the historical financial statements of Birch and
Valu-Line during the periods presented, adjusted to give effect to the
Transactions and the Private Offering.
The Unaudited Pro Forma Condensed Consolidated Statements of Operations for
the year ended December 31, 1997 and the nine months ended September 30, 1998
give effect to the Transactions and the Private Offering as if they had occurred
as of January 1, 1997. The pro forma adjustments are described in the
accompanying notes and are based upon available information and certain
assumptions that management believes are reasonable. A pro forma balance sheet
has not been presented as the Transactions and the Private Offering are
reflected in the September 30, 1998 historical consolidated balance sheet
included elsewhere in this Prospectus.
The Pro Forma Condensed Consolidated Statements of Operations do not
purport to represent what Birch's results of operations would actually have been
had the Transactions and the Private Offering in fact occurred on January 1,
1997 or to project Birch's results of operations for any future period. The Pro
Forma Condensed Consolidated Statements of Operations should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements included
elsewhere in this Prospectus.
Prior to the Merger, Birch was a development stage company. In February
1998, Birch merged with and into Valu-Line in the Merger. In connection with the
Merger, the Company issued shares of its Series A Preferred Stock and its Series
C Preferred Stock to stockholders of Valu-Line. On March 13, 1998, Birch
completed a private placement of its Series B Preferred Stock, raising aggregate
net proceeds of approximately $12.4 million, which were used to pay the cash
portion of the consideration in the Merger, to repay certain debt and for
general corporate purposes. In May 1998, Birch acquired Dunn & Associates, Inc.,
which does business as Boulevard Phone Company. Also in May 1998, the Company
acquired Telesource Communications, Inc. In September 1998, the Company acquired
TFSnet, Inc.
The Merger, the Telesource Acquisition, Boulevard Acquisition and TFSnet
Acquisition were accounted for under the purchase method of accounting. The
total purchase price has been allocated to the identifiable tangible and
intangible assets and liabilities of the applicable acquired business based upon
Birch's preliminary estimate of their fair values with the remainder allocated
to goodwill and other intangible assets. The allocations of the purchase prices
are subject to revision when additional information concerning asset and
liability valuations is obtained. There can be no assurance that the actual
adjustments will not differ significantly from the pro forma adjustments
reflected in the Pro Forma Condensed Consolidated Statements of Operations.
Management expects that the preliminary allocation of the total purchase price
will not materially differ from the final allocation.
38
<PAGE> 44
BIRCH TELECOM, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND OTHER
DATA
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
-------------------------------- FOR THE
TELESOURCE TRANSACTIONS
BOULEVARD AND THE
AND PRO FORMA PRIVATE
BIRCH VALU-LINE TFSNET ADJUSTMENTS OFFERING
------- --------- ---------- ----------- ------------
(IN THOUSANDS EXCEPT RATIO, PER SHARE AND OPERATING DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue.................................. $ -- $16,801 $2,046 $ -- $ 18,847
Cost of services......................... -- 11,842 1,019 -- 12,861
------- ------- ------ -------- --------
Gross margin............................. -- 4,959 1,027 -- 5,986
Selling, general and administrative...... 1,776 4,067 888 -- 6,731
Depreciation and amortization............ 27 341 85 1,880(a) 2,333
------- ------- ------ -------- --------
Income (loss) from operations............ (1,803) 551 54 (1,880) (3,078)
Interest (income) expense................ (14) 97 30 16,134(b) 16,247
------- ------- ------ -------- --------
Income (loss) before tax................. (1,789) 454 24 (18,014) (19,325)
Income taxes............................. -- 186 (3) (183)(c) --
------- ------- ------ -------- --------
Net income (loss)........................ $(1,789) $ 268 $ 27 $(17,831) $(19,325)
======= ======= ====== ======== ========
Loss per common share -- basic and
diluted................................ $ (1.45) $ (15.65)
======= ========
Weighted average number of common shares
outstanding -- basic and diluted....... 1,235 1,235
======= ========
Ratio of earnings to fixed charges(d).... -- --
======= ========
OTHER FINANCIAL DATA:
Capital expenditures..................... 128 243 163 534
</TABLE>
- ---------------
(a) To reflect the amortization of customer base ($2.0 million) and goodwill
($15.5 million) related to the Merger (5-25 years), deferred debt expenses
($4.8 million) related to the Private Offering (10 years), customer base
($325,000) and goodwill ($328,000) related to the Telesource Acquisition
(5-25 years), goodwill ($274,000) related to the Boulevard Acquisition (25
years) and customer base ($1.2 million) and goodwill ($1.1 million) related
to the TFSnet Acquisition (5-25 years).
(b) To reflect interest on the Notes, amortization over a 10 year period of
discount relating to the Notes, and repayment of the Telesource debt.
(c) To reflect income tax on a consolidated basis with reserve for income tax
benefits.
(d) For purposes of calculating the ratio of earnings to fixed charges, earnings
are defined as loss before income taxes plus fixed charges. Fixed charges
consist of interest expense and a reasonable approximation of the interest
factor included in rental payments on operating leases. Earnings were
insufficient to cover fixed charges for the year ended December 31, 1997 by
$1.8 million and pro forma earnings for the year ended December 31, 1997
would have been insufficient by $19.3 million.
39
<PAGE> 45
BIRCH TELECOM, INC.
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS AND OTHER
FINANCIAL DATA
NINE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
PRO FORMA
HISTORICAL FOR THE
-------------------------------------- TRANSACTIONS
TELESOURCE, AND THE
BOULEVARD PRO FORMA PRIVATE
BIRCH VALU-LINE(a) AND TFSNET(a) ADJUSTMENTS OFFERING
------- ------------ ------------- ----------- ------------
(IN THOUSANDS EXCEPT RATIO AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue........................... $17,243 $1,675 $1,430 $ -- $ 20,348
Cost of services.................. 12,247 1,194 614 -- 14,055
------- ------ ------ -------- --------
Gross margin...................... 4,996 481 816 -- 6,293
Selling, general and
administrative.................. 8,816 315 579 -- 9,710
Depreciation and amortization..... 1,229 31 58 746(b) 2,064
------- ------ ------ -------- --------
Income (loss) from operations..... (5,049) 135 179 (746) (5,481)
Interest expense.................. 2,808 5 7 12,269(c) 15,089
------- ------ ------ -------- --------
Income (loss) before tax.......... (7,857) 130 172 (13,015) (20,570)
Income taxes...................... -- 52 -- (52)(d) --
------- ------ ------ -------- --------
Net income (loss)................. (7,857) 78 172 (12,963) (20,570)
Preferred stock dividends......... 1,204 -- -- 1,204
Amortization of preferred stock
issuance costs.................. 21 -- -- -- 21
------- ------ ------ -------- --------
Income (loss) applicable to common
stock........................... $(9,082) $ 78 $ 172 $(12,963) $(21,795)
======= ====== ====== ======== ========
Loss per common share -- basic and
diluted......................... $ (2.69) $ (6.45)
======= ========
Weighted average number of common
shares outstanding -- basic
and diluted..................... 3,381 3,381
======= ========
Ratio of earnings to fixed
charges(e)...................... -- --
======= ========
OTHER FINANCIAL DATA:
Capital expenditures.............. 9,959 30 34 10,023
</TABLE>
- ---------------
(a) Reflects results of operations from January 1, 1998 through the date of
purchase.
(b) To reflect the amortization of customer base ($2.0 million) and goodwill
($15.5 million) related to the Merger (5-25 years), deferred debt expenses
($4.8 million) related to the Private Offering (10 years), customer base
($325,000) and goodwill ($328,000) related to the Telesource Acquisition
(5-25 years), goodwill ($274,000) related to the Boulevard Acquisition (25
years) and customer base ($1.2 million) and goodwill ($1.1 million) related
to the TFSnet Acquisition (5-25 years).
(c) To reflect interest on the Notes, amortization over a 10 year period of
discount relating to the Notes, eliminate interest on Convertible Notes due
to conversion to Series B Preferred Stock, and eliminate interest on the
Telesource debt.
(d) To reflect income tax on a consolidated basis with reserve for income tax
benefits.
(e) For purposes of calculating the ratio of earnings to fixed charges, earnings
are defined as loss before income taxes plus fixed charges. Fixed charges
consist of interest expense and a reasonable approximation of the interest
factor included in rental payments on operating leases. Earnings were
insufficient to cover fixed charges for the nine months ended September 30,
1998 by $7.9 million and pro forma earnings for the nine months ended
September 30, 1998 would have been insufficient by $20.6 million.
40
<PAGE> 46
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA AND OTHER DATA
The following table sets forth selected historical consolidated financial
data and other data of Valu-Line, Birch's predecessor, for the years ended
December 31, 1993, 1994, 1995, 1996 and 1997 and the selected historical
financial information of Birch for the year ended December 31, 1997 and the nine
months ended September 30, 1997 and 1998. Financial statements of the
Predecessor for the years ended December 31, 1995, 1996 and 1997 and Birch
financial statements for the year ended December 31, 1997 have been derived
from, and are qualified by reference to, the audited consolidated financial
statements of Valu-Line and Birch included elsewhere in this Prospectus. The
selected historical financial data of Birch for the nine months ended September
30, 1997 and 1998 has been derived from, and is qualified by reference to, the
unaudited financial statements of Birch included elsewhere herein. The unaudited
condensed consolidated financial statements have been prepared on the same basis
as the audited consolidated financial statements and, in the opinion of
management, include all adjustments (consisting only of normal recurring
adjustments) necessary to present fairly the information included therein.
Operating results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the entire year
ended December 31, 1998. The information set forth below should be read in
conjunction with "Management's Discussion and
41
<PAGE> 47
Analysis of Financial Condition and Results of Operations" and the consolidated
financial statements and related notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
------------------------------------------------------------------ --------------------------------------
PERIOD
ENDED NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, FEBRUARY 10, YEAR ENDED SEPTEMBER 30
-------------------------------------------------- ------------ DECEMBER 31, ---------------------
1993 1994 1995 1996 1997 1998 1997(A) 1997 1998(B)
------ ------- ------- ------- ------- ------------ ------------- -------- ---------
(IN THOUSANDS EXCEPT RATIO, PER SHARE
(IN THOUSANDS EXCEPT RATIO, PER SHARE AND OPERATING DATA) AND OPERATING DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF
OPERATIONS DATA:
Revenue.............. $8,321 $10,741 $12,226 $13,217 $16,801 $ 1,675 $ -- $ -- $ 17,243
Cost of services..... 5,504 6,713 8,284 8,749 11,842 1,194 -- -- 12,247
------ ------- ------- ------- ------- ------- ------- ------- --------
Gross margin......... 2,817 4,028 3,942 4,468 4,959 481 -- -- 4,996
Selling, general and
administrative...... 2,085 3,022 3,520 3,561 4,067 315 1,776 1,214 8,816
Depreciation and
amortization........ 161 199 189 311 341 31 27 19 1,229
------ ------- ------- ------- ------- ------- ------- ------- --------
Income (loss) from
operations.......... 571 807 233 596 551 135 (1,803) (1,233) (5,049)
Interest (income)
expense............. 49 48 58 102 97 5 (14) (8) 2,808
------ ------- ------- ------- ------- ------- ------- ------- --------
Income (loss) before
taxes............... 522 759 175 494 454 130 (1,789) (1,225) (7,857)
Income taxes......... 191 319 81 205 186 52 -- -- --
------ ------- ------- ------- ------- ------- ------- ------- --------
Net income (loss).... $ 331 $ 440 $ 94 $ 289 $ 268 $ 78 (1,789) (1,225) (7,857)
====== ======= ======= ======= ======= =======
Preferred stock
dividends(c)........ -- -- 1,204
Amortization of
preferred stock
issuance costs...... -- -- 21
------- ------- --------
Income (loss)
applicable to common
stock............... $(1,789) $(1,225) $ (9,082)
======= ======= ========
Earnings (loss) per
Common Share --
basic and diluted... $ (1.45) $ (1.15) $ (2.69)
======= ======= ========
Weighted average
number of common
shares
outstanding -- basic
and diluted......... 1,235 1,064 3,381
OPERATING DATA:
Customers served at
end of period....... * * 12,002 12,733 15,810 * -- -- 22,696
Access lines at end
of period........... -- -- -- -- 14,700 15,650 -- -- 30,871
Employees at end of
period.............. 40 51 58 61 84 84 14 13 283
</TABLE>
42
<PAGE> 48
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
-------------------------------------------------------------- ---------------------------------------
PERIOD
ENDED
AS OF DECEMBER 31, FEBRUARY 10,
---------------------------------------------- ------------ AS OF AS OF
1993 1994 1995 1996 1997 1998 DECEMBER 31, 1997 SEPTEMBER 30, 1998
------ ------ ------ ------ ------ ------------ ----------------- ------------------
(IN THOUSANDS) (IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents.......... $ 123 $ 333 $ 96 $ 158 $ 258 $ -- $ 210 $ 53,378
Pledged securities.... -- -- -- -- -- -- -- 44,917
Property and
equipment............ 1,342 2,063 2,265 2,721 2,964 3,182 128 16,638
Total assets.......... 2,760 3,748 3,971 3,868 4,802 5,287 534 145,624
Long-term debt and
capital lease
obligations.......... 587 1,188 1,431 792 681 650 -- 115,320
Redeemable preferred
stock................ -- -- -- -- -- -- -- 13,572
Total stockholders'
equity............... 574 1,014 1,108 1,397 1,665 1,743 29 1,752
OTHER FINANCIAL DATA:
Cash flows from
operating
activities........... $ 515 $ 568 $ (267) $ 834 $ 488 $(215) (1,464) (1,353)
Cash flows from
investing
activities........... (371) (753) (230) (513) (243) (30) (215) (62,616)
Cash flows from
financing
activities........... 27 395 259 (257) (145) (13) (1,889) 117,137
EBITDA................ 732 1,006 422 907 892 166 (1,776) (3,820)
Capital
expenditures......... 371 753 230 513 243 30 128 9,959
Ratio of earnings to
fixed charges(e)..... 10.00x 14.09x 3.46x 5.19x 4.91x 11.12x -- --
Deficiency of earnings
to fixed charges..... -- -- -- -- -- -- (1,789) (7,857)
</TABLE>
- ---------------
(a) Birch, which was formed on December 23, 1996, had no assets, liabilities, or
financial activity prior to January 1, 1997.
(b) Includes the results of operations of Valu-Line, Telesource, Boulevard and
TFSnet for the period from the date of the closing of the transactions
through September 30, 1998.
(c) Includes accretion of mandatorily redeemable preferred shares to redemption
value.
(d) "EBITDA" is defined as earnings before interest, taxes, depreciation and
amortization. Although EBITDA is not a measure of performance calculated in
accordance with generally accepted accounting principles ("GAAP"), Birch's
management believes that EBITDA is accepted as a generally recognized
measure of performance in the telecommunications industry. Nevertheless,
this measure should not be considered in isolation or as a substitute for
operating income (as determined in accordance with GAAP) as an indicator of
Birch's operating performance, or to cash flows from operating activities
(as determined in accordance with GAAP) as a measure of liquidity. In
addition, it should be noted that companies calculate EBITDA differently
and, therefore, EBITDA as presented for the Company may not be comparable to
EBITDA reported by other companies. See the consolidated financial
statements of Valu-Line and Birch and related notes thereto (collectively,
the "Consolidated Financial Statements") included elsewhere in this
Prospectus for a review of the cash used in and provided by operating and
investing activities. Furthermore, there are legal and functional
requirements that limit management's discretionary use of funds depicted by
EBITDA. See "Risk Factors -- Substantial Future Operating Losses; Negative
Cash Flow from Operations, Risk Factors -- Substantial Leverage; Ability to
Service Indebtedness and Risk Factors -- Discretionary Use of Funds."
(e) For purposes of calculating the ratio of earnings to fixed charges, earnings
are defined as loss before income taxes plus fixed charges. Fixed charges
consist of interest expense and a reasonable approximation of the interest
factor included in rental payments on operating leases. The Company's
earnings were insufficient to cover fixed charges for the year ended
December 31, 1997 and for the nine months ended September 30, 1997 and 1998.
* Information not available
43
<PAGE> 49
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis of Birch's financial condition and
results of operations should be read in conjunction with the consolidated
financial statements and the notes thereto contained elsewhere in this
Prospectus. Certain information contained in the discussion and analysis set
forth below and elsewhere in this Prospectus, including information with respect
to Birch's plans and strategy for its business and related financing, includes
forward-looking statements that involve risk and uncertainties. See "Risk
Factors" for a discussion of important factors that could cause actual results
to differ materially from the results described in or implied by the
forward-looking statements contained herein.
OVERVIEW
Birch Telecom, Inc. was organized on December 23, 1996 to become a leading
provider of telecommunications services to small and mid-sized businesses in its
target markets in Missouri, Kansas, Texas, Oklahoma and Arkansas. Since such
date and prior to the Merger, Birch Telecom, Inc. was a development stage
company with no revenue and principal activities consisting of procuring
governmental authorizations, raising capital, hiring management and other key
personnel, designing and developing its telephone networks, acquiring equipment
and facilities, negotiating resale and interconnection agreements and pursuing
acquisition opportunities. Birch had no assets, liabilities or financial
activity prior to January 1, 1997.
In February 1998, Birch Telecom, Inc. merged with Valu-Line in a
transaction valued at $19.5 million, consisting of $4.75 million in cash,
2,968,750 shares of Series A Preferred Stock having an aggregate liquidation
preference of $4.75 million, and 6,593,750 shares of Series C Preferred Stock
having an aggregate liquidation preference of $10.0 million. Valu-Line's revenue
and EBITDA for the year ended December 31, 1997 were $16.8 million and $892,000,
respectively. Valu-Line, founded in 1982, has been primarily providing switched
long distance services, CPE sales and services and, since March 1997, local
service. In May 1998, Birch acquired Boulevard, a shared tenant service provider
in the Kansas City metropolitan area, for $300,000 in cash. Boulevard's revenue
and EBITDA for the year ended December 31, 1997 were $339,000 and $4,000,
respectively. In May 1998, Birch acquired Telesource, a CPE provider in the
Kansas City metropolitan area, for $325,000 in cash. In connection with the
Telesource acquisition, the Company assumed $290,000 of Telesource's debt which
has since been repaid. Telesource's revenue and EBITDA for the year ended
December 31, 1997 were $911,000 and $(75,000), respectively. In June 1998, the
Company purchased certain assets and liabilities of TFSnet, an ISP in the Kansas
City metropolitan area for $2.65 million. TFSnet's revenue and EBITDA for the
year ended December 31, 1997 were $796,000 and $210,000, respectively. The
Merger, the Boulevard Acquisition, the Telesource Acquisition and the TFSnet
Acquisition were recorded using the purchase method of accounting. On March 13,
1998, Birch completed a private placement of 6,264,063 shares of its Series B
Preferred Stock having an aggregate liquidation preference of $9.5 million and
$3.5 million in aggregate principal amount of its Convertible Notes, raising
aggregate net proceeds of approximately $12.4 million which were used to pay the
cash portion of the consideration in the Merger, to repay certain debt and for
general corporate purposes. The Convertible Notes have been converted to
2,307,965 shares of Series B Preferred Stock.
The Company has experienced operating losses to date and expects to
continue to experience increasing operating losses and negative EBITDA as it
expands its operations. See "Risk Factors -- Substantial Future Operating
Losses; Negative Cash Flow from Operations."
EXPANSION STRATEGY
Birch's current business plan is focused on the development of its existing
markets in Missouri and Kansas and expansion into neighboring markets in SWBT's
service area. Birch currently operates a long distance switch in Wichita,
Kansas, is in the process of installing and testing a switch in Kansas City,
Missouri and intends to deploy additional switches in St. Louis, Missouri and
Wichita and Topeka, Kansas during the next six to nine months. Subject to its
ability to obtain additional financing, Birch anticipates deploying additional
switches in other markets in Missouri, Kansas and Texas commencing in 1999. By
operating its own
44
<PAGE> 50
switch in a particular market, Birch can "unbundle" the services traditionally
offered by the ILEC in that market and retain a much higher percentage of the
service charges paid by its customers.
Initially, Birch intends to resell the traditional bundle of local services
currently provided by the ILEC in its markets, together with a flat rate long
distance service, CPE, and, in selected markets, Internet access service,
primarily to small and mid-sized business and residential customers. Birch is
providing local and long distance service and CPE in Missouri and Kansas,
including Kansas City, St. Louis and St. Joseph, Missouri and Wichita, Topeka,
Manhattan, Lawrence, Emporia, Salina and Dodge City, Kansas and Internet access
in selected markets in Kansas. The Company intends to provide service in 12
markets in Texas by the end of 1999.
Once Birch has its own switching facilities in a market, most customers
will be served using the Birch switch and the ILEC's transmission facilities.
Birch also intends to expand the geographic reach of its operations to other
cities and states, either through internal growth, through acquisitions of
existing CLECs or by entering into joint ventures, any of which may require
additional financing. Birch regularly engages in discussions with respect to
future acquisitions and assesses opportunities on an ongoing basis. See "Risk
Factors -- Risks Associated with Acquisitions" and "-- Need for Additional
Financing."
FACTORS AFFECTING FUTURE OPERATIONS
Revenue
Birch generates most of its revenue from the sale of local and long
distance telephone service, CPE and, to a lesser extent, Internet access service
to small to mid-sized business and residential customers. Birch is offering
resold basic local and long distance service packages and CPE in certain markets
in Missouri and Kansas. Revenue from local services consists of charges for
basic local service and custom calling features. Birch offers local telephone
service at a discount to the competing ILEC and offers long distance service at
a flat per minute rate for calls within the continental United States. CPE and
related services are offered at negotiated rates generally consistent with other
competitors. Birch also offers Internet access in selected markets primarily at
a flat monthly rate. For the nine months ended September 30, 1998, as a percent
of total revenue, communications and other services were 86.5% (including
revenue from Internet access services which was 2% of total revenue for such
period) and CPE sales were 13.5%.
Switched local service will generate access fees charged to long-distance
companies for the local origination and termination of inter-exchange calls.
Similarly, switched local service will also generate reciprocal compensation
(which results from Birch terminating calls made by ILEC customers). In
addition, the Company may also be able to derive revenue by providing local
services at wholesale to other telecommunications carriers. See "Risk
Factors -- Reciprocal Compensation for Internet Access" and
"Business -- Regulation -- Interconnection with ILEC Facilities."
Operating Expenses
Birch's primary operating expenses consist of cost of services and selling,
general and administrative expenses.
Cost of Services. Birch's cost of services include the cost of purchasing
the "bundle" of traditional ILEC services for resale to its local service
subscribers. Birch purchases local telephone service for its customers on a
"wholesale" basis pursuant to an interconnection agreement with the ILEC in
Birch's targeted market. Once a switch is operational in a market, Birch can
"unbundle" the local services offered by the ILEC in that market and retain a
much higher percentage of the service charges paid by its customers as most
charges relate only to leasing the transmission lines.
Additionally, ILECs typically charge both a start-up fee as well as a
monthly recurring fee for use of their central offices for collocation of CLEC
transmission equipment. By physically collocating its transmission equipment in
or near existing ILEC switching offices, Birch will have more direct control
over its ILEC links for both unbundled loops and trunking facilities. Birch will
also be required to invest in transmission and distribution electronics
equipment associated with its switches.
45
<PAGE> 51
The Company's primary long distance expenses are expenses associated with
the Company's leased long distance network. For calls terminating outside of
Birch's network, long distance carriers are used to provide services.
Birch's primary expense associated with providing Internet access to its
customers is the cost of leasing transmission facilities. Birch's primary
expense associated with CPE is the cost of purchasing equipment from
manufacturers and labor for equipment installation.
Selling, General and Administrative Expenses. Birch's selling, general and
administrative expenses include its selling and marketing costs and customer
service, billing, corporate administration, personnel and network maintenance
expense.
Birch employs a direct sales force in each of its target markets. To
attract and retain a highly qualified sales force, Birch offers its sales
personnel a compensation package that emphasizes commissions. Birch expects to
incur significant selling and marketing costs as it continues to expand its
operations.
Birch has implemented and continues to refine tailored systems for
operations support systems and other back office systems that provision and
track customer orders from point of sale to the installation and testing of
service. Along with the development cost of these systems, Birch will also incur
ongoing expenses for customer service and billing systems. As Birch's strategy
stresses the importance of personalized customer service, Birch expects that its
customer service department will become a larger part of Birch's ongoing
administrative expenses. Birch also expects billing costs to increase as its
number of customers and the call volume increases. Birch incurs other costs and
expenses, including the costs associated with the maintenance of its network,
administrative overhead, office leases and bad debt. Birch expects that these
costs will grow significantly as it expands its operations and that
administrative overhead will be a large portion of these expenses during the
expansion phase of Birch's business. However, Birch expects these expenses to
become smaller as a percentage of Birch's revenue as Birch builds its customer
base.
RESULTS OF OPERATIONS
BIRCH TELECOM, INC.
Nine Months Ended September 30, 1998 compared to the Nine Months Ended
September 30, 1997
Revenue. Revenue was $17.2 million for the nine months ended September 30,
1998 compared to $0 for the nine months ended September 30, 1997, principally as
a result of the Merger, Boulevard, Telesource and TFSnet acquisitions and
opening five new markets in 1998. On a pro forma basis, revenue for the nine
months ended September 30, 1998 would have been $20.3 million.
Cost of services. Cost of services was $12.2 million for the nine months
ended September 30, 1998 compared to $0 for the nine months ended September 30,
1997, principally as a result of the Merger, Boulevard, Telesource and TFSnet
acquisitions and opening five new markets in 1998. Gross margin for the nine
months ended September 30, 1998 was $5.0 million, or 29.0% of revenue. On a pro
forma basis, cost of services for the nine months ended September 30, 1998 would
have been $14.1 million and gross margin would have been $6.3 million, or 30.9%
of revenue.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $8.8 million for the nine months ended September
30, 1998 compared to $1.2 million for the nine months ended September 30, 1997.
These expenses increased principally as a result of the Merger, Boulevard,
Telesource and TFSnet acquisitions and opening five new markets in 1998.
Additionally, the Company expanded its engineering and operations staff in
preparation for switch deployment. EBITDA was $(3.8) million for the nine months
ended September 30, 1998 compared to $(1.2) million for the nine months ended
September 30, 1997. On a pro forma basis, selling, general and administrative
expenses for the nine months ended September 30, 1998 would have been $9.7
million and EBITDA would have been $(3.4) million.
Depreciation and amortization. Depreciation and amortization was $1.2
million for the nine months ended September 30, 1998 compared to $19,000 for the
nine months ended September 30, 1997, most of which was attributable to the
fixed and intangible assets acquired in the Merger, Boulevard, Telesource and
46
<PAGE> 52
TFSnet acquisitions. On a pro forma basis, depreciation and amortization for the
nine months ended September 30, 1998 would have been $2.1 million primarily as a
result of the amortization of Merger-related intangibles and deferred debt cost.
Interest expense. Interest expense was $4.5 million and interest income
was $1.7 million for the nine months ended September 30, 1998 compared to
interest income of $8,000 for the nine months ended September 30, 1997,
primarily as a result of the interest expense related to the Notes and interest
income from the proceeds of the Notes. On a pro forma basis, net interest
expense for the nine months ended September 30, 1998 would have been $15.1
million, primarily reflecting interest expense in connection with the Notes.
Income taxes. Income taxes were $0 for the nine months ended September 30,
1998 and 1997 and on a pro forma basis.
Net loss. Net loss was $7.9 million for the nine months ended September
30, 1998 compared to $1.2 million for the nine months ended September 30, 1997,
as discussed above. On a pro forma basis, net loss for the nine months ended
September 30, 1998 would have been $20.6 million as discussed above.
Year Ended December 31, 1997
Revenue. Revenue for the year ended December 31, 1997 was $0. On a pro
forma basis after giving effect to the Transactions, revenue for the year ended
December 31, 1997 would have been $18.1 million.
Cost of services. Cost of services for the year ended December 31, 1997
was $0. On a pro forma basis, cost of services for the year ended December 31,
1997 would have been $12.7 million and gross margin would have been $5.4
million, or 29.7% of revenue.
Selling, general and administrative expenses. Selling, general and
administrative expenses were $1.8 million for the year ended December 31, 1997
related to the developmental costs of Birch Telecom, Inc.'s business. EBITDA was
$(1.8) million for the year ended December 31, 1997. On a pro forma basis,
selling, general and administrative expenses for the year ended December 31,
1997 would have been $6.3 million and EBITDA would have been $(955,000).
Depreciation and amortization. Depreciation and amortization was $27,000
for the year ended December 31, 1997. On a pro forma basis, depreciation and
amortization for the year ended December 31, 1997 would have been $2.0 million
primarily as a result of the amortization of Merger-related intangibles.
Interest income (expense). Interest income was $14,000 for the year ended
December 31, 1997. On a pro forma basis, interest expense for the year ended
December 31, 1997 would have been $16.2 million primarily as a result of the
Notes.
Income taxes. Income taxes were $0 for the year ended December 31, 1997 on
an actual and pro forma basis.
Net loss. Net loss was $1.8 million for the year ended December 31, 1997
as discussed above. On a pro forma basis, net loss for the year ended December
31, 1997 would have been $19.2 million as discussed above.
VALU-LINE
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenue. Revenue increased 27.1% to $16.8 million for the year ended
December 31, 1997, from $13.2 million for the year ended December 31, 1996,
primarily as a result of entering the local service market in March 1997 and
long distance volumes increasing faster than the decline in long distance
pricing. As a percent of total revenue, communications and other services were
82%, or $13.8 million, and CPE sales were 18%, or $3.0 million compared to
80.9%, or $10.7 million and 19.1%, or $2.5 million, respectively for the year
ended December 31, 1997 and 1996.
Cost of services. Cost of services increased 35.4% to $11.8 million for
the year ended December 31, 1997, from $8.7 million for the year ended December
31, 1996 primarily as a result of the increase in revenue. Gross margin
increased 11.0% to $5.0 million, or 29.5% of revenue, for the year ended
December 31, 1997
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from $4.5 million, or 33.8% of revenue, for the year ended December 31, 1996
primarily as a result of relatively low margins generated from resold local
service, which was started in March 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 14.2% to $4.1 million for the year ended
December 31, 1997, from to $3.6 million for the year ended December 31, 1996,
primarily as a result of sales commissions related to increased business volumes
and increased customer service expenditures associated with the commencement of
local service. EBITDA decreased 1.7% to $892,000 for the year ended December 31,
1997 from $907,000 for the year ended December 31, 1996 primarily a result of
the start-up costs associated with offering local service.
Depreciation and amortization. Depreciation and amortization increased
9.6% to $341,000 for the year ended December 31, 1997, compared to $311,000 for
the year ended December 31, 1996.
Interest expense. Interest expense was $97,000 for the year ended December
31, 1997 compared to $102,000 for the year ended December 31, 1996.
Income taxes. Income taxes decreased 9.3% to $186,000 for the year ended
December 31, 1997, compared to $205,000 for the year ended December 31, 1996.
The effective income tax rate was 41.0% for the year ended December 31, 1997,
compared to 41.5% for the year ended December 31, 1996.
Net income. Net income decreased 7.3% to $268,000 for the year ended
December 31, 1997, from $289,000 for the year ended December 31, 1996 as
discussed above.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenue. Revenue increased 8.1% to $13.2 million for the year ended
December 31, 1996, from $12.2 million for the year ended December 31, 1995,
primarily as a result of long distance volumes increasing faster than the
decline in long distance pricing. As a percent of total revenue, communications
and other services were 80.9%, or $10.7 million and CPE sales were 19.1%, or
$2.5 million for the year ended December 31, 1996 compared to 84.8%, or $10.3
million and 15.2%, or $1.9 million, respectively for the year ended December 31,
1995.
Cost of services. Cost of services increased 5.6% to $8.7 million for the
year ended December 31, 1996, from $8.3 million for the year ended December 31,
1995, primarily as a result of the increase in revenue. Gross margin was $4.5
million, or 33.8% of revenue for the year ended December 31, 1996, compared to
$3.9 million, or 32.2% of revenue for the year ended December 31, 1995,
reflecting the increased margins generated from the installation of a long
distance switch in late 1995.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 1.2% to $3.6 million for the year ended
December 31, 1996, from $3.5 million for the year ended December 31, 1995,
primarily as a result of expenses related to increased business volumes. EBITDA
increased 114.9% to $907,000 for the year ended December 31, 1996 compared to
$422,000 for the year ended December 31, 1995 primarily as a result of leasing a
long distance switch.
Depreciation and amortization. Depreciation and amortization increased
64.6% to $311,000 for the year ended December 31, 1996, from $189,000 for the
year ended December 31, 1995. The increase in amortization for the year ended
December 31, 1996 is primarily a result of incurring a capital lease for a long
distance switch in late 1995.
Interest expense. Interest expense increased 75.9% to $102,000 for the
year ended December 31, 1996 from $58,000 for the year ended December 31, 1995
primarily as a result of interest on the long distance switch lease.
Income taxes. Income taxes increased 153.1% to $205,000 for the year ended
December 31, 1996, from $81,000 for the year ended December 31, 1995. The
effective income tax rate was 41.5% for the year ended December 31, 1996,
compared to 46.3% for the year ended December 31, 1995.
Net income. Net income increased 207.4% to $289,000 for the year ended
December 31, 1996, from $94,000 for the year ended December 31, 1995 as
discussed above.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1998, net cash used in operating
activities was $1.4 million as compared to $1.1 million during the nine months
ended September 30, 1997. The 1998 period reflected net
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losses reduced by non-cash depreciation and increases in accrued expenses. The
1997 period reflected the losses associated with starting the Company.
During the 1998 period, net cash used in investing activities was $62.6
million as compared to $111,000 during the 1997 period. The 1998 period included
$10.0 million for purchases of property and equipment, $7.7 million for
purchases of companies, and $43.6 million for net purchases of restricted
securities related to the Private Offering. Management anticipates that cash
used for the purchase of property and equipment will continue to increase.
Cash provided by financing activities was $117.1 million during the 1998
period as compared to $1.8 million in the 1997 period. During the 1997 period,
the Company sold equity securities worth $1.8 million. In February and March of
1998, Birch raised approximately $12.4 million in a private placement of its
Series B Preferred Stock and the Convertible Notes. In June 1998, the Company
sold the Notes for net proceeds of $110.2 million.
The first six interest payments related to the Notes will be funded by the
Pledged Securities. Beginning in December 2001, the Company will be required to
make semi-annual interest payments of $8.1 million related to the Notes. A lump
sum principal payment is due in June 2008. Additional interest expense may be
incurred in connection with the funding of future capital requirements.
The impact on future results of operations due to interest expense related
to the Notes is estimated to be approximately $16.1 million per year.
The expansion of Birch's business will require significant capital to fund
capital expenditures, working capital needs, debt service and the cash flow
deficits generated by increasing operating losses. Birch's principal capital
expenditure requirements include the purchase and installation of switches and
transmission equipment collocated in ILEC central offices and the further
development of operations support systems and other automated back office
systems. Management does not expect that the growth of Birch's long distance and
CPE business will require significant capital expenditures. See "Use of
Proceeds."
Birch currently estimates that the cash required to fund capital
expenditures for its expansion plans will be approximately $25.0 million for
1998 and $80.0 million in 1999. Actual capital expenditures may increase
substantially if the Company consummates any significant acquisitions or deploys
additional switches or if current deployment schedules are revised. The proceeds
from the Notes will not be sufficient to fund Birch's projected capital
expenditures beyond the next nine months and the Company will be required to
seek additional financing in the near term to implement its current business
plan and to pursue planned expansion into Texas. The Company does not currently
have any planned sources of additional capital. When the Company is required to
seek additional financing, it may be required to, among other things, refinance
its existing indebtedness and incur bank debt (if permitted by the terms of the
Indenture). There can be no assurance that any of the foregoing alternatives
will be available to the Company or that Birch will be able to raise additional
capital on satisfactory terms or at all. See "Risk Factors -- Need for
Additional Financing."
Birch expects to make significant capital outlays for the foreseeable
future in order to continue the development activities called for in its current
business plan and to fund expected operating losses. In order for the Company to
implement its current business plan and finance its projected capital
expenditures for 1999 and thereafter, Birch will be required to seek and obtain
significant amounts of additional financing (debt and/or equity) within the next
nine months. The Company's expansion into Texas is dependent upon raising
substantial additional financing in the near term. If Birch's plans or
assumptions change, if its assumptions prove to be inaccurate, or if it
experiences unanticipated costs or competitive pressures, Birch will be required
to seek additional capital sooner than currently anticipated, possibly within
the next six months. In particular, if Birch elects to pursue significant
additional acquisition opportunities or to deploy more switches than currently
planned, its cash needs may be increased substantially. There can be no
assurance that Birch's current projection of cash flow (and losses) from
operations (which will depend upon numerous future factors and conditions, many
of which are outside of Birch's control) will be accurate. Because Birch's cost
of developing new networks and services, funding other strategic initiatives and
operating its business will depend on a variety of factors (including, among
other things, the number of subscribers and the service for which they
subscribe, the nature and penetration of services that may be offered by Birch,
regulatory changes, and actions taken by competitors in response to Birch's
strategic initiatives), it is almost certain that actual costs and revenue will
vary from expected amounts, very likely to a material degree, and such
variations are likely to affect Birch's future capital requirements. The
proceeds from the Notes will not be sufficient to fund Birch's current business
plan beyond
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the next nine months. As a consequence, Birch intends to seek additional debt
and/or equity financing to fund Birch's liquidity needs after the use of the
proceeds from the Notes. There can be no assurance that Birch will be able to
raise additional capital on satisfactory terms or at all. If Birch is unable to
raise additional capital, Birch will deploy fewer switches and/or enter fewer
new markets than currently planned. If Birch decides to raise additional funds
through the incurrence of debt, its interest obligations will increase and it
may become subject to additional or more restrictive financial covenants. For
example, Birch's ability to access the cash flow of its subsidiaries may be
restricted by such future debt covenants. See "Risk Factors -- Holding Company
Structure; Effective Subordination and Ranking." In the event that Birch is
unable to obtain such additional capital or to obtain it on acceptable terms or
in sufficient amounts, Birch will be required to delay the development of its
network or take other actions that could have a material adverse effect on
Birch's business, operating results and financial condition and its ability to
achieve sufficient cash flow to service the Notes. In addition, Birch may, from
time to time or on one or more occasion, elect to repurchase a portion of the
Notes in the open market.
The ability of Birch to fund the capital expenditures and other costs
contemplated by its business plan and to make scheduled payments with respect to
the Notes, will depend upon, among other things, its ability to seek and obtain
additional financing within the next nine months, to implement its business
plan, to deploy its network and expand its operations and to obtain and retain a
significant number of customers in its target markets, and the future operating
performance of Birch and its subsidiaries. Each of these factors is, to a large
extent, subject to economic, financial, competitive, political, regulatory and
other factors, many of which are beyond Birch's control. Birch expects that it
will generate operating losses for the foreseeable future and that its business
will not generate positive cash flow for the foreseeable future. In addition,
the Company will require significant amounts of additional financing, which may
not be available, before it will be able to generate positive cash flow. No
assurance can be given that Birch will be successful in developing and
maintaining a level of cash flow from operations sufficient to permit it to pay
the principal of, and interest and Liquidated Damages, if any, on, the Notes. If
Birch is unable to generate sufficient cash flow from operations to service its
indebtedness, including the Notes, it may have to modify its growth plans, limit
its capital expenditures, restructure or refinance its indebtedness or seek
additional capital or liquidate its assets. There can be no assurance (i) that
any of these strategies could be effected on satisfactory terms, if at all, in
light of Birch's high leverage or (ii) that any such strategy would yield
sufficient proceeds to service the Notes. In such event, purchasers of Notes may
suffer a complete loss of their investment. See "Risk Factors."
YEAR 2000 ISSUE
The year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of Birch's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. The Company anticipates
spending $15 million on new systems through the end of 1999 from funds provided
by the Private Offering or from new sources of capital. Specific expenditures
for Year 2000 costs are not being made related to the new systems. The Company
has completed its assessment on the consequences of the Year 2000 on information
technology systems. As the Company has a relatively short history, virtually all
systems are newly created or are being created. During the information
technology development, Year 2000 issues have been consistently addressed. The
new information technology systems will, in certain cases, replace systems of
acquired companies in order to provide consistent and integrated systems. The
acquired companies' systems are not all Year 2000 compliant, however, these
systems will be replaced by the third quarter of 1999. If all such systems are
not replaced and Year 2000 issues occur, significant disruption to the Company's
operations could occur. The most significant system of the acquired companies
relates to the provisioning and billing of resale local and long distance
services which, if not replaced, could prevent the Company from billing or
provisioning service to existing and future customers. Installation of the
integrated billing and provisioning system is on schedule to date.
Other non-information technology systems which may be affected by the Year
2000 issue include systems provided to the Company by third parties. The most
significant third party systems are those which operate Southwestern Bell's
interfaces and billing records, switching equipment and customer premise
equipment. The Company has been assured by significant third parties that Year
2000 compliance will be accomplished by the end of 1999. If such compliance is
not achieved by these third parties, it would have a material adverse effect on
Birch's business, operating results and financial condition and its ability to
achieve sufficient cash flow to service the Notes.
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ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information." Both are required for financial
statements in fiscal years beginning after December 15, 1997. SFAS No. 130
requires comprehensive income to be reported in a financial statement that is
displayed with the same prominence as other financial statements. Adoption of
this statement had no material impact on the Company's consolidated financial
position, results of operations or cash flows. SFAS No. 131 requires entities to
disclose financial and detailed information about its operating segments in a
manner consistent with internal segment reporting used by the Company to
allocate resources and assess financial performance. The Company has determined
that additional disclosures will not be required under SFAS No. 131.
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BUSINESS
GENERAL
Birch is a rapidly growing CLEC serving small to mid-sized business and, to
a lesser extent, residential customers in selected markets in Missouri and
Kansas. As of September 30, 1998, Birch had over 20,000 customers. The Company
provides its customers with a full range of telecommunications services,
including local and long distance service, CPE and, in selected markets,
Internet access service. Since it began offering local service in March 1997,
Birch has increased aggregate local access lines to over 30,000, making it one
of the largest CLECs in the territory served by SWBT. On a pro forma basis, the
Company's revenue for the nine months ended September 30, 1998 would have been
$20.3 million and the Company's net losses for the nine months ended September
30, 1998 would have been $20.6 million.
Birch currently provides local, and long distance and CPE services in
Missouri and Kansas, including Kansas City, St. Louis and St. Joseph, Missouri
and Wichita, Topeka, Manhattan, Lawrence, Emporia, Salina and Dodge City,
Kansas, and Internet access in selected markets in Kansas. The Company intends
to provide service in 12 markets in Texas by the end of 1999. Birch currently
operates a long distance switch in Wichita, Kansas and is in the process of
installing and testing a Lucent Series 5ESS(R)-2000 digital switch in Kansas
City, Missouri. The Company also intends to deploy additional switches in St.
Louis, Missouri and Wichita and Topeka, Kansas, during the next six to nine
months, and, subject to obtaining additional financing, anticipates deploying
additional switches in other markets in Missouri, Kansas and Texas commencing in
1999.
The Company believes that deregulation of the telecommunications industry
has created opportunities for providers who deliver simple, integrated services
at a price lower than the ILECs. Birch believes that other CLECs have
concentrated primarily on the largest cities and largest customers and have
focused primarily on the construction of fiber-optic networks in concentrated
business districts. This has created an opportunity for CLECs that focus on
underserved customers, such as small and mid-sized businesses in larger cities
and all customers in smaller metropolitan areas. Birch provides services to
these customers through a combination of owned and leased network facilities and
resold services. Management believes that the Company's comprehensive portfolio
of telecommunications services, competitive pricing, local market expertise and
superior customer service provide it with a competitive advantage over the
ILECs, CLECs, IXCs, and other telecommunications providers against which the
Company competes.
MARKET OPPORTUNITY
The Company plans to concentrate its activity in the five-state region of
Missouri, Kansas, Texas, Arkansas and Oklahoma which is dominated by SWBT and
GTE for local services and IXCs such as AT&T, MCI, Sprint and WorldCom for long
distance services. Based on data provided by the FCC, Birch estimates its
addressable telecommunications services market opportunity (defined as total
wireline intrastate and interstate telephone revenue in Birch's targeted
five-state region) to be approximately $21.4 billion, or 11.6% of the U.S. total
of $184.0 billion, in 1996. As of December 31, 1996, there were approximately
18.3 million access lines in Birch's targeted five-state region, representing
11.6% of the U.S. total of 157.4 million. The FCC data on which Birch's estimate
of addressable telecommunications services market opportunity is based do not
include the Internet access and CPE markets in which Birch competes.
BUSINESS STRATEGY
Birch's objective is to be a leading provider of telecommunications
services to small and mid-sized businesses in its target markets. The key
components of Birch's strategy are:
Provide a Broad Set of Services.
Management believes that Birch currently offers the most comprehensive
array of telecommunications services of any provider in its markets. The
Company's service offerings include local and long distance service, CPE and, in
selected markets, Internet access service. The Company offers its services
through a
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single sales representative, a single customer service number and a single,
integrated invoice. Birch targets customers who prefer uncomplicated, personal
service from a dependable provider.
Target Underserved Customers.
Management believes that there is an opportunity to serve small and
mid-sized businesses in its larger markets and all business and residential
customers in its smaller markets. Management believes that small and mid-sized
businesses are neglected by the ILECs and CLECs serving larger metropolitan
areas and that Birch's smaller target markets are currently underserved by SWBT.
The Company believes it devotes more attention to its customers during the sales
process, provides superior ongoing customer service and provides a more
comprehensive product offering than do ILECs and other direct competitors. See
"Business -- Sales and Marketing" and " -- Operations."
Own Strategic Network Assets.
The Company is deploying a capital efficient network and will own assets it
considers strategic -- primarily central office facilities that include switches
and Internet access servers -- while leasing a majority of its transmission
capacity. Management believes this strategy will yield several advantages,
including the ability to: (i) achieve higher gross margins on local service
(approximately 60% versus approximately 10% on pure resale); (ii) collect access
charges for the local portion of long-distance calls made or received by Birch
customers; (iii) collect reciprocal compensation (the compensation paid to and
from a CLEC and the ILEC for termination of a local call on each other's
network); and (iv) provide local services on a wholesale basis to other
telecommunications carriers.
Employ a Direct Sales Force with Extensive Local Market Experience.
Management believes that the Company's success in a particular market is
enhanced by employing a commission-based sales force with extensive local market
and telecommunications sales experience supported by experienced customer
service personnel. Salespeople with experience in a particular market provide
Birch with extensive knowledge of its target customer base and in many cases
already have existing relationships with target customers.
Build Regionally Clustered Operations.
Birch is focusing on developing dense coverage of particular regions
clustered around core target markets. This density of coverage is expected to
yield many benefits, including economies of scale in management, network
operations, sales and marketing. Additional benefits include brand awareness
throughout the region and a manageable scope of operations.
Leverage Experience with SWBT.
The Company intends to leverage its experience with SWBT to enter its
target markets as quickly as possible. Birch was among the first CLECs to
develop electronic provisioning systems for resale of SWBT services. Birch's
Emporia service center served as a beta test site for certain SWBT electronic
interfaces. Development of these provisioning systems is critical for carriers
seeking to grow rapidly. As a result of its experience with SWBT, Birch is
positioned to roll out services to additional SWBT markets more rapidly and with
less expense and uncertainty than it would face in a new market with a different
ILEC.
The Company expects to grow through the development of new markets and
through increased sales and marketing efforts in its current markets. The
Company will also have opportunities to expand its reach through acquisitions or
joint ventures that bring Birch an existing customer base, a new target market
or business and technological capabilities that complement its business
objectives. The Company intends to pursue acquisition candidates that offer one
or more of these benefits as opportunities arise. Birch currently has no
definitive agreement with respect to any acquisition or joint venture, although
from time to time it has discussions with other companies and assesses
opportunities on an ongoing basis. See "Prospectus Summary -- Recent
Developments" and "Risk Factors -- Risks Associated with Acquisitions."
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PRODUCTS AND SERVICES
Birch's products and services are designed to appeal to customers who not
only rely on their telecommunications networks but who also value integrated
product packages from a single provider.
Bundled Local and Long Distance
Birch provides a complete set of local and long distance services. The
local services are currently resold from SWBT and therefore match the offerings
of that provider. Birch services feature simple long-distance pricing structures
and simple percentage discounts (compared to SWBT) that increase with contract
term. All Birch services are billed on a single invoice and customer inquiries
are directed to a single customer service number. Conversion of local service to
Birch is typically seamless and is accomplished in less than a week from order
receipt.
Long distance calling services include outbound, toll free (800/888), and
calling card. Customers may subscribe to long distance services provided by IXCs
upon request.
Enhanced Local and Long Distance Packages
Taking advantage of its own switches, Birch intends to introduce simplified
service packages that combine popular custom calling features such as Call
Waiting and Caller ID.
Internet Services
Birch intends to provide both dial-up and dedicated Internet access
services. Its recently formed Internet Services Division is developing web
hosting, web-site design and Intranet development services. Birch anticipates
that its targeted customers will use the Internet as their primary wide-area
data network, and therefore expects their Internet requirements to grow both in
terms of access capacity and in the sophistication of related Internet services.
Shared Tenant Services
Through its recent acquisition of Boulevard, Birch provides fully
integrated local, long distance and CPE services in the greater Kansas City
metropolitan area. Customers pay a monthly fee based solely on the number of
telephone stations they require and the amount of long distance traffic they
generate.
Customer Premises Equipment
Birch sells and services CPE, including key systems, PBXs, and voice-mail
systems, and provides inside-wire services for commercial accounts, including
wiring for data networking. Birch serves as an authorized equipment distributor
for Northern Telecom, Inc. ("NORTEL"), Toshiba America Information Systems, Inc.
and NEC America Inc.
SALES AND MARKETING
Sales
Birch has a direct sales force of 51 representatives operating from nine
offices throughout Missouri and Kansas. Of these, three primarily sell CPE and
the remainder sell Birch's bundled local and long-distance products. Birch
intends to add approximately 20 salespeople during the remainder of 1998.
Although Birch's strategy is to focus on simple account conversions in its
targeted small to mid-size business segment, Birch seeks to establish a solid,
long-term relationship with customers, and has developed a commission structure
that it believes will enable it to attract experienced, productive sales people.
The Company's commission structure incorporates both a revenue and a local-line
quota, and is based on productivity parameters. Birch's sales managers are
experienced in disciplined, activity-based sales management.
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In the past, Birch did not actively market to residential customers, but
found that its other sales and promotional efforts attracted residential
customers, many of whom are owners or employees of businesses using Birch's
services. Birch currently is developing marketing efforts targeted at
residential customers.
Advertising and Promotion
Birch conducts an extensive grassroots marketing campaign in its local
markets, making use of advertising and public relations to position itself in
the small to mid-size business sector and contrasting its product and service
attributes with that of SWBT. This grassroots campaign includes sponsorship of
major local events and affiliations with local organizations. Management
believes that Birch's willingness to serve residential subscribers -- unlike
many CLECs -- creates a greater interest in Birch's development among the news
media and general public. In the past, Birch market launches have been
accompanied by extensive local media coverage.
In keeping with Birch's philosophy of being accessible to its customers,
Birch establishes local sales and customer service offices, open to walk-in
traffic, in high-profile locations. Birch believes that it is one of the only
providers of local telephone service that maintains an office in the cities and
towns in many of its markets.
Pricing
Price continues to be an important factor in the telecommunications
industry. Birch does not intend to position itself as the cheapest provider of
services, especially with respect to its long-distance product. Birch targets
customers who value the service and convenience of its offerings. Customers who
have the highest price sensitivity are likely to move frequently among
providers, driving up churn rates. Birch has historically experienced a low
churn rate, and believes the key to this has been setting reasonable price
discount expectations and then meeting them.
BIRCH NETWORK FACILITIES
Ownership of Strategic Facilities
Using its own switches and leased transmission lines, Birch is in the
process of deploying advanced voice and data telecommunications networks
throughout each of its target markets. The heart of the Birch network will be
the switch, which will permit Birch to provide both local and long distance
services on the same switching platform. Birch has a five-year purchase
agreement with Lucent that allows it to purchase switching equipment at a deep
discount from published list prices and that contains no minimum purchase
requirements. Birch believes that it will be able to better match its capital
expenditures to its revenue opportunities by leasing transmission lines and
through its purchasing agreement with Lucent.
Birch currently operates a long distance switch in Wichita, Kansas. Birch
and Lucent engineers are currently installing Birch's first local and long
distance switch in Kansas City, Missouri, which is scheduled to be operational
in September 1998. Additional Lucent switches are scheduled for St. Louis,
Missouri and Wichita (replacing the existing long-distance switch) and Topeka,
Kansas, during the next six to nine months. Birch plans to deploy switches in
additional cities during the remainder of 1999. Smaller cities may be served
with remote switching modules connected to nearby full-function switches which
will support a full array of calling features.
Birch is also investing in collocation facilities at SWBT's main central
offices. Collocation "cages" will allow Birch to utilize electronic equipment
that connects to both individual SWBT "unbundled loops" and SWBT's higher
capacity unbundled T1 facilities. Management believes that utilizing SWBT's
transmission lines will allow Birch to avoid the extensive capital costs of
complete network construction and enable it to build its market share
unencumbered by a lengthy construction program. Electronic equipment in
collocation cages will be connected to Birch's switches via leased fiber lines.
At the customer's premises, Birch intends to connect unbundled loops
directly to customer-owned equipment. However, there will be instances when
Birch deploys electronic equipment (intelligent channel
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banks, access concentrators or digital subscriber line ("DSL") equipment) that
concentrate traffic from one or more customers and enable Birch to obtain higher
capacity from raw ILEC transmission lines.
Birch intends to deploy advanced Internet Service Nodes alongside its
switches, making use of the same monitoring, environmental control and power
infrastructure that supports the switch. The ability to multiplex voice and data
traffic over its leased transmission lines and route that traffic at its
switching facility with digital cross connect electronics will enable Birch to
offer both advanced voice and data services.
The figure below sets forth the elements of the Company's network.
Birch Telecom, Inc. Flow Chart
Leasing of Transmission Facilities
Birch believes its choice to lease rather than build transmission
facilities will give it several key advantages. Within cities, first-generation
CLECs continue to specialize in deploying fiber networks to areas with dense
business clusters. Management believes that this trend, coupled with federally
mandated unbundling of ILEC networks, the introduction of DSL technology (which
creates greater capacity over the existing copper networks), and the development
of a variety of wireless transmission services, gives Birch access to needed
transmission facilities at a competitive price through leasing. Similarly,
management believes that the rapid increase in the capacity of long-distance
networks renders direct ownership of these facilities unnecessary for Birch.
Leasing rather than building transmission lines supports Birch's strategy
of rapid market development. Sales activity is not constrained by network
construction, and Birch's services can generally be made available throughout a
metropolitan area rather than at a limited number of locations.
Benefits of Traffic Aggregation
Because of Birch's concentrated regional focus and its wide service array,
management believes it will be able to generate relatively large volumes of
network traffic between the cities in its region, enabling it to lower its unit
cost of long-haul capacity. As Birch deploys Internet Service Nodes throughout
the region, Management believes unit cost will continue to decrease.
Success-based Capital Requirements
Management believes that one of the benefits of its chosen network
architecture is that much of its capital requirement will be success-based.
Birch believes it will be able to avoid the risky deployment of capital and
market development delays associated with extensive fiber-network construction.
Management believes that focused capital spending for strategic assets such as
switches and Internet servers will allow Birch to achieve higher gross margins
versus resellers while incurring lower capital outlays as compared to full-
facilities-based CLECs.
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OPERATIONS
Emporia Service Center
Central to Birch's ability to offer excellent service and support its
growth is its Emporia service center which has been operational since 1982. This
center processes orders, interfaces with SWBT's operational support systems,
provides customer service, trouble resolution, billing and collection for all of
the Company's markets. The service center has provisioned as many as 2,500 local
lines in a month, and since then, the workforce has been expanded by
approximately 100% to support the acceleration in market rollouts.
The Emporia service center provides rapid, human assistance, rather than
the automated, cumbersome customer interface currently used by SWBT. Birch
customers are given a single number for all customer contact, and the center
meets Birch's goal of providing "one-call solution" on the large majority of
inquiries. The center's workforce is highly skilled in meeting customers' needs,
and annual employee turnover has been minimal.
Kansas City Network Control Center
Under construction in Kansas City is Birch's Network Control Center, an
around-the-clock operation that will monitor the health of the entire Birch
infrastructure, including leased facilities and data networks. This facility is
scheduled to open concurrently with the in-service date of Birch's first switch
in Kansas City during 1998.
Field Technical Operations
Birch's field technicians service both Birch's network and customer-owned
facilities. Their areas of expertise include installation, repair and
maintenance of all major types of telecommunications network elements, including
digital switches, transmission equipment, PBXs, key systems, data equipment and
inside wiring, including wiring for data networking. Birch believes that having
a skilled, in-demand workforce gives it a substantial advantage over CLECs who
limit their offerings to network services and therefore do not have a
significant field technical capability. Field technicians are often the most
respected source of advice for small business customers on telecommunications.
Management believes that having this point of customer contact supports Birch's
goal of total service for its customer base and strengthens customer loyalty.
INFORMATION SYSTEMS
Birch's integrated systems have been the key to its ability to provide
single-invoice billing and support its "one-call solution" customer service,
giving it an advantage over ILECs who have difficulty with this challenge of
integration across their many legacy systems.
Birch's integrated customer service, ordering, provisioning, trouble
tracking and billing systems are Birch proprietary systems, and are managed and
upgraded by personnel at its Emporia service center. This operation served as a
beta test site for several of SWBT's operation support systems' electronic
interfaces for provisioning, trouble management and billing -- making Birch one
of the first CLECs to have such interfaces with SWBT. Birch believes its ability
to improve continually this interface with SWBT will afford it a competitive
advantage over other CLECs in its region.
Work is underway on an upgrade of Birch's information systems that
management believes will add capabilities of multi-state management of its local
networks, automate the provisioning process and improve Birch's billing
capabilities. These upgrades will be accomplished through the licensing of
industry-leading operations support systems and billing systems, with Birch
personnel responsible for integrating these modules with each other and with its
current systems.
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REGULATION
Overview
Telecommunications services provided by Birch are subject to regulation by
federal, state and local government agencies. At the federal level, the FCC has
jurisdiction over interstate and international services. Jurisdictionally,
interstate services are communications that originate in one state and terminate
in another. Intrastate services are communications that originate and terminate
in a single state. State regulatory commissions ("State PSCs") exercise
jurisdiction over intrastate services. Additionally, municipalities and other
local government agencies may regulate limited aspects of Birch's business, such
as use of government-owned rights-of-way, and may require permits such as zoning
approvals and building permits.
Removal of Entry Barriers
Federal law prohibits state and local governments from enforcing any law,
rule or legal requirement that prohibits or has the effect of prohibiting any
entity from providing interstate or intrastate telecommunications services. This
should enable Birch to provide a full range of local telecommunications services
in any state. This also reduces the barriers to entry by other potential
competitors and therefore increases the level of competition Birch will likely
face in all its markets. Operating companies providing telecommunications
services in the five states in which the Company is targeting are required to
obtain certification or register prior to offering service, but the
Telecommunications Act limits the ability of a state to deny a request by the
Company to enter a particular market.
Interconnection with ILEC Facilities
A CLEC cannot compete effectively with an ILEC in switched local telephone
services unless it is able to connect its facilities with the ILEC and obtain
access to certain essential services and resources under reasonable rates, terms
and conditions. The Telecommunications Act imposes a number of access and
interconnection requirements on all local exchange carriers ("LECs"), including
CLECs, with additional requirements imposed on ILECs. These requirements will
provide access to certain networks under reasonable rates, terms and conditions.
Specifically, all LECs, including the Company, must provide the following:
- Telephone Number Portability. Telephone number portability enables a
customer to keep the same telephone number when the customer switches
LECs.
- Dialing Parity. All LECs must provide dialing parity, which means that a
customer calling to or from a competing LEC network cannot be required to
dial more digits than would be required for a comparable call originating
and terminating on the other LEC's network.
- Reciprocal Compensation. The duty to provide reciprocal compensation
means that a carrier must terminate calls that originate on another
carrier's network in exchange for compensation.
- Resale. LECs generally may not prohibit or place unreasonable
restrictions on the resale of their services by other carriers.
- Access to Rights-of-Way. All LECs must provide access to their poles,
ducts, conduits and rights-of-way to competing carriers on a reasonable,
nondiscriminatory basis.
In addition, ILECs must offer local exchange services to resellers at a
wholesale rate that is less than the retail rate charged to end users. The
states are charged with determining the size of this discount. ILECs also must
offer access to various unbundled elements of their network. This requirement
allows new entrants to purchase at cost-based rates elements of an ILEC's
network that may be necessary to provide service to a new entrant's customers.
While ILECs are generally required to offer to CLECs interconnection, including
reciprocal compensation for mutual termination of traffic, unbundled network
elements and services that can be resold by CLECs, ILEC-CLEC interconnection
agreements may have short terms, requiring the CLEC to renegotiate the
agreements. See "-- Terms of Birch Interconnection Agreements." ILECs may not
provide timely provisioning or adequate service quality, thereby impairing a
CLEC's reputation with customers who can easily switch back to the ILEC. In
addition, the prices set in the agreements or through State PSC
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arbitration proceedings may be subject to changes mandated by state regulatory
commissions as they develop permanent rules governing interconnection.
All LECs must phase in a long-term service provider number portability
method in the coming months. Specifically, each LEC must make number portability
available within six months after receiving a specific request by another
telecommunications carrier. Until long-term service number portability is
available, all LECs must provide currently available number portability measures
as soon as reasonably possible after specific request from another carrier.
On July 16, 1997, the U.S. Court of Appeals for the Eighth Circuit (the
"Eighth Circuit") vacated certain portions of the FCC rules governing
interconnection between CLECs and the ILECs. The Eighth Circuit decision created
uncertainty about individual states' rules governing the pricing, terms and
conditions of interconnection agreements, and may make negotiating and enforcing
such agreements more difficult and protracted. The U.S. Supreme Court accepted
for review the Eighth Circuit's decision but is not expected to issue a decision
before the end of 1998.
On August 22, 1997, the Eighth Circuit issued an order vacating the FCC's
dialing parity rules to the extent they apply to intrastate traffic and certain
non-toll interstate services. On October 14, 1997, the Eighth Circuit vacated an
FCC rule that obligated ILECs, under certain circumstances, to provide
combinations of network elements, rather than provide them individually. This
decision may make it more difficult or expensive for competitors to use
combinations of ILEC elements.
There is uncertainty as to how future decisions by the states, the courts
and the FCC will affect these rules. Finally, continuing challenges to state and
federal rules and policies and individual actions by State PSCs could cause
Birch to incur substantial legal and administrative expenses.
In June 1997, SWBT notified Birch and other CLECs in SWBT's service
territory that it would not pay or collect reciprocal compensation under
interconnection agreements for traffic terminated at an ISP. On December 31,
1997, Birch filed a petition with the Missouri Public Service Commission to
arbitrate the terms of an interconnection agreement between Birch and SWBT. In
its pleading, Birch claimed, among other things, that ISP traffic is local in
nature, and that the rate of reciprocal compensation payments for traffic to an
ISP should be the same as the rate for other local calls. On April 23, 1998, the
Missouri Public Service Commission ordered the parties, pending final resolution
of these issues by the FCC, to compensate each other for ISP traffic at the same
rate as is applicable to other local calls. If a decision adverse to Birch is
issued on any appeal or review of the order of the Missouri Public Service
Commission or by the FCC, the ability of Birch to serve existing and future ISP
customers profitably would be limited, which could have a material adverse
effect on Birch's business, operating results and financial condition and its
ability to achieve sufficient cash flow to service the Notes. See "Risk
Factors -- Reciprocal Compensation for Internet Access."
Terms of Birch Interconnection Agreements
On March 31, 1997, Birch entered into a Resale Agreement (the "Kansas
Resale Agreement") with SWBT providing the right to purchase SWBT's local
telecommunications services in Kansas at the state-specific wholesale discount
percentage (initially 14.9% and increased to 21.6% in December 1997). The Kansas
Resale Agreement continues in force until either party gives the other at least
60 days notice of its intention to terminate. On August 18, 1997, Birch entered
into a Resale Agreement (the "Missouri Resale Agreement") with SWBT providing
the right to purchase SWBT's local telecommunications services in Missouri at
the state-specific wholesale discount percentage (currently 13.2%, although
Birch presently is working with SWBT to adopt the 19.2% wholesale discount
ordered by the Missouri Public Service Commission in subsequent proceedings).
The Missouri Resale Agreement continues in effect until either party gives at
least 60 days notice of termination to the other. Notwithstanding the foregoing,
if SWBT seeks to terminate the Missouri Resale Agreement upon 60 days notice,
the Missouri Resale Agreement will remain in effect until a replacement
agreement has been negotiated by the parties, arbitrated (if necessary to
resolve any disputed issues), and approved by the Missouri Public Service
Commission.
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From August through December, 1997, Birch negotiated the terms of an
Interconnection Agreement for Missouri (the "Missouri Interconnection
Agreement") with SWBT. Birch and SWBT were able to resolve all issues through
the negotiation process except one: the payment of reciprocal compensation for
traffic delivered to ISPs. The parties arbitrated that issue before the Missouri
Public Service Commission, which ruled in favor of Birch on April 23, 1998. See
"Risk Factors -- Reciprocal Compensation for Internet Access" and "-- Legal
Proceedings." As a result of the resolution of the ISP reciprocal compensation
issue, Birch and SWBT signed the Missouri Interconnection Agreement on May 21,
1998. The Missouri Interconnection Agreement was submitted to the Missouri
Public Service Commission for approval on May 22, 1998. The Missouri
Interconnection Agreement is comprehensive, covering collocation,
interconnection, exchange of traffic between the Birch and SWBT networks, access
to rights of way, number portability, and Birch's purchase of unbundled network
elements from SWBT for transmission facilities to Birch's customers. The initial
term of the Missouri Interconnection Agreement is one year, and thereafter
renews automatically until either party gives at least 90 days notice of
termination to the other. Notwithstanding the foregoing, if SWBT seeks to
terminate the Missouri Interconnection Agreement upon 90 days notice after the
initial term, the Agreement will remain in effect until a replacement agreement
has been negotiated by the parties, arbitrated (if necessary to resolve any
disputed issues), and approved by the Missouri Public Service Commission.
From December, 1996 through March, 1997, Boulevard negotiated the terms of
an Interconnection Agreement (the "Kansas Interconnection Agreement") for Kansas
with SWBT. Boulevard and SWBT were unable to resolve several issues through the
negotiation process, and arbitrated several issues before the Kansas Corporation
Commission, which on July 15, 1997 ruled in favor of Boulevard on nine of the
eleven issues submitted to it. Following extensive negotiations and mediation by
the Kansas Corporation Commission over contract language to implement the
arbitration ruling, Birch, as successor to Boulevard, and SWBT are expected to
sign the Kansas Interconnection Agreement in the near future. The Kansas
Interconnection Agreement is comprehensive, covering collocation,
interconnection, exchange of traffic between the Birch and SWBT networks, access
to rights of way, number portability, and Birch's purchase of unbundled network
elements from SWBT for transmission facilities to Birch's customers. The initial
term of the Agreement is one year, and thereafter renews automatically for two
additional one-year periods unless either party gives the other notice of
nonrenewal at least 180 days before the end of the current term delineating the
items desired to be negotiated. If the party receiving the notice of termination
seeks to enter into a new interconnection agreement, negotiations must commence
no later than 135 days from receipt of the notice of nonrenewal and the existing
interconnection agreement will remain in effect until a replacement agreement
has been negotiated by the parties, arbitrated (if necessary to resolve any
disputed issues), and approved by the Kansas Corporation Commission.
Birch is in the process of negotiating the terms of resale and
interconnection agreements with SWBT in Texas.
BOC Entry into New Markets
Birch's principal competitor in each area it enters is the ILEC. See
"-- Competition." Many of the most significant ILECs, in terms of size and
market location, are BOCs. Section 271 of the Telecommunications Act establishes
procedures under which a BOC can provide services originating from (and in
certain cases, terminating in) its telephone exchange service area ("in-region"
interLATA service). BOCs are currently permitted to provide interLATA services
to customers outside of their telephone exchange service areas ("out-of-region"
interLATA service), and other "incidental" interLATA service. Before a BOC can
provide non-incidental in-region interLATA service, it must offer
interconnection on terms approved by the State PSC and receive approval from the
FCC, with input from the U.S. Department of Justice. The interconnection offered
by the ILEC must comply with a "competitive checklist" that incorporates the
interconnection requirements discussed above, as well as other requirements.
SWBT sought authority pursuant to Section 271 to enter the in-region interLATA
market in Oklahoma, and this application was denied by the FCC on June 26, 1997.
SWBT has no other Section 271 applications pending before the FCC at this time.
See "--Interconnection with ILEC Facilities."
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After receiving approval from the FCC as described above, BOCs will be able
to provide in-region interLATA services, which will enable them to provide
customers with a full range of local and long distance telecommunications
services. The provision of interLATA services by BOCs is expected to reduce the
market share of the major IXCs, which may be significant customers of Birch's
services. Consequently, the entry of the BOCs into the long distance market may
have adverse consequences on the ability of CLECs both to generate access
revenue from the IXCs and to compete in offering a package of local and long
distance services. No BOC has yet won FCC approval to enter the interLATA
market, but industrial analysts believe approval for the first such entry could
occur as early as the fourth quarter of 1998.
The ability of SWBT and other BOCs to gain in-region interLATA entry
approval may be affected by a decision of a U.S. District Court in Wichita
Falls, Texas on December 31, 1997 (the "SWBT Decision"), holding that Section
271 of the Communications Act, which contains the BOC interLATA restrictions, is
a "bill of attainder" which violates the BOCs' constitutional rights. On
February 11, 1998, the district court agreed to stay its decision pending appeal
to the U.S. Court of Appeals for the Fifth Circuit. If upheld, the SWBT Decision
could speed interLATA entry for the BOCs who were parties to the case, including
SWBT. On May 15, 1998, the U.S. Court of Appeals for the District of Columbia
Circuit found that Section 274 of the Communications Act, which restricts the
BOCs' ability to engage in electronic publishing, is not a "bill of attainder"
in violation of the U.S. Constitution. The D.C. Circuit's decision is not
binding on the Fifth Circuit. The Fifth Circuit has agreed to hear the case on
an expedited basis in July, and a decision could be handed down by the end of
this year.
In May, 1998, two BOCs, Ameritech and US West, announced their agreement to
market the long-distance services of Qwest Communications Corp. in the BOCs'
telephone exchange services territories. The FCC is studying whether such
arrangements are permitted by the Telecommunications Act.
Relaxation of Regulation
A long-term goal of the Telecommunications Act is to increase competition
for telecommunications services, thereby reducing the need for regulation of
these services. To this end, the Telecommunications Act requires the FCC to
streamline its regulation of ILECs and permits the FCC to forbear from
regulating particular classes of telecommunications services or providers. Since
Birch considered is a non-dominant carrier and, therefore, is not heavily
regulated by the FCC, the potential for regulatory forbearance likely will be
more beneficial to the ILECs than Birch in the long run.
In the exercise of its "forbearance authority," the FCC on October 29, 1996
ordered IXCs to withdraw, and refrain from filing in the future, any interstate
tariffs for domestic interexchange services. This order was stayed by the U.S.
Court of Appeals for the District of Columbia Circuit on February 13, 1997,
pending review. A decision from the Court of Appeals is expected imminently.
On June 19, 1997, the FCC adopted an order allowing non-dominant (non-ILEC)
providers of interstate exchange access services the option of tariffing their
services or not filing federal tariffs. The FCC also requested comment on
whether to mandate detariffing for interstate exchange access services. Birch
currently has no interstate tariffs on file.
The Telecommunications Act also limits the FCC's ability to review LEC
tariff filings, as well as to obtain FCC approval prior to extending lines or
commencing service. These changes are likely to have both positive and negative
impacts on Birch's ability to compete with other LECs.
Universal Service and Access Charge Reform
On May 8, 1997, and in subsequent orders, the FCC made a number of changes
to its rules regarding the definition, funding and provision of "universal
service," to achieve the Telecommunications Act's goal of preserving and
enhancing access to quality services at affordable rates in all regions of the
country. Among other things, the FCC ordered that all telecommunications
carriers, including CLECs, contribute to universal service subsidies, and that
the rules for designating carriers eligible to receive universal service support
should
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not favor one provider over another, such as incumbent LECs over CLECs, nor
favor one technology over another.
In a related proceeding, on May 16, 1997, the FCC issued an order to
implement certain reforms to its access charge rules. Access charges are charges
imposed by LECs on long distance providers for access to the local exchange
network, and are designed to partly compensate the LEC for its investment in the
local network. The FCC regulates interstate access and the states regulate
intrastate access. The FCC required ILECs to substantially decrease over time
the prices they charge for switched and special access and changed how access
charges are calculated. These changes are intended to reduce access charges paid
by IXCs to LECs and shift certain usage-based charges to flat-rated, monthly
per-line charges. To the extent that these rules are effective in reducing ILEC
access charges, the ability of Birch to provide customers with lower-cost access
services might be impaired. Additionally, the FCC ruled that ILECs may no longer
impose certain interconnection charges on competitive providers, such as Birch,
that interconnect with the ILEC at the ILEC's end offices but do not use the
ILEC's transport facilities.
The FCC's access charge orders and universal service orders create
potential competitive benefits as well as burdens for CLECs such as Birch. These
FCC orders are subject to petitions seeking reconsideration by the FCC and
petitions for review before U.S. Courts of Appeal. Until the time when any such
review, proceeding or appeals are decided, there can be no assurance of how
these orders will be implemented, or what effect these orders will have on
competition within the telecommunications industry, generally, or on the
competitive position of Birch, specifically.
The FCC has indicated that it intends to begin a rulemaking proceeding
during 1998 to reform the federal access charge system. States often mirror
these federal rules in establishing intrastate access charges. It is unknown at
this time what changes, if any, the FCC may eventually adopt. In addition, some
State PSCs, including State PSCs in Missouri, Kansas and Texas, are currently
conducting proceedings to preserve universal service and promote the public
interest. The actions may impose conditions on the authorizations issued to
Birch which could increase the cost to Birch of providing services, or could
otherwise affect Birch's flexibility to offer certain services.
Federal Regulation Generally
Through a series of proceedings, the FCC has established different levels
of regulation for "dominant carriers" and "non-dominant carriers." Only ILECs
are classified as dominant; all other providers of domestic interstate services
are classified as non-dominant carriers. As a non-dominant carrier, Birch is
subject of relatively limited regulation by the FCC. Birch may offer domestic
interstate service without prior FCC approval. Birch must offer interstate
services at just and reasonable rates in a manner that is not unreasonably
discriminatory.
The FCC has adopted rules requiring ILECs to provide "collocation" to CLECs
for the purpose of interconnecting their competing networks. Under the rules
adopted by the FCC, ILECs are required to provide either physical collocation or
virtual collocation at their switching offices.
As discussed earlier, all LECs, including CLECs, must make their services
available for resale by other carriers, provide nondiscriminatory access to
rights-of-way, offer reciprocal compensation for termination of traffic and
provide dialing parity and telephone number portability. ILECs must offer "equal
access" to competing IXCs, making it easier for new IXCs to attract customers.
The Telecommunications Act requires all telecommunications carriers to
contribute to the universal service mechanism established by the FCC and to
ensure that their services are accessible to and usable by persons with
disabilities. Moreover, the FCC is currently engaged in a number of rulemakings
in which it is considering regulatory implications of various aspects of local
exchange competition. Any or all of these proceedings may negatively affect
CLECs, including Birch.
The FCC could grant ILECs substantial pricing flexibility with regard to
interstate access services. The May 21, 1997 order reforming the FCC's price cap
formula affords LECs greater flexibility in establishing rates and provides
additional incentives to foster efficiency. To the extent these regulatory
initiatives enable or
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require ILECs to offer selectively reduced rates for access services, the rates
Birch may charge for access services will likely be constrained by competitive
pressures. Birch's rates also will likely be constrained by the fact that
competitors other than the ILECs are subject to the same streamlined regulatory
regime as Birch and can price their services to meet competition.
States who have ruled on the issue treat traffic to ISPs terminated in the
local exchange as local calls, for which end user customers normally pay fixed
monthly charges or low per minute rates up to a cap. ILECs contend that traffic
routed to ISPs is interstate in nature and the charge for such calls should be
charged at a different rate. The FCC is considering these arguments. If the FCC
changes its policy and requires a different payment arrangement for calls routed
to local ISPs, CLECs may no longer receive the benefit of substantial reciprocal
compensation call-termination revenue from LECs for CLEC ISP customers whose
traffic is mostly inbound (such that CLEC payments to the LEC for terminating
calls are minimal). Every state that has considered the issue to date has
determined that traffic to ISPs should be treated as local. See "Risk
Factors -- Reciprocal Compensation for Internet Access" and
"-- Regulation -- Interconnection with ILEC Facilities."
Federal law also protects the privacy of certain information about
telecommunications customers that a carrier such as Birch acquires by virtue of
its provision of telecommunications services to such customers. Protected
information, known as Customer Proprietary Network Information ("CPNI"),
includes information related to the quantity, technological configuration, type,
destination and the amount of use of a telecommunications service. A carrier may
not use the CPNI acquired through one of its service offerings to market certain
other service offerings without the approval of the affected customers. These
restrictions may affect Birch's ability to market a variety of packaged services
to existing customers.
State Regulation Generally
Most State PSCs require companies that wish to provide intrastate common
carrier services to register or be certified to provide such services. These
certifications generally require a showing that the carrier has adequate
financial, managerial and technical resources to offer the proposed services in
a manner consistent with the public interest. States also impose a variety of
other requirements, including service quality, universal service and other
obligations on CLECs.
Several states, including Missouri, Kansas and Texas, provide ILECs with
flexibility for their rates, special contracts (selective discounting) and
tariffs, particularly for services deemed subject to competition. This pricing
flexibility increases the ability of SWBT and other ILECs to compete with Birch
and constrains the rates Birch may charge for its services. In light of the
additional competition that is expected to result from the Telecommunications
Act, states may grant ILECs additional pricing flexibility. At the same time,
some ILECs may request increases in local exchange rates to offset revenue
losses due to competition.
Birch is currently certified by the Missouri Public Service Commission and
the Kansas Corporation Commission to provide both local and long distance
service in Missouri and Kansas. Birch is applying for certification to provide
local and long distance service in Texas.
Local Regulation Generally
If Birch desires to install its own transmission facilities, Birch may be
required, in certain cities, to obtain from municipal authorities zoning
variances, street opening and construction permits, permission to use rights-
of-way, and other approvals. Birch also may be required to obtain a franchise to
place facilities in public rights of way. In some areas, Birch may be required
to pay license or franchise fees for such approvals. There can be no assurances
that fees will remain at current levels, or that Birch's competitors will face
the same expenses, although the Telecommunications Act does require that any
such fees charged by municipalities be reasonable and non-discriminatory as
among telecommunications carriers.
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COMPETITION
The telecommunications industry is highly competitive. The Company believes
that the principal competitive factors affecting its business will be customer
service, accurate billing, variety of services, and, to a lesser extent, pricing
levels and clear pricing policies. The ability of the Company to compete
effectively will depend upon its continued ability to maintain high quality,
market-driven services at prices generally equal to or below those charged by
its competitors. To maintain its competitive posture, the Company believes that
it must be in a position to reduce its prices in order to meet reductions in
rates, if any, by others. Any such reductions could adversely affect the
Company. Many of the Company's current and potential competitors have financial,
personnel and other resources, including brand name recognition, substantially
greater than those of the Company, as well as other competitive advantages over
the Company.
Local Exchange Carriers
In each of the markets targeted by Birch, Birch will compete principally
with the ILEC serving that area, such as SWBT, GTE and Sprint. The Company
believes the BOCs' primary agenda is to be able to offer long distance service
in their service territories. Industry analysts expect the BOCs to be successful
in entering the long distance market in many states by mid-1999. The Company
believes the BOCs expect to offset share losses in their local markets by
capturing a significant percentage of the in-region interLATA long distance
market, especially in the residential segment where the BOCs' strong regional
brand names and extensive advertising campaigns may be successful. In the event
that the SWBT Decision, which held that the Telecommunications Act's
restrictions on the lines of business in which BOCs may engage (including the
conditions to the BOCs provision of in-region interLATA telecommunications
services) are unconstitutional, is upheld, the BOCs who were parties to the
case, including SWBT, could be able to enter the long distance market in their
service territories far more quickly than previously anticipated. See
" -- Regulation -- BOC Entry into New Markets."
As a recent entrant in the telecommunications services industry, Birch has
not achieved and does not expect to achieve a significant market share for any
of its services in its larger markets. In particular, the BOCs, GTE and other
local telephone companies have long-standing relationships with their customers,
have financial, technical and marketing resources substantially greater than
those of the Company, have the potential to subsidize competitive services with
revenue from a variety of businesses and currently benefit from certain existing
regulations that favor the ILECs over Birch in certain respects. While recent
regulatory initiatives, which allow CLECs such as the Company to interconnect
with ILEC facilities, provide increased business opportunities for Birch, such
interconnection opportunities have been (and likely will continue to be)
accompanied by increased pricing flexibility for and relaxation of regulatory
oversight of the ILECs.
Recent FCC administrative decisions and initiatives have provided ILECs
with increased pricing flexibility for their private line and special access and
switched access services. In addition, with respect to competitive access
services (as opposed to switched local exchange services), the FCC recently
proposed a rule that would provide for increased ILEC pricing flexibility and
deregulation for such access services either automatically or after certain
competitive levels are reached. If the ILECs are allowed by regulators to offer
discounts to large customers through contract tariffs, engage in aggressive
volume and term discount pricing practices for their customers, and/or seek to
charge competitors excessive fees for interconnection to their networks, the
operating results and financial conditions of CLECs, including the Company,
could be materially adversely affected. If future regulatory decisions afford
the ILECs increased access services pricing flexibility or other regulatory
relief, such decisions could also have a material adverse effect on competitors
to the ILEC, including the Company. See " -- Regulation."
CLECs/IXCs/Other Market Entrants
The Company also faces, and expects to continue to face, competition from
other current and potential market entrants, including long distance carriers
seeking to enter, reenter or expand entry into the local exchange market such as
AT&T, MCI, GTE and Sprint, and from other CLECs such as Teleport Communications
Group Inc. ("Teleport Communications"), Brooks Fiber Properties, Inc. and
e.spire
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<PAGE> 70
Communications, Inc., resellers of local exchange services, competitive access
providers ("CAPs"), cable television companies, electric utilities, microwave
carriers, wireless telephone system operators and private networks built by
large end users. In addition, a continuing trend toward consolidation of
telecommunications companies and the formation of strategic alliances within the
telecommunications industry, as well as the development of new technologies,
could give rise to significant new competitors to the Company. For example, in
December 1996 WorldCom, a national long distance carrier, acquired Metropolitan
Fiber Systems, and in January 1998 AT&T announced its intention to acquire
Teleport Communications. These types of consolidations and strategic alliances
could put Birch at a competitive disadvantage. The Telecommunications Act
includes provisions which impose certain regulatory requirements on all LECs,
including CLECs such as the Company, while granting the FCC expanded authority
to reduce the level of regulation applicable to any or all telecommunications
carriers, including ILECs. The manner in which these provisions of the
Telecommunications Act are implemented and enforced could have a material
adverse effect on the Company's ability to compete successfully against ILECs
and other telecommunications service providers. See " -- Regulation."
The changes in the Telecommunications Act radically altered the market
opportunity for traditional CAPs and CLECs. Due to the fact that most existing
CAP/CLECs initially entered the market providing dedicated access in the
pre-1996 era, these companies had to build a fiber infrastructure before
offering services. Since passage of the Telecommunications Act, many CAPs have
added switches to become CLECs to take advantage of the opening of the local
market. With the Telecommunications Act requiring unbundling of the LEC
networks, CAP/CLECs will now be able to more rapidly enter the market by
installing switches and leasing trunk and loop capacity until traffic volume
justifies building facilities. Newer CLECs, like the Company and some
competitors that Birch may encounter in some of its markets, will not have to
replicate existing facilities and can be more opportunistic in designing and
implementing networks.
The Company believes the major IXCs in the short term have a two pronged
strategy: (1) to keep the BOCs out of in-region long distance as long as
possible and (2) to develop a local resale product with adequate margins to stem
BOC attacks on the major IXCs' market position. The Company believes the IXCs'
longer term strategy is to develop facilities-based and unbundled local service,
an approach already being pursued by WorldCom with the acquisition of
Metropolitan Fiber Systems, and more recently by AT&T with its proposed
acquisition of Teleport Communications.
In addition to the CLECs, IXCs and other competitors listed above, the
Company may face competition from other market entrants such as electric
utilities, cable television companies and wireless companies. Electric utilities
have existing assets and low cost access to capital which could allow them to
enter a market rapidly and accelerate network development. Cable television
companies are also entering the telecommunications market. Some cable television
companies are upgrading their networks with fiber optics and installing
facilities to provide fully interactive transmission of broadband voice, video
and data communications. Some cable companies are attempting to offer Internet
access and local telephone service over hybrid fiber-coaxial cable systems.
Finally, wireless companies have announced intentions to develop wireless
technology to be deployed in the United States as a broadband substitute for
traditional wireline local telephones.
Long Distance Services
The long distance telecommunications industry has numerous entities
competing for the same customers and a high average churn rate, as customers
frequently change long distance providers in response to the offering of lower
rates or promotional incentives by competitors. Prices in the long distance
market have declined significantly in recent years and are expected to continue
to decline. Birch's primary competitors are the major IXCs and resellers of long
distance services. The Company believes that pricing levels are a principal
competitive factor in providing long distance service; however Birch seeks to
avoid direct price competition by bundling long distance service, local service,
CPE and Internet access service together with a simple pricing plan.
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CPE
The Company competes with equipment vendors and installers, and
telecommunications management companies with respect to CPE sales and related
services.
Data/Internet Services Providers
The Internet services market is highly competitive, and the Company expects
that competition will continue to intensify. Internet service, both Internet
access and on-line content services, is provided by ISPs, satellite-based
companies, long-distance carriers and cable television companies. Many of these
companies provide businesses and individuals with direct access to the Internet
and a variety of supporting services. In addition, many companies (such as
America Online, Inc., MSN, Prodigy Services Company and WebTV Networks) offer
"online" services consisting of access to closed, proprietary information
networks with services similar to those available on the Internet, in addition
to direct access to the Internet. Long distance companies, for example, are
aggressively entering the Internet access markets. Long distance carriers have
substantial transmission capabilities, traditionally carry data to large numbers
of customers and have an established billing system infrastructure that permits
them to add new services. Satellite companies are offering broadband access to
the Internet from desktop PCs and cable companies are starting to provide
Internet services using cable modems to customers in major markets. Many of
these competitors have substantially greater financial, technological,
marketing, personnel and other resources than those available to Birch.
EMPLOYEES
As of September 30, 1998, Birch had 283 employees, none of whom are
represented by a collective bargaining agreement. Birch considers its employee
relations to be good.
FACILITIES
Birch is headquartered in Kansas City, Missouri, where it currently leases
its principal executive office. The Company also leases sales offices in Kansas
City, St. Louis, and St. Joseph, Missouri; sales offices in Wichita, Topeka,
Dodge City and Hutchinson, Kansas; and switching facilities in Wichita, Kansas
and Kansas City, Missouri. The Company owns the customer care and CPE facility
in Emporia, Kansas and the sales and CPE facility in Salina, Kansas.
The Company believes that its leased facilities are adequate to meet its
current needs in the markets in which it has begun to deploy networks, and that
additional facilities are available to meet its expansion needs in its target
markets for the foreseeable future.
LEGAL PROCEEDINGS
The Company is currently not involved in any legal proceedings, the outcome
of which could be expected to have a material adverse effect on Birch's
business, operating results and financial condition. For a description of the
Company's arbitration proceeding with SWBT involving Internet reciprocal
compensation see "Risk Factors -- Reciprocal Compensation for Internet Access"
and " -- Regulation -- Interconnection with ILEC Facilities."
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<PAGE> 72
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES
The following table sets forth certain information concerning the
directors, executive officers and other key personnel of Birch, including their
ages as of September 30, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Henry H. Bradley........................... 52 Chairman of the Board
President, Chief Executive Officer and
David E. Scott............................. 38 Director
Senior Vice President of Public Policy and
Gregory C. Lawhon.......................... 39 General Counsel
Senior Vice President of Engineering and
Gary L. Chesser............................ 52 Operations
Senior Vice President of Business
David W. Vranicar.......................... 39 Development
Bradley A. Moline.......................... 31 Senior Vice President of Finance and Chief
Financial Officer
Senior Vice President of Sales and
Jeffrey D. Shackelford..................... 37 Marketing
Donald H. Goldman.......................... 38 Senior Vice President of Internet Services
Stephen L. Sauder.......................... 52 Vice President and Director
Ian R. N. Bund............................. 54 Director
David W. Bergmann.......................... 48 Director
</TABLE>
Henry H. Bradley is Birch's Chairman of the Board of Directors (the
"Board"). Mr. Bradley also is the Chairman of the Board of News-Press & Gazette
Company ("NPG"), a co-founder of Birch. NPG is a family-owned company that owns
and operates a daily newspaper, cable television systems, network affiliate
broadcast television stations and FM and AM radio stations. Mr. Bradley has held
a number of other positions with NPG since joining NPG in 1971, including terms
as the Editor and Publisher of the St. Joseph News-Press.
David E. Scott, a co-founder and Director of Birch, is also its President
and Chief Executive Officer. Mr. Scott has 16 years of managerial experience in
the telecommunications industry. Prior to joining Birch, Mr. Scott was President
and General Manager of Kansas City FiberNet, a CLEC owned jointly by the
country's two largest cable operators, TCI and Time Warner. Prior to his tenure
at Kansas City FiberNet, Mr. Scott was Vice President of Strategic Development
for Sprint, responsible for developing investment plans in the competitive local
exchange, wireless (PCS) and international marketplaces. Mr. Scott also served
as Director of Strategic Planning for Sprint from 1988 to 1991. Mr. Scott also
serves as a Director of DNS Publishing, an Internet publishing company he
co-founded with Donald H. Goldman. DNS Publishing produces web sites that serve
as on-line trade publications. Their first web site, C-LECinfo (www.clec.com),
serves the competitive local exchange carrier industry.
Gregory C. Lawhon joined Birch in January 1997 as its Senior Vice President
of Public Policy and General Counsel. Prior to joining Birch, Mr. Lawhon
practiced law for twelve years with the 90-lawyer Kansas City firm of Spencer
Fane Britt & Browne. A partner in the firm since 1990, he was head of the firm's
Communications and Media Group and a member of its Business Group. Mr. Lawhon's
areas of practice were mergers and acquisitions, with an emphasis on
communications industry acquisitions, cable television franchising, and
commercial and regulatory issues with respect to the telecommunications
industry.
Gary L. Chesser joined Birch in March 1997 as its Senior Vice President of
Engineering and Operations. Prior to joining Birch, Mr. Chesser was Vice
President-Director of Engineering & Operations with Time Warner Connect, a
startup business unit offering local and long distance telephony, cable
television, and home security services. Prior to joining Time Warner, Mr.
Chesser was employed by US West leading business process development and
implementation for a startup data communications business unit called
!NTERPRISE. Prior to joining US West, Mr. Chesser was employed by SWBT from 1965
to 1991 in a variety of engineering and operations and managerial positions.
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<PAGE> 73
David W. Vranicar joined Birch in March 1997 as its Senior Vice President
of Business Development. Prior to joining Birch, Mr. Vranicar was Vice
President, International Business Development, at Sprint. In that capacity, he
directed Sprint's pursuit of numerous international strategic partnering
opportunities, including ventures in China, Israel, Taiwan, Japan, Italy and
Spain. During his tenure at Sprint, which began in 1992, Mr. Vranicar played a
key role in many domestic business development activities, including a PCS joint
venture with TCI, Cox Cable Communications, Inc. and Comcast Corp.
Bradley A. Moline joined Birch in July 1997 as its Senior Vice President of
Finance and Chief Financial Officer. Prior to joining Birch, Mr. Moline was the
Treasurer and Chief Financial Officer of Covenant Transport, Inc., a publicly
traded transportation company in Chattanooga, Tennessee from 1994 to 1997.
During his tenure at Covenant Transport, annual revenue grew from $82 million to
$236 million, making the company the nation's fastest-growing truckload
transportation company in 1994 and the tenth largest one in 1996. Prior to
joining Covenant Transport, Mr. Moline worked for Ernst & Young LLP in Kansas
City, Missouri and Grant Thornton in Lincoln, Nebraska, providing client
services in the auditing and consulting areas.
Jeffrey D. Shackelford, a co-founder of Birch, is Senior Vice President of
Sales and Marketing. Mr. Shackelford has 13 years of experience in the
telecommunications industry. Prior to joining Birch, Mr. Shackelford served as
Director of Sales and Marketing for Kansas City FiberNet. Prior to joining
Kansas City FiberNet, Mr. Shackelford was the Branch Manager for Sprint's
Commercial Sales office in Kansas City and was responsible for sales and service
of small to large business clients. During his tenure at Sprint, which began in
1988, Mr. Shackelford also developed the long distance industry's first PC-based
call management system, FONVIEW.
Donald H. Goldman joined Birch in March 1998 as its Senior Vice President
of Internet Services. Mr. Goldman has over 13 years of managerial experience in
the telecommunications industry. Prior to joining Birch, Mr. Goldman served as
Vice President, Corporate Development at Sprint where he developed the strategy
and managed the acquisition of companies in the areas of systems integration,
Internet telephony, and wireless (PCS) services among others. Mr. Goldman also
serves as President of DNS Publishing, an Internet publishing company he
co-founded with David E. Scott.
Stephen L. Sauder is a Vice President and Director of the Company. Mr.
Sauder was elected as a Director of Birch in February 1998, as the designee of
the holders of the Company's Series C Preferred Stock. Mr. Sauder was a
co-founder of Valu-Line in 1982, and served as President and Chief Executive
Officer of Valu-Line until February 1998, when Birch and Valu-Line consummated
the Merger.
Ian R. N. Bund was elected as a director of Birch in February 1998, as the
designee of White Pines Management L.L.C. ("White Pines"). Mr. Bund also has
been President of White Pines since 1996. From 1990 to 1996, Mr. Bund served as
president of White Pines Capital Corporation, a management company, and general
partner of its predecessor partnership. In addition, from 1993 to 1995, while
continuing to operate his management company, Mr. Bund served as Senior Vice
President -- Corporate Finance of First of Michigan Corporation, a leading
Michigan investment banking and brokerage firm. Mr. Bund also currently serves
on the boards of directors of several private companies.
David W. Bergmann was elected as a director of Birch in February 1998, as
the designee of Advantage Capital Missouri Partners I, L.P. ("Advantage"). Since
1992, he has been involved in the analysis, negotiation of terms, and
structuring of various portfolio company investments at Advantage Capital
Partners, which he co-founded. Mr. Bergmann also serves on the boards of
directors of several private companies as well as one commercial bank. In
addition, he is the Chairman of the Board of Interface Security, L.L.C., an
electronic security firm. He also serves as a consultant to Barnes Associates,
an investment banking firm specializing in evaluations, mergers, acquisitions,
and financing in the electronic security and communications fields.
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EXECUTIVE COMPENSATION
The following table sets forth the cash and non-cash compensation paid or
incurred on behalf of Birch to its Chief Executive Officer and four other
executive officers for the year ended December 31, 1997:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
---------------------
AWARDS
ANNUAL COMPENSATION ---------------------
--------------------------- SECURITIES UNDERLYING ALL OTHER
NAME AND OTHER ANNUAL OPTIONS/SARS COMPENSATION
PRINCIPAL POSITION YEAR SALARY($) COMPENSATION($) (#)(A) ($)
- ------------------ ---- --------- --------------- --------------------- ------------
<S> <C> <C> <C> <C> <C>
David E. Scott................... 1997 164,904 -- 1,052,362 --
President and Chief Executive
Officer(b)
Gregory C. Lawhon................ 1997 164,904 -- 328,863 --
Senior Vice President of Public
Policy and General Counsel(b)
Gary L. Chesser.................. 1997 115,769 35,000 301,458 --
Senior Vice President of
Engineering and Operations(c)
David W. Vranicar................ 1997 118,269 -- 274,052 --
Senior Vice President of
Business Development(c)
Stephen L. Sauder................ 1997 134,577 128,667 -- --
Vice President(d)
</TABLE>
- ---------------
(a) Includes options to purchase shares of the Company's Common Stock, which
were issued pursuant to the 1998 Stock Option Plan. Prior to the private
placement of the Company's Series B Preferred Stock, Birch was a party to
various stock option agreements with employees of the Company, all of which
were governed by the Company's 1997 Stock Option Plan. In connection with
this private placement of Series B Preferred Stock, the 1997 Stock Option
Plan was replaced with the 1998 Stock Option Plan, and all stock option
agreements governed by the 1997 Stock Option Plan were terminated. Options
issued pursuant to the 1998 Stock Option Plan are exercisable immediately on
grant at an exercise price of $.001 per share, and vest over a four-year
period, at a rate of 6.25% per quarter. The stock options have been adjusted
to reflect the Stock Dividend on June 23, 1998. Holders of exercised options
have voting power with respect to all shares of Common Stock underlying the
options. Upon termination of employment with the Company, Birch has the
right to purchase all options which have not vested as of that date, subject
to certain exceptions. See "-- 1998 Stock Option Plan -- Early Exercise."
(b) Reflects compensation paid to Messrs. Scott and Lawhon commencing in January
1997.
(c) Reflects compensation paid to Messrs. Chesser and Vranicar commencing in
March 1997.
(d) Mr. Sauder joined Birch after the Merger and currently serves as Vice
President of the Company. Compensation listed was paid by Valu-Line in 1997.
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<PAGE> 75
OPTIONS/SAR GRANTS(A)
<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE VALUE
INDIVIDUAL GRANTS AT ASSUMED
------------------------------------------------------- ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK PRICE
SECURITIES OPTIONS/SARS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM(C)
OPTIONS/SARS EMPLOYEES IN BASE PRICE EXPIRATION -----------------
NAME GRANTED(#)(B) FISCAL YEAR ($/SH) DATE 5%($) 10%($)
- ---- ------------- ------------ ----------- ---------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
David E. Scott................. 931,696 20.5% .001 2/10/2008 555 1,407
120,666 2.7% .001 3/13/2008 72 182
Gregory C. Lawhon.............. 291,155 6.4% .001 2/10/2008 174 440
37,708 0.8% .001 3/13/2008 22 57
Gary L. Chesser................ 266,893 5.9% 001 2/10/2008 159 403
34,565 0.8% .001 3/13/2008 21 52
David W. Vranicar.............. 242,628 5.3% .001 2/10/2008 145 367
31,424 0.7% .001 3/13/2008 19 47
Stephen L. Sauder.............. -- -- -- -- -- --
</TABLE>
- ---------------
(a) The options/SARs shown reflect options granted as of September 30, 1998.
(b) Includes options to purchase shares of Common Stock, which were issued
pursuant to the 1998 Stock Option Plan. Prior to the private placement of
Series B Preferred Stock, Birch was a party to various stock option
agreements with employees of the Company, all of which were governed by the
Company's 1997 Stock Option Plan. In connection with this private placement
of Series B Preferred Stock, the 1997 Stock Option Plan was replaced with
the 1998 Stock Option Plan, and all stock option agreements governed by the
1997 Stock Option Plan were terminated. Options issued pursuant to the 1998
Stock Option Plan are exercisable immediately on grant at an exercise price
of $.001 per share, and vest over a four-year period, at a rate of 6.25% per
quarter. Holders of exercised options have voting power with respect to all
shares of Common Stock underlying the options. Upon termination of
employment with the Company, Birch has the right to purchase all options
which have not vested as of that date, subject to certain exceptions. See
"-- 1998 Stock Option Plan -- Early Exercise."
(c) The potential realizable value assumes a per-share market price at the time
of the grant to be approximately $.001 with an assumed rate of appreciation
of 5% and 10%, respectively, compounded annually for 10 years.
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<PAGE> 76
AGGREGATED OPTIONS/SAR EXERCISES AND OPTION/SAR VALUES(A)
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
SHARES OPTIONS/SARS(#) OPTIONS/SARS($)
ACQUIRED ON VALUE EXERCISABLE(E) EXERCISABLE(E)
NAME EXERCISE(#)(B) REALIZED($) UNEXERCISABLE(U)(C) UNEXERCISABLE(U)(C)
- ---- -------------- ----------- -------------------- -------------------
<S> <C> <C> <C> <C>
David E. Scott................... 131,546 -- --(E) --(E)
920,816(U) --(U)
Gregory C. Lawhon................ 41,108 -- --(E) --(E)
287,755(U) --(U)
Gary L. Chesser.................. 37,682 -- --(E) --(E)
263,776(U) --(U)
David W. Vranicar................ 34,256 -- --(E) --(E)
239,796(U) --(U)
Stephen L. Sauder................ -- -- --(E) --(E)
--(U) --(U)
</TABLE>
- ---------------
(a) The options/SARs shown reflect options granted as of September 30, 1998.
(b) For purposes of this table alone, "exercise" means an employee's acquisition
of shares of Common Stock which have already vested, "exercisable" means
options to purchase shares of Common Stock which are subject to exercise and
"unexercisable" means all other options to purchase shares of Common Stock.
See "-- 1998 Stock Option Plan -- Early Exercise."
(c) Includes options to purchase shares of Common Stock, which were issued
pursuant to the 1998 Stock Option Plan. Prior to the private placement of
Series B Preferred Stock, Birch was a party to various stock option
agreements with employees of the Company, all of which were governed by the
Company's 1997 Stock Option Plan. In connection with this private placement
of Series B Preferred Stock, the 1997 Stock Option Plan was replaced with
the 1998 Stock Option Plan, and all stock option agreements governed by the
1997 Stock Option Plan were terminated. Options issued pursuant to the 1998
Stock Option Plan are exercisable immediately on grant at an exercise price
of $.001 per share, and vest over a four-year period, at a rate of 6.25% per
quarter. The stock options have been adjusted to reflect the Stock Dividend
on June 23, 1998. Holders of exercised options have voting power with
respect to all shares of Common Stock underlying the options. Upon
termination of employment with the Company, Birch has the right to purchase
all options which have not vested as of that date, subject to certain
exceptions. See "-- 1998 Stock Option Plan."
EMPLOYMENT AGREEMENTS
David E. Scott. Mr. Scott is party to an employment agreement with Birch
dated as of February 10, 1998. Under his employment agreement, Mr. Scott
receives a base salary of $175,000 per annum. Mr. Scott is also eligible for a
bonus based on achievement of performance criteria established by the Board. Mr.
Scott's employment agreement is for an initial three-year term, and
automatically renews for additional one-year terms unless either Mr. Scott or
Birch provides written notice to each other at least 90 days prior to such
renewal. Mr. Scott's employment agreement provides that upon termination of
employment by Birch, other than for cause, disability or death, Birch shall pay
Mr. Scott's salary for the remainder, if any, of the calendar month in which
such termination is effective and for 24 consecutive calendar months thereafter.
The agreement also provides for noncompetition, nonsolicitation and
nondisclosure covenants.
Gregory C. Lawhon. Mr. Lawhon is party to an employment agreement with
Birch dated as of February 10, 1998. Under his employment agreement, Mr. Lawhon
receives a base salary of $175,000 per annum. Mr. Lawhon is also eligible for a
bonus based on achievement of performance criteria established by the Board. Mr.
Lawhon's employment agreement is for an initial one-year term, and automatically
renews for additional one-year terms unless either Mr. Lawhon or Birch provides
written notice to each other at least 90 days prior to such renewal. Mr.
Lawhon's employment agreement provides that upon termination of
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employment by Birch, other than for cause, disability or death, Birch shall pay
Mr. Lawhon's salary for the remainder, if any, of the calendar month in which
such termination is effective and for 12 consecutive calendar months thereafter.
The agreement also provides for noncompetition, nonsolicitation and
nondisclosure covenants.
Gary L. Chesser. Mr. Chesser is party to an employment agreement with
Birch dated as of February 10, 1998. Under his employment agreement, Mr. Chesser
receives a base salary of $150,000 per annum. Mr. Chesser is also eligible for a
bonus based on achievement of performance criteria established by the Board. Mr.
Chesser's employment agreement is for an initial one-year term, and
automatically renews for additional one-year terms unless either Mr. Chesser or
Birch provides written notice to each other at least 90 days prior to such
renewal. Mr. Chesser's employment agreement provides that upon termination of
employment by Birch, other than for cause, disability or death, Birch shall pay
Mr. Chesser's salary for the remainder, if any, of the calendar month in which
such termination is effective and for 12 consecutive calendar months thereafter.
The agreement also provides for noncompetition, nonsolicitation and
nondisclosure covenants.
David W. Vranicar. Mr. Vranicar is party to an employment agreement with
Birch dated as of February 10, 1998. Under his employment agreement, Mr.
Vranicar receives a base salary of $150,000 per annum. Mr. Vranicar is also
eligible for a bonus based on achievement of performance criteria established by
the Board. Mr. Vranicar's employment agreement is for an initial one-year term,
and automatically renews for additional one-year terms unless either Mr.
Vranicar or Birch provides written notice to each other at least 90 days prior
to such renewal. Mr. Vranicar's employment agreement provides that upon
termination of employment by Birch, other than for cause, disability or death,
Birch shall pay Mr. Vranicar's salary for the remainder, if any, of the calendar
month in which such termination is effective and for 12 consecutive calendar
months thereafter. The agreement also provides for noncompetition,
nonsolicitation and nondisclosure covenants.
Stephen L. Sauder. Mr. Sauder is party to an employment agreement with
Birch dated as of February 10, 1998. Under his employment agreement, Mr. Sauder
receives a base salary of $213,000 per annum. Mr. Sauder is also eligible for a
bonus based on achievement of performance criteria established by the Board. Mr.
Sauder's employment agreement is for an initial one-year term, and automatically
renews for additional one-year terms unless either Mr. Sauder or Birch provides
written notice to each other at least 90 days prior to such renewal. Mr.
Sauder's employment agreement provides that upon termination of employment by
Birch, other than for cause, disability or death, Birch shall pay Mr. Sauder's
salary for the remainder, if any, of the calendar month in which such
termination is effective and for 12 consecutive calendar months thereafter. The
agreement also provides for noncompetition, nonsolicitation and nondisclosure
covenants.
ELECTION OF DIRECTORS
Birch's certificate of incorporation establishes the size of the Board at
five Directors. Birch's certificate of incorporation provides that, as long as
there are 4,285,938 shares of Series B Preferred Stock outstanding, the holders
of Birch's Series B Preferred Stock, voting as a separate class, shall be
entitled to elect three Directors; as long as there are 4,246,375 shares of
Series C Preferred Stock outstanding, the holders of Birch's Series C Preferred
Stock, voting as a separate class, shall be entitled to elect one Director and
the holders of Birch's Common Stock, voting as a separate class, shall be
entitled to elect one Director; and each such class shall be entitled to remove
such directors and to fill any vacancy caused by the resignation, death or
removal of such directors.
The current stockholders of Preferred Stock of Birch are parties to a
Purchasers Rights Agreement, dated February 10, 1998 pursuant to which they have
each agreed to vote their respective shares in such a manner as to elect certain
persons to serve as Directors. The holders of Series B Preferred Stock have
agreed to vote their shares for the election of one designee of NPG; one
designee of Advantage and one designee of White Pines. In addition, the holders
of Series C Preferred Stock have agreed to vote their shares for the election of
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Stephen L. Sauder, and the holders of Common Stock have agreed to vote their
shares for the election of David E. Scott.
BOARD COMMITTEES
The Board has an Audit Committee and a Compensation Committee. The Audit
Committee is comprised of Messrs. David W. Bergmann, Ian R. N. Bund and Henry H.
Bradley and is charged with reviewing Birch's audit policies, overseeing the
engagement of Birch's independent auditors, developing financing strategies for
Birch and approving outside suppliers to implement these strategies. The
Compensation Committee is comprised of Messrs. Ian R. N. Bund, Henry H. Bradley
and David E. Scott, and is charged with establishing salaries, incentives and
other forms of compensation for executive officers and administering incentive
compensation and benefit plans provided for employees.
1998 STOCK OPTION PLAN
On February 9, 1998, Birch's Board of Directors adopted the 1998 Stock
Option Plan (the "Option Plan"), under which Birch may issue Incentive Stock
Options and Nonstatutory Stock Options (collectively, the "Options") to
employees of Birch, exercisable for an aggregate of 4,595,845 shares of Birch's
Common Stock (subject to adjustment in the Board's discretion upon the
occurrence of certain events that might otherwise lead to the expansion or
dilution of the rights of participants under the Option Plan). On July 27, 1998,
the Company's Board of Directors increased the authorized shares of the Common
Stock in the Option Plan to 6,195,845. The Option Plan authorizes the Board to
issue Options in such forms and amounts and on such terms as determined by the
Board. The per-share exercise price for Incentive Stock Options will be set by
the Board, but may not be less than the fair market value of a share of Birch's
Common Stock on the date the Incentive Stock Options are granted. The per-share
exercise price for Nonstatutory Stock Options will be set by the Board, but may
not be less than 50% of the fair market value of a share of Birch's Common Stock
on the date the Nonstatutory Stock Options are granted. The Board currently
intends to issue Options under the Option Plan only to employees of Birch. The
terms of the Options issued under the Option Plan to date are, and the Board
presently anticipates that the terms of all Options issued under the Option Plan
in the future will be, as follows:
Vesting. The total number of shares of stock subject to Options may, at
the discretion of the Board, be allotted in periodic installments of equal or
unequal size. The conditions on which Options vest are determined by the written
agreement evidencing the terms of an individual grant of Options. In the event
of termination of employment of an option recipient (an "Optionee") (other than
upon the Optionee's death or disability), the Optionee may exercise his or her
Options (to the extent that the Optionee was entitled to exercise them as of the
date of termination) but only within such period of time ending on the earlier
of the date three months following the termination of the Optionee's employment
(or such longer or shorter period specified in the option agreement governing
the Options), or the expiration of the term of the Options as set forth in such
option agreement. If, at the date of termination, the Optionee is not entitled
to exercise all of his or her Options, the shares covered by the unexercisable
portion of the Options shall revert to and again become available for issuance
under the Option Plan. In the event of termination of employment of an Optionee
as a result of the Optionee's disability, the Optionee may exercise his or her
Options (to the extent that the Optionee was entitled to exercise them as of the
date of termination), but only within such period of time ending on the earlier
of the date 12 months following such termination (or such longer or shorter
period specified in the option agreement governing the Options), or the
expiration of the term of the Options as set forth in such option agreement. If,
at the date of termination, the Optionee is not entitled to exercise all of his
or her Options, the shares covered by the unexercisable portion of the Options
shall revert to and again become available for issuance under the Option Plan.
In the event of the death of an Optionee during, or within a period specified in
the option agreement after the termination of employment of an Optionee, the
Options may be exercised (to the extent the Optionee was entitled to exercise
them as of the date of death) by the Optionee's estate, by a person who acquired
the right to exercise the Options by bequest or inheritance or by a person
designated to exercise the Options upon the Optionee's death, but only within
the period ending on the earlier of the date 18 months following the date of
death (or such longer or shorter period specified in the
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<PAGE> 79
option agreement governing the Options), or the expiration of the term of such
Options as set forth in such option agreement. If, at the time of death, the
Optionee was not entitled to exercise all of his or her Options, the shares
covered by the unexercisable portion of the Options shall revert to and again
become available for issuance under the Option Plan.
Expiration of Options. Options expire if not exercised within ten years
after the date of grant.
Restrictions on Transfer. Incentive Stock Options are nontransferable
during the life of the Optionee. Nonstatutory Stock Options are transferable
only if permitted by the terms of the option agreement governing such
Nonstatutory Stock Options, subject to certain exceptions.
Early Exercise. The Option Plan permits any option agreement to include a
provision whereby the Optionee may elect at any time while an employee to
exercise the Option as to any part or all of the shares subject to the Option
prior to the full vesting of the Option. Any unvested shares so purchased may be
subject to a repurchase right in favor of the Company or to any other
restriction the Board determines to be appropriate. The existing Options issued
by the Company during the period from February to May, 1998, were issued under
Nonstatutory Stock Option Agreements that included (i) a four-year vesting
schedule, with 6.25% of the Options vesting each quarter, and (ii) an early
exercise provision under which the Optionee is permitted to exercise the Option
at any time at an exercise price of $0.001 per share. Those Optionees who have
elected to exercise the Option before full vesting have entered into an Early
Exercise Stock Purchase Agreement with the Company under which the Company
delivers certificates for the shares of Common Stock purchased pursuant to the
Option to an escrow agent, who holds the shares as attorney-in-fact for the
employee. Upon termination of the Optionee's employment, the Company has the
right to repurchase the shares of Common Stock with respect to which Options had
not fully vested as of that date at the same price per share as the exercise
price paid by the Optionee, subject to certain exceptions. Subject to certain
restrictions on transfer and the Company's right to repurchase the shares,
employees who have purchased Common Stock pursuant to the early exercise
provisions of the Options have all rights and privileges of a holder of Common
Stock, including the right to vote those shares on matters coming before the
holders of Common Stock. The existing options of the Company issued during
September 1998 were issued under Incentive Stock Option Agreements that included
a four-year vesting schedule with 25% of the Options vesting each year, but did
not include an early exercise provision.
1998 EMPLOYEE STOCK PURCHASE PLAN
On February 9, 1998, Birch's Board of Directors adopted the 1998 Employee
Stock Purchase Plan (the "Stock Purchase Plan"), under which Birch may issue
shares of Common Stock to employees of Birch. The Common Stock issuable pursuant
to the Stock Purchase Plan is limited to 474,750 shares, and the Stock Purchase
Plan authorizes the Board to determine the terms and conditions upon which
shares of Common Stock may be purchased.
Price. The exercise price of each share is the par value ($.001) of the
Common Stock.
Consideration. The purchase price of the Common Stock must be paid in
cash.
Restrictions. All purchases of the Common Stock under the Stock Purchase
Plan are subject to such restrictions and have such rights with respect to the
Common Stock as the Board shall determine.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation of executive officers and other key employees of Birch is
determined by Birch's Compensation Committee. David E. Scott, Birch's President
and Chief Executive Officer, is currently a member of Birch's Compensation
Committee.
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<PAGE> 80
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Birch's outstanding capital stock as of September 30, 1998 consisted of
5,016,889 shares of Common Stock, 8,572,039 shares of Series B Preferred Stock
and 8,492,749 shares of Series C Preferred Stock.
The following table sets forth certain information regarding the beneficial
ownership of the capital stock of Birch by: (i) each of the directors and the
executive officers of Birch; (ii) all directors and executive officers as a
group and (iii) each owner of more than 5% of the equity securities of Birch
("5% Owners"). Unless otherwise noted, the address for each director and
executive officer of Birch is c/o Birch Telecom, Inc., 1004 Baltimore Ave.,
Suite 900, Kansas City, Missouri 64105.
<TABLE>
<CAPTION>
PERCENTAGE OF
TOTAL VOTING
POWER OF
NUMBER OF SHARES PERCENTAGE OF FULLY DILUTED
BENEFICIALLY OWNED CLASS OWNED COMMON STOCK
NAME AND ADDRESS OF --------------------------------- ------------------------------- PRIOR TO THE
BENEFICIAL OWNER(a) COMMON(b) SERIES B SERIES C COMMON(b) SERIES B SERIES C PRIVATE OFFERING
- ------------------- --------- --------- --------- --------- -------- -------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
DIRECTORS AND
EXECUTIVE OFFICERS:
Henry H. Bradley(c)... -- 1,978,128 1,582,500 -- 23.1% 18.6% 16.2%
David E. Scott........ 1,190,768 -- 189,900 23.7 -- 2.2 6.3
Gregory C. Lawhon..... 380,137 49,453 -- 7.6 * -- 2.0
Gary L. Chesser....... 348,459 32,969 -- 6.9 * -- 1.7
David W. Vranicar..... 316,780 36,266 -- 6.3 * -- 1.6
Bradley A.
Moline(d)........... 297,932 70,625 -- 5.9 * -- 1.7
Jeffrey D.
Shackelford......... 794,160 -- 126,600 15.8 -- 1.5 4.2
Stephen L.
Sauder(e)........... -- 85,719 6,311,797 -- 1.0 74.3 29.1
Donald H. Goldman..... 263,750 -- -- 5.3 -- -- 1.2
Ian R.N. Bund(f)...... -- 47,808 -- -- * -- *
David W.
Bergmann(g)......... -- -- -- -- -- -- --
All directors and
executive officers
as a group (11
persons)............ 3,591,987 2,300,968 8,210,797 71.5 26.8 96.7 64.0
5% OWNERS:
News-Press & Gazette
Company(h).......... -- 1,648,438 1,582,500 -- 19.2 18.6 14.7
Advantage Capital
Missouri Partners I,
L.P.(g)(i).......... -- 1,318,750 -- -- 15.4 -- 6.0
Pacific Capital,
L.P.(f)(j).......... -- 1,219,925 -- -- 14.2 -- 5.5
<CAPTION>
PERCENTAGE OF
TOTAL VOTING
POWER OF
FULLY DILUTED
COMMON STOCK
NAME AND ADDRESS OF AS ADJUSTED FOR
BENEFICIAL OWNER(a) THE PRIVATE OFFERING
- ------------------- --------------------
<S> <C>
DIRECTORS AND
EXECUTIVE OFFICERS:
Henry H. Bradley(c)... 15.2
David E. Scott........ 5.9
Gregory C. Lawhon..... 1.8
Gary L. Chesser....... 1.6
David W. Vranicar..... 1.5
Bradley A.
Moline(d)........... 1.6
Jeffrey D.
Shackelford......... 3.9
Stephen L.
Sauder(e)........... 27.3
Donald H. Goldman..... 1.1
Ian R.N. Bund(f)...... *
David W.
Bergmann(g)......... --
All directors and
executive officers
as a group (11
persons)............ 60.2
5% OWNERS:
News-Press & Gazette
Company(h).......... 13.8
Advantage Capital
Missouri Partners I,
L.P.(g)(i).......... 5.6
Pacific Capital,
L.P.(f)(j).......... 5.2
</TABLE>
- ---------------
* Less than one percent
(a) Beneficial ownership is determined in accordance with the Commission's rules
and includes voting and investment power with respect to the shares.
(b) Includes exercised options to purchase shares of the Common Stock, which
were issued pursuant to the Option Plan. Such options are exercisable
immediately on grant at an exercise price of $.001 per share, and vest over
a four-year period, at a rate of 6.25% per quarter. Holders of exercised
options have voting power with respect to all shares of Common Stock
underlying the options. Upon termination of employment with the Company,
Birch has the right to purchase all options which have not vested as of that
date, subject to certain exceptions. See "Management -- 1998 Stock Option
Plan -- Early Exercise."
(c) Includes 1,648,438 shares of Series B Preferred Stock and 1,582,500 shares
of Series C Preferred Stock held by NPG. Mr. Bradley and his brother hold
voting power of NPG. Also includes 329,687 shares of Series B Preferred
Stock held by various trusts and relatives of the Bradley family.
(d) Includes 5,275 shares of Series B Preferred Stock held by Mr. Moline's
father.
(e) Includes 65,937 shares of Series B Preferred Stock held by Mr. Sauder's
father.
(f) Mr. Bund is the president of White Pines Management which provides
management of White Pines L.P. I and the Pacific Capital, L.P. investment
funds. Mr. Bund serves on the Board of Birch.
(g) Mr. Bergmann is a general partner of Advantage Capital Missouri Partners I,
L.P. and serves on the Board of Birch.
(h) The principal business address of NPG is 825 Edmond Street, St. Joseph, MO
64501.
(i) The principal business address of Advantage is 7733 Forsyth Boulevard, Suite
1850, St. Louis, MO 63105.
(j) The principal business address of Pacific Capital, L.P. is 2401 Plymouth
Road, Suite B, Ann Arbor, MI 48105.
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<PAGE> 81
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PURCHASE OF SERIES A PREFERRED STOCK BY STEPHEN L. SAUDER
In connection with the Merger, the Company paid to Stephen L. Sauder, the
principal stockholder of Valu-Line, 2,968,750 shares of its Series A Preferred
Stock, 5,982,746 shares of its Series C Preferred Stock and $4,500,000 in cash.
During the nine months ended September 30, 1998, the Company paid dividends of
$168,000 to Mr. Sauder, the holder of all of the Company's Series A Preferred
Stock. Pursuant to the Purchasers Rights Agreement dated February 10, 1998 (the
"Purchasers Rights Agreement"), Mr. Sauder was elected as a Director of the
Company. In June 1998, Birch repurchased all of the outstanding shares of
Birch's Series A Preferred Stock, which were issued in connection with the
Merger.
THE SERIES B PREFERRED STOCK OFFERING
On March 13, 1998, Birch completed a private placement of 6,264,074 shares
of its Series B Preferred Stock (the "Series B Preferred Stock Offering") having
an aggregate liquidation preference of $9.5 million and $3.5 million in
aggregate principal amount of its Convertible Notes which on June 18, 1998 were
converted to 2,307,965 shares of Series B Preferred Stock, raising aggregate net
proceeds of approximately $12.4 million. The transaction was consummated
pursuant to the Purchasers Rights Agreement and the Securities Purchase
Agreement, agreements which designate certain rights and obligations of the
Series B Preferred Stock. See "-- Purchasers Rights Agreement" and
"-- Securities Purchase Agreement." Pursuant to the Securities Purchase
Agreement, NPG, a stockholder which owns in excess of 5% of the Company's voting
securities, purchased $2,500,000 of Series B Preferred Stock, and certain
parties affiliated with NPG, including Henry H. Bradley, Chairman of the Board
of the Company, purchased $500,000 of Series B Preferred Stock. In addition,
pursuant to the Securities Purchase Agreement, Bradley A. Moline and Gregory C.
Lawhon, executive officers of Birch, purchased $105,000 and $75,000 of Series B
Preferred Stock, respectively. In connection with this Series B Preferred Stock
Offering, NPG surrendered 1,500,000 shares of Common Stock and 1,500,000
warrants exercisable into shares of Common Stock in exchange for 1,582,500
shares of Series C Preferred Stock; David E. Scott, Birch's President, Chief
Executive Officer and Director, surrendered 180,000 shares of Common Stock and
180,000 warrants exercisable into shares of Common Stock in exchange for 189,900
shares of Series C Preferred Stock; and Jeffrey D. Shackelford, Birch's Senior
Vice President of Sales and Marketing, surrendered 120,000 shares of Common
Stock and 120,000 warrants exercisable into shares of Common Stock in exchange
for 126,600 shares of Series C Preferred Stock. The Company then cancelled the
exchanged shares and warrants exercisable into shares of common stock.
PURCHASERS RIGHTS AGREEMENT
Current stockholders of Birch are parties to the Purchasers Rights
Agreement, pursuant to which they agreed to vote their respective shares in such
a manner as to elect certain persons to serve as Directors. The holders of
Series B Preferred Stock have agreed to vote their shares to elect one designee
of NPG; one designee of Advantage and one designee of White Pines. In addition,
the holders of Series C Preferred Stock agreed to vote their shares to elect
Stephen L. Sauder, and the holders of Common Stock agreed to vote their shares
for the election of David E. Scott. As a result, so long as the Purchasers
Rights Agreement is in effect, these investors will effectively control the
election of the Company's Board of Directors.
Registration Rights
The parties to the Purchasers Rights Agreement, subject to certain
conditions, have certain registration rights with respect to shares of Common
Stock, including shares of Common Stock issuable upon conversion or redemption
of shares of Series B Preferred Stock or upon conversion of shares of Series C
Preferred Stock. Such purchasers may, subject to certain conditions, require
Birch to register their shares of Common Stock pursuant to the Securities Act in
connection with an underwritten public offering of the Common Stock to the
general public. Each purchaser of stock pursuant to the Purchasers Rights
Agreement is subject to lock-up restrictions in the event of a public offering
of Birch's securities.
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<PAGE> 82
Restrictions on Transfer
Birch's outstanding Common Stock (including shares issued pursuant to
Options), Series B Preferred Stock and Series C Preferred Stock are subject to
certain restrictions on transfer. Holders of Common Stock, Series B Preferred
Stock and Series C Preferred Stock that are parties to the Purchasers Rights
Agreement, subject to certain exceptions, may not transfer their shares without
first giving Birch the opportunity to purchase such shares (a "Right of First
Refusal"). In addition, holders of Common Stock and Series C Preferred Stock
that are parties to the Purchasers Rights Agreement, subject to certain
exceptions, may not transfer their shares without first giving the holders of
Series B Preferred Stock the opportunity to participate in such transfer (a
"Co-Sale Right"). Holders of Common Stock, Series B Preferred Stock and Series C
Preferred Stock that are parties to the Purchasers Rights Agreement are required
to sell their shares in the event of an agreement by 66 2/3% of the outstanding
shares of Common Stock (assuming conversion or exercise of all convertible
securities, options or warrants) to sell or transfer their shares, or to sell
all or substantially all of the assets of Birch to a third party.
Pre-Emptive Rights
Holders of Birch's Series B Preferred Stock and Series C Preferred Stock
have the right to purchase a pro rata portion of any Common Stock or Preferred
Stock that Birch proposes to sell and issue, subject to certain exceptions.
Size of the Board of Directors
The Purchasers Rights Agreement provides that so long as 10% or more of the
outstanding shares of Series B Preferred Stock are held by the parties to the
Purchasers Rights Agreement, the approval by the vote or written consent of the
holders of at least a majority of the then-outstanding shares of Series B
Preferred Stock shall be necessary to change the size of the Board of Directors.
SECURITIES PURCHASE AGREEMENT
In connection with the Series B Preferred Stock Offering, the current
stockholders entered into the Securities Purchase Agreement. Pursuant to this
agreement, Birch sold shares of its Common Stock to certain of its employees
pursuant to the Stock Purchase Plan and sold shares of its Series B Preferred
Stock and Convertible Notes to certain investors. In addition, pursuant to the
Securities Purchase Agreement, Birch implemented a plan of recapitalization
whereby it exchanged all shares of its Common Stock and warrants for shares of
its Common Stock issued and outstanding prior to the Securities Purchase
Agreement for shares of its Series C Preferred Stock. Birch then cancelled the
exchanged shares of common stock and warrants exercisable into shares of common
stock.
SALES OF COMMON STOCK TO EXECUTIVE OFFICERS OF THE COMPANY
In connection with the Series B Preferred Stock Offering, 474,750 shares of
the Company's Common Stock were sold to certain employees of the Company, at a
price of $0.001 per share, as determined by an independent valuation, or an
aggregate purchase price of $450.00. The shares were sold pursuant to the
Company's Stock Purchase Plan. In connection with this transaction, David E.
Scott, Birch's President, Chief Executive Officer and Director, purchased
138,405 shares of Common Stock, Jeffrey D. Shackelford, Birch's Senior Vice
President of Sales and Marketing, purchased 92,587 shares of Common Stock,
Gregory C. Lawhon, Birch's Senior Vice President of Public Policy and General
Counsel, purchased 51,273 shares of Common Stock, Gary L. Chesser, Birch's
Senior Vice President of Engineering and Operations, purchased 47,000 shares of
Common Stock, David W. Vranicar, Senior Vice President of Business Development,
purchased 42,728 shares of Common Stock and Bradley A. Moline, Birch's Senior
Vice President of Finance and Chief Financial Officer, purchased 34,182 shares
of Common Stock.
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<PAGE> 83
NPG LOAN
On December 16, 1997, the Company borrowed $250,000 from NPG in order to
satisfy its working capital needs. NPG is a stockholder which owns in excess of
5% of the Company's voting securities. The loan was repaid with the proceeds of
the Company's private placement of its Series B Preferred Stock and Convertible
Notes.
VALU-LINE LOANS
As of December 31, 1997, Valu-Line, which merged into Birch on February 10,
1998, had notes payable of $111,870 from Stephen L. Sauder. Mr. Sauder was the
President and principal stockholder of Valu-Line at the time the loan was made
and is currently a Vice President and a Director of the Company. In addition, as
of December 31, 1997, Valu-Line had notes payable of $105,457 from Mr. Sauder's
father. The loans are due on demand. As of June 30, 1998, the amounts
outstanding under these loans were fully repaid.
DEALINGS WITH VALU-BROADCASTING, INC.
In 1995, 1996, and 1997, Valu-Line provided services principally related to
rent and operating costs to Valu-Broadcasting, Inc., an affiliate of Valu-Line
at the time of the transactions, in the amounts of $65,000, $74,000 and $81,000
respectively. Valu-Line also received services principally related to
advertising from Valu-Broadcasting, Inc. in the amounts of $39,000, $31,000 and
$41,000 in 1995, 1996 and 1997, respectively. In February 1998, Valu-Line merged
with and into the Company pursuant to the Merger.
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<PAGE> 84
DESCRIPTION OF CAPITAL STOCK
As of September 30, 1998, the authorized capital stock of Birch consisted
of: (i) 27,000,000 shares of Common Stock, of which 5,016,889 shares have been
issued and are outstanding, 8,572,039 shares are reserved for issuance upon
conversion of the Series B Preferred Stock, and 8,492,749 shares are reserved
for issuance upon conversion of the Series C Preferred Stock; and (ii)
25,000,000 shares of Preferred Stock, of which 17,064,788 shares are issued and
outstanding.
COMMON STOCK
General
Holders of Common Stock of Birch are entitled to one vote for each share
held on all matters submitted to a vote of stockholders. These voting rights are
exercised together with the rights of Series B Preferred Stock and Series C
Preferred Stock. Except as otherwise required by law, actions at Birch's
stockholders meetings require the affirmative vote of a majority of the shares
represented at the meeting and that a quorum be present. Holders of Common Stock
are entitled, subject to the preferences of the Preferred Stock, to receive such
dividends, if any, as may be declared by the Board out of funds legally
available therefor. The Indenture restricts the ability of Birch to pay
dividends on the Common Stock. See "Description of the Exchange Notes -- Certain
Covenants." The holders of Common Stock have no preemptive, redemption,
conversion or sinking fund rights. In the event of a liquidation, dissolution or
winding up of Birch, holders of Common Stock are entitled to share ratably in
the assets of Birch which are legally available for distribution, if any,
remaining after the payment of all debts and liabilities of Birch and the
liquidation preference of any outstanding Preferred Stock.
At present, there is no established trading market for the Common Stock.
Restrictions on Transfer
Birch's outstanding Common Stock, including shares issued pursuant to
Options, is subject to certain restrictions on transfer pursuant to the
Purchasers Rights Agreement. Holders of Common Stock that are parties to the
Purchasers Rights Agreement, subject to certain exceptions, may not transfer
their shares without first giving Birch a Right of First Refusal. In addition,
holders of Common Stock that are parties to the Purchasers Rights Agreement,
subject to certain exceptions, may not transfer their shares without first
giving the holders of Series B Preferred Stock a Co-Sale Right. Holders of
Common Stock that are parties to the Purchasers Rights Agreement are required to
sell their shares in the event of an agreement by 66 2/3% of the outstanding
shares of Common Stock (assuming conversion or exercise of all convertible
securities, options or warrants) to sell or transfer their shares, or to sell
all or substantially all of the assets of Birch to a third party.
PREFERRED STOCK
General
As of September 30, 1998, the authorized Preferred Stock of Birch consisted
of 25,000,000 shares, of which 2,968,750 shares were designated Series A
Preferred Stock, 8,750,000 were designated Series B Preferred Stock and
8,500,000 were designated Series C Preferred Stock.
Certain Amendments to the Rights of the Preferred Stock
The Company amended its certificate of incorporation to provide that (i) so
long as any of the Notes remains outstanding, no redemption of the Series B
Preferred Stock may be required by the holders thereof to be made until the
earlier of (a) June 15, 2008 and (b) the 91st day after the redemption in full
of the Notes, except through an IPO Redemption (as defined) described below and
(ii) (notwithstanding the conversion price adjustment provisions applicable to
the Preferred Stock described herein) the issuance of Warrants and Warrant
Shares in connection with the Private Offering will not result in any adjustment
to the conversion price applicable to the Preferred Stock.
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<PAGE> 85
In addition, on the Closing Date, the holders of the Series B Preferred
Stock and the Series C Preferred Stock waived their pre-emptive rights with
respect to the issuance of the Warrants and the Warrant Shares.
SERIES B PREFERRED STOCK
Dividends
The holders of Series B Preferred Stock are entitled to receive dividends
in cash at the rate of 15% per annum on an amount equal to $1.52 plus all unpaid
dividends accrued on such shares of Series B Preferred Stock, on each
outstanding share of Series B Preferred Stock (as adjusted for any stock
dividends, combinations, splits and the like with respect to such shares), when
and as declared by the Board out of funds legally available for that purpose.
Such dividends are cumulative from the date of issuance of the Series B
Preferred Stock, whether or not earned, whether or not funds of Birch are
legally available for the payment of dividends and whether or not declared by
the Board, but such dividends shall be payable only when, as, and if declared by
the Board. So long as any shares of Series B Preferred Stock are outstanding, no
dividend, whether in cash or in property, can be paid or declared, nor can any
other distribution be made, on any shares of Series C Preferred Stock or Common
Stock, nor can any shares of Series C Preferred Stock or Common Stock be
purchased, redeemed or otherwise acquired for value by Birch (except for
acquisitions of Common Stock by Birch pursuant to agreements which permit Birch
to repurchase such shares upon termination of services to Birch or in exercise
of Birch's right of first refusal upon a proposed transfer) until all dividends
on the Series B Preferred Stock have been paid or declared and set apart. The
Indenture restricts the ability of Birch to pay dividends on the Series B
Preferred Stock.
Liquidation Preference
Upon any liquidation, dissolution, or winding up of Birch and before any
distribution or payment can be made to the holders of Series C Preferred Stock
and Common Stock, the holders of Series B Preferred Stock are entitled to be
paid out of the assets of Birch an amount equal to the greater of (i) the sum of
$1.52 for each share of Series B Preferred Stock held by them (as adjusted for
any stock dividends, combinations, splits and the like with respect to such
shares) plus all unpaid dividends accrued on such shares of Series B Preferred
Stock to the date of payment of such preference, whether or not earned, whether
or not funds of Birch are legally available for the payment of dividends and
whether or not such dividends have been declared by the Board; or (ii) (x) $1.52
for each share of Series B Preferred Stock held by them (as adjusted for any
stock dividends, combinations, splits and the like with respect to such shares)
less the per share amount of any dividends previously declared and paid on such
shares plus (y) the Participation Amount (as that term is defined below) (the
"Series B Liquidation Preference"), for each share of Series B Preferred Stock
held by them. If the assets of Birch are insufficient to make payment in full to
all holders of Series B Preferred Stock of the liquidation preference, then such
assets will be distributed among the holders of Series B Preferred Stock at the
time outstanding ratably in proportion to the full amounts to which they would
otherwise be respectively entitled.
"Participation Amount" with respect to the Series B Preferred Stock means:
(x) the Residual Amount multiplied by a fraction, the numerator of which is the
number of shares of Series B Preferred Stock issued and outstanding and the
denominator of which is the number of shares of Series B Preferred Stock, Series
C Preferred Stock and Common Stock issued and outstanding (including all shares
reserved for issuance under the Option Plan), on an as-converted to Common Stock
basis, divided by (y) the number of shares of Series B Preferred Stock issued
and outstanding. "Residual Amount" is defined as the assets of Birch remaining
after the payment of: (i) the Series A Liquidation Preference multiplied by all
the outstanding shares of Series A Preferred Stock; (ii) $1.52 (as adjusted for
any stock dividend, combination, splits and the like with respect to such
shares) less the per share amount of any dividends previously declared and paid
on such shares multiplied by all outstanding shares of Series B Preferred Stock;
and (iii) $1.52 (as adjusted for any stock dividend, combination, splits and the
like with respect to such shares) less the per share amount of any dividends
previously declared and paid on such shares multiplied by all outstanding shares
of Series C Preferred Stock.
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<PAGE> 86
Conversion
The following is a description of the conversion provisions of the Series B
Preferred Stock as currently in effect. On or prior to the Closing Date, the
Company's Certificate of Incorporation was amended as described above under
"-- Certain Amendments to the Rights of the Preferred Stock." The shares of
Series B Preferred Stock may, at the option of the holder, be converted at any
time into fully paid and nonassessable shares of Common Stock. The number of
shares of Common Stock to which a holder of Series B Preferred Stock is entitled
upon conversion is the product obtained by multiplying the applicable Preferred
Stock Rate then in effect by the number of shares of Series B Preferred Stock
being converted. The "Preferred Stock Rate" for shares of Series B Preferred
Stock is obtained by dividing the original issue price of the Series B Preferred
Stock (which price initially equaled $1.60 per share) by the preferred stock
price (which price initially equaled $1.60 per share). In addition, the
Preferred Stock Rate for the Series B Preferred Stock is subject to adjustment
upon the issuance of additional shares of Common Stock, subject to certain
exceptions. The issuance of Warrants and Warrant Shares in connection with the
Private Offering did not result in any adjustment to the conversion price
applicable to the Series B Preferred Stock.
Redemption
The following is a description of the redemption provisions of the Series B
Preferred Stock as currently in effect. The holders of at least 75% of the then
outstanding shares of Series B Preferred Stock, voting as a separate class, may
require Birch, to the extent it may lawfully do so, to redeem all of the
outstanding shares of Series B Preferred Stock, upon giving notice to Birch
provided, however, that so long as any of the Notes remains outstanding, no
redemption of the Series B Preferred Stock may be required by the holders
thereof to be made until the earlier of (a) June 15, 2008 and (b) the 91st day
after the redemption in full of the Notes, except through an IPO Redemption (as
defined) described below. Once notice has been given, Birch shall redeem Series
B Preferred Stock in three equal annual installments on February 28, 2003, 2004
and 2005, respectively. Birch shall effect such redemption or redemptions by
paying in cash in exchange for the shares of Series B Preferred Stock to be
redeemed a sum equal to the greater of: (x) $1.52 per share of Series B
Preferred Stock (as adjusted for any stock dividends, combinations, splits or
the like with respect to such shares) plus the fair market value of such number
of shares of Common Stock that would be issuable upon conversion of one share of
Series B Preferred Stock as of the date of redemption; or (y) $1.52 per share of
Series B Preferred Stock (as adjusted for any stock dividends, combinations,
splits or the like with respect to such shares) plus all declared or accumulated
but unpaid dividends on such shares (the "Series B Redemption Price"). In
addition, Birch is required to redeem, from any source of funds legally
available therefor, all of the Series B Preferred Stock in the event of and
concurrently with the closing of a firmly underwritten public offering of its
common stock pursuant to an effective registration statement under the
Securities Act of 1933, as amended, with gross cash proceeds to Birch (before
underwriting discounts, commissions and fees) of not less than $30,000,000 (an
"IPO Redemption"). Birch will effect such redemption (x) by paying in cash in
exchange for the shares of Series B Preferred Stock to be redeemed a sum equal
to $1.52 per share of Series B Preferred Stock (as adjusted for any stock
dividends, combinations, splits or the like with respect to such shares) and (y)
by issuing such number of shares of Common Stock that would be issuable upon
conversion of such shares of Series B Preferred Stock as of such closing. In the
event that Birch fails to redeem the total number of shares of Series B
Preferred Stock on the applicable redemption date, the holders of Series B
Preferred Stock at the time outstanding, voting separately as a class, shall be
entitled to elect the smallest number of directors of Birch that shall
constitute a majority of the Board of Directors of the Company (and, if there
are not a sufficient number of resignations by the members of the Board of
Directors at the time of such default, the Board shall be expanded by such
number of directors as is necessary to give effect to the foregoing right). Such
right supersedes any limitations to vote for directors until such time as the
Series B Preferred Stock has been redeemed.
Voting Rights
Subject to certain exceptions, the holders of Series B Preferred Stock are
entitled to cast one vote for each share of Series B Preferred Stock held by
them on an as-converted to Common Stock basis. Such votes
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will be cast together with those cast by the holders of Series C Preferred Stock
and Common Stock and not as a separate class, except as otherwise provided
herein or required by applicable law. The Series B Preferred Stock does not have
cumulative voting rights.
For as long as the outstanding shares of Series B Preferred Stock represent
at least five percent (5%) or more of the outstanding shares of Common Stock of
Birch (on an as-if converted to Common Stock basis), the approval by the vote or
written consent of the holders of at least a majority of the then outstanding
shares of Series B Preferred Stock is necessary for effecting or validating the
following actions: (i) any action that results in the payment or declaration of
a dividend on any shares of Common Stock; (ii) the purchase or other acquisition
of any Series A Preferred Stock or Series C Preferred Stock or Common Stock;
provided, however, that this restriction does not apply to: (x) the repurchase
of shares of Common Stock by Birch pursuant to agreements which permit Birch to
repurchase such shares upon termination of services to Birch; (y) the exercise
of Birch's Right of First Refusal with the approval of the Board upon a proposed
transfer; or (z) the redemption of the Series A Preferred Stock; or (iii) any
agreement by Birch or its stockholders regarding certain acquisitions or asset
transfers.
For as long as the outstanding shares of Series B Preferred Stock represent
at least five percent (5%) or more of the outstanding shares of Common Stock of
Birch (on an as-if converted to Common Stock basis), the approval by the vote or
written consent of the holders of at least seventy-five percent (75%) of the
then outstanding shares of Series B Preferred Stock is necessary for effecting
or validating the following actions: (i) any amendment, alteration, or repeal of
any provision of the certificate of incorporation or bylaws of the Company
(including the filing of a certificate of designation), that adversely affects
the voting powers, preferences or other special rights or privileges,
qualifications, limitations, or restrictions of the Series B Preferred Stock; or
(ii) any amendment, alteration, or repeal of the section of the Birch's
Certificate of Incorporation pertaining to restrictions on voting rights.
Restrictions on Transfer
Birch's Series B Preferred Stock is subject to certain restrictions on
transfer. Holders of Series B Preferred Stock, subject to certain exceptions,
may not transfer their shares without first giving Birch a Right of First
Refusal. In addition, all holders of Series B Preferred Stock are required to
sell their shares in the event of an agreement by 66 2/3% of the outstanding
shares of Common Stock (assuming conversion or exercise of all convertible
securities, options or warrants) to sell or transfer their shares, or to sell
all or substantially all of the assets of Birch to a third party.
Pre-Emptive Rights
Holders of Birch's Series B Preferred Stock have the right to purchase a
pro-rata portion of any Common Stock or Preferred Stock that Birch proposes to
sell and issue, subject to certain exceptions. On the Closing Date, the holders
of the Series B Preferred Stock waived their pre-emptive rights with respect to
the issuance of the Warrants and the Warrant Shares.
SERIES C PREFERRED STOCK
Dividends
The holders of Series C Preferred Stock are entitled to receive dividends
in cash at the rate of 10% per annum on an amount equal to $1.52 on each
outstanding share of Series C Preferred Stock (as adjusted for any stock
dividends, combinations, splits and the like with respect to such shares), when
and as declared by the Board out of funds legally available for that purpose.
Such dividends are payable only when, as and if declared by the Board and will
not be cumulative. So long as any shares of Series C Preferred Stock are
outstanding, no dividend, whether in cash or in property, can be paid or
declared, nor can any other distribution be made, on any shares of Common Stock,
nor can any shares of Common Stock be purchased, redeemed or otherwise acquired
for value by Birch (except for acquisitions of Common Stock by Birch pursuant to
agreements which permit Birch to repurchase such shares upon termination of
services to Birch or in exercise of Birch's right of first refusal upon a
proposed transfer) until all dividends on the Series C
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Preferred Stock shall have been paid or declared and set apart. The Indenture
restricts the ability of Birch to pay dividends on the Series C Preferred Stock.
Liquidation Preference
Upon any liquidation, dissolution, or winding up of Birch, and after the
payment of the full liquidation preference of the Series B Preferred Stock, and
before any distribution or payment can be made to the holders of Common Stock,
the holders of Series C Preferred Stock are entitled to be paid out of the
assets of Birch an amount equal to the greater of: (i) the sum of $1.52 per
share of Series C Preferred Stock (as adjusted for any stock dividends,
combinations, splits and the like with respect to such shares), plus an amount
equal to the declared and unpaid dividends for each share of Series C Preferred
Stock held by them; or (ii) (x) $1.52 for each share of Series C Preferred Stock
held by them (as adjusted for any stock dividends, combinations, splits and the
like with respect to such shares) less the per share amount of any dividends
previously paid on such shares plus (y) the Participation Amount (the "Series C
Liquidation Preference"). If the assets of Birch are insufficient to make
payment in full to all holders of Series C Preferred Stock of the liquidation
preference, then such assets will be distributed among the holders of Series C
Preferred Stock at the time outstanding ratably in proportion to the full
amounts to which they would otherwise be respectively entitled.
"Participation Amount" with respect to the Series C Preferred Stock means:
(x) the Residual Amount multiplied by a fraction the numerator of which is the
number of shares of Series C Preferred Stock issued and outstanding and the
denominator of which is the number of shares of Series B Preferred Stock, Series
C Preferred Stock and Common Stock issued and outstanding (including all shares
reserved for issuance under the Option Plan), on an as-converted to Common Stock
basis, divided by (y) the number of shares of Series C Preferred Stock issued
and outstanding.
Conversion
The following is a description of the conversion provisions of the Series C
Preferred Stock as currently in effect. On or prior to the Closing Date, the
Company's Certificate of Incorporation was amended as described above under
"-- Certain Proposed Amendments to the Rights of the Preferred Stock." The
shares of Series C Preferred Stock may, at the option of the holder, be
converted at any time into fully paid and nonassessable shares of Common Stock.
The number of shares of Common Stock to which a holder of Series C Preferred
Stock is entitled upon conversion is the product obtained by multiplying the
applicable Preferred Stock Rate then in effect by the number of shares of Series
C Preferred Stock being converted. All outstanding shares of Series C Preferred
Stock will be automatically converted into shares of Common Stock immediately
prior to the closing of a firmly underwritten public offering pursuant to an
effective registration statement under the Securities Act of 1933, as amended,
covering the offer and sale of Common Stock for the account of Birch in which
the gross proceeds to Birch (before underwriting discounts, commissions and
fees) are at least $30,000,000. The number of shares of Common Stock to which a
holder of Series C Preferred Stock shall be entitled upon conversion shall be
the product obtained by multiplying the applicable Preferred Stock Rate then in
effect by the number of shares of Series C Preferred Stock being converted. The
"Preferred Stock Rate" for shares of Series C Preferred Stock is obtained by
dividing the original issue price of the Series C Preferred Stock (which price
initially equaled $1.60 per share) by the preferred stock price (which price
initially equaled $1.60 per share.) In addition, the Preferred Stock Rate for
the Series C Preferred Stock is subject to adjustment upon the issuance of
additional shares of Common Stock, subject to certain exceptions. The issuance
of Warrants and Warrant Shares in connection with the Private Offering did not
result in any adjustment to the conversion price applicable to the Series C
Preferred Stock.
Redemption
Birch's Series C Preferred Stock has no mandatory redemption requirement.
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Voting Rights
Subject to certain exceptions, the holders of Series C Preferred Stock are
entitled to cast one vote for each share of Series C Preferred Stock held by
them on an as-converted to Common Stock basis. Such votes shall be cast together
with those cast by the holders of Series B Preferred Stock and Common Stock and
not as a separate class, except as otherwise provided herein or required by
applicable law. The Series C Preferred Stock shall not have cumulative voting
rights.
Restrictions on Transfer
Birch's Series C Preferred Stock is subject to certain restrictions on
transfer. Holders of Series C Preferred Stock, subject to certain exceptions,
may not transfer their shares without first giving Birch a Right of First
Refusal. In addition, holders of Series C Preferred Stock, subject to certain
exceptions, may not transfer their shares without first giving the holders of
Series B Preferred Stock a Co-Sale Right. All holders of Series C Preferred
Stock are required to sell their shares in the event of an agreement by 66 2/3%
of the outstanding shares of Common Stock (assuming conversion or exercise of
all convertible securities, options or warrants) to sell or transfer their
shares, or to sell all or substantially all of the assets of Birch to a third
party.
Pre-Emptive Rights
Holders of Birch's Series C Preferred Stock have the right to purchase a
pro-rata portion of any Common Stock or Preferred Stock that Birch proposes to
sell and issue, subject to certain exceptions. On the Closing Date, the holders
of the Series C Preferred Stock waived their pre-emptive rights with respect to
the issuance of the Warrants and the Warrant Shares.
REGISTRATION RIGHTS
Current stockholders of Birch are parties to the Purchasers Rights
Agreement, pursuant to which the stockholders of Birch, subject to certain
conditions, have certain registration rights with respect to any shares of
Common Stock, including shares of Common Stock issuable upon conversion or
redemption of shares of Series B Preferred Stock or upon conversion of shares of
Series C Preferred Stock. Under the terms of the Purchasers Rights Agreement,
the stockholders may, subject to certain conditions, require Birch to register
their shares of Common Stock pursuant to the Securities Act in connection with
an underwritten public offering of the Common Stock to the general public. Each
purchaser of stock pursuant to the Purchasers Rights Agreement is subject to
lock-up restrictions in the event of a public offering of Birch's securities.
DESCRIPTION OF THE WARRANTS
The Warrants were issued pursuant to a Warrant Agreement (the "Warrant
Agreement") between the Company and Norwest Bank Minnesota, National
Association, as Warrant Agent (the "Warrant Agent"). The following summary of
material provisions of the Warrant Agreement does not purport to be complete and
is qualified in its entirety by reference to the Warrants and the Warrant
Agreement, including the definitions therein of certain terms used below.
Capitalized terms used in this Description of the Warrants and not otherwise
defined herein have the meanings ascribed to such terms in the Warrant
Agreement. Copies of the Warrant Agreement are available as set forth under
"Available Information." The Warrants are represented by one or more registered
Warrants in global form and in certain limited circumstances may be represented
by Warrants in certificated form. See "Book-Entry, Delivery and Form."
GENERAL
Each Warrant, when exercised, entitles the holder thereof to receive 12.26
fully paid and non-assessable shares of Common Stock of the Company (the
"Warrant Shares") at an exercise price of $0.01 per share (the "Exercise
Price"). The Exercise Price and the number of shares of Common Stock issuable
upon exercise of a Warrant are both subject to adjustment in certain
circumstances described below. The Warrants are exercisable to purchase an
aggregate of 1,409,734 shares of Common Stock representing (on a fully diluted
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basis, assuming all options outstanding are exercised on the date of this
Offering Memorandum, but without giving effect to the issuance of shares of
Common Stock reserved for future issuance pursuant to the 1998 Stock Option
Plan) approximately 6% of the shares of Common Stock to be outstanding upon
consummation of the offering of the Units.
The Warrants will be exercisable on or after December 15, 1998. The
Warrants may also be exercised (prior to such date) upon the occurrence of an
Exercise Event (as defined under "-- Registration Rights; Warrant Liquidated
Damages") in connection with an effective Demand Registration Statement. Unless
earlier exercised, the Warrants will expire on June 15, 2008 (the "Expiration
Date"). The Company will give notice of expiration not less than 90 nor more
than 120 days prior to the Expiration Date to the registered holders of the then
outstanding Warrants. If the Company fails to give such notice, the Warrants
will nevertheless expire and become void on the Expiration Date. The Warrants
will not trade separately from the Notes until the Separation Date.
In order to exercise all or any of the Warrants, the holder thereof is
required to surrender to the Warrant Agent the related registered certificate
issued by the Company representing the Warrants (the "Warrant Certificate") with
the accompanying form of election to purchase properly completed and executed,
and to pay in full the Exercise Price for each share of Common Stock or other
securities issuable upon exercise of such Warrants. The exercise procedure for
Warrants held in book-entry form are governed by DTC's standing procedure for
such exercise. The Exercise Price may be paid at the option of the holder (i) by
tendering Notes in a principal amount at the time of tender equal to the
Exercise Price (a "Note Cashless Exercise"), (ii) by reducing the number of
shares of Common Stock that would be obtainable upon the exercise of a Warrant
by such number of shares of Common Stock as have a Current Market Value (as
defined under "-- Registration Rights; Warrant Liquidated Damages") equal to the
Exercise Price (a "Common Stock Cashless Exercise"), or (iii) by any combination
of Note Cashless Exercises or Common Stock Cashless Exercises (together a
"Cashless Exercise"). All provisions of the Warrant Agreement shall be
applicable with respect to a surrender of a Warrant Certificate pursuant to a
Cashless Exercise for less than the full number of Warrants represented thereby.
Upon surrender of the Warrant Certificate and payment of the Exercise Price, the
Company will deliver or cause to be delivered to or upon the written order of
such holder, a stock certificate representing shares of Common Stock of the
Company for each Warrant evidenced by such Warrant Certificate, subject to
adjustment as described herein. If less than all of the Warrants evidenced by a
Warrant Certificate are to be exercised, a new Warrant Certificate will be
issued for the remaining number of Warrants. No fractional shares of Common
Stock will be issued upon exercise of the Warrants. The Company will pay to the
holder of the Warrant at the time of exercise an amount in cash equal to the
Current Market Value of any such fractional share of Common Stock.
The holders of unexercised Warrants are not entitled, by virtue of being
such holders, to receive dividends, to vote, to consent, to exercise any
preemptive rights or to receive notice as stockholders of the Company in respect
of any stockholders meeting for the election of directors of the Company or any
other purpose, or to exercise any other rights whatsoever as stockholders of the
Company.
No service charge will be made for registration of transfer or exchange
upon surrender of any Warrant Certificate at the office of the Warrant Agent
maintained for that purpose. The Company may require payment of a sum sufficient
to cover any tax or other governmental charge that may be imposed in connection
with any registration or transfer or exchange of Warrant Certificates. The
Warrant Agent will not register a transfer pursuant to Rule 903 under Regulation
S of any Warrant or Warrant Share if, during the applicable Distribution
Compliance Period (as defined under "Book-Entry, Delivery and Form"), such
transfer is not made in accordance with the provisions of Regulation S, pursuant
to registration under the Securities Act or pursuant to an available exemption
from such registration and unless such transfer complies with the restrictions
on transfer of such Warrant or Warrant Share, as applicable, set forth in the
Warrant Agreement. See "Book-Entry, Delivery and Form" and "Notice to
Investors."
In the event a bankruptcy or reorganization is commenced by or against the
Company, a bankruptcy court may hold that unexercised Warrants are executory
contracts which may be subject to rejection by the Company with approval of the
bankruptcy court. As a result, holders of the Warrants may not, even if
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sufficient funds are available, be entitled to receive any consideration or may
receive an amount less than they would be entitled to receive if they had
exercised their Warrants prior to the commencement of any such bankruptcy or
reorganization.
ADJUSTMENTS
The number of shares of Common Stock of the Company issuable upon the
exercise of the Warrants and the Exercise Price will be subject to adjustment in
certain circumstances, including:
(i) the payment by the Company of dividends and other distributions on
its Common Stock payable in Common Stock or other equity interests of the
Company;
(ii) subdivisions, combinations and certain reclassifications of the
Common Stock;
(iii) the issuance to all holders of Common Stock of rights, options
or warrants entitling them to subscribe for additional shares of Common
Stock, or of securities convertible into or exercisable or exchangeable for
additional shares of Common Stock at an offering price (or with an initial
conversion, exercise or exchange price plus such offering price) which is
less than the Current Market Value per share of Common Stock;
(iv) the distribution to all holders of Common Stock of any assets of
the Company (including cash), debt securities of the Company or any rights
or warrants to purchase any securities (excluding those rights and warrants
referred to in clause (iii) above and cash dividends and other cash
distributions from current or retained earnings);
(v) the issuance of shares of Common Stock for a consideration per
share which is less than the Current Market Value per share of Common
Stock; and
(vi) the issuance of securities convertible into or exercisable or
exchangeable for Common Stock for a conversion, exercise or exchange price
per share which is less than the Current Market Value per share of Common
Stock.
The events described in clauses (v) and (vi) above are subject to certain
exceptions described in the Warrant Agreement, including, without limitation,
certain bona fide public offerings and private placements and certain issuances
of Common Stock pursuant to employee stock incentive plans.
No adjustment in the Exercise Price will be required unless and until such
adjustment would result, either by itself or with other adjustments not
previously made, in an increase or decrease of at least 1% in the Exercise Price
or the number of shares of Common Stock issuable upon exercise of Warrants
immediately prior to the making of such adjustment; provided, however, that any
adjustment that is not made as a result of this paragraph will be carried
forward and taken into account in any subsequent adjustment. In addition, the
Company may at any time reduce the Exercise Price (but not to an amount that is
less than the par value of the Common Stock) for any period of time (but not
less than 20 business days) as deemed appropriate by the Board of Directors of
the Company.
In case of certain consolidations or mergers of the Company, or the sale of
all or substantially all of the assets of the Company to another Person, each
Warrant will thereafter be exercisable for the right to receive the kind and
amount of shares of stock or other securities or property to which such holder
would have been entitled as a result of such consolidation, merger or sale had
the Warrants been exercised immediately prior thereto. However, if (i) the
Company consolidates, merges or sells all or substantially all of its assets to
another person and, in connection therewith, the consideration payable to the
holders of Common Stock in exchange for their shares is payable solely in cash
or (ii) there is a dissolution, liquidation or winding-up of the Company, then
the holders of the Warrants will be entitled to receive distributions on an
equal basis with the holders of Common Stock or other securities issuable upon
exercise of the Warrants, as if the Warrants had been exercised immediately
prior to such event, less the Exercise Price. Upon receipt of such payment, if
any, the Warrants will expire and the rights of holders thereof will cease. In
the case of such consolidation, merger or sale of assets, the surviving or
acquiring person and, in the event of any dissolution, liquidation or winding-
up of the Company, the Company must deposit promptly with the Warrant Agent the
funds, if any, required to
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pay the holders of the Warrants. After such funds and the surrendered Warrant
Certificate are received, the Warrant Agent is required to deliver a check in
such amount as is appropriate (or, in the case of consideration other than cash,
such other consideration as is appropriate) to such Persons as it may be
directed in writing by the holders surrendering such Warrants.
In the event of a taxable distribution to holders of Common Stock of the
Company which results in an adjustment to the number of shares of Common Stock
or other consideration for which a Warrant may be exercised, the holders of the
Warrants may, in certain circumstances, be deemed to have received a
distribution subject to United States federal income tax as a dividend. See
"Certain United States Federal Income Tax Considerations -- U.S. Holders -- Tax
Treatment of Warrants."
RESERVATION OF SHARES
The Company has authorized and has reserved for issuance such number of
shares of Common Stock as will be issuable upon the exercise of all outstanding
Warrants. Such shares of Common Stock, when issued and paid for in accordance
with the Warrant Agreement, will be duly and validly issued, fully paid and
nonassessable, free of preemptive rights and free from all taxes, liens, charges
and security interests.
PROVISION OF FINANCIAL STATEMENTS AND REPORTS
The Warrant Agreement provides that, whether or not required by the rules
and regulations of the Commission, so long as any Warrants or Warrant Shares are
outstanding, the Company will furnish to the holder of the Warrants or Warrant
Shares (i) all quarterly and annual financial information that would be required
to be contained in a filing with the Commission on Forms 10-Q and 10-K if the
Company were required to file such Forms, including a "Management's Discussion
and Analysis of Financial Condition and Results of Operations" that describes
the financial condition and results of operations of the Company and its
consolidated Subsidiaries (in each case to the extent not prohibited by the
Commission's rules and regulations), and, with respect to the annual information
only, a report thereon by the Company's certified independent accountants and
(ii) all current reports that would be required to be filed with the Commission
on Form 8-K if the Company were required to file such reports, in each case
within the time periods specified in the Commission's rules and regulations;
provided, however, that with respect to quarterly information relating to the
fiscal quarter of the Company ending on June 30, 1998, the Company shall not be
required to furnish such quarterly information to such holders until 60 days
after the end of such quarter. In addition, following the effectiveness of the
Warrant Registration Statement contemplated by the Warrant Agreement, whether or
not required by the rules and regulations of the Commission, the Company will
file a copy of all such information and reports with the Commission for public
availability within the time periods specified in the Commission's rules and
regulations (unless the Commission will not accept such a filing) and make such
information available to securities analysts and prospective investors upon
requests. In addition, the Company will, for so long as any Warrants or Warrant
Shares remain outstanding, furnish to the holders thereof and to securities
analysts and prospective investors, upon their request, the information required
to be delivered pursuant to Rule 144A(d)(4) under the Securities Act.
AMENDMENT
Any amendment or supplement to the Warrant Agreement that has an adverse
effect on the interests of the holders of the Warrants will require the written
consent of the holders of a majority of the then outstanding Warrants (excluding
any Warrants held by the Company or any of its Affiliates (as defined in the
Warrant Agreement)). Notwithstanding the foregoing, the Company and the Warrant
Agent, without the consent of the holders of the Warrants, may, from time to
time, amend or supplement the Warrant Agreement for certain purposes, including
to cure any ambiguities, defects or inconsistencies or to make any change that
does not adversely affect the rights of any holder. The consent of each holder
of the Warrants affected will be required for any amendment pursuant to which
the Exercise Price would be increased or the number of shares of Common Stock
issuable upon exercise of the Warrants would be decreased (other than pursuant
to adjustments provided for in the Warrant Agreement) or the exercise period
with respect to the Warrants would be shortened.
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REGISTRATION RIGHTS; WARRANT LIQUIDATED DAMAGES
Shelf Registration Right
The Warrant Agreement provides, for the benefit of the holders of the
Warrants, that the Company will file with the Commission a registration
statement (the "Warrant Registration Statement") on an appropriate form under
the Securities Act covering resales of all Warrants and Warrant Shares that are
Transfer Restricted Warrant Securities (as defined) by the holders thereof, and
will use all commercially reasonable efforts to cause the Warrant Registration
Statement to be declared effective by the Commission on or before the earlier of
(the "Warrant Registration Statement Effectiveness Date") (i) 180 days following
an Initial Public Offering (as defined) and (ii) the second anniversary of the
Closing Date. The Company will covenant and agree, subject to certain limited
exceptions, to use its best efforts to keep the Warrant Registration Statement
continuously effective, supplemented and amended to ensure that it is available
for its intended use by the holders of the Transfer Restricted Warrant
Securities entitled to this benefit and to ensure that the Warrant Registration
Statement conforms and continues to conform with the requirements of the
Securities Act and the policies, rules and regulations of the Commission, as
announced from time to time, until the day which is one year after the
effectiveness of the Warrant Registration Statement or such earlier time when
all the Warrants and/or Warrant Shares have been sold pursuant to the Warrant
Registration Statement; provided, however, that during such period, the holders
may be prevented or restricted by the Company from effecting sales pursuant to
the Warrant Registration Statement as more fully described in the Warrant
Agreement. A holder of Warrants or Warrant Shares acquired upon an exercise of
Warrants at a time when the Warrant Registration Statement is not effective or
available for use generally will be required to be named as a selling
securityholder in the related prospectus and to deliver a prospectus to
purchasers, will be subject to certain of the civil liability provisions of the
Securities Act in connection with such sales and will be bound by the provisions
of the Warrant Agreement applicable to such holder (including certain
indemnification and contribution obligations).
If the Warrant Registration Statement (i) has not become effective on or
before the Warrant Registration Statement Effectiveness Date or (ii) such
registration statement becomes effective but shall thereafter cease to be
effective or fails to be usable for its intended purpose without being succeeded
within five business days by a post-effective amendment to such Warrant
Registration Statement that cures such failure and that is itself immediately
declared effective (each such event being a "Warrant Registration Default"), the
Company shall pay to the holders of Warrants and/or Warrant Shares that in
either case are Transfer Restricted Warrant Securities an amount in cash in the
amount of $1.00 per Warrant or Warrant Share ("Warrant Liquidated Damages") for
the first 90-day period (or portion thereof) following such Warrant Registration
Default, such amount to increase by an additional $0.50 per Warrant or Warrant
Share with respect to each subsequent 90-day period (or portion thereof) until
all Warrant Registration Defaults have been cured, up to a maximum rate of
Warrant Liquidated Damages of $2.50 per Warrant or Warrant Share per 90-day
period (or portion thereof). All accrued and unpaid Warrant Liquidated Damages
shall be paid to the holders of record of the Warrants or Warrant Shares
entitled thereto on the last day of each calendar quarter during which any such
payment shall have become due.
Demand Registration Right
The Warrant Agreement further provides that upon the occurrence of an
Exercise Event, the Holders of at least 25% of the Warrants will be entitled to
require the Company to use all commercially reasonable efforts to effect one
registration under the Securities Act in respect of an underwritten sale of
Warrant Shares (a "Demand Registration"), subject to certain limitations, unless
an exemption from the registration requirements of the Securities Act is then
available for the sale of such Warrant Shares. Upon a demand, the Company will
prepare, file and use all commercially reasonable efforts to cause to be
effective within 120 days of such demand a registration statement in respect of
all Warrant Shares that are requested to be included in such registration
statement (a "Demand Registration Statement"); provided that in lieu of filing
such Demand Registration Statement, the Company may purchase all of the Warrant
Shares the holders of which have requested their inclusion in the Demand
Registration Statement at their Current Market Value.
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Piggyback Registration Right
If the Company proposes to effect an Initial Public Offering (as defined
below), the Company must, not later than the date of the initial filing of a
registration statement pertaining thereto, provide written notice thereof to the
holders of the Warrants and the Warrant Shares. Each such holder will have the
right, within 20 days after receipt of such notice, to request (which request
will indicate the intended method of distribution) that the Company include such
holder's Warrant Shares for sale pursuant to such registration statement.
The Company will include in such Initial Public Offering all the Warrant
Shares for which it receives notice pursuant to the preceding paragraph, unless
the managing underwriter for such Initial Public Offering (the "Managing
Underwriter") determines that, in its opinion, the number of Warrant Shares that
the holders of Warrants and Warrant Shares (the "Requesting Holders") have
requested to be sold in such Initial Public Offering, plus the total number of
shares of such Common Stock that the Company and any other selling stockholders
entitled to sell shares in such Initial Public Offering propose to sell in such
Initial Public Offering, exceed the maximum number of shares that may be
distributed without adversely affecting the price, timing or distribution of the
shares to be sold by the Company. In such event, the Company will be required to
include in such Initial Public Offering only that number of shares which the
Managing Underwriter believes may be sold without causing such adverse effect in
the following order: (i) all the shares that the Company proposes to sell in
such Initial Public Offering, (ii) all the shares that are proposed to be sold
by any holder of Common Stock who is exercising a demand registration right
existing on the Closing Date, if such Initial Public Offering is being made
pursuant to such demand and (iii) shares of the Requesting Holders and all other
shares that are proposed to be sold by any holder of Common Stock on a pro rata
basis in an aggregate number which is equal to the difference between the
maximum number of shares that may be distributed in such Initial Public Offering
as determined by the Managing Underwriter and the number of shares to be sold in
such Initial Public Offering pursuant to clauses (i) and (ii) above. The Company
will have the right to postpone or withdraw any registration statement prior to
the effective date without obligation to any Requesting Holder. In the event
that the shares of the Requesting Holders are excluded from such Initial Public
Offering as a result of the preceding sentence, holders of more than 50% of the
Warrant Shares (whether outstanding or subject to issuance upon exercise of
outstanding Warrants) that have not been sold pursuant to a registration
statement may request the Company to register, on one occasion only, all of
their Warrant Shares that are Transfer Restricted Warrant Securities (and those
of any other holder of Warrant Shares that have not been sold pursuant to a
registration statement) in connection with a Public Offering.
The Warrant Agreement includes customary covenants with respect to the
registration rights of the holders on the part of the Company and provides that
the Company will indemnify the holders included in any registration statement
and any underwriter with respect thereto against certain liabilities. Holders of
Warrants and Warrant Shares that wish to participate in any registered offering
contemplated by the Warrant Agreement will be required to provide certain
information to the Company within the time periods set forth in the Warrant
Agreement.
"Current Market Value" per share of Common Stock or any other security at
any date means (i) if the security is not of a class registered under the
Exchange Act, (a) the value of the security determined in good faith by the
Board of Directors of the Company and certified in a board resolution, based on
the most recently completed arm's length transaction between the Company and a
Person other than an Affiliate of the Company, the closing of which occurred on
such date or within the three-month period preceding such date, or (b) if no
such transaction shall have occurred on such date or within such three-month
period, the value of the security as determined by an Independent Financial
Expert (as defined in the Warrant Agreement); or (ii) if such security is of a
class registered under the Exchange Act, the average of the last reported sale
price of the Common Stock (or the equivalent in an over-the-counter market) for
each Business Day (as defined in the Warrant Agreement) during the period
commencing 15 Business Days before such date and ending one day prior to such
date, or if the security is of a class registered under the Exchange Act for
less than 15 Business Days before such date, the average of the daily closing
bid prices (or such equivalent) for all Business Days before such date for which
daily closing bid prices are available (provided, however, that if the closing
bid price is not determinable for at least 10 Business Days in such period, then
clause (i) above and
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not this clause (ii) shall be used to determine Current Market Value); provided,
however, that if the Warrant Shares requested to be included in a Demand
Registration Statement shall be underlying an unexercised Warrant, then Current
Market Value shall be calculated as aforesaid, but shall have deducted therefrom
the exercise price of the related Warrant.
"Exercise Event" means, with respect to each Warrant as to which such event
is applicable, the earliest to occur of: (i) a Change of Control (as defined in
the Indenture), (ii) the 180th day (or such earlier date as determined by the
Company in its sole discretion) following an Initial Public Offering, (iii) a
class of equity securities of the Company is listed on a national securities
exchange or authorized for quotation on the Nasdaq National Market or is
otherwise subject to registration under the Exchange Act, or (iv) any date when
the Company (A) consolidates or merges into or with another Person (but only
where the holders of Common Stock receive consideration in exchange for all or
part of such Common Stock other than common stock of the surviving Person) or
(B) sells all or substantially all of its assets to another Person if the Common
Stock (or other securities) thereafter issuable upon exercise of the Warrants is
not registered under the Exchange Act; provided, that the events in (A) and (B)
will not be deemed to have occurred if the consideration for the Common Stock in
either such transaction consists solely of cash.
"Initial Public Offering" means a primary underwritten public offering (but
excluding any offering pursuant to Form S-8 under the Securities Act or any
other publicly registered offering pursuant to the Securities Act pertaining to
an issuance of Common Stock or securities exercisable therefor under any benefit
plan, employee compensation plan, or employee or director stock purchase plan)
of Common Stock by the Company pursuant to an effective registration statement
under the Securities Act.
"Public Offering" means an underwritten public offering of Common Stock by
the Company or one or more holders of the Common Stock pursuant to an effective
registration statement under the Securities Act.
"Transfer Restricted Warrant Securities" means each Warrant and/or Warrant
Share until the earlier to occur of (i) the date on which such Warrant and/or
Warrant Share has been effectively registered under the Securities Act and
disposed of in accordance with the Warrant Registration Statement or (ii) the
date on which such Warrant and/or Warrant Share is distributed to the public
pursuant to Rule 144 under the Securities Act or is eligible for resale pursuant
to Rule 144(k) under the Securities Act.
DESCRIPTION OF THE EXCHANGE NOTES
GENERAL
The Exchange Notes will be issued pursuant to an Indenture (the
"Indenture"), dated June 23, 1998 between the Company and Norwest Bank
Minnesota, National Association, as trustee (the "Trustee"). The Exchange Notes
will evidence the same indebtedness as the Private Notes (which they replace)
and will be entitled to the benefits of the Indenture. The form and terms of the
Exchange Notes are the same as the form and terms of the Private Notes except
that (i) the Exchange Notes will have been registered under the Securities Act,
and therefore, the Exchange Notes will not bear legends restricting the transfer
thereof and (ii) Holders of the Exchange Notes will not be entitled to certain
rights of Holders of Private Notes under the Registration Rights Agreement,
which rights will terminate upon the consummation of the Exchange Offer. The
terms of the Exchange Notes include those stated in the Indenture and those made
part of the Indenture by reference to the Trust Indenture Act of 1939 (the
"TIA"), as in effect on the date of the Indenture. The following is a summary of
the material provisions of the Indenture. Copies of the Indenture are available
as set forth below under "-- Additional Information." The definitions of certain
terms used in the following summary are set forth below under "-- Certain
Definitions."
The Notes will be general obligations of the Company, will be unsecured
(except as provided below) and will rank pari passu in right of payment with all
future unsecured senior Indebtedness of the Company. However, the operations of
the Company are conducted through its Subsidiaries and, therefore, the Company
is dependent upon the cash flow of its Subsidiaries to meet its obligations,
including its obligations under the Notes. The Company's Subsidiaries will not
be guarantors of the Notes and the Notes will be effectively
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subordinated to all current and future Indebtedness and other liabilities and
commitments (including trade payables and lease obligations) of the Company's
Subsidiaries. Any right of the Company to receive assets of any of its
Subsidiaries upon the latter's liquidation or reorganization (and the consequent
right of the Holders of the Notes to participate in those assets) will be
effectively subordinated to the claims of that Subsidiary's creditors, except to
the extent that the Company is itself recognized as a creditor of such
Subsidiary, in which case the claims of the Company would still be subordinate
to any security in the assets of such Subsidiary and any indebtedness of such
Subsidiary senior to that held by the Company. As of September 30, 1998, the
Company had approximately $114.7 million of Indebtedness outstanding and the
Company's Subsidiaries had approximately $764,000 of Indebtedness outstanding.
The Indebtedness of the Company includes the amount represented by the Notes.
Currently, no Indebtedness of the Company ranks senior in right of payment to
the Notes and $764,000 of Indebtedness of the Company's subsidiaries effectively
ranks senior in right of payment to the Notes. In addition, no Indebtedness of
the Company ranks pari passu in right of payment to the Notes. See "Risk
Factors -- Holding Company Structure; Effective Subordination and Ranking."
As of the date of the Indenture, all of the Company's Subsidiaries were
Restricted Subsidiaries. However, under certain circumstances, the Company is
able to designate current or future Subsidiaries as Unrestricted Subsidiaries.
Unrestricted Subsidiaries will not be subject to many of the restrictive
covenants set forth in the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The Notes will be limited in aggregate principal amount to $115.0 million
and will mature on June 15, 2008. The Notes bear interest at the rate of 14% per
annum and interest will be payable in U.S. dollars semiannually in arrears on
June 15 and December 15, commencing on December 15, 1998, to Holders of record
on the immediately preceding June 1 and December 1. Holders of record on such
record dates will become irrevocably entitled to receive accrued interest and
Liquidated Damages, if any, in respect of the interest period during which such
record date occurs as of the close of business on such record date. Interest on
the Notes will accrue from the most recent date to which interest has been paid
or, if no interest has been paid, from the date of original issuance. Interest
will be computed on the basis of a 360-day year comprised of twelve 30-day
months. Principal, premium, if any, and interest and Liquidated Damages, if any,
on the Notes will be payable at the office or agency of the Company maintained
for such purpose within the City and State of New York or, at the option of the
Company, payment of interest and Liquidated Damages may be made by check mailed
to the Holders of the Notes at their respective addresses set forth in the
register of Holders of Notes; provided that all payments of principal, premium,
interest and Liquidated Damages with respect to Notes having a principal amount
of at least $1.0 million the Holders of which have given wire transfer
instructions to the Company will be required to be made by wire transfer of
immediately available funds to the accounts in the United States specified by
the Holders thereof. Until otherwise designated by the Company, the Company's
office or agency in New York will be the office of the Trustee maintained for
such purpose. The Notes will be issued in denominations of $1,000 and integral
multiples thereof.
OPTIONAL REDEMPTION
Except as described below, the Notes will not be redeemable at the
Company's option prior to June 15, 2003. Thereafter, the Notes will be subject
to redemption at any time at the option of the Company, in whole or in part,
upon not less than 30 nor more than 60 days' notice, at the redemption prices
(expressed as percentages of principal amount) set forth below plus accrued and
unpaid interest and Liquidated Damages
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thereon, if any, to the applicable redemption date, if redeemed during the
twelve-month period beginning on of the years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- ---- ----------
<S> <C>
2003........................................................ 107.000%
2004........................................................ 104.667%
2005........................................................ 102.333%
2006 and thereafter......................................... 100.000%
</TABLE>
During the first 36 months after the date of original issuance of the
Notes, the Company may on any one or more occasions redeem up to 35% of the
originally issued aggregate principal amount of the Notes at a redemption price
of 114% of the principal amount thereof on the redemption date, plus accrued and
unpaid interest and Liquidated Damages thereon, if any, to the redemption date,
with the net cash proceeds of one or more Equity Offerings; provided that at
least 65% of the originally issued aggregate principal amount of the Notes
remains outstanding immediately after the occurrence of such redemption
(excluding Notes held by the Company or any of its Subsidiaries); and provided,
further, that notice of any such redemption shall be given within 60 days of the
date of the closing of such Equity Offering.
SELECTION AND NOTICE
If less than all of the Notes are to be redeemed at any time, selection of
Notes for redemption will be made by the Trustee in compliance with the
requirements of the principal national securities exchange, if any, on which the
Notes are listed, or, if the Notes are not so listed, on a pro rata basis, by
lot or by such method as the Trustee shall deem fair and appropriate; provided
that no Notes of $1,000 or less shall be redeemed in part. Notices of redemption
shall be mailed by first class mail at least 30 but not more than 60 days before
the redemption date to each Holder of Notes to be redeemed at its registered
address. Notices of redemption may not be conditional. If any Note is to be
redeemed in part only, the notice of redemption that relates to such Note shall
state the portion of the principal amount thereof to be redeemed. A new Note in
principal amount equal to the unredeemed portion thereof will be issued in the
name of the Holder thereof upon cancellation of the original Note. Notes called
for redemption become due on the date fixed for redemption. On and after the
redemption date, interest ceases to accrue on Notes or portions of them called
for redemption.
MANDATORY REDEMPTION
The Company is not required to make mandatory redemption or sinking fund
payments with respect to the Notes.
SECURITY
The Indenture required the Company to purchase and pledge to the Trustee,
as security for the benefit of the Holders of the Notes, Pledged Securities in
such amount as will be sufficient upon receipt of scheduled interest and/or
principal payments of such securities, in the opinion of a nationally recognized
firm of independent public accountants selected by the Company, to provide for
payment in full of the first six scheduled interest payments due on the Notes.
The Company used approximately $44.2 million of the net proceeds of the Private
Offering to acquire the Pledged Securities. See "Use of Proceeds." The Pledged
Securities were pledged by the Company to the Trustee for the benefit of the
Holders of the Notes pursuant to the Pledge Agreement and are held by the
Trustee in the Pledge Account pending disposition pursuant to the Pledge
Agreement. Pursuant to the Pledge Agreement, immediately prior to one of the
first six scheduled interest payment dates with respect to the Notes, the
Company may either (a) deposit with the Trustee from funds otherwise available
to the Company cash sufficient to pay the interest scheduled to be paid on such
date or (b) direct the Trustee to release from the Pledge Account proceeds
sufficient to pay interest then due. In the event that the Company exercises the
option under clause (a) above, the Company may thereafter direct the Trustee to
release to the Company proceeds or Pledged Securities from the Pledge Account in
like amount. A failure by the Company to pay interest on the Notes in a timely
manner through the first six
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scheduled interest payment dates will constitute an immediate Event of Default
under the Indenture, with no grace or cure period.
Interest earned on the Pledged Securities will be added to the Pledge
Account. In the event that the funds or Pledged Securities held in the Pledge
Account exceed the amount sufficient, in the opinion of a nationally recognized
firm of independent public accountants selected by the Company, to provide for
payment in full of the first six scheduled interest payments due on the Notes
(or, in the event an interest payment or payments have been made, an amount
sufficient to provide for payment in full of any interest payments remaining, up
to and including the sixth scheduled interest payment) the Trustee will be
permitted to release to the Company, at the Company's request, any such excess
amount.
The Notes will be secured by a first priority security interest in the
Pledged Securities and in the Pledge Account and, accordingly, the Pledged
Securities and the Pledge Account will also secure repayment of the principal
amount of and Liquidated Damages, if any, on the Notes to the extent of such
security.
Under the Pledge Agreement, assuming that the Company makes the first six
scheduled interest payments on the Notes in a timely manner, any remaining
Pledged Securities will be released from the Pledge Account and the Notes will
be unsecured.
REPURCHASE AT THE OPTION OF HOLDERS
Change of Control
Upon the occurrence of a Change of Control, each Holder of Notes will have
the right to require the Company to repurchase all or any part (equal to $1,000
or an integral multiple thereof) of such Holder's Notes pursuant to the offer
described below (the "Change of Control Offer") at an offer price in cash equal
to 101% of the principal amount thereof plus accrued and unpaid interest and
Liquidated Damages thereon, if any, to the date of purchase (the "Change of
Control Payment"). Within 60 days following any Change of Control, the Company
will mail a notice to each Holder describing the transaction or transactions
that constitute the Change of Control and offering to repurchase Notes on the
date specified in such notice, which date shall be no earlier than 30 days and
no later than 60 days from the date such notice is mailed (the "Change of
Control Payment Date"), pursuant to the procedures required by the Indenture and
described in such notice.
On the Change of Control Payment Date, the Company will, to the extent
lawful, (1) accept for payment all Notes or portions thereof properly tendered
pursuant to the Change of Control Offer, (2) deposit with the Paying Agent an
amount equal to the Change of Control Payment in respect of all Notes or
portions thereof so tendered and (3) deliver or cause to be delivered to the
Trustee the Notes so accepted together with an officers' certificate stating the
aggregate principal amount of Notes or portions thereof being purchased by the
Company. The Paying Agent will promptly mail to each Holder of Notes so tendered
the Change of Control Payment for such Notes, and the Trustee will promptly
authenticate and mail (or cause to be transferred by book entry) to each Holder
a new Note equal in principal amount to any unpurchased portion of the Notes
surrendered, if any; provided that each such new Note will be in a principal
amount of $1,000 or an integral multiple thereof.
The Change of Control provisions described above will be applicable whether
or not any other provisions of the Indenture are applicable. The Company will
comply, to the extent applicable, with the requirements of Section 14(e) of the
Exchange Act and any other securities laws or regulations applicable to any
Change of Control Offer. To the extent that the provisions of any such
securities laws or securities regulations conflict with the provisions of the
covenant described above, the Company will comply with the applicable securities
laws and regulations and will not be deemed to have breached its obligations
under the covenant described above by virtue thereof.
The Change of Control purchase feature is a result of negotiations between
the Company and the Initial Purchasers. Management has no present intention to
engage in a transaction involving a Change of Control, although it is possible
that the Company would decide to do so in the future. Subject to the limitations
discussed below, the Company could, in the future, enter into certain
transactions, including acquisitions,
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refinancings or other recapitalizations, that would not constitute a Change of
Control under the Indenture, but that could increase the amount of Indebtedness
outstanding at such time or otherwise affect the Company's capital structure.
Restrictions on the ability of the Company to incur additional Indebtedness are
contained in the covenants described under "-- Certain Covenants -- Incurrence
of Indebtedness and Issuance of Disqualified Stock," "-- Certain
Covenants -- Liens" and "-- Certain Covenants -- Sale and Leaseback
Transactions." Such restrictions can only be waived with the consent of the
Holders of a majority in principal amount of the Notes then outstanding. Except
for the limitations contained in such covenants, however, the Indenture does not
contain any covenants or provisions that may afford holders of the Notes
protection in the event of certain highly leveraged transactions.
Future Credit Facilities may limit the Company's access to the cash flow of
its Subsidiaries and may, therefore, restrict the Company's ability to purchase
any Notes. Such Credit Facilities may also provide that the occurrence of
certain change of control events with respect to the Company constitute a
default thereunder. In the event that a Change of Control occurs at a time when
the Company's Subsidiaries are prohibited from making distributions to the
Company to purchase Notes under the terms of any agreements governing future
Indebtedness of the Company and its Subsidiaries, the Company could cause its
Subsidiaries to seek the consent of the lenders under such agreements to allow
such distributions or could attempt to refinance the borrowings that contain
such prohibition. If the Company does not obtain such a consent or repay such
borrowings, the Company will remain prohibited from purchasing Notes. In such
case, the Company's failure to purchase tendered Notes would constitute an Event
of Default under the Indenture which would, in turn, constitute a default under
such agreements. Future Indebtedness of the Company and its Subsidiaries may
contain prohibitions on the occurrence of certain events that would constitute a
Change of Control or require such Indebtedness to be repurchased upon a Change
of Control. Moreover, the exercise by the holders of their right to require the
Company to repurchase the Notes could cause a default under such Indebtedness,
even if the Change of Control itself does not, due to the financial effect of
such repurchase on the Company. Finally, the Company's ability to pay cash to
the Holders of Notes following the occurrence of a Change of Control may be
limited by the Company's then existing financial resources, including its
ability to access the cash flow of its Subsidiaries. See "Risk
Factors -- Holding Company Structure; Effective Subordination and Ranking" and
"Risk Factors -- Repurchase of the Notes Upon a Change of Control." There can be
no assurance that sufficient funds will be available when necessary to make any
required repurchases.
The Company will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set forth
in the Indenture applicable to a Change of Control Offer made by the Company and
purchases all Notes validly tendered and not withdrawn under such Change of
Control Offer. The provisions under the Indenture relative to the Company's
obligation to make an offer to repurchase the Notes as a result of a Change of
Control may be waived or modified with the written consent of the Holders of a
majority in principal amount of the Notes then outstanding.
The definition of Change of Control includes a phrase relating to the sale,
lease, transfer, conveyance or other disposition of "all or substantially all"
of the assets of the Company and its Restricted Subsidiaries taken as a whole.
Although there is a limited body of case law interpreting the phrase
"substantially all," there is no precise established definition of the phrase
under applicable law. Accordingly, the ability of a Holder of Notes to require
the Company to repurchase such Notes as a result of a sale, lease, transfer,
conveyance or other disposition of less than all of the assets of the Company
and its Subsidiaries taken as a whole to another Person or group may be
uncertain.
Asset Sales
The Indenture provides that the Company may not, and may not permit any of
its Restricted Subsidiaries to, consummate an Asset Sale unless (i) the Company
(or the Restricted Subsidiary, as the case may be) receives consideration at the
time of such Asset Sale at least equal to the fair market value of the assets or
Equity Interests issued or sold or otherwise disposed of and (ii) at least 75%
of the consideration therefor received by the Company or such Restricted
Subsidiary is in the form of cash or Cash Equivalents; provided
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that the amount of (x) any liabilities (as shown on the Company's or such
Restricted Subsidiary's most recent balance sheet), of the Company or any
Restricted Subsidiary (other than contingent liabilities and liabilities that
are by their terms subordinated to the Notes or any guarantee thereof) that are
assumed by the transferee of any such assets pursuant to a binding written
agreement that releases the Company or such Restricted Subsidiary from further
liability and (y) any securities, notes or other obligations received by the
Company or any such Restricted Subsidiary from such transferee that are
converted by the Company or such Restricted Subsidiary into cash within 30 days
of the applicable Asset Sale (to the extent of the cash received), shall be
deemed to be cash for purposes of this provision.
Within 365 days after the receipt of any Net Proceeds from an Asset Sale,
the Company or the applicable Restricted Subsidiary may apply such Net Proceeds
to: (a) the reduction of Indebtedness under a Credit Facility; (b) the reduction
of other Indebtedness of any of the Company's Restricted Subsidiaries; (c) the
acquisition of all or substantially all the assets of a Telecommunications
Business; (d) the acquisition of Voting Stock of a Person engaged in a
Telecommunications Business from a Person that is not a Subsidiary of the
Company; provided, that, after giving effect thereto, the Person whose Voting
Stock was so acquired is a Restricted Subsidiary of the Company; or (e) the
making of a capital expenditure or the acquisition of other long-term assets
that are used or useful in a Telecommunications Business. Pending the final
application of any such Net Proceeds, the Company may temporarily reduce
revolving credit borrowings or otherwise invest such Net Proceeds in any manner
that is not prohibited by the Indenture. Any Net Proceeds from Asset Sales that
are not applied or invested as provided in the first sentence of this paragraph
will be deemed to constitute "Excess Proceeds." When the aggregate amount of
Excess Proceeds exceeds $5.0 million, the Company will be required to make an
offer to all Holders of Notes and all holders of other senior Indebtedness of
the Company containing provisions similar to those set forth in the Indenture
with respect to offers to purchase or redeem with the proceeds of sales of
assets (an "Asset Sale Offer") to purchase the maximum principal amount of Notes
and such other senior Indebtedness of the Company that may be purchased out of
the Excess Proceeds, at an offer price in cash in an amount equal to 100% of the
principal amount thereof plus accrued and unpaid interest and Liquidated Damages
thereon, if any, to the date of purchase, in accordance with the procedures set
forth in the Indenture and such other senior Indebtedness of the Company. To the
extent that any Excess Proceeds remain after consummation of an Asset Sale
Offer, the Company may use such Excess Proceeds for any purpose not otherwise
prohibited by the Indenture. If the aggregate principal amount of Notes and such
other senior Indebtedness of the Company tendered into such Asset Sale Offer
surrendered by Holders thereof exceeds the amount of Excess Proceeds, the
Trustee shall select the Notes and such other senior Indebtedness to be
purchased on a pro rata basis. Upon completion of such offer to purchase, the
amount of Excess Proceeds shall be reset at zero.
CERTAIN COVENANTS
Restricted Payments
The Indenture provides that the Company may not, and may not permit any of
its Restricted Subsidiaries to, directly or indirectly: (i) declare or pay any
dividend or make any other payment or distribution on account of the Company's
or any of its Restricted Subsidiaries' Equity Interests (including, without
limitation, any payment in connection with any merger or consolidation involving
the Company or any of its Restricted Subsidiaries) or to the direct or indirect
holders of the Company's or any of its Restricted Subsidiaries' Equity Interests
in their capacity as such (other than cash to the extent required to pay for
fractional shares of such Equity Interests (other than Disqualified Stock),
dividends or distributions payable in Equity Interests (other than Disqualified
Stock) of the Company or to the Company or a Restricted Subsidiary of the
Company and other than dividends, payments or other distributions on or with
respect to any Equity Interests of any Restricted Subsidiary of the Company to
the holders of its Equity Interests on a pro rata basis); (ii) purchase, redeem
or otherwise acquire or retire for value (including without limitation, in
connection with any merger or consolidation involving the Company) any Equity
Interests of the Company or any direct or indirect parent of the Company (other
than any such Equity Interests owned by the Company or any Restricted Subsidiary
of the Company); (iii) make any payment on or with respect to, or purchase,
redeem, defease or otherwise acquire or retire for value any Indebtedness that
is subordinated to the Notes, except a payment of interest or
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principal at Stated Maturity; or (iv) make any Restricted Investment (all such
payments and other actions set forth in clauses (i) through (iv) above being
collectively referred to as "Restricted Payments"), unless, at the time of and
after giving effect to such Restricted Payment:
(a) no Default or Event of Default shall have occurred and be
continuing or would occur as a consequence thereof; and
(b) the Company would have been permitted to incur at least $1.00 of
additional Indebtedness pursuant to the Debt to Consolidated Cash Flow
Ratio test set forth in the first paragraph of the covenant described below
under the caption "-- Incurrence of Indebtedness and Issuance of
Disqualified Stock;" and
(c) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by the Company and its Restricted
Subsidiaries after the date of the Indenture (excluding Restricted Payments
permitted by clauses (ii) through (v) of the next succeeding paragraph), is
less than the sum, without duplication, of (i) 50% of the Consolidated Net
Income of the Company for the period (taken as one accounting period) from
the beginning of the first fiscal quarter commencing after the date of the
Indenture to the end of the Company's most recently ended fiscal quarter
for which internal financial statements are available at the time of such
Restricted Payment (or, if such Consolidated Net Income for such period is
a deficit, less 100% of such deficit), plus (ii) 100% of the aggregate net
cash proceeds received by the Company since the date of the Indenture as a
contribution to its common equity capital or from the issue or sale of
Equity Interests of the Company (other than Disqualified Stock and except
to the extent such net cash proceeds are used to incur new Indebtedness
outstanding pursuant to clause (ix) of the second paragraph of the covenant
described below under the caption "-- Incurrence of Indebtedness and
Issuance of Disqualified Stock") or from the issue or sale of Disqualified
Stock or debt securities of the Company that have been converted into such
Equity Interests (other than Equity Interests (or Disqualified Stock or
convertible debt securities) sold to a Subsidiary of the Company and other
than Disqualified Stock or convertible debt securities that have been
converted into Disqualified Stock), plus (iii) to the extent that any
Restricted Investment that was made after the date of the Indenture is sold
for cash or otherwise liquidated or repaid for cash, the lesser of (A) the
cash return of capital with respect to such Restricted Investment (less the
cost of disposition, if any) and (B) the initial amount of such Restricted
Investment, plus (iv) to the extent that any Unrestricted Subsidiary of the
Company is designated as a Restricted Subsidiary after the date of the
Indenture, the lesser of (A) the fair market value of the Company's
Investment in such Subsidiary as of the date of such designation, or (B)
the sum of (x) the fair market value of the Company's Investment in such
Subsidiary as of the date on which such Subsidiary was originally
designated as an Unrestricted Subsidiary and (y) the amount of any
Investments made in such Subsidiary subsequent to such designation (and
treated as a Restricted Payment) by the Company or any Restricted
Subsidiary, plus (v) 50% of any dividends received by the Company or a
Restricted Subsidiary after the date of the Indenture from an Unrestricted
Subsidiary of the Company, to the extent that such dividends were not
otherwise included in Consolidated Net Income of the Company for such
period.
The foregoing provisions do not prohibit (i) the payment of any dividend
within 60 days after the date of declaration thereof, if at said date of
declaration such payment would have complied with the provisions of the
Indenture; (ii) the making of any Investment or the redemption, repurchase,
retirement, defeasance or other acquisition of any subordinated Indebtedness or
Equity Interests of the Company in exchange for, or out of the net cash proceeds
of the substantially concurrent sale (other than to a Subsidiary of the Company)
of, any Equity Interests of the Company (other than any Disqualified Stock;
provided that such net cash proceeds are not used to incur new Indebtedness
pursuant to clause (ix) of the second paragraph of the covenant described below
under the caption "-- Incurrence of Indebtedness and Issuance of Disqualified
Stock"); and provided further that, in each such case, the amount of any such
net cash proceeds that are so utilized shall be excluded from clause (c)(ii) of
the preceding paragraph; (iii) the defeasance, redemption, repurchase or other
acquisition of subordinated Indebtedness with the net cash proceeds from an
incurrence of Permitted Refinancing Indebtedness; (iv) payments or distributions
to dissenting stockholders, pursuant to applicable law, pursuant to or in
connection with a consolidation, merger or transfer of assets that complies with
the
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provisions of the Indenture applicable to mergers, consolidations and transfers
of all or substantially all of the property and assets of the Company; and (v)
the repurchase, retirement or other acquisition or retirement for value of
Equity Interests of the Company that is held by any current or former employee,
director or consultant (or their estates or the beneficiaries of such estates)
of the Company or any Subsidiary, not to exceed (A) $1.0 million in any calendar
year or (B) $5.0 million in aggregate.
The Board of Directors of the Company may designate any Restricted
Subsidiary to be an Unrestricted Subsidiary if such designation would not cause
a Default or Event of Default; provided that in no event shall the businesses
operated by the Company's Restricted Subsidiaries as of the date of the
Indenture be transferred to or held by an Unrestricted Subsidiary. For purposes
of making such determination, all outstanding Investments by the Company and its
Restricted Subsidiaries (except to the extent repaid in cash) in the Subsidiary
so designated will be deemed to be Restricted Payments at the time of such
designation and will reduce the amount available for Restricted Payments under
the first paragraph of this covenant. All such outstanding Investments will be
deemed to constitute Investments in an amount equal to the fair market value of
such Investments at the time of such designation. Such designation will only be
permitted if such Restricted Payment would be permitted at such time and if such
Restricted Subsidiary otherwise meets the definition of an Unrestricted
Subsidiary. The Board of Directors of the Company may designate any Unrestricted
Subsidiary to be a Restricted Subsidiary if such designation would not cause a
Default or Event of Default.
The amount of all Restricted Payments (other than cash) shall be the fair
market value on the date of the Restricted Payment of the asset(s) or securities
proposed to be transferred or issued by the Company or the applicable Restricted
Subsidiary, as the case may be, pursuant to the Restricted Payment.
Incurrence of Indebtedness and Issuance of Disqualified Stock
The Indenture provides that the Company may not, and may not permit any of
its Restricted Subsidiaries to, directly, or indirectly, create, incur, issue,
assume, guarantee or otherwise become directly or indirectly liable,
contingently or otherwise, with respect to (collectively, "incur") any
Indebtedness (including Acquired Debt) and that the Company may not issue any
Disqualified Stock and may not permit any of its Restricted Subsidiaries to
issue any shares of preferred stock; provided, however, that the Company may
incur Indebtedness (including Acquired Debt) or issue shares of Disqualified
Stock and the Company's Restricted Subsidiaries may incur Eligible Indebtedness
if, in each case, (i) no Default or Event of Default shall have occurred and be
continuing or would occur as a consequence thereof and (ii) the Debt to
Consolidated Cash Flow Ratio at the time of incurrence of such Indebtedness or
the issuance of such Disqualified Stock, after giving pro forma effect to such
incurrence or issuance as of such date and to the use of proceeds therefrom as
if the same had occurred at the beginning of the most recently ended four full
fiscal quarter period of the Company for which internal financial statements are
available, would have been no greater than 5.5 to 1.
The provisions of the first paragraph of this covenant do not apply to the
incurrence of any of the following items of Indebtedness (collectively,
"Permitted Debt"):
(i) the incurrence by the Company or any of its Restricted
Subsidiaries of Indebtedness under Credit Facilities in an aggregate
principal amount (with letters of credit being deemed to have a principal
amount equal to the maximum potential liability of the Company and its
Restricted Subsidiaries thereunder) at any one time outstanding not to
exceed the greater of (x) $50.0 million less the aggregate amount of all
Net Proceeds of Asset Sales applied to repay Indebtedness under a Credit
Facility pursuant to the covenant described above under the caption
"-- Repurchase at the Option of Holders -- Asset Sales" and (y) 80% of the
Eligible Receivables that are outstanding as of such date of incurrence;
(ii) the incurrence by the Company and its Restricted Subsidiaries of
Existing Indebtedness;
(iii) the incurrence by the Company of Indebtedness represented by the
Notes and the Exchange Notes;
(iv) the incurrence by the Company or any of its Restricted
Subsidiaries of Indebtedness to finance the cost (including the cost of
design, development, acquisition, construction, installation, improvement,
transportation or integration) to acquire equipment, inventory or network
assets (including acquisitions of
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the Capital Stock of a Person that is or becomes a Restricted Subsidiary of
the Company to the extent of the fair market value of the equipment,
inventory or network assets so acquired) after the date of the Indenture;
(v) the incurrence by the Company or any of its Restricted
Subsidiaries of Permitted Refinancing Indebtedness in exchange for, or the
net proceeds of which are used to extend, refinance, renew, replace,
defease or refund Indebtedness (other than intercompany Indebtedness) that
was permitted by the Indenture to be incurred under the first paragraph
hereof or clauses (ii) through (v) of this paragraph;
(vi) the incurrence by the Company or any of its Restricted
Subsidiaries of intercompany Indebtedness between or among the Company and
any of its Restricted Subsidiaries; provided, however, that (i) if the
Company is the obligor on such Indebtedness, such Indebtedness is expressly
subordinated to the prior payment in full in cash of all Obligations with
respect to the Notes and (ii)(A) any subsequent issuance or transfer of
Equity Interests that results in any such Indebtedness being held by a
Person other than the Company or a Restricted Subsidiary and (B) any sale
or other transfer of any such Indebtedness to a Person that is not either
the Company or a Restricted Subsidiary shall be deemed, in each case, to
constitute an incurrence of such Indebtedness by the Company or such
Restricted Subsidiary, as the case may be, not permitted by this clause
(vi) of this paragraph;
(vii) the incurrence by the Company or any of its Restricted
Subsidiaries of Hedging Obligations that are incurred for the purpose of
fixing or hedging interest rate risk with respect to any floating rate
Indebtedness that is permitted by the terms of the Indenture to be
outstanding or currency exchange risk;
(viii) the guarantee by the Company or any of its Restricted
Subsidiaries of Indebtedness of the Company or a Restricted Subsidiary of
the Company that was permitted to be incurred by another provision of the
Indenture;
(ix) the incurrence by the Company of Indebtedness or by a Restricted
Subsidiary of the Company of Acquired Debt not to exceed, at any one time
outstanding the sum of (A) 2.0 times the aggregate net cash proceeds
received by the Company after the Closing Date from the issuance and sale
of its Common Stock (other than Disqualified Stock) to a Person that is not
a Subsidiary of the Company, to the extent such net cash proceeds have not
been used pursuant to clause (c)(ii) of the first paragraph or clause (ii)
of the second paragraph of the covenant described above under the caption
"-- Restricted Payments" to make a Restricted Payment and (B) the fair
market value of assets (other than cash and Cash Equivalents) that are used
or useful in a Telecommunications Business or Capital Stock of a Person
engaged in a Telecommunications Business that is or becomes a Restricted
Subsidiary of the Company, in each case, received by the Company after the
Closing Date from the issuance and sale of its Common Stock (other than
Disqualified Stock) to a Person that is not a Subsidiary of the Company, to
the extent such issuance and sale of Common Stock has not been used
pursuant to clause (ii) of the second paragraph of the covenant described
above under the caption "-- Restricted Payments" to effect a Restricted
Payment; and provided further that such Indebtedness (other than Acquired
Debt) does not mature prior to the Stated Maturity of the Notes and the
Weighted Average Life to Maturity of such Indebtedness is longer than that
of the Notes;
(x) the incurrence by the Company of Indebtedness, to the extent that
the net proceeds thereof are promptly (A) used to repurchase Notes tendered
in a Change of Control Offer or (B) deposited to defease all of the Notes
as described below under "-- Legal Defeasance and Covenant Defeasance;" and
(xi) the incurrence by the Company or any of its Restricted
Subsidiaries of additional Indebtedness in an aggregate principal amount
(or accreted value, as applicable) at any time outstanding, not to exceed
$50.0 million.
The Indenture also provides that (i) the Company may not incur any
Indebtedness that is contractually subordinated in right of payment to any other
Indebtedness of the Company unless such Indebtedness is also contractually
subordinated in right of payment to the Notes on substantially identical terms;
provided, however, that no Indebtedness of the Company shall be deemed to be
contractually subordinated in right of
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payment to any other Indebtedness of the Company solely by virtue of being
unsecured and (ii) the Company may not permit any of its Unrestricted
Subsidiaries to incur any Indebtedness other than Non-Recourse Debt.
For purposes of determining compliance with this covenant, in the event
that an item of Indebtedness meets the criteria of more than one of the
categories of Permitted Debt described in clauses (i) through (xi) above or is
entitled to be incurred pursuant to the first paragraph of this covenant, the
Company shall, in its sole discretion, be permitted to classify such item of
Indebtedness in any manner that complies with this covenant and may from time to
time reclassify such item of Indebtedness in any manner that would comply with
this covenant at the time of reclassification. Accrual of interest, accrual of
dividends, accretion or amortization of original issue discount, the payment of
interest in the form of additional Indebtedness, and the payment of dividends in
the form of additional shares of Disqualified Stock will not be deemed to be an
incurrence of Indebtedness or an issuance of Disqualified Stock, as the case may
be, for purposes of this covenant.
Liens
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, directly or indirectly, create, incur, assume
or suffer to exist any Lien securing Indebtedness or trade payables on any asset
now owned or hereafter acquired, or any income or profits therefrom or assign or
convey any right to receive income therefrom, except Permitted Liens.
Dividend and Other Payment Restrictions Affecting Subsidiaries
The Indenture provides that the Company may not, and may not permit any of
its Restricted Subsidiaries to, directly or indirectly, create or otherwise
cause or suffer to exist or become effective any encumbrance or restriction on
the ability of any Restricted Subsidiary to (i)(a) pay dividends or make any
other distributions to the Company or any of its Restricted Subsidiaries (1) on
its Capital Stock or (2) with respect to any other interest or participation in,
or measured by, its profits, or (b) pay any indebtedness owed to the Company or
any of its Restricted Subsidiaries, (ii) make loans or advances to the Company
or any of its Restricted Subsidiaries or (iii) transfer any of its properties or
assets to the Company or any of its Restricted Subsidiaries. However, the
foregoing restrictions will not apply to encumbrances or restrictions existing
under or by reason of (a) Existing Indebtedness as in effect on the date of the
Indenture, and any amendments, modifications, restatements, renewals, increases,
supplements, refundings, replacements or refinancings thereof; provided that
such amendments, modifications, restatements, renewals, increases, supplements,
refundings, replacements or refinancings are no more restrictive, taken as a
whole, with respect to such dividend and other payment restrictions than those
contained in the applicable series of Existing Indebtedness as in effect on the
date of the Indenture, (b) any Indebtedness or any agreement pursuant to which
such Indebtedness was issued if (A) the encumbrance or restriction either (1)
applies only in the event of a payment default or a default with respect to a
financial covenant contained in such Indebtedness or agreement or (2) is
contained in one or more Credit Facilities, and (B) the encumbrance or
restriction is not materially more disadvantageous to the holders of the Notes
than is customary in comparable financings (as determined in good faith by the
Company) based on market conditions prevailing at the time such encumbrance or
restriction is created, (c) the Indenture and the Notes, (d) applicable law, (e)
any instrument governing Indebtedness or Capital Stock of a Person acquired by
the Company or any of its Restricted Subsidiaries as in effect at the time of
such acquisition (except to the extent such Indebtedness was incurred in
connection with or in contemplation of such acquisition), which encumbrance or
restriction is not applicable to any Person, or the properties or assets of any
Person, other than the Person, or the property or assets of the Person, so
acquired, provided that, in the case of Indebtedness, such Indebtedness was
permitted by the terms of the Indenture to be incurred, (f) customary
non-assignment provisions in leases or licenses entered into in the ordinary
course of business, (g) purchase money obligations for property acquired in the
ordinary course of business that impose restrictions of the nature described in
clause (iii) above on the property so acquired, (h) any agreement for the sale
of a Restricted Subsidiary that restricts that Restricted Subsidiary pending its
sale, (i) Permitted Refinancing Indebtedness, provided that the restrictions
contained in the agreements governing such Permitted Refinancing Indebtedness
are no more restrictive than those contained in the
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agreements governing the Indebtedness being refinanced, (j) Liens permitted to
be incurred pursuant to the provisions of the covenant described under the
caption "-- Liens" that limit the right of the debtor to transfer the assets
subject to such Liens, and (k) customary provisions with respect to the
disposition or distribution of assets or property in joint venture agreements
and other similar agreements.
Merger, Consolidation or Sale of Assets
The Indenture provides that the Company may not consolidate or merge with
or into (whether or not the Company is the surviving corporation), or sell,
assign, transfer, lease, convey or otherwise dispose of all or substantially all
of its properties or assets in one or more related transactions, to another
corporation, Person or entity unless (i) the Company is the surviving
corporation or the entity or the Person formed by or surviving any such
consolidation or merger (if other than the Company) or to which such sale,
assignment, transfer, lease, conveyance or other disposition shall have been
made is a corporation organized or existing under the laws of the United States,
any state thereof or the District of Columbia; (ii) the entity or Person formed
by or surviving any such consolidation or merger (if other than the Company) or
the entity or Person to which such sale, assignment, transfer, lease, conveyance
or other disposition shall have been made assumes all the obligations of the
Company under the Notes and the Indenture pursuant to a supplemental indenture
in a form reasonably satisfactory to the Trustee; (iii) immediately after such
transaction no Default or Event of Default exists; and (iv) except in the case
of a merger of the Company with or into a Wholly Owned Restricted Subsidiary of
the Company and except in the case of a merger entered into solely for the
purpose of reincorporating the Company in another jurisdiction, the Company or
the entity or Person formed by or surviving any such consolidation or merger (if
other than the Company), or to which such sale, assignment, transfer, lease,
conveyance or other disposition shall have been made (A) will, immediately after
giving pro forma effect to such transaction, have a Consolidated Net Worth equal
to or greater than the Consolidated Net Worth of the Company immediately prior
to such transaction and (B) will, at the time of such transaction and after
giving pro forma effect thereto as if such transaction had occurred at the
beginning of the applicable four-quarter period, be permitted to incur at least
$1.00 of additional Indebtedness pursuant to the Debt to Consolidated Cash Flow
Ratio test set forth in the first paragraph of the covenant described above
under the caption "-- Incurrence of Indebtedness and Issuance of Disqualified
Stock."
Transactions with Affiliates
The Indenture provides that the Company may not, and may not permit any of
its Restricted Subsidiaries to, make any payment to, or sell, lease, transfer or
otherwise dispose of any of its properties or assets to, or purchase any
property or assets from, or enter into or make or amend any transaction,
contract, agreement, understanding, loan, advance or guarantee with, or for the
benefit of, any Affiliate (each of the foregoing, an "Affiliate Transaction"),
unless (i) such Affiliate Transaction is on terms that are no less favorable to
the Company or the relevant Restricted Subsidiary than those that would have
been obtained in a comparable transaction by the Company or such Restricted
Subsidiary with an unrelated Person and (ii) the Company delivers to the Trustee
(a) with respect to any Affiliate Transaction or series of related Affiliate
Transactions involving aggregate consideration in excess of $1.0 million, a
resolution of the Board of Directors of the Company set forth in an officers'
certificate certifying that such Affiliate Transaction complies with clause (i)
above and that such Affiliate Transaction has been approved by a majority of the
disinterested members of the Board of Directors of the Company and (b) with
respect to any Affiliate Transaction or series of related Affiliate Transactions
involving aggregate consideration in excess of $5.0 million, an opinion as to
the fairness to the Holders of such Affiliate Transaction from a financial point
of view issued by a nationally recognized investment banking firm (or, if no
such investment banking firm is qualified to issue such an opinion, by a
nationally recognized appraisal firm or public accounting firm). Notwithstanding
the foregoing, the following items shall not be deemed to be Affiliate
Transactions: (i) any employment arrangements with any executive officer of the
Company or a Restricted Subsidiary that is entered into by the Company or any of
its Restricted Subsidiaries in the ordinary course of business and consistent
with past practice, (ii) transactions between or among the Company and/or its
Restricted Subsidiaries, (iii) payment of directors fees in an aggregate annual
amount not to exceed $25,000 per Person, (iv) Restricted Payments that are
permitted by the provisions of
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the Indenture described above under the caption "-- Restricted Payments," and
(v) the issuance or sale of Equity Interests (other than Disqualified Stock) of
the Company.
Sale and Leaseback Transactions
The Indenture provides that the Company may not, and may not permit any of
its Restricted Subsidiaries to, enter into any sale and leaseback transaction;
provided that the Company or any of its Restricted Subsidiaries may enter into a
sale and leaseback transaction if (i) the Company or such Restricted Subsidiary,
as applicable, could have (a) incurred Indebtedness in an amount equal to the
Attributable Debt relating to such sale and leaseback transaction pursuant to
the Debt to Consolidated Cash Flow Ratio test set forth in the first paragraph
of the covenant described above under the caption "-- Incurrence of Indebtedness
and Issuance of Disqualified Stock" and (b) incurred a Lien to secure such
Indebtedness pursuant to the covenant described above under the caption
"-- Liens," (ii) the gross cash proceeds of such sale and leaseback transaction
are at least equal to the fair market value of the property that is the subject
of such sale and leaseback transaction and (iii) the transfer of assets in such
sale and leaseback transaction is permitted by, and the Company applies the
proceeds of such transaction in compliance with, the covenant described above
under the caption "-- Repurchase at the Option of Holders -- Asset Sales."
Limitation on Issuances and Sales of Equity Interests of Restricted
Subsidiaries
The Indenture provides that the Company (i) may not, and may not permit any
Restricted Subsidiary of the Company to, transfer, convey, sell, lease or
otherwise dispose of any Equity Interests in any Restricted Subsidiary of the
Company to any Person (other than the Company or a Wholly Owned Restricted
Subsidiary of the Company) and (ii) will not permit any Restricted Subsidiary of
the Company to issue any of its Equity Interests (other than, if necessary,
shares of its Capital Stock constituting directors' qualifying shares) to any
Person other than to the Company or a Wholly Owned Restricted Subsidiary of the
Company, unless, in each such case: (a) as a result of such transfer,
conveyance, sale, lease or other disposition or issuance such Restricted
Subsidiary no longer constitutes a Subsidiary and (b) the Net Proceeds from such
transfer, conveyance, sale, lease or other disposition or issuance are applied
in accordance with the covenant described above under the caption "-- Repurchase
at the Option of Holders -- Asset Sales."
Limitations on Issuances of Guarantees of Indebtedness
The Indenture provides that the Company may not permit any Restricted
Subsidiary, directly or indirectly, to Guarantee or pledge any assets to secure
the payment of any other Indebtedness of the Company unless such Subsidiary
simultaneously executes and delivers a supplemental indenture to the Indenture
providing for the Guarantee of the payment of the Notes by such Subsidiary,
which Guarantee shall be senior to or pari passu with such Subsidiary's
Guarantee of or pledge to secure such other Indebtedness. Notwithstanding the
foregoing, any such Guarantee by a Subsidiary of the Notes shall provide by its
terms that it shall be automatically and unconditionally released and discharged
upon any sale, exchange or transfer, to any Person other than a Subsidiary of
the Company, of all of the Company's Equity Interests in, or all or
substantially all the assets of, such Subsidiary, which sale, exchange or
transfer is made in compliance with the applicable provisions of the Indenture.
The form of such Guarantee will be attached as an exhibit to the Indenture. The
Indenture allows the Company to designate current or future subsidiaries as
Unrestricted Subsidiaries. See "-- Certain Definitions -- Unrestricted
Subsidiary."
Business Activities
The Company may not, and may not permit any Restricted Subsidiary of the
Company to, engage in any business other than a Telecommunications Business,
except to such extent as would not be material to the Company and its Restricted
Subsidiaries taken as a whole.
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Reports
The Indenture provides that, whether or not required by the rules and
regulations of the Commission, so long as any Notes are outstanding, the Company
must furnish to the Holders of Notes (i) all quarterly and annual financial
information that would be required to be contained in a filing with the
Commission on Forms 10-Q and 10-K if the Company were required to file such
Forms, including a "Management's Discussion and Analysis of Financial Condition
and Results of Operations" that describes the financial condition and results of
operations of the Company and its consolidated Subsidiaries (showing in
reasonable detail, in the footnotes to the financial statements and in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" (in each case to the extent not prohibited by the Commission's rules
and regulations), the financial condition and results of operations of the
Company and its Restricted Subsidiaries separate from the financial condition
and results of operations of the Unrestricted Subsidiaries of the Company and,
with respect to the annual information only, a report thereon by the Company's
certified independent accountants and (ii) all current reports that would be
required to be filed with the Commission on Form 8-K if the Company were
required to file such reports, in each case within the time periods specified in
the Commission's rules and regulations; provided, however, that with respect to
quarterly information relating to the fiscal quarter of the Company ending on
June 30, 1998, the Company shall not be required to furnish such quarterly
information to the Holders of the Notes until 60 days after the end of such
quarter. In addition, following the consummation of the exchange offer
contemplated by the Registration Rights Agreement, whether or not required by
the rules and regulations of the Commission, the Company must file a copy of all
such information and reports with the Commission for public availability within
the time periods specified in the Commission's rules and regulations (unless the
Commission will not accept such a filing) and make such information available to
securities analysts and prospective investors upon request. In addition, the
Company must, for so long as any Notes remain outstanding, furnish to the
Holders and to securities analysts and prospective investors, upon their
request, the information required to be delivered pursuant to Rule 144A(d)(4)
under the Securities Act.
EVENTS OF DEFAULT AND REMEDIES
The Indenture provides that each of the following constitutes an Event of
Default: (i) default in the payment of interest or Liquidated Damages, if any,
on the Notes when due and payable as to any Interest Payment Date falling on or
prior to June 15, 2001; (ii) default in the payment of interest or Liquidated
Damages, if any, on the Notes when due and payable as to any Interest Payment
Date falling after June 15, 2001, and any such failure continues for 30 days;
(iii) default in payment when due of the principal of or premium, if any, on the
Notes; (iv) failure by the Company or any of its Subsidiaries to comply with the
provisions described under the caption "-- Certain Covenants -- Merger,
Consolidation or Sale of Assets" or failure by the Company to consummate a
Change of Control Offer or Asset Sale Offer in accordance with the provisions of
the Indenture applicable thereto; (v) failure by the Company or any of its
Subsidiaries for 30 days after notice to comply with any of its other agreements
in the Indenture or the Notes; (vi) default under any mortgage, indenture or
instrument under which there may be issued or by which there may be secured or
evidenced any Indebtedness for money borrowed by the Company or any of its
Restricted Subsidiaries (or the payment of which is guaranteed by the Company or
any of its Restricted Subsidiaries) whether such Indebtedness or guarantee now
exists, or is created after the date of the Indenture, which default (a) is
caused by a failure to pay principal of or premium, if any, or interest on such
Indebtedness prior to the expiration of the grace period provided in such
Indebtedness on the date of such default (a "Payment Default") or (b) results in
the acceleration of such Indebtedness prior to its express maturity and, in each
case, the principal amount of any such Indebtedness, together with the principal
amount of any other such Indebtedness under which there has been a Payment
Default or the maturity of which has been so accelerated, aggregates $5.0
million or more; (vii) failure by the Company or any of its Restricted
Subsidiaries to pay final judgments aggregating in excess of $5.0 million, which
judgments are not paid, discharged or stayed for a period of 60 days; (viii) the
Company asserts in writing that the Pledge Agreement ceases to be in full force
and effect before payment in full of the obligations thereunder; or (ix) certain
events of bankruptcy or insolvency with respect to the Company or any of its
Restricted Subsidiaries.
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If any Event of Default occurs and is continuing, the Trustee or the
Holders of at least 25% in principal amount of the then outstanding Notes may
declare all the Notes to be due and payable immediately. Notwithstanding the
foregoing, in the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to the Company, all outstanding Notes
will become due and payable without further action or notice. Holders of the
Notes may not enforce the Indenture or the Notes except as provided in the
Indenture. Subject to certain limitations, Holders of a majority in principal
amount of the then outstanding Notes may direct the Trustee in its exercise of
any trust or power.
In the case of any Event of Default occurring by reason of any willful
action (or inaction) taken (or not taken) by or on behalf of the Company with
the intention of avoiding payment of the premium that the Company would have had
to pay if the Company then had elected to redeem the Notes pursuant to the
optional redemption provisions of the Indenture, an equivalent premium shall
also become due and payable immediately to the extent permitted by law upon the
acceleration of the Notes. If an Event of Default occurs prior to June 15, 2003
by reason of any willful action (or inaction) taken (or not taken) by or on
behalf of the Company with the intention of avoiding the prohibition on
redemption of the Notes prior to June 15, 2003, then the premium specified in
the Indenture shall also become due and payable immediately to the extent
permitted by law upon the acceleration of the Notes.
The Holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee may on behalf of the Holders of all of the
Notes waive any existing Default or Event of Default and its consequences under
the Indenture except a continuing Default or Event of Default in the payment of
interest on, or the principal of, the Notes.
The Indenture provides that if a Default or Event of Default occurs and is
continuing and is known to the Trustee, the Trustee must mail to each Holder of
the Notes notice of the Default or Event of Default within 90 days after it
occurs. Except in the case of a Default or Event of Default in the payment of
principal of or interest on any Note, the Trustee may withhold notice if and so
long as a committee of its trust officers determines that withholding notice is
not opposed to the interest of the holders of the Notes. In addition, the
Company is required to deliver to the Trustee, within 90 days after the end of
each fiscal year, an officers' certificate indicating whether the signers
thereof know of any Default or Event of Default that occurred during the
previous year. The Company is also required to deliver to the Trustee, forthwith
after the occurrence thereof, written notice of any event that would constitute
a Default or Event of Default, the status thereof and what action the Company is
taking or proposes to take in respect thereof.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company,
as such, has any liability for any obligations of the Company under the Notes,
the Indenture or for any claim based on, in respect of, or by reason of, such
obligations or their creation. Each Holder of Notes by accepting a Note waives
and releases all such liability. The waiver and release are part of the
consideration for issuance of the Notes. Such waiver may not be effective to
waive liabilities under the federal securities laws and it is the view of the
Commission that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance") except for (i) the rights of Holders of outstanding Notes to
receive payments in respect of the principal of, premium, if any, and interest
and Liquidated Damages on such Notes when such payments are due from the trust
referred to below, (ii) the Company's obligations with respect to the Notes
concerning issuing temporary Notes, registration of Notes, mutilated, destroyed,
lost or stolen Notes and the maintenance of an office or agency for payment and
money for security payments held in trust, (iii) the rights, powers, trusts,
duties and immunities of the Trustee, and the Company's obligations in
connection therewith and (iv) the Legal Defeasance provisions of the Indenture.
In addition, the Company may, at its option and at any time, elect to have the
obligations of the Company released with respect to certain covenants that are
described in the Indenture ("Covenant Defeasance") and
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thereafter any omission to comply with such obligations shall not constitute a
Default or Event of Default with respect to the Notes. In the event Covenant
Defeasance occurs, certain events (not including non-payment and bankruptcy,
receivership, rehabilitation and insolvency events with respect to the Company)
described under "-- Events of Default and Remedies" will no longer constitute an
Event of Default with respect to the Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i)
the Company must irrevocably deposit with the Trustee, in trust, for the benefit
of the Holders of the Notes, cash in United States dollars, non-callable U.S.
Government Obligations, or a combination thereof, in such amounts as will be
sufficient, in the opinion of a nationally recognized firm of independent public
accountants, to pay the principal of, premium, if any, and interest and
Liquidated Damages on the outstanding Notes on the stated maturity or on the
applicable redemption date, as the case may be, and the Company must specify
whether the Notes are being defeased to maturity or to a particular redemption
date; (ii) in the case of Legal Defeasance, the Company shall have delivered to
the Trustee an opinion of counsel in the United States reasonably acceptable to
the Trustee confirming that (A) the Company has received from, or there has been
published by, the Internal Revenue Service a ruling or (B) since the date of the
Indenture, there has been a change in the applicable federal income tax law, in
either case to the effect that, and based thereon such opinion of counsel shall
confirm that, the Holders of the outstanding Notes will not recognize income,
gain or loss for federal income tax purposes as a result of such Legal
Defeasance and will be subject to federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if such Legal
Defeasance had not occurred; (iii) in the case of Covenant Defeasance, the
Company shall have delivered to the Trustee an opinion of counsel in the United
States reasonably acceptable to the Trustee confirming that the Holders of the
outstanding Notes will not recognize income, gain or loss for federal income tax
purposes as a result of such Covenant Defeasance and will be subject to federal
income tax on the same amounts, in the same manner and at the same times as
would have been the case if such Covenant Defeasance had not occurred; (iv) no
Default or Event of Default shall have occurred and be continuing on the date of
such deposit (other than a Default or Event of Default resulting from the
borrowing of funds to be applied to such deposit) or insofar as Events of
Default from bankruptcy or insolvency events with respect to the Company are
concerned, at any time in the period ending on the 91st day after the date of
deposit; (v) such Legal Defeasance or Covenant Defeasance will not result in a
breach or violation of, or constitute a default under any material agreement or
instrument (other than the Indenture) to which the Company or any of its
Restricted Subsidiaries is a party or by which the Company or any of its
Restricted Subsidiaries is bound; (vi) the Company must have delivered to the
Trustee an opinion of counsel to the effect that after the 91st day following
the deposit, the trust funds will not be subject to the effect of any applicable
bankruptcy, insolvency, reorganization or similar laws affecting creditors'
rights generally; (vii) the Company must deliver to the Trustee an officers'
certificate stating that the deposit was not made by the Company with the intent
of preferring the Holders of Notes over the other creditors of the Company with
the intent of defeating, hindering, delaying or defrauding creditors of the
Company or others; and (viii) the Company must deliver to the Trustee an
officers' certificate and an opinion of counsel, each stating that all
conditions precedent provided for relating to the Legal Defeasance or the
Covenant Defeasance have been complied with.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange Notes in accordance with the Indenture.
The Registrar and the Trustee may require a Holder, among other things, to
furnish appropriate endorsements and transfer documents and the Company may
require a Holder to pay any taxes and fees required by law. The Company is not
required to transfer or exchange any Note selected for redemption. Also, the
Company is not required to transfer or exchange any Note for a period of 15 days
before a selection of Notes to be redeemed.
The registered Holder of a Note will be treated as the owner of it for all
purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the Indenture or
the Notes may be amended or supplemented with the consent of the Holders of at
least a majority in principal amount of the Notes then
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outstanding (including, without limitation, consents obtained in connection with
a purchase of, or tender offer or exchange offer for, Notes), and any existing
default or compliance with any provision of the Indenture or the Notes may be
waived with the consent of the Holders of a majority in principal amount of the
then outstanding Notes (including consents obtained in connection with a tender
offer or exchange offer for Notes).
Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any Notes held by a non-consenting Holder): (i) reduce the
principal amount of Notes whose Holders must consent to an amendment, supplement
or waiver, (ii) reduce the principal of or change the fixed maturity of any Note
or alter the provisions with respect to the redemption of the Notes
(specifically excluding the provisions relating to the covenants described above
under the caption "-- Repurchase at the Option of Holders"), (iii) reduce the
rate of or change the time for payment of interest on any Note, (iv) waive a
Default or Event of Default in the payment of principal of or premium, if any,
or interest on the Notes (except a rescission of acceleration of the Notes by
the Holders of at least a majority in aggregate principal amount of the Notes
and a waiver of the payment default that resulted from such acceleration), (v)
make any Note payable in money other than that stated in the Notes, (vi) make
any change in the provisions of the Indenture relating to waivers of past
Defaults or Events of Default or the rights of Holders of Notes to receive
payments of principal of or premium, if any, or interest on the Notes, (vii)
waive a redemption payment with respect to any Note (specifically excluding the
payment required by one of the covenants described above under the caption
"-- Repurchase at the Option of Holders"), (viii) except as provided under the
caption "-- Legal Defeasance and Covenant Defeasance" or in accordance with the
terms of any Subsidiary Guarantee, release a Subsidiary Guarantor from its
obligations under its Subsidiary Guarantee or make any change in a Subsidiary
Guarantee that would adversely affect the Holders of the Notes, (ix) modify the
provisions of the Pledge Agreement or the Indenture relating to the Pledged
Securities in any manner adverse to the Holders or release the Pledge Account
from the Lien under the Pledge Agreement or permit any other obligation to be
secured by the Pledge Account or (x) make any change in the foregoing amendment
and waiver provisions.
Notwithstanding the foregoing, without the consent of any Holder of Notes,
the Company and the Trustee may amend or supplement the Indenture or the Notes
to cure any ambiguity, defect or inconsistency, to provide for uncertificated
Notes in addition to or in place of certificated Notes, to provide for the
assumption of the Company's obligations to Holders of Notes in the case of a
merger or consolidation, to make any change that would provide any additional
rights or benefits to the Holders of Notes or that does not adversely affect the
legal rights under the Indenture of any such Holder, or to comply with
requirements of the Commission in order to effect or maintain the qualification
of the Indenture under the Trust Indenture Act.
CONCERNING THE TRUSTEE
The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Company, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any such
claim as security or otherwise. The Trustee will be permitted to engage in other
transactions; however, if it acquires any conflicting interest it must eliminate
such conflict within 90 days, apply to the Commission for permission to continue
or resign.
The Holders of a majority in principal amount of the then outstanding Notes
will have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the conduct
of his own affairs. Subject to such provisions, the Trustee will be under no
obligation to exercise any of its rights or powers under the Indenture at the
request of any Holder of Notes, unless such Holder shall have offered to the
Trustee security and indemnity satisfactory to it against any loss, liability or
expense.
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REGISTRATION RIGHTS; LIQUIDATED DAMAGES
The Company and the Initial Purchasers entered into the Registration Rights
Agreement on the Closing Date. Pursuant to the Registration Rights Agreement,
the Company agreed to file with the Commission the Exchange Offer Registration
Statement on the appropriate form under the Securities Act with respect to the
Exchange Notes. Upon the effectiveness of the Exchange Offer Registration
Statement, the Company must offer to the Holders of Transfer Restricted
Securities pursuant to the Exchange Offer who are able to make certain
representations the opportunity to exchange their Transfer Restricted Securities
for Exchange Notes. If (i) the Company is not required to file the Exchange
Offer Registration Statement or permitted to consummate the Exchange Offer
because the Exchange Offer is not permitted by applicable law or Commission
policy or (ii) any Holder of Transfer Restricted Securities notifies the Company
prior to the 20th business day following consummation of the Exchange Offer that
(A) it is prohibited by law or Commission policy from participating in the
Exchange Offer or (B) that it may not resell the Exchange Notes acquired by it
in the Exchange Offer to the public without delivering a Prospectus and the
Prospectus contained in the Exchange Offer Registration Statement is not
appropriate or available for such resales or (C) that it is a broker-dealer and
owns Notes acquired directly from the Company or an affiliate of the Company,
the Company must file with the Commission a Shelf Registration Statement to
cover resales of the Notes by the Holders thereof, subject to such Holders
satisfying certain conditions relating to the provision of information in
connection with the Shelf Registration Statement. The Company must use all
commercially reasonable efforts to cause the applicable registration statement
to be declared effective as promptly as possible by the Commission. For purposes
of the foregoing, "Transfer Restricted Securities" means each Private Note until
(i) the date on which such Note has been exchanged by a person other than a
broker-dealer for an Exchange Note in the Exchange Offer, (ii) following the
exchange by a broker-dealer in the Exchange Offer of a Private Note for an
Exchange Note, the date on which such Exchange Note is sold to a purchaser who
receives from such broker-dealer on or prior to the date of such sale a copy of
the Prospectus contained in the Exchange Offer Registration Statement, (iii) the
date on which such Note has been effectively registered under the Securities Act
and disposed of in accordance with the Shelf Registration Statement or (iv) the
date on which such Note is distributed to the public pursuant to Rule 144 under
the Securities Act or is eligible for resale pursuant to Rule 144(k) under the
Securities Act.
The Registration Rights Agreement provides that (i) the Company must file
an Exchange Offer Registration Statement with the Commission on or prior to 90
days after the Closing Date, (ii) the Company must use all commercially
reasonable efforts to have the Exchange Offer Registration Statement declared
effective by the Commission on or prior to 150 days after the Closing Date,
(iii) unless the Exchange Offer would not be permitted by applicable law or
Commission policy, the Company must commence the Exchange Offer and use its best
efforts to issue on or prior to 30 business days after the date on which the
Exchange Offer Registration Statement was declared effective by the Commission,
Exchange Notes in exchange for all Private Notes tendered prior thereto in the
Exchange Offer and (iv) if obligated to file the Shelf Registration Statement,
the Company will use its best efforts to file the Shelf Registration Statement
with the Commission on or prior to 90 days after such filing obligation arises
and to cause the Shelf Registration to be declared effective by the Commission
on or prior to 150 days after such obligation arises. If (a) the Company fails
to file any of the Registration Statements required by the Registration Rights
Agreement on or before the date specified for such filing, (b) any of such
Registration Statements is not declared effective by the Commission on or prior
to the date specified for such effectiveness (the "Effectiveness Target Date"),
or (c) the Company fails to consummate the Exchange Offer within 30 business
days of the Effectiveness Target Date with respect to the Exchange Offer
Registration Statement, or (d) the Shelf Registration Statement or the Exchange
Offer Registration Statement is declared effective but thereafter ceases to be
effective or usable in connection with resales of Transfer Restricted Securities
during the periods specified in the Registration Rights Agreement (each such
event referred to in clauses (a) through (d) above a "Registration Default"),
then the Company will pay Liquidated Damages to each Holder of Notes, with
respect to the first 90-day period immediately following the occurrence of the
first Registration Default in an amount equal to $.05 per week per $1,000
principal amount of the Notes held by such Holder. The amount of the Liquidated
Damages will increase by an additional $.05 per week per $1,000 principal amount
of the Notes with respect to each subsequent 90-day period until all
Registration Defaults have been cured, up to a maximum amount of Liquidated
Damages for
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all Registration Defaults of $.50 per week per $1,000 principal amount of the
Notes. All accrued Liquidated Damages will be paid by the Company on each
interest payment date to the Holders of record on the immediately preceding
record date by wire transfer of immediately available funds, in the case of the
Global Note Holder, and to Holders of Certificated Securities by wire transfer
to the accounts specified by them or by mailing checks to their registered
addresses if no such accounts have been specified. Following the cure of all
Registration Defaults, the accrual of Liquidated Damages will cease.
Holders of Notes will be required to make certain representations to the
Company (as described in the Registration Rights Agreement) in order to
participate in the Exchange Offer and will be required to deliver certain
information to be used in connection with the Shelf Registration Statement and
to provide comments on the Shelf Registration Statement within the time periods
set forth in the Registration Rights Agreement in order to have their Notes
included in the Shelf Registration Statement and benefit from the provisions
regarding Liquidated Damages set forth above.
CERTAIN DEFINITIONS
Set forth below are material defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.
"Acquired Debt" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or became a Subsidiary of such specified Person, other than
Indebtedness incurred in connection with, or in contemplation of, such other
Person merging with or into or becoming a Subsidiary of such specified Person,
and (ii) Indebtedness secured by a Lien encumbering any asset acquired by such
specified Person.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall mean
the possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise; provided that
beneficial ownership of 10% or more of the Voting Stock of a Person shall be
deemed to be control.
"Asset Sale" means (i) the sale, lease, conveyance or other disposition of
any assets or rights (including, without limitation, by way of a sale and
leaseback) provided that the sale, lease, conveyance or other disposition of all
or substantially all of the assets of the Company and its Subsidiaries taken as
a whole will be governed by the provisions of the Indenture described above
under the caption "-- Repurchase at the Option of Holders -- Change of Control"
and/or the provisions described above under the caption "-- Certain
Covenants -- Merger, Consolidation or Sale of Assets" and not by the provisions
of the Asset Sale covenant, and (ii) the issue or sale by the Company or any of
its Restricted Subsidiaries of Equity Interests of any of the Company's
Subsidiaries (other than directors' qualifying shares or shares required by
applicable law to be held by a Person other than the Company or a Restricted
Subsidiary), in the case of either clause (i) or (ii), whether in a single
transaction or a series of related transactions (a) that have a fair market
value in excess of $1.0 million or (b) for net proceeds in excess of $1.0
million. Notwithstanding the foregoing, the following items shall not be deemed
to be Asset Sales: (i) a transfer of assets by the Company to a Restricted
Subsidiary or by a Restricted Subsidiary to the Company or to another Restricted
Subsidiary, (ii) an issuance of Equity Interests by a Subsidiary to the Company
or to another Restricted Subsidiary, (iii) a Restricted Payment or Permitted
Investment that is permitted by the covenant described above under the caption
"-- Certain Covenants -- Restricted Payments," (iv) the sale or other
disposition of real or personal property or equipment that has become worn out,
obsolete or damaged or otherwise unsuitable or not required for use in
connection with the business of the Company or any Restricted Subsidiary, as the
case may be, (v) disposals of Cash Equivalents and (vi) sales or other
dispositions of assets for consideration, received substantially concurrently
with such sale or disposition, at least equal to the fair market value of the
assets sold or disposed of, to the extent that the consideration received would
constitute property or assets of the kind described in
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clauses (c), (d), or (e) of the second paragraph under the caption
"-- Repurchase at the Option of Holders -- Asset Sales," provided that such
consideration may also include a cash equalization payment, in which case such
cash payment, if received by the Company or any of its Restricted Subsidiaries,
will be deemed to be proceeds received from an Asset Sale which will be applied
in accordance with the provisions of the covenant described above under the
caption "-- Repurchase at the Option of Holders -- Asset Sales."
"Attributable Debt" in respect of a sale and leaseback transaction means,
at the time of determination, the present value (discounted at the rate of
interest implicit in such transaction, determined in accordance with GAAP) of
the obligation of the lessee for net rental payments during the remaining term
of the lease included in such sale and leaseback transaction (including any
period for which such lease has been extended or may, at the option of the
lessor, be extended).
"Broker-Dealer" means any broker or dealer registered under the Exchange
Act.
"Capital Lease Obligation" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that would
at such time be required to be capitalized on a balance sheet in accordance with
GAAP.
"Capital Stock" means (i) in the case of a corporation, corporate stock,
(ii) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership or limited liability
company, partnership or membership interests (whether general or limited) and
(iv) any other interest or participation that confers on a Person the right to
receive a share of the profits and losses of, or distributions of assets of, the
issuing Person.
"Cash Equivalents" means (i) United States dollars, (ii) securities issued
or directly and fully guaranteed or insured by the United States government or
any agency or instrumentality thereof (provided that the full faith and credit
of the United States is pledged in support thereof) having maturities of not
more than one year from the date of acquisition, (iii) certificates of deposit
and eurodollar time deposits with maturities of one year or less from the date
of acquisition, bankers' acceptances with maturities not exceeding one year and
overnight bank deposits, in each case with any domestic commercial bank having
capital and surplus in excess of $500.0 million and a Thompson Bank Watch Rating
of "B" or better, (iv) repurchase obligations with a term of not more than 30
days for underlying securities of the types described in clauses (ii) and (iii)
above entered into with any financial institution meeting the qualifications
specified in clause (iii) above, (v) commercial paper or other indebtedness
issued by domestic corporations having the highest rating obtainable from
Moody's Investors Service, Inc. or Standard & Poor's Ratings Group and in each
case maturing within one year after the date of acquisition and (vi) money
market funds at least 95% of the assets of which constitute Cash Equivalents of
the kinds described in clauses (i) through (v) of this definition.
"Change of Control" means the occurrence of any of the following: (i) the
sale, lease, transfer, conveyance or other disposition (other than by way of
merger or consolidation), in one or a series of related transactions, of all or
substantially all of the assets of the Company and its Restricted Subsidiaries,
taken as a whole to any "person" (as such term is used in Section 13(d)(3) of
the Exchange Act), other than any of the Principals and their Related Parties;
(ii) the adoption of a plan relating to the liquidation or dissolution of the
Company; (iii) the consummation of any transaction (including, without
limitation, any merger or consolidation) the result of which is that any
"person" (as defined above), other than the Principals, their Related Parties or
(prior to the establishment of a Public Market) a Permitted Group, becomes the
"beneficial owner" (as such term is defined in Rule 13d-3 and Rule 13d-5 under
the Exchange Act, except that a person shall be deemed to have "beneficial
ownership" of all securities that such person has the right to acquire, whether
such right is currently exercisable or is exercisable only upon the occurrence
of a subsequent condition), directly or indirectly, of (A) more than 40% of the
Voting Stock of the Company and (B) more of the Voting Stock of the Company than
is at the time "beneficially owned" (as defined above) by the Principals and
their Related Parties in the aggregate (Voting Stock, in each case, measured by
voting power rather than number of shares); (iv) the first day on which a
majority of the members of the Board of Directors of the Company are not
Continuing Directors; or (v) the Company consolidates with, or merges with or
into, any Person, or any Person consolidates with, or merges with or into, the
Company, in any such event pursuant to a transaction in which any of the
outstanding Voting Stock of the Company is converted into or exchanged for cash,
securities
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or other property, other than any such transaction where the Voting Stock of the
Company outstanding immediately prior to such transaction is converted into or
exchanged for Voting Stock (other than Disqualified Stock) of the surviving or
transferee Person constituting a majority of the outstanding shares of such
Voting Stock of such surviving or transferee Person (immediately after giving
effect to such issuance).
"Common Stock" of any Person means Capital Stock of such Person that does
not rank prior, as to the payment of dividends or as to the distribution of
assets upon any voluntary or involuntary liquidation, dissolution or winding up
of such Person, to shares of Capital Stock of any other class of such Person.
"Consolidated Cash Flow" means, with respect to any Person for any period,
the Consolidated Net Income of such Person for such period plus (i) provision
for taxes based on income or profits of such Person and its Restricted
Subsidiaries for such period, to the extent that such provision for taxes was
included in computing such Consolidated Net Income, plus (ii) consolidated
interest expense of such Person and its Restricted Subsidiaries for such period,
whether paid or accrued and whether or not capitalized (including, without
limitation, amortization of debt issuance costs and original issue discount,
non-cash interest payments, the interest component of any deferred payment
obligations, the interest component of all payments associated with Capital
Lease Obligations, imputed interest with respect to Attributable Debt,
commissions, discounts and other fees and charges incurred in respect of letter
of credit or bankers' acceptance financings, and net payments (if any) pursuant
to Hedging Obligations), to the extent that any such expense was deducted in
computing such Consolidated Net Income, plus (iii) depreciation, amortization
(including amortization of goodwill and other intangibles but excluding
amortization of prepaid cash expenses that were paid in a prior period) and
other non-cash expenses (excluding any such non-cash expense to the extent that
it represents an accrual of or reserve for cash expenses in any future period or
amortization of a prepaid cash expense that was paid in a prior period) of such
Person and its Restricted Subsidiaries for such period to the extent that such
depreciation, amortization and other non-cash expenses were deducted in
computing such Consolidated Net Income, minus (iv) non-cash items increasing
such Consolidated Net Income for such period (excluding any items that were
accrued in the ordinary course of business), in each case on a consolidated
basis and determined in accordance with GAAP.
"Consolidated Indebtedness" means, with respect to any Person as of any
date of determination, the sum, without duplication, of (i) the total amount of
Indebtedness of such Person and its Restricted Subsidiaries, plus (ii) the total
amount of Indebtedness of any other Person, to the extent that such Indebtedness
has been Guaranteed by the referent Person or one or more of its Restricted
Subsidiaries, plus (iii) the aggregate liquidation value of all Disqualified
Stock of such Person and all preferred stock of Restricted Subsidiaries of such
Person, in each case, determined on a consolidated basis in accordance with
GAAP.
"Consolidated Net Income" means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Restricted Subsidiaries
for such period, on a consolidated basis, determined in accordance with GAAP;
provided that (i) the Net Income (but not loss) of any Person other than the
Company that is not a Restricted Subsidiary or that is accounted for by the
equity method of accounting shall be included only to the extent of the amount
of dividends or distributions paid in cash to the referent Person or a
Restricted Subsidiary thereof, (ii) the Net Income of any Person acquired in a
pooling of interests transaction for any period prior to the date of such
acquisition shall be excluded, (iii) the cumulative effect of a change in
accounting principles shall be excluded and (iv) the Net Income (but not loss)
of any Unrestricted Subsidiary shall be excluded whether or not distributed to
the Company or one of its Restricted Subsidiaries.
"Consolidated Net Worth" means, with respect to any Person as of any date
of determination, stockholders' equity as set forth on the most recently
available quarterly or annual consolidated balance sheet of such Person (which
shall be as of a date not more than 90 days prior to the date of such
computation, and which shall not take into account Unrestricted Subsidiaries),
less any amounts attributable to Disqualified Stock or any equity security
convertible into or exchangeable for Indebtedness, the cost of treasury stock
and the principal amount of any promissory notes receivable from the sale of the
Capital Stock of such Person, in each case determined on a consolidated basis in
accordance with GAAP.
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"Consolidated Assets" means, with respect to the Company, the total
consolidated assets of the Company and its Restricted Subsidiaries, as shown on
the most recent internal consolidated balance sheet of the Company and such
Restricted Subsidiaries calculated on a consolidated basis in accordance with
GAAP.
"Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who (i) was a member of such Board of
Directors on the date of the Indenture or (ii) was nominated for election or
elected to such Board of Directors with the approval of a majority of the
Continuing Directors who were members of such Board at the time of such
nomination or election.
"Credit Facilities" means one or more debt facilities or commercial paper
facilities with banks or other institutional lenders providing for revolving
credit loans, term loans, receivables financing (including through the sale of
receivables to such lenders or to special purpose entities formed to borrow from
such lenders against such receivables) or letters of credit, in each case, as
amended, restated, modified, renewed, refunded, replaced or refinanced in whole
or in part from time to time.
"Debt to Consolidated Cash Flow Ratio" means, as of any date of
determination (the "Calculation Date"), the ratio of (a) the Consolidated
Indebtedness of the Company as of such date to (b) the Consolidated Cash Flow of
the Company for the four most recent full fiscal quarters ending immediately
prior to the Calculation Date for which internal financial statements are
available, in each case determined on a pro forma basis after giving effect to
all acquisitions or dispositions of assets made by the Company and its
Subsidiaries from the beginning of such four-quarter period through and
including the Calculation Date as if such acquisitions and dispositions had
occurred at the beginning of such four-quarter period. For purposes of making
the computation referred to above, (i) acquisitions that have been made by the
Company or any of its Restricted Subsidiaries, including through mergers or
consolidations, during the reference period or subsequent to such reference
period and on or prior to the Calculation Date shall be deemed to have occurred
on the first day of the reference period and Consolidated Cash Flow for such
reference period shall be calculated without giving effect to clause (ii) of the
proviso set forth in the definition of Consolidated Net Income, and (ii) the
Consolidated Cash Flow attributable to discontinued operations, as determined in
accordance with GAAP, and operations or businesses disposed of prior to the
Calculation Date, shall be excluded.
"Default" means any event that is, or with the passage of time or the
giving of notice or both would be, an Event of Default.
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable, in each case, at the option of the holder thereof), or upon the
happening of any event, matures or is mandatorily redeemable, pursuant to a
sinking fund obligation or otherwise, or redeemable at the option of the Holder
thereof, in whole or in part, on or prior to the date that is 91 days after the
date on which the Notes mature (other than with the proceeds of an IPO
Redemption (as defined under "Description of Capital Stock -- Series B Preferred
Stock -- Redemption") in the case of the Series B Preferred Stock); provided,
however, that any Capital Stock that would constitute Disqualified Stock solely
because the holders thereof have the right to require the Company to repurchase
such Capital Stock upon the occurrence of a Change of Control or an Asset Sale
shall not constitute Disqualified Stock if the terms of such Capital Stock
provide that the Company may not repurchase or redeem any such Capital Stock
pursuant to such provisions unless such repurchase or redemption complies with
the covenant described above under the caption "-- Certain
Covenants -- Restricted Payments."
"Eligible Indebtedness" means any Indebtedness other than (i) Indebtedness
in the form of, or represented by, bonds or other securities or any guarantee
thereof and (ii) Indebtedness that is, or may be, quoted, listed or purchased
and sold on any stock exchange, automated trading system or over-the-counter or
other securities market (including, without prejudice to the generality of the
foregoing, the market for securities eligible for resale pursuant to Rule 144A
under the Securities Act).
"Eligible Receivables" means the accounts receivable (net of any reserves
and allowances for doubtful accounts in accordance with GAAP) of the Company and
its Restricted Subsidiaries that are not more than 60 days past their due date
and that were entered into in the ordinary course of business on normal payment
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terms as shown on the most recent internal consolidated balance sheet of the
Company and such Restricted Subsidiaries, all calculated on a consolidated basis
in accordance with GAAP.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).
"Equity Offering" means a public or private offering of Common Stock of the
Company pursuant to an effective registration statement under the Securities Act
or otherwise of which the net cash proceeds to the Company are equal to or
greater than $25.0 million.
"Exchange Offer" means exchange and issuance by the Company of a principal
amount of New Notes (which shall be registered pursuant to the Exchange Offer
Registration Statement) equal to the outstanding principal amount of Notes that
are tendered by such Holders in connection with such exchange and issuance.
"Exchange Offer Registration Statement" means the Registration Statement
relating to the Exchange Offer, including the related Prospectus.
"Existing Indebtedness" means Indebtedness of the Company and its
Subsidiaries in existence on the date of the Indenture, until such amounts are
repaid.
"fair market value" means the price that would be paid in an arm's-length
transaction between an informed and willing seller under no compulsion to sell
and an informed and willing buyer under no compulsion to buy, as determined in
good faith by the Board of Directors of the Company, whose determination shall
be evidenced by a resolution thereof set forth in an officers' certificate
delivered to the Trustee; provided that for purposes of clause (ix) of the
second paragraph of the covenant described above under the caption "-- Certain
Covenants -- Incurrence of Indebtedness and Issuance of Disqualified Stock," and
only for purposes of such clause: (x) the fair market value of any security
registered under the Exchange Act shall be the average of the closing prices,
regular way, of such security for the 20 consecutive trading days immediately
preceding the sale of Capital Stock and (y) in the event the aggregate fair
market value of any other property (other than cash or Cash Equivalents)
received by the Company exceeds $10.0 million, the fair market value of such
property shall be determined by a nationally recognized investment banking firm
(or, if no such investment banking firm is qualified to issue such an opinion,
by a nationally recognized appraisal firm or public accounting firm) and set
forth in the written opinion of such firm which shall be delivered to the
Trustee.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect from time to time.
"Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, by way of a pledge of
assets or through letters of credit or reimbursement agreements in respect
thereof), of all or any part of any Indebtedness.
"Hedging Obligations" means, with respect to any Person, the obligations of
such Person under (i) interest rate swap agreements, interest rate cap
agreements and interest rate collar agreements and (ii) other agreements or
arrangements designed to protect such Person against fluctuations in interest
rates or currency exchange rates.
"Indebtedness" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of borrowed money or evidenced by
bonds, notes, debentures or similar instruments or letters of credit (or
reimbursement agreements in respect thereof) or banker's acceptances or
representing Capital Lease Obligations or the balance deferred and unpaid of the
purchase price of any property or representing any Hedging Obligations, except
any such balance that constitutes an accrued expense or trade payable, if and to
the extent any of the foregoing indebtedness (other than letters of credit and
Hedging Obligations) would appear as a liability upon a balance sheet of such
Person prepared in accordance with
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GAAP, as well as all Indebtedness of others secured by a Lien on any asset of
such Person whether or not such Indebtedness is assumed by such Person (the
amount of such Indebtedness as of any date being deemed to be the lesser of the
value of such property or assets as of such date or the principal amount of such
Indebtedness of such other Person so secured) and, to the extent not otherwise
included, the Guarantee by such Person of any Indebtedness of any other Person.
The amount of any Indebtedness outstanding as of any date shall be (i) the
accreted value thereof, in the case of any Indebtedness issued with original
issue discount, and (ii) the principal amount thereof in the case of any other
Indebtedness.
"Investments" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the form of direct or indirect
loans (including guarantees of Indebtedness or other obligations), advances or
capital contributions (excluding commission, travel and similar advances to
officers and employees made in the ordinary course of business), purchases or
other acquisitions for consideration of Indebtedness, Equity Interests or other
securities, together with all items that are or would be classified as
investments on a balance sheet prepared in accordance with GAAP. If the Company
or any Restricted Subsidiary of the Company sells or otherwise disposes of any
Equity Interests of any direct or indirect Subsidiary of the Company or a
Restricted Subsidiary of the Company issues any of its Equity Interests such
that, in each case, after giving effect to any such sale or disposition, such
Person is no longer a Restricted Subsidiary of the Company, the Company shall be
deemed to have made an Investment on the date of any such sale or disposition
equal to the fair market value of the Equity Interests of such Subsidiary not
sold or disposed of in an amount determined as provided in the final paragraph
of the covenant described above under the caption "-- Certain
Covenants -- Restricted Payments."
"Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of such asset,
whether or not filed, recorded or otherwise perfected under applicable law
(including any conditional sale or other title retention agreement, any lease in
the nature thereof, any option or other agreement to sell or give a security
interest in and any filing of or agreement to give any financing statement under
the Uniform Commercial Code (or equivalent statutes) of any jurisdiction).
"New Notes" means the Company's Senior Notes due 2008 to be issued pursuant
to the Indenture (i) in the Exchange Offer or (ii) as contemplated by Section 4
of the Registration Rights Agreement.
"Net Income" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain or loss,
together with any related provision for taxes on such gain or loss, realized in
connection with (a) any Asset Sale (including, without limitation, dispositions
pursuant to sale and leaseback transactions) or (b) the disposition of any
securities by such Person or any of its Restricted Subsidiaries or the
extinguishment of any Indebtedness of such Person or any of its Restricted
Subsidiaries and (ii) any extraordinary gain or loss, together with any related
provision for taxes on such extraordinary gain or loss.
"Net Proceeds" means the aggregate cash proceeds received by the Company or
any of its Restricted Subsidiaries in respect of any Asset Sale (including,
without limitation, any cash received upon the sale or other disposition of any
non-cash consideration received in any Asset Sale), net of (i) the direct costs
relating to such Asset Sale (including, without limitation, legal, accounting
and investment banking fees, and sales commissions) and any relocation expenses
incurred as a result thereof, (ii) taxes paid or payable as a result thereof
(after taking into account any available tax credits or deductions and any tax
sharing arrangements), (iii) amounts required to be applied to the repayment of
Indebtedness (other than Indebtedness under a Credit Facility) secured by a Lien
on the asset or assets that were the subject of such Asset Sale, (iv) all
distributions and other payments required to be made to minority interest
holders in Restricted Subsidiaries as a result of such Asset Sale, (v) the
deduction of appropriate amounts provided by the seller as a reserve in
accordance with GAAP against any liabilities associated with the assets disposed
of in such Asset Sale and retained by the Company or any Restricted Subsidiary
after such Asset Sale and (vi) without duplication, any reserves that the
Company's Board of Directors determines in good faith should be made in respect
of the sale price of such asset or assets for post closing adjustments; provided
that in the case of any reversal of any
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reserve referred to in clause (v) or (vi) above, the amount so reserved shall be
deemed to be Net Proceeds from an Asset Sale as of the date of such reversal.
"Non-Recourse Debt" means Indebtedness (i) as to which neither the Company
nor any of its Restricted Subsidiaries (a) provides credit support of any kind
(including any undertaking, agreement or instrument that would constitute
Indebtedness), (b) is directly or indirectly liable (as a guarantor or
otherwise), or (c) constitutes the lender and (ii) no default with respect to
which (including any rights that the holders thereof may have to take
enforcement action against an Unrestricted Subsidiary) would permit (upon
notice, lapse of time or both) any holder of any other Indebtedness of the
Company or any of its Restricted Subsidiaries to declare a default on such other
Indebtedness or cause the payment thereof to be accelerated or payable prior to
its stated maturity; and (iii) as to which the lenders have been notified in
writing that they will not have any recourse to the stock or assets of the
Company or any of its Restricted Subsidiaries.
"Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"Permitted Group" means any group of investors that is deemed to be a
"person" (as such term is used in Section 13(d)(3) of the Exchange Act) by
virtue of the Purchasers Rights Agreement, as the same may be amended, modified
or supplemented from time to time, provided that no single Person (together with
its Affiliates), other than the Principals and their Related Parties, is the
"beneficial owner" (as such term is defined in Rule 13d-3 and Rule 13d-5 under
the Exchange Act, except that a person shall be deemed to have "beneficial
ownership" of all securities that such person has the right to acquire, whether
such right is currently exercisable or is exercisable only upon the occurrence
of a subsequent condition, and beneficial ownership shall be determined without
regard to the Purchasers Rights Agreement, as the same may be amended, modified
or supplemented from time to time), directly or indirectly, of (A) more than 40%
of the Voting Stock of the Company that is "beneficially owned" (as defined
above) by such group of investors and (B) more of the Voting Stock of the
Company than is at the time "beneficially owned" (as defined above) by the
Principals and their Related Parties in the aggregate (Voting Stock, in each
case, measured by voting power rather than number of shares).
"Permitted Investments" means (a) any Investment in the Company or in a
Restricted Subsidiary of the Company; (b) any Investment in Cash Equivalents or
Pledged Securities; (c) any Investment by the Company or any Restricted
Subsidiary of the Company in a Person, if as a result of such Investment (i)
such Person becomes a Restricted Subsidiary of the Company or (ii) such Person
is merged, consolidated or amalgamated with or into, or transfers or conveys
substantially all of its assets to, or is liquidated into, the Company or a
Restricted Subsidiary of the Company; (d) any Restricted Investment made as a
result of the receipt of non-cash consideration from an Asset Sale that was made
pursuant to and in compliance with the covenant described above under the
caption "-- Repurchase at the Option of Holders -- Asset Sales;" (e) any
acquisition of assets to the extent that the consideration therefor consists of
Equity Interests (other than Disqualified Stock) of the Company; (f) receivables
created in the ordinary course of business; (g) loans or advances to employees
made in the ordinary course of business not to exceed $500,000 at any one time
outstanding; (h) securities and other assets received in settlement of trade
debts or other claims arising in the ordinary course of business; (i) Guarantees
permitted by the covenant described above under the caption "-- Certain
Covenants -- Incurrence of Indebtedness and Issuance of Disqualified Stock;" (j)
Investments in prepaid expenses, negotiable instruments held for collection and
lease, utility and workers' compensation, performance and other similar
deposits; (k) Investments in Permitted Joint Ventures in an amount not to exceed
$10.0 million at any one time outstanding; and (l) other Investments not to
exceed 5% of the Company's Consolidated Assets at any one time outstanding (each
such Investment being measured as of the date made and without giving effect to
subsequent changes in value).
"Permitted Joint Venture" means any corporation, partnership or other
entity engaged in one or more Telecommunications Businesses (i) of which the
Company owns, directly or indirectly, at least 45% of the outstanding Capital
Stock and (ii) that is managed and operated by the Company or any of its
Subsidiaries.
"Permitted Liens" means (i) Liens securing Indebtedness of the Company
under one or more Credit Facilities that was permitted by the terms of the
Indenture to be incurred; (ii) Liens on the property or assets
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of one or more Restricted Subsidiaries of the Company securing Indebtedness of
one or more Restricted Subsidiaries of the Company that was permitted by the
terms of the Indenture to be incurred; (iii) Liens in favor of the Company; (iv)
Liens existing on the date of the Indenture; (v) Liens for taxes, assessments or
governmental charges or claims that are not yet delinquent or that are being
contested in good faith by appropriate proceedings promptly instituted and
diligently concluded, provided that any reserve or other appropriate provision
as shall be required in conformity with GAAP shall have been made therefor; (vi)
Liens securing Indebtedness permitted to be incurred under clause (iv) of the
second paragraph of the covenant described above under the caption "-- Certain
Covenants -- Incurrence of Indebtedness and Issuance of Disqualified Stock,
provided that (A) any such Lien is created solely for the purpose of securing
Indebtedness (1) to finance the cost (including the cost of design, development,
acquisition, construction, installation, improvement, transportation or
integration) of the item of property or assets subject thereto and such Lien is
created prior to, at the time of or within six months after the later of the
acquisition, the completion of construction or the commencement of full
operation of such property or (2) to refinance any Indebtedness previously so
secured, (B) the principal amount of the Indebtedness secured by such Lien does
not exceed 100% of such cost and (C) such Lien does not extend to or cover any
property or assets other than such item of property or assets and any
improvements on such item; (vii) Liens on property of a Person existing at the
time such Person is merged into or consolidated with the Company or any
Subsidiary; provided that such Liens were in existence prior to the
contemplation of such merger or consolidation and do not extend to any assets
other than those of the Person merged into or consolidated with the Company or
such Subsidiary; (viii) Liens on property existing at the time of acquisition
thereof by the Company or any Subsidiary, provided that such Liens were in
existence prior to the contemplation of such acquisition; (ix) Liens to secure
the performance of statutory obligations, surety or appeal bonds, performance
bonds or other obligations of a like nature incurred in the ordinary course of
business; (x) Liens securing the Notes, the New Notes and the Indenture or any
guarantee thereof; (xi) Liens granted in favor of the Holders of the Notes; and
(xii) Liens incurred in the ordinary course of business of the Company or any
Restricted Subsidiary of the Company with respect to obligations that do not
exceed $10.0 million at any one time outstanding.
"Permitted Refinancing Indebtedness" means any Indebtedness of the Company
or any of its Restricted Subsidiaries issued in exchange for, or the net
proceeds of which are used to extend, refinance, renew, replace, defease or
refund other Indebtedness of the Company or any of its Restricted Subsidiaries
(other than intercompany Indebtedness); provided that: (i) the principal amount
(or initial accreted value, if applicable) of such Permitted Refinancing
Indebtedness does not exceed the principal amount of (or accreted value, if
applicable), plus accrued interest on, the Indebtedness so extended, refinanced,
renewed, replaced, defeased or refunded (plus the amount of expenses and
prepayment premiums incurred in connection therewith); (ii) such Permitted
Refinancing Indebtedness has a final maturity date later than the final maturity
date of, and has a Weighted Average Life to Maturity equal to or greater than
the Weighted Average Life to Maturity of, the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded; (iii) if the Indebtedness
being extended, refinanced, renewed, replaced, defeased or refunded is
subordinated in right of payment to the Notes, such Permitted Refinancing
Indebtedness is subordinated in right of payment to, the Notes on terms at least
as favorable to the Holders of Notes as those contained in the documentation
governing the Indebtedness being extended, refinanced, renewed, replaced,
defeased or refunded; and (iv) such Indebtedness is incurred either by the
Company or by the Restricted Subsidiary who is the obligor on the Indebtedness
being extended, refinanced, renewed, replaced, defeased or refunded.
"Person" means any individual, corporation, partnership, joint venture,
association, joint-stock company, trust, unincorporated organization or
government or agency or political subdivision thereof (including any subdivision
or ongoing business of any such entity or substantially all of the assets of any
such entity, subdivision or business).
"Pledge Account" is defined to mean an account established with the Trustee
pursuant to the terms of the Pledge Agreement for the deposit of the Pledged
Securities purchased by the Company with a portion of the net proceeds from the
Offering.
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"Pledge Agreement" is defined to mean the Collateral Pledge and Security
Agreement, dated as of the date of the Indenture, from the Company to the
Trustee, governing the Pledge Account and the disbursement of funds therefrom.
"Pledged Securities" is defined to mean the securities purchased by the
Company with a portion of the net proceeds from the Offering, which shall
consist of U.S. Government Obligations, to be deposited in the Pledge Account.
The Pledged Securities may be held in book-entry form through Bankers Trust
Company, acting as securities intermediary.
"Principal" means Henry H. Bradley, David E. Scott and Jeffrey D.
Shackelford.
"Prospectus" means the prospectus included in a Registration Statement at
the time such Registration Statement is declared effective, as amended or
supplemented by any prospectus supplement and by all other amendments thereto,
including post-effective amendments, and all material incorporated by reference
into such Prospectus.
"Public Equity Offering" means an underwritten primary public offering of
Common Stock of the Company pursuant to an effective registration statement
under the Securities Act.
A "Public Market" shall be deemed to exist if (i) a Public Equity Offering
has been consummated and (ii) at least 35% of the total issued and outstanding
Common Stock of the Company immediately prior to the consummation of such Public
Equity Offering has been distributed by means of an effective registration
statement under the Securities Act.
"Registration Statement" means any registration statement of the Company
relating to (a) an offering of New Notes pursuant to an Exchange Offer or (b)
the registration for resale of Transfer Restricted Securities pursuant to the
Shelf Registration Statement, in each case, (i) that is filed pursuant to the
provisions of the Registration Rights Agreement and (ii) including the
Prospectus included therein, all amendments and supplements thereto (including
post-effective amendments) and all exhibits and material incorporated by
reference therein.
"Related Party" with respect to any Principal means (a)(1) any spouse,
sibling, parent or child of such Principal or (2) the estate of any Principal
during any period in which such estate holds Equity Interests of the Company for
the benefit of any person referred to in clause (a)(1) or (b) any trust,
corporation, partnership or other entity, the beneficiaries, stockholders,
partners, owners or Persons beneficially owning an interest of more than 50% of
which consist of such Principal and/or such other Persons referred to in the
immediately preceding clause (a).
"Restricted Investment" means an Investment other than a Permitted
Investment.
"Restricted Subsidiary" of a Person means any Subsidiary of the referent
Person that is not an Unrestricted Subsidiary.
"Shelf Registration Statement" means the Shelf Registration Statement as
defined in the Registration Rights Agreement.
"Stated Maturity" means, with respect to any installment of interest or
principal on any series of Indebtedness, the date on which such payment of
interest or principal was scheduled to be paid in the original documentation
governing such Indebtedness, and shall not include any contingent obligations to
repay, redeem or repurchase any such interest or principal prior to the date
originally scheduled for the payment thereof.
"Subsidiary" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a combination
thereof) and (ii) any partnership (a) the sole general partner or the managing
general partner of which is such Person or a Subsidiary of such Person or (b)
the only general partners of which are such Person or of one or more
Subsidiaries of such Person (or any combination thereof).
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"Telecommunications Business" means any business engaged primarily in the
development, ownership or operation of one or more telephone, telecommunications
or information systems or the provision of telephony, telecommunications or
information services (including, without limitation, any voice, video
transmission, data or Internet services) and any related, ancillary or
complementary business; provided that the determination of what constitutes a
Telecommunications Business shall be made in good faith by the Board of
Directors of the Company.
"Unrestricted Subsidiary" means (i) any Subsidiary of the Company that is
designated by the Board of Directors of the Company as an Unrestricted
Subsidiary pursuant to a Board Resolution; but only to the extent that such
Subsidiary: (a) has no Indebtedness other than Non-Recourse Debt; (b) is not
party to any agreement, contract, arrangement or understanding with the Company
or any Restricted Subsidiary of the Company unless the terms of any such
agreement, contract, arrangement or understanding are no less favorable to the
Company or such Restricted Subsidiary than those that might be obtained at the
time from Persons who are not Affiliates of the Company; (c) is a Person with
respect to which neither the Company nor any of its Restricted Subsidiaries has
any direct or indirect obligation (x) to subscribe for additional Equity
Interests or (y) to maintain or preserve such Person's financial condition or to
cause such Person to achieve any specified levels of operating results; (d) has
not guaranteed or otherwise directly or indirectly provided credit support for
any Indebtedness of the Company or any of its Restricted Subsidiaries; and (e)
has at least one director on its board of directors that is not a director or
executive officer of the Company or any of its Restricted Subsidiaries and has
at least one executive officer that is not a director or executive officer of
the Company or any of its Restricted Subsidiaries. Any such designation by the
Board of Directors of the Company shall be evidenced to the Trustee by filing
with the Trustee a certified copy of the Board Resolution giving effect to such
designation and an officers' certificate certifying that such designation
complied with the foregoing conditions and was permitted by the covenant
described above under the caption "-- Certain Covenants -- Restricted Payments."
If, at any time, any Unrestricted Subsidiary would fail to meet the foregoing
requirements as an Unrestricted Subsidiary, it shall thereafter cease to be an
Unrestricted Subsidiary for purposes of the Indenture and any Indebtedness of
such Subsidiary shall be deemed to be incurred by a Restricted Subsidiary of the
Company as of such date (and, if such Indebtedness is not permitted to be
incurred as of such date under the covenant described above under the caption
"-- Certain Covenants -- Incurrence of Indebtedness and Issuance of Disqualified
Stock," the Company shall be in default of such covenant). The Board of
Directors of the Company may at any time designate any Unrestricted Subsidiary
to be a Restricted Subsidiary; provided that such designation shall be deemed to
be an incurrence of Indebtedness by a Restricted Subsidiary of the Company of
any outstanding Indebtedness of such Unrestricted Subsidiary and such
designation shall only be permitted if (i) such Indebtedness is permitted under
the covenant described above under the caption "-- Certain
Covenants -- Incurrence of Indebtedness and Issuance of Disqualified Stock,"
calculated on a pro forma basis as if such designation had occurred at the
beginning of the four-quarter reference period, and (ii) no Default or Event of
Default would occur or be in existence following such designation.
"U.S. Government Obligations" means securities that are (x) direct
obligations of the United States of America for the timely payment of which its
full faith and credit is pledged or (y) obligations of a Person controlled or
supervised by and acting as an agency or instrumentality of the United States of
America the timely payment of which is unconditionally guaranteed as a full
faith and credit obligation by the United States of America, which, in either
case, are not callable or redeemable at the option of the issuer thereof, and
shall also include a depository receipt issued by a "bank" (as defined in
Section 3(a)(2) of the Securities Act), as custodian with respect to any such
U.S. Government Obligation or a specific payment of principal of or interest on
any such U.S. Government Obligation held by such custodian for the account of
the holder of such depository receipt, provided (except as required by law) such
custodian is not authorized to make any deduction from the amount payable to the
holder of such depository receipt from any amount received by the custodian in
respect of the U.S. Government Obligation or the specific payment of principal
of or interest on the U.S. Government Obligation evidenced by such depository
receipt.
"Voting Stock" of any Person as of any date means the Capital Stock of such
Person that is at the time entitled to vote in the election of the Board of
Directors of such Person.
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"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (i) the sum of the
products obtained by multiplying (a) the amount of each then remaining
installment, sinking fund, serial maturity or other required payments of
principal, including payment at final maturity, in respect thereof, by (b) the
number of years (calculated to the nearest one-twelfth) that will elapse between
such date and the making of such payment, by (ii) the then outstanding principal
amount of such Indebtedness.
"Wholly Owned Restricted Subsidiary" of any Person means a Restricted
Subsidiary of such Person all of the outstanding Capital Stock or other
ownership interests of which (other than directors' qualifying shares) shall at
the time be owned by such Person or by one or more Wholly Owned Restricted
Subsidiaries of such Person and one or more Wholly Owned Restricted Subsidiaries
of such Person.
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BOOK-ENTRY; DELIVERY AND FORM
Except as set forth in the next paragraph, the Notes will be represented by
one or more permanent global certificates in fully registered form (each a
"Global Note" or a "Global Certificate"). Each Global Note will be deposited
with, or on behalf of, DTC and registered in the name of a nominee of DTC.
Notes (i) originally purchased by or transferred to Institutional
"Accredited Investors" (as defined in Rule 501(a)(1), (2), (3) or (7)
promulgated under the Securities Act) who are not QIBs or (ii) held by QIBs who
elect to take physical delivery of their certificates instead of holding their
interest through the Global Certificates (and which are thus ineligible to trade
through DTC) (collectively referred to herein as the "Non-Global Purchasers")
will be issued, in registered form, without interest coupons, "Certificated
Notes" ("Certificated Securities"). Upon the transfer to a QIB of such
Certificated Securities initially issued to a Non-Global Purchaser, such
Certificated Securities will, unless the transferee requests otherwise or the
Global Certificates have previously been exchanged in whole for such
Certificated Securities, be exchanged for an interest in the applicable Global
Certificates.
THE GLOBAL CERTIFICATES
The Company expects that pursuant to procedures established by DTC (i) upon
deposit of the Global Notes, DTC or its custodian will credit, on its internal
system, portions of the Global Notes to the respective accounts of persons who
have accounts with such depository and (ii) ownership of the Notes will be shown
on, and the transfer of ownership thereof will be effected only through, records
maintained by DTC or its nominee (with respect to interests of participants) and
the records of participants (with respect to interests of persons other than
participants). Such accounts initially will be designated by or on behalf of the
Initial Purchasers and ownership of beneficial interests in the Global Notes
will be limited to persons who have accounts with DTC ("participants") or
persons who hold interests through participants. QIBs may hold their interests
in the Global Certificates directly through DTC if they are participants in such
system, or indirectly through organizations which are participants in such
system.
So long as DTC, or its nominee, is the registered owner or holder of the
Notes, DTC or such nominee will be considered the sole owner or holder of the
Notes represented by the applicable Global Certificate for all purposes under
the Indenture. No beneficial owner of an interest in the Global Certificates
will be able to transfer such interest except in accordance with DTC's
applicable procedures in addition to those provided for under the Indenture with
respect to the Exchange Notes.
Payments of the principal of, premium (if any) and interest (including
Additional or Special Interest) on, the Global Notes will be made to DTC or its
nominee, as the case may be, as the registered owner thereof. None of the
Company, the Trustee or any paying agent will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests in the Global Notes or for maintaining,
supervising or reviewing any records relating to such beneficial ownership
interest.
The Company expects that DTC or its nominee, upon receipt of any payment of
the principal of, premium (if any) and interest (including Additional on Special
Interest) on, the Global Notes, will credit participants' accounts with payments
in amounts proportionate to their respective beneficial interests in the
principal amount of such Global Note, as shown on the records of DTC or its
nominee. The Company also expects that payments by participants to owners of
beneficial interests in any such Global Certificates held through such
participants will be governed by standing instructions and customary practice,
as is now the case with securities held for the accounts of customers registered
in the names of nominees for such customers. Such payments will be the
responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in clearinghouse funds. If a
holder requires physical delivery of a Certificated Security for any reason,
including to sell Units, Notes, or Warrants to persons in states which require
physical delivery of such securities or to pledge such securities, such holder
must transfer its interest in the applicable Global Certificate in accordance
with the normal procedures of DTC, and including, with respect to the Exchange
Notes and the Warrants, in accordance with the procedures set forth in the
Indenture.
118
<PAGE> 124
DTC has advised the Company that DTC will take any action permitted to be
taken by a holder of Notes, (including the presentation of Notes for exchange as
described below) only at the direction of one or more participants to whose
account the DTC interests in the applicable Global Certificate is credited and
only in respect of such portion of Notes, the aggregate principal amount of
Notes, as to which such participant or participants has or have given such
direction. However, if there is an Event of Default under the Indenture, DTC
will exchange the applicable Global Certificate for Certificated Securities,
which it will distribute to its participants.
DTC has advised the Company as follows: DTC is a limited purpose trust
company organized under the laws of the State of New York, a member of the
Federal Reserve System, a "clearing corporation" within the meaning of the
Uniform Commercial Code and a "Clearing Agency" registered pursuant to the
provisions of Section 17A of the Exchange Act. DTC was created to hold
securities for its participants and facilitate the clearance and settlement of
securities transactions between participants through electronic book-entry
changes in accounts of its participants, thereby eliminating the need for
physical movement of certificates. Participants include securities brokers and
dealers, banks, trust companies and clearing corporations and certain other
organizations. Indirect access to the DTC system is available to others such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a participant, either directly or indirectly
("indirect participants").
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of interests in the Global Certificates among participants of DTC, it
is under no obligation to perform such procedures, and such procedures may be
discontinued at any time. None of the Company or the Trustee will have any
responsibility for the performance by DTC or its participants or indirect
participants of their respective obligations under the rules and procedures
governing their operations.
CERTIFICATED SECURITIES
If DTC is at any time unwilling or unable to continue as a depository for
any Global Certificate and a successor depository is not appointed by the
Company within 90 days, the Company will issue Certificated Securities in
exchange for the Global Certificates.
119
<PAGE> 125
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following general discussion summarizes certain of the material U.S.
federal income tax aspects of the Exchange Offer to holders of the Private
Notes. This discussion is summary for general information only and does not
consider all aspects of the Private Notes in light of such holder's personal
circumstances. This discussion also does not address the U.S. federal income tax
consequences to holders subject to special treatment under the U.S. federal
income tax laws, such as dealers in securities, or foreign currency, tax-exempt
entities, banks, thrifts, insurance companies, persons that hold the Notes as
part of a "straddle", a "hedge" against currency risk or a "conversion
transaction"; persons that have a "functional currency" other than the U.S.
dollar, and investors in pass-through entities. In addition, this discussion
does not prescribe any tax consequences arising out of the tax laws of any
state, local or foreign jurisdiction.
This discussion is based upon the Code, existing and proposed regulations
thereunder, Internal Revenue Service ("IRS") rulings and pronouncements and
judicial decisions now in effect, all of which are subject to change (possibly
on a retroactive basis). The Company has not and will not seek any rulings or
opinions from the IRS or counsel with respect to the matters discussed below.
There can be no assurance that the IRS will not take positions concerning the
tax consequences of the Exchange Offer which are different from those discussed
herein.
HOLDERS OF THE PRIVATE NOTES SHOULD CONSULT THEIR OWN ADVISORS CONCERNING
THE APPLICATION OF U.S. FEDERAL INCOME TAX LAWS, AS WELL AS THE LAWS OF ANY
STATE, LOCAL OR FOREIGN TAXING JURISDICTION, TO THE EXCHANGE OFFER IN LIGHT OF
THEIR PARTICULAR SITUATIONS.
The exchange of Private Notes for Exchange Notes pursuant to the Exchange
Offer should not constitute a taxable exchange. As a result, a holder (i) should
not recognize taxable gain or loss as a result of exchanging Private Notes for
Exchange Notes pursuant to the Exchange Offer; (ii) the holding period of the
Exchange Notes should include the holding period of the Private Notes exchanged
therefor and (iii) the adjusted tax basis of the Exchange Notes should be the
same as the adjusted tax basis of the Private Notes exchanged therefor
immediately before the exchange.
120
<PAGE> 126
PLAN OF DISTRIBUTION
Each broker-dealer that receives Exchange Notes for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such Exchange Notes. This
Prospectus, as it may be amended or supplemented from time to time, may be used
by a broker-dealer in connection with the resales of Exchange Notes received in
exchange for Private Notes where such Private Notes were acquired as a result of
market-making activities or other trading activities. The Company has agreed
that for a period of up to 180 days after the Expiration Date, it will make this
Prospectus, as amended or supplemented, available to any broker-dealer that
requests such document in the Letter of Transmittal for use in connection with
any such resale.
The Company will not receive any proceeds from any sale of Exchange Notes
by broker-dealers or any other persons. Exchange Notes received by
broker-dealers for their own account pursuant to the Exchange Offer may be sold
from time to time in one or more transactions in the over-the-counter market, in
negotiated transactions, through the writing of options on the Exchange Notes or
a combination of such methods of resale, at market prices prevailing at the time
of resale, at prices related to such prevailing market prices or negotiated
prices. Any such resale may be made directly to purchasers or to or through
brokers or dealers who may receive compensation in the form of commissions or
concessions from any such broker-dealer and/or the purchasers of any such
Exchange Notes. Any broker-dealer that resells Exchange Notes that were received
by it for its own account pursuant to the Exchange Offer and any broker or
dealer that participates in a distribution of such Exchange Notes may be deemed
to be an "underwriter" within the meaning of the Securities Act and any profit
on any such resale of Exchange Notes and any commissions or concessions received
by any such persons may be deemed to be underwriting compensation under the
Securities Act. The Letter of Transmittal states that by acknowledging that it
will deliver and by delivering a prospectus, a broker-dealer will not be deemed
to admit that it is an "underwriter" within the meaning of the Securities Act.
The Company has agreed to pay all expenses incident to the Company's
performance of, or compliance with, the Registration Rights Agreement and will
indemnify the holders of Private Notes (including any broker-dealers), and
certain parties related to such holders, against certain liabilities, including
liabilities under the Securities Act.
LEGAL MATTERS
Certain legal matters with respect to the Exchange Notes offered hereby
will be passed upon for the Company by Latham & Watkins, New York, New York.
EXPERTS
The consolidated financial statements of Birch Telecom, Inc. at December
31, 1997 and for the year then ended, appearing in this Prospectus and
Registration Statement and the consolidated financial statements of Valu-Line
Companies, Inc. at December 31, 1997 and 1996 and for each of the three years in
the period ended December 31, 1997, also appearing in this Prospectus and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports thereon appearing elsewhere herein, and
are included in reliance upon such reports given upon the authority of such firm
as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 under the Securities Act with respect to the Exchange Notes offered hereby.
As permitted by the rules and regulations of the Commission, this Prospectus
omits certain information, exhibits and undertakings contained in the
Registration Statement. For further information with respect to the Company and
the Exchange Notes offered hereby, reference is made to the Registration
Statement, including the exhibits thereto and the financial statements, notes
and schedules filed as a part thereof. As a result of the Exchange Offer, the
Company will become
121
<PAGE> 127
subject to the informational requirements of the Exchange Act. The Registration
Statement (and the exhibits and schedules thereto), as well as the periodic
reports and other information filed by the Company with the Commission, may be
inspected and copied at the Public Reference Section of the Commission at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the Commission located at Room 1400, 75 Park Place, New
York, New York 10007 and Suite 1400, Northwestern Atrium Center, 500 West
Madison Street, Chicago, Illinois 6061-2511. Information on the operation of the
Public Reference Room may be obtained by calling the Commission at
1-800-SEC-0330. Copies of such materials may be obtained from the Public
Reference Section of the Commission, Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, and its public reference facilities in New
York, New York and Chicago, Illinois at the prescribed rates. The Commission
maintains a web site (http://www.sec.gov), that contains periodic reports, proxy
and information statements and other information regarding registrants that file
documents electronically with the Commission. While all material provisions of
documents and agreements filed as exhibits are included in the Prospectus, in
each instance reference is made to the copy of such contract or document filed
as an exhibit to the Registration Statement, and prospective investors should
review each such contract or document for the complete contents of such contract
or document.
Pursuant to the Indenture, the Company has agreed to furnish to the Trustee
and to registered holders of the Exchange Notes, without cost to the Trustee or
such registered holders, copies of all reports and other information that would
be required to be filed by the Company with the Commission under the Exchange
Act (and, with respect to the annual information only, a report thereon by the
Company's certified independent accountants), whether or not the Company is then
required to file reports with the Commission. As a result of this Exchange
Offer, the Company will become subject to the periodic reporting and other
informational requirements of the Exchange Act. In the event that the Company
ceases to be subject to the informational requirements of the Exchange Act, the
Company has agreed that, so long as any Notes remain outstanding, it will file
with the Commission (but only if the Commission at such time is accepting such
voluntary filings) and distribute to holders of the Private Notes or the
Exchange Notes, as applicable, copies of the financial information that would
have been contained in such annual reports and quarterly reports, including a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," that would have been required to be filed with the Commission
pursuant to the Exchange Act. The Company will also furnish such other reports
as it may determine or as may be required by law.
The principal address of the Company is 1004 Baltimore Ave., Suite 900,
Kansas City, Missouri 64105, and the Company's telephone number is (816)
842-7560.
122
<PAGE> 128
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
BIRCH TELECOM, INC. (UNAUDITED)
Condensed Consolidated Balance Sheets as of December 31,
1997 and September 30, 1998............................... F-2
Condensed Consolidated Statements of Operations for the nine
months ended September 30, 1997 and 1998.................. F-3
Condensed Consolidated Statement of Stockholders' Equity for
the nine months ended
September 30, 1998........................................ F-4
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1997 and 1998.................. F-5
Notes to Condensed Consolidated Financial Statements........ F-6
BIRCH TELECOM, INC.
Report of Independent Auditors.............................. F-9
Consolidated Balance Sheet as of December 31, 1997.......... F-10
Consolidated Statement of Operations for the year ended
December 31, 1997......................................... F-11
Consolidated Statement of Stockholders' Equity for the year
ended December 31, 1997................................... F-12
Consolidated Statement of Cash Flows for the year ended
December 31, 1997......................................... F-13
Notes to Consolidated Financial Statements.................. F-14
VALU-LINE COMPANIES, INC.
Report of Independent Auditors.............................. F-20
Consolidated Balance Sheets as of December 31, 1996 and
1997...................................................... F-21
Consolidated Statements of Income and Retained Earnings for
the years ended December 31, 1995, 1996 and 1997.......... F-22
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996 and 1997.......................... F-23
Notes to Consolidated Financial Statements.................. F-24
</TABLE>
F-1
<PAGE> 129
BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 210 $ 53,378
Pledged securities........................................ -- 15,709
Accounts receivable....................................... -- 3,499
Inventory................................................. -- 1,246
Prepaid expenses and other current assets................. 7 394
------- --------
Total current assets........................................ 217 74,226
Property and equipment, net................................. 101 16,638
Pledged securities -- noncurrent............................ -- 29,208
Goodwill, net............................................... -- 16,855
Customer lists, net......................................... -- 3,237
Deferred debt costs, net.................................... -- 4,498
Other assets................................................ 216 962
------- --------
Total assets................................................ $ 534 $145,624
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and capital lease
obligation............................................. $ -- $ 115
Notes payable to related parties.......................... 250 --
Accounts payable.......................................... 255 8,875
Accrued interest.......................................... -- 4,425
Accrued expenses.......................................... -- 1,564
------- --------
Total current liabilities................................... 505 14,980
14% Senior Notes............................................ -- 114,671
Capital lease obligation and other long-term debt, net of
current maturities........................................ -- 649
------- --------
Total liabilities........................................... 505 130,300
Preferred stock, $.001 par value; 25,000,000 shares
authorized:
Series B Redeemable Preferred Stock, 8,572,039 shares
issued and outstanding (stated at redemption and
aggregate liquidation value)........................... -- 13,572
Stockholders' equity:
Series C Preferred Stock, 8,492,749 shares issued and
outstanding............................................ -- 8
Common stock, $.01 par value, 20,000,000 shares
authorized, 1,800,000 shares issued and outstanding at
December 31, 1997...................................... 18 --
Common stock, $.001 par value, 27,000,000 shares
authorized, 5,016,889 shares issued and outstanding.... -- 5
Warrants.................................................. 18 337
Additional paid-in capital................................ 1,782 12,273
Accumulated deficit....................................... (1,789) (10,871)
------- --------
Total stockholders' equity.................................. 29 1,752
------- --------
Total liabilities and stockholders' equity.................. $ 534 $145,624
======= ========
</TABLE>
See accompanying notes.
F-2
<PAGE> 130
BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
1997 1998
------- -------
<S> <C> <C>
Revenue:
Communications services, net.............................. $ -- $14,919
Equipment sales, net...................................... -- 2,324
------- -------
Total revenue............................................... -- 17,243
Cost of services:
Cost of communications services........................... -- 10,729
Cost of equipment sales................................... -- 1,518
------- -------
Total cost of services...................................... -- 12,247
------- -------
Gross margin................................................ -- 4,996
Selling, general and administrative......................... 1,214 8,816
Depreciation and amortization expense....................... 19 1,229
------- -------
Loss from operations........................................ (1,233) (5,049)
Interest expense............................................ -- 4,517
Interest income............................................. (8) (1,709)
------- -------
Net loss before income tax.................................. (1,225) (7,857)
Income taxes................................................ -- --
------- -------
Net loss.................................................... (1,225) (7,857)
Preferred stock dividends................................... -- 1,204
Amortization of preferred stock issuance costs.............. -- 21
------- -------
Loss applicable to common stock............................. $(1,225) $(9,082)
======= =======
Loss per common share -- basic and diluted.................. $ (1.15) $ (2.69)
======= =======
Weighted average number of common shares outstanding........ 1,064 3,381
</TABLE>
See accompanying notes.
F-3
<PAGE> 131
BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES A PREFERRED SERIES C PREFERRED
STOCK STOCK COMMON STOCK
--------------------- --------------------- ---------------------------
NUMBER OF NUMBER OF NUMBER OF $.01
SHARES $.001 PAR SHARES $.001 PAR SHARES PAR WARRANTS
--------- --------- --------- --------- --------- ---- --------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1997................... -- $ -- -- $-- 1,800 $ 18 $ 18
Recapitalization......... -- -- 1,800 2 (1,800) (18) (18)
Issuance of common
stock.................. -- -- -- -- -- -- --
Merger with Valu-Line.... 2,969 3 6,250 6 -- -- --
Issuance of Warrants in
connection with 14%
Senior Notes........... -- -- -- -- -- -- --
Redemption of Series A
Preferred.............. (2,969) (3) -- -- -- -- --
Stock dividend........... -- -- 443 -- -- -- --
Option exercise.......... -- -- -- -- -- -- --
Restatement of Series B
dividends.............. -- -- -- -- -- -- --
Amortization of preferred
stock issuance costs... -- -- -- -- -- -- --
Series A Preferred Stock
dividends.............. -- -- -- -- -- -- --
Series B Preferred Stock
dividends.............. -- -- -- -- -- -- --
Net loss................. -- -- -- -- -- -- --
------ ---- ----- -- ------ ---- ----
BALANCE AT SEPTEMBER 30,
1998................... -- $ -- 8,493 $8 -- $ -- $ --
====== ==== ===== == ====== ==== ====
<CAPTION>
COMMON STOCK
--------------------------------
NUMBER OF ADDITIONAL ACCUMULATED
SHARES $.001 PAR WARRANTS PAID-IN CAPITAL DEFICIT TOTAL
--------- --------- -------- --------------- ----------- -------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1997................... -- $-- $ -- $ 1,782 $ (1,789) $ 29
Recapitalization......... -- -- -- 34 -- --
Issuance of common
stock.................. 450 -- -- -- -- --
Merger with Valu-Line.... -- -- -- 14,741 -- 14,750
Issuance of Warrants in
connection with 14%
Senior Notes........... -- -- 337 -- -- 337
Redemption of Series A
Preferred.............. -- -- -- (4,747) -- (4,750)
Stock dividend........... 262 1 -- (1) -- --
Option exercise.......... 4,305 4 -- -- -- 4
Restatement of Series B
dividends.............. -- -- -- 464 -- 464
Amortization of preferred
stock issuance costs... -- -- -- -- (21) (21)
Series A Preferred Stock
dividends.............. -- -- -- -- (168) (168)
Series B Preferred Stock
dividends.............. -- -- -- -- (1,036) (1,036)
Net loss................. -- -- -- -- (7,857) (7,857)
----- -- ---- ------- -------- -------
BALANCE AT SEPTEMBER 30,
1998................... 5,017 $5 $337 $12,273 $(10,871) $ 1,752
===== == ==== ======= ======== =======
</TABLE>
See accompanying notes.
F-4
<PAGE> 132
BIRCH TELECOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
1997 1998
------- --------
<S> <C> <C>
Operating activities
Net loss.................................................... $(1,225) $ (7,857)
Adjustments to reconcile net loss to net cash from operating
activities:
Depreciation and amortization............................. 19 1,229
Change in operating assets and liabilities:
Accounts receivable.................................... -- (1,159)
Inventory.............................................. -- (630)
Prepaid expenses and other current assets.............. (10) (209)
Other assets........................................... (49) 4
Accounts payable....................................... 27 1,992
Accrued interest....................................... -- 4,425
Accrued expenses....................................... 105 852
------- --------
Net cash from operating activities.......................... (1,133) (1,353)
INVESTING ACTIVITIES
Purchase of property and equipment.......................... (111) (9,959)
Purchase of companies....................................... -- (7,740)
Purchase of pledged securities.............................. -- (43,576)
------- --------
Net cash from investing activities.......................... (111) (62,616)
FINANCING ACTIVITIES
Proceeds from issuance of common stock and warrants......... 1,818 4
Proceeds from issuance of preferred stock................... -- 9,500
Proceeds from Warrants...................................... -- 337
Payment of financing costs.................................. -- (5,105)
Payment of Series A Preferred Stock dividends............... -- (168)
Proceeds from convertible notes............................. -- 3,500
Proceeds from 14% Senior Notes.............................. -- 114,663
Redemption of Series A Preferred Stock...................... -- (4,750)
Repayment of capital lease obligations...................... -- (65)
Repayment of long-term debt................................. -- (529)
Repayment of notes payable.................................. -- (250)
------- --------
Net cash from financing activities.......................... 1,818 117,137
------- --------
Net increase in cash and cash equivalents................... 574 53,168
Cash and cash equivalents at beginning of period............ -- 210
------- --------
Cash and cash equivalents at end of period.................. $ 574 $ 53,378
======= ========
Supplementary schedule of non-cash investing and financing
activities:
Amounts recorded in connection with acquisitions:
Fair value of net assets acquired, net of cash
acquired.............................................. $ -- $ 5,687
Fair value of intangible assets........................ -- 20,802
Assumption of long-term debt and capital lease
obligations........................................... -- (3,999)
Issuance of Series A Preferred Stock................... -- (10,000)
Issuance of Series C Preferred Stock................... -- (4,750)
Property and equipment additions included in accounts
payable................................................ -- 4,703
</TABLE>
See accompanying notes.
F-5
<PAGE> 133
BIRCH TELECOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
1. GENERAL
The information contained in the notes to the condensed consolidated
financial statements should be reviewed in conjunction with the audited
consolidated financial statements of Birch Telecom, Inc. (Birch or the Company)
as of December 31, 1997 and for the period from December 23, 1996 (date of
inception) to December 31, 1997 and of Valu-Line Companies, Inc. (Valu-Line) as
of December 31, 1997 and 1996 and for each of the three years in the period
ended December 31, 1997, included elsewhere herein.
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation of the financial position of the Company at September 30, 1998, and
the results of its operations and its cash flows for the nine month periods
ended September 30, 1998 and 1997 have been included. Results for the period
ended September 30, 1998 are not necessarily indicative of the results that may
be expected for the year ended December 31, 1998.
2. PROPERTY AND EQUIPMENT
During the nine months ended September 30, 1998, the Company began
construction of its Kansas City, St. Louis, Wichita, and Topeka local and long
distance switches and certain information technology systems and had recorded
$12.5 million in construction in process.
3. ACQUISITIONS
In February 1998, Birch merged with Valu-Line in a transaction valued at
$19.5 million, consisting of $4.75 million in cash, 2,968,750 shares of Series A
Preferred Stock having an aggregate liquidation preference of $4.75 million and
6,250,000 shares of Series C Preferred Stock having an aggregate liquidation
preference of $10.0 million. Valu-Line's revenue and net income relating to the
businesses acquired by Birch for the year ended December 31, 1997 were $16.8
million and $268,000, respectively. Since 1982, Valu-Line has been primarily
providing switched long distance services, customer premises equipment (CPE)
sales and services and, since March 1997, local service. The operations of
Valu-Line are included in the condensed consolidated statement of operations and
cash flows from the date of acquisition. In connection with the merger,
intangible assets were recorded related to customer lists and goodwill totaling
$2 million and $15.5 million, respectively. Amortization periods will be 5 years
for the customer lists and 25 years for the goodwill. Birch was a development
stage company until the Valu-Line Merger.
In May 1998, Birch acquired Boulevard Phone Company (Boulevard), a shared
tenant service provider in the Kansas City metropolitan area, for $300,000 in
cash. Boulevard's revenue and net loss for the year ended December 31, 1997 were
$339,000 and $19,000, respectively. Goodwill totaling $274,000 was recorded and
will be amortized over 25 years.
In May 1998, Birch acquired Telesource Communications, Inc. (Telesource), a
CPE provider in the Kansas City metropolitan area, for $325,000 in cash. In
connection with the Telesource acquisition, the Company assumed $290,000 of
Telesource's liabilities. Telesource's revenue and net loss for the year ended
December 31, 1997 were $911,000 and $124,000, respectively. Goodwill and
customer lists associated with the acquisition were capitalized totaling
$325,000 and $328,000, respectively. Amortization periods will be 25 years for
goodwill and 5 years for the customer lists.
F-6
<PAGE> 134
BIRCH TELECOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In September 1998, Birch acquired TFSnet, Inc. (TFSnet), an Internet
service provider based in the Kansas City metropolitan area for $2.65 million.
TFSnet's revenue and net income for the year ended December 31, 1997 were
$796,000 and $135,000, respectively. Goodwill and customer lists associated with
the acquisitions were capitalized totaling $1.1 million and $1.2 million,
respectively. Amortization periods will be 25 years for goodwill and 5 years for
the customer list.
The Valu-Line, Boulevard, Telesource and TFSnet acquisitions were recorded
using the purchase method of accounting.
The following is pro forma information reflecting the acquisitions as
though they had been completed effective January 1, 1997 and 1998 (in thousands
except per share amounts):
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
<S> <C> <C>
Revenue.................................... $18,847 $20,348
Net Loss................................... 19,325 20,570
Loss per common share -- basic and
diluted.................................. 15.65 6.45
</TABLE>
4. CAPITAL STRUCTURE
In addition to the merger transactions discussed above, the Company issued
$9.5 million of Series B Preferred Stock, $3.5 million of Convertible Notes,
converted common shareholders to Series C Preferred Stock, canceled the 1997
Stock Option Plan, and created the 1998 Stock Option Plan in transactions
related to new investors.
The common stock has voting rights together with Series B and C Preferred
Stock. Dividends, if any, will be declared by the board of directors.
The Series A Preferred Stock was fully redeemed in June 1998. Dividends
paid totaled $168,000 in 1998.
The Series B Preferred Stock and Convertible Notes generated net proceeds
of $12.4 million. The Series B Preferred Stock accrues cumulative compounding
dividends at 15% per annum and is redeemable in equal annual installments in
2003, 2004 and 2005; provided, however, that so long as any of the Company's 14%
Senior Notes due 2008 are outstanding, no redemption of the Series B Preferred
Stock may be redeemed until the earlier of (a) June 15, 2008 and (b) the 91st
day after redemption in full of the Notes. The Convertible Notes were converted
into 2,307,965 shares of Series B Preferred Stock in June 1998. The Series B
Preferred Stock is convertible into 8,572,039 shares of common stock at the
option of the holders. The Series B Preferred Stock has a liquidation
preference.
In February 1998, the common stockholders exchanged the $1.00 par value
common stock for an equal number of shares of Series C Preferred Stock and
relinquished all rights to the warrants previously held. The Series C Preferred
Stock outstanding after the conversion and merger transactions total 8,492,748
shares. All shares were issued at $1.60 per share and have a $0.001 par value.
The convertible, voting shares have a 10% non-cumulative dividend. The shares
have liquidation preference over the common stock at the greater of (1) par
value plus accrued but unpaid dividends or (2) par value plus the fair market
value of common stock into which the shares could be converted. Each share can
be converted into a share of common stock at the option of the holder. Voting
rights are exercised together with Series B Preferred Stock and the common
stock. The Series C Preferred Stock is subordinate to the Series B Preferred
Stock.
The 1997 Stock Option Plan was canceled and vested shares were forfeited.
Certain employees were allowed to purchase 474,750 shares of common stock at par
($0.001 per share) in exchange for the forfeiture of the vested options. During
the six months ended June 30, 1998, options to purchase 4,546,358 shares of
F-7
<PAGE> 135
BIRCH TELECOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common stock were granted to certain employees at the estimated fair value at
the date of grant, $0.001 per share. The options vest in even quarterly amounts
over four years.
During June 1998, the Company completed the sale of $115 million 14% Senior
Notes due 2008 and warrants to purchase 1,409,734 shares of common stock.
Interest is payable semi-annually in arrears on June 15 and December 15 of each
year commencing on December 15, 1998. The Company received net proceeds of
$110.2 million and concurrently purchased pledged securities of $44.2 million.
The pledged securities and interest accruing thereon will be used to satisfy
interest payments through June 2001. The Company classifies its pledged
securities, consisting of $44.9 million of U.S. Treasury securities, as held to
maturity recorded at amortized cost and maturing between six months and three
years. These securities are restricted for interest payments on the Notes. A
portion of the proceeds of this offering, $337,000, was allocated to the
warrants, and the resulting debt discount is being amortized over the life of
the debt on the straight-line method which does not differ materially from the
effective interest method. The amount allocated to the Warrants represents the
fair value of the Warrants at the date of issuance. The Senior Notes rank pari
passu in right of payment to all existing and future senior indebtedness of the
Company and rank senior in right of payment to all existing and future
subordinated indebtedness of the Company. As of September 30, 1998, the Senior
Notes had not been registered under the Securities Act and therefore cannot be
offered for resale, resold or otherwise transferred unless so registered or
unless an applicable exemption from the registration requirements of the
Securities Act is available. The indenture related to the Senior Notes contains
certain covenants which, among other things, restrict the ability of the Company
to incur additional indebtedness, pay dividends or make distributions of the
Company's or its subsidiaries' stock, enter into sale and leaseback
transactions, create liens, enter into transactions with affiliates or related
persons, consolidate, merge or sell all of its assets.
For further discussion of the Company's current financing and liquidity
requirements, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations," and "Risk Factors -- Need for Additional Financing."
5. STOCK DIVIDEND
On June 23, 1998, the Company paid a dividend in kind, in the amount of
0.055 shares per share, to the holders of the Company's Series B Preferred
Stock, Series C Preferred Stock, and Common Stock as of June 15, 1998. Loss per
common share and weighted average common shares outstanding have been restated
to reflect the stock dividend.
F-8
<PAGE> 136
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
BIRCH TELECOM, INC.
We have audited the accompanying consolidated balance sheet of Birch
Telecom, Inc. (the Company) (a development stage company) as of December 31,
1997, and the related consolidated statements of operations, stockholders'
equity, and cash flows for the year ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Birch Telecom,
Inc. at December 31, 1997, and the consolidated results of its operations and
its cash flows for the year ended December 31, 1997, in conformity with
generally accepted accounting principles.
Ernst & Young LLP
Kansas City, Missouri
April 24, 1998
F-9
<PAGE> 137
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS EXCEPT SHARE DATA)
DECEMBER 31, 1997
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 210
Prepaid expenses and other current assets................. 7
-------
Total current assets........................................ 217
Property and equipment:
Office equipment.......................................... 105
Furniture and fixtures.................................... 23
-------
128
Less accumulated depreciation............................. (27)
-------
Net property and equipment.................................. 101
Capitalized financing costs................................. 129
Interconnection and resale agreements....................... 87
-------
Total assets................................................ $ 534
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable to stockholder............................... $ 250
Accounts payable and accrued liabilities.................. 255
-------
Total current liabilities................................... 505
Stockholders' equity:
Common stock -- $.01 par value, 20,000,000 shares
authorized, 1,800,000 shares issued and outstanding.... 18
Warrants.................................................. 18
Additional paid-in capital................................ 1,782
Deficit accumulated during the development stage............ (1,789)
-------
Total stockholders' equity.................................. 29
-------
Total liabilities and stockholders' equity.................. $ 534
=======
</TABLE>
See accompanying notes.
F-10
<PAGE> 138
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
Revenue..................................................... $ --
Operating expenses:
Selling general and administrative........................ 1,776
Depreciation expense...................................... 27
-------
Total operating expenses.................................... 1,803
-------
Operating loss.............................................. (1,803)
Interest income............................................. 14
-------
Loss before income taxes.................................... (1,789)
Income taxes................................................ --
-------
Net loss.................................................... $(1,789)
-------
Net loss per common share -- basic and diluted.............. $ (1.45)
=======
Weighted average number of common shares outstanding --
basic and diluted......................................... 1,235
</TABLE>
See accompanying notes.
F-11
<PAGE> 139
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
DEFICIT
COMMON STOCK ACCUMULATED
----------------------------- ADDITIONAL DURING THE TOTAL
NUMBER OF PAID-IN DEVELOPMENT STOCKHOLDERS'
SHARES AMOUNT WARRANTS CAPITAL STAGE EQUITY
--------- ------ -------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 23, 1996 (date
of inception) and at December 31,
1996............................. -- $-- $-- $ -- $ -- $ --
Issuance of common stock and
warrants:
January 1997..................... 600 6 6 594 -- 606
April 1997....................... 600 6 6 594 -- 606
August 1997...................... 600 6 6 594 -- 606
Net loss........................... -- -- -- -- (1,789) (1,789)
----- --- --- ------ ------- -------
Balance at December 31, 1997....... 1,800 $18 $18 $1,782 $(1,789) $ 29
===== === === ====== ======= =======
</TABLE>
See accompanying notes.
F-12
<PAGE> 140
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<S> <C>
OPERATING ACTIVITIES
Net loss.................................................... $(1,789)
Adjustments to reconcile net loss to net cash from operating
activities:
Depreciation.............................................. 27
Write-off of other assets................................. 50
Change in operating assets and liabilities:
Prepaid expenses and other current assets.............. (7)
Accounts payable and accrued liabilities............... 255
-------
Net cash from operating activities.......................... (1,464)
INVESTING ACTIVITIES
Purchase of property and equipment.......................... (128)
Costs of interconnection and resale agreements.............. (87)
-------
Net cash from investing activities.......................... (215)
FINANCING ACTIVITIES
Proceeds from issuance of common stock and warrants......... 1,768
Borrowings under note payable to stockholder................ 250
Capitalized financing costs................................. (129)
-------
Net cash from financing activities.......................... 1,889
-------
Net increase in cash and cash equivalents................... 210
Cash and cash equivalents at beginning of year.............. --
-------
Cash and cash equivalents at end of year.................... $ 210
=======
Supplemental disclosure of noncash financing activities:
Common stock issued in exchange for other assets.......... $ 50
=======
</TABLE>
See accompanying notes.
F-13
<PAGE> 141
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1997
1. THE COMPANY
Birch Telecom, Inc., a competitive local exchange carrier, was incorporated
December 23, 1996, as a Delaware corporation for the purpose of providing local,
long distance, Internet, and other communications services to business and
residential customers initially in Kansas and Missouri. The consolidated
financial statements of Birch Telecom, Inc. include the accounts of Birch
Telecom, Inc. and the accounts of its wholly-owned subsidiaries, Birch Telecom
of Kansas, Inc., Birch Telecom of Missouri, Inc., Birch Telecom of Nebraska,
Inc., and Birch Telecom of Arizona, Inc. (collectively, the "Company").
The Company is in the development stage and has generated no revenue for
the period from December 23, 1996 (date of inception) to December 31, 1997.
Since its inception, the Company's principal activities have included developing
its business plans, developing its marketing plans, procuring governmental
authorizations, raising capital, hiring management and other key personnel,
negotiating interconnection and resale agreements, and analyzing and negotiating
certain acquisition opportunities. Accordingly, the Company has had no operating
revenue and has incurred operating losses and operating cash flow deficits.
The Company had no assets, liabilities or financial activity prior to 1997.
Approximately $13,000 of legal expense incurred by the founders prior to, and in
connection with, the incorporation of the Company effective December 23, 1996
were assumed and paid by the Company in 1997.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
For purposes of reporting cash flows, the Company includes as cash and cash
equivalents, cash and marketable securities with original maturities of three
months or less.
Property and Equipment
Property and equipment includes office equipment, furniture and fixtures.
These assets are stated at cost and depreciated using the straight-line method
over the estimated useful lives of the assets. The estimated useful lives of
office equipment are three to seven years and furniture and fixtures are five to
seven years.
Interconnection and Resale Agreements
Interconnection and resale agreements consist primarily of legal expenses
incurred to negotiate the agreements. These costs will be amortized on a
straight-line basis over five years beginning in 1998 upon the commencement of
operations. No amortization expense was recorded for the year ended December 31,
1997.
Capitalized Financing Costs
Capitalized financing costs consist primarily of legal and other related
expenses incurred in obtaining the 1998 Financing (see Note 8).
Fair Values of Financial Instruments
As of December 31, 1997, the fair value of the Company's financial
instruments, including cash equivalents and note payable to stockholder,
approximate their carrying value.
Cash and Cash Equivalents
The carrying amount approximates fair value because of the short maturity
of those instruments.
Pledged Securities
The carrying amount and fair value are reported at amortized cost since
these securities are to be held to maturity.
Long-Term Debt
The fair value is based on the quoted market prices for the same or similar
issues or the carrying value is used where a market price is unavailable.
F-14
<PAGE> 142
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Use of Estimates in Financial Statements
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
Loss Per Share
The net loss per share amount reflected on the consolidated statement of
operations is based on the weighted-average number of common shares outstanding
of 1,235,000 shares. Warrants and options have not been included because of the
anti-dilutive effect on loss per share.
3. CAPITAL STRUCTURE
Stock Purchase Agreement and Securityholders Agreement
During 1997, 1,750,000 shares of common stock and 1,800,000 warrants were
sold to management and equity investors for $1.00 and $0.01 per share,
respectively. The warrants entitled the holders to purchase an additional 1.8
million shares in the aggregate of common stock at $1.00 per share. In addition
to cash investments, members of management contributed the business plan to the
Company in exchange for 50,000 shares of common stock, which transaction was
recorded in the amount of $50,000 with a corresponding charge to income to
reflect the expense to Birch of acquiring the business plan. Subsequent to
year-end, all common stock was exchanged for Series C Preferred Stock and the
warrants were surrendered (see Note 8).
Common Stock
At December 31, 1997, the Company had authorized 20,000,000 million shares
of $0.01 par value common stock of which 1,800,000 shares were issued and
outstanding. Of the authorized but unissued common stock, 1,800,000 shares are
reserved for issuance upon exercise of warrants as described above and 2,783,000
shares are reserved for issuance upon exercise of stock options issued under the
Company's 1997 Stock Option Plan (see Notes 7 and 8).
4. RELATED-PARTY TRANSACTIONS
During December 1997, the Company borrowed $250,000 from the Company's
principal stockholder under a note payable. The note payable bears interest at
the prime rate plus two percent (10.5% at December 31, 1997). The note payable
was fully repaid in February 1998 (see Note 8).
5. COMMITMENTS AND CONTINGENCIES
Future minimum rental commitments at December 31, 1997 for all
noncancelable operating leases, consisting mainly of leases for office space and
equipment, are as follows (in thousands):
<TABLE>
<S> <C>
1998........................................................ $ 40
1999........................................................ 48
2000........................................................ 33
2001........................................................ 29
2002........................................................ 29
Thereafter.................................................. 10
----
Total............................................. $189
====
</TABLE>
Total rent expense for the year ended December 31, 1997 was $81,000.
F-15
<PAGE> 143
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In February 1998, the Company entered into a five-year general agreement
with Lucent Technologies, Inc. (Lucent) establishing terms and conditions for
the purchase of Lucent products, services and licensed materials. This agreement
includes a five-year exclusivity commitment for the purchase of products and
services related to new switches. The agreement contains no minimum purchase
requirements.
6. INCOME TAXES
The Company has certain net deferred tax assets related primarily to
expenses incurred during the development stage. The Company has recorded a
valuation allowance equal to the net deferred tax assets at December 31, 1997,
due to the uncertainty of future operating results. The valuation allowance will
be reduced at such time as management believes that the net deferred tax assets
will be realized. Any reductions in the valuation allowance will reduce future
income tax provisions.
The sources of differences between the financial accounting and tax basis
of assets and liabilities which gave rise to the net deferred tax assets are as
follows (in thousands):
<TABLE>
<S> <C>
Deferred assets:
Start-up costs capitalized for tax purposes............... $ 681
Valuation allowance....................................... (681)
-----
$ --
=====
</TABLE>
The primary differences that caused the effective tax rate to vary from the
statutory federal income tax rate of 34% were state income taxes and the
valuation allowance.
Under existing tax law, all operating expenses prior to a company
commencing its principle operations are capitalizable for income tax purposes.
7. STOCK OPTION PLAN
At December 31, 1997, the Company had a stock option plan (the 1997 Stock
Option Plan) under which it granted options to purchase common stock. The
options granted had a term of 10 years and vested over a four-year period. This
plan was terminated and superseded in 1998 by the 1998 Stock Option Plan (see
Note 8). No options were or ever will be exercised and no shares were or ever
will be issued under the terminated and superseded 1997 Stock Option Plan.
The Company applied the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and the related
interpretations in accounting for the 1997 Stock Option Plan. Had compensation
cost for the Plan been determined based on the fair value of the options as of
the grant dates for awards under the Plan consistent with the method prescribed
in Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," (SFAS No. 123), the Company's net loss and loss per
share would have increased to the pro forma amount indicated below (in thousands
except for loss per share information). The Company estimated the fair value of
each option grant using the minimum value method permitted by SFAS No. 123 for
entities not publicly traded. The Company utilized the following assumptions in
the calculation: risk-free interest rate of 5.25%, expected life of four years
and no dividends being paid over the life of the options (in thousands except
per share data).
<TABLE>
<S> <C>
Net loss -- as reported.................................... $(1,789)
Net loss -- pro forma...................................... (1,921)
Loss per share -- Basic and Diluted -- Pro Forma........... (1.56)
</TABLE>
F-16
<PAGE> 144
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the new 1998 Stock Option Plan as described above 3,972,000 options
were granted during 1998 at an exercise price of $0.001 per share, the fair
value of common stock at the date of grant. The weighted-average fair value of
the 1998 options granted under the new plan approximated the exercise price.
8. SUBSEQUENT EVENTS
During February 1998, the Company simultaneously completed a merger with
the Valu-Line Companies, Inc. a Kansas Corporation (Valu-Line) and closed a
financing transaction resulting in gross proceeds to the Company (see "1998
Financing" below) of $13 million. The financing included a recapitalization of
the founders equity, termination of the 1997 Stock Option Plan, and creation of
the 1998 Stock Option Plan as further described below. Additionally, the note
payable to a stockholder was repaid during February 1998 (see Note 4).
Merger
The Company completed a merger with Valu-Line whose shareholders received
$4.75 million in cash, $4.75 million in the Company's Series A Preferred Stock
at $1.60 per share, and $10 million in the Company's Series C Preferred Stock at
$1.60 per share in the Merger. Additionally, certain employees of Valu-Line were
granted options to purchase 779,297 shares of the Company's common stock under
the 1998 Stock Option Plan (see below). Valu-Line provides switched long
distance, customer premise equipment, and local services to certain Kansas
customers.
The merger will be recorded using the purchase method of accounting. During
1997, Valu-Line had net income of $268,000 on revenue of $16.8 million exclusive
of a former subsidiary and a former division of Valu-Line that were spun-off in
December 1997 and not purchased by the Company. The purchase price totaled $19.5
million; the excess of the purchase price over the estimated fair value of the
net assets acquired will be allocated to goodwill in the amount of $15.3 million
and customer lists in the amount of $2.3 million. These intangible assets will
be amortized over 25 years and five years, respectively.
1998 Financing
During February and March 1998, 5,937,500 shares of Series B Preferred
Stock were sold for $1.60 per share or $9.5 million and 450,000 shares of the
Company's common stock were sold for $0.001 per share or a total of $450.
Certain employees were allowed new options to acquire (see "Stock Option Plans"
below) common stock in exchange for the forfeiture and resulting loss of
ownership related to the 1997 Stock Option Plan. Additionally, the Company
issued $3.5 million of convertible subordinated debt which was convertible into
Series B Preferred Stock at $1.60 per share. These transactions collectively are
referred to as the "1998 Financing".
Recapitalization of Founders Equity
In conjunction with the 1998 Financing, the existing common stock was
exchanged for Series C Preferred Stock and the warrants were surrendered.
Stock Option Plans
In conjunction with the 1998 Financing, the 1997 Stock Option Plan was
terminated and superseded by the 1998 Stock Option Plan. Options granted through
April 24, 1998 under the 1998 Stock Option Plan have an exercise price of $.001
per share, the estimated fair value of common stock at the date of grant. The
1998 Stock Option Plan provides for equal quarterly vesting over four years with
an option term of 10 years. Common shares reserved for issuance under the 1998
Stock Option Plan total 4,156,250 and options to
F-17
<PAGE> 145
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
purchase 3,972,000 shares have been granted. The 1998 Stock Option Plan provides
for the exercise of options by the option holders at any time after the date of
grant. The early exercised shares are forfeitable based on the vesting schedule
described above.
Description of Convertible Subordinated Debt, Preferred Stock and Common Stock
After the merger and financing, the following debt and equity instruments
were outstanding:
Convertible Subordinated Debt
Convertible subordinated debt of $3.5 million may be converted into
2,187,500 shares of Series B Preferred Stock, and ultimately into the same
number of shares of common stock at the option of the holder at any time and is
automatically converted immediately prior to the closing of a public offering by
the Company in excess of $30 million. The convertible subordinated debt bears
interest at 14% per annum, payable quarterly. The Company may elect to defer
payment of 3% per annum of the interest due on any scheduled interest payment
date, which deferred amount shall then be added to the outstanding principal
balance of the convertible subordinated debt. If not converted, the principal is
due in equal annual installments in February 2003, 2004 and 2005. The
convertible subordinated debt is secured by all assets of the Company.
Preferred Stock
In 1998, the Company authorized 25 million shares of Preferred Stock. As of
February 1998, 2,968,750 shares were designated Series A Preferred Stock,
8,125,000 shares (2,187,500 of which are reserved for the potential conversion
of the 3.5 million convertible subordinated debt) were designated Series B
Preferred Stock and 8,050,000 were designated Series C Preferred Stock.
Series A Preferred Stock
The Series A Preferred Stock outstanding after the transactions described
above totals 2,968,750 shares. All shares were issued at $1.60 per share and
have a $0.001 par value. The non-convertible, non-voting shares have a 10%
cumulative dividend. The shares maintain a liquidation preference over the
Series B and Series C Preferred Stock and common stock including accrued but
unpaid dividends.
Series B Preferred Stock
The Series B Preferred Stock outstanding after the transactions described
above totals 5,937,500 shares. All shares were issued at $1.60 per share and
have a $0.001 par value. The convertible, voting shares have a 15% cumulative
compounding dividend. The shares are redeemable in equal annual installments in
February 2003, 2004, and 2005 at the greater of (1) par value plus accrued but
unpaid dividends or (2) par value plus the fair market value of common stock
into which the shares could be converted. Redemption is at the option of the
holder; provided that redemption is mandatory for all holders if at least 75% of
the holders request the option redemption. The shares have liquidation
preference over the Series C Preferred Stock and common stock at the greater of
the stated value plus accrued but unpaid dividends, or the stated value plus the
fair market value of common stock into which the shares could be converted. Each
share can be converted into a share of common stock at the option of the holder.
Voting rights are exercised together with Series C Preferred Stock and common
stock.
Series C Preferred Stock
The Series C Preferred Stock outstanding after the transactions described
above totals 8,050,000 shares. All shares were issued at $1.60 per share and
have a $0.001 par value. The convertible, voting shares have a
F-18
<PAGE> 146
BIRCH TELECOM, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10% non-cumulative dividend. The shares have no mandatory redemption rights. The
shares have liquidation preference over the Common Stock at the greater of (1)
par value plus accrued but unpaid dividends or (2) par value plus the fair
market value of common stock into which the shares could be converted. Each
share can be converted into a share of common stock at the option of the holder.
Voting rights are exercised together with Series B and Series C Preferred Stocks
but not common stock.
Common Stock
The Company authorized 27.0 million shares of Common Stock, of which
450,000 shares have been issued and are outstanding, 16.2 million shares are
reserved for issuance upon conversion of the Series B and Series C Preferred
Stock.
The common stock has voting rights together with Series B and C Preferred
Stock and no mandatory redemption. Dividends, if any, will be declared by the
board of directors.
9. YEAR 2000 COMPLIANCE -- UNAUDITED
Year 2000 issues arise from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have time-sensitive software may recognize a date using 00 as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculation causing disruptions of operations, including, among other things,
a temporary inability to process transactions, send invoices or engage in
similar normal business activities.
While the Company believes that its systems will be year 2000 compliant,
there can be no assurance until the year 2000 occurs that all systems will
function adequately. In addition, the Company interconnects and uses various
local exchange companies' facilities to service its customers, and such
facilities currently utilize numerous date-sensitive computer applications. If
these facilities are not year 2000 compliant, or if the systems of other local
exchange companies, long-distance carriers and others upon which the Company
relies are not year 2000 compliant, it could have a material adverse effect on
the Company's business, operating results and financial condition.
F-19
<PAGE> 147
REPORT OF INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS
VALU-LINE COMPANIES, INC.
We have audited the accompanying consolidated balance sheets of the
Valu-Line Companies, Inc. (the Company) as of December 31, 1997 and 1996, and
the related consolidated statements of income and retained earnings, and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Valu-Line
Companies, Inc. at December 31, 1997 and 1996 and the consolidated results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Kansas City, Missouri
May 15, 1998
F-20
<PAGE> 148
VALU-LINE COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 158 $ 258
Accounts receivable, net of allowance of $80 and $70,
respectively........................................... 1,203 1,790
Other receivables -- related parties...................... 45 97
Inventories............................................... 436 530
Prepaid expenses.......................................... 4 37
Income taxes receivable................................... -- 30
Other assets.............................................. 5 60
Deferred income taxes..................................... 44 71
------ ------
Total current assets........................................ 1,895 2,873
Property and equipment, net................................. 1,710 1,612
Other assets................................................ 263 317
------ ------
Total assets................................................ $3,868 $4,802
====== ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt and capital lease
obligation............................................. $ 100 $ 110
Notes payable -- related parties.......................... 284 240
Accounts payable.......................................... 742 1,262
Accrued expenses.......................................... 84 225
Customer deposits......................................... 187 39
Accrued salaries and commissions.......................... 221 266
Deferred revenue.......................................... 21 287
Income taxes payable...................................... 26 --
------ ------
Total current liabilities................................... 1,665 2,429
Long-term debt, net of current maturities................... 357 345
Capital lease obligation, net of current maturities......... 435 336
Deferred income taxes....................................... 14 27
Stockholders' equity:
Common stock, no par value, 100,000 shares authorized;
10,360 issued and outstanding.......................... 181 181
Retained earnings......................................... 1,216 1,484
------ ------
Total stockholders' equity.................................. 1,397 1,665
------ ------
Total liabilities and stockholders' equity.................. $3,868 $4,802
====== ======
</TABLE>
See accompanying notes.
F-21
<PAGE> 149
VALU-LINE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
--------- --------- ---------
(IN THOUSANDS EXCEPT SHARES AND PER
SHARE DATA)
<S> <C> <C> <C>
Revenue:
Communications services, net.............................. $10,363 $10,686 $13,785
Equipment sales, net...................................... 1,863 2,531 3,016
------- ------- -------
Total revenue............................................... 12,226 13,217 16,801
Cost of services:
Cost of communications services........................... 7,323 7,308 9,859
Cost of equipment sales................................... 961 1,441 1,983
------- ------- -------
Total cost of services...................................... 8,284 8,749 11,842
------- ------- -------
Gross margin................................................ 3,942 4,468 4,959
Selling, general and administrative......................... 3,520 3,561 4,067
Depreciation and amortization............................... 189 311 341
------- ------- -------
Income from operations...................................... 233 596 551
Interest expense............................................ 58 102 97
------- ------- -------
Income before income taxes.................................. 175 494 454
Income tax expense.......................................... 81 205 186
------- ------- -------
Net income.................................................. 94 289 268
Retained earnings, beginning of year........................ 833 927 1,216
------- ------- -------
Retained earnings, end of year.............................. $ 927 $ 1,216 $ 1,484
======= ======= =======
Earnings per share -- basic and diluted..................... $ 9.07 $ 27.90 $ 25.87
======= ======= =======
Common shares outstanding -- basic and diluted.............. 10,360 10,360 10,360
======= ======= =======
</TABLE>
See accompanying notes.
F-22
<PAGE> 150
VALU-LINE COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
----- ----- -----
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 94 $ 289 $ 268
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization............................. 189 311 341
Deferred income taxes..................................... (23) 7 (14)
Income tax expense........................................ 101 43 73
Changes in operating assets and liabilities:
Accounts receivable.................................... (81) 185 (660)
Other receivables -- related parties................... (16) (18) (52)
Inventory.............................................. (11) (122) (94)
Income taxes receivable/payable........................ (427) 290 (56)
Accounts payable....................................... (64) (303) 520
Accrued expenses and other current liabilities......... 29 188 304
Other.................................................. (58) (36) (142)
----- ----- -----
Net cash from operating activities.......................... (267) 834 488
INVESTING ACTIVITIES
Purchase of property and equipment.......................... (230) (513) (243)
----- ----- -----
Net cash from investing activities.......................... (230) (513) (243)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt.................... -- 92 --
Proceeds from issuance of note payable...................... 300 -- --
Proceeds from issuance of notes payable -- related
parties................................................... -- 33 --
Payment of notes payable.................................... -- (300) (11)
Payment of notes payable -- related parties................. (32) -- (44)
Payment of long-term debt................................... (9) -- --
Payment of capital lease obligation......................... -- (82) (90)
----- ----- -----
Net cash from financing activities.......................... 259 (257) (145)
----- ----- -----
Net increase (decrease) in cash and cash equivalents........ (238) 64 100
Cash and cash equivalents, beginning of year................ 332 94 158
----- ----- -----
Cash and cash equivalents, end of year...................... $ 94 $ 158 $ 258
===== ===== =====
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Equipment financed under capital lease...................... $ 607 $ -- $ --
===== ===== =====
</TABLE>
See accompanying notes.
F-23
<PAGE> 151
VALU-LINE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
1. THE COMPANY
These consolidated financial statements include the accounts of Valu-Line
Companies, Inc., a Kansas Corporation, and its wholly-owned subsidiaries
(collectively, the "Company"), Valu-Line of Kansas, Inc. and IS Advertising. The
Company was acquired by Birch Telecom, Inc. in February 1998 (see Note 11). The
accounts of Valu Broadcasting, Inc. and Steve Sauder Real Estate, respectively,
a wholly-owned subsidiary of and a division of Valu-Line Companies, Inc., both
of which were spun off in December 1997, have been excluded for all periods from
these consolidated financial statements in order to reflect financial position
and operating results on a basis consistent with the businesses acquired by
Birch Telecom, Inc. All intercompany balances and transactions have been
eliminated in consolidation.
The Company provides local, long distance, Internet, customer premises
equipment and other communications services to business and residential
customers in the state of Kansas.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
For purposes of reporting cash flows, the Company includes as cash and cash
equivalents, cash and marketable securities with original maturities of three
months or less.
Revenue Recognition
Revenue from communications services is recognized when the services are
provided. Revenue on billings to customers in advance of providing services is
deferred and recognized when earned.
Concentration of Credit Risk
The Company is exposed to concentrations of credit risk principally from
customer accounts receivable. At December 31, 1997, the Company's customers are
located in the state of Kansas. The Company performs ongoing credit evaluations
of its customers as a means to reduce credit risk.
Fair Values of Financial Instruments
As of December 31, 1996 and 1997, the fair values of the Company's
financial instruments, including cash equivalents and notes payable -- related
parties, approximate their carrying value.
Inventories
Inventories, which consist of customer premises communications equipment
held for sale and supplies, are valued at lower of average cost or market.
Property and Equipment
Property and equipment, including assets held under capital leases, are
stated at cost and are depreciated using the straight-line method over the
estimated useful lives of the related assets or lease term.
Use of Estimates in Financial Statements
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.
F-24
<PAGE> 152
VALU-LINE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTY AND EQUIPMENT
The components of property and equipment at December 31, 1996 and 1997 are
as follows:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIVES 1996 1997
------------ ------ ------
(In thousands)
<S> <C> <C> <C>
Telecommunications and other equipment........ 5 years $1,042 $1,103
Office equipment, furniture and other......... 3 - 7 years 996 1,178
Buildings and improvements.................... 40 years 683 683
------ ------
2,721 2,964
Accumulated depreciation and amortization..... (1,011) (1,352)
------ ------
$1,710 $1,612
====== ======
</TABLE>
Telecommunication equipment under capital lease was $607,000 at December
31, 1996 and 1997. Accumulated amortization totaled $97,000 as of December 31,
1996 and $194,000 as of December 31, 1997. Amortization of assets under capital
lease is included in depreciation and amortization expense. Interest expense
associated with the obligations under these leases amounted to $55,000 and
$47,000 in 1996 and 1997, respectively.
4. CAPITAL LEASE OBLIGATION
The Company leases telecommunications equipment under a capital lease. The
future minimum lease payments under the capitalized lease and the present value
of the net minimum lease payments as of December 31, 1997 are as follows (in
thousands):
<TABLE>
<S> <C>
1998........................................................ $137
1999........................................................ 137
2000........................................................ 137
2001........................................................ 57
2002........................................................ 57
2003........................................................ 57
----
Total minimum lease payments................................ 582
Less amount representing interest........................... (147)
----
Present value of net minimum lease payments with interest at
10.0%..................................................... 435
Less current maturities..................................... (99)
----
$336
====
</TABLE>
5. LONG TERM DEBT AND NOTES PAYABLE
The Company entered into a note payable with a financial institution in the
amount of $300,000 in 1992 to finance the remodeling of a building. The note is
payable in monthly installments through 2007. Interest is payable at prime plus
1 1/2% (10.0% at December 31, 1997). The note is secured by the building and the
deposit accounts of the Company with the financial institution. The outstanding
principal balance on the note was $269,000 and $262,000 at December 31, 1996 and
1997, respectively.
In 1996, the Company issued a note payable of $100,000 to finance the
purchase of an office building. The note is payable in monthly installments
through 2011. Interest is payable at a variable rate (8.90% at December, 31,
1997). The note is secured by the building. The outstanding principal balance on
the note was $98,000 and $94,000 at December 31, 1996 and 1997, respectively.
F-25
<PAGE> 153
VALU-LINE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities on the aforementioned notes payable are as follows (in
thousands):
<TABLE>
<S> <C>
1998........................................................ $ 11
1999........................................................ 13
2000........................................................ 14
2001........................................................ 15
2002........................................................ 17
Thereafter.................................................. 286
----
Total....................................................... $356
====
</TABLE>
The Company also has notes payable to officers of the Company and members
of their families. The notes are unsecured and payable on demand. Interest is
payable at the treasury rate (5.85% at December 31, 1997). The outstanding
principal balance on these notes was $284,000 and $240,000 at December 31, 1996
and 1997, respectively. Principal and interest payments were $122,000, $43,000
and $128,000 for 1995, 1996 and 1997.
Total interest paid for the years 1995, 1996 and 1997 was $58,000, $102,000
and $97,000, respectively.
6. EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) profit-sharing plan covering substantially
all employees under which employees can contribute up to 15% of their annual
salary subject to annual Internal Revenue Code maximum limitations. Employees
can participate after meeting the plan's eligibility requirements. The Company
may make a discretionary contribution. Company contributions to the plan were
$61,000, $72,000 and $81,000 for 1995, 1996 and 1997, respectively.
7. INCOME TAXES
The income tax expense (benefit) consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
----- ----- -----
(In thousands)
<S> <C> <C> <C>
Current:
Federal............................................. $91 $174 $175
State............................................... 13 24 25
--- ---- ----
Total Current......................................... 104 198 200
Deferred:
Federal............................................. (20) 6 (12)
State............................................... (3) 1 (2)
--- ---- ----
Total deferred........................................ (23) 7 (14)
--- ---- ----
Income tax expense.................................... $81 $205 $186
=== ==== ====
</TABLE>
F-26
<PAGE> 154
VALU-LINE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The differences between the amount computed by applying the statutory
federal income tax rate to income before income taxes and the provision for
income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996 1997
----- ----- -----
(In thousands)
<S> <C> <C> <C>
Tax computed at statutory rate........................ $61 $173 $159
State taxes, net of federal effect.................... 8 24 22
Other, net............................................ 12 8 5
--- ---- ----
Income tax expense.................................... $81 $205 $186
=== ==== ====
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for federal and state income tax purposes.
Significant components of the Company's deferred tax assets and liabilities at
December 31, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------
1996 1997
----- -----
(In thousands)
<S> <C> <C>
Deferred tax assets (current):
Accrued liabilities....................................... $-- $32
Allowance for doubtful accounts........................... 33 28
Inventory capitalization.................................. 11 11
--- ---
44 71
Deferred tax liability (noncurrent):
Depreciation.............................................. 14 27
--- ---
Net deferred tax assets..................................... $30 $44
=== ===
</TABLE>
Net cash paid (refunded) for income taxes for the years ended December 31,
1995, 1996 and 1997 was $527,000, $(48,000) and $225,000, respectively.
8. ADDITIONAL FINANCIAL INFORMATION
Related Parties
In 1995, 1996, and 1997 Valu-Line provided services principally related to
rent and operating costs to Valu-Broadcasting, Inc., an affiliate of Valu-Line
at the time of the transactions, in the amounts of $65,000, $74,000 and $81,000
respectively. Valu-Line also received services principally related to
advertising from Valu-Broadcasting, Inc. in the amounts of $39,000, $31,000 and
$41,000 in 1995, 1996 and 1997, respectively. In February 1998, Valu-Line merged
with and into the Company pursuant to the Merger.
Major Supplier Information
Cost of communications services provided by Southwestern Bell approximated
27%, 39% and 40% of the total cost of communication services for the years ended
December 31, 1995, 1996 and 1997, respectively. Equipment purchases from Toshiba
approximated 73%, 76% and 59% of cost of equipment sales for the years ended
December 31, 1995, 1996 and 1997, respectively.
F-27
<PAGE> 155
VALU-LINE COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES
Minimum rental commitments at year-end 1997 for all noncancelable operating
leases, consisting mainly of leases for office space and vehicles, are as
follows (in thousands):
<TABLE>
<S> <C>
1998........................................................ $30
1999........................................................ 19
2000........................................................ 9
---
Thereafter.................................................. $58
===
</TABLE>
Total rent expense for the year ended 1997, 1996 and 1995 was $56,000,
$48,000 and $40,000, respectively.
10. SUBSEQUENT EVENT
In February 1998, the Company was acquired by Birch Telecom, Inc. for
$19,500,000. Shareholders of the Company received $4,750,000 of cash and
$14,750,000 of preferred stock in Birch Telecom, Inc.
11. YEAR 2000 COMPLIANCE -- UNAUDITED
Year 2000 issues arise from computer programs written using two digits
rather than four to define the applicable year. Any of the Company's computer
programs that have time-sensitive software may recognize a date using 00 as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculation causing disruptions of operations, including, among other things,
a temporary inability to process transactions, send invoices or engage in
similar normal business activities.
Based on ongoing assessments, the Company determined that it will be
required to modify or replace portions of its software so that its computer
systems will function properly with respect to dates in the year 2000 and
thereafter. The Company presently believes that with modifications to existing
software and conversions to new software, the year 2000 issue will not pose
significant operational problems for its computer systems. The Company estimates
it will incur minimal expenses to modify and convert its systems and anticipates
completing the year 2000 project by the year ending December 31, 1998.
While the Company believes that its systems will be year 2000 compliant,
there can be no assurance until the year 2000 occurs that all systems will
function adequately. In addition, the Company interconnects and uses various
local exchange companies' facilities to service its customers, and such
facilities currently utilize numerous, date-sensitive computer applications. If
these facilities are not year 2000 compliant, or if the systems of other local
exchange companies, long-distance carriers and others upon which the Company
relies are not year 2000 compliant, it could have a material effect on the
Company's business, operating results and financial condition.
F-28
<PAGE> 156
- ------------------------------------------------------
- ------------------------------------------------------
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFER
CONTAINED HEREIN OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL,
OR THE SOLICITATION OF AN OFFER TO BUY, ANY SECURITY OTHER THAN THOSE TO WHICH
IT RELATES NOR DOES IT CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN
OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR
SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING SUCH OFFER OR
SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE OF THIS PROSPECTUS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................... 1
Risk Factors............................... 15
The Exchange Offer......................... 28
Use of Proceeds............................ 35
Dividend Policy............................ 36
Capitalization............................. 37
Unaudited Pro Forma Condensed Consolidated
Financial Statements..................... 38
Selected Historical Consolidated Financial
Data and Other Data...................... 41
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 44
Business................................... 52
Management................................. 67
Security Ownership of Certain Beneficial
Owners and Management.................... 75
Certain Relationships and Related
Transactions............................. 76
Description of Capital Stock............... 79
Description of the Warrants................ 84
Description of the Exchange Notes.......... 90
Book-Entry, Delivery and Form.............. 118
Certain United States Federal Income Tax
Considerations........................... 120
Plan of Distribution....................... 121
Legal Matters.............................. 121
Experts.................................... 121
Available Information...................... 121
Index to Financial Statements.............. F-1
</TABLE>
UNTIL , 1998, ALL DEALERS EFFECTING TRANSACTIONS IN THE EXCHANGE
NOTES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR
UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
-----------------
PROSPECTUS
-----------------
BIRCH TELECOM, INC.
OFFER TO EXCHANGE ITS
14% SENIOR NOTES
DUE 2008 WHICH HAVE
BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933,
AS AMENDED, FOR ANY
AND ALL OF ITS OUTSTANDING
14% SENIOR NOTES DUE 2008
, 1998
------------------------------------------------------
------------------------------------------------------
<PAGE> 157
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the General Corporation Law of the State of Delaware
("DGCL") provides that a corporation has the power to indemnify any director or
officer, or former director or officer, who was or is a party or is threatened
to be made a party to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of the corporation) against the expenses (including
attorney's fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by him in connection with the defense of any action by
reason of being or having been directors or officers, if such person shall have
acted in good faith and in a manner reasonably believed to be in or not opposed
to the best interests of the corporation, and, with respect to any criminal
action or proceeding, provided that such person had no reasonable cause to
believe his conduct was unlawful, except that, if such action shall be in the
right of the corporation, no such indemnification shall be provided as to any
claim, issue or matter as to which such person shall have been judged to have
been liable to the corporation unless and only to the extent that the Court of
Chancery of the State of Delaware (the "Court of Chancery"), or any court in
such suit or action was brought, shall determine upon application that, despite
the liability judgment, but in view of all of the circumstances of the case,
such person is fairly and reasonably entitled to indemnity for such expenses as
the Court of Chancery or such other court shall deem proper.
Accordingly, the Certificate of Incorporation and the amendments thereto
dated February 10, 1998 and June 23, 1998 of the Company (filed herewith as
Exhibit 3.1) provide that subject to certain exceptions, the Company shall
indemnify each director or officer against any and all expenses (including
attorneys' fees), judgments, fines, excise taxes assessed with respect to any
employee benefit plan, or penalties and amounts paid in settlement actually and
reasonably incurred by such director or officer in connection with any
threatened, pending or completed action, suit or proceeding, whether civil,
criminal, administrative or investigative (including an action by or in the
right of the Company), to which such director or officer is, was or at any time
becomes a party, or is threatened to be made a party, by reason of the fact that
such director or officer is, was or at any time becomes a director or officer of
the Company, or is, or was serving, or at any time serves at the request of the
Company as a director or officer of another corporation, partnership, joint
venture, trust or other enterprise. The Certificate of Incorporation and the
amendments thereto also provide that the Company shall advance expenses
(including attorneys' fees) actually and reasonably incurred by a director or
officer in defending any proceeding and any judgments, fines or amounts to be
paid in settlement thereof. The Certificate of Incorporation and the amendments
thereto provide, however, that the foregoing provisions shall not require the
Company to pay any indemnity (i) for which payment is actually made to such
director or officer under a valid and collectible insurance policy, except in
respect of any excess beyond the amount of payment under such insurance; (ii)
for which such director or officer is indemnified by the Company pursuant to
applicable law or otherwise than pursuant to the Certificate of Incorporation of
the Company; (iii) for an accounting of profits made from the purchase or sale
by such director or officer of securities of the Company within the meaning of
Section 16(b) of the Securities Exchange Act of 1934 and amendments thereto or
similar provisions of any state statutory law or common law; (iv) on account of
such director's or officer's conduct which is finally adjudged by a court to
have been knowingly fraudulent, deliberately dishonest or willful misconduct; or
(v) if a final decision by a court having jurisdiction in the matter shall
determine that such indemnity is not lawful. Such indemnification shall not be
deemed exclusive of any other rights to which a director or officer seeking
indemnification may be entitled under any statute, the Bylaws, other provisions
of the Certificate of Incorporation of the Company, agreement, vote of
stockholders or disinterested directors or otherwise, both as to action in such
director's or officer's official capacity and as to action in any other capacity
while holding such office.
Furthermore, a director of the Company shall not be liable to the Company
or its stockholders for monetary damages for breach of fiduciary duty as a
director, except for liability (a) for any breach of the director's duty of
loyalty to the Company or its stockholders, (b) for acts or omissions not in
good faith or which involve intentional misconduct or a knowing violation of
law, (c) for the unlawful payment of a
II-1
<PAGE> 158
dividend, unlawful stock purchase or unlawful redemption, (d) for any
transaction from which the director derived an improper personal benefit, or
such exemption from liability or limitation thereof is not permitted under the
DGCL as currently in effect or as the same may hereafter be amended.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- -------- ----------------------
<C> <C> <S>
**2.1 -- Agreement and Plan of Merger among Birch Telecom, Inc.,
Valu-Line Companies, Inc., Stephen L. Sauder, Paula K.
Sauder, Richard L. Tidwell, Sarah J. Tidwell, Stormy Supiran
and Carla S. Supiran.
**3.1 -- Amended and Restated Certificate of Incorporation of Birch
Telecom, Inc.
**3.2 -- Restated Bylaws of Birch Telecom, Inc.
**4.1 -- Indenture, dated as of June 23, 1998, between Birch Telecom,
Inc. and Norwest Bank Minnesota, National Association, as
trustee, relating to $115,000,000 aggregate principal amount
of 14% Senior Notes due 2008.
**4.2 -- Specimen Certificate of 14% Senior Notes due 2008 (the
"Private Notes") (included in Exhibit 4.1 hereto).
**4.3 -- Specimen Certificate of 14% Senior Notes due 2008 (the
"Exchange Notes") (included in Exhibit 4.1 hereto).
**4.4 -- Registration Rights Agreement, dated as of June 23, 1998,
between Birch Telecom, Inc. and Lehman Brothers Inc. and BT
Alex. Brown Incorporated.
**4.5 -- Collateral Pledge and Security Agreement, dated as of June
23, 1998 from Birch Telecom, Inc., Pledgor, to Norwest Bank
Minnesota, National Association, Trustee.
**5.1 -- Opinion of Latham & Watkins regarding the validity of the
Exchange Notes.
**10.1 -- Birch Telecom, Inc. Securities Purchase Agreement.
**10.2 -- Birch Telecom, Inc. Purchasers Rights Agreement.
**10.3 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and David E. Scott.
**10.4 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and Gregory C. Lawhon.
**10.5 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and Gary L. Chesser.
**10.6 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and David W. Vranicar.
**10.7 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and Stephen L. Sauder.
**10.8 -- Stock Purchase Agreement, dated as of May 21, 1998, among
Birch Telecom, Inc., Dunn & Associates, Inc. and Patricia A.
Dunn.
**10.9 -- Stock Purchase Agreement, dated as of May 28, 1998, among
Birch Telecom, Inc., Telesource Communications Inc., Michael
W. Hicks and Marjorie G. Hicks.
**10.10 -- Resale Agreement between Southwestern Bell Telephone Company
and Birch Telecom of Missouri, Inc.
**10.11 -- Resale Agreement between Southwestern Bell Telephone Company
and Valu-Line of Kansas, Inc.
**+10.12 -- General Agreement between Birch Telecom, Inc. and Lucent
Technologies Inc.
**10.13 -- Interconnection Agreement under Sections 251 and 252 of the
Telecommunications Act of 1996 by and between Southwestern
Bell Telephone Company and Birch Telecom of Missouri, Inc.
**+10.14 -- Software License Agreement between Birch Telecom, Inc. and
Saville Systems Inc.
12.1 -- Statement of Computation of Ratio of Earnings to Fixed
Charges.
**21.1 -- Subsidiaries of Birch Telecom, Inc.
**23.1 -- Consent of Latham & Watkins (included in their opinion filed
as Exhibit 5.1 hereto).
</TABLE>
II-2
<PAGE> 159
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- -------- ----------------------
<C> <C> <S>
23.2 -- Consent of Ernst & Young LLP.
**24.1 -- Power of Attorney of Birch Telecom, Inc. (included on
signature page to this Registration Statement on Form S-4).
**25.1 -- Statement of Eligibility and Qualification (Form T-1) under
the Trust Indenture Act of 1939 of Norwest Bank Minnesota,
National Association.
**27.1 -- Financial Data Schedule.
**99.1 -- Form of Letter of Transmittal and related documents to be
used in conjunction with the Exchange Offer.
</TABLE>
- ---------------
* To be filed by amendment.
+ Indicates that portions of the exhibit have been omitted pursuant to a
request for confidential treatment and such portions have been filed with the
Commission separately.
** Previously filed
(b) Financial Statement Schedules:
** Schedule II. Valuation of Qualifying Accounts.
II-3
<PAGE> 160
SCHEDULES OMITTED
Schedules not listed above are omitted because of the absence of the
conditions under which they are required or because the information required by
such omitted schedules is set forth in the financial statements or the notes
thereto.
ITEM 22. UNDERTAKINGS.
The undersigned Registrant hereby undertakes that insofar as
indemnification for liabilities arising under the Securities Act of 1933 may be
permitted to directors, officers and controlling persons of the Registrant
pursuant to the foregoing provisions described under Item 20 above, or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the
event that a claim of indemnification against such liabilities (other than the
payment by the Registrant of expenses incurred or paid by a director, officer or
controlling person of the Registrant in the successful defense of any action,
suit paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted against the
Registrant by such director, officer or controlling person in connection with
the securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question of whether such indemnification
by it is against public policy as expressed in the Securities Act of 1933 and
will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes (i) to respond to requests for
information that is incorporated by reference into this Prospectus pursuant to
Items 4, 10(b), 11, or 13 of Form S-4, within one business day of receipt of
such request, and to send the incorporated documents by first class mail or
other equally prompt means. This undertaking also includes documents filed
subsequent to the effective date of the Registration Statement through the date
of responding to the request.
The undersigned Registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the Registration Statement when it became effective.
The undersigned Registrant hereby undertakes to file, during any period in
which offers or sales are being made, a post-effective amendment to this
registration statement: (i) to include any prospectus required by Section
10(a)(3) of the Securities Act of 1933; (ii) to reflect in the prospectus any
facts or events arising after the effective date of the registration statement
(or the most recent post-effective amendment thereof) which, individually or in
the aggregate, represent a fundamental change in the information set forth in
the registration statement (notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any deviation
from the low or high end of the estimated maximum offering range may be
reflected in the form of prospectus filed with the Commission pursuant to Rule
424(b) if, in the aggregate, the changes in volume and price represent no more
than 20 percent change in the maximum aggregate offering price set forth in the
"Calculation of Registration Fee" table in the effective registration
statement); and (iii) to include any material information with respect to the
plan of distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
The undersigned Registrant hereby undertakes as follows: that prior to any
public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this Registration Statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c), the
undersigned undertakes that such reoffering prospectus will contain the
information called for by the applicable registration form with respect to
reofferings by persons who may be deemed underwriters, in addition to the
information called for by the other Items of the application form.
The undersigned Registrant hereby undertakes that every prospectus: (i)
that is filed pursuant to the immediately preceding paragraph or (ii) that
purports to meet the requirements of Section l0(a)(3) of the Securities Act of
1933 and is used in connection with an offering of securities subject to Rule
415, will be filed
II-4
<PAGE> 161
as a part of an amendment to the registration statement and will not be used
until such amendment is effective, and that, for purposes of determining any
liability under the Securities Act of 1933, each such post-effective amendment
shall be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
The undersigned Registrant hereby undertakes to remove from registration by
means of a post-effective amendment any of the securities being registered which
remain unsold at the termination of the Exchange Offer.
II-5
<PAGE> 162
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Kansas
City, State of Missouri, on November 10, 1998.
BIRCH TELECOM, INC.
By: /s/ GREGORY C. LAWHON
------------------------------------
Gregory C. Lawhon
Senior Vice President of
Public Policy and General Counsel
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers and
directors of Birch Telecom, Inc., a Delaware corporation (the "Company"), for
himself and not for one another, does hereby constitute and appoint David E.
Scott and Gregory C. Lawhon and each of them, his true and lawful
attorneys-in-fact and agents, with full power of substitution and resubstitution
for him and in his name, place and stead, in any and all capacities, to sign any
and all amendments to this Registration Statement with respect to the proposed
issuance, sale and delivery by the Company of 14% Senior Notes due 2008, or any
registration statement for this offering that is to be effective upon the filing
pursuant to rule 462(b) under the Securities Act of 1933, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that each of said attorneys-in-fact or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
* President and Chief Executive Officer November 10, 1998
- ------------------------------------ (Principal Executive Officer)
David E. Scott
* Chief Financial Officer (Principal November 10, 1998
- ------------------------------------ Financial and Accounting Officer)
Bradley A. Moline
* Director November 10, 1998
- ------------------------------------
Henry H. Bradley
* Director November 10, 1998
- ------------------------------------
Stephen L. Sauder
* Director November 10, 1998
- ------------------------------------
Ian R. N. Bund
* Director November 10, 1998
- ------------------------------------
David W. Bergmann
*By: /s/ GREGORY C. LAWHON
- ------------------------------------
Gregory C. Lawhon
Attorney-in-fact
</TABLE>
II-6
<PAGE> 163
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S> <C>
**2.1 -- Agreement and Plan of Merger among Birch Telecom, Inc.,
Valu-Line Companies, Inc., Stephen L. Sauder, Paula K.
Sauder, Richard L. Tidwell, Sarah J. Tidwell, Stormy Supiran
and Carla S. Supiran.
**3.1 -- Amended and Restated Certificate of Incorporation of Birch
Telecom, Inc.
**3.2 -- Restated Bylaws of Birch Telecom, Inc.
**4.1 -- Indenture, dated as of June 23, 1998, between Birch Telecom,
Inc. and Norwest Bank Minnesota, National Association, as
trustee, relating to $115,000,000 aggregate principal amount
of 14% Senior Notes due 2008.
**4.2 -- Specimen Certificate of 14% Senior Notes due 2008 (the
"Private Notes") (included in Exhibit 4.1 hereto).
**4.3 -- Specimen Certificate of 14% Senior Notes due 2008 (the
"Exchange Notes") (included in Exhibit 4.1 hereto).
**4.4 -- Registration Rights Agreement, dated as of June 23, 1998,
between Birch Telecom, Inc. and Lehman Brothers Inc. and BT
Alex. Brown Incorporated.
**4.5 -- Collateral Pledge and Security Agreement, dated as of June
23, 1998 from Birch Telecom, Inc., Pledgor, to Norwest Bank
Minnesota, National Association, Trustee.
**5.1 -- Opinion of Latham & Watkins regarding the validity of the
Exchange Notes.
**10.1 -- Birch Telecom, Inc. Securities Purchase Agreement.
**10.2 -- Birch Telecom, Inc. Purchasers Rights Agreement.
**10.3 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and David E. Scott.
**10.4 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and Gregory C. Lawhon.
**10.5 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and Gary L. Chesser.
**10.6 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and David W. Vranicar.
**10.7 -- Employment Agreement dated as of February 10, 1998 between
Birch Telecom, Inc. and Stephen L. Sauder.
**10.8 -- Stock Purchase Agreement, dated as of May 21, 1998, among
Birch Telecom, Inc., Dunn & Associates, Inc. and Patricia A.
Dunn.
**10.9 -- Stock Purchase Agreement, dated as of May 28, 1998, among
Birch Telecom, Inc., Telesource Communications Inc., Michael
W. Hicks and Marjorie G. Hicks.
**10.10 -- Resale Agreement between Southwestern Bell Telephone Company
and Birch Telecom of Missouri, Inc.
**10.11 -- Resale Agreement between Southwestern Bell Telephone Company
and Valu-Line of Kansas, Inc.
**+10.12 -- General Agreement between Birch Telecom, Inc. and Lucent
Technologies Inc.
**10.13 -- Interconnection Agreement under Sections 251 and 252 of the
Telecommunications Act of 1996 by and between Southwestern
Bell Telephone Company and Birch Telecom of Missouri, Inc.
**+10.14 -- Software License Agreement between Birch Telecom, Inc. and
Saville Systems Inc.
12.1 -- Statement of Computation of Ratio of Earnings to Fixed
Charges.
</TABLE>
<PAGE> 164
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S> <C>
**21.1 -- Subsidiaries of Birch Telecom, Inc.
**23.1 -- Consent of Latham & Watkins (included in their opinion filed
as Exhibit 5.1 hereto).
23.2 -- Consent of Ernst & Young LLP.
**24.1 -- Power of Attorney of Birch Telecom, Inc. (included on
signature page to this Registration Statement on Form S-4).
**25.1 -- Statement of Eligibility and Qualification (Form T-1) under
the Trust Indenture Act of 1939 of Norwest Bank Minnesota,
National Association.
**27.1 -- Financial Data Schedule.
**99.1 -- Form of Letter of Transmittal and related documents to be
used in conjunction with the Exchange Offer.
</TABLE>
- ---------------
* To be filed by amendment.
+ Indicates that portions of the exhibit have been omitted pursuant to a
request for confidential treatment and such portions have been filed with the
Commission separately.
** Previously filed
<PAGE> 1
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES EXHIBIT 12.1
(Dollars in thousands)
<TABLE>
<CAPTION>
The Predecessor The Company
--------------- -----------
Year Ended Nine Months Ended
Year Ended December 31, December 31, September 30,
----------------------- ------------ --------
1993 1994 1995 1996 1997 1997 1997 1998
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Earnings
Total earnings (loss) $ 331 $ 440 $ 94 $ 289 $ 268 $ (1,789) $(1,225) $(7,857)
Income tax 191 319 81 205 186 -- -- --
-------- ------- -------- ------- -------- ---------- -------- ---------
Pre-tax earnings (loss) 522 759 175 494 454 (1,789) (1,225) (7,857)
-------- ------- -------- ------- -------- ----------- -------- ---------
Fixed charges
Interest charges 49 48 58 102 97 -- -- --
Interest factor of operating
rents 9 10 13 16 19 -- -- --
-------- ------- -------- ------- -------- ---------- -------- ---------
Total fixed charges 58 58 71 118 116 -- -- --
Earnings, as adjusted $ 580 $ 817 $ 246 $ 612 $ 570 (1,789) (1,225) (7,857)
Ratio of earnings to fixed 10.00x 14.09x 3.46x 5.19x 4.91x -- -- --
charges(a)
</TABLE>
<TABLE>
<CAPTION>
Pro Forma
---------
Year Ended Nine Months
December 31, Ended September 30,
------------ -------------------
1997 1998
---- ----
<S> <C> <C>
Earnings
Total earnings (loss) $(19,325) $ (20,570)
Income tax -- --
----------- -------------
Pre-tax earnings (loss) (19,325) (20,570)
----------- -------------
Fixed charges
Interest charges -- --
Interest factor of operating rent -- --
----------- -------------
Total fixed charges -- --
Earnings, as adjusted (19,325) (20,570)
Ratio of earnings to fixed charges(a) -- --
</TABLE>
(a) For purposes of calculating the ratio of earnings to fixed charges,
earnings are defined as loss before income taxes plus fixed charges. Fixed
charges consist of interest expense and a reasonable approximation of the
interest factor included in rental payments on operating leases. The
Company's earnings were insufficient to cover fixed charges for the year
ended December 31, 1997 by $1.8 million and for the nine months ended
September 30, 1997 and 1998 by $1.2 million and $7.9 million,
respectively.
Additionally, on a pro forma basis, the Company's earnings would have been
insufficient to cover fixed charges for the year ended December 31, 1997
by $19.3 million and for the nine months ended September 30, 1998 by $20.6
million.
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to the
use of our reports dated April 24, 1998, with respect to the consolidated
financial statements of Birch Telecom, Inc., and May 15, 1998, with respect to
the consolidated financial statements of Valu-Line Companies, Inc., in Amendment
No. 4 to the Registration Statement (Form S-4 No. 333-62797) and related
Prospectus of Birch Telecom, Inc. for the registration of 14% Senior Notes due
2008.
Ernst & Young LLP
Kansas City, Missouri
November 10, 1998
