<PAGE>
As filed with the Securities and Exchange Commission on April 26, 2000
Registration No. 333-33166
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------
Time Warner Telecom Inc.
(Exact name of registrant as specified in its charter)
---------------
<TABLE>
<S> <C>
Delaware 84-1500624
(State or other jurisdiction of incorporation or
organization) (I.R.S. Employer Identification Number)
</TABLE>
---------------
10475 Park Meadows Drive
Littleton, Colorado 80124
(303) 566-1000
(Address, including zip code, and telephone number, including area
code, of registrant's principal executive office)
---------------
PAUL B. JONES
Senior Vice President and General Counsel
Time Warner Telecom Inc.
10475 Park Meadows Drive
Littleton, Colorado 80124
(303) 566-1000
(Name, address, including zip code, and telephone number,
including phone number, of agent for service)
---------------
Copies to:
<TABLE>
<S> <C> <C>
WILLIAM P. ROGERS, JR. FAITH D. GROSSNICKLE STEPHEN M. BESEN
Cravath, Swaine & Moore Shearman & Sterling Weil, Gotshal & Manges, LLP
Worldwide Plaza, 599 Lexington Avenue 767 Fifth Avenue
825 Eighth Avenue New York, New York 10022-6069 New York, New York 10153
New York New York 10019 (212) 848-4000 (212) 310-8000
(212) 474-1270
</TABLE>
---------------
Approximate date of commencement of proposed sale to the public: At such time
or times after the effective date of this registration statement as the selling
stockholder shall determine.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [_]
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or
interest reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
---------------
CALCULATION OF REGISTRATION FEE
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Proposed Proposed
maximum maximum
Title of each class of Amount to be offering price aggregate Amount of
securities to be registered registered per share offering price registration fee
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Class A Common Stock,
par value $.01 per
share 15,289,842 shares $73.0625(1) $1,117,114,081(1) $294,918
Class A Common Stock,
par value $.01 per
share 1,400,000 shares $70.6875(2) $ 98,962,500(2) $ 26,126
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act on the basis of the
average of the high and low prices of the Class A Common Stock of Time
Warner Telecom Inc. as reported on the Nasdaq National Market on March 16,
2000.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act on the basis of the
average of the high and low prices of the Class A Common Stock of Time
Warner Telecom Inc. as reported on the Nasdaq National Market on March 27,
2000.
---------------
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 such Section 8(a),
may determine.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PROSPECTUS
9,000,000 Shares
[LOGO OF TIME WARNER TELECOM]
Time Warner Telecom Inc.
Class A Common Stock
- --------------------------------------------------------------------------------
The selling stockholder is offering 9,000,000 shares of our Class A Common
Stock in the U.S. and Canada. We will not receive any of the proceeds from the
sale of shares being sold by the selling stockholder.
Our Class A Common Stock is listed on the Nasdaq National Market under the
symbol "TWTC." The last reported sale price of our Class A Common Stock on the
Nasdaq National Market on April 25, 2000 was $51.875 per share.
Investing in the shares involves risks. "Risk Factors" begin on page 7.
<TABLE>
<CAPTION>
Per Share Total
--------- ------------
<S> <C> <C>
Public Offering Price................................... $50.00 $450,000,000
Underwriting Discount................................... $ 1.75 $ 15,750,000
Proceeds to Selling Stockholder......................... $48.25 $434,250,000
</TABLE>
The selling stockholder has granted the underwriters a 30-day option to
purchase up to 500,000 additional shares of Class A Common Stock on the same
terms and conditions as set forth above to cover over-allotments, if any.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Lehman Brothers, on behalf of the underwriters, expects to deliver the shares
on or about May 1, 2000.
- --------------------------------------------------------------------------------
Lehman Brothers Morgan Stanley Dean Witter
----------------
Bear, Stearns & Co. Inc. Donaldson, Lufkin & Jenrette
April 26, 2000
<PAGE>
[TIME WARNER TELECOM MARKETS MAP]
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 1
Risk Factors........................ 7
Use of Proceeds..................... 17
Dividend Policy..................... 17
Price Range of Common Stock......... 17
Background of the Company........... 18
Capitalization...................... 20
Selected Consolidated and Combined
Financial and Other Operating
Data............................... 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 23
Business............................ 33
Management.......................... 54
Certain Relationships and Related
Transactions....................... 65
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Principal and Selling Stockholders.. 69
Description of Certain
Indebtedness....................... 71
Description of Capital Stock........ 73
Certain United States Federal Tax
Consequences to Non-United States
Holders of Common Stock............ 77
Shares Eligible for Future Sale..... 80
Underwriting........................ 81
Legal Matters....................... 83
Experts............................. 83
Where You Can Find More
Information........................ 83
Glossary............................ 84
Index to Consolidated and Combined
Financial Statements............... F-1
</TABLE>
----------------
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell shares of Class A Common
Stock and seeking offers to buy shares of Class A Common Stock only in
jurisdictions where offers and sales are permitted. The information contained
in this prospectus is accurate only as of the date of this prospectus,
regardless of the time of delivery of this prospectus or any sale of the Class
A Common Stock.
Until June 5, 2000, all dealers that buy, sell or trade shares of Class A
Common Stock, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
This prospectus contains forward-looking statements, including statements
regarding, among other items, our business and operating strategy, operations,
economic performance and financial condition. These forward-looking statements
are subject to risks, uncertainties and assumptions, some of which are beyond
our control. Actual results may differ materially from those expressed or
implied by such forward-looking statements. Factors that could cause such
differences include, but are not limited to, those discussed under "Risk
Factors." We undertake no obligation to publicly update or revise any forward-
looking statements, whether as a result of new information, future events or
otherwise. In light of these risks, uncertainties and assumptions, the forward-
looking events and circumstances discussed in this prospectus might not occur.
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding the Company, the Class A Common Stock being sold in this
offering and our financial statements and the notes to these financial
statements appearing elsewhere in this prospectus.
We have summarized the history and structure of our company under
"Background of the Company." For simplicity, we use the terms "we" and the
"Company" throughout this prospectus to refer to the business that is owned and
conducted by the corporation that became Time Warner Telecom Inc. shortly prior
to the initial public offering of the Class A Common Stock, and that was owned
and conducted by its predecessors prior to that time. We use the term "selling
stockholder" throughout this prospectus to refer to MediaOne Group, Inc.
Other important terms are defined in "Background of the Company." In
addition, to assist you in understanding certain terms relating to the
telephony business that we explain and use in the body of this prospectus, we
have also included a glossary at the back of this prospectus.
THE COMPANY
The Company is a leading fiber facilities-based integrated communications
provider offering local business "last mile" broadband connections for data,
high-speed internet access, local voice and long distance services. It offers a
wide range of business telephony services, primarily to medium- and large-sized
telecommunications-intensive business end-users, long distance carriers,
internet service providers, wireless communications companies and governmental
entities. These business telephony services include dedicated transmission,
local switched, long distance, data and video transmission services and high-
speed dedicated internet access. The Company offers its services in 21
metropolitan markets and expects to initiate service in three additional
markets during 2000. In addition, the Company expects to commence construction
in an additional 8 to 12 markets during 2000 and 2001. As of December 31, 1999,
the Company had deployed digital telephony switches in 19 of its 21 service
areas. As of that date, the Company's network spanned 8,872 route miles,
contained 332,263 fiber miles and offered service to 5,566 buildings.
The Company believes that the Telecommunications Act of 1996 (the "1996
Act") and certain state regulatory initiatives provide increased opportunities
in the telecommunications marketplace by opening all local markets to
competition and requiring existing local telephone companies, which are often
referred to as incumbent local exchange carriers, to provide increased direct
interconnection.
Business Strategy
The key elements of the Company's business strategy are discussed in detail
under "Business--Business Strategy," which we urge you to read carefully
because we believe it is important to understanding our business. The following
is a summary of the Company's business strategy.
Leverage Existing Fiber Optic Networks. The Company has designed and built
local and regional fiber networks to serve geographic locations where
management believes there are large numbers of potential customers. These
highly concentrated networks have not yet been fully exploited and provide the
capacity to serve a substantially larger base of customers with a larger array
of products.
Enter New Geographic Areas. The Company is in the process of constructing
three additional networks in Los Angeles/Orange County, California, Dayton,
Ohio, and Fayetteville, North Carolina during 2000, for a total of 24 markets.
Also, the Company has recently announced a more accelerated geographic
expansion plan that presently calls for commencing construction in an
additional 8 to 12 metropolitan statistical areas during 2000 and 2001. The
Company will also evaluate other expansion opportunities.
1
<PAGE>
Expand Switched Services. The Company provides a broad range of switched
services in 20 of its 21 service areas. The Company has rapidly installed
switches in its markets and expects to derive a growing portion of its revenue
from switched services. In addition, the Company is currently evaluating how to
best integrate new "softswitch" technology into its infrastructure, which would
allow voice over Internet Protocol and other applications.
Expand Data Services. The Company will continue to deliver high-speed
traditional transport services through its fiber optic networks and will also
focus on the delivery of next generation data networking and converged network
services.
Target Business Customers. The Company has historically targeted
telecommunications-intensive medium- and large-sized business customers who
require the high quality networks that we operate. In order to achieve further
economies of scale and network utilization, the Company is targeting smaller
business customers in buildings the Company already serves where the Company
can offer a package of network services that may not otherwise be available to
them.
Interconnect Service Areas. The Company is in the process of interconnecting
its 21 existing service areas within regional clusters with owned or licensed
fiber optic facilities. This is expected to increase the Company's revenue
potential and increase margins by addressing customers' regional long distance
voice, data and video requirements.
Utilize Strategic Relationships with Time Warner Cable. The Company has
benefited from and continues to leverage its relationships with Time Warner
Cable, one of the largest multiple system cable operators in the U.S., by
licensing and sharing the cost of fiber optic facilities. The Company has
agreements with Time Warner Cable that allow the Company access to rights-of-
way, easements, poles, ducts and conduits. The Company may also benefit from
positive awareness of the "Time Warner" name, which it licenses from Time
Warner Inc.
Continue Disciplined Expenditure Program. The Company increases operating
efficiencies by pursuing a capital expenditure program that focuses on projects
that meet stringent financial criteria. The Company evaluates every capital
expenditure on the basis of whether or not it meets several minimum
requirements, including minimum recurring revenue, cash flow margin and rate of
return.
2
<PAGE>
THE OFFERING
Class A Common Stock offered by
the selling stockholder (1).....
9,000,000 shares.
Class A Common Stock offered by
the selling stockholder in the
over-allotment option(1)...
500,000 shares.
Common Stock to be outstanding
after the offering and the
over-allotment option........... 33,368,601 shares of Class A Common Stock.
71,726,500 shares of Class B Common Stock.
Relative rights of Common The Company's Class A Common Stock and Class
Stock........................... B Common Stock are identical in all respects,
except that:
(a) holders of Class A Common Stock are
entitled to one vote per share and holders of
Class B Common Stock are entitled to 10 votes
per share on all matters submitted to a vote
of stockholders;
(b) certain matters require the approval of
100% of the outstanding Class B Common Stock,
voting separately as a class; and
(c) certain other matters require the
approval of a majority of the outstanding
Class A Common Stock, voting separately as a
class.
Each share of Class B Common Stock is
convertible into one share of Class A Common
Stock.
Use of proceeds.................
We will not receive any proceeds from the
shares sold by the selling stockholder.
Nasdaq National Market symbol... "TWTC"
The number of shares of Common Stock to be outstanding after this offering
is based on the number of shares outstanding as of February 29, 2000, and
excludes:
. 7,865,203 shares underlying options outstanding as of February 29, 2000,
at a weighted average exercise price of $19.26 per share;
. 514,554 shares available for future grants under our option plan; and
. 750,000 shares available for issuance under our employee stock purchase
plan.
- --------
(1) In connection with the offering, MediaOne Group, Inc. will convert
8,987,785 shares of Class B Common Stock (9,487,785 shares if the over-
allotment option is fully exercised) into an equal number of shares of
Class A Common Stock. MediaOne will retain up to 5,789,842 shares of Class
B Common Stock. See "Risk Factors--Each of the Class B Stockholders has
veto rights over certain actions; the selling stockholder will retain those
rights as long as it retains Class B Common Stock."
3
<PAGE>
BACKGROUND OF THE COMPANY
The Company began its business by providing telephony services through cable
television systems owned by its Former Parent Companies. On July 14, 1998, Time
Warner Telecom LLC ("TWT LLC") was formed to acquire the assets and liabilities
of the Company's business and to conduct the offering on July 21, 1998 of $400
million principal amount 9 3/4% Senior Notes due July 2008. On May 10, 1999, in
preparation for the Company's initial public offering, TWT LLC was
reconstituted as a Delaware corporation under the name Time Warner Telecom Inc.
by merging into a newly formed Delaware corporation. As part of the merger, the
outstanding Class A limited liability company interests were converted into
Class A Common Stock and the outstanding Class B limited liability company
interests were converted into Class B Common Stock of the newly formed
corporation. On May 14, 1999, in conjunction with the reconstitution, the
Company completed an initial public offering of 20,700,000 shares of Class A
Common Stock at a price of $14 per share. See "Background of the Company,"
beginning on page 18.
The Company's principal executive offices are located at 10475 Park Meadows
Drive, Littleton, CO 80124, and its telephone number is (303) 566-1000.
RISK FACTORS
You should consider all of the information contained in this prospectus
before making an investment in the Class A Common Stock. In particular, you
should consider the factors described under "Risk Factors," beginning on page
7.
4
<PAGE>
SUMMARY CONSOLIDATED AND COMBINED FINANCIAL AND OTHER OPERATING DATA
The summary statements of operations data for the years ended December 31,
1997, 1998 and 1999 are derived from the audited consolidated and combined
financial statements of the Company, including the notes, appearing elsewhere
in this prospectus. The summary statements of operations data for the years
ended December 31, 1995 and 1996 have been derived from audited financial
statements of the Company not included in this prospectus. The financial
statements of the Company for all periods prior to the Reorganization of the
Company that occurred on July 14, 1998 reflect the "carved out" historical
financial position, results of operations, cash flows and changes in
stockholders' equity of the commercial telecommunications operations of
predecessors of the Company, as if they had been operating as a separate
company. The summary financial and other operating data set forth below should
be read together with the information contained in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
financial statements, including the notes, appearing elsewhere in this
prospectus.
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------------------------
1995 1996 1997 1998 1999
-------- --------- --------- --------- ----------
(thousands, except per share amounts
and operating data amounts)
<S> <C> <C> <C> <C> <C>
Statements of Operations
Data:
Revenue:
Dedicated transport
services.............. $ 6,505 $ 20,362 $ 44,529 $ 84,024 $ 152,468
Switched services
(1)................... 350 3,555 10,872 37,848 116,285
-------- --------- --------- --------- ----------
Total revenue........ 6,855 23,917 55,401 121,872 268,753
-------- --------- --------- --------- ----------
Costs and expenses(2):
Operating.............. 15,106 25,715 40,349 67,153 117,567
Selling, general and
administrative........ 34,222 60,366 54,640 77,401 113,389
Depreciation and
amortization.......... 7,216 22,353 38,466 50,717 68,785
-------- --------- --------- --------- ----------
Total costs and
expenses............ 56,544 108,434 133,455 195,271 299,741
-------- --------- --------- --------- ----------
Operating loss.......... (49,689) (84,517) (78,054) (73,399) (30,988)
Interest expense, net
and other (2).......... (1,416) (1,599) 7,398 (19,340) (28,473)
-------- --------- --------- --------- ----------
Net loss before income
taxes.................. (51,105) (86,116) (70,656) (92,739) (59,461)
Income tax expense (3).. -- -- -- -- 29,804
-------- --------- --------- --------- ----------
Net loss................ $(51,105) $ (86,116) $ (70,656) $ (92,739) $ (89,265)
======== ========= ========= ========= ==========
Basic and diluted loss
per common share....... $ (0.63) $ (1.06) $ (0.87) $ (1.14) $ (0.93)
======== ========= ========= ========= ==========
Other Operating Data:
EBITDA(1) (4)........... $(42,473) $ (62,164) $ (39,588) $ (22,682) $ 37,797
EBITDA Margin (1) (5)... (620)% (260)% (72)% (19)% 14%
Net cash provided by
(used in) operating
activities............. (35,605) (52,274) (29,419) (343) 54,235
Capital expenditures.... 141,479 144,815 127,315 126,023 221,224
Operating Data (6):
Operating Networks...... 15 18 19 19 21
Route miles............. 3,207 5,010 5,913 6,968 8,872
Fiber miles............. 116,286 198,490 233,488 272,390 332,263
Voice grade equivalent
circuits............... 158,572 687,001 1,702,431 2,953,454 5,331,000
Digital telephone
switches............... 1 2 14 16 19
Employees............... 508 673 714 919 1,259
Access lines............ 493 2,793 16,078 78,036 192,369
Balance Sheet Data:
Cash and cash
equivalents............ $ -- $ -- $ -- $ 105,140 $ 90,586
Marketable securities... -- -- -- 250,857 173,985
Property, plant and
equipment, net......... 199,005 323,161 415,158 494,158 677,106
Total assets............ 214,963 341,480 438,077 904,344 1,043,012
Long-term debt and
capital lease
obligations (6)........ -- -- 75,475 574,940 403,627
Total stockholders'
equity................. $179,589 $ 294,937 $ 300,390 $ 207,651 $ 422,916
</TABLE>
5
<PAGE>
- --------
(1) Includes the recognition of a non-recurring $7.6 million settlement of
reciprocal compensation in the fourth quarter of 1999.
(2) Includes expenses resulting from transactions with affiliates of $6.5
million, $12.4 million, $17.1 million, $27.7 million and $20.0 million in
1995, 1996, 1997, 1998 and 1999, respectively. See note 6 to the Company's
financial statements appearing elsewhere in this prospectus for an
explanation of these expenses.
(3) During 1999, the Company recorded a non-recurring $39.4 million charge to
earnings to record a net deferred tax liability associated with the
Reconstitution. This change occurred immediately prior to the Company's
initial public offering. Since the Reconstitution, the Company has
recorded a deferred income tax benefit aggregating $9.6 million, which is
primarily due to a decrease in the net deferred tax liability.
(4) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income (loss), cash flow and other measures of
financial performance and liquidity reported in accordance with generally
accepted accounting principles. Rather, EBITDA is a measure of operating
performance and liquidity that investors may consider in addition to such
measures. Management believes that EBITDA is a standard measure of
operating performance and liquidity that is commonly reported and widely
used by analysts, investors and other interested parties in the
telecommunications industry because it eliminates many differences in
financial, capitalization and tax structures, as well as non-operating
charges to earnings. EBITDA is used internally by the Company's management
to assess on-going operations and is a component of a covenant of the
Senior Notes that limits the Company's ability to incur additional future
indebtedness. However, EBITDA as used in this report may not be comparable
to similarly titled measures reported by other companies due to
differences in accounting policies.
(5) EBITDA Margin represents EBITDA as a percentage of revenue.
(6) Includes all managed properties including unconsolidated affiliates
(MetroComm AxS, L.P. in Columbus, Ohio and the Albany and Binghamton, New
York networks). Albany and Binghamton were wholly owned at December 31,
1997 and MetroComm AxS, L.P. was wholly owned at December 31, 1999.
6
<PAGE>
RISK FACTORS
An investment in our Class A Common Stock is risky. You should carefully
consider the following risks, as well as the other information contained in
this prospectus. If any of the following risks actually occurs, our business
could be harmed. In that case, the trading price of our Class A Common Stock
could decline, and you might lose all or part of your investment. The risks and
uncertainties described below are not the only ones facing us. Additional risks
and uncertainties not presently known to us, or that we currently see as
immaterial, may also harm our business.
Our limited operating history may not be a reliable basis for evaluating our
prospects.
Time Warner Cable began the Company's business in 1993. Since the beginning
of 1997, our business has changed substantially as it has rapidly expanded into
switched services. As a result, prospective purchasers have limited historical
financial information available to evaluate our likely future performance. When
making a decision to invest in the Class A Common Stock, prospective purchasers
should consider the risks, expenses and difficulties frequently encountered by
companies that are in the development stage.
We have a history of operating losses and expect to experience operating losses
for the foreseeable future.
The Company has incurred operating losses since inception. For the years
ended December 31, 1998 and 1999, the Company had operating losses of $73.4
million and $31.0 million. The Company expects to continue to incur operating
losses as the Company builds its networks and expands its customer base. This
will reduce our ability to meet working capital needs and increase our need for
external financing.
The development of our business requires substantial capital expenditures.
As described below, we have plans to increase our annual capital expenditures
during 2000 and 2001 to expand our operations. A substantial part of these
expenditures are incurred before any related revenue is realized. Capital
expenditures and other operating expenditures will result in negative cash flow
and operating losses for our new markets until and unless we develop an
adequate customer base and revenue stream from those markets. We expect that
each network will produce negative cash flow for at least two and a half years
after it begins operations in that network. Moreover, the Company may never
develop an adequate customer base, sustain profitability, or generate
sufficient cash flow.
We will require substantial capital to expand our operations.
The development and expansion of our networks requires substantial capital.
If this capital is not available when needed, our business will be adversely
affected. We expect our principal capital requirements for 2000 and 2001 to be:
. approximately $700 million to purchase and install switches,
electronics, fiber and other technologies in existing and future
networks; and
. approximately $50 million for capital expenditures for our management
information system infrastructure.
We expect to require additional third party financing.
The Company recently entered into a secured revolving bank credit facility
with available credit of $475 million, the proceeds of which will be used
primarily to expand into new markets. The Company may also be required to seek
additional financing if:
. the Company's business plans and cost estimates prove to be inaccurate;
. the Company decides to further accelerate the expansion of its business
and existing networks;
. the Company consummates acquisitions or joint ventures that require
capital; or
. the Company is not able to license additional capacity from Time Warner
Cable at acceptable rates.
7
<PAGE>
When we seek additional financing, the terms offered may place significant
limits on our financial and operating flexibility, or may not be acceptable to
us. The failure to raise sufficient funds when needed and on reasonable terms
may require us to modify or significantly curtail our business expansion plans.
This could have a material adverse impact on the Company's growth, ability to
compete, and ability to service its existing debt.
Although the Class B Stockholders financed the Company's business prior to
the offering of the Senior Notes, they are not required to provide any future
financing.
Our significant indebtedness may impair our financial and operating
flexibility.
The Company has a significant amount of debt outstanding. This substantial
indebtedness may have an adverse impact on the Company. For example:
. the Company's ability to obtain additional financing may be limited;
. a substantial portion of its cash flow will be dedicated to pay interest
and principal on its debt;
. the Company's ability to satisfy its debt obligations may be diminished;
. the Company may be more vulnerable to economic downturns; and
. the Company's ability to withstand competitive pressure may be more
limited.
As of December 31, 1999, the Company had approximately $400 million of
consolidated total debt.
The indenture for the Senior Notes contains restrictive covenants that may
limit our flexibility.
The indenture limits, and in some circumstances prohibits, the ability of
the Company to:
. incur additional debt;
. pay dividends;
. make investments or other restricted payments;
. engage in transactions with stockholders and affiliates;
. create liens;
. sell assets;
. issue or sell capital stock of subsidiaries; and
. engage in mergers and consolidations.
These covenants may limit our financial and operating flexibility. In
addition, if the Company does not comply with these covenants, the holders of
the Senior Notes may accelerate the Company's debt under the Senior Notes. If
and when we execute an agreement for the senior secured revolving bank credit
facility that we are currently negotiating, we expect to be subject to
additional covenants under that agreement that will limit our flexibility.
The market value of your investment may be adversely affected if we do not
successfully manage our expansion into new markets and services.
The Company plans to offer new communications services, expand service in
its existing markets, interconnect its existing markets and enter new markets.
If we are not successful in implementing these changes, our results of
operations and stock price will likely be adversely affected.
8
<PAGE>
Our ability to manage this expansion depends on many factors, including the
ability to:
. attract new customers and sell new services to existing customers;
. design, acquire and install transmission and switching facilities;
. employ new technologies;
. obtain any required governmental permits and rights-of-way;
. implement interconnection with local exchange carriers;
. expand, train and manage our employee base;
. enhance our financial, operating and information systems to effectively
manage our growth; and
. accurately predict and manage the cost and timing of our capital
expenditure programs.
Even if the Company is successful in completing the infrastructure to
support its expanded business, that business may not be profitable and may not
generate positive cash flow for the Company.
We may make additional acquisitions that increase leverage and pose other
risks.
The Company continues to evaluate potential acquisitions and joint ventures
that would extend the Company's geographic markets, expand the Company's
products and services and/or enlarge the capacity of its networks. Some of
these transactions may be considerably larger than the transactions it has
completed in the past. If the Company enters into a definitive agreement with
respect to any material transaction, it could result in the Company increasing
its leverage or issuing additional Common Stock or both. There can be no
assurance, however, that the Company will enter into any transaction or, if it
does, on what terms.
Any acquisition that the Company completes will likely also involve some or
all of the following operating risks:
. the difficulty of assimilating the acquired operations and personnel;
. the potential disruption of the Company's ongoing business;
. the diversion of resources;
. the possible inability of management to maintain uniform standards,
controls, procedures and policies;
. the possible difficulty of managing its growth and information systems;
. the risks of entering markets in which the Company has little
experience; and
. the potential impairment of relationships with employees or customers.
We will require additional fiber optic capacity beyond what Time Warner Cable
provides us.
The Company licenses much of its fiber optic capacity from Time Warner
Cable. However, Time Warner Cable is not obligated to provide additional
capacity to the Company and may or may not choose to do so and we are not
obligated to take capacity from them. Also, we expect to expand our operations
to markets not served by Time Warner Cable where we would be required to obtain
fiber optic capacity from other sources. The increased costs of obtaining
capacity from sources other than Time Warner Cable may adversely affect our
business in some locations. Also, if Time Warner Cable fails to maintain the
necessary permits, rights-of-way and governmental authorization, or if the
Company cannot rely on Time Warner Cable's licenses and permits, the Company's
business may be adversely affected in some locations.
Our business may be limited if the capacity license with Time Warner Cable
expires or is terminated.
If the capacity license is not renewed on expiration in 2028 or is
terminated prior to that time, the Company may need to build, lease or
otherwise obtain fiber optic capacity. The terms of those arrangements may be
materially less favorable to the Company than the terms of its existing
capacity license. See "Certain Relationships and Related Transactions--Certain
Operating Agreements."
9
<PAGE>
At expiration of the capacity license, Time Warner Cable is obligated to
negotiate a renewal in good faith, but the Company may be unable to reach
agreement with Time Warner Cable on acceptable terms. In addition, Time Warner
Cable may terminate the capacity license before expiration upon:
. a material impairment of Time Warner Cable's ability to provide the
license by law;
. a material breach of the capacity license by the Company; or
. the institution of any proceedings to impose any public utility or
common carrier status or obligations on Time Warner Cable, or any other
proceedings challenging Time Warner Cable's operating authority as a
result of the services provided to the Company under the capacity
license.
The capacity license prohibits the Company from offering residential
services or content services with the capacity licensed from Time Warner Cable.
We may lose the right to use the "Time Warner" name.
The Company believes the "Time Warner" brand name is valuable and its loss
could have an adverse effect on the Company. Under a license agreement with
Time Warner, the Company is required to discontinue use of the "Time Warner"
name in the following circumstances:
. the license agreement expires after an initial term ending July 2002 or
any permitted renewal;
. Time Warner no longer owns at least 30% of the Common Stock of the
Company;
. Time Warner no longer has the right to nominate at least three members
of the Company's board of directors;
. the Company violates covenants in the capacity license with Time Warner
Cable relating to residential services and content services; or
. a Class B Stockholder transfers its Class B Common Stock and its rights
to designate nominees to the board of directors to a third party.
Under these circumstances, the Company may change its name to "TW Telecom
Inc." Such name change, and the inability to use the "Time Warner" name could
have an adverse effect on the Company's ability to conduct its business and on
its financial condition and results of operations.
The Company depends on interconnection with incumbent local exchange carriers.
The Company's services may be less attractive if it cannot obtain high
quality, reliable and reasonably priced interconnection from incumbent local
exchange carriers. The 1996 Act requires incumbent local exchange carriers to
allow the Company to connect to their networks, thereby connecting to end users
not on the Company's networks ("interconnection"). However, negotiating
interconnection agreements with the incumbent local exchange carriers takes
considerable time, effort and expense. The agreements are also subject to state
and local regulation. The Company may be unable to obtain interconnection at
rates that are both competitive and profitable.
The local services market is highly competitive, and many of our competitors
have significant advantages that may adversely affect our ability to compete
with them.
The Company operates in an increasingly competitive environment and some
companies may have competitive advantages over the Company. Most incumbent
local exchange carriers offer substantially the same services as those offered
by the Company. Incumbent local exchange carriers benefit from:
. longstanding relationships with their customers;
. greater financial and technical resources;
. the ability to subsidize local services from revenues in unrelated
businesses; and
10
<PAGE>
. recent regulations that relax price restrictions and decrease regulatory
oversight of incumbent local exchange carriers.
The Company also faces competition from new entrants into the local services
business who may also be better established and have greater financial
resources. These advantages may impair the Company's ability to compete in
price and service offerings or require the Company to sustain prolonged periods
of operating losses in order to retain customers. The current trend of
consolidation of telecommunications companies and strategic alliances within
the industry could give rise to significant new or stronger competitors for the
Company. Some long distance carriers who are customers of the Company are
pursuing alternative ways to obtain local telecommunications services,
including by acquiring local exchange carriers or constructing their own
facilities.
Competition in local services has also increased as a result of changing
government regulations.
The 1996 Act has increased competition in the local telecommunications
business. The 1996 Act:
. requires incumbent local exchange carriers to interconnect their
networks with those of requesting telecommunications carriers and to
allow requesting carriers to collocate equipment at the premises of the
incumbent local exchange carriers;
. requires all local exchange providers to offer their services for
resale;
. allows long distance carriers to resell local services;
. requires incumbent local exchange carriers to offer to requesting
telecommunications carriers network elements on an unbundled basis; and
. requires incumbent local exchange carriers to offer to requesting
telecommunications carriers the services they provide to end-users to
other carriers at wholesale rates.
However, under the 1996 Act, the FCC and some state regulatory authorities
may provide incumbent local exchange carriers with increased flexibility to
reprice their services as competition develops and as incumbent local exchange
carriers allow competitors to interconnect to their networks. In addition, some
new entrants in the local market may price certain services to particular
customers or for particular routes below the prices charged by the Company for
services to those customers or for those routes. If the incumbent local
exchange carriers and other competitors lower their rates and can sustain
significantly lower prices over time, this may adversely affect revenue of the
Company if it is required by market pressure to price at or below the incumbent
local exchange carriers' prices.
Competition may also increase as a result of a recent World Trade
Organization agreement on telecommunications services. As a result of the
agreement, the FCC has made it easier for foreign companies to enter the U.S.
telecommunications market.
Several customers account for a significant amount of our revenue.
The Company has substantial business relationships with a few large
customers. For the year ended December 31, 1999, the Company's top 10 customers
accounted for 39% of the Company's total revenue. The Company's largest
customer for the year ended December 31, 1999, AT&T Corp. and its affiliates,
represented 13.5% of the Company's total revenue. However, a substantial
portion of that revenue results from traffic that is directed to the Company by
customers that have selected that long distance carrier. No other customer,
including customers who direct their business through long distance carriers,
accounted for 10% or more of revenue.
Some of the Company's customer arrangements may not continue.
Some of the Company's customer arrangements are subject to termination on
short notice and do not require the customer to maintain its arrangement at
current levels, and there can be no assurance that such customers will continue
to purchase the same service quantity levels. The Company believes that certain
11
<PAGE>
interexchange carriers are pursuing alternatives to their current practices
with regard to obtaining local telecommunications services, including
acquisition or construction of their own facilities. In addition, interexchange
carriers may be able to provide local service by reselling the facilities or
services of an incumbent local exchange carrier, which may be more cost-
effective for an interexchange carrier than using the services of the Company
or another competitive access provider or competitive local exchange carrier.
We are subject to significant federal and state regulation that can
significantly affect pricing and profitability.
Existing Federal and state regulations, or new regulations, could have a
material impact on the prices and revenue of the Company. Certain rates charged
by the Company to its customers must be filed with the FCC and/or state
regulators, which provides price transparency to customers and competitors.
In addition, when the Company provides local exchange services in a market,
the 1996 Act and FCC rules require it to:
. not unreasonably limit the resale of its services;
. provide telephone number portability if technically feasible;
. provide dialing parity to competing providers;
. provide access to poles, ducts and conduits owned by it; and
. establish reciprocal compensation arrangements for the transport and
termination of telecommunications.
We may receive less revenue if incumbent local exchange carriers successfully
challenge reciprocal compensation.
The Company currently receives compensation from incumbent local exchange
carriers for terminating local calls at the premises of internet service
providers. Some companies have challenged the right of the Company and others
to receive this compensation. Determinations by the FCC or by state utility
commissions that such traffic should not be subject to termination compensation
could be adverse to the Company. See "Business--Government Regulation."
We may experience a reduction in switched access revenue as a result of
regulatory rate reform.
The FCC has established a framework for the eventual deregulation of
incumbent local exchange carrier interstate access charges, which will exert a
downward pressure on the Company's interstate access rates. There is no
assurance that the Company will be able to compensate for the reduction in
switched access revenue from regulatory rate reform with other revenue sources.
We depend on governmental and other authorizations.
The development, expansion and maintenance of the Company's networks will
depend on, among other things, its ability to obtain rights-of-way and other
required governmental authorizations and permits. Any increase in the
difficulty or cost of obtaining these authorizations and permits could
adversely affect the Company, particularly where it must compete with companies
that already have the necessary permits. In order to compete effectively, the
Company must obtain these authorizations in a timely manner, at reasonable
costs and on satisfactory terms and conditions. In certain of the cities or
municipalities where the Company provides network services, it pays license or
franchise fees. The 1996 Act permits municipalities to charge these fees only
if they are competitively neutral and nondiscriminatory, but certain
municipalities may not conform their practices to the requirements of the 1996
Act in a timely manner or without legal challenge. The Company also faces the
risks that other cities may start imposing fees, fees will be raised or
franchises will not be renewed. Some of the Company's franchise agreements also
provide for increases or renegotiation of fees at certain
12
<PAGE>
intervals. Any increases in these fees may have a negative impact on the
Company's financial condition. The Company is in the process of obtaining any
necessary regulatory approvals in connection with the underwriters' over-
allotment option.
We are dependent on Time Warner Cable's permits, licenses and rights-of-way.
The Company currently licenses a significant portion of its fiber optic
capacity from Time Warner Cable. Municipalities that regulate Time Warner Cable
may or may not seek to impose additional franchise fees or otherwise charge
Time Warner Cable. The Company must reimburse Time Warner Cable for any new
fees or increases. Time Warner Cable or the Company may not be able to obtain
all necessary permits, licenses or agreements from governmental authorities or
private rights-of-way providers necessary to effect future license
transactions. This would hinder the Company's ability to expand its existing
networks or develop new networks successfully in locations served by Time
Warner Cable.
We expect that our quarterly operating results will fluctuate.
As a result of the limited revenue and significant expenses associated with
the expansion and development of its networks and services, the Company
anticipates that its operating results could vary significantly from quarter to
quarter. Changes in the usage or payment patterns of significant customers may
also cause operating results to vary.
We expect to depend on third party vendors for information systems.
The Company has entered into agreements with vendors that provide for the
development and operation of back office systems, such as ordering,
provisioning and billing systems. The failure of those vendors to perform their
services in a timely and effective manner at acceptable costs could have a
material adverse effect on the Company's growth and its ability to monitor
costs, bill customers, provision customer orders and achieve operating
efficiencies.
The Class B Stockholders control the Company.
The Class B Stockholders hold all the outstanding shares of Class B Common
Stock. The Class B Stockholders generally have the collective ability to
control all matters requiring stockholder approval, including the nomination
and election of directors. Even after the sale of the shares in this offering,
the Class B Stockholders will still control the Company. The Class B Common
Stock is not subject to any mandatory conversion provisions other than pursuant
to certain transfer restrictions. The disproportionate voting rights of the
Class B Common Stock relative to the Class A Common Stock may delay or prevent
a change in control of the Company, and may make the Company a less attractive
takeover target. See "Principal and Selling Stockholders" and "Description of
Capital Stock."
After this offering, the Company's board of directors will consist of seven
directors. Under the Stockholders Agreement, Time Warner has the right to
designate three nominees for the board of directors and Advance/Newhouse
Partnership has the right to designate one nominee. Under the Stockholders
Agreement, Class B Stockholders agree to vote in favor of all nominees selected
by the Class B Stockholders. Class B Stockholders will also have the power to
elect the other members of the Company's board of directors.
Each of the Class B Stockholders has veto rights over certain actions; the
selling stockholder will retain those rights as long as it retains Class B
Common Stock.
Under the Restated Certificate of Incorporation, as long as the outstanding
Class B Common Stock represents at least 50% of the aggregate voting power of
both classes of Common Stock outstanding, the approval of 100% of the Class B
Stockholders is required:
. to permit the Company to provide residential services or content
services prior to May 2004;
13
<PAGE>
. to amend the Restated Certificate of Incorporation, other than in
connection with certain ministerial actions; or
. for any direct or indirect disposition by the Company of capital stock
of subsidiaries or assets that in either case represents substantially
all the assets of the Company on a consolidated basis.
The approval of 100% of the Class B Stockholders is also required for the
issuance of any additional shares of Class B Common Stock or any capital stock
having more than one vote per share.
After the offering, the selling stockholder will retain up to 5,789,842
shares of Class B Common Stock. So long as the selling stockholder retains any
of these shares as Class B Common Stock, it will be entitled to exercise the
veto and other rights outlined above.
The holders of Class B Common Stock can sell control of the Company at a time
when they do not have a majority economic interest in the Company, and exclude
the holders of Class A Common Stock from participating in the sale.
The Stockholders Agreement provides that, subject to the rights of first
refusal of the other holders of Class B Common Stock, the Class B Stockholders
may transfer their Class B Common Stock. If a holder sells all, but not less
than all, of its Class B Common Stock as shares of Class B Common Stock, such
holder may transfer its right to nominate Class B nominees for election to the
board of directors. In addition, all of the holders of Class B Common Stock
have the right to participate in certain sales by Time Warner of its Class B
Common Stock. Accordingly, majority control of the Company could be transferred
by one or more holders of Class B Common Stock at a time when such holder or
holders of Class B Common Stock do not have a majority of the economic interest
in the Company and with no assurance that the holders of Class A Common Stock
would be given the opportunity to participate in the transaction or, if they
were permitted to participate in the transaction, to receive the same amount
and type of consideration for their stock in the Company as the holders of
Class B Common Stock.
In addition, the Company has elected not to be subject to Section 203 of the
Delaware General Corporation Law, which would otherwise provide certain
restrictions on "business combinations" between the Company and any person
acquiring a significant (15% or greater) interest in the Company other than in
a transaction approved by the board of directors and in certain cases by
stockholders of the Company.
The Class B Stockholders may compete with the Company.
The Class B Stockholders are in the cable television business. There is no
restriction on the Class B Stockholders' ability to compete with the Company.
They may, now or in the future, provide the same or similar services to those
provided by the Company.
Some of the Company's business activities are restricted.
The Company's Restated Certificate of Incorporation restricts the Company's
business activities. These restrictions limit our ability to expand our
business and could deprive the Company of valuable future opportunities. Under
the Restated Certificate of Incorporation, the Company may not, directly or
through a subsidiary or affiliate:
. provide residential services; or
. produce or otherwise provide entertainment, information, or any other
content services, with certain limited exceptions.
The Company may engage in these activities with the affirmative vote of all
the holders of the Class B Common Stock or on the earlier of:
. five years from the date of the Restated Certificate of Incorporation
(May 2004); or
14
<PAGE>
. the date the Class B Common Stock represents less than 50% of the voting
power of the Company (after the offering, Class B Common Stock will
represent approximately 95.5% of the voting power of the Company).
See "Description of Capital Stock."
The Company is subject to the same restrictions under the capacity license
with Time Warner Cable, except that those restrictions apply only to the
Company's use of the leased capacity but last until the capacity license
expires in 2028 or is terminated. The Company believes these restrictions will
not materially affect its ability to operate its business as currently planned.
Some of our directors may have conflicts of interest.
Some directors of the Company are also directors, officers or employees of
the Class B Stockholders or their affiliates. Although these directors have
fiduciary obligations to the Company under Delaware law, they may face
conflicts of interest. For example, conflicts of interest may arise with
respect to certain business opportunities available to, and certain
transactions involving, the Company. The Class B Stockholders have not adopted
any special voting procedures to deal with such conflicts of interest. The
resolution of these conflicts may be unfavorable to the Company. The Company's
Restated Certificate of Incorporation provides for the allocation of corporate
opportunities between the Company and the Class B Stockholders. See
"Description of Capital Stock" and "Certain Relationships and Related
Transactions."
If we do not adapt to rapid changes in the telecommunications industry, we
could lose customers or market share.
The telecommunications industry will continue to experience rapid changes in
technology. The Company's future success may depend on its ability to adapt to
any changes in the industry. A failure by the Company to adopt new technology,
or the Company's choice of one technological innovation over another, may have
an adverse impact on the Company's ability to compete or meet customer demands.
Future sales of shares of Class A Common Stock could depress the price of the
Class A Common Stock.
The market price of the Class A Common Stock could drop as a result of
significant sales in the market. The perception that such sales could occur may
also affect its trading price. These factors could also make it more difficult
for the Company to raise funds through future offerings of Common Stock.
Upon completion of this offering and exercise of the underwriters' over-
allotment option, there will be 33,368,601 shares of Class A Common Stock
outstanding and 71,726,500 shares of Class B Common Stock outstanding, all of
which are convertible into Class A Common Stock on a share for share basis. The
Company has reserved for issuance 9,027,000 shares of Class A Common Stock upon
the exercise of stock options. Options to purchase 7,865,203 shares were
outstanding as of February 29, 2000.
The selling stockholder has agreed that, without the prior written consent
of Lehman Brothers and Morgan Stanley & Co. Incorporated, it will not, during
the period ending 180 days after the date of this prospectus, (1) publicly
offer, pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend, or otherwise transfer, dispose of or distribute, directly or
indirectly, any shares of Class A Common Stock or any securities convertible
into the Class A Common Stock, or (2) enter into any public swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of the Class A Common Stock, whether any such
transaction described in clause (1) or (2) above is to be settled by delivery
of Class A Common Stock or such other securities, in cash or otherwise. The
foregoing sentence shall not apply to (a) the sale of any shares of Class A
Common Stock to the underwriters pursuant to the underwriting agreement, (b)
transactions relating to shares of Class A Common Stock or other securities
acquired in open market transactions after the
15
<PAGE>
completion of this offering, (c) private transactions relating to shares of
Class A Common Stock or any securities convertible into the Class A Common
Stock, provided that the selling stockholder shall ensure that any transferee
that receives such shares in a private transaction shall be subject to the
remainder of the 180-day lock-up period set forth in clauses (1) and (2) above,
or (d) the registration of shares of Class A Common Stock pursuant to the
selling stockholder's incidental registration rights under Section 4.2 of the
Stockholders' Agreement, dated as of May 10, 1999, among the Class B
Stockholders.
The Company and each of the Class B Stockholders, other than the selling
stockholder, has agreed that, without the prior written consent of Lehman
Brothers Inc. and Morgan Stanley & Co. Incorporated, it will not, during the
period ending 90 days after the date of this prospectus, (1) publicly offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend, or otherwise transfer, dispose of or distribute, directly or
indirectly, any shares of Class A Common Stock or any securities convertible
into the Class A Common Stock (other than the Class B Common Stock) or (2)
enter into any public swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the Class A
Common Stock, whether any such transaction described in clause (1) or (2) above
is to be settled by delivery of Class A Common Stock or such other securities,
in cash or otherwise. The foregoing sentence shall not apply to (a) the sale of
any shares of Class A Common Stock to the underwriters pursuant to the
underwriting agreement, (b) transactions relating to shares of Class A Common
Stock or other securities acquired in open market transactions after the
completion of this offering, (c) the surrender of unexercised options or shares
upon a "cashless exercise" of options or other incentive compensation awards or
(d) private transactions relating to shares of Class A Common Stock, provided
that the Company or such Class B Stockholder shall ensure that any transferee
that receives shares of Class A Common Stock in a private transaction shall be
subject to the remainder of the 90-day lock-up period set forth in clauses (1)
and (2) above. See "Underwriters." After that, holders of the Class B Common
Stock may or may not decide, based upon then prevailing market and other
conditions, to convert their Class B Common Stock to Class A Common Stock and
to dispose of all or a portion of such stock pursuant to the provisions of Rule
144 under the Securities Act or pursuant to the demand registration rights
contained in the stockholders agreement among the Class B Stockholders. See
"Certain Relationships and Related Transactions--Stockholders Agreement."
The stock price of the Class A Common Stock may be volatile.
The price of the Class A Common Stock may be volatile, and may fluctuate due
to factors such as:
. actual or anticipated fluctuations in quarterly and annual results;
. announcements of technological innovations;
. introduction of new services;
. mergers and strategic alliances in the telecommunications industry; and
. changes in government regulation.
In recent years, the market for stock in technology, telecommunications, and
computer companies has been highly volatile. This is particularly true for
companies with relatively small capitalizations, such as the Company.
We do not expect to pay dividends for the foreseeable future.
The Company is effectively prohibited from paying dividends on its Common
Stock for the foreseeable future under the terms of the indenture for the
Senior Notes. Moreover, we plan to retain all earnings for investment in our
business, and do not plan to pay dividends at any time in the foreseeable
future. See "Dividend Policy."
16
<PAGE>
USE OF PROCEEDS
The Company will not receive any of the proceeds from the sale of the shares
by the selling stockholder in this offering. All proceeds from the sale of the
Common Stock offered hereby will be for the account of the selling stockholder.
DIVIDEND POLICY
The Company has never paid or declared any dividends and does not anticipate
paying any dividends in the foreseeable future. The decision whether to pay
dividends will be made by the Company's board of directors in light of
conditions then existing, including the Company's results of operations,
financial condition and requirements, business conditions, covenants under loan
agreements and other contractual arrangements, and other factors. In addition,
the indenture for the Senior Notes contains covenants that effectively prevent
the Company from paying dividends on the Common Stock for the foreseeable
future.
PRICE RANGE OF COMMON STOCK
The Company's Class A Common Stock has traded on the Nasdaq National Market
under the symbol "TWTC" since May 12, 1999. The following table sets forth the
high and low sale prices for the Class A Common Stock for the period from May
12, 1999 to June 30, 1999, the third and fourth quarters of 1999 and the first
quarter of 2000 through April 25 as reported by the Nasdaq National Market:
<TABLE>
<CAPTION>
Common Stock
---------------
High Low
------- -------
<S> <C> <C>
1999
Second Quarter (May 12-June 30)......................... $29.250 $19.938
Third Quarter........................................... $32.875 $19.875
Fourth Quarter.......................................... $51.625 $20.875
2000
First Quarter (through April 25)........................ $93.000 $39.500
</TABLE>
17
<PAGE>
BACKGROUND OF THE COMPANY
The Company began its business in 1993 by providing telephony services
through cable systems owned by Time Warner Entertainment Company, L.P. ("TWE"),
Time Warner Entertainment-Advance/Newhouse Partnership ("TWE-A/N") and Time
Warner Inc. ("Time Warner"), collectively referred to as the "Former Parent
Companies." Time Warner Cable refers to the cable systems owned by TWE, TWE-A/N
and Time Warner.
TWE and TWE-A/N are owned as follows:
(1) TWE is a partnership of subsidiaries of Time Warner and MediaOne
Group, Inc. ("MediaOne"); and
(2) TWE-A/N is a partnership of TWE, Time Warner and Advance/Newhouse
Partnership ("Advance").
The Company's original business was to provide certain telephony services
together with cable television. In January 1997, the Company put in place a new
management team that implemented a business strategy focused exclusively on
serving business customers, rapidly providing switched services in the
Company's service areas and expanding the range of business telephony services
offered by the Company.
On July 14, 1998, TWT LLC succeeded to the ownership of the Company's
business. At that time, Time Warner, MediaOne and Advance (collectively
referred to as the "Class B Stockholders") formed TWT LLC to acquire the assets
and liabilities of the Company's business from the Former Parent Companies and
to conduct the offering on July 21, 1998 of $400 million principal amount 9
3/4% Senior Notes due July 2008 (the "Senior Notes"). In the transaction,
referred to as the "Reorganization," the Class B Stockholders (either directly
or through subsidiaries) became the owners of all the limited liability company
interest in TWT LLC.
On May 6, 1999, MediaOne and AT&T entered into a merger agreement providing
for MediaOne to be acquired by AT&T. The MediaOne stockholders have approved
the merger, but the merger is subject to various regulatory approvals. The
consummation of this transaction will not affect MediaOne's rights and status
as a Class B Stockholder.
On May 10, 1999, in preparation for the Company's initial public offering,
TWT LLC was reconstituted as a Delaware corporation (the "Reconstitution")
under the name Time Warner Telecom Inc. by merging into a newly formed Delaware
corporation. As part of the merger, the outstanding Class A limited liability
company interests were converted into Class A Common Stock and the Class B
Stockholders exchanged their limited liability company interests in TWT LLC for
Class B Common Stock of the newly formed corporation. Prior to the
Reconstitution, the only outstanding Class A interest were those held by the
former shareholders of Internet Connect, Inc. ("Inc.Net") which the Company
acquired in April 1999.
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A Common
Stock at a price of $14 per share (the "IPO"). See "Management's Discussion and
Analysis of Financial Conditions and Results of Operations."
On January 10, 2000, Time Warner announced an agreement to merge with
America Online Inc. in a stock-for-stock transaction that would create a new
company called AOL Time Warner Inc. The transaction is subject to stockholder
approval of both companies and various regulatory approvals. The consummation
of this transaction will not affect Time Warner's rights and status as a Class
B Stockholder.
The Company's authorized capital includes two classes of Common Stock, Class
A Common Stock and Class B Common Stock, are identical in all respects except
that:
(a) holders of Class A Common Stock are entitled to one vote per share
and holders of Class B Common Stock are entitled to 10 votes per share on
all matters submitted to a vote of stockholders;
(b) certain matters require the approval of 100% of the outstanding
Class B Common Stock, voting separately as a class; and
18
<PAGE>
(c) certain other matters require the approval of a majority of the
outstanding Class A Common Stock, voting separately as a class. Each share
of Class B Common Stock is convertible into one share of Class A Common
Stock.
See "Description of Capital Stock" and "Principal and Selling Stockholders."
The following diagram shows the organizational structure of the Company
immediately following this offering, based on the number of shares outstanding
as of February 29, 2000, and assuming the underwriters' over-allotment option
is exercised. The interests of Time Warner, Advance and MediaOne consist of
Class B Common Stock. The diagram also shows the voting power of the Company's
principal shareholder groups after the offering.
[GRAPHIC ORGANIZATIONAL CHART]
19
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1999.
This table should be read together with "Selected Combined Financial and
Other Operating Data," "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and the Company's financial statements,
including the notes, appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
As of
December 31,
As of 1999, Including
December 31, the Effects of
1999(2) the Offering(3)
------------ ---------------
(thousands)
<S> <C> <C>
Cash and cash equivalents................... $ 90,586 $ 90,586
========= ========
Marketable securities....................... $ 173,985 $173,985
========= ========
Long-term debt and capital lease
obligations(1)............................. $ 403,627 $403,627
Stockholder's equity (deficit):
Preferred stock, $0.01 par value,
20,000,000 shares authorized, no shares
outstanding.............................. -- --
Class A Common Stock, $0.01 par value;
277,300,000 shares authorized, 23,543,422
and 33,368,601 shares issued and
outstanding on an actual and a pro forma
basis.................................... 235 334
Class B Common Stock, $0.01 par value;
162,500,000 shares authorized, 81,214,285
and 71,726,500 shares issued and
outstanding on an actual and a pro forma
basis.................................... 812 717
Additional paid-in capital................ 559,950 559,950
Accumulated deficit....................... (138,081) (138,811)
--------- --------
Total stockholders' equity.................. 422,916 422,190
--------- --------
Total capitalization.................... $ 826,543 $825,817
========= ========
</TABLE>
- --------
(1) Does not reflect the senior secured revolving bank credit facility
recently entered into by the Company.
(2) Does not reflect the conversion by MediaOne of 9,487,785 shares of Class B
Common Stock into an equal number of shares of Class A Common Stock in
connection with the offering.
(3) Reflects the conversion by MediaOne of 9,487,785 shares of Class B Common
Stock into an equal number of shares of Class A Common Stock and the
recognition of $730,000 in expenses in connection with the offering.
20
<PAGE>
SELECTED CONSOLIDATED AND COMBINED FINANCIAL AND OTHER OPERATING DATA
The selected statements of operations data for the years ended December 31,
1997, 1998 and 1999, and the selected balance sheet data as of December 31,
1998 and 1999, are derived from, and are qualified by reference to, the
financial statements of the Company, including the notes, audited by Ernst &
Young LLP, independent auditors, appearing elsewhere in this prospectus. The
selected statements of operations data for the year ended December 31, 1995 and
1996 and the selected balance sheet data as of December 31, 1995, 1996 and 1997
have been derived from audited financial statements of the Company not included
in this prospectus. The financial statements of the Company for all periods
prior to the Reorganization of the Company that occurred on July 14, 1998
reflect the "carved out" historical financial position, results of operations,
cash flows and changes in stockholders' equity of the commercial
telecommunications operations of predecessors of the Company, as if they had
been operating as a separate company. The selected financial and other
operating data set forth below should be read together with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's financial statements, including the notes, appearing elsewhere in
this prospectus.
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- --------- --------- ----------
(thousands, except per share amounts
and operating data amounts)
<S> <C> <C> <C> <C> <C>
Statements of Operations
Data:
Revenue:
Dedicated transport
services.............. $ 6,505 $ 20,362 $ 44,529 $ 84,024 $ 152,468
Switched services
(1)................... 350 3,555 10,872 37,848 116,285
-------- -------- --------- --------- ----------
Total revenue........ 6,855 23,917 55,401 121,872 268,753
-------- -------- --------- --------- ----------
Costs and expense (2):
Operating.............. 15,106 25,715 40,349 67,153 117,567
Selling, general and
administrative........ 34,222 60,366 54,640 77,401 113,389
Depreciation and
amortization.......... 7,216 22,353 38,466 50,717 68,785
-------- -------- --------- --------- ----------
Total costs and
expenses............ 56,544 108,434 133,455 195,271 299,741
-------- -------- --------- --------- ----------
Operating loss.......... (49,689) (84,517) (78,054) (73,399) (30,988)
Interest expense, net
and other (2).......... (1,416) (1,599) 7,398 (19,340) (28,473)
-------- -------- --------- --------- ----------
Net loss before income
taxes.................. (51,105) (86,116) (70,656) (92,739) (59,461)
Income tax expense (3).. -- -- -- -- 29,804
-------- -------- --------- --------- ----------
Net loss................ $(51,105) $(86,116) $ (70,656) $ (92,739) $ (89,265)
======== ======== ========= ========= ==========
Basic and diluted loss
per common share....... $ (0.63) $ (1.06) $ (0.87) $ (1.14) $ (0.93)
======== ======== ========= ========= ==========
Other Operating Data:
EBITDA(1)(4)............ $(42,473) $(62,164) $ (39,588) $ (22,682) $ 37,797
EBITDA Margin (1) (5)... (620)% (260)% (72)% (19)% 14%
Net cash provided by
(used in) operating
activities............. (35,605) (52,274) (29,419) (343) 54,235
Capital expenditures.... 141,479 144,815 127,315 126,023 221,224
Operating Data (6):
Operating Networks...... 15 18 19 19 21
Route miles............. 3,207 5,010 5,913 6,968 8,872
Fiber miles............. 116,286 198,490 233,488 272,390 332,263
Voice grade equivalent
circuits............... 158,572 687,001 1,702,431 2,953,454 5,331,000
Digital telephone
switches............... 1 2 14 16 19
Employees............... 508 673 714 919 1,259
Access lines............ 493 2,793 16,078 78,036 192,369
Balance Sheet Data:
Cash and cash
equivalents............ $ -- $ -- $ -- $ 105,140 $ 90,586
Marketable securities... -- -- -- 250,857 173,985
Property, plant and
equipment, net......... 199,005 323,161 415,158 494,158 677,106
Total assets............ 214,963 341,480 438,077 904,344 1,043,012
Long-term debt and
capital lease
obligations (6)........ -- -- 75,475 574,940 403,627
Total stockholders'
equity................. $179,589 $294,937 $ 300,390 $ 207,651 $ 422,916
</TABLE>
21
<PAGE>
- --------
(1) Includes the recognition of a non-recurring $7.6 million settlement of
reciprocal compensation in the fourth quarter of 1999.
(2) Includes expenses resulting from transactions with affiliates of $6.5
million, $12.4 million, $17.1 million, $27.7 million and $20.0 million in
1995, 1996, 1997, 1998 and 1999, respectively. See note 6 to the Company's
financial statements appearing elsewhere in this prospectus for an
explanation of these expenses.
(3) During 1999, the Company recorded a non-recurring $39.4 million charge to
earnings to record a net deferred tax liability associated with the
Reconstitution. This change occurred immediately prior to the Company's
initial public offering. Since the Reconstitution, the Company has recorded
a deferred income tax benefit aggregating $9.6 million, which is primarily
due to a decrease in the net deferred tax liability.
(4) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income (loss), cash flow and other measures of
financial performance and liquidity reported in accordance with generally
accepted accounting principles. Rather, EBITDA is a measure of operating
performance and liquidity that investors may consider in addition to such
measures. Management believes that EBITDA is a standard measure of
operating performance and liquidity that is commonly reported and widely
used by analysts, investors and other interested parties in the
telecommunications industry because it eliminates many differences in
financial, capitalization and tax structures, as well as non-operating
charges to earnings. EBITDA is used internally by the Company's management
to assess on-going operations and is a component of a covenant of the
Senior Notes that limits the Company's ability to incur additional future
indebtedness. However, EBITDA as used in this report may not be comparable
to similarly titled measures reported by other companies due to differences
in accounting policies.
(5) EBITDA Margin represents EBITDA as a percentage of revenue.
(6) Includes all managed properties including unconsolidated affiliates
(MetroComm AxS, L.P. in Columbus, Ohio and the Albany and Binghamton, New
York networks). Albany and Binghamton were wholly owned at December 31,
1997 and MetroComm AxS, L.P. was wholly owned at December 31, 1999.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis together with the
Company's financial statements, including the notes, appearing 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 the Company'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 in this prospectus.
Overview
The Company is a leading fiber facilities-based integrated communications
provider offering local businesses "last mile" broadband connections for data,
high-speed internet access, local voice and long distance services. The Company
serves customers in 21 metropolitan markets in the United States. The markets
include: Austin, Dallas, Houston and San Antonio, Texas; Charlotte, Greensboro
and Raleigh, North Carolina; Albany, Binghamton, New York City and Rochester,
New York; Northern New Jersey; Cincinnati and Columbus, Ohio; Memphis,
Tennessee; Orlando and Tampa, Florida; Indianapolis, Indiana; Milwaukee,
Wisconsin; San Diego, California and Honolulu, Hawaii. The Company plans to
enter Los Angeles/Orange County, California; Fayetteville, North Carolina and
Dayton, Ohio during 2000.
The Company began its business in 1993 by providing telephony services
through cable systems owned by TWE, TWE-A/N and Time Warner. The Company's
original business was to provide certain telephony services together with cable
television. In January 1997, the Company put in place a new management team
that implemented a business strategy focused exclusively on serving business
customers, rapidly providing switched services in the Company's service areas
and expanding the range of business telephony services offered by the Company.
On July 14, 1998, TWT LLC succeeded to the ownership of the Company's
business. At that time, the Class B Stockholders formed TWT LLC to acquire the
assets and liabilities of the Company's business from the Former Parent
Companies and to conduct the offering of the Senior Notes. In the transaction,
referred to as the "Reorganization," the Class B Stockholders (either directly
or through subsidiaries) became the owners of all the limited liability company
interests in TWT LLC.
On May 10, 1999, in preparation for the Company's initial public offering,
TWT LLC was reconstituted as a Delaware corporation under the name Time Warner
Telecom Inc. by merging into a newly formed Delaware corporation. As part of
the merger, the outstanding Class A limited company interests were converted
into Class A Common Stock and the Class B Stockholders exchanged their
interests in TWT LLC for Class B Common Stock of the newly formed corporation,
Time Warner Telecom Inc. Prior to the Reconstitution, the only outstanding
Class A interests were those hold by the former shareholders of Inc.Net, which
the Company acquired in April 1999. The Company accounted for the
Reorganization and the Reconstitution at each of the Class B Stockholders'
historical cost basis and, except as noted below, the Reorganization and the
Reconstitution had no effect on the Company's total stockholders' equity, which
has been presented on a consistent basis.
The primary change to the Company's operating structure since the
Reconstitution is that the management of the Company became accountable to the
Board of Directors, instead of to the management committee of TWT LLC. In
addition, all future net operating loss carryforwards from the date of the
Reconstitution can be utilized against future earnings of the Company as a
result of the change in the Company's operating and legal structure from a
limited liability company to a corporation. Prior to the Reconstitution, all
net operating losses were allocated to and utilized primarily by the Class B
Stockholders. The Company has not been, and will not be compensated for net
operating losses utilized by the Class B Stockholders. As a result of the
Reconstitution, which occurred during the second quarter of 1999, the Company
recorded a non-recurring charge to earnings for a net deferred tax liability of
approximately $39.4 million.
23
<PAGE>
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares of Class A Common
Stock at a price of $14 per share. The IPO generated approximately $270.2
million in proceeds for the Company, net of underwriting discounts and
expenses. A portion of the proceeds of the IPO was used to repay $180 million
of loans from the Former Parent Companies that were generated from the
financing requirements of the Company from July 1, 1997 through July 14, 1998,
which had remained outstanding, accruing interest, through May 14, 1999. The
proceeds of the IPO remaining after repayment of the loans were used to repay
assumed debt from acquisitions and to fund capital expenditures.
As a result of the IPO, the Company has two classes of Common Stock
outstanding, Class A Common Stock and Class B Common Stock. In general, holders
of Class A Common Stock have one vote per share and holders of Class B Common
Stock have ten votes per share. Each share of Class B Common Stock is
convertible, at the option of the holder, into one share of Class A Common
Stock. Holders of Class A Common Stock and Class B Common Stock generally vote
together as a single class. However, some matters require the approval of 100%
of the holders of the Class B Common Stock voting separately as a class, and
some matters require the approval of a majority of the holders of the Class A
Common Stock, voting separately as a class. Upon completion of the IPO, the
Class B Stockholders owned all of the 81,250,000 shares of outstanding Class B
Common Stock. Subsequent to the IPO, 35,715 shares of Class B Common Stock were
converted into Class A Common Stock. As of December 31, 1999, the Class B
Stockholders had approximately 97.2% of the combined voting power of the
outstanding Common Stock.
In connection with the Reconstitution, the Company assumed the obligations
under the former Time Warner Telecom LLC 1998 Option Plan, amended the plan,
and renamed it the Time Warner Telecom 1998 Stock Option Plan. The plan
provides for the granting of stock options to purchase shares of Class A Common
Stock to directors and current or prospective employees of, and consultants or
other individuals providing services to, the Company and its subsidiaries. As
of December 31, 1999, options for approximately 8.2 million shares were
outstanding.
Acquisitions
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Inc.Net, an internet service provider, for
consideration consisting of $3.8 million of Class A limited liability interests
in TWT LLC, the Company's predecessor, approximately $3.5 million in net cash
and the assumption of $1.9 million in liabilities. At the time of the IPO, the
Class A limited liability interests were converted into 307,550 shares of Class
A Common Stock of the Company. The Class A Common Stock of the Company into
which the limited liability interests were converted will be held in escrow to
be released to the former Inc.Net's shareholders over a period of three years.
Through the acquisition of this subsidiary, the Company manages current and
future data networks and provides new internet products.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm, Inc. through the issuance of 2,190,308
shares of Class A Common Stock of the Company valued at $24.1 million, and the
assumption of $20.1 million in liabilities. Through the acquisition of
MetroComm, the Company acquired the 50% interest of MetroComm AxS, L.P., a
competitive local exchange carrier in Columbus, Ohio, not already owned by the
Company.
24
<PAGE>
Results of Operations
The following table sets forth certain consolidated and combined statements
of operations data of the Company, in thousands of dollars and expressed as a
percentage of total revenue, for each of the periods presented. This table
should be read together with the Company's financial statements, including the
notes, appearing elsewhere in this prospectus:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------
1999 1998 1997
-------------- -------------- ---------------
(amounts in thousands, except per share
amounts)
<S> <C> <C> <C> <C> <C> <C>
Statements of Operations
Data:
Revenue:
Dedicated transport
services............... $ 152,468 57% $ 84,024 69% $ 44,529 80%
Switched services (1)... 116,285 43 37,848 31 10,872 20
--------- --- --------- --- --------- ----
Total revenue......... 268,753 100 121,872 100 55,401 100
--------- --- --------- --- --------- ----
Costs and expenses (2):
Operating............... 117,567 44 67,153 55 40,349 73
Selling, general and
administrative......... 113,389 42 77,401 63 54,640 99
Depreciation and
amortization........... 68,785 25 50,717 42 38,466 69
--------- --- --------- --- --------- ----
Total costs and
expenses............. 299,741 111 195,271 160 133,455 241
--------- --- --------- --- --------- ----
Operating loss............ (30,988) (11) (73,399) (60) (78,054) (141)
Interest expense (2)...... (45,264) (17) (29,198) (24) (1,538) (3)
Interest income........... 16,589 6 9,731 8 -- --
Equity in income (losses)
of unconsolidated
affiliate................ 202 -- 127 -- (2,082) (4)
Gain on disposition of
investments (3).......... -- -- -- -- 11,018 20
--------- --- --------- --- --------- ----
Net loss before income
taxes.................... (59,461) (22) (92,739) (76) (70,656) (128)
Income tax expense (4).... 29,804 11 -- -- -- --
--------- --- --------- --- --------- ----
Net loss.................. $ (89,265) (33)% $ (92,739) (76)% $ (70,656) (128)%
========= === ========= === ========= ====
Basic and diluted loss per
common share............. (0.93) (1.14) (0.87)
Basic and diluted loss per
common share before
income taxes (4)......... $ (0.62) (1.14) (0.87)
Average common shares
outstanding.............. 95,898 81,250 81,250
EDITDA(1)(5).............. $ 37,797 14% (22,682) (19)% (39,588) (71)%
Net cash provided by (used
in) operating
activities............... 54,235 (343) (29,419)
Net cash used in investing
activities............... (146,917) (378,083) (120,621)
Net cash provided by
financing activities..... 78,128 483,566 150,040
</TABLE>
- --------
(1) Includes the recognition of a non-recurring $7.6 million settlement of
reciprocal compensation in the fourth quarter of 1999.
(2) Includes expenses resulting from transactions with affiliates of $20.0
million, $27.7 million and $17.1 million in 1999, 1998 and 1997,
respectively.
(3) In 1997, the Company completed a series of transactions related to its
interests in the Hyperion Partnerships, a group of unconsolidated
telecommunication partnerships serving the New York area, whereby it sold
its interests in the partnerships serving the Buffalo and Syracuse markets
in exchange for approximately $7.0 million of cash and all of the minority
interests in the partnerships serving the Albany and Binghamton markets
that were not already owned by the Company. In connection with these
transactions, the Company recognized a gain of approximately $11.0 million.
(4) A non-recurring charge to earnings of $39.4 million was recorded in 1999 to
reflect the initial net deferred tax liability associated with the change
from a limited liability company to a corporation. Income tax expense for
1999 reflects the $39.4 million charge, net of a $9.6 million deferred
income tax benefit, resulting in net income tax expense of approximately
$29.8 million.
25
<PAGE>
(5) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income (loss), cash flow and other measures of
financial performance and liquidity reported in accordance with generally
accepted accounting principles. Rather, EBITDA is a measure of operating
performance and liquidity that investors may consider in addition to those
measures. Management believes that EBITDA is a standard measure of
operating performance and liquidity that is commonly reported and widely
used by analysts, investors and other interested parties in the
telecommunications industry because it eliminates many differences in
financial, capitalization, and tax structures, as well as non-operating
one-time charges to earnings. EBITDA is used internally by the Company's
management to assess ongoing operations and is a component of a covenant of
the Senior Notes that limits the Company's ability to incur certain
additional future indebtedness. However, EBITDA as used in this report may
not be comparable to similarly titled measures reported by other companies
due to differences in accounting policies.
General
The Company's revenue has been derived primarily from business telephony
services, including dedicated transport, local switched, long distance, data
and high-speed internet access services. The Company's customers are
principally telecommunications-intensive business end-users, long distance
carriers, internet service providers, wireless communications companies and
governmental entities. Since its inception in 1993, the Company has experienced
significant growth in revenue and the geographic scope of its operations. An
increasing portion of the Company's growth in revenue has come from the
provision of local switched services as a result of the 19 digital voice
switches deployed as of December 31, 1999. The Company believes that switched
services provide the opportunity for a greater return on invested capital than
that expected from dedicated transport services. The shift of the revenue
growth to switched services may cause the Company's revenue to become less
predictable since a portion of those services are billed to customers on a
usage basis. Dedicated transport customers are typically billed a flat monthly
rate which produces a less variable stream of revenue for the Company.
Furthermore, it is expected that the growth in the switched service offerings,
as well as data and internet services, will expand the Company's customer base
to customers that are generally smaller than those who purchase dedicated
transport services. Key to the Company's strategy is leveraging its existing
fiber optic networks by adding additional services such as data and internet
and an integrated product for smaller customers. The Company expects to
experience a higher churn rate for these customers than it has traditionally
experienced with dedicated transport services. The Company intends to minimize
churn in services to smaller customers by offering the service under minimum
one-year contracts.
Reciprocal compensation revenue is an element of switched services revenue,
which represents compensation from local exchange carriers for local exchange
traffic terminated on the Company's facilities originated by other local
exchange carriers. Reciprocal compensation is based on contracts between the
Company and local exchange carriers. The Company recognizes reciprocal
compensation revenue as it is earned, except in those cases where the revenue
is under dispute. Under several of its contracts, the local exchange carriers
have disputed the payment of reciprocal compensation for traffic terminating to
internet service provider customers contending that the traffic was not local.
As a result, the Company has filed complaints with various public utility
commissions contending that the internet service provider traffic is local.
Various of these state public utility commissions have ruled in favor of the
Company, but all of these favorable decisions have subsequently been appealed
by the local exchange carriers. While the Company believes that these disputes
will ultimately be resolved in its favor, the Company only recognizes revenue
on a portion of the cash received and defers recognition of a significant
portion of this revenue pending outcome of the dispute. As of December 31,
1999, the Company has deferred recognition of $32.8 million in reciprocal
compensation revenue for payments received associated with these disputes. 1999
switched services revenue includes the recognition of a non-recurring $7.6
million settlement of reciprocal compensation. The Company pays reciprocal
compensation expense to the other local exchange carriers for local exchange
traffic it terminates on the local exchange carriers facilities. These costs
are recognized as incurred.
26
<PAGE>
The Company benefits from its strategic relationship with Time Warner Cable
both through access to local right-of-way and construction cost-sharing. The
Company's networks have been constructed primarily through the use of fiber
capacity licensed from Time Warner Cable. As of December 31, 1999, the Company
operated networks in 21 metropolitan areas that spanned 8,872 route miles,
contained 332,263 fiber miles and offered service to 5,566 buildings.
The Company plans to continue expanding its revenue base by fully utilizing
available network capacity in its existing markets, by adding networks in new
markets and by continuing to develop and selectively tailor new services in
competitively-priced packages to meet the needs of its medium- and large-sized
business customers. The Company intends to expand its product offerings on a
continuous basis to achieve a diverse revenue base. As part of that process,
the Company is targeting the expansion of data and internet products that can
be offered on the Company's existing network.
Operating expenses consist of costs directly related to the operation and
maintenance of the networks and the provision of the Company's services. This
includes the salaries and related expenses of operations and engineering
personnel, as well as costs incurred from the incumbent local exchange
carriers, other competitors and long distance providers for facility leases and
interconnection. These costs have increased over time as the Company has
increased its operations and revenue. The Company expects these costs to
continue to increase as the Company's revenue growth continues, but generally
at a slower rate than revenue growth.
Selling, general and administrative expenses consist of salaries and related
costs for employees other than those involved in operations and engineering.
Such expenses include costs related to sales and marketing, information
technology, billing, regulatory and legal costs. These costs have increased
over time as the Company has increased its operations and revenue. The Company
expects these costs to continue to increase as the Company's revenue growth
continues, but generally at a slower rate than revenue growth.
In the normal course of business, the Company engages in various
transactions with Time Warner Cable, generally on negotiated terms among the
affected units that, in management's view, result in reasonable allocations. In
connection with the Reorganization, the Company entered into several contracts
with the Former Parent Companies with respect to certain of those transactions.
The Company's selling, general and administrative expenses include charges
allocated from Time Warner Cable for office rent and overhead charges for
various administrative functions they perform for the Company. These charges
are required to reflect all costs of doing business and are based on various
methods, which management believes result in reasonable allocations of those
costs that are necessary to present the Company's operations as if they are
operated on a stand alone basis. In addition, the Company licenses the right to
use the majority of its fiber optic cable capacity from Time Warner Cable
through prepaid right-to-use agreements and reimburses Time Warner Cable for
facility maintenance and pole rental costs. The maintenance and pole rental
costs are included in the Company's operating expenses.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Revenue. Revenue increased $146.9 million, or 121%, to $268.8 million for
1999, from $121.9 million for 1998. This increase in revenue is primarily
because of increased customers, increased revenue from existing customers, a
broader array of products offered and acquisitions. Revenue from the provision
of dedicated transport services increased $68.4 million, or 81%, to $152.5
million for 1999, from $84.0 million for 1998. Switched service revenue
increased $78.4 million, or 207%, to $116.3 million for 1999, from $37.8
million for 1998. Exclusive of the effects of acquisitions and the effects of
the recognition of a non-recurring $7.6 million settlement of reciprocal
compensation in the fourth quarter of 1999, dedicated transport service and
switched service revenue increased 73% and 182%, respectively. The increase in
revenue from dedicated transport services primarily reflects a 54% increase in
average dedicated transport customers and a broader array of products and
services offered in existing markets. The increase in switched service revenue
reflects a 136% increase in average switched service customers, and an increase
in revenue from switched access services,
27
<PAGE>
reciprocal compensation, and a broader array of products and services offered
in existing markets. Reciprocal compensation, the mutual charges by local
carriers for recovery of costs associated with the termination of traffic on
each other's networks, represented 7% and 8% of total revenue for 1999 and
1998, respectively, excluding the effects of the recognition of a non-recurring
$7.6 million settlement of reciprocal compensation in the fourth quarter of
1999. At December 31, 1999, the Company offered dedicated transport services in
21 metropolitan areas, 20 of which also offered switched services. At December
31, 1998, the Company offered dedicated transport services in 19 metropolitan
areas, 16 of which also offered switched services.
Operating Expenses. Operating expenses increased $50.4 million, or 75%, to
$117.6 million for 1999, from $67.2 million for 1998. Exclusive of the effects
of acquisitions, these expenses increased 67%. The increase in operating
expenses was primarily attributable to the Company's expansion of its business,
principally switched services, the ongoing development of existing markets
resulting in higher local exchange carrier charges for circuit leases and
interconnection, and higher technical personnel costs. As a percentage of
revenue, operating expenses decreased to 44% for 1999 from 55% for 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $36.0 million, or 46%, to $113.4 million for
1999, from $77.4 million for 1998. Exclusive of the effects of acquisitions,
these expenses increased 43%. The increase in selling, general and
administrative expenses was primarily attributable to an increase in employee
headcount and higher direct sales costs associated with the increase in
revenue, higher data processing costs and an increase in the provision for
doubtful accounts related to the increase in revenue. As a percentage of
revenue, selling, general and administrative expenses decreased to 42% for 1999
from 63% for 1998.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased $18.1 million, or 36%, to $68.8 million for 1999, from $50.7 million
for 1998. Exclusive of the effects of acquisitions, this expense increased 28%.
The increase in depreciation and amortization expense was primarily
attributable to increased capital expenditures and increased goodwill generated
from acquisitions.
EBITDA. EBITDA increased $60.5 million, to $37.8 million, for 1999 from a
loss of $22.7 million for 1998. Exclusive of the effects of acquisitions and
the effects of the recognition of a non-recurring $7.6 million settlement of
reciprocal compensation in the fourth quarter of 1999, this amount increased
$51.6 million. This improvement was primarily the result of economies of scale
as more revenue was generated in existing markets, increased utilization of
networks and facilities, and a more skilled and productive workforce.
Interest Expense. During the period July 1, 1997 through July 14, 1998, all
of the Company's financing requirements were funded with loans from the Former
Parent Companies. These loans remained outstanding, accruing interest, through
May 14, 1999. On July 21, 1998, the Company issued $400 million in Senior Notes
in a public offering. On May 14, 1999, the subordinated loans of approximately
$180 million, including accrued interest, were repaid in full to the Former
Parent Companies from the IPO proceeds. Interest expense relating to these
loans and Senior Notes totaled $45.3 million and $29.2 million for 1999 and
1998, respectively. The increase of $16.1 million is primarily due to the
higher weighted average debt balance during 1999.
Net Loss. Net loss decreased $3.5 million, or 4%, to $89.3 million for 1999,
from a net loss of $92.7 million for 1998. The decrease in net loss is
primarily related to improved results from operations, partially offset by an
increase in net interest expense of $9.2 million and income tax expense of
$29.8 million.
Loss per Common Share. The basic and diluted loss per common share was
computed by dividing net loss applicable to common shares by the weighted
average outstanding common shares for the period. Potential common shares were
not included in the computation of weighted average shares outstanding because
their inclusion would be anti-dilutive. The increase in the weighted average
shares outstanding is due to the issuance of Class A Common Stock for the IPO,
for acquisitions and upon the exercise of stock options. For 1999, the basic
and diluted loss per common share decreased $0.21 per share, or 18%, to ($0.93)
per share from ($1.14) per share for 1998.
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Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Revenue increased $66.5 million, or 120%, to $121.9 million for
1998, from $55.4 million for 1997. Revenue from the provision of dedicated
transport services increased $39.5 million, or 89%, to $84.0 million for 1998,
from $44.5 million for 1997. Switched service revenue increased $27.0 million,
or 248%, to $37.8 million for 1998, from $10.9 million for 1997. The increase
in revenue from dedicated transport services primarily reflects growth of
services and new products offered in existing markets. The increase in switched
services resulted from the offering of services in new markets and the growth
of services in existing markets including reciprocal compensation. Reciprocal
compensation represented 8% and 9% of total revenue for 1998 and 1997,
respectively. At December 31, 1998, the Company offered dedicated transport
services in 19 metropolitan areas, 16 of which also offered switched services,
as compared to offering dedicated transport services in 19 metropolitan areas,
14 of which also offered switched services at December 31, 1997. The
metropolitan areas do not include MetroComm AxS, L.P., a 50% owned entity of
the Company.
Operating Expenses. Operating expenses increased $26.8 million, or 66%, to
$67.2 million for 1998, from $40.3 million for 1997. The increase in operating
expenses was primarily attributable to the Company's expansion of its business,
principally switched services, the ongoing development of existing markets
resulting in higher local exchange carrier charges for circuit leases and
interconnection, higher technical personnel costs, and higher data processing
costs. As a percentage of revenue, operating expenses decreased to 55% in 1998
from 73% for 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $22.8 million, or 42%, to $77.4 million for
1998, from $54.6 million for 1997. The increase in selling, general and
administrative expenses was primarily attributable to higher direct sales costs
associated with the increase in revenue, higher property taxes, an increase in
consulting expenses relating to local regulatory matters, the implementation of
new billing and system software, and an increase in the provision for doubtful
accounts related to the increase in revenue. As a percentage of revenue,
selling, general and administrative expenses decreased to 63% for 1998 from 99%
for 1997.
Depreciation and Amortization Expense. Depreciation and amortization expense
increased $12.3 million, or 32%, to $50.7 million for 1998, from $38.5 million
for 1997. The increase in depreciation and amortization expense was primarily
attributable to higher capital expenditures related to the ongoing construction
and expansion of the Company's telecommunications networks in both 1998 and
1997. As a percentage of revenue, depreciation and amortization expenses
decreased to 42% for 1998, from 69% for 1997.
EBITDA. The EBITDA loss for 1998 decreased $16.9 million, or 43%, to a loss
of $22.7 million for 1998, from a loss of $39.6 million for 1997. This
improvement was primarily the result of increased revenue due to the Company's
expansion of local telecommunications networks in new and existing markets and
growth of the Company's customer base, partially offset by higher operating
expenses in support of the larger customer base, and higher selling, general
and administrative expenses required to support the expansion.
Interest Expense. During the period July 1, 1997 through July 14, 1998, all
of the Company's financing requirements were funded with loans from the Former
Parent Companies. On July 21, 1998, the Company issued $400 million in Senior
Notes in a public offering. Interest expense relating to these loans and Senior
Notes totaled $29.2 million and $1.5 million for 1998 and 1997, respectively.
Net Loss. Net loss increased $22.1 million, or 31%, to $92.7 million for
1998, from a net loss of $70.7 million for 1997. This increase resulted from
higher depreciation and amortization expenses relating to the Company's
expansion of telecommunications networks in new and existing markets, as well
as interest expense relating to the subordinated loans payable to the Former
Parent Companies and the Senior Notes.
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Liquidity and Capital Resources
Sources and Uses of Funds
Operations. For 1999, the Company's cash provided by operations was $54.2
million, as compared to cash used in operations of $343,000 for 1998. This
increase in cash provided by operations of $54.6 million principally resulted
from an increase in EBITDA of $60.5 million. During the second quarter of
1999, the Company achieved positive EBITDA and expects to continue to generate
positive EBITDA for the foreseeable future. As the Company continues its
expansion plan to enter into new markets, the expenditures incurred, together
with initial operating expenses, will generally result in negative EBITDA and
operating losses from a network until an adequate customer base and revenue
stream for the network have been established. Accordingly, the Company expects
that the network constructed in each new market will generally produce
negative EBITDA for at least two and a half years after operations commence in
each market. Although overall, the Company expects to continue to have
positive EBITDA for the near future as it develops and expands its business,
there can be no assurance that the Company will sustain sufficient positive
EBITDA to meet its working capital requirements and to service its
indebtedness.
Investing. Cash used in investing activities decreased $231.2 million to
$146.9 million in 1999, as compared to $378.1 million in 1998. During 1999, a
portion of the proceeds from maturities of marketable securities were used to
partially fund capital expenditures and working capital requirements. During
1998, the net proceeds from the issuance of the Senior Notes were primarily
invested in marketable securities.
During 1999, capital expenditures were $221.2 million (net of capital
leases incurred of $3.7 million), an increase of $95.2 million from 1998. The
largest commitment of capital was related to the installation of transport and
switch related electronics to support the increase in sales activity and the
addition of 1,904 route miles of fiber since December 31, 1998. Based on
historic capital requirements for network construction in relation to sales
volumes and network expansion plans, the Company anticipates it will commit
approximately $350 million in 2000 to fund its capital expenditures. This
target spending includes requirements for current operating markets and the
Company's expansion plans.
The facilities-based telecommunications service business is a capital
intensive business. The Company's operations have required and will continue
to require substantial capital investment for:
. the purchase and installation of switches, electronics, fiber and other
technologies in existing networks and in additional networks to be
constructed in new service areas;
. the acquisition and expansion of networks currently owned and operated
by other companies; and
. the evolution of the network to support new products, services and
technologies.
The Company's expected capital expenditures for general corporate and
working capital purposes include:
. expenditures with respect to the Company's management information system
and corporate service support infrastructure; and
. operating and administrative expenses with respect to new networks and
debt service.
The Company plans to make substantial capital investments in connection
with plans to construct and develop new networks, as well as for technology
upgrades. Expansion of the Company's networks will include the geographic
expansion of the Company's existing operations, and the Company will consider
the development of new markets. In addition, the Company may acquire existing
networks in the future.
The Company regularly evaluates potential acquisitions of, and joint
ventures relating to, networks currently owned and operated by other
companies, including affiliates of the Class B Stockholders, and expects to
continue to do so. In the event the Company enters into a definitive agreement
with respect to any
30
<PAGE>
acquisition or joint venture, it may require additional financing or it may
elect to use a portion of the proceeds from the sale of the Senior Notes not
theretofore expended for other purposes, including but not limited to, capital
expenditures and working capital requirements.
While the Company intends to continue to leverage its relationship with Time
Warner Cable in pursuing expansion opportunities, to the extent the Company
seeks to expand into service areas where Time Warner Cable does not conduct
cable operations, the Company may incur significant additional costs in excess
of those historically incurred by the Company when expanding into existing Time
Warner Cable service areas. In addition, Time Warner Cable is not obligated to
construct or provide additional fiber optic capacity in excess of what is
already licensed to the Company under the Capacity License Agreements.
Accordingly, if the Company is unable to lease additional capacity at the same
rates as are currently provided for under the Capacity License Agreements, the
Company may be required to obtain additional capacity on more expensive terms.
See "Certain Relationships and Related Transactions--Certain Operating
Agreements."
The development and expansion of the Company's existing and future networks
and services will require significant capital to fund these capital
expenditures. The Company expects that its future cash requirements will
principally be for funding future growth and capital expenditures. The Company
recently entered into a secured revolving bank credit facility with available
credit of $475 million. The Company expects that the $264.6 million in cash,
cash equivalents and marketable securities at December 31, 1999, borrowings
under the new revolving credit facility along with internally generated funds,
will provide sufficient funds for the Company to meet its expected capital and
liquidity needs to expand its business as currently planned and pay interest on
the Senior Notes. In the event that the Company's plans or assumptions change
or prove to be inaccurate, or the foregoing sources of funds prove to be
insufficient to fund the Company's growth and operations, or if the Company
consummates acquisitions or joint ventures, the Company may be required to seek
additional capital sooner than currently anticipated. The Company's revenue and
costs are dependent upon factors that are not within the Company's control, for
example as regulatory changes, changes in technology and increased competition.
Due to the uncertainty of these and other factors, actual revenue and costs may
vary from expected amounts, possibly to a material degree, and these variations
are likely to affect the level of the Company's future capital expenditures and
expansion plans. Sources of financing may include public or private debt,
equity financing by the Company or its subsidiaries or other financing
arrangements. For a description of the senior secured revolving bank credit
facility, see "Description of Certain Indebtedness--Bank Facility."
Financing. Net cash provided by financing activities for 1999 decreased by
$405.4 million, as compared to 1998. Net cash provided by financing activities
for 1999, reflects the net proceeds from the IPO of $270.2 million, offset by
the repayment of loans from the Former Parent Companies of $180 million, as
well as acquired debt and capital lease obligations. Net cash provided by
financing activities for 1998, reflects proceeds from issuance of the Senior
Notes and loans from the Former Parent Companies.
During the period from July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with subordinated loans from the
Former Parent Companies. These loans remained outstanding, accruing interest,
through May 14, 1999. The loans from the Former Parent Companies were
subordinated in right of payment to the Senior Notes, except for a provision
allowing repayment prior to maturity with the net proceeds of any offering of
Common Stock or equivalent interest of the Company. The $400 million principal
amount in Senior Notes that the Company issued in July 1998 are unsecured,
unsubordinated obligations of the Company. Interest on the Senior Notes is
payable semiannually on January 15 and July 15, beginning on January 15, 1999.
Aggregate annual interest payments on the Senior Notes through 2008 are
expected to be approximately $39 million. The Senior Notes are required to be
repaid on July 15, 2008. On May 14, 1999, approximately $180 million of the
proceeds from the IPO were used to repay the subordinated loans payable to the
Former Parent Companies in full, including accrued interest. The proceeds of
the IPO remaining after repayment of the subordinated loans payable, combined
with the proceeds from the Senior Notes, have been used to continue funding the
Company's continued growth, which includes expansion of the Company's networks,
and for general corporate purposes. The Former Parent Companies are not under
any obligation to make any additional equity investments or loans to the
Company.
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The Company continues to evaluate potential acquisitions and joint ventures
that would extend the Company's geographic markets, expand the Company's
products and services and/or enlarge the capacity of its networks. Some of
these transactions may be considerably larger than the transactions it has
completed in the past. If the Company enters into a definitive agreement with
respect to any material transaction, it could result in the Company increasing
its leverage or issuing additional Common Stock or both. There can be no
assurance, however, that the Company will enter into any transaction or, if it
does, on what terms.
Impact of Year 2000
In prior years, the Company discussed the nature and progress of its plans
to become Year 2000 ready. In late 1999, the Company completed its remediation
and testing of systems. As a result of those planning and implementation
efforts, the Company experienced no significant disruptions in mission critical
information technology and non-information technology systems and believes
those systems successfully responded to the Year 2000 date change, including
the leap year date. The Company expensed approximately $2.8 million during 1999
in connection with remediating its systems. The Company is not aware of any
material problems resulting from Year 2000 issues, either with its products,
its internal systems or the products and services of third parties. The Company
will continue to monitor its mission critical computer applications and those
of its suppliers and vendors throughout the year 2000 to ensure that any latent
Year 2000 matters that may arise are addressed promptly.
Effects of Inflation
Historically, inflation has not had a material effect on the Company.
Quantitative and Qualitative Disclosures About Market Risk
The Company's interest income is sensitive to changes in the general level
of interest rates. In this regard, changes in interest rates can affect the
interest earned on the Company's cash equivalents and marketable securities. To
mitigate the impact of fluctuations in interest rates, the Company generally
enters into fixed rate investing arrangements.
The following table provides information at December 31, 1999, about the
Company's financial instruments that are sensitive to changes in interest
rates. For investment securities, the table presents related weighted-average
interest rates expected by the maturity dates. These investment securities will
mature within one year. At December 31, 1999, the fair value of the Company's
fixed rate 9 3/4% Senior Notes due 2008 was $415 million, as compared to a
carrying value of $400 million on such date, based on market prices at December
31, 1999.
<TABLE>
<CAPTION>
2000 Maturities
-----------------------------
(dollar amounts in thousands)
<S> <C>
Assets
Marketable securities:
Shares of money market mutual funds........... $ 4,510
Average interest rate....................... 5.5%
Certificates of deposit with banks............ $ 54,797
Average interest rate....................... 5.3%
Corporate and municipal debt securities....... $196,455
Average interest rate....................... 5.9%
</TABLE>
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<PAGE>
BUSINESS
Overview
The Company is a leading fiber facilities-based integrated communications
provider offering local business "last mile" broadband connections for data,
high-speed internet access, local voice and long distance services. The Company
serves customers in 21 metropolitan markets in the United States. The Company's
customers are principally telecommunications-intensive business end-users, long
distance carriers, internet service providers, wireless communications
companies and governmental entities. The Company offered switched services in
20 of its 21 service areas as of December 31, 1999, and management expects that
a growing portion of the Company's revenue will be derived from providing
switched services. In addition, the Company benefits from its strategic
relationship with Time Warner Cable both through access to local right-of-way
and construction cost-sharing. As a result, the Company's networks have been
constructed primarily through licensing the use of fiber capacity from Time
Warner Cable. As of December 31, 1999, the Company's fiber optic networks
spanned 8,872 route miles and contained 332,263 fiber miles and the Company
offered service to 5,566 buildings.
Business Strategy
The Company's primary objective is to be a leading provider to medium- and
large-sized businesses of superior telecommunications services through advanced
networks in its existing and future service areas. The key elements of the
Company's business strategy include the following:
Leverage Existing Fiber Optic Networks. The Company has designed and built
local and regional fiber networks to serve geographic locations where
management believes there are large numbers of potential customers. As of
December 31, 1999, the Company operated networks that spanned over 8,872 route
miles and contained over 332,263 fiber miles. During 1999, the Company deployed
a fully managed, fiber-based nationwide infrastructure to ensure that its long-
haul internet products provide the capacity and high quality level of service
increasingly demanded by its customers. The Company's highly concentrated
networks have yet to be fully exploited and provide the capacity to serve a
substantially larger base of customers with a larger array of products.
Management believes that the Company's extensive fiber network capacity allows
it to:
. increase orders substantially from new and existing customers while
realizing higher gross margins than non-fiber facilities based carriers;
. emphasize its fiber facilities-based services rather than resale of
network capacity of other providers; and
. provide better customer service because the Company can exert greater
control over its services than its competitors that depend on off-net
facilities.
The Company plans to extend its network in its present markets in order to
reach additional commercial buildings directly with its fiber facilities. In
addition, the Company plans to integrate new technologies such as dense wave
division multiplexing to provide additional bandwidth and higher speed without
the need to add additional fiber capacity.
Enter New Geographic Areas. The Company's strategy is to target metropolitan
areas possessing demographic, economic and telecommunications demand profiles
that it believes provide it with the potential to generate an attractive
economic return. Currently, the Company operates networks in a total of 21
metropolitan areas and is in the process of constructing networks in Los
Angeles/Orange County, California, Dayton, Ohio, and Fayetteville, North
Carolina, during 2000, bringing the total to 24. Also, the Company has recently
announced a more accelerated geographic expansion plan that presently calls for
commencing construction in an additional 8 to 12 metropolitan statistical areas
during 2000 and 2001. These markets will be a combination of small, medium and
large markets, including some served by Time Warner Cable where the Company may
obtain fiber capacity through its relationship with Time Warner Cable, and
others outside of Time Warner Cable's service area.
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<PAGE>
Expand Switched Services. The Company provided a broad range of switched
services in 20 of its 21 service areas as of December 31, 1999. For 1999,
revenue from switched services grew by 207% as compared to 1998. Because of the
market demand for switched services, the Company has rapidly installed switches
in its markets and management expects the Company to derive a growing portion
of its revenue from switched services. The Company utilizes high-capacity
digital 5ESS switches manufactured by Lucent Technologies Inc. ("Lucent").
However, as new technologies arise that enable the switching of voice calls
over an internet protocol and local area network infrastructure, the Company
will evaluate how to best integrate this "softswitch" technology into its
infrastructure. The Company is currently evaluating suppliers of this
capability/technology and plans to begin deployment in late 2000 to serve a
variety of applications including primary rate interface services and voice
over internet protocol.
Expand Data Services. Data services are becoming increasingly more important
to the Company's target customer base. In particular, the Company believes that
the demand for high-speed, high quality local area network and wide area
network connectivity will continue to grow over the near term. This demand will
grow in support of specific applications such as virtual private networks,
website hosting, e-commerce, intranet and internet access. The Company will
continue to deliver high-speed traditional transport services (e.g., DS1, DS3,
OC-n) through its fiber optic networks, but will also focus on the delivery of
next generation data networking and converged network services, which means
voice and data applications delivered over a common network infrastructure. The
Company anticipates that the converged network will be capable of providing
applications such as virtual private networking, hosted web and e-mail services
and new applications such as unified messaging. The Company believes that key
to the evolution of the converged network is delivery of management services
along with the network service so that the medium and small business customers
in the multi-tenant buildings the Company serves can rely on the Company to
manage the network 24 hours-a-day, 7 days-a-week.
Target Business Customers. The Company operates networks in metropolitan
areas that have high concentrations of medium- and large-sized businesses.
These businesses tend to be telecommunications-intensive and are more likely to
seek the greater reliability provided by an advanced network such as the
Company's. Historically, the Company has focused its sales and marketing
efforts on such businesses, as they are potentially high volume users of the
Company's services. To drive revenue growth in these markets, the Company is
expanding its direct sales force to focus on such business customers while it
develops managed services offerings to meet the voice, data and internet needs
of those customers. In addition, in order to achieve further economies of scale
and network utilization, the Company is targeting smaller business customers in
buildings the Company already serves where the Company can offer a package of
network services that may not otherwise be available to those customers.
Interconnect Service Areas. The Company groups the 21 service areas in which
the Company currently operates into geographic clusters across the United
States. The Company is in the process of interconnecting the Company's existing
service areas within regional clusters with owned or licensed fiber optic
facilities. This is expected to increase the Company's revenue potential and
increase margins by addressing customers' regional long distance voice, data
and video requirements. The Company began interconnecting its service areas in
1998.
Utilize Strategic Relationships with Time Warner Cable. The Company has
benefited from and continues to leverage its relationships with Time Warner
Cable, one of the largest multiple system cable operators in the U.S., by
licensing and sharing the cost of fiber optic facilities. This licensing
arrangement allows the Company to benefit from Time Warner Cable's access to
rights-of-way, easements, poles, ducts and conduits. See "Certain Relationships
and Related Transactions--Certain Operating Agreements." By leveraging its
existing relationship with Time Warner Cable, the Company believes that it can
benefit from existing regulatory approvals and licenses, derive economies of
scale in network costs and extend its existing networks in a rapid, efficient
and cost-effective manner. Furthermore, management believes that the strong
awareness and positive recognition of the "Time Warner" brand name
significantly contributes to its marketing programs and sales efforts by
distinguishing it from its competitors.
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Continue Disciplined Expenditure Program. The Company increases operational
efficiencies by pursuing a disciplined approach to capital expenditures. This
capital expenditure program requires that prior to making any expenditure on a
project, the project must be evaluated to determine whether it meets stringent
financial criteria such as minimum recurring revenue, cash flow margins and
rate of return.
The telecommunications industry has experienced, and is expected to continue
to experience, rapid and significant changes in technology. While the Company
believes that, for the foreseeable future, these changes will neither
materially affect the continued use of fiber optic cable or digital switches
and transmission equipment nor materially hinder the Company's ability to
acquire necessary technologies, the effect of technological changes on the
Company's business and operations cannot be predicted. The Company believes
that its future success will depend, in part, on its ability to anticipate or
adapt to these changes and to offer, on a timely basis, services that meet
customer demands on a competitive basis. There can be no assurance that the
Company will obtain access to new technologies on a timely basis or on
satisfactory terms. Any failure by the Company to obtain new technologies could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, the Company's growth plans depend in
part upon the Company's ability to obtain fiber capacity at rates that will
allow it to generate a reasonable rate of return. There is no assurance that
the Company will be successful in obtaining such fiber capacity.
Market Opportunity
The Company believes that the 1996 Act and certain state regulatory
initiatives provide increased opportunities in the telecommunications
marketplace by opening all local markets to competition and requiring incumbent
local exchange carriers to provide increased direct interconnection. According
to the U.S. Department of Commerce, in 1998 the total revenue for the U.S.
telecommunications industry, excluding wireless, amounted to approximately $240
billion, of which approximately $136 billion was local service and
approximately $104 billion was long distance. To capitalize on these
significant opportunities, the Company deploys high-capacity digital switches
in its markets and is aggressively marketing switched services to its
customers.
A number of important trends are reshaping the U.S. communications industry,
creating substantial opportunities for competitive local exchange carriers
beyond capturing market share from incumbent local exchange carriers in local
exchange services. These trends include:
. increasing customer demand for high-speed, broadband services, such as
internet access, transport and internet protocol-based applications;
. the emergence of e-commerce as a new paradigm for business transactions;
and
. continued consolidation among service providers to broaden their service
offerings and technical capabilities.
By leveraging customer relationships and bundling service offerings,
competitive local exchange carriers have begun to exploit a variety of
opportunities, including high-speed internet access and transport, digital
subscriber line, local area network and wide area network connectivity, managed
network services, virtual private networks, remote access, and e-commerce
services. The Company believes that new entrants have an excellent opportunity
to establish themselves as leading providers of such value-added services.
High-speed connectivity has become important to business due to the dramatic
increase in internet usage and the proliferation of personal computer and
internet protocol-based applications. According to the Gartner Group, an
independent telecommunications and technology research company, the number of
internet users worldwide reached approximately 68 million in 1997 and is
forecasted to grow to approximately 316 million by 2002. The popularity of the
internet with consumers has also driven the rapid growth in exploiting the
internet as a commercial medium, as businesses establish websites, corporate
intranets and extranets and implement e-commerce applications to expand their
customer reach and improve their communications efficiency. The
35
<PAGE>
Gartner Group estimates that internet access revenue will increase from $4.7
billion in 1997 to over $21.5 billion in 2002. The Company believes that
internet infrastructure is becoming increasingly important to businesses of all
sizes, making the availability of broadband capacity, network quality, a value-
added services portfolio and technical capability an important competitive
distinction among service providers.
Services
The Company currently provides its customers with a wide range of
telecommunications services, including dedicated transmission, local switched,
long distance, data and video transmission services and high-speed dedicated
internet access services. The Company's dedicated services, which include
private line and special access services, use high-capacity digital circuits to
carry voice, data and video transmissions from point-to-point in multiple
configurations. Switched voice services offered by the Company use high-
capacity digital switches to route voice transmissions anywhere on the public
switched telephone network. In offering its dedicated transmission and switched
services, the Company also provides private network management and systems
integration services for businesses that require combinations of various
dedicated and switched telecommunications services. Data services provided by
the Company allow customers to create their own internal computer networks and
access external computer networks and the internet. The Company can provide its
customers, including companies in the media industry, with advanced video
transport services such as point-to-point, broadcast-quality video to major
television networks as well as to advertising agencies and other customers.
Internet services provided by the Company include dedicated internet access,
website hosting, transport and e-commerce services for business customers and
local internet service providers.
Dedicated Transport Services
The Company currently provides a complete range of dedicated transport
services with transmission speeds from 64 kilobits per second to 2.488 gigabits
per second to its long distance carrier and end-user customers. All products
and services can be used for voice, data, image and video transmission.
The Company offers the following dedicated transport links:
. POP-to-POP Special Access. Telecommunications lines linking the points
of presence ("POPs") of one long distance carrier or the points of
presence of different long distance carriers in a market, allowing the
points of presence to exchange transmissions for transport to their
final destinations.
. End-user/Long Distance Carrier Special Access. Telecommunications lines
between an end-user, such as a large business, and the local points of
presence of its selected long distance carrier.
. Private Line. Telecommunications lines connecting various locations of a
customer's operations, suitable for transmitting voice and data traffic
internally.
. Transport Arrangement Service. Provides dedicated transport between
local exchange carrier central offices and customer designated points of
presence of a long distance carrier for transport of local exchange
carrier-provided switched access or local exchange carrier-provided
special access. This point-to-point service is available at DS1 or DS3
interfaces at both ends. DS1 and DS3 interfaces are standard North
American telecommunications industry digital signal formats that are
distinguishable by the number of binary digits transmitted per second,
or bit rate. DS1 has a bit rate of 1.544 megabits per second and DS3 has
a bit rate of 44.736 megabits per second.
The Company provides the following services that use high-capacity digital
circuits to carry voice, data and video transmissions from point to point in
flexible configurations involving different standardized transmission speeds
and circuit capacities:
. broadcast video TV-1, which is the dedicated transport of broadcast
quality video signals;
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<PAGE>
. STS-1, which is the full duplex, synchronous optical transmission of
digital data on synchronous optical network, or SONET, standards, and
eliminates the need to maintain and pay for multiple dedicated lines;
and
. private network transport service, which is a private, dedicated premium
quality service over fully redundant, diverse routed, SONET rings with
bandwidth that is dedicated and always available.
The transmission speeds and circuit capacities used for these services
include DSO, DS1, DS3 and SONET OC-N. DSO is a standard North American
telecommunications industry digital signal format that has a bit rate of 64
kilobits per second.
Switched Services
The Company's switched services provide business customers with local
calling capabilities and connections to their long distance carriers. The
Company owns, houses, manages and maintains the switch used to provide the
services. The Company's switched services include the following:
. Business Access Line Service. This service provides voice and data
customers quality analog voice grade telephone lines for use at any
time. Business access line service provides customers with flexibility
in network configurations because lines can be added, deleted and moved
as needed.
. Access Trunks. Access trunks provide communication lines between two
switching systems. These trunks are utilized by private branch exchange
customers, which are customers that own and operate a switch on their
own premises. Private branch exchange customers use these trunks to
provide access to the local, regional and long distance telephone
networks. Private branch exchange customers may use either the Company's
telephone numbers or their incumbent local exchange carrier-assigned
telephone numbers. Customer access to the Company's local exchange
services is accomplished by a DS1 digital connection or DS0 analog
trunks between the customer's private branch exchange port and the
Company's switching centers.
. Local Toll Service. This service provides customers with a competitive
alternative to incumbent local exchange carrier service for intraLATA
toll calls. It is a customized, high-quality local calling plan
available to business access line and access trunk customers. The
Company works with customers to devise cost-saving programs based on
actual usage and calling patterns.
. Local Telephone Service. Local telephone service is basic local exchange
service which can be tailored to a customer's particular calling
requirements. Local telephone service includes operator and directory
assistance services, as well as an optional intraLATA toll plan.
. Long Distance Service. Long distance service provides the capabilities
for a customer to place a voice call from one local calling area to
another, including international calling.
. Switched Access Service. The connection between a long distance
carrier's POP and an end-user's premises that is provided through the
switching facilities of a local exchange carrier are referred to as
switched access services. These services provide long distance carriers
with a switched connection to their customers for the origination and
termination of long distance telephone calls.
. Other Services. Other services offered by the Company include telephone
numbers, listings, customized calling features, voice messaging,
hunting, blocking services and two-way, simultaneous voice and data
transmission in digital formats over the same transmission line, which
is an international standard referred to as integrated services digital
network or ISDN.
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Data Transmission Services
The Company offers its customers a broad array of data transmission services
that enable customers to create their own internal computer networks and access
external computer networks and the internet. In 1996, the Company introduced
its native speed local area network inter-networking data service that is used
to connect workstations and personal computer users on one or more local area
networks. Native speed services avoid the bottleneck problems that are
frequently encountered with customary DS1 connections by providing the customer
with a circuit that matches the transmission speeds of its local area network.
The Company's local area network service provides dedicated circuits,
guaranteed transmission capacity and guaranteed bandwidth for virtually all
local area network applications. Users can share files and databases as if they
are all working on the same computer, or within the same local area network.
As companies and communications become more sophisticated, there is an
increased need for customer access to superior traffic management of sensitive
data, video and voice transmission within a single metropolitan area, or
between various company operations. The Company's switched data services offer
sophisticated switching technology and provide high standards in reliability
and flexibility while enabling users to reduce the costs associated with
interconnecting architecturally diverse information systems. The Company's data
service offerings support evolving high-speed applications, such as multimedia,
desktop video conferencing and medical imaging. The Company offers native speed
connections to end-users as well as interexchange data carriers. The Company's
services allow users to interconnect both high-speed and low-speed local area
network environments and to benefit from flexible billing, as well as detailed
usage reports.
In 2000, the Company plans to extend its current base of native local area
network services operating at 10 megabits per second to include gigabit
ethernet that operates at 1000 megabits per second (1 gigabit per second). This
extended bandwidth capacity will allow customers to connect at very high-speeds
to the internet, to the application service provider of choice or to other
customer locations.
Video Transmission Services
The Company provides broadcast quality digital and analog video link
services to its video services customers, including media industry customers,
such as television networks, and advertising agencies. The Company's video
services include offering broadcast quality, digital channel transmissions that
can be provided on a point-to-point or point-to-multipoint basis.
Internet Services
During 1999, the Company deployed a fiber-based internet protocol backbone
connecting the Company's hub cities, including 21 asynchronous transfer mode
data switches through which it provides dedicated internet connectivity at
speeds of up to DS3. This deployment was accomplished in part through the
acquisition of Inc.Net, a regional internet service provider that became a
wholly owned subsidiary of the Company in April 1999. Through this subsidiary,
known as the Company's Internet & Data Division, the Company will manage its
data network and new internet products. Although data and internet revenue
represented only 4% of total 1999 revenue, the Company expects an increasing
portion of its future total revenue to be contributed by these services. The
Company is upgrading its internet backbone to include OC-3c and greater
capacity.
Long Distance Services
The Company began to offer basic long distance services in 1998 including
toll free, calling card and international calling. The Company offers these
services primarily to enhance its ability to offer a complete package of
services to customers, rather than as core services. The target customers are
medium- and small-size business customers. Generally, large businesses tend to
obtain their long distance needs directly from the major long distance
carriers. The Company believes medium- and small-size businesses are more
likely to obtain their long distance services from competitive local exchange
carriers rather than the major long distance carriers. As
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<PAGE>
a result, management believes that such medium- and small-sized end-users
represent a potential customer base for developing a market for the Company's
long distance services. This is a market segment that has not been a principal
focus of the Company's business in the past and thus one to which the Company
has limited experience marketing. The Company purchases long distance capacity
under a non-exclusive resale agreement with a long distance carrier, which
includes all support and billing services. The Company is considering
additional suppliers. Although long distance contributed less than 1% of the
Company's total revenue in 1999, management believes that the offering of long
distance services adds strategic sales and marketing value as a bundled
product. The long distance business is extremely competitive and prices have
declined 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. The
Company is attempting to minimize churn through the use of minimum term
agreements.
Telecommunications Networks and Facilities
Overview. The Company uses the latest technologies and network architectures
to develop a highly reliable infrastructure for delivering high-speed, quality
digital transmissions of voice, data and video telecommunications. The
Company's basic transmission platform consists primarily of optical fiber
equipped with high-capacity SONET equipment deployed in fully redundant, self-
healing rings. These SONET rings give the Company the capability of routing
customer traffic in both directions around the ring, thereby eliminating loss
of service in the event of a cable cut. The Company's networks are designed for
remote automated provisioning, which allows the Company to meet customers' real
time service needs. The Company extends SONET rings or point-to-point links
from rings to each customer's premises over its own fiber optic cable and
unbundled facilities obtained from incumbent local exchange carriers. The
Company also installs diverse building entry points where a customer's security
needs require such redundancy. The Company then places necessary customer-
dedicated or shared electronic equipment at a location near or in the
customer's premises to terminate the link.
The Company serves its customers from one or more central offices or hubs
strategically positioned throughout its networks. The central offices house the
transmission and switching equipment needed to interconnect customers with each
other, the long distance carriers and other local exchange networks. Redundant
electronics, with automatic switching to the backup equipment in the event of
failure, protects against signal deterioration or outages. The Company
continuously monitors system components from its network operations center and
proactively focuses on avoiding problems rather than merely reacting to
trouble.
The Company adds switched, dedicated and data services to its basic fiber
optic transmission platform by installing sophisticated digital electronics at
its central offices and nodes and at customer locations. The Company's advanced
5ESS digital telephone switches from Lucent are connected to multiple incumbent
local exchange carrier and long distance carrier switches to provide the
Company's customers access to telephones in the local market as well as the
public switched telephone network. Similarly, in certain markets, the Company
provides asynchronous transfer mode switched and local area network
multiplexers at its customers' premises and in its central offices to provide
high-speed local area network interconnection services.
The Company's strategy for adding customers is designed to maximize the
speed and impact of its marketing efforts while maintaining attractive rates of
return on capital invested to connect customers directly to its networks. To
initially serve a new customer, the Company may use various transitional links,
such as reselling a portion of an incumbent local exchange carrier's network.
Once the new customer's communications volume and product needs are identified,
the Company may build its own fiber optic connection between the customer's
premises and the Company's network to accommodate: (i) the customer's needs;
and (ii) the Company's efforts to maximize return on network investment.
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<PAGE>
Telecommunications Networks. The following chart sets forth information
regarding each of the Company's telecommunications networks as of December 31,
1999:
<TABLE>
<CAPTION>
Dec. 31, 1999
-----------------------------------
Switched
Network Services Commercial MSA Business
Metropolitan Service Commercially Commercially Fiber Route Buildings Lines (000)
Area Available Available(1) Miles(2) On-Net (3)
-------------------- ------------ ------------ ----------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Albany, New York (4).... Jul. 95 Sep. 99 127 23 403.1
Austin, Texas (4)....... Sep. 94 Apr. 97 502 107 547.0
Binghamton, New York
(4).................... Jan. 95 TBD 88 30 109.4
Charlotte, N. Carolina
(4).................... Sept. 94 Dec. 97 697 230 638.4
Cincinnati, Ohio (4).... Jul. 95 Nov. 97 330 114 567.4
Columbus, Ohio (4)...... Mar. 91(5) Jul. 97 447 116 485.9
Dallas, Texas........... Sep. 99 Sep. 99 303 13 1,521.1
Dayton, Ohio (4)........ Nov. 00(6) Nov. 00(6) -- -- 277.4
Fayetteville, N.
Carolina (4)........... Apr. 00(6) Apr. 00(6) 36 -- 59.6
Greensboro, N. Carolina
(4).................... Jan. 96 Sep. 99 189 42 404.5
Honolulu, Hawaii (4).... Jun. 94 Jan. 98 300 221 226.1
Houston, Texas (4)...... Jan. 96 Sep. 97 736 112 1,722.7
Indianapolis, Indiana
(4).................... Sep. 87(5) Dec. 97 378 173 461.3
Jersey City, New
Jersey................. Jul. 99 Jul. 99 5 3 205.2
Manhattan, New York
(4).................... Feb. 96 Feb. 96 158 62 3,627.1
Memphis, Tennessee (4).. May 95 May 97 531 120 285.5
Milwaukee, Wisconsin
(4).................... Feb. 96 Sep. 97 444 101 520.5
Orange County,
California............. Jun. 00(6) Aug. 00(6) 80 -- 1,387.9
Orlando, Florida (4).... Jul. 95 Jul. 97 1,063 180 975.2
Raleigh, N. Carolina
(4).................... Oct. 94 Sep. 97 570 159 366.2
Rochester, New York
(4).................... Dec. 94 Feb. 95 363 115 474.0
San Antonio, Texas (4).. May 93(5) Nov. 97 713 181 578.1
San Diego, California
(4).................... Jun. 95 Jul. 97 324 92 1,186.0
Tampa, Florida (4)...... Dec. 97 Jan. 98 488 37 1,134.9
------ ------ ---------
Total................... 8,872 2,231 18,164.5
====== ====== =========
</TABLE>
- --------
(1) Date of "Switched Services Commercially Available" is the first date on
which switched services were provided to a customer of the Company.
(2) Licensed and owned fiber optic route miles.
(3) Metropolitan statistical area business lines data are modeled from
Statistics of Communications Common Carrier 1998 Business Data.
(4) Metropolitan statistical areas in which the Company obtains or expects to
obtain fiber capacity through licensing agreements with Time Warner Cable.
See "Certain Relationships and Related Transactions--Certain Operating
Agreements."
(5) The networks in Columbus, Ohio, San Antonio, Texas and Indianapolis,
Indiana were built by certain predecessor companies prior to the
commencement of the Company's business.
(6) Estimated.
Information Systems Infrastructure. The Company uses state of the art
technology in its information systems infrastructure. The Company also uses a
centrally deployed series of client server platforms and relational database
servers to provide cost effective nationwide computing support. These services
and products enable employees to support customers directly, manage the
telephony infrastructure and report and manage trouble resolution. The
computing infrastructure strategy enables the Company to mix and match
platforms to create the best compliment of computing engines to meet the
Company's specific business needs. This includes telephony ordering,
provisioning, inventory, engineering, installation, billing, decision support
and customer
40
<PAGE>
care business functions. The strategy of buying "off the shelf" products and
integrating them into the Company's existing information systems infrastructure
versus utilizing several stand-alone applications supports a more responsive
and flexible environment that better suits the needs of a nimble market
competitor. The Company's information systems provide real time support of
network operations and deliver data at the network, regional and corporate
level, and can sort by customer and vendor. The systems selected or built
utilize open system standards and architectures, thus allowing maximum
interoperability with third parties' systems. The Company's Information Systems
Development teams have developed competencies in application integration using
the latest in Enterprise Application products and strategies. The Company has
implemented an enterprise resource system, which provides improved real-time
management information for the Company's financial, procurement and human
resource functions. The Company's Business Systems Analysis teams have
supported the identification and implementation of new revenue assurance
platforms and billing platform enhancements which improve revenue stream
accuracy.
Network Monitoring and Management. The Company provides a single point of
contact for all of its customers and consolidates all of its systems support,
expertise and technical training at its network operations center in Greenwood
Village, Colorado. With approximately 600 technicians and customer service
representatives dedicated to providing superior customer service, the Company
is able to quickly correct, and often anticipate, any problems that may arise
in its networks. The Company provides 24 hour-a-day, 7 days-a-week surveillance
and monitoring of networks to achieve the Company's network reliability and
performance targets. Network analysts monitor real-time alarm, status and
performance information for network circuits, which allows them to react
swiftly to repair network trouble.
Network Development and Application Laboratory. The Company's network
development and application laboratory is a comprehensive telecommunications
technology, applications and services development laboratory, equipped with
advanced systems and equipment, including those used by the Company in the
operation of its local digital networks. The center is designed to provide a
self-contained testing and integration environment, fully compatible with the
Company's digital networks, for the purposes of:
. verifying the technical and operational integrity of new equipment prior
to installation in the networks;
. developing new services and applications;
. providing a realistic training environment for technicians, engineers
and others; and
. providing a network simulation environment to assist in fault isolation
and recovery.
Technologies currently under evaluation in the laboratory include dense wave
division multiplexing equipment from new vendors, optical bandwidth management,
internet protocol telephony, including components used to service next
generation softswitches, media gateway technologies, Signaling System 7 gateway
systems and related data applications.
Billing Systems. The Company contracts with outside vendors for customer
billing. The Company has licensed a system for switched services billing that
it operates on its own equipment and has a service bureau arrangement with
another vendor for dedicated transport service and interconnection billing. See
"Risk Factors--We expect to depend on third party vendors for information
systems."
Network Design and Construction
In order to take advantage of its relationship with Time Warner Cable, the
Company has constructed most of its existing networks in selected metropolitan
statistical areas served by Time Warner Cable's fiber optic infrastructure.
This has allowed the Company to develop, in a cost-efficient way, an extensive
network in each of its metropolitan statistical areas. As of December 31, 1999,
the Company's networks spanned 8,872 route miles, contained 332,263 fiber miles
and offered service to 5,566 buildings with 5,331,000 voice grade equivalent
circuits and 192,369 access lines in service.
41
<PAGE>
The Company plans to begin constructing new networks in approximately 8 to
12 metropolitan statistical areas during 2000 and 2001, using its relationship
with Time Warner Cable or other fiber providers, or by developing the networks
in house, whichever is most effective and economical. Before deciding to
construct or acquire a network in a particular metropolitan statistical area,
the Company's corporate development staff reviews the demographic, economic,
competitive and telecommunications demand characteristics of the metropolitan
statistical area, including its location, the concentration of potential
business, government and institutional end-user customers, the economic
prospects for the area, available data regarding long distance carrier and end-
user special access and switched access transport demand and actual and
potential competitive access provider and competitive local exchange carrier
competitors. Market demand is estimated on the basis of market research
performed by Company personnel and others, utilizing a variety of data
including estimates of the number of interstate access and intrastate private
lines in the metropolitan statistical area based primarily on FCC reports and
commercial databases. This process has enabled the Company to reduce its start-
up costs and shorten lead times.
If a particular metropolitan statistical area targeted for development is
found to have sufficiently attractive demographic, economic, competitive and
telecommunications demand characteristics, the Company's network planning and
design personnel design a network targeted to provide access to the major long
distance carrier, points of presence and the incumbent local exchange carrier's
principal central office(s) in the metropolitan statistical area. Consistent
with the Company's disciplined capital expenditure program, distribution rings
are designed to cover strategic or highly concentrated business parks and
downtown metropolitan areas. Through a combination of its own network and the
use of Type II circuits purchased from the incumbent local exchange carrier to
reach low density areas where the Company cannot economically build facilities,
the Company can serve virtually any customer within the metropolitan
statistical area it serves.
Based on the data obtained through the foregoing process, in connection with
either the construction or an acquisition of a network, the Company develops
detailed financial estimates based on the anticipated demand for the Company's
current services. If the financial estimates meet or exceed the Company's
minimum rate of return thresholds using a discounted cash flow analysis, the
Company's corporate planning personnel prepare a detailed business and
financial plan for the proposed network.
Prior to commencing construction, the Company's local staff, working
together with Time Warner Cable, where applicable, obtains any needed city
franchises, permits or other municipal requirements to initiate construction
and operate the network. In some cities, a construction permit is all that is
required. In other cities, a right-of-way agreement or franchise may also be
required. Such agreements and franchises are generally for a term of limited
duration. In addition, the 1996 Act requires that local governmental
authorities treat all telecommunications carriers in a competitively neutral,
non-discriminatory manner. The Company's current right-of-way agreements and
franchises expire in years ranging from 2008 to 2015. City franchises often
require payment of franchise fees that in some cases can be directly passed
through on customers' invoices. The Company's local staff also finalizes
arrangements for other needed rights-of-way. Rights-of-way are typically
licensed from Time Warner Cable under multi-year agreements with renewal
options and are generally non-exclusive. See "Certain Relationships and Related
Transactions--Certain Operating Agreements." The Company leases underground
conduit and pole space and other rights-of-way from entities such as local
exchange carriers and other utilities, railroads, long distance providers,
state highway authorities, local governments and transit authorities. The 1996
Act requires most utilities, including most local exchange carriers and
electric companies, to afford competitive access providers and competitive
local exchange carriers access to their poles, conduits and rights-of-way at
reasonable rates on non-discriminatory terms and conditions.
The Company's networks are constructed to cost-effectively access areas of
significant commercial end-user telecommunications traffic, as well as the
points of presence of most long distance carriers and cellular companies and
the principal local exchange carrier central offices in a metropolitan
statistical area. The Company establishes general requirements for network
design, and internally engineers the contemplated network and the required
deployment. Construction and installation services are provided by independent
contractors, including Time Warner Cable, selected through a competitive
bidding process. Company personnel
42
<PAGE>
provide project management services, including contract negotiation and
supervision of the construction, testing and certification of all facilities.
The construction period for a new network varies depending upon the number of
route miles to be installed, the initial number of buildings targeted for
connection to the network, the general deployment of the network and other
field conditions. Networks that the Company has installed to date generally
have become operational within nine to twelve months after the beginning of
construction.
Equipment Supply
The Company acquires Lucent 5ESS digital switches pursuant to an exclusive
vendor agreement which provides for discounted pricing. The Lucent agreement
expires in June 2002 and is renewable for up to four additional years upon the
parties' mutual agreement. The Lucent agreement provides that if the Company
purchases digital switches from a vendor other than Lucent during the term of
the agreement, Lucent, among other things, may discontinue the agreed upon
discounted pricing on all future orders, renegotiate higher prices for digital
switches and may not be liable for failures to meet certain delivery and
installation schedules on future orders.
Customers and Sales and Marketing
The Company's customers are principally telecommunications-intensive medium-
and large-sized businesses, long distance carriers, internet service providers,
wireless communications companies, other local providers and various
governmental entities. Historically, the Company's customers were primarily
long distance carriers. While the Company's long distance carrier business has
grown by approximately 98% in 1999 over 1998, it has declined as a proportion
of total revenue from approximately 26% of the Company's total 1998 revenue to
approximately 24% of the Company's total 1999 revenue. Of this long distance
carrier revenue, approximately 72% is directed by the end-user customer rather
than the long distance carrier since an end user may switch long distance
carriers while retaining the Company as its local exchange carrier.
The Company's largest customer for the year ended December 31, 1999, AT&T
and its affiliates, represented 13.5% of the Company's total revenue. However,
a substantial portion of that revenue results from traffic that is directed to
the Company by customers that have selected that long distance carrier. No
other customer, including customers who direct their business through long
distance carriers, accounted for 10% or more of revenue. For the year ended
December 31, 1999, the Company's top 10 customers accounted for 39% of the
Company's total revenue. The Company's primary contract with AT&T is summarized
below. The Company does not believe that the termination of the contract would
have a material adverse effect on its business.
The agreement between the Company and AT&T specifies the terms under which
AT&T will purchase certain switched and dedicated services in selected
metropolitan statistical areas of the Company. The agreement (but not the
individual services purchased under such agreement) has a 13-year term ending
in September 2008, but may be terminated, in whole or in part, under specified
circumstances prior to that time. Interexchange company affiliates of AT&T and
AT&T Wireless Services, Inc. are also eligible to purchase services under the
agreement. In December 1999, the Company triggered the dispute resolution
process under the agreement with AT&T over the appropriate billing rates for
switched access services. The Company does not expect the outcome of this
dispute to have a material effect on revenue or operating results.
The Company provides incentives to its sales force to negotiate service
contracts that have a minimum term of 1 year, and provides enhanced commissions
to its sales force for executing agreements with terms of 3 years or greater.
Currently, more than half of service agreements have a duration of greater than
3 years.
The Company's marketing emphasizes its:
. reliable, facilities-based networks;
. flexibly priced, bundled products and services;
43
<PAGE>
. responsive customer service orientation; and
. integrated operations, customer support and network monitoring and
management systems.
The Company's centrally managed customer support operations are designed to
facilitate the processing of orders for changes and upgrades in customer
services. To reduce the inherent risk in bringing new and untested
telecommunications products and services to a dynamically changing market, the
Company introduces its products and services once market demand develops and
offers them in diversified, competitively-priced bundles, thereby increasing
usage among its existing customers and attracting new customers. The services
offered by the Company are typically priced at a discount to the prices of the
incumbent local exchange carriers.
With a direct sales force in each of its service areas along with regional
and national sales support, the Company targets medium- and large-sized
telecommunications-intensive businesses in the areas served by its networks.
Compensation for the Company's sales representatives is based primarily on
commissions that are tied to sales generated. The Company's customers include
financial services firms, health care, media, telecommunications services and
high tech companies and various governmental institutions. In addition, the
Company markets its services through sales agents, landlords, advertisements,
trade journals, media relations, direct mail and participation in trade
conferences.
The Company also targets long distance carriers, internet service providers,
large, strategic business accounts and wireless telephone companies through its
national sales organization. The Company has master services agreements (which
generally set forth technical standards, ordering processes, pricing
methodologies and service grade requirements, but do not guarantee any
specified level of business for the Company) with a significant number of the
long distance carriers, including AT&T, MCI-WorldCom, Sprint Corporation, and
Qwest Communications. By providing long distance carriers with a local
connection to their customers, the Company enables them to avoid complete
dependence on the incumbent local exchange carriers for access to customers and
to obtain a high quality and reliable local connection. The Company provides a
variety of transport services and arrangements that allow long distance
carriers to connect their own switches in both local areas, or intra-city, and
in wide areas, or inter-city. Additionally, long distance carriers may purchase
the Company's transport services that allow them to connect their switch to an
incumbent local exchange carrier switch and to end-user locations directly. The
Company's advanced networks allow it to offer high volume business customers
and long distance carriers uniformity of services, pricing, quality standards
and customer service.
Customer Service
With approximately 600 expert technicians and customer service
representatives at December 31, 1999, the Company provides its customers with
continuous support and superior service. To serve its customers, account
representatives are assigned to the Company's customers to act as effective
liaisons with the Company. Technicians and other support personnel are
available in each of the Company's service areas to react to any network
failures or problems. In addition, the network operations center provides 24
hour-a-day, 7 days-a-week surveillance and monitoring of networks to maintain
the Company's network reliability and performance. See "--Telecommunications
Networks and Facilities--Network Monitoring and Management."
Competition
The Company believes that the principal competitive factors affecting its
business are, and will continue to be:
. pricing;
. the availability of proven support systems for the Company's back office
systems, including provisioning and billing;
44
<PAGE>
. competition for skilled, experienced personnel; and
. regulatory decisions and policies that promote competition.
The Company believes that it competes favorably with other companies in the
industry or is impacted favorably with respect to each of these factors. The
technologies and systems which provide back office support for the competitive
local exchange carrier industry are nascent and may not keep pace with the
growth of order volume, integration with other systems, and production of
required information for systems managers. The best personnel in all areas of
the Company's operations are in demand by the numerous participants in the
highly specialized competitive local exchange carrier industry. While the
Company's employee base is generally stable, it is anticipated that others in
the industry will continue to demand high quality personnel and will thus drive
pressure to maintain extremely competitive compensation and benefits packages
in addition to an attractive work environment. Regulatory environments at both
the state and Federal level differ widely and have considerable influence on
the Company's market and economic opportunities and resulting investment
decisions. The Company believes it must continue monitoring regulatory
developments and remain active in its participation in regulatory issues.
Services substantially similar to those offered by the Company are also
offered by the incumbent local exchange carriers, which include Ameritech
Corporation, Bell Atlantic Corporation, BellSouth Corporation, SBC
Communications, Inc. and GTE Corporation. The Company believes that many
incumbent local exchange carriers may have competitive advantages over the
Company. incumbent local exchange carriers generally benefit from their long-
standing relationships with customers and greater technical and financial
resources. The incumbent local exchange carriers have the potential to
subsidize services of the type offered by the Company from service revenue in
unrelated businesses. While regulatory initiatives that allow competitive local
exchange carriers such as the Company to interconnect with incumbent local
exchange carrier facilities and provide increased business opportunities for
the Company, such interconnection opportunities have been accompanied by
increased pricing flexibility for and relaxation of regulatory oversight of the
incumbent local exchange carriers. In addition, in most of the metropolitan
areas in which the Company currently operates, at least one, and sometimes
several, other competitive access providers or competitive local exchange
carriers offer substantially similar services at substantially similar prices
to those of the Company.
The Company also faces competition from new entrants in the local services
business who may also be better established and have greater financial
resources. Other competitive local exchange carriers, competitive access
providers, cable television companies, electric utilities, long distance
carriers, microwave carriers, wireless telephone system operators and private
networks built by large end-users currently do, and may in the future, offer
services similar to those offered by the Company.
The Company believes that the 1996 Act will provide increased business
opportunities by opening all local markets to competition. The 1996 Act:
. requires all local exchange providers to offer their services for
resale;
. requires incumbent local exchange carriers to provide increased direct
interconnection;
. requires incumbent local exchange carriers to offer network elements on
an unbundled basis; and
. requires incumbent local exchange carriers to offer the services they
provide to end-users to other carriers at wholesale rates.
However, under the 1996 Act, the FCC and some state regulatory authorities
may provide incumbent local exchange carriers with increased flexibility to
reprice their services as competition develops and as incumbent local exchange
carriers allow competitors to interconnect to their networks. In addition, some
new entrants in the local market may price certain services to particular
customers or for particular routes below the prices charged by the Company for
services to those customers or for those routes, just as the Company may itself
underprice those new entrants for other services, customers or routes. If the
incumbent local exchange carriers
45
<PAGE>
and other competitors lower their rates and can sustain significantly lower
prices over time, this may adversely affect revenue of the Company if it is
required by market pressure to price at or below the incumbent local exchange
carriers' prices. If regulatory decisions permit the incumbent local exchange
carriers to charge competitive access providers and competitive local exchange
carriers substantial fees for interconnection to the incumbent local exchange
carriers' networks or afford incumbent local exchange carriers other regulatory
relief, such decisions could also have a material adverse effect on the
Company.
However, the Company believes that the negative effects of the 1996 Act may
be more than offset by:
. the increased revenue available as a result of being able to address the
entire local exchange market;
. reciprocal compensation with the incumbent local exchange carrier;
. obtaining access to off-network customers through more reasonably priced
expanded interconnection with incumbent local exchange carrier networks;
and
. a shift by long distance carriers to purchase access services from
competitive access providers and competitive local exchange carriers
instead of incumbent local exchange carriers.
There can be no assurance, however, that these anticipated results will
offset completely the effects of increased competition as a result of the 1996
Act.
The current trend of business combinations and alliances in the
telecommunications industry, including mergers between subsidiaries of Bell
operating companies, between Bell operating companies and other incumbent local
exchange carriers or competitive local exchange carriers, and between major
long distance carriers and competitive local exchange carriers, may create
significant new competitors for the Company and may result in competitors
favoring the use of their subsidiaries and division for services provided by
the Company. For example, Bell Atlantic has acquired the local exchange
carriers owned by NYNEX, and SBC, corporate parent of Southwestern Bell
Telephone Company, has acquired Southern New England Telephone and Pacific
Telesis. In addition, SBC and Ameritech have agreed to merge, as have Bell
Atlantic and GTE Corporation, Qwest Communications and U S WEST and MCI-
WorldCom and Sprint. In July 1998, AT&T acquired TCG, a competitor of the
Company, and in March 1999, AT&T acquired Tele-Communications, Inc., a major
cable operator.
In addition, the 1996 Act allows the regional Bell operating companies and
others such as electric utilities to enter the long distance market. Certain of
the regional Bell operating companies have begun providing out-of-region long
distance services across local access and transport areas, or interLATA. When a
regional Bell operating company obtains authority to provide in-region
interLATA services, it will be able to offer customers both local and long
distance telephone services. Given the market power the regional Bell operating
companies currently possess in the local exchange market, the ability to
provide both local and long distance services is expected to make the regional
Bell operating companies very strong competitors. Certain regional Bell
operating companies are actively working to satisfy prerequisites for entry
into the in-region long distance business. To date, only Bell Atlantic has been
granted authority to provide in-region inter-LATA services only in the state of
New York.
The WTO agreement on basic telecommunications services which became
effective in 1998 could increase the Company's competition for
telecommunications services both domestically and internationally. Under this
agreement, the United States and other members of the WTO committed themselves
to opening their telecommunications markets to competition and foreign
ownership and to adopting regulatory measures to protect competitors against
anticompetitive behavior by dominant telephone companies. As part of the U.S.
government's implementation of the WTO agreement, the FCC has established new
rules making it easier for foreign carriers to enter the U.S.
telecommunications market. See "Business--Government Regulation."
Additional competition will arise from internet service providers as they
begin to deliver advanced communications services (e.g., internet protocol
telephony) over their networks. Some of these internet service
46
<PAGE>
providers benefit from the very large scale of their backbones because of their
or their affiliates' other businesses (e.g., Sprint owns its own backbone and
benefits through its long haul assets).
To the extent the Company interconnects with and uses incumbent local
exchange carrier networks to service its customers, the Company will be
dependent upon the technology and capabilities of the incumbent local exchange
carriers to meet certain telecommunications needs of the Company's customers
and to maintain its service standards. The Company will become increasingly
dependent on interconnection with incumbent local exchange carriers as switched
services become a greater percentage of the Company's business. The 1996 Act
imposes interconnection obligations on incumbent local exchange carriers;
however, such interconnection requires the negotiation of interconnection and
collocation agreements with the incumbent local exchange carriers, which can
take considerable time, effort and expense and are subject to Federal and state
regulation. There can be no assurance that the Company will be able to obtain
the interconnection it requires at rates, and on terms and conditions, that
permit the Company to offer switched services at rates that are both
competitive and profitable. In the event that the Company experiences
difficulties in obtaining high quality, reliable and reasonably priced service
from the incumbent local exchange carriers, the attractiveness of the Company's
services to its customers could be impaired.
Historically, the Company has been able to build new networks and expand
existing networks in a timely and economical manner through strategic
arrangements such as leasing fiber optic cable from Time Warner Cable, which
already possesses rights-of-way. The Company intends to use its experience and
presence in the telecommunications industry to fully exploit its available
capacity, further develop and expand its existing telecommunications
infrastructure and offer a diversified range of products and services in
competitively priced bundles.
Government Regulation
Historically, interstate and foreign communication services were subject to
the regulatory jurisdiction of the FCC, and intrastate and local
telecommunications services were subject to regulation by state public service
commissions. With the enactment of the 1996 Act, competition in all
telecommunications market segments, including interstate and intrastate, local
and long distance, became matters of national policy. The Company believes that
the national policy fostered by the 1996 Act has contributed to significant
market opportunities for the Company. As Federal and state regulatory
commissions have largely implemented the provisions of the 1996 Act, the
Company believes that future regulation will focus largely on enforcement of
carrier-to-carrier requirements under the law and consumer protection measures.
Telecommunications Act of 1996. The 1996 Act is intended to increase
competition in local telecommunications services by requiring incumbent local
exchange carriers to interconnect their networks with competitive local
exchange carriers. The 1996 Act imposes a number of access and interconnection
requirements on all local exchange carriers, including competitive local
exchange carriers, with additional requirements imposed on incumbent local
exchange carriers. Competitive local exchange carriers and incumbent local
exchange carriers are required to attempt to negotiate interconnection
agreements for at least 135 days. During these negotiations, the parties may
submit disputes to state regulators for mediation and, after the negotiation
period has expired, the parties may submit outstanding disputes to state
regulators for arbitration. The Company has executed interconnection agreements
with the incumbent local exchange carriers in each of the markets in which it
offers switched services and has negotiated, or is negotiating, secondary
interconnection arrangements with carriers whose territories are adjacent to
the Company's for intrastate intraLATA toll traffic and extended area services.
Many of these agreements expired in 1999 or are expiring in 2000, and the
Company is in the process of negotiating new contracts. Typically, the expired
agreements allow the Company to continue to exchange traffic with the other
carrier pending execution of a new agreement. Incumbent local exchange carriers
are seeking renegotiation of certain terms and conditions, including reciprocal
compensation for internet service provider-bound traffic. The Company cannot
predict the outcome of the negotiations, especially in light of pending legal
and regulatory actions pertaining to reciprocal compensation, as described
below.
47
<PAGE>
Under the 1996 Act, the FCC was required to establish rules and regulations
to implement the local competition provisions of the 1996 Act within six months
of enactment. In August 1996, the FCC issued two reports and orders
promulgating rules to govern interconnection, resale, unbundled network
elements, and the pricing of those facilities and services, as well as rules to
govern, among other things, the dialing parity requirements of the 1996 Act.
Certain incumbent local exchange carriers and states challenged the authority
of the FCC to issue these rules.
On January 25, 1999, the Supreme Court issued a decision upholding most of
the FCC's rules with respect to interconnection, resale and the dialing parity
rule and confirming the FCC's jurisdiction to issue national pricing rules for
interconnection, unbundled network elements and resale. However, the Supreme
Court did not address the lawfulness of the pricing rules established by the
FCC. The Supreme Court also reinstated the FCC's rule that requires the
incumbent local exchange carriers to offer network elements in combined form
where those elements are already combined in the incumbent local exchange
carrier's networks. This potentially enables non-facilities-based carriers to
obtain all of the network elements necessary to serve end-users without making
capital investments. The Company believes that the availability of combined
platforms of network elements at prices based on the FCC's Total Element Long
Run Incremental Cost standard could create economic incentives for new
competitors to enter local markets through acquisition of incumbent local
exchange carrier network element platforms rather than by investing in their
own network facilities as the Company does.
The Court also vacated a rule requiring incumbent local exchange carriers to
make available to requesting carriers any of the network elements within the
FCC's definition of that term. The Court remanded to the FCC for further
consideration the criteria for determining what constitutes an unbundled
network element. In response to the Court's remand, the FCC conducted a further
rulemaking proceeding. In its November 1999 order, the FCC reaffirmed the
necessity for continued incumbent local exchange carrier provision of most of
the original unbundled network elements, but allowed incumbent local exchange
carriers to withdraw the local switching element in the highest density areas
of the top 50 metropolitan statistical areas. The withdrawal of the local
switching element also effectively withdraws the unbundled network element
platform in those same high-density areas. The FCC also declined to allow the
combination of loop and transport regional Bell operating companiess purely for
the provision of interexchange special access services. This issue is pending
final resolution in a separate proceeding.
The 1996 Act provides a detailed list of items that are subject to
interconnection negotiations, as well as a detailed set of duties for all
affected carriers. All local exchange carriers, including the Company, have a
duty to:
. not unreasonably limit the resale of their services;
. provide number portability if technically feasible;
. provide dialing parity to competing telecommunications providers;
. provide access to poles, ducts and conduits; and
. establish reciprocal compensation arrangements for the transport and
termination of telecommunications.
The Company has fully complied with these requirements. The Company does not
restrict the resale of its services, engages in reciprocal compensation
arrangements, provides dialing parity, and provides full number portability,
satisfying four of the five requirements. The Company generally licenses poles,
ducts and conduits, and therefore owns few such rights-of-way subject to the
requirement to make them available to other carriers.
Pursuant to the requirements of the 1996 Act and the FCC's rules under the
1996 Act, the Company is required to compensate other local exchange carriers
for termination of local exchange traffic originated by the Company.
Conversely, the Company is entitled to receipt of compensation from other local
exchange carriers
48
<PAGE>
when it terminates local exchange traffic originated by other local exchange
carriers. This requirement is commonly referred to as reciprocal compensation.
The Company, like other competitive local exchange carriers, receives
reciprocal compensation from incumbent local exchange carriers for local calls
it terminates at the premises of internet service providers. Incumbent local
exchange carriers have attempted to persuade state commissions and the FCC that
such traffic is not local traffic and that such traffic should not be subject
to reciprocal compensation. To date, nearly every state commission which has
considered the issue has concluded that local traffic terminated at internet
service provider locations is local traffic and is subject to reciprocal
compensation under state-approved interconnection agreements. However, on
February 26, 1999, the FCC released a declaratory ruling in which it concluded
that internet service provider-bound traffic is largely interstate and that the
reciprocal compensation provisions of the 1996 Act do not apply to internet
service provider-bound traffic. The FCC held, however, that states could
nonetheless order the incumbent local exchange carriers to pay reciprocal
compensation for internet service provider-bound traffic pursuant to
interconnection agreements or state law. On March 24, 2000, the United States
Court of Appeals for the District of Columbia vacated the FCC ruling in the
February 26, 1999 declaratory ruling that reciprocal compensation does not
apply to internet service provider-bound traffic. The court held that the FCC
had not adequately explained why its decision was reasonable, and the court
remanded the issue back to the FCC for further consideration. The FCC has not
commenced this remanded proceeding. Pending completion of that further
rulemaking, determinations of whether reciprocal compensation should be paid on
traffic terminated at internet service provider locations will be made by state
commissions and under the terms of approved interconnection agreements.
Incumbent local exchange carriers have continued attempts to persuade the FCC
and state commissions that traffic delivered to internet service providers
should not be subject to reciprocal compensation. The Company cannot predict
the outcome of those proceedings. In some cases the Company's right to receive
reciprocal compensation for traffic destined for its internet service provider
customers is contractually dependent on the outcome of the FCC rulemaking and
pending state proceedings addressing reciprocal compensation for internet
service provider traffic generally. In some cases, decisions by state
commissions that reciprocal compensation is payable to the Company for internet
service provider traffic are under appeal in federal courts. Exclusion of such
traffic from reciprocal compensation requirements will reduce the revenue
received by the Company for terminating traffic originated by incumbent local
exchange carriers.
Federal Regulation. The 1996 Act obligates the FCC to establish mechanisms
for ensuring that consumers, including low income consumers and those located
in rural, insular and high cost areas, have access to telecommunications and
information services at rates reasonably comparable to those charged for
similar services in urban areas. The 1996 Act also requires the FCC to
establish funding mechanisms to make available access to telecommunications
services, including advanced services, to schools, libraries and rural health
care centers. These requirements are generally referred to as the "universal
service requirements" of the 1996 Act. In May 1997, the FCC adopted rules to
implement the universal service requirements. Under those rules, all
telecommunications carriers, including the Company, must contribute to support
universal service. If the Company offers to provide local exchange service to
all customers within certain geographic areas, it may be deemed to be an
"Eligible Carrier" and therefore entitled to subsidy funds under the program
established by the FCC. The FCC estimates that its action in November 1999,
that revised certain formulas and the cost study models for universal service
funding, will result in approximately $230 million in additional universal
service funding for 2000.
In December 1998, the FCC established rules to govern the manner in which
telecommunications carriers effectuate and verify selection by consumers of
preferred providers of local exchange and interexchange services. The Company
is subject to those rules and is required to comply with the specific
verification requirements established by the FCC. Violation of those rules
could subject the Company to sanctions imposed by the FCC.
In its August 1999 Order on Access Reform, the FCC established a framework
for the eventual deregulation of incumbent local exchange carrier interstate
access charges. Degrees of increased pricing flexibility and ultimate price
deregulation are triggered by the extent of competitive development within
49
<PAGE>
metropolitan statistical areas. This will exert greater downward pressure on
the Company's interstate access prices as the various conditions are met over
the next few years.
In addition, a group of incumbent local exchange carriers and long distance
carriers, the Coalition for Affordable Local and Long Distance Services, or
CALLS, has recently submitted to the FCC a proposal for reforming the federal
access charge and universal service regimes. The proposal includes a
substantial reduction in incumbent local exchange carrier per-minute access
charges and an increase in the flat monthly charge paid by local residential
service subscribers. In addition, the proposal includes a significant increase
in the size of the federal universal service fund. If implemented in its
entirety, the CALLS proposal could result in lower access charge revenue for
the Company.
In a related access reform proceeding pending before the FCC, the FCC is
considering imposing regulation on competitive local exchange carrier access
charges that would restrict such prices to levels below an established
"benchmark" price. Some parties have proposed benchmarks that are no higher
than individual incumbent local exchange carrier prices, while others have
argued that the tariffed rates of the National Exchange Carrier Association are
more representative of competitive local exchange carrier cost characteristics.
A regulated price cap at incumbent local exchange carrier rate levels would
reduce the per-minute rates the Company receives for access service.
Sprint is withholding access charge payments from competitive local exchange
carriers, including the Company, arguing that competitive local exchange
carrier access rates should be no higher than individual incumbent local
exchange carrier rates. The Company does not believe that Sprint has a
sustainable legal basis for its position and has filed a complaint against
Sprint with the FCC. The Company can provide no assurance, however, that it
will prevail in this proceeding.
The Communications Assistance for Law Enforcement Act, enacted in 1994,
requires telecommunications carriers, including the Company, to make their
equipment and facilities capable of assisting authorized law enforcement
agencies to conduct electronic surveillance. The FCC has extended the date for
compliance with some of these requirements until June 30, 2000 and other
requirements by September 2001. The Company has ordered the switch upgrades
necessary to meet the surveillance requirements and anticipates that
approximately half of its switches will meet the requirements by the June 30,
2000 FCC compliance date. The Company intends to file a request for a waiver
with the FCC to extend the due date for the remaining switches. The Company
does not anticipate any difficulty in obtaining the extension of time for
compliance. There is no assurance, however, that the extension will be granted.
The FCC may impose substantial monetary penalties for non-compliance.
State Regulation. The Company has acquired all state government authority
needed to conduct its business as currently contemplated. Most state public
service commissions require carriers that wish to provide local and other
jurisdictionally intrastate common carrier services to be authorized to provide
such services. The Company's operating subsidiaries and affiliates are
authorized as common carriers in 12 states. These certifications cover the
provision of switched and dedicated services including local basic exchange
service, point-to-point private line, competitive access services and long
distance services. The Company is in the process of obtaining any necessary
regulatory approvals in connection with the underwriters' over-allotment
option.
Local Government Authorizations. The Company may be required to obtain from
municipal authorities street opening and construction permits and other rights-
of-way to install and expand its networks in certain cities. In some cities,
the Company's affiliates or subcontractors may already possess the requisite
authorizations to construct or expand the Company's networks. Any increase in
the difficulty or cost of obtaining these authorizations and permits could
adversely affect the Company, particularly where it must compete with companies
that already have the necessary permits.
In some of the metropolitan areas where the Company provides network
services, the Company pays license or franchise fees based on a percent of
gross revenue. There can be no assurance that municipalities that
50
<PAGE>
do not currently impose fees will not seek to impose fees in the future, nor is
there any assurance that, following the expiration of existing franchises, fees
will remain at their current levels. Under the 1996 Act, municipalities are
required to impose such fees on a competitively neutral and nondiscriminatory
basis. However, municipalities that currently favor the incumbent local
exchange carriers may or may not conform their practices in a timely manner or
without legal challenges by the Company or another competitive access provider
or competitive local exchange carrier. Moreover, there can be no assurance that
incumbent local exchange carriers with whom the Company competes will not be
excluded from such local franchise fee requirements by previously-enacted
legislation allowing them to utilize rights-of-way throughout their states
without being required to pay franchise fees to local governments.
If any of the Company's existing franchise or license agreements for a
particular metropolitan area were terminated prior to its expiration date and
the Company were forced to remove its fiber optic cables from the streets or
abandon its network in place, even with compensation, such termination could
have a material adverse effect on the Company's operation in that metropolitan
area and could have a material adverse effect on the Company.
The Company is party to various regulatory and administrative proceedings,
however, subject to the discussion above, the Company does not believe that any
such proceedings will have a material adverse effect on its business.
Company Name
The Company's use of the "Time Warner" name is subject to a license
agreement with Time Warner. See "Risk Factors--We may lose the right to use the
"Time Warner' name" and "Certain Relationships and Related Transactions--
Certain Operating Agreements."
Employees
As of December 31, 1999, the Company employed approximately 1,259 employees.
The Company believes that its relations with its employees are good. By
succession, the New York City operating entity is a party to a collective
bargaining agreement. In connection with the construction and maintenance of
its networks and the conduct of its other business operations, the Company uses
third party contractors, some of whose employees may be represented by unions
or collective bargaining agreements. The Company believes that its success will
depend in part on its ability to attract and retain highly qualified employees
and maintain good working relations with its current employees.
Properties
The Company leases network hub sites and other facility locations and sales
and administrative offices, many from Time Warner Cable, in each of the cities
in which it operates networks. During 1999, 1998 and 1997, rental expense for
the Company's facilities and offices totaled approximately $6.6 million, $4.8
million and $4.7 million, respectively. The Company owns no material real
estate. Management believes that its properties, taken as a whole, are in good
operating condition and are suitable and adequate for the Company's business
operations. The Company currently leases approximately 83,107 square feet of
space in Littleton, Colorado, where its corporate headquarters are located and
approximately 130,000 square feet of space in Greenwood Village, Colorado,
where the network operations center and other administrative functions are
located.
Legal Proceedings
Southwestern Bell Telephone Company v. Public Utility Commission of Texas et
al.
The Company filed a complaint with the Texas Public Utility Commission
("PUC") in October 1997, as a result of Southwestern Bell Telephone's refusal
to pay the Company reciprocal compensation under the
51
<PAGE>
Interconnection Agreement between the parties for calls terminated to the
Company's internet service provider customers in Texas based on Southwestern
Bell's contention that such traffic was not "local". The PUC ruled that calls
to internet service providers are local and required Southwestern Bell to
compensate the Company for those calls under the Interconnection Agreement.
Southwestern Bell then sought to enjoin and stay the PUC's order in Federal
District Court for the Western District of Texas and sought a declaration that
calls to internet service providers are not local. On April 16, 1998, the
District Court denied all relief sought by Southwestern Bell and Southwestern
Bell appealed that decision. Southwestern Bell's appeal to the Fifth Circuit
Court of Appeals is still pending. Following the PUC's order, Southwestern Bell
began to make reciprocal compensation payments for internet service provider
traffic under the Interconnection Agreement. If Southwestern Bell prevails upon
appeal, the Company may be required to repay the amounts received from
Southwestern Bell since April 1997 in respect of internet service provider
traffic with interest.
Southwestern Bell v. Time Warner Telecom
On December 17, 1999, Southwestern Bell filed a Demand for Commercial
Arbitration under the Interconnection Agreement between the Company and
Southwestern Bell. Southwestern Bell alleged that the Company breached the
Interconnection Agreement by refusing to amend the Interconnection Agreement to
replace the reciprocal compensation rates stated in the contract with lower
rates established by the PUC in a consolidated arbitration with AT&T, MCI and
MFS Communications. The Company has filed a response contending that the PUC is
the only proper forum for resolution of disputes under the Interconnection
Agreement. If Southwestern Bell is successful in this proceeding, the Company
may be required to refund to Southwestern Bell the difference between the
contract rate and the lower rate advocated by Southwestern Bell for minutes of
use terminated to the Company since April 1998, net of offsetting credits to
the Company for traffic terminated to Southwestern Bell during the same period.
Indiana Bell Telephone Company, Inc. d/b/a Ameritech Indiana v. Time Warner
Communications of Indiana, L.P., et al.
The Company filed a complaint with the Indiana Utility Regulatory Commission
("IURC") in January 1998, as a result of Ameritech Indiana's refusal to pay the
Company reciprocal compensation under the Interconnection Agreement between the
parties for calls terminated to the Company's internet service provider
customers in Indiana based on Ameritech Indiana's contention that such traffic
was not "local". The IURC ruled that calls to internet service providers are
local and required Ameritech Indiana to compensate the Company for those calls
under the Interconnection Agreement. Ameritech Indiana then appealed the ruling
to the Indiana Court of Appeals and sought injunctive relief and to stay the
IURC's order in the Federal District Court for the Southern District of Indiana
and sought a declaration that calls to internet service providers are not
local. Ameritech Indiana's appeal to the Indiana Court of Appeals has been
stayed pending resolution by the Federal District Court for the Southern
District of Indiana, and the procedural schedule for resolving the District
Court action is on hold until the Seventh Circuit Court of Appeals resolves a
similar action involving different companies. Following IURC's order, Ameritech
Indiana began to make reciprocal compensation payments for internet service
provider traffic under the Interconnection Agreement. If Ameritech Indiana
prevails upon appeal, the Company may be required to repay the amounts received
from Ameritech Indiana in respect of internet service provider traffic without
interest.
Ohio Bell Telephone Company d/b/a/ Ameritech Ohio v. ICG Telecom Group, Inc.,
et al.
The Company filed a complaint with the Public Utilities Commission of Ohio
("PUCO") on February 18, 1998, as a result of Ameritech Ohio's refusal to pay
the Company reciprocal compensation under the Interconnection Agreement between
the parties for calls terminated to the Company's internet service provider
customers in Ohio based on Ameritech Ohio's contention that such traffic was
not "local." The PUCO ruled that calls to internet service providers are local
and required Ameritech Ohio to compensate the Company for those calls under the
Interconnection Agreement. Ameritech Ohio has appealed the ruling to the United
States
52
<PAGE>
District Court for the Southern District of Ohio, Eastern Division, seeking a
declaration that calls to internet service providers are not local and not
subject to the payment of reciprocal compensation under the parties'
Interconnection Agreement. If Ameritech Ohio prevails upon appeal, the Company
may be required to repay the amounts received from Ameritech Ohio in respect of
internet service provider traffic without interest.
Wisconsin Bell, Inc. d/b/a Ameritech Wisconsin v. TCG Milwaukee, Inc., et al.
The Company filed a complaint with the Public Service Commission of
Wisconsin (the "PSCW") on December 2, 1997, as a result of Ameritech
Wisconsin's refusal to pay the Company reciprocal compensation under the
Interconnection Agreement between the parties for calls terminated to the
Company's internet service provider customers in Wisconsin based on Ameritech
Wisconsin's contention that such traffic was not "local." The PSCW ruled that
calls to internet service providers are local and required Ameritech Wisconsin
to compensate the Company for calls under the Interconnection Agreement.
Ameritech Wisconsin appealed the PSCW ruling to the United States District
Court for the Western District of Wisconsin, seeking a declaration that calls
to internet service providers are not local and not subject to the payment of
reciprocal compensation under the parties' Interconnection Agreement. The
District Court dismissed Ameritech Wisconsin's appeal on July 12, 1999, for
lack of subject matter jurisdiction based upon the Eleventh Amendment immunity
of the PSCW. Ameritech Wisconsin appealed the decision of the District Court to
the United States Court of Appeals for the Seventh Circuit on July 16, 1999.
The Seventh Circuit appeal has been briefed and argued and is awaiting
decision. If Ameritech Wisconsin prevails on the Seventh Circuit appeal, the
case would be remanded to the District Court for a decision concerning
Ameritech Wisconsin's appeal of the PSCW ruling. If Ameritech Wisconsin
prevails on the remand before the District Court and prevails upon a further
appeal before the Seventh Circuit Court of Appeals, the Company may be required
to repay the amounts received from Ameritech Wisconsin in respect of internet
service provider traffic without interest.
The Company is a party to various other claims and legal and regulatory
proceedings arising in the ordinary course of business. The Company does not
believe that such claims or proceedings, individually or in the aggregate, will
have a material adverse effect on the Company's business, financial condition
or results of operations.
53
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MANAGEMENT
Executive Officers and Directors
The following table sets forth information concerning the individuals who
serve as directors and executive officers of the Company.
<TABLE>
<CAPTION>
Director Principal Occupation and
Name and Age Since Other Information
------------ --------- ------------------------
<C> <C> <S>
Larissa L. Herda (41)............ July 1998 President and Chief Executive
Officer of the Company since June
1998.
Senior Vice President--Sales of
the Company from March 1997 to
June 1998.
1989-1997 employed by MFS
Telecom, Inc., a competitive
local exchange carrier, most
recently as Southeast Regional
Vice president and General
Manager.
David J. Rayner (42)............. N/A Senior Vice President and Chief
Financial Officer of the Company
since June 1998.
Vice President, Finance of the
Company from February 1997 to May
1998.
Controller of the Company from
May 1994 to February 1997.
Financial and operational
management positions at Time
Warner Cable from 1982 to 1994.
Paul B. Jones (53)............... N/A Senior Vice President, General
Counsel and Regulatory Policy of
the Company since August 1998.
Senior Vice President, Legal and
Regulatory Policy of the Company
from October 1993 to August 1998.
Senior Vice President, Corporate
Development of Time Warner Cable
Ventures from 1992-1993.
Senior Vice President and General
Counsel of Time Warner Cable from
1987 to 1992.
Vice President, Strategy and
Development of CBS Publishing
Group from 1985 to 1986.
Assistant General Counsel for the
FCC from 1977 to 1979.
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
Director Principal Occupation and
Name and Age Since Other Information
------------ -------- ------------------------
<C> <C> <S>
John T. Blount (40).............. N/A Senior Vice President--Sales of
the Company since June 1998.
Regional Vice President for the
Midwest and Southwest Regions of
the Company from January 1997 to
June 1998.
Vice President and General
Manager/Milwaukee of the Company
from January 1996 to January 1997.
General Manager/Milwaukee of the
Company from February 1995 to
January 1996.
Employed by U S WEST !nterprise
from 1988 to February 1995.
Michael Rouleau (41)............. N/A Senior Vice President, Marketing
and Business Development of the
Company since November 1999.
Vice President, Marketing and
Product Development of Transport
Service of U S WEST, Inc. from
July 1997 to November 1999.
Executive Director, Marking and
Product Development of U S WEST,
Inc. from April 1995 to June 1997.
A. Graham Powers (53)............ N/A Senior Vice President, Chief
Information Officer of the Company
since April 1998.
Senior Vice President, Engineering
and Technology of the Company from
June 1996 to March 1998.
Senior Vice President, Operations
Development and Business
Implementation of the Company from
August 1993 to May 1996.
President of Telecommunications
Strategy Inc., a technology
consulting service, from May 1992
to July 1993.
Raymond H. Whinery (45).......... N/A Senior Vice President,
Engineering, Technology and
Operations of the Company since
April 1999.
Senior Vice President, Technical
Operations of the Company from
January 1997 to April 1999.
Senior Director of Engineering and
Planning of the Company from May
1994 to January 1997.
Employed by U S WEST, Inc. from
1978 to May 1994.
</TABLE>
55
<PAGE>
<TABLE>
<CAPTION>
Director Principal Occupation and
Name and Age Since Other Information
------------ ------------ ------------------------
<C> <C> <S>
Julie A. Rich (46)............... N/A Senior Vice President, Human
Resources and Business
Administration of the Company
since April 1999.
Vice President, Human
Resources and Business
Administration of the Company
from March 1998 to April 1999.
Owner of an independent human
resources consulting practice
from June 1996 to February
1998.
Founder of XEL Communications,
Inc., a telecommunications
manufacturer, holding
positions of Director and Vice
President of Human Resources
from 1984 to 1996.
Glenn A. Britt (51).............. July 1998 Vice President of the Company
and non-executive Chairman of
the Board of Directors since
July 1998.
President of Time Warner Cable
since January 1999.
Chief Executive Officer and
President of Time Warner Cable
Ventures, a division of Time
Warner Cable, for more than
the past five years.
Bruce Claflin (48)............... August 1999 President and Chief Operating
Officer for 3Com Corporation
since August 1998.
Senior Vice President and
General Manager, Sales and
Marketing at Digital Equipment
Corporation from July 1997 to
June 1998.
Vice President and General
Manager--Personal Computer
Business Unit at Digital
Equipment Corporation from
October 1995 to June 1997.
Senior management and
executive positions at
International Business
Machines Corporation from
April 1973 to October 1995.
Richard J. Davies (52)........... October 1998 Senior Vice President,
Corporate Development of Time
Warner Cable since January
1999.
Senior Vice President of Time
Warner Cable Ventures from
June 1996 to December 1998.
Chief Financial Officer of the
Company from March 1993 to
June 1996.
Spencer B. Hays (55)............. October 1999 Vice President and Deputy
General Counsel of Time Warner
Inc. since its formation in
1990.
Prior to 1990 employed in
various capacities by Time
Warner Inc.'s predecessor,
Warner Communications Inc.,
most recently as Senior Vice
President and General Counsel.
</TABLE>
56
<PAGE>
<TABLE>
<CAPTION>
Director Principal Occupation and
Name and Age Since Other Information
------------ ----------- ------------------------
<C> <C> <S>
Douglas Holmes (39)*............. April 1999 Executive Vice President--
Strategy and Business
Development for MediaOne since
May 1998.
Executive Vice President--
Finance, Strategy and Business
Development for MediaOne's
domestic cable business from
January 1997 to May 1998.
Chief Financial Officer for U S
WEST Media Group and various
strategy and marketing
positions since 1990.
Lisa Hook (42)................... August 1999 Director and major shareholder
representative of Classic
Communications, a cable
television operator, since
1999.
Principal of Brera Capital
Partners, a private equity
firm, since 1998.
Director of Roberts Radio since
1997.
Principal of Alpine Capital, a
private equity firm, from 1996-
1998.
Robert J. Miron (62)............. July 1998 President of Advance/Newhouse
Communications since April
1995.
President of Newhouse
Broadcasting Corporation from
October 1986 to April 1995.
Audley M. Webster, Jr. (47)*..... July 1998 Vice President--Shared
Corporate Resources of MediaOne
since December 1997.
Vice President--Corporate
Strategy of MediaOne from
December 1996 to December 1997.
Executive Director of U S WEST,
Inc. from February 1993 to
December 1996.
James N. Zerefos (38)*........... March 2000 Corporate Counsel--Mergers &
Acquisitions for MediaOne since
March 1999.
Senior Attorney--Mergers &
Acquisitions for MediaOne from
June 1997 to March 1999.
Previously a partner in private
law practice, most recently
with Thompson, Hine & Flory, a
private law firm.
</TABLE>
- --------
* Indicates a director designated by the selling stockholder who will resign
as a director of the Company upon completion of this offering.
57
<PAGE>
Structure of the Board
Our directors are elected annually. The Stockholders Agreement among the
Class B Stockholders, Time Warner, MediaOne and Advance, provides that the
board of directors will have up to ten directors. At each annual stockholders
meeting at which directors are elected, the Class B Stockholders will vote
their shares in favor of the following nominees:
. up to seven nominees selected by the holders of Class B Common Stock;
. the Chief Executive Officer of the Company; and
. two nominees selected by the Nominating Committee who are neither
employed by nor affiliated with the Company or any holder of Class B
Common Stock.
Upon completion of this offering, the directors designated by MediaOne will
resign and the board of directors will be reduced from ten directors to seven.
The holders of the Class A Common Stock do not have the right, as a class,
under the Company's Restated Certificate of Incorporation to nominate any
individuals for election to the board of directors.
Committees of the Board
Audit Committee. The Audit Committee reviews the internal accounting and
financial controls for the Company and the accounting principles and auditing
practices and procedures to be employed in preparation and review of financial
statements of the Company. It also makes recommendations to the board of
directors regarding the appointment of the Company's independent public
accountants and the scope of their audit. The board of directors established
the Audit Committee in August 1999 and the committee held one meeting in 1999.
The members are the independent directors, Ms. Hook and Mr. Claflin.
Human Resources and Benefits Committee. The Human Resources and Benefits
Committee determines the salary, bonus and other compensation for our senior
management personnel and makes recommendations with respect to grants of
options and other grants of Company equity securities to senior management
personnel and to directors of the Company, subject to approval of such grants
by the Compensation Committee. The Human Resources and Benefits Committee also
establishes policies with respect to compensation of employees generally and
any other matters that the board of directors may delegate to the committee.
The committee was established in August 1999 and its members are Messrs. Britt,
Miron, Holmes, and Claflin and Ms. Hook. The Human Resources and Benefits
Committee members communicate with each other from time to time in person and
by telephone and act on matters by way of a formal meeting or by unanimous
written consent. The committee met twice in 1999.
Compensation Committee. The Compensation Committee approves option grants to
our senior officers and directors under the Company's 1998 Stock Option Plan
and future option plans and addresses other matters that the board of directors
may delegate to it. The committee also makes other determinations regarding
compensation matters that any tax, stock exchange or Federal securities law or
regulation requires to be made by a committee composed entirely of independent
or non-employee directors. The members are the independent directors as defined
by the Securities and Exchange Commission and the Internal Revenue Service, Ms.
Hook and Mr. Claflin. The Compensation Committee acted twice by unanimous
written consent and met twice in 1999.
Nominating Committee. The Nominating Committee consists of Messrs. Britt,
Davies, Hays, Holmes, Miron, Webster and Zerefos. The Nominating Committee
nominates the independent directors. The committee met twice in 1999.
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<PAGE>
Compensation Committee Interlocks and Insider Participation
We did not have a Compensation Committee until August 1999. Our Class B
Stockholders determined the compensation of our executive officers in effect at
the time of our initial public offering in May 1999, and that compensation was
approved by the board of directors, as reflected in the initial employment
agreements. Some of the members of the board of directors at that time were
employees or officers of the Class B Stockholders or their affiliates. In
addition, our Human Resources and Benefits Committee makes recommendations with
respect to some matters involving executive compensation. Mr. Britt, an officer
of an affiliate of Time Warner, is a member of the Human Resources and Benefits
Committee. We have described certain relationships and transactions between the
Company and Time Warner under "Certain Relationships and Related Transactions."
Compensation of Directors
We do not compensate directors who are our employees or employees of any
Class B Stockholders or their affiliates for services as directors. We provide
a $25,000 annual retainer to the independent directors, payable quarterly, 50%
in cash and 50% in Company Common Stock. Independent directors also receive
$1,000 and reimbursement of reasonable expenses for each board of directors
meeting they attend and $1,000 annually for each committee of the board of
directors that they chair.
Executive Compensation
The following table summarizes the compensation we paid during the last two
years to the President and Chief Executive Officer and to each of the four
other most highly compensated executive officers of the Company as of the end
of 1999, based on salary and annual incentive plan bonus.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term Compensation
Annual Compensation Awards Payouts
----------------------- ---------------------- ----------
Time
Warner
Telecom Time
Class A Warner Inc.
Common Common
Stock Stock
Underlying Underlying
Name & Principal Options Options LTIP All Other
Position Year(1) Salary Bonus Awarded(2) Awarded(8) Payouts(7) Compensation(3)
---------------- ------- ------- ------- ---------- ----------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Larissa L. Herda, 1999 312,025 234,009 1,000,000 -- -- 8,000
President and Chief 1998 300,000 169,381 375,000 7,600 -- --
Executive Officer(4)
Paul B. Jones, Senior 1999 259,242 184,710 100,000 -- 96,900 8,000
Vice President, General 1998 259,242 171,748 166,000 16,700 134,400 --
Counsel & Regulatory
Policy(5)
A. Graham Powers, Senior 1999 182,500 132,311 100,000 -- 43,605 8,000
Vice President 1998 175,479 118,448 100,000 7,600 60,480 --
Engineering &
Technology(5)
David J. Rayner, Senior 1999 182,970 132,653 300,000 -- -- 8,000
Vice President and 1998 171,000 94,792 125,000 7,600 -- --
Chief Financial
Officer(5)
John T. Blount, Senior 1999 180,730 128,770 300,000 -- -- 8,000
Vice President, 1998 170,500 65,963 100,000 -- -- --
Sales(6)
</TABLE>
- --------
(1) The Company's predecessor, Time Warner Telecom LLC, was created in July
1998. Prior to that time, the Company operated as a division of Time Warner
Entertainment Company. The amounts shown for 1998 are the actual salaries
received by the named executive officers for 1998.
(2) Options awarded under the Company's 1998 Option Plan.
(3) Includes contributions made by the Company to the Company's defined
contribution 401(k) plan on behalf of the named executive officers.
59
<PAGE>
(4) Ms. Herda became President and Chief Executive Officer of the Company on
June 22, 1998. Prior to June 22, 1998, Ms. Herda served as the Senior Vice
President, Sales.
(5) The Company does not currently have its own pension plan. However, Messrs.
Jones, Powers and Rayner will, upon retirement, be entitled to receive
benefits under the Time Warner Cable Pension Plan based on service to the
Company and/or Time Warner Cable on or prior to December 31, 1998.
(6) As a result of his previous employment with U S WEST, Inc., the predecessor
of MediaOne, Mr. Blount and certain other former employees of U S WEST
participate in a pension plan under the administration of MediaOne. Mr.
Blount's benefits under that plan upon his retirement are based on service
to U S WEST and/or the Company.
(7) These payouts were made in 1999 to participants in the Time Warner Cable
Long-Term Cash-Flow Incentive Plan for the 1995-1998 four-year cycle.
(8) Options awarded under Time Warner Inc. stock option plans. No options under
Time Warner Inc. plans were awarded to the named executive officers during
1999.
Employment Agreements
The Company has employment agreements with the each of the current named
executive officers of the Company. Among other things, these agreements provide
for:
. a three-year term of employment in a specified post, commencing on July
14, 1998;
. an annual salary and an annual bonus at the discretion of the Company,
generally targeted at 50% of the named executive's salary; and
. participation in any pension, profit-sharing, employee equity ownership,
vacation, insurance, hospitalization, medical, health, disability and
other employee benefit or welfare plan, program or policy that the
Company may adopt if employees at the executive's level are eligible
under the provisions of the plan or program.
The minimum annual salaries under the agreements in effect in 1999 are
$300,000 for Ms. Herda; $259,000 for Mr. Jones; $175,497 for Mr. Powers;
$171,000 for Mr. Rayner and $170,500 for Mr. Blount.
In connection with additional option grants to the named executive officers
in November 1999, the named executive officers entered into new employment
agreements with the Company with terms beginning January 1, 2000:
. Ms. Herda's contract has a five-year term;
. Messrs. Blount and Rayner's contracts have four-year terms; and
. Messrs. Jones and Powers' contracts have three-year terms.
The new agreements also increased the minimum annual salaries for Ms. Herda
and Messrs. Powers, Rayner and Blount and increased the target bonus
percentages to 75% of base salary for Ms. Herda and Messrs. Rayner and Blount.
The agreements include a narrow definition of the term "cause". If the
contract is terminated for cause, the executive will only receive earned and
unpaid base salary accrued through such date of termination.
These agreements provide that if the Company materially breaches or
terminates the executive's employment during the term without cause, the
executive may elect either:
. to receive a lump-sum payment of the present value of the base salary
and annual bonus otherwise payable during the remaining term of
employment, but not less than the sum of such salary and bonus prorated
for an 18-month period; or
60
<PAGE>
. to remain an employee of the Company for up to 18 months and, without
performing any services, receive the base salary and annual bonus
otherwise payable.
The executives have the same two options if a change of control occurs and
that change results in:
. a change of more than 50 miles in the location of the executive's office
or the Company's principal executive offices;
. a material reduction in the executive's responsibilities; or
. the Company's material breach of the agreement.
The agreements define change of control to mean that:
. the Class B Stockholders cease to have the ability as a group to elect a
majority of the Company's board of directors;
. another person or group has become the beneficial owner of more than 35%
of the total voting power of the Company's voting interests; and
. the percentage voting interest of that person or group is greater than
that held by the Class B Stockholders.
Executives are not generally required to mitigate damages after such a
termination, except as necessary to prevent the Company from losing any tax
deductions that it otherwise would have been entitled to for any payments
deemed to be "contingent on a change" under the Internal Revenue Code.
If an executive becomes disabled during the term of his or her employment
agreement, the executive typically will receive 75% of the executive's then
current salary and his or her applicable target annual bonus amount prorated
for an 18-month period. These payments will be reduced by amounts received from
worker's compensation, Social Security and disability insurance policies
maintained by the Company.
If an executive dies during the term of an employment agreement, generally
the executive's beneficiaries will receive the executive's earned and unpaid
salary up to thirty days after the date of death and a pro rata portion of the
executive's bonus for the year of death.
61
<PAGE>
Stock Options Awarded by the Company During 1999
The following table lists our grants during 1999 of stock options to the
officers named in the "Summary Compensation Table." All of the options were
nonqualified under the tax code and the Company did not award any stock
appreciation rights. The amounts shown as potential realizable values rely on
arbitrarily assumed increases in value required by the Securities and Exchange
Commission. In assessing those amounts, please note that the ultimate value of
the options, as well as your shares, depends on actual future share prices.
Market conditions and the efforts of the directors, the officers and others to
foster the future success of the Company can influence those future share
values.
OPTION GRANTS IN THE LAST FISCAL YEAR
Individual Grants (1)
<TABLE>
<CAPTION>
Potential Realizable
Value at
% of Total Assumed Annual Rates of
Number of Options Stock Price
Securities Granted to Appreciation
Underlying Employees Exercise or for Option Term
Options in 1999 Base Price Expiration -----------------------
Name Granted(#) Fiscal Year ($/share) Date 5%(1) 10%(1)
- ---- ---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Larissa L. Herda........ 1,000,000 33.9% $34.50 11/17/09 $21,696,864 $54,984,114
Paul B. Jones........... 100,000 3.4% 34.50 11/17/09 2,169,686 5,498,411
A. Graham Powers........ 100,000 3.4% 34.50 11/17/09 2,169,686 5,498,411
David J. Rayner......... 300,000 10.2% 34.50 11/17/09 6,509,059 16,495,234
John T. Blount.......... 300,000 10.2% 34.50 11/17/09 6,509,059 16,495,234
</TABLE>
- --------
Total shares granted to all employees in 1999: 2,950,750(2)
(1) The options shown in the above table were awarded to the named executive
officers under the Company's 1998 Option Plan and the terms are governed by
that plan and the recipient's option agreement. The exercise price is the
fair market value of the Class A Common Stock on the date of grant. The
options become exercisable over a four-year vesting period and expire ten
years from the date of grant. As required by Securities and Exchange
Commission rules, the dollar amounts in the last two columns represent the
hypothetical gain or "option spread" that would exist for the options based
on assumed 5% and 10% annual compounded rates of Class A Common Stock
appreciation over the full ten-year option term (resulting in 63% and 159%
appreciation, respectively). These assumed rates of appreciation applied to
the exercise price would result in a Class A Common Stock value on November
17, 2009 of $56.20 and $89.48, respectively. These prescribed rates are not
intended to forecast possible future appreciation, if any, of the Class A
Common Stock.
(2) The options granted to all employees in 1999 include options to purchase
100,000 shares that were granted outside of the Company's 1998 Option Plan.
62
<PAGE>
Option Exercises and Values in 1999
None of the named executive officers listed under the heading "Option Grants
in the Last Fiscal Year" exercised options in 1999. The table below shows the
number and value of their exercisable and non-exercisable options as of
December 31, 1999.
Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option
Values Table
<TABLE>
<CAPTION>
Number of Securities
Underlying Unexercised Value of Unexercised
Options at Fiscal Year- In-the-Money Options at
End Fiscal Year-End
Shares Acquired Value Realized ------------------------- -------------------------
Name on Exercise (#) On Exercise Exercisable Unexercisable Exercisable Unexercisable
- ---- --------------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Larissa H. Herda........ -- -- 140,625 1,234,375 $5,335,031 $24,329,719
Paul B. Jones........... -- -- 62,250 203,750 2,361,641 5,479,868
A. Graham Powers........ -- -- 37,500 162,500 1,422,675 3,914,925
David J. Rayner......... -- -- 46,875 378,125 1,778,344 7,595,306
John T. Blount.......... -- -- 37,500 362,500 1,422,675 7,002,525
</TABLE>
The in-the-money value of unexercised options is equal to the excess of the
per share market price of our Class A Common Stock at December 31, 1999
($49.94) over the per share exercise price, multiplied by the number of
unexercised options.
The following table lists for each of the named executive officers
information with respect to option exercises during 1999 and the status of
their options on December 31, 1999:
. the number of shares of Time Warner common stock, or MediaOne common
stock in the case of Mr. Blount, underlying options exercised during
1999;
. the aggregate dollar value realized upon exercise of such options;
. the total number of shares of Time Warner common stock or of MediaOne
common stock in the case of Mr. Blount, underlying exercisable and
nonexercisable stock options held on December 31, 1999; and
. the aggregate dollar value of in-the-money exercisable and
nonexercisable stock options on December 31, 1999.
None of the named executive officers has been awarded stock appreciation
rights alone or in tandem with options.
Aggregate Option Exercises of Time Warner and MediaOne Options in
Last Fiscal Year End and Fiscal Year-End Option Values Table
<TABLE>
<CAPTION>
Number of Shares Dollar Value of
Number of Dollar Underlying Unexercised Unexercised
Shares Value Options on In-the Money Options on
Underlying Realized December 31, 1999 December 31, 1999*
Options on -------------------------- --------------------------
Name Exercised Exercise Exercisable Nonexercisable Exercisable Nonexercisable
- ---- ---------- ---------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Larissa L. Herda........ -- $ -- 17,600 -- $ 766,772 $--
Paul B. Jones........... 101,778 4,133,526 16,698 -- 671,594 --
A. Graham Powers........ 10,000 475,627 34,600 -- 1,635,207 --
David J. Rayner......... 3,868 170,720 5,732 -- 179,691 --
John T. Blount.......... -- -- 521 -- 32,583 --
</TABLE>
- --------
* Based on a closing price of $72.31 per share of Time Warner common stock,
and $76.81 per share of MediaOne common stock with respect to stock options
held by Mr. Blount, on December 31, 1999 as reported on the New York Stock
Exchange Composite Listing.
63
<PAGE>
The option exercise price of all options held by the named executive
officers is the fair market value of the stock on the date of grant. All of the
options held by the named executive officers become immediately exercisable in
full upon the occurrence of certain events, including the death or total
disability of the option holder, certain change-of-control transactions and, in
most cases, the Company's breach of the holder's employment agreement. The Time
Warner options held by the named executive officers generally remain
exercisable for three years after their employment is terminated without cause,
for one year after death or total disability, for five years after retirement
and for three months after termination for any other reason, except that such
stock options awarded before 1996 are exercisable for three months after a
termination without cause and after retirement and those awarded after July
1997 are exercisable for three years after death or disability. All Time Warner
options terminate immediately if the holder's employment is terminated for
cause. The terms of the options shown in the chart are ten years.
64
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Stockholders Agreement
The Class B Stockholders entered into a Stockholders Agreement in connection
with the Reconstitution in May 1999. These Class B Stockholders presently hold
all of the Company's Class B Common Stock. We cannot assure you that the Class
B Stockholders will not change the Stockholders Agreement or terminate it or
cause the Company to waive any provision of such agreement.
Under the Stockholders Agreement, Time Warner initially has the right to
designate three nominees for the board of directors at each annual stockholders
meeting at which directors are elected. MediaOne has the right to designate
three nominees and Advance has the right to designate one. The Class B
Stockholders' ability to designate any nominees depends on the identity of the
particular stockholder and the percentage of shares of Common Stock owned by
it. The Stockholders Agreement provides that the percentage of Common Stock
that each Class B Stockholder must own in order to have the right to nominate
directors will be adjusted over time to reflect new issuances of Common Stock
by the Company. As of December 31, 1999, each Class B Stockholder must own at
least 7.32% of the Common Stock to appoint one director. Time Warner is
entitled to nominate three directors so long as it owns at least 14.64% of the
Common Stock. If Time Warner owns less than 14.64% of the Common Stock ("Time
Warner Step Event"), the number of directors that Time Warner may nominate
decreases proportionally with its ownership of the Common Stock until it owns
less than 7.32%. MediaOne is entitled to nominate three directors as long as it
owns at least 7.32% of the Common Stock. If a Time Warner Step Event occurs,
the number of directors that MediaOne is entitled to nominate decreases
proportionally with its ownership of the Common Stock. Advance is entitled to
nominate one director as long as it owns at least 7.32% of the Common Stock.
None of the Class B Stockholders have the right to designate nominees if they
own less than 7.32% of the Common Stock. These percentages continue to adjust
from time to time if the Company issues additional shares of Common Stock or
takes actions such as stock splits or recapitalizations so as to maintain the
same relative rights.
The Stockholders Agreement requires the Class B Stockholders to vote their
shares in favor of:
. the nominees selected by the holders of Class B Common Stock, as
previously described;
. the Chief Executive Officer of the Company; and
. two nominees who are not affiliated with the Company or any holder of
Class B Common Stock and are selected by the Nominating Committee.
The Stockholders Agreement prohibits the Class B Stockholders from any
transfer of Class B Common Stock, unless expressly permitted by the agreement.
In addition, the Stockholders Agreement prohibits any of the Class B
Stockholders from entering into voting agreements relating to the Class B
Common Stock with any third party.
If a Class B Stockholder wants to sell all of its Class B Common Stock
pursuant to a bona fide offer from an unaffiliated third party, that
stockholder must give notice (the "Refusal Notice") to all Class B
Stockholders. The notice must contain the identity of the offeror and offer to
sell the stock to the other Class B Stockholders upon the same terms and
subject to the conditions as the offer from the third party. The non-selling
holders of Class B Common Stock will have the right to purchase pro rata all,
but not less than all, of the Class B Common Stock. If the non-selling holders
fail to exercise their right to purchase all of the shares, the selling Class B
Stockholder is free, for a period of 90 days, to sell the shares of Class B
Common Stock (as shares of Class B Stock) to the third party offeror on terms
and conditions no less favorable to the selling Class B Common Stockholder than
those contained in the Refusal Notice. A Class B Stockholder may transfer all
of its right to nominate Class B nominee" for election to the board of
directors if it sells all of its shares Class B Common Stock. If Time Warner
wants to sell all of its Class B Common Stock and its Class A Common Stock that
represent more than one-third of the outstanding shares of Common Stock, the
other holders of Class B Common Stock will have certain "tag-along" rights.
These rights provide them the right to sell their shares of
65
<PAGE>
Class A Common Stock and Class B Common Stock on a pro rata basis along with,
and on the same terms and conditions as Time Warner. In that sale, Time Warner
(and any other stockholder transferring all of its shares of Class B Common
Stock) will have the right to transfer its right to nominate Class B nominees
for election to the board of directors.
Except for transfers to affiliates and the other transfers described above,
all shares of Class B Common Stock must be converted to Class A Common Stock
immediately prior to any direct transfer or certain indirect transfers of Class
B Common Stock. In addition, except for transfers described in the paragraph
above, a stockholder will not have the right to transfer its right to nominate
Class B nominees. A Class B Stockholder that is acquired by a third party or
spins off to its stockholders a company holding its shares of Class B Common
Stock (as well as other assets), is required to convert its shares into Class A
Common Stock and its right to nominate Class B nominees to the board of
directors will not terminate.
The Class B Stockholders have demand registration rights for shares of Class
A Common Stock (including shares of Class A Common Stock resulting from the
conversion of shares of Class B Common Stock) if they wish to register Class A
Common Stock constituting at least 1% of the total outstanding Class A Common
Stock. Once the Company has registered shares of Class A Common Stock as a
result of a demand registration, it is not required to register shares again,
pursuant to a Class B Stockholder demand, until 180 days after the first
registration statement is effective. In addition, each Class B Stockholder may
require the Company to include its shares in certain other registered offerings
under the Securities Act of 1933, subject to certain conditions. Each Class B
Stockholder must pay all underwriting discounts, commissions and transfer taxes
attributable to the sale of its shares. The Company will pay all expenses
relating to the filing and effectiveness of a registration statement, the legal
fees of one counsel representing the Class B Stockholders and the auditors'
fees and expenses.
Restated Certificate of Incorporation
Our Restated Certificate of Incorporation prohibits us from (i) engaging in
the business of providing, offering, packaging, marketing, promoting or
branding (alone or jointly with or as an agent for other parties) any
residential services, or (ii) producing or otherwise providing entertainment,
information or other content services, without the consent of all the Class B
Stockholders. This prohibition expires in May 2004 or earlier if the Class B
Stockholders no longer hold 50% of the total voting power for the board of
directors.
Certain Operating Agreements
Capacity License Agreements. We currently license much of our fiber capacity
from Time Warner Cable. Each of our local operations where Time Warner Cable
has a network is party to a Capacity License Agreement with the local cable
television operation of Time Warner Cable, providing us with a 30 year
exclusive right to use all of the capacity of specified fiber-optic cable owned
by the Time Warner Cable operation. The Capacity Licenses for network that
existed as of July 1998 have been fully paid and do not require additional
license fees. However, we must pay certain maintenance fees and fees for
splicing and similar services. We may request that Time Warner Cable construct
and provide additional fiber-optic cable capacity to meet our future needs.
Time Warner Cable is not obligated to provide such fiber capacity to us. If
Time Warner Cable provides additional capacity, we must pay an allocable share
of the cost of construction of the fiber upon which capacity is to be provided,
plus a permitting fee. We are responsible for all taxes and franchise or
similar fees arising out of our use of the capacity, and a portion of other
out-of-pocket expenses incurred by Time Warner Cable for the cable use to
provide us the capacity. We are permitted to use the capacity for
telecommunications services and any other lawful purpose, but not for the
provision of residential services and content services. If we violate the
limitations on our business activities contained in our the Restated
Certificate of Incorporation or the Capacity License Agreements, Time Warner
Cable may terminate the Capacity License Agreements. Accordingly, the Capacity
License Agreements restrictions will apply after the restrictions in the
Restated Certificate of Incorporation have terminated. Although management does
not believe that the restrictions contained in the Capacity License Agreements
will materially affect our business and operations in the immediate future, we
cannot predict the effect of such restrictions in the rapidly changing
telecommunications industry.
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<PAGE>
The Capacity License Agreements do not restrict us from licensing fiber-
optic capacity from parties other than Time Warner Cable. The Capacity License
Agreements expire in 2028. Although Time Warner Cable has agreed to negotiate
renewal or alternative provisions in good faith at that time, we cannot assure
that the parties will agree on the terms of any renewal or alternative
provisions or that the terms of any renewal or alternative provisions will be
favorable to us. If the Capacity License Agreements are not renewed in 2028, we
will have no further interest in the capacity under the Capacity License
Agreements and may need to build, lease or otherwise obtain transmission
capacity in order to serve our customers in the service areas covered by the
Capacity License Agreements. The terms of such arrangements could have a
material adverse effect on our business, financial condition and results of
operations. We have the right to terminate a Capacity License Agreement in
whole or in part at any time upon 180 days' notice and payment of any
outstanding fees regarding the terminated capacity. Time Warner Cable has the
right to terminate a Capacity License Agreement upon 180 days' notice in the
event of, among other things, certain governmental proceedings or third party
challenges to Time Warner Cable's franchises or a Capacity License Agreement.
The Capacity License Agreements include substantial limitations on liability
for service interruptions.
Facility Lease Agreements. We lease or sublease physical space located at
Time Warner Cable's facilities for various purposes under Facility Lease
Agreements. If certain events occur we will be required, at our own expense, to
segregate and partition our space in a reasonable, secure manner. Those events
are:
. at least a majority of any Time Warner Cable system is not owned by one
or more of the Class B Stockholders;
. Time Warner owning less than 30% of the Company's Common Stock;
. Time Warner having the right to nominate less than three nominees to our
board of directors;
. our non-compliance with the restrictions in the Restated Certificate of
Incorporation regarding residential services and content services; or
. a Class B Stockholder transferring its Class B Common Stock together
with its rights to designate nominees to the board of directors under
the Stockholders Agreement.
The lease rates for properties Time Warner Cable owns and leases to us are
based upon comparable rents in the local market, taking into account other
factors such as the term of the lease, type of space, square footage, location
and leasehold improvements funded. Generally, the leases have 15-year terms,
with two five year options to renew. For properties Time Warner Cable subleases
to us, we pay a pro rata portion of the rent and fees payable under the primary
lease. The duration of our subleases are as long as Time Warner Cable's primary
lease.
Services Agreement. Time Warner Cable provides us certain tax and management
information systems and support services pursuant to the Administrative
Services Agreement. Time Warner Cable determines the costs for such services
based upon our historical and projected usage, depending on the amount and type
of administrative services to be provided.
Residential Support Agreements. We provide certain support services or
service elements, on an unbundled basis, to Time Warner Cable for its
residential telephony business. Generally, we may adjust all rates for such
residential support services we provide to Time Warner Cable annually, but the
rates may not be less favorable than the rates we charge other customers for
comparable services.
Time Warner License Agreement. We use the "Time Warner" name under a license
agreement with Time Warner. We may change our name to "TW Telecom Inc." and
will no longer have the right to use the "Time Warner" name when the initial
four year term or any renewal term expires. We must also discontinue using the
"Time Warner" name if:
. Time Warner owns less than 30% of the Company's Common Stock;
. Time Warner has the right to nominate less than three nominees to our
board of directors;
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. our non-compliance with the restrictions in the Restated Certificate of
Incorporation regarding residential services and content services; or
. a Class B Stockholder transfers its Class B Common Stock together with
its rights to designate nominees to the board of directors under the
Stockholders Agreement.
This name change, and the inability to use the "Time Warner" name could
adversely effect our ability to conduct our business and our financial
condition and results of operations.
We believe that the terms and conditions, taken as a whole, of the
transactions described under the headings "Capacity License Agreements,"
"Facility Lease Agreements," "Services Agreement," "Residential Support
Agreements" and the "Time Warner License Agreement" were no less favorable to
us than we could have obtained from unaffiliated parties.
The Class B Stockholders hold all of our Class B Common Stock and have the
collective ability to control all matters requiring stockholder approval,
including the election of directors. All of the Class B Stockholders are in the
cable television business and may provide the same services or similar services
to those we provide. There is no restriction on the Class B Stockholders'
ability to compete with the Company and we cannot assure that the Class B
Stockholders will not compete with the Company. Our directors, who are also
directors, officers or employees of the Class B Stockholders, may encounter
conflicts of interest in certain business opportunities available to, and
certain transactions involving, the Company. The Class B Stockholders have not
adopted any special voting procedures to deal with conflicts of interest, and
we cannot assure that any conflict will be resolved in the Company's favor.
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PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the equity securities of the Company as of March 17, 2000,
assuming the underwriters' over-allotment option is not exercised, for:
. each owner of more than 5% of any class of equity securities of the
Company, other than MediaOne;
. each of the directors and the named executive officers;
. all directors and executive officers as a group; and
. the selling stockholder.
To the Company's knowledge, each person, along with his or her spouse, has
sole voting and investment power over the shares unless otherwise noted.
Information in the first table is as of the latest reports by those entities
received by us. Ownership includes direct and indirect (beneficial) ownership,
as defined by SEC rules. Each executive officer's address is c/o the Company,
10475 Park Meadows Drive, Littleton, CO 80124.
<TABLE>
<CAPTION>
Class A Common Stock (1)(2) Class B Common Stock (1)(2) Total Common Stock
---------------------------- ----------------------------- ---------------------------------------
% of
Percent of Class Percent of Class Percent of Equity Voting
------------------ ------------------ ------------------ Power
Prior to Following Prior to Following Prior to Following Following
Name of Beneficial No. of the the No. of the the No. of the the the
Owner Shares Offering Offering Shares Offering Offering Shares Offering Offering Offering
- ------------------ --------- -------- --------- ---------- -------- --------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Five Percent
Stockholders:
Time Warner(3)..... -- -- -- 50,363,739 62.0% 70.2% 50,363,739 47.9% 47.9% 67.1%
Advance(4)......... -- -- -- 15,572,919 19.2% 21.7% 15,572,919 14.8% 14.8% 20.7%
FMR Corp.(5)....... 2,628,315 11.0% 6.7% -- -- -- 2,628,315 2.5% 2.5% *
Pequot Capital
Management,
Inc.(6)........... 1,541,700 6.4% 3.9% -- -- -- 1,541,700 1.5% 1.5% *
Directors and
Executive
Officers:
Larissa L. Herda... 79,062 * * -- -- -- 79,062 * * *
Glenn A. Britt..... -- -- -- -- --
Bruce Claflin...... 1,700 * * -- -- -- 1,700 * * *
Richard J. Davies.. -- -- -- -- --
Spencer B. Hays.... 2,000 * * -- -- -- 2,000 * * *
Douglas Holmes..... 2,000 * * -- -- -- 2,000 * * *
Lisa Hook.......... -- -- -- -- --
Robert J. Miron.... 7,500 * * -- -- -- 7,500 * * *
Audley M. Webster,
Jr................ -- * * -- -- -- --
James N. Zerefos... 1,000 * * -- -- -- 1,000 * * *
David J. Rayner.... 34,687 * * -- -- -- 34,687 * * *
Paul B. Jones...... 79,625 * * -- -- -- 79,625 * * *
John T. Blount..... 29,750 * * -- -- -- 29,750 * * *
A. Graham Powers... 44,850 * * -- -- -- 44,850 * * *
All directors and
executive officers
as a group (17
persons)(7)....... 368,599 1.5% * -- -- -- 368,599 * * *
Selling
Stockholder:
MediaOne(8)........ 12,215 * -- 15,277,627 18.8% 8.1% 15,289,842 14.5% 5.5% 7.7%
</TABLE>
- --------
* Represents less than one percent.
(1) The Company has two classes of outstanding Common Stock, the Class A
Common Stock and the Class B Common Stock. Beneficial ownership of Common
Stock has been determined in accordance with the rules of the Securities
and Exchange Commission, which is based upon having or sharing the power
to vote or dispose of shares. Includes shares of Class A Common Stock
issuable upon exercise of options exercisable within 60 days of March 17,
2000, as follows: Ms. Herda--64,062 shares; Mr. Rayner--34,687 shares; Mr.
Jones--72,625 shares; Mr. Blount--23,750 shares; Mr. Powers--43,750
shares; and all directors and executive officers as a group--301,499
shares.
(2) Excludes an equal amount of Class A Common Stock into which Class B Common
Stock are convertible. The Class B Common Stock held by Time Warner,
MediaOne and Advance represented on a converted basis 47.9%, 14.5% and
14.8%, respectively, of the Class A Common Stock prior to the offering.
(3) Owned by Time Warner Companies, Inc., American Television and
Communications Corporation, Warner Communications Inc., TW/TAE, Inc.,
FibrCOM Holdings, L.P. and Paragon Communications, each a direct or
indirect wholly owned subsidiary of Time Warner Inc. The business address
of Time Warner Inc. is 75 Rockefeller Plaza, New York, NY 10019.
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(4) Owned by Advance/Newhouse Partnership. The business address of
Advance/Newhouse is 5015 Campuswood Drive, East Syracuse, NY 13057.
(5) Based on a Schedule 13G dated March 10, 2000. Consists of 2,513,015 shares
of Class A Common Stock beneficially owned by Fidelity Management &
Research Company, a wholly owned subsidiary of FMR Corp., and 115,300
shares beneficially owned by Fidelity Management Trust Company, a wholly
owned subsidiary of FMR Corp. Sole power to vote or direct the voting of
the 2,513,015 shares owned by Fidelity Management & Research Company
resides with the Fidelity Funds' Board of Trustees. The business address
of FMR Corp. is 82 Devonshire Street, Boston, Massachusetts 02109.
(6) Based on a Schedule 13G dated February 10, 2000. The business address of
Pequot Capital Management, Inc. is 500 Nyala Farm Road, Westport,
Connecticut 06880.
(7) Solely as a result of the agreement of the Class B Stockholders to vote in
favor of the others' director nominees under the stockholders agreement,
the Class B Stockholders may be deemed to share beneficial ownership of
the shares beneficially owned by each of them. See "Certain Relationships
and Related Transactions--Stockholders Agreement."
(8) Owned by MediaOne Holdings II, Inc., a Delaware corporation and wholly
owned subsidiary of MediaOne Group, Inc., a Delaware corporation. The
business address of MediaOne is 188 Inverness Drive West, Englewood, CO
80112.
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DESCRIPTION OF CERTAIN INDEBTEDNESS
Senior Notes
On July 21, 1998, the Company completed the public offering of $400.0
million aggregate principal amount of the Senior Notes. The Senior Notes were
issued pursuant to the indenture. For the purposes of this section only, the
term "obligor":
. when used in relation to any period prior to the Reconstitution, refers
collectively to TWT LLC and TWT Inc., as co-obligors of the Senior
Notes, and does not include any other consolidated or unconsolidated
subsidiary of TWT LLC; and
. when used in relation to any period after the Reconstitution, refers to
New Time Warner Telecom, as successor obligor to the Senior Notes.
The Senior Notes are unsecured unsubordinated obligations of the obligor,
ranking equally in right of payment with all existing and future unsubordinated
indebtedness of the obligor and senior in right of payment to all subordinated
indebtedness of the obligor. Interest on the Senior Notes will accrue at the
rate of 9 3/4% per annum from July 21, 1998 or from the most recent interest
payment date to which interest has been paid or provided for, payable
semiannually on January 15 and July 15. The Senior Notes will be subject to
redemption at the option of the obligor, in whole or in part, at any time on or
after July 15, 2003, initially at 104.875% of their principal amount and
declining to 100% of their principal amount at maturity on or after July 15,
2006, plus accrued and unpaid interest to the applicable redemption date. In
addition, at any time prior to July 15, 2001, in the event of an offering of
the Common Stock of the Company for cash, the obligor may, at its option,
within 90 days of an offering, use the net proceeds of the offering to redeem
up to 35% of the aggregate principal amount at maturity of the Senior Notes at
a redemption price of 109.75% of the principal amount on the redemption date;
provided that at least 65% of the aggregate principal amount at maturity of the
Senior Notes originally issued remain outstanding immediately after each
redemption. Upon the occurrence of a change of control under the indenture, the
obligor must commence, within 30 days of the later of the occurrence of such
change of control and the end of the change of control period required under
the indenture, an offer to purchase the Senior Notes then outstanding at a
purchase price of 101% of their principal amount; provided that the obligor
shall not be required to commence an offer to purchase if, at any time within
30 days of the later of the occurrence of the change of control and the end of
the change of control period, the Senior Notes shall be rated investment grade
under the indenture.
The indenture limits, and in some circumstances prohibits, the ability of
the Company to:
. incur additional debt;
. pay dividends;
. make investments or other restricted payments;
. engage in transactions with stockholders and affiliates;
. create liens;
. sell assets;
. issue or sell capital stock of subsidiaries; and
. engage in mergers and consolidations.
The indenture also provides for the repayment of subordinated debt,
including the subordinated indebtedness to affiliates of the Class B
Stockholders, prior to maturity with the net proceeds of any offering of Common
Stock or equivalent interests of the Company.
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Bank Facility
The Company recently entered into a senior secured revolving credit facility
that provides for credit to certain subsidiaries of $475 million on a revolving
basis. We also have the option to increase the available credit under the
facility with the consent of the participating banks.
Our obligations under the facility are secured by substantially all of the
assets of our subsidiaries together with any assets that may be acquired in the
future. We also have pledged the capital stock of all of our subsidiaries as
collateral.
The facility has a termination date of December 31, 2007, and we will have
to repay any outstanding amounts on this date. Beginning in 2004, the total
amount available to us will be reduced each year by a fixed percentage. Loans
under the proposed facility will bear interest initially at a yearly rate equal
to:
. for base rate loans, the banks' announced base rate plus a margin of
1.0%; and
. for LIBOR loans, the eurodollar rate plus an applicable margin of 2.0%.
The applicable margins may be reduced based upon our financial performance. We
expect to be required to pay commitment fees on a quarterly basis ranging from
.875% to .500% on the undrawn available commitment.
We will be required to prepay any amounts that we have borrowed with the
proceeds we receive from a number of specified events or transactions. In
addition, our obligations under the facility are subject to various covenants
that will limit our ability to:
. borrow and incur liens on our property;
. pay dividends or make other distributions; and
. make capital expenditures.
The facility also contains financial covenants, including a consolidated
leverage ratio, a consolidated interest coverage ratio and a consolidated debt
service coverage ratio. In addition, the facility contains customary events of
default, including cross default provisions. Under the cross default
provisions, we will be deemed to be in default under the facility if we have
defaulted under any of our other material outstanding obligations, such as our
Senior Notes.
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DESCRIPTION OF CAPITAL STOCK
The Company's Restated Certificate of Incorporation provides for authorized
capital stock of 459.8 million shares, including 277.3 million shares of Class
A Common Stock, $.01 par value per share, 162.5 million shares of Class B
Common Stock, $.01 par value per share, and 20 million shares of preferred
stock, $.01 par value per share. No preferred stock is outstanding and the
Class B Stockholders own of record all of the outstanding shares of Class B
Common Stock. See "Principal and Selling Stockholders."
The following summary description relating to the capital stock of the
Company does not purport to be complete. The rights of the holders of the
Company's capital stock are set forth in the Company's Restated Certificate of
Incorporation, a copy of which is filed as an exhibit to the registration
statement of which this prospectus forms a part. The summary set forth below is
qualified by reference to such exhibits and to the applicable provisions of the
Delaware General Corporation Law.
Common Stock
The relative rights of the Class A Common Stock and Class B Common Stock are
substantially identical in all respects, except for voting rights and
conversion rights.
Voting Rights. Each share of Class A Common Stock entitles the holder to one
vote and each share of Class B Common Stock entitles the holder to 10 votes on
each matter to be voted upon by the holders of the Common Stock. The holders of
the shares of Class A Common Stock and Class B Common Stock vote as one class
on all matters to be voted on by stockholders, including, without limitation,
the election of directors and any proposed amendment to the Restated
Certificate of Incorporation of the Company that would increase the authorized
number of shares of Common Stock or any class thereof or any other class or
series of stock or decrease the number of authorized shares of any class or
series of stock (but not below the number then outstanding), except as required
by the Delaware General Corporation Law and except that,
(1) as long as the outstanding Class B Common Stock represents at least
50% of the aggregate voting power of both classes of Common Stock
outstanding, the approval of 100% of the Class B Stockholders is required:
. to amend, alter or repeal any provision of the Restated Certificate
of Incorporation, other than in connection with certain ministerial
actions; or
. for any direct or indirect disposition by the Company of capital
stock of subsidiaries or assets that in either case represent
substantially all the assets of the Company and its subsidiaries on
a consolidated basis.
(2) The approval of 100% of the Class B Stockholders is required for the
issuance of any additional shares of Class B Common Stock or any capital
stock having more than one vote per share.
(3) without a majority vote of the holders of the Class A Common Stock,
certain provisions of the Restated Certificate of Incorporation relating to
the termination of, and vote required to waive, the limitations on business
purposes described in the next sentence may not be amended, altered or
repealed.
Under the Restated Certificate of Incorporation, the Company may not
directly or indirectly, through a subsidiary or affiliate of the Company,
(a) engage in the business of providing, offering, packaging, marketing,
promoting or branding (alone or jointly with or as an agent for other
parties) any wireline telecommunications services or other services,
including data services, to residences (collectively, "residential
services") or
(b) engage in the business of producing, packaging, distributing,
marketing, hosting, offering, promoting, branding or otherwise providing
entertainment, information or any other content services, whether fixed or
interactive, or any services incidental thereto, but excluding acting
solely as a carrier of video, audio or data of unaffiliated third parties
by providing transport services, so long as the Company
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has no other direct or indirect pecuniary interest in the transmitted
information or content (collectively, "content services"), in each case
until the earlier of (1) the date that is five years after the date of the
filing of the Restated Certificate of Incorporation and (2) the date on
which the holders of Class B Common Stock no longer represent at least 50%
of the voting power of the outstanding Common Stock of the Company.
Neither the holders of Class A Common Stock nor the holders of Class B
Common Stock have cumulative voting rights. For a discussion of the effects of
the disproportionate voting rights of the Class A Common Stock and Class B
Common Stock, see "Risk Factors--The Class B Stockholders control the Company."
Dividends. Each share of Common Stock is entitled to receive dividends from
funds legally available therefor if, as and when declared by the board of
directors of the Company. Class A Common Stock and Class B Common Stock share
equally, on a share-for-share basis, in any dividends declared by the board of
directors. If at any time a distribution of the Class A Common Stock or Class B
Common Stock is to be paid in shares of Class A Common Stock, Class B Common
Stock or any other securities of the Company or any other person, such
dividends may be declared and paid only as follows:
(1) a share distribution consisting of Class A Common Stock to holders
of Class A Common Stock and Class B Common Stock, on an equal per share
basis; or to holders of Class A Common Stock only, but in such event there
shall also be a simultaneous share distribution to holders of Class B
Common Stock consisting of shares of Class B Common Stock on an equal per
share basis;
(2) a share distribution consisting of Class B Common Stock to holders
of Class B Common Stock and Class A Common Stock, on an equal per share
basis; or to holders of Class B Common Stock only, but in such event there
shall also be a simultaneous share distribution to holders of Class A
Common Stock consisting of shares of Class A Common Stock on an equal per
share basis; and
(3) a share distribution of shares of any class of securities of the
Company or any other person other than the Common Stock, either on the
basis of a distribution of identical securities, on an equal per share
basis to the holders of Class A Common Stock and Class B Common Stock, or
on the basis of a distribution of one class of securities to the holders of
Class A Common Stock and another class of securities to holders of Class B
Common Stock, provided that the securities so distributed do not differ in
any respect other than relative voting rights and related differences in
designations, conversion and share distribution provisions, with the
holders of Class B Common Stock receiving the class having the higher
relative voting rights, provided that if the securities so distributed
constitute capital stock of a subsidiary of the Company, such rights shall
not differ to a greater extent than the corresponding differences in voting
rights, designations, conversion and distribution provisions between Class
A Common Stock and Class B Common Stock.
If the Company shall in any manner subdivide or combine the outstanding
shares of Class A Common Stock or Class B Common Stock, the outstanding shares
of the other class of Common Stock shall be proportionally subdivided or
combined in the same manner and on the same basis as the outstanding shares of
Class A Common Stock or Class B Common Stock, as the case may be, that have
been subdivided or combined.
Conversion. Under the Restated Certificate of Incorporation, each share of
Class B Common Stock is convertible at any time and from time to time at the
option of the holder thereof into one share of Class A Common Stock. The Class
A Common Stock has no conversion rights.
Equivalent Consideration in Certain Transactions. In the event of any
merger, consolidation, acquisition of all or substantially all the assets of
the Company or other reorganization to which the Company is a party, in which
any consideration is to be received by the holders of Class A Common Stock and
Class B Common Stock, those holders must receive the Equivalent Consideration
(as defined below) on a per share basis. Under the Restated Certificate of
Incorporation of the Company, "Equivalent Consideration" is defined as
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consideration of substantially equivalent economic value as determined by the
board of directors of the Company at the time of execution of the definitive
agreement relating to the applicable merger, consolidation, acquisition or
reorganization, provided, that (i) the holders of Class A Common Stock can
receive consideration of a different form from the consideration to be received
by the holders of Class B Common Stock and (ii) if the holders of Class A
Common Stock and Class B Common Stock are to receive securities of any other
person, such securities (and, if applicable, the securities into which the
received securities are convertible, or for which they are exchangeable, or
which they evidence the right to purchase) can differ with respect to their
relative voting rights and related differences in conversion and share
distribution provisions, with the holders of shares of Class B Common Stock
receiving the class or series having the higher relative voting rights, and the
differences permitted by this clause (ii) are not taken into account in the
determination of equivalent economic value.
Other. Stockholders of the Company have no preemptive or other rights to
subscribe for additional shares. All holders of Common Stock, regardless of
class, are entitled to share equally on a share-for-share basis in any assets
available for distribution to stockholders on liquidation, dissolution or
winding up of the Company. All outstanding shares are, and all shares offered
by this prospectus will be, when sold, validly issued, fully paid and
nonassessable. The Company may not subdivide or combine shares of Common Stock
without at the same time proportionally subdividing or combining shares of the
other classes.
Preferred Stock
The Company's board of directors is authorized to provide for the issuance
of preferred stock in one or more series and to fix the designation,
preferences, powers and relative, participating, optional and other rights,
qualifications, limitations and restrictions thereof, including the dividend
rate, conversion rights, voting rights, redemption price and liquidation
preference and to fix the number of shares to be included in any such series.
Any preferred stock so issued may rank senior to the Common Stock with respect
to the payment of dividends or amounts upon liquidation, dissolution or winding
up, or both. In addition, any such shares of preferred stock may have class or
series voting rights.
Corporate Opportunities
The Restated Certificate of Incorporation provides that the Class B
Stockholders are not restricted from engaging directly or indirectly in the
same or similar business activities or lines of business as the Company. In the
event that any of the Class B Stockholders acquires knowledge of a potential
transaction or matter that may be a corporate opportunity for any of the Class
B Stockholders and the Company, such corporate opportunity shall be allocated
to the Class B Stockholder if offered to any person who is an officer, employee
or director of the Class B Stockholder and/or the Company, unless such
opportunity is expressly offered to such person primarily in his or her
capacity as an officer, employee or director of the Company. Other than under
these circumstances, the Class B Stockholders shall have no duty to communicate
or present such corporate opportunity to the Company.
Section 203 of the Delaware General Corporation Law
The Restated Certificate of Incorporation of the Company expressly states
that the Company has elected not to be governed by Section 203 of the Delaware
General Corporation Law, which prohibits a publicly held Delaware corporation
from engaging in a "business combination", as defined in clause (c)(3) of that
section, with an "interested stockholder", as defined in clause (c)(5) of that
section, for a period of three years after the date of the transaction in which
the stockholder became an interested stockholder.
Limitations on Liability and Indemnification of Officers and Directors
The Restated Certificate of Incorporation limits the liability of directors
to the fullest extent permitted by the Delaware General Corporation Law. In
addition, the Restated Certificate of Incorporation provides that the
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Company shall indemnify directors and officers of the Company to the fullest
extent permitted by that law. The Company has entered into separate
indemnification agreements with its current directors and executive officers
which have the effect of providing such persons indemnification protection in
the event the Restated Certificate of Incorporation is subsequently amended.
Nasdaq Trading
The Class A Common Stock is listed on the Nasdaq National Market of the
Nasdaq National Market under the symbol "TWTC."
Transfer Agent and Registrar
The transfer agent and registrar for the Common Stock is Norwest Bank,
Minnesota N.A.
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CERTAIN UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS OF COMMON STOCK
General
The following is a general discussion of U.S. Federal income and estate tax
consequences of the ownership and disposition of common stock that may be
relevant to you if you are a "non-U.S. holder". For purposes of this summary, a
non-U.S. holder is a beneficial owner of common stock that is, for U.S. Federal
income tax purposes, (1) a nonresident alien individual, (2) a foreign
corporation, (3) a nonresident alien fiduciary of a foreign estate or trust or
(4) a foreign partnership one or more of the members of which is, for U.S.
Federal income tax purposes, a nonresident alien individual, a foreign
corporation or a nonresident alien fiduciary of a foreign estate or trust.
This discussion does not address all aspects of U.S. Federal income and
estate taxation that may be relevant to you in light of your particular
circumstances, and does not address any foreign, state or local tax
consequences. Furthermore, this discussion is based on provisions of the
Internal Revenue Code, Treasury regulations and administrative and judicial
interpretations as of the date hereof. All of these are subject to change,
possibly with retroactive effect, or different interpretations. If you are
considering buying common stock you should consult your own tax advisor about
current and possible future tax consequences of holding and disposing of common
stock in your particular situation.
Distributions
We do not anticipate paying cash dividends on our Common Stock in the
foreseeable future. See "Risk Factors--The indenture for the Senior Notes
contains restrictive covenants that may limit our flexibility." However, if
distributions are paid on the shares of Common Stock, these distributions
generally will constitute dividends for U.S. Federal income tax purposes to the
extent paid from our current or accumulated earnings and profits, as determined
under U.S. Federal income tax principles. Dividends paid to a non-U.S. holder
that are not effectively connected with a U.S. trade or business of the non-
U.S. holder will be subject to United States withholding tax at a 30% rate or,
if a tax treaty applies, a lower rate specified by the treaty. To receive a
reduced treaty rate, a non-U.S. holder must furnish to us or our paying agent a
duly completed Form 1001 or Form W-8BEN (or substitute form) certifying to its
qualification for such rate.
Currently, withholding is generally imposed on the gross amount of a
distribution, regardless of whether we have sufficient earnings and profits to
cause the distribution to be a dividend for U.S. Federal income tax purposes.
However, withholding on distributions made after December 31, 2000 may be on
less than the gross amount of the distribution if the distribution exceeds a
reasonable estimate of our accumulated and current earnings and profits.
Dividends that are effectively connected with the conduct of a trade or
business within the U.S. and, if a tax treaty applies, are attributable to a
U.S. permanent establishment of the non-U.S. holder, are exempt from U.S.
Federal withholding tax, provided that the non-U.S. holder furnishes to us or
our paying agent a duly completed Form 4224 or Form W-8ECI (or substitute form)
certifying the exemption. However, dividends exempt from U.S. withholding
because they are effectively connected or they are attributable to a U.S.
permanent establishment are subject to U.S. Federal income tax on a net income
basis at the regular graduated U.S. Federal income tax rates. Any such
effectively connected dividends received by a foreign corporation may, under
certain circumstances, be subject to an additional "branch profits tax" at a
30% rate or a lower rate specified by an applicable income tax treaty.
Under current U.S. Treasury regulations, dividends paid before January 1,
2001 to an address outside the United States are presumed to be paid to a
resident of the country of address for purposes of the withholding discussed
above and for purposes of determining the applicability of a tax treaty rate.
However, U.S. Treasury
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regulations applicable to dividends paid after December 31, 2000 eliminate this
presumption, subject to certain transition rules.
For dividends paid after December 31, 2000, a non-U.S. holder generally will
be subject to U.S. backup withholding tax at a 31% rate under the backup
withholding rules described below, rather than at a 30% rate or a reduced rate
under an income tax treaty, as described above, unless the non-U.S. holder
complies with certain Internal Revenue Service certification procedures or, in
the case of payments made outside the U.S. with respect to an offshore account,
certain IRS documentary evidence procedures. Further, to claim the benefit of a
reduced rate of withholding under a tax treaty for dividends paid after
December 31, 2000, a non-U.S. holder must comply with certain modified IRS
certification requirements. Special rules also apply to dividend payments made
after December 31, 2000 to foreign intermediaries, U.S. or foreign wholly owned
entities that are disregarded for U.S. Federal income tax purposes and entities
that are treated as fiscally transparent in the U.S., the applicable income tax
treaty jurisdiction, or both. You should consult your own tax advisor
concerning the effect, if any, of the rules affecting post-December 31, 2000
dividends on your possible investment in common stock.
A non-U.S. holder may obtain a refund of any excess amounts withheld by
filing an appropriate claim for refund along with the required information with
the IRS.
Gain on Disposition of Common Stock
A non-U.S. holder will generally not be subject to U.S. Federal income tax
with respect to gain recognized on a sale or other disposition of our Common
Stock unless one of the following apply:
. If the gain is effectively connected with a trade or business of the
non-U.S. holder in the United States and, if a tax treaty applies, the
gain is attributable to a U.S. permanent establishment maintained by the
non-U.S. holder. The non-U.S. holder will, unless an applicable treaty
provides otherwise, be taxed on its net gain derived from the sale under
regular graduated U.S. Federal income tax rates. If the non-U.S. holder
is a foreign corporation, it may be subject to an additional branch
profits tax equal to 30% of its effectively connected earnings and
profits within the meaning of the Internal Revenue Code for the taxable
year, as adjusted for certain items, unless it qualifies for a lower
rate under an applicable income tax treaty and duly demonstrates such
qualification.
. If a non-U.S. holder who is an individual and holds our Common Stock as
a capital asset is present in the United States for 183 or more days in
the taxable year of the disposition and certain other conditions are
met, the non-U.S. holder will be subject to a flat 30% tax on the gain
derived from the sale, which may be offset by certain U.S. capital
losses.
. If we are or have been a "U.S. real property holding corporation" for
U.S. Federal income tax purposes at any time during the shorter of the
five-year period ending on the date of the disposition or the period
during which the non-U.S. holder held the Common Stock. We believe that
we never have been and are not currently a U.S. real property holding
corporation for U.S. Federal income tax purposes. Although we consider
it unlikely based on our current business plans and operations, we may
or may not become a U.S. real property holding corporation in the
future. Even if we were to become a U.S. real property holding
corporation, any gain recognized by a non-U.S. holder still would not be
subject to U.S. tax if the shares were considered to be "regularly
traded on an established securities market" and the non-U.S. holder did
not own, actually or constructively, at any time during the shorter of
the periods described above, more than five percent of a class of Common
Stock.
Federal Estate Tax
Common Stock held by an individual non-U.S. holder at the time of death will
be included in such holder's gross estate for U.S. Federal estate tax purposes,
unless an applicable estate tax treaty provides otherwise.
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Information Reporting and Backup Withholding Tax
Under U.S. Treasury regulations, we must report annually to the IRS and to
each non-U.S. holder the amount of dividends paid to such holder and the tax
withheld with respect to such dividends. These information reporting
requirements apply even if withholding was not required because the dividends
were effectively connected dividends or withholding was reduced or eliminated
by an applicable income tax treaty. Pursuant to an applicable tax treaty, that
information may also be made available to the tax authorities in the country in
which the non-U.S. holder resides.
United States Federal backup withholding generally is a withholding tax
imposed at the rate of 31% on certain payments to persons that fail to furnish
certain required information. Backup withholding generally will not apply to
dividends paid before January 1, 2001 to non-U.S. holders. See the discussion
under "Distributions" above for rules regarding reporting requirements to avoid
backup withholding on dividends paid after December 31, 2000.
As a general matter, information reporting and backup withholding will not
apply to a payment by or through a foreign office of a foreign broker of the
proceeds of a sale of Common Stock effected outside the U.S. However,
information reporting requirements, but not backup withholding, will apply to a
payment by or through a foreign office of a broker of the proceeds of a sale of
Common Stock effected outside the U.S. if that broker:
. is a U.S. person;
. is a foreign person that derives 50% or more of its gross income for
certain periods from the conduct of a trade or business in the U.S.;
. is a "controlled foreign corporation" as defined in the Internal Revenue
Code; or
. is a foreign partnership with certain U.S. connections (for payments
made after December 31, 2000).
Information reporting requirements will not apply in the above cases if the
broker has documentary evidence in its records that the holder is a non-U.S.
holder and certain conditions are met or the holder otherwise establishes an
exemption.
Payment by or through a U.S. office of a broker of the proceeds of a sale of
Common Stock is subject to both backup withholding and information reporting
unless the holder certifies to the payor in the manner required as to its non-
U.S. status under penalties of perjury or otherwise establishes an exemption.
Amounts withheld under the backup withholding rules do not constitute a
separate U.S. Federal income tax. Rather, any amounts withheld under the backup
withholding rules will be refunded or allowed as a credit against the holder's
U.S. Federal income tax liability, if any, provided the required information or
appropriate claim for refund is filed with the IRS.
The foregoing discussion is a summary of certain U.S. Federal Income and
Estate Tax consequences of the ownership, sale or other disposition of Common
Stock by non-U.S. holders. You are urged to consult your own tax advisor with
respect to the particular tax consequences to you of ownership and disposition
of common stock, including the effect of any state, local, foreign or other tax
laws.
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SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering and exercise of the underwriters' over-
allotment option, there will be 33,368,601 shares of Class A Common Stock
outstanding and 71,726,500 shares of Class B Common Stock outstanding, all of
which are convertible into Class A Common Stock on a share for share basis. The
Company has reserved for issuance 9,027,000 shares of Class A Common Stock upon
the exercise of stock options. Options to purchase 7,865,203 shares were
outstanding as of February 29, 2000.
The selling stockholder has agreed that, without the prior written consent
of Lehman Brothers and Morgan Stanley & Co. Incorporated, it will not, during
the period ending 180 days after the date of this prospectus, (1) publicly
offer, pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend, or otherwise transfer, dispose of or distribute, directly or
indirectly, any shares of Class A Common Stock or any securities convertible
into the Class A Common Stock, or (2) enter into any public swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of the Class A Common Stock, whether any such
transaction described in clause (1) or (2) above is to be settled by delivery
of Class A Common Stock or such other securities, in cash or otherwise. The
foregoing sentence shall not apply to (a) the sale of any shares of Class A
Common Stock to the underwriters pursuant to the underwriting agreement, (b)
transactions relating to shares of Class A Common Stock or other securities
acquired in open market transactions after the completion of this offering, (c)
private transactions relating to shares of Class A Common Stock or any
securities convertible into the Class A Common Stock, provided that the selling
stockholder shall ensure that any transferee that receives such shares in a
private transaction shall be subject to the remainder of the 180-day lock-up
period set forth in clauses (1) and (2) above, or (d) the registration of
shares of Class A Common Stock pursuant to the selling stockholder's incidental
registration rights under Section 4.2 of the Stockholders' Agreement, dated as
of May 10, 1999, among the Class B Stockholders.
The Company and each of the Class B Stockholders, other than the selling
stockholder, has agreed that, without the prior written consent of Lehman
Brothers Inc. and Morgan Stanley & Co. Incorporated, it will not, during the
period ending 90 days after the date of this prospectus, (1) publicly offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend, or otherwise transfer, dispose of or distribute, directly or
indirectly, any shares of Class A Common Stock or any securities convertible
into the Class A Common Stock (other than the Class B Common Stock) or (2)
enter into any public swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the Class A
Common Stock, whether any such transaction described in clause (1) or (2) above
is to be settled by delivery of Class A Common Stock or such other securities,
in cash or otherwise. The foregoing sentence shall not apply to (a) the sale of
any shares of Class A Common Stock to the underwriters pursuant to the
underwriting agreement, (b) transactions relating to shares of Class A Common
Stock or other securities acquired in open market transactions after the
completion of this offering, (c) the surrender of unexercised options or shares
upon a "cashless exercise" of options or other incentive compensation awards or
(d) private transactions relating to shares of Class A Common Stock, provided
that the Company or such Class B Stockholder shall ensure that any transferee
that receives shares of Class A Common Stock in a private transaction shall be
subject to the remainder of the 90-day lock-up period set forth in clauses (1)
and (2) above. See "Underwriting." After that 90-day period, other holders of
the Class B Common Stock may or may not decide, based upon then prevailing
market and other conditions, to convert their Class B Common Stock to Class A
Common Stock and to dispose of all or a portion of such stock pursuant to the
provisions of Rule 144 under the Securities Act of 1933 or pursuant to the
demand registration rights contained in the stockholders agreement among the
Class B Stockholders. See "Certain Relationships and Related Transactions--
Stockholders Agreement."
Future sales of substantial amounts of Class A Common Stock in the public
market, or the perception that such sales could occur, may have an adverse
impact on the market price for the shares of Class A Common Stock offered
hereby or on the ability of the Company to raise capital through a public
offering of its equity securities. See "Risk Factors--Future sales of shares of
Class A Common Stock could depress the price of the Class A Common Stock."
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UNDERWRITING
Subject to the terms and conditions stated in the underwriting agreement
dated the date hereof, the underwriters of the offering in the United States
and Canada named below, for whom Lehman Brothers Inc., Morgan Stanley & Co.
Incorporated, Bear, Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation are acting as representatives, severally agreed to
purchase from the selling stockholder, and the selling stockholder has agreed
to sell to the underwriters, the number of shares of Class A Common Stock set
forth opposite the name of each underwriter. Lehman Brothers Inc. and Morgan
Stanley & Co. Incorporated are acting as joint book-running managers for the
offering.
<TABLE>
<CAPTION>
Number
Underwriters of shares
------------ ---------
<S> <C>
Lehman Brothers Inc............................................ 4,050,000
Morgan Stanley & Co. Incorporated.............................. 4,050,000
Bear, Stearns & Co. Inc........................................ 450,000
Donaldson, Lufkin & Jenrette Securities Corporation............ 450,000
---------
Total........................................................ 9,000,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase the shares included in the offering are subject to
approval of legal matters by counsel as well as to other conditions. The
underwriters are obligated to purchase all the shares, other than those covered
by the over-allotment option described below, if they purchase any of the
shares.
The underwriters propose to offer some of the shares directly to the public
at the public offering price set forth on the cover page of this prospectus and
some of the shares to certain dealers at the public offering price less a
concession not in excess of $1.05 per share. The underwriters may allow, and
such dealers may reallow, a concession not in excess of $.10 per share on sales
to certain other dealers. If all of the shares are not sold at the initial
offering price, the representatives may change the public offering price and
the other selling terms.
The selling stockholder has granted the underwriters an option to purchase
up to an aggregate of 500,000 additional shares of Class A Common Stock,
exercisable to cover over-allotments, if any, at the public offering price less
the underwriting discount shown on the cover page of this prospectus. The
underwriters may exercise this option at any time until 30 days after the date
of the underwriting agreement. If the option is exercised, each underwriter
will be committed, so long as the conditions of the underwriting agreement are
satisfied, to purchase a number of additional shares of Class A Common Stock
proportionate to the underwriters' initial commitment as indicated in the table
above, and the selling stockholder will be obligated, under the over-allotment
option, to sell the shares of Class A Common Stock to the underwriters.
The selling stockholder has agreed that, without the prior written consent
of Lehman Brothers and Morgan Stanley & Co. Incorporated, it will not, during
the period ending 180 days after the date of this prospectus, (1) publicly
offer, pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend, or otherwise transfer, dispose of or distribute, directly or
indirectly, any shares of Class A Common Stock or any securities convertible
into the Class A Common Stock, or (2) enter into any public swap or other
arrangement that transfers to another, in whole or in part, any of the economic
consequences of ownership of the Class A Common Stock, whether any such
transaction described in clause (1) or (2) above is to be settled by delivery
of Class A Common Stock or such other securities, in cash or otherwise. The
foregoing sentence shall not apply to (a) the sale of any shares of Class A
Common Stock to the underwriters pursuant to the underwriting agreement, (b)
transactions relating to shares of Class A Common Stock or other securities
acquired in open market transactions after the completion of this offering, (c)
private transactions relating to shares of Class A Common Stock or any
securities convertible into the Class A Common Stock, provided that the selling
stockholder shall ensure that any transferee that receives such shares in a
private transaction shall be subject to the remainder of the 180-day
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lock-up period set forth in clauses (1) and (2) above, or (d) the registration
of shares of Class A Common Stock pursuant to the selling stockholder's
incidental registration rights under Section 4.2 of the Stockholders'
Agreement, dated as of May 10, 1999, among the Class B Stockholders.
The Company and each of the Class B Stockholders, other than the selling
stockholder, has agreed that, without the prior written consent of Lehman
Brothers Inc. and Morgan Stanley & Co. Incorporated, it will not, during the
period ending 90 days after the date of this prospectus, (1) publicly offer,
pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase, lend, or otherwise transfer, dispose of or distribute, directly or
indirectly, any shares of Class A Common Stock or any securities convertible
into the Class A Common Stock (other than the Class B Common Stock) or (2)
enter into any public swap or other arrangement that transfers to another, in
whole or in part, any of the economic consequences of ownership of the Class A
Common Stock, whether any such transaction described in clause (1) or (2) above
is to be settled by delivery of Class A Common Stock or such other securities,
in cash or otherwise. The foregoing sentence shall not apply to (a) the sale of
any shares of Class A Common Stock to the underwriters pursuant to the
underwriting agreement, (b) transactions relating to shares of Class A Common
Stock or other securities acquired in open market transactions after the
completion of this offering, (c) the surrender of unexercised options or shares
upon a "cashless exercise" of options or other incentive compensation awards or
(d) private transactions relating to shares of Class A Common Stock, provided
that the Company or such Class B Stockholder shall ensure that any transferee
that receives shares of Class A Common Stock in a private transaction shall be
subject to the remainder of the 90-day lock-up period set forth in clauses (1)
and (2) above. After that 90-day period, holders of the Class B Common Stock
may convert their Class B Common Stock to Class A Common Stock and dispose of
all or a portion of such stock pursuant to the provisions of Rule 144 under the
Securities Act of 1933 or pursuant to the demand registration rights contained
in the Stockholders Agreement among the Class B Stockholders. See "Certain
Relationships and Related Transactions--Stockholders Agreement."
Our Class A Common Stock is quoted on the Nasdaq National Market under the
symbol "TWTC".
Any offer of the shares of Class A Common Stock in Canada will be made only
under an exemption from the prospectus filing requirement and an exemption from
the dealer registration requirement; where such an exemption is not available,
offers shall be made only by a registered dealer, in the relevant Canadian
jurisdiction where any such offer is made.
In connection with the offering, Lehman Brothers Inc. or Morgan Stanley &
Co. Incorporated, on behalf of the underwriters, may purchase and sell shares
of our Class A Common Stock in the open market. These transactions may include
over-allotment, syndicate covering transactions and stabilizing transactions.
Over-allotment involves syndicate sales of common stock in excess of the number
of shares to be purchased by the underwriters in the offering, which creates a
syndicate short position. Syndicate covering transactions involve purchases of
our Class A Common Stock in the open market after the distribution has been
completed in order to cover syndicate short positions. Stabilizing transactions
consist of certain bids or purchases of our Class A Common Stock made for the
purpose of preventing or retarding a decline in the market price of our Class A
Common Stock while the offering is in progress.
The underwriters also may impose a penalty bid. Penalty bids permit the
underwriters to reclaim a selling concession from a syndicate member when
Lehman Brothers Inc. or Morgan Stanley & Co. Incorporated, in covering
syndicate short positions or making stabilizing purchases, repurchases shares
originally sold by that syndicate member.
Any of these activities may cause the price of our Class A Common Stock to
be higher than the price that otherwise would exist in the open market in the
absence of such transactions. These transactions may be effected in the over-
the-counter market or otherwise and, if commenced, may be discontinued at any
time.
Purchasers of the shares of Class A Common Stock offered in this prospectus
may be required to pay stamp taxes and other charges in accordance with the
laws and practices of the country of purchase, in addition to the offering
price set forth on the cover of this prospectus.
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We have agreed to indemnify the underwriters against liabilities, including
liabilities under the Securities Act of 1933, or to contribute to payments the
underwriters may be required to make in respect of any of those liabilities.
Certain of the representatives and their affiliates have provided from time
to time, and may in the future provide, investment banking, financial advisory
and other services to us for which these representatives may receive customary
fees and commissions.
LEGAL MATTERS
Certain legal matters in connection with the Class A Common Stock offered
hereby will be passed upon for the Company by Cravath, Swaine & Moore, New
York, New York, for the underwriters by Shearman & Sterling, New York, New
York, and for MediaOne by Weil, Gotshal & Manges, LLP, New York, New York.
EXPERTS
The consolidated and combined financial statements of Time Warner Telecom
Inc. at December 31, 1999 and 1998, and for each of the three years in the
period ended December 31, 1999, appearing in this prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their report thereon appearing elsewhere herein, and are included in
reliance upon such report given on the authority of such firm as experts in
accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We are currently subject to the public reporting requirements of the
Securities Exchange Act of 1934, as amended, and file periodic reports and
other information with the Securities and Exchange Commission. These documents
may be inspected and copied at the public reference facilities maintained by
the Securities and Exchange Commission at:
<TABLE>
<S> <C> <C>
Public Reference Room New York Regional Office Chicago Regional Office
450 Fifth Street, N.W. 7 World Trade Center Citicorp Center
Room 1024 Suite 1300 500 West Madison Street
Washington, DC 20549 New York, NY 10048 Suite 1400
Chicago, IL 60661
</TABLE>
Information on the operation of the Public Reference Room may be obtained by
calling the Securities and Exchange Commission at 1-800-SEC-0330. These
Securities and Exchange Commission filings are also available to the public
from commercial document retrieval services and at the internet world wide web
site maintained by the Securities and Exchange Commission at
"http://www.sec.gov".
83
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GLOSSARY
Access Charges. The fees paid by long distance carriers for the local
connections between the long distance carriers' networks and the long distance
carriers' customers.
ATM (asynchronous transfer mode). A recently commercialized switching and
transmission technology that is one of a general class of packet technologies
that relay traffic by way of an address contained within the first five bits of
a standard fifty-three bit-long packet or cell. ATM-based packet transport was
specifically developed to allow switching and transmission of mixed voice, date
and video at varying rates. The ATM format can be used by many different
information systems, including LANs.
Bell Operating Company. A telephone operating subsidiary of an RBOC; an
incumbent local exchange carrier.
Broadcast Video TV-1. This Company service provides dedicated transport of
broadcast quality video signals.
CDMA (Code Division Multiple Access). A form of wireless communications
technology.
Central Offices. A telecommunications center where switches and other
telecommunications facilities are housed. CAPs may connect with incumbent local
exchange carrier networks either at this location or through a remote location.
Collocation. The ability of a telecommunications carrier to interconnect its
network to the incumbent local exchange carrier's network by extending its
facilities to the incumbent local exchange carrier's central office. Physical
collocation occurs when the interconnecting carrier places its network
equipment within the incumbent local exchange carrier's central offices.
Virtual collocation is an alternative to physical collocation under which the
incumbent local exchange carrier permits a carrier to interconnect its network
to the ILEC's network in a manner which is technically, operationally and
economically comparable to physical collocation, even though the
interconnecting carrier's network connection equipment is not physically
located within the central offices.
Competitive Access Provider. A company that provides dedicated
telecommunications services (private line, local transport and special access)
as an alternative to the incumbent local exchange carrier.
Competitive Local Exchange Carrier. A company that provides local exchange
services, including Dedicated service, in competition with the incumbent local
exchange carrier.
Dedicated. Telecommunications lines dedicated to, or reserved for use by, a
particular customer along predetermined routes (in contrast to links which are
temporarily established).
Dedicated Transmission. The sending of electronic signals carrying
information over a direct transport facility.
Dense Wavelength Division Multiplexing (DWDM). A technology that multiplies
the capacity of single fiber to 8, 16, 32, or 80 new transmission channels.
Higher capacity multiples are under testing.
Digital. A means of storing, processing and transmitting information by
using distinct electronic or optical pulses that represent the binary digits 0
and 1. Digital transmission and switching technologies use a sequence of these
pulses to represent information as opposed to the continuously variable analog
signal. The precise digital numbers preclude distortion (such as graininess or
snow in the case of video transmission, or static or other background
distortion in the case of audio transmission).
Direct Transport (aka Dedicated Transport). A non-switched point-to-point
telecommunications facility leased from a telecommunications provider by an end
user and used exclusively by that end user.
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Diverse Routing. A telecommunications network configuration in which signals
are transmitted simultaneously along two different paths so that if one path is
cut or impaired, traffic can continue in the other direction without
interrupting service. The Company's networks generally provide diverse routing.
DS0, DS1, DS3. Standard North American telecommunications industry digital
signal formats, which are distinguishable by bit rate (the number of binary
digits (0 and 1) transmitted per second). DS0 service has a bit rate of 64
kilobits per second. DS1 service has a bit rate of 1.544 megabits per second
and DS3 service as a bit rate of 44.736 megabits per second. A DS0 can transmit
a single uncompressed voice conversation.
FCC. Federal Communications Commission.
FDMA (Frequency Division Multiple Access). A form of wireless communications
technology.
Fiber Miles. The number of route miles of fiber optic cable installed
(excluding pending installations) along a telecommunications path multiplied by
the number of fibers in the cable. See the definition of "route mile" below.
Fiber Optics. Fiber optic technology involves sending laser light pulses
across glass strands in order to transmit digital information. Fiber optic
cable is the medium of choice for the telecommunications and cable industries.
Fiber is immune to electrical interference and environmental factors that
effect copper wiring and satellite transmission.
Hub. Collocation centers located centrally in an area where
telecommunications traffic can be aggregated for transport and distribution.
Incumbent Local Exchange Carriers. The local phone companies, either a Bell
Operating Company or an independent (such as GTE) which provides local exchange
services.
Integrated Services Digital Network. ISDN is an internationally agreed
standard which, through special equipment, allows two-way, simultaneous voice
and data transmission in digital formats over the same transmission line. ISDN
permits video conferencing over a single line, for example, and also supports a
multitude of value-added switched service applications such as Incoming Calling
Line Identification. ISDN's combined voice and data networking capabilities
reduce costs for end users and result in more efficient use of available
facilities. ISDN combines standards for highly flexible customer to network
signaling with both voice and data within a common facility.
Interexchange Carrier. A long distance carrier.
Internet. The name used to describe the global open network of computers
that permits a person with access to the network to exchange information with
any other computer connected to the network.
IntraLATA. A call that originates and terminates within the same LATA.
Kilobits (Kbps). One thousand bits of information. The information-carrying
capacity (i.e., bandwidth) of a circuit may be measured in "thousands of bits
per second."
LATA (Local Access and Transport Area). The geographical areas within which
a local telephone company may offer telecommunications services, as defined in
the divestiture order known as the Modification of Final Judgment ("MFJ")
unless and until redefined by the FCC pursuant to the 1996 Act.
Local Area Networks. The interconnection of computers for the purpose of
sharing files, programs and peripheral devices such as printers and high-speed
modems. LANs may include dedicated computers or file servers that provide a
centralized source of shared files and programs. LANs are generally confined to
a single customer's premises and may be extended or interconnected to other
locations through the use of bridges and routers.
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Local Exchange. A geographic area defined by the appropriate state
regulatory authority in which telephone calls generally are transmitted without
toll charges to the calling or called party.
Local Exchange Service/Local Exchange Telephone Service. Basic local
telephone service, including the provision of telephone numbers, dial tone and
calling within the local exchange area.
Long Distance Carriers (Interexchange Carriers). Long distance carriers
providing services between LATAs, on an interstate or intrastate basis. A long
distance carrier may be facilities-based or offer service by reselling the
services of a facilities-based carrier.
Local Transport Services. Dedicated lines between the incumbent local
exchange carrier's central offices and long distance carrier POPs used to carry
switched traffic.
Megabit (Mbps). One million bits of information. The information carrying
capacity (i.e., bandwidth) of a circuit may be measured in "millions of bits
per second."
Multiplexing. An electronic or optical process that combines a number of
lower speed transmission signals into one higher speed signal. There are
various techniques for multiplexing, including frequency division (splitting
the total available frequency bandwidth into smaller frequency slices), time
division (slicing a channel into timeslots and placing each signal into its
assigned timeslot), and statistical (wherein multiplexed signals share the same
channel and each transmits only when it has data to send).
OC-3c. Optical Carrier level-3, combined into a single data stream. Optical
carrier refers to a SONET optical signal.
OC-N. Optical carrier levels ranging from OC1 (51.84 Mbps) to OC192 (9.9
Gbps).
Node. A point of connection into a fiber optic network.
PBX (Private Branch Exchange). A customer owned and operated switch on
customer premises, typically used by large businesses with multiple telephone
lines.
PBX Trunk. A transmission facility which connects a PBX to the Company's or
ILEC's central office switching center.
POPs (Points of Presence). Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
telephone calls to, a network switching center of the same long distance
carrier.
Primary Rate Interface (PRI). A transport mechanism provided currently over
class 5 switches to terminate at managed model pools. The primary application
is for dial-up internet access.
Private Line. A private, dedicated telecommunications link between different
customer locations (excluding long distance carrier POPs).
Private Network Transport Service. This service is a private, dedicated high
capacity premium quality service over fully redundant, diverse routed, SONET
rings with band width that is dedicated and always available.
Public Switched Telephone Network. The switched network available to all
users generally on a shared basis (i.e., not dedicated to a particular user).
The local exchange telephone service networks operated by incumbent local
exchange carriers are the largest and often the only public switched networks
in a given locality.
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Reciprocal Compensation. An arrangement in which two local exchange carriers
agree to terminate traffic originating on each other's networks in exchange for
a negotiated level of compensation.
Redundant Electronics. A telecommunications facility that uses two separate
electronic devices to transmit a telecommunications signal so that if one
device malfunctions, the signal may continue without interruption.
Regional Bell Operating Company. The holding company which owns a Bell
operating company.
Route Mile. The number of miles along which fiber optic cables are
installed.
SONET (Synchronous Optical Network). A set of standards for optical
communications transmission systems that define the optical rates and formats,
signal characteristics, performance, management and maintenance information to
be embedded within the signals and the multiplexing techniques to be employed
in optical communications transmission systems. SONET facilitates the
interoperability of dissimilar vendors equipment. SONET benefits business
customers by minimizing the equipment necessary for various telecommunications
applications and supports networking diagnostic and maintenance features.
Special Access Services. The lease of private, dedicated telecommunications
lines or circuits on an incumbent local exchange carrier's or a competitive
access provider's network which run to or from the long distance carrier's
POPs. Special access services do not require the use of switches. Examples of
special access services are telecommunications circuits running between POPs of
a single long distance carrier, from one long distance carrier's POP to another
long distance carrier's POP or from an end user to its long distance carrier's
POP.
STS-1. This dedicated transmission service is carried over high capacity
channels for full duplex, synchronous optical transmission of digital data on
SONET standards. This service eliminates the need to maintain and pay for
multiple dedicated lines.
Switch. A mechanical or electronic device that opens or closes circuits or
selects the paths or circuits to be used for the transmission of information.
Switching is a process of linking different circuits to create a temporary
transmission path between users. Within this document, switches generally refer
to voice grade telecommunications switches unless specifically stated
otherwise.
Switched Access Services. The connection between a long distance carrier's
POP and an end user's premises through the switching facilities of a local
exchange carrier.
Switched Services. Telecommunications services that support the connection
of one calling party with another calling party via use of a telephone switch
(i.e., an electronic device that opens or closes circuits, completes or breaks
an electrical path, or selects paths or circuits).
TDMA (Time Division Multiple Access). A form of wireless communications
technology.
Toll Services. Otherwise known as EAS or intra LATA toll services are those
calls that are beyond the free local calling area but originate and terminate
within the same LATA; such calls are usually priced on a measured basis.
Type II. A circuit offered to a customer by a telecommunications provider
including a portion of the circuit provided by another LEC, where the first
provider bills the customer for the entire circuit.
Voice Grade Equivalent (VGE) Circuit. One DS0. One voice grade equivalent
circuit is equal to 64 kilobits of bandwidth.
87
<PAGE>
TIME WARNER TELECOM INC.
INDEX TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Audited Financial Statements:
Report of Independent Auditors.......................................... F-2
Consolidated Balance Sheets at December 31, 1999 and 1998............... F-3
Consolidated and Combined Statements of Operations for the years ended
December 31, 1999, 1998 and 1997....................................... F-4
Consolidated and Combined Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997....................................... F-5
Consolidated and Combined Statements of Changes in Stockholders' Equity
for the years ended December 31, 1999, 1998 and 1997................... F-6
Notes to Consolidated and Combined Financial Statements................. F-7
Schedule II Valuation of Qualifying Accounts.............................. F-21
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors of Time Warner Telecom Inc:
We have audited the accompanying consolidated balance sheets of Time Warner
Telecom Inc. (the "Company") as of December 31, 1999 and 1998, and the related
consolidated and combined statements of operations, cash flows and
stockholders' equity for each of the three years in the period ended December
31, 1999. Our audits also included the financial statement schedule listed on
the index at page F-1. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of the Company at
December 31, 1999 and 1998, and the consolidated and combined results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken
as a whole, presents fairly, in all material respects the information set forth
therein.
/s/ Ernst & Young LLP
Denver, Colorado
February 4, 2000
F-2
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
December 31,
---------------------
1999 1998
---------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 90,586 $ 105,140
Marketable securities (note 3)........................ 173,985 231,107
Receivables, less allowances of $7,857 and $2,692..... 52,652 26,690
Prepaid expenses...................................... 2,938 2,176
---------- ---------
Total current assets................................ 320,161 365,113
---------- ---------
Investment in unconsolidated affiliate (note 2)......... -- 5,707
Property, plant and equipment........................... 868,770 612,119
Less accumulated depreciation......................... (191,664) (117,961)
---------- ---------
677,106 494,158
---------- ---------
Long-term marketable securities (note 3)................ -- 19,750
Intangible and other assets, net of accumulated
amortization (note 2).................................. 45,745 19,616
---------- ---------
Total assets........................................ $1,043,012 $ 904,344
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable...................................... $ 64,678 $ 38,946
Deferred revenue...................................... 37,913 10,524
Accrued taxes, franchise and other fees............... 23,280 15,214
Accrued interest...................................... 17,983 17,333
Accrued payroll and benefits.......................... 13,945 8,821
Payable to Time Warner Cable (note 6)................. 5,085 16,801
Other current liabilities............................. 26,459 14,114
---------- ---------
Total current liabilities........................... 189,343 121,753
---------- ---------
Long-term debt and capital lease obligations (notes 4
and 9)................................................. 403,627 400,000
Deferred income taxes (note 7).......................... 27,126 --
Subordinated loans payable to the Former Parent
Companies (including
$3,399 of accrued interest in 1998) (note 5)........... -- 174,940
Stockholders' equity (note 1):
Preferred stock, $0.01 par value, 20,000,000 shares
authorized, no shares issued and outstanding......... -- --
Class A common stock, $0.01 par value, 277,300,000
shares authorized, 23,543,422 shares issued and
outstanding in 1999.................................. 235 --
Class B common stock, $0.01 par value, 162,500,000
shares authorized, 81,214,285 and 81,250,000 shares
issued and outstanding in 1999
and 1998, respectively............................... 812 813
Additional paid-in capital............................ 559,950 255,654
Accumulated deficit................................... (138,081) (48,816)
---------- ---------
Total stockholders' equity.......................... 422,916 207,651
---------- ---------
Total liabilities and stockholders' equity.......... $1,043,012 $ 904,344
========== =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Revenue:
Dedicated transport services.................. $152,468 $ 84,024 $ 44,529
Switched services............................. 116,285 37,848 10,872
-------- -------- --------
Total revenue............................... 268,753 121,872 55,401
-------- -------- --------
Costs and expenses(a):
Operating..................................... 117,567 67,153 40,349
Selling, general and administrative........... 113,389 77,401 54,640
Depreciation and amortization................. 68,785 50,717 38,466
-------- -------- --------
Total costs and expenses.................... 299,741 195,271 133,455
-------- -------- --------
Operating loss.................................. (30,988) (73,399) (78,054)
Interest expense(a)............................. (45,264) (29,198) (1,538)
Interest income................................. 16,589 9,731 --
Equity in income (losses) of unconsolidated
affiliate (note 2)............................. 202 127 (2,082)
Gain on disposition of investments.............. -- -- 11,018
-------- -------- --------
Net loss before income taxes.................... (59,461) (92,739) (70,656)
Income tax expense (note 7)..................... 29,804 -- --
-------- -------- --------
Net loss........................................ $(89,265) $(92,739) $(70,656)
======== ======== ========
Basic and diluted loss per common share......... $ (0.93) $ (1.14) $ (0.87)
======== ======== ========
Average common shares outstanding............... 95,898 81,250 81,250
======== ======== ========
(a) Includes expenses resulting from transactions with affilitates (note 6):
Operating................................... $ 2,513 $ 2,041 $ 1,731
======== ======== ========
Selling, general and administrative......... $ 1,579 $ 5,063 $ 6,810
======== ======== ========
Depreciation and amortization............... $ 10,792 $ 9,010 $ 7,064
======== ======== ========
Interest expense............................ $ 5,078 $ 11,582 $ 1,544
======== ======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss..................................... $ (89,265) $ (92,739) $ (70,656)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization................ 68,785 50,717 38,466
Equity in (income) losses of unconsolidated
affiliate................................... (202) (127) 2,082
Deferred income tax expense.................. 29,804 -- --
Gain on disposition of investments........... -- -- (11,018)
Changes in operating assets and liabilities,
net of the effect of acquisitions:
Receivables and prepaid expenses............ (22,384) (17,808) (4,019)
Accounts payable............................ 27,491 6,037 7,265
Accrued interest............................ 650 20,732 1,544
Payable to Time Warner Cable................ (11,716) 16,801 --
Accrued payroll and benefits................ 5,124 2,488 4,093
Other current liabilities................... 44,698 16,882 5,472
Other balance sheet changes................. 1,250 (3,326) (2,648)
--------- --------- ---------
Net cash provided by (used in) operating
activities................................ 54,235 (343) (29,419)
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures......................... (221,224) (126,023) (127,315)
Cash paid for acquisitions, net of cash
acquired.................................... (2,565) (1,204) (334)
Purchases of marketable securities........... (290,811) (286,356) --
Proceeds from maturities of marketable
securities.................................. 367,683 35,500 --
Proceeds from sale of investments............ -- -- 7,028
--------- --------- ---------
Net cash used in investing activities...... (146,917) (378,083) (120,621)
--------- --------- ---------
Cash flows from financing activities:
Proceeds of loans from Former Parent
Companies................................... -- 96,066 73,931
Repayment of loans to Former Parent
Companies................................... (180,018) -- --
Payment of capital lease obligations......... (174) -- --
Repayment of acquired debt................... (15,668) -- --
Net proceeds from issuance of debt........... -- 387,500 --
Net proceeds from issuance of common stock
upon exercise of stock options.............. 3,806 -- --
Net proceeds from initial public offering.... 270,182 -- --
Capital contributions from the Former Parent
Companies................................... -- -- 127,550
Distributions to the Former Parent
Companies................................... -- -- (51,441)
--------- --------- ---------
Net cash provided by financing activities.. 78,128 483,566 150,040
--------- --------- ---------
Increase (decrease) in cash and cash
equivalents............................... (14,554) 105,140 --
Cash and cash equivalents at beginning of
period.................................... 105,140 -- --
--------- --------- ---------
Cash and cash equivalents at end of
period.................................... $ 90,586 $ 105,140 $ --
========= ========= =========
Supplemental disclosures of cash flow
information:
Cash paid for interest..................... $ 47,011 $ -- $ --
========= ========= =========
Cash paid for income taxes................. $ 168 $ 181 $ 4
========= ========= =========
</TABLE>
Supplemental schedule for noncash investing and financing activities:
Time Warner Telecom Inc. (the "Company") issued Class A common stock
aggregating $27.9 million to purchase the common stock of Internet Connect,
Inc. ("Inc.Net") and MetroComm, Inc. ("MetroComm").
In 1999, the Company incurred capital lease obligations of $3.7 million for the
purchase of fiber, equipment and furniture leases.
See accompanying notes.
F-5
<PAGE>
TIME WARNER TELECOM INC.
CONSOLIDATED AND COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 1999, 1998 and 1997
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
Common Stock
----------------------------
Class A Class B Additional Total
------------- -------------- paid-in Accumulated stockholders'
Shares Amount Shares Amount capital deficit equity
------ ------ ------ ------ ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1,
1997................... -- $-- 81,250 $813 478,885 (184,761) 294,937
Net capital
contributions from
the Former Parent
Companies............ -- -- -- -- 76,109 -- 76,109
Net loss.............. -- -- -- -- -- (70,656) (70,656)
------ ---- ------ ---- -------- -------- -------
Balance at December 31,
1997................... -- -- 81,250 813 554,994 (255,417) 300,390
Net loss prior to
Reorganization....... -- -- -- -- -- (43,923) (43,923)
------ ---- ------ ---- -------- -------- -------
-- -- 81,250 813 554,994 (299,340) 256,467
Effect of
Reorganization
(note 1)............. -- -- -- -- (299,340) 299,340 --
Net loss after
Reorganization....... -- -- -- -- -- (48,816) (48,816)
------ ---- ------ ---- -------- -------- -------
Balance at December 31,
1998................... -- -- 81,250 813 255,654 (48,816) 207,651
Initial public
offering, net of
offering expenses of
$19,618 (note 1)..... 20,700 207 -- -- 269,975 -- 270,182
Issuance of common
stock for
acquisitions (note
2)................... 2,498 25 -- -- 27,839 -- 27,864
Issuance of common
stock upon exercise
of stock options..... 309 2 -- -- 6,482 -- 6,484
Conversion of shares
by related party..... 36 1 (36) (1) -- -- --
Net loss.............. -- -- -- -- -- (89,265) (89,265)
------ ---- ------ ---- -------- -------- -------
Balance at December 31,
1999................... 23,543 $235 81,214 $812 559,950 (138,081) 422,916
====== ==== ====== ==== ======== ======== =======
</TABLE>
See accompanying notes.
F-6
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
December 31, 1999, 1998 and 1997
1. Organization and Summary of Significant Accounting Policies
Description of Business and Capital Structure
The Company, a Delaware corporation, is a leading fiber facilities-based
integrated communications provider in selected metropolitan markets across the
United States, offering local businesses "last-mile" broadband connections for
data, high-speed internet access, local voice and long distance services.
Time Warner Cable, as defined below, began the Company's business in 1993 by
providing telephony services through cable systems owned by Time Warner
Entertainment Company, L.P. ("TWE"), Time Warner Entertainment-Advance/Newhouse
Partnership ("TWE-A/N") and Time Warner Inc. ("Time Warner"), collectively
referred to as the "Former Parent Companies." "Time Warner Cable" refers to the
cable systems owned by TWE, TWE-A/N and Time Warner.
TWE and TWE-A/N are owned as follows:
(1) TWE is a partnership of subsidiaries of Time Warner and MediaOne
Group, Inc. ("MediaOne"); and
(2) TWE-A/N is a partnership of TWE, Time Warner and Advance/Newhouse
Partnership ("Advance").
The Company's original business was to provide certain telephony services
together with cable television. In January 1997, the Company put in place a new
management team that implemented a business strategy focused exclusively on
serving business customers, rapidly providing switched services in all the
Company's service areas and expanding the range of business telephony services
offered by the Company.
On July 14, 1998, Time Warner Telecom LLC ("TWT LLC") succeeded to the
ownership of the Company's business. At that time, Time Warner, MediaOne and
Advance (collectively referred to as the "Class B Stockholders") formed TWT LLC
to acquire the assets and liabilities of the Company's business from the Former
Parent Companies and to conduct the offering on July 21, 1998 of $400 million
principal amount 9 3/4% Senior Notes due July 2008 (the "Senior Notes"). In
such transaction, referred to as the "Reorganization," the Class B Stockholders
(either directly or through subsidiaries) became the owners of all the limited
liability company interests in TWT LLC. The Reorganization has been reflected
as of July 1, 1998 for accounting purposes.
On May 10, 1999, in preparation for the Company's initial public offering,
TWT LLC was reconstituted as a Delaware corporation (the "Reconstitution")
under the name Time Warner Telecom Inc. by merging into a newly formed Delaware
corporation. The Company accounted for the Reorganization and the
Reconstitution at each of the Class B Stockholders' historical cost basis and,
except as noted below, the Reorganization and Reconstitution had no effect on
the Company's total stockholders' equity, which has been presented on a
consistent basis. In connection with the Reconstitution, the Company's
capitalization was authorized to include two classes of common stock, Class A
Common Stock and Class B Common Stock. As part of the merger, the outstanding
Class A limited liability company interests were converted into Class A Common
Stock and the Class B Stockholders exchanged their Class B limited liability
company interests in TWT LLC for Class B Common Stock of the newly formed
corporation, Time Warner Telecom Inc. Prior to the Reconstitution, the only
outstanding Class A interests were those held by the former shareholders of
Inc.Net, which the Company acquired in April 1999 (see note 2). Following the
Reconstitution, the Class B Stockholders held all of the Company's Class B
Common Stock. Accordingly, the accompanying financial statements have been
adjusted to retroactively reflect the authorization and issuance of the shares
of Class A Common Stock and Class B Common Stock for all periods presented.
F-7
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
On May 14, 1999, in conjunction with the Reconstitution, the Company
completed an initial public offering of 20,700,000 shares, including an over-
allotment of 2,700,000 shares, of Class A Common Stock at a price of $14 per
share (the "IPO"). The IPO generated $270.2 million in proceeds for the
Company, net of underwriting discounts and expenses. The net proceeds were used
primarily to repay indebtedness to the Former Parent Companies (see note 5).
Remaining proceeds have been and will continue to be used to fund the Company's
continued growth, which may include acquisitions and joint ventures, and for
general corporate purposes.
As a result of the IPO, the Company has two classes of Common Stock
outstanding, Class A Common Stock and Class B Common Stock. Holders of Class A
Common Stock have one vote per share and holders of Class B Common Stock have
ten votes per share. Each share of Class B Common Stock is convertible, at the
option of the holder, into one share of Class A Common Stock. Holders of Class
A Common Stock and Class B Common Stock generally vote together as a single
class. However, some matters require the approval of 100% of the holders of the
Class B Common Stock voting separately as a class, and some matters require the
approval of a majority of the holders of the Class A Common Stock, voting
separately as a class. Upon completion of the IPO, the Class B Stockholders
owned all of the 81,250,000 shares of outstanding Class B Common Stock.
Subsequent to the IPO, 35,715 shares of Class B Common Stock were converted
into Class A Common Stock. As of December 31, 1999, the Class B Stockholders
had approximately 97.2% of the combined voting power of the outstanding common
stock.
The Company also is authorized to issue shares of Preferred Stock. The
Company's board of directors has the authority to establish the voting powers,
the preferences and special rights for the Preferred Stock. No such voting
powers, preferences or special rights have been established and no shares of
Preferred Stock have been issued as of December 31, 1999.
On May 6, 1999, MediaOne and AT&T Corp. ("AT&T") entered into a merger
agreement providing for MediaOne to be acquired by AT&T. The MediaOne
stockholders have approved the merger, but the merger is subject to various
regulatory approvals. There is no assurance that the approvals will be obtained
or that the merger will be consummated. If the merger is completed, the Class B
Common Stock beneficially owned by MediaOne (through a subsidiary) will be
beneficially owned by AT&T. However, the transaction will not affect the
MediaOne subsidiary's rights as a Class B Stockholder.
On January 10, 2000, Time Warner announced an agreement to merge with
America Online, Inc. ("AOL") in a stock-for-stock transaction that would create
a new company called AOL Time Warner Inc. As a result of the mergers, both AOL
and Time Warner will become wholly owned subsidiaries of AOL Time Warner. Under
the terms of the merger agreement, Time Warner and AOL stock will be converted
to AOL Time Warner stock at fixed exchange ratios. Upon consummation of the
merger, current Time Warner shareholders will receive approximately 45% of the
stock of AOL Time Warner, and current AOL shareholders will receive
approximately 55%. If the merger is completed, the Class B Common Stock
beneficially owned by Time Warner will be beneficially owned by AOL Time Warner
and its subsidiaries. However, the transaction will not affect the rights of
Time Warner subsidiaries as Class B Stockholders. The merger is subject to
customary closing conditions, including regulatory clearance and stockholder
approvals. There is no assurance that the approvals will be obtained or that
the merger will be consummated.
Basis of Presentation
Until July 14, 1998, the historical financial statements of the Company
reflected the "carved out" historical financial position, results of
operations, cash flows and changes in stockholders' equity of the commercial
telecommunications operations of the Former Parent Companies, as if they had
been operating as a
F-8
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
separate company. Although these financial statements are presented as if the
Company had operated as a corporation, the Company operated as a partnership
for tax purposes and continued to operate in a partnership structure through
May 10, 1999. The consolidated and combined statements of operations have been
adjusted to retroactively reflect an allocation of certain expenses pursuant to
the final terms of agreements related to the Reorganization, primarily relating
to office rent, overhead charges for various administrative functions performed
by the Former Parent Companies and certain facility maintenance and pole rental
costs. These allocations were required to reflect all costs of doing business
and have been based on various methods which management believes result in
reasonable allocation of such costs.
Basis of Consolidation and Accounting for Investments
The consolidated and combined financial statements include the accounts of
the Company and all entities in which the Company has a controlling voting
interest ("subsidiaries"). Significant intercompany accounts and transactions
have been eliminated. Significant accounts and transactions with the Former
Parent Companies are disclosed as related party transactions.
Investments in entities in which the Company has significant influence, but
less than a controlling voting interest, are accounted for using the equity
method. At December 31, 1998, the Company's investment in unconsolidated
affiliate consisted solely of a 50% investment in MetroComm AxS, L.P.
("MetroComm L.P."), a joint venture providing commercial telecommunications
services in the central Ohio area. Under the equity method, only the Company's
investment in and amounts due to and from the equity investee are included in
the consolidated balance sheets, and only the Company's share of the investee's
income (losses) are included in the consolidated and combined statements of
operations. During the second quarter of 1999, the remaining 50% of MetroComm
L.P. was acquired (see note 2) and, accordingly, is accounted for on a
consolidated basis as of May 31, 1999.
Cash, Cash Equivalents and Marketable Securities
Prior to July 14, 1998, the Company did not maintain any cash or marketable
securities since all funding of the Company's operating, investing and
financing activities was provided by capital contributions from the Former
Parent Companies or by subordinated loans payable to the Former Parent
Companies (see note 5). Such funding consisted of subordinated loans during the
period from July 1, 1997 through July 14, 1998, and remained outstanding until
May 14, 1999. The capital contributions of the Former Parent Companies, which
are non-interest bearing, have been included in additional paid-in capital.
Prior to repayment of the subordinated loans in May 1999, the subordinated
loans, including accrued interest, had been reflected as long-term liabilities
in the accompanying consolidated balance sheets.
The Company considers all highly liquid debt instruments with an original
maturity of three months or less, when purchased, to be cash equivalents.
The Company records its marketable securities in conformity with the
provisions of Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." This statement entails
categorizing all debt and equity securities as held-to-maturity securities,
trading securities, or available-for-sale securities, and then measuring the
securities at either fair value or amortized cost.
Management determines the appropriate classification of debt securities at
the time of purchase and reevaluates such designation as of each balance sheet
date. Debt securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity. Held-to-
maturity securities are stated at amortized cost, adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Interest on securities classified as held-to-maturity is
included in interest income.
F-9
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
Receivables
The Company does not require collateral for telecommunication services
provided to customers. However, the Company performs ongoing credit evaluations
of its customers' financial conditions and has provided an allowance for
doubtful accounts based on the expected collectability of all accounts
receivable. The provision for doubtful accounts was $6.7 million, $2.0 million
and $1.2 million for 1999, 1998 and 1997, respectively.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Construction costs,
labor and applicable overhead related to the development, installation and
expansion of the Company's networks, and interest costs related to construction
are capitalized. During 1999, 1998 and 1997, interest capitalized was not
significant. Repairs and maintenance costs are charged to expense when
incurred.
The Company licenses the right to use the majority of its fiber optic cable
from Time Warner Cable, in which they are co-located. The cost of these rights,
which are prepaid by the Company, is capitalized and reflects an allocable
share of Time Warner Cable's costs, which, prior to the Reorganization,
generally reflected the incremental costs incurred by Time Warner Cable to
construct the fiber for the Company. Subsequent to the Reorganization, the
Company pays for its allocable share of the cost of fiber and construction
incurred by Time Warner Cable in routes where they are in joint construction.
In routes where the Company is not in joint construction with Time Warner
Cable, the Company pays for the full cost of construction. Depreciation is
provided on the straight-line method over estimated useful lives as follows:
<TABLE>
<S> <C>
Buildings and improvements........................................ 5-20 years
Communications networks........................................... 5-15 years
Vehicles and other equipment...................................... 3-10 years
Fiber optic right to use.......................................... 15 years
</TABLE>
Property, plant and equipment consist of:
<TABLE>
<CAPTION>
December 31,
--------------------
1999 1998
--------- ---------
(amounts in
thousands)
<S> <C> <C>
Buildings and improvements............................. $ 15,741 $ 14,453
Communications networks................................ 556,054 380,150
Vehicles and other equipment........................... 91,666 58,224
Fiber optic right to use............................... 205,309 159,292
--------- ---------
868,770 612,119
Less accumulated depreciation.......................... (191,664) (117,961)
--------- ---------
Total................................................ $ 677,106 $ 494,158
========= =========
</TABLE>
Intangible Assets
Intangible assets primarily consist of goodwill, deferred right of way costs
and covenants not to compete, which are amortized over periods of 10 to 20
years using the straight-line method. Amortization expense amounted to $2.7
million, $2.3 million and $2.0 million for 1999, 1998 and 1997, respectively.
Accumulated amortization of intangible assets at December 31, 1999 and 1998,
amounted to $7.0 million and $2.2 million, respectively.
F-10
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
Impairment of Long-Lived Assets
The Company periodically reviews the carrying amounts of property, plant and
equipment and its identifiable intangible assets to determine whether current
events or circumstances warrant adjustments to such carrying amounts. If an
impairment adjustment is deemed necessary, such loss is measured by the amount
that the carrying value of such assets exceeds their fair value. Considerable
management judgment is necessary to estimate the fair value of assets;
accordingly, actual results could vary significantly from such estimates.
Assets to be disposed of are carried at the lower of their financial statement
carrying amount or fair value less costs to sell.
Revenue
The Company's revenue has been derived primarily from the provision of
"private line" or "direct access" telecommunications services; however, an
increasing portion is derived from the provision of switched services. The
Company's customers are principally telecommunications-intensive business end-
users, long distance carriers, internet service providers, wireless
communications companies and governmental entities. Such customers are offered
a wide range of integrated telecommunications products and services, including
dedicated transmission, local switched, long distance, data and high-speed
internet access services. In addition, the Company benefits from its strategic
relationship with the Class B Stockholders both through access rights and
construction cost-sharing. As a result, the Company's networks have been
constructed primarily through the use of fiber capacity licensed from the Class
B Stockholders.
Revenue for dedicated transport services is generally billed in advance on a
fixed rate basis and recognized over the period the services are provided.
Revenue for switched services, data and Internet services and long distance are
generally billed on a transactional basis determined by customer usage with
some fixed rate elements. The transactional elements of switched services are
billed in arrears and estimates are used to recognize revenue in the period
earned. The fixed rate elements are billed in advance and recognized over the
period provided.
Reciprocal compensation revenue is an element of switched services revenue,
which represents compensation from local exchange carriers for local exchange
traffic terminated on the Company's facilities originated by other local
exchange carriers. Reciprocal compensation is based on contracts between the
Company and local exchange carriers. The Company recognizes reciprocal
compensation revenue as it is earned, except in such cases where the revenue is
under dispute. Under several of its contracts, the local exchange carriers have
disputed the payment of reciprocal compensation for traffic terminating to
internet service provider customers contending that such traffic was not local.
As a result, the Company has filed complaints with various public utility
commissions contending that the internet service provider traffic is local.
Various of these state public utility commissions have ruled in favor of the
Company, but all of these favorable decisions have subsequently been appealed
by the local exchange carriers. While the Company believes that these disputes
will ultimately be resolved in its favor, the Company only recognizes revenue
on a portion of the cash received and defers recognition of a significant
portion of this revenue pending outcome of the dispute. As of December 31,
1999, the Company deferred recognition of $32.8 million in reciprocal
compensation revenue for payments received associated with these disputes. 1999
switched services revenue includes the recognition of a non-recurring $7.6
million settlement of reciprocal compensation. The Company pays reciprocal
compensation expense to the other local exchange carriers for local exchange
traffic it terminates on the local exchange carrier's facilities. These costs
are recognized as incurred and are reported as a component of operating
expenses in the Consolidated and Combined Statements of Operations.
Significant Customers
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. For the years ended
December 31, 1999 and 1998, the Company's top 10 customers accounted
F-11
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
for 39% and 38% of the Company's consolidated and combined revenue,
respectively. AT&T accounted for more than 10% of the Company's total revenue
in 1999 and AT&T and MCI WorldCom, Inc., accounted for more than 10% of the
Company's total revenue in 1998. However, a substantial portion of such revenue
results from traffic that is directed to the Company by the Company's customers
who have selected such carriers as their long distance providers. Revenue
includes sales to both AT&T and MCI WorldCom, Inc. (including sales directed to
the Company by the Company's customers) of approximately $58.8 million, $28.9
million and $14.7 million 1999, 1998 and 1997, respectively.
Segment Reporting
The Company operates in 21 service areas and the Company's management makes
decisions on resource allocation and assesses performance based on total
revenue, EBITDA and capital spending of these operating locations. Each of the
service areas offers the same products and services, have similar customers and
networks, are regulated by the same type of authorities, and are managed
directly by the Company's executives, allowing the 21 service areas to be
aggregated, resulting in one reportable line of business.
Loss Per Common Share
The Company computes loss per common share in accordance with the provisions
of Statement of Financial Accounting Standard No. 128, Earnings Per Share
("SFAS 128"). SFAS 128 requires companies with complex capital structures to
present basic and diluted earnings per share. Basic earnings per share is
measured as the income or loss available to common stockholders divided by the
weighted average outstanding common shares for the period. Diluted earnings per
share is similar to basic earnings per share, but presents the dilutive effect
on a per share basis of potential common shares (e.g., convertible securities,
stock options, etc.) as if they had been converted at the beginning of the
periods presented. Potential common shares that have an anti-dilutive effect
(e.g., those that increase income per share or decrease loss per share) are
excluded from diluted earnings per share.
The basic and diluted loss per common share for all periods presented herein
was computed by dividing the net loss attributable to common shares by the
weighted average outstanding common shares for the period. Potential common
shares were not included in the computation of weighted average shares
outstanding because their inclusion would be anti-dilutive.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
Reclassifications
Certain prior year amounts have been reclassified for comparability with the
1999 presentation.
2. Acquisitions
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of Inc.Net, an internet service provider, for
consideration consisting of $3.8 million of Class A limited liability interests
in TWT LLC, the Company's predecessor, approximately $3.5 million in net cash
and the assumption of $1.9 million in liabilities. At the time of the IPO, such
Class A limited liability interests were converted into 307,550
F-12
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
shares of Class A Common Stock of the Company. The Class A Common Stock of the
Company into which the limited liability interests were converted will be held
in escrow to be released to the former Inc.Net shareholders over a period of
three years. Through the acquisition of this subsidiary, the Company plans to
manage current and future data networks and provide new internet products. The
transaction was accounted for under the purchase method of accounting and
generated $6.9 million in goodwill, which is being amortized on a straight-line
basis over a ten-year period. Amortization expense for 1999 was approximately
$462,000.
During the second quarter of 1999, the Company acquired all of the
outstanding common stock of MetroComm through the issuance of 2,190,308 shares
of Class A Common Stock of the Company valued at $24.1 million, and the
assumption of $20.1 million in liabilities. Through the acquisition of
MetroComm, the Company acquired the 50% interest of MetroComm AxS, L.P. not
already owned by the Company. After the acquisition, the Company's Columbus,
Ohio assets were transferred to MetroComm L.P. and all operations in Columbus,
Ohio are now reported under the new entity. The transaction was accounted for
under the purchase method of accounting and generated $18.8 million in
goodwill, which is being amortized on a straight-line basis over a ten-year
period. Amortization expense for 1999 was approximately $1.1 million.
The two acquisitions completed during 1999 are summarized as follows
(amounts in thousands):
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Recorded value of assets acquired.................................. $ 32,003
Goodwill........................................................... 25,746
Elimination of investment in unconsolidated affiliate.............. (5,278)
Assumed liabilities................................................ (22,042)
Common stock issued in acquisitions................................ (27,864)
--------
Cash paid for acquisitions....................................... $ 2,565
========
</TABLE>
Since both acquisitions are accounted for as purchases, the results of
operations of Inc.Net and MetroComm are consolidated with the Company's results
of operations from their respective acquisition dates. Had both acquisitions
occurred on January 1, 1998, revenue, net loss, and basic and diluted loss per
common share would not have been materially different for 1998 and 1999.
3. Marketable Securities
The Company's marketable securities portfolio includes shares of money
market mutual funds, corporate debt securities, certificates of deposit with
banks and foreign government debt securities. All of the Company's marketable
securities are categorized as "held-to-maturity" and carried at amortized cost.
F-13
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
Marketable securities at December 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
(amounts in thousands)
<S> <C> <C>
Cash equivalents:
Shares of money market mutual funds............... $ 4,510 $ 3,338
Certificates of deposit with banks................ -- 5,000
Corporate and municipal debt securities........... 77,267 93,394
----------- -----------
81,777 101,732
----------- -----------
Current marketable securities:
Certificates of deposit with banks................ 54,797 57,014
Corporate and municipal debt securities........... 119,188 169,085
Foreign government debt securities................ -- 5,008
----------- -----------
173,985 231,107
----------- -----------
Long-term marketable securities:
Corporate debt securities......................... -- 19,750
----------- -----------
Total marketable securities..................... $ 255,762 $ 352,589
=========== ===========
</TABLE>
The estimated fair value of the marketable securities is not materially
different from the amortized cost.
4. Long-Term Debt
The Senior Notes are unsecured, unsubordinated obligations of the Company.
Interest on the Senior Notes is payable semi-annually on January 15 and July
15, and began on January 15, 1999. Interest expense, including amortization of
debt discount, relating to the Senior Notes totaled approximately $40.3
million and $17.9 million for 1999 and 1998, respectively. At December 31,
1999, the fair market value for the $400 million of Senior Notes was $415
million, based on market prices.
The Senior Notes are governed by an Indenture that contains certain
restrictive covenants. Such restrictions affect, and in many respects
significantly limit or prohibit, among other things, the ability of the
Company to incur indebtedness, make prepayments of certain indebtedness, pay
dividends, make investments, engage in transactions with shareholders and
affiliates, issue capital stock of subsidiaries, create liens, sell assets and
engage in mergers and consolidations.
5. Subordinated Loans Payable to the Former Parent Companies
During the period from July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with subordinated loans from the
Former Parent Companies. Such loans remained outstanding, accruing interest,
through May 14, 1999. Such loans from the Former Parent Companies were
subordinated in right of payment to the Senior Notes, except for a provision
allowing repayment prior to maturity with the net proceeds of any offering of
common stock or equivalent interest of the Company. Such loans bore interest
(payable in kind) at The Chase Manhattan Bank's prime rate, which was 7.75%
from January 1, 1999 through the payoff of the loan in May 1999. Interest
expense relating to such loans totaled approximately $5.1 million, $11.6
million and $1.5 million for 1999, 1998 and 1997, respectively. On May 14,
1999, approximately $180 million of the proceeds from the IPO were used to
repay the subordinated loans payable to the Former Parent Companies in full,
including accrued interest.
F-14
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
6. Related Party Transactions
In the normal course of business, the Company engages in various
transactions with the Former Parent Companies, generally on negotiated terms
among the affected units that, in management's opinion, result in reasonable
allocations.
The Company licenses the right to use the majority of its fiber optic cable
from Time Warner Cable. The Company paid Time Warner Cable $16.8 million, $23.8
million and $32.5 million for 1999, 1998 and 1997, respectively, under this
arrangement. Such costs have been capitalized by the Company. The amortization
expense of these costs and fiber previously capitalized in the amount of $10.8
million, $9.0 million and $7.1 million for 1999, 1998 and 1997, respectively,
has been classified as a component of depreciation and amortization expense in
the accompanying consolidated and combined statements of operations. In
addition, under this licensing arrangement, the Company reimburses Time Warner
Cable for facility maintenance and pole rental costs, which aggregated $2.5
million, $2.0 million and $1.7 million for 1999, 1998 and 1997, respectively.
The Company's operations, which in certain cases are co-located with Time
Warner Cable's divisions, are allocated a charge for various overhead expenses
for services provided by such divisions. Prior to the Reorganization, such
allocations were based on direct labor, total expenses or headcount relative to
each operating unit. The Company is also allocated rent based on the square
footage of space occupied by the Company at Time Warner Cable's facilities.
After the Reorganization, these costs are based on contracts with Time Warner
Cable. Such charges aggregated approximately $1.6 million, $2.1 million and
$4.4 million for 1999, 1998 and 1997, respectively.
During the period July 1, 1997 through May 14, 1999, the Former Parent
Companies provided all or a portion of the Company's financing requirements.
Interest expense relating to such loans aggregated approximately $5.1 million,
$11.6 million and $1.5 million for 1999, 1998 and 1997, respectively (see note
5).
During 1998 and 1997, the Company participated in the Time Warner Cable
Pension Plan (the "TW Pension Plan"), a noncontributory defined benefit pension
plan which covered approximately 75% of all employees. The remaining 25% of
employees participated in a pension plan under the administration of MediaOne,
their previous employer (the "MediaOne Pension Plan"). The Company also
participated in the Time Warner Cable Employees Savings Plan (the "Savings
Plan"), a defined contribution plan. Both the TW Pension Plan and Savings Plan
were administered by a committee appointed by the Board of Representatives of
TWE and covered substantially all employees.
Benefits under the TW Pension Plan are determined based on formulas which
reflect employees' years of service and compensation levels during their
employment period. Total pension cost aggregated $1.1 million for 1998 and
1997.
Benefit costs under the MediaOne Pension Plan for certain employees of the
Company aggregated $0.8 million and $0.6 million for 1998 and 1997,
respectively.
The Company's contributions to the Savings Plan represented up to 6.67% of
the employees' compensation during the plan year. Defined contribution plan
expense aggregated $1.0 million and $0.7 million for 1998 and 1997,
respectively.
As of January 1, 1999, the Company did not participate in the TW Pension
Plan, the MediaOne Pension Plan or the Savings Plan because the Company adopted
its own benefit plans (see note 10). The Company has no future obligation to
fund either the TW Pension Plan or the MediaOne Pension Plan.
F-15
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
7. Income Taxes
On May 10, 1999, in conjunction with the Reconstitution, a one-time charge
to earnings of $39.4 million was recorded to recognize the net deferred tax
liability associated with the change from a limited liability company to a
corporation, as all of the Company's tax operating losses prior to May 10, 1999
were absorbed by the Former Parent Companies. The income tax benefit for 1999,
shown below, includes the effect of the Reconstitution and the tax impact of
operations from the date of the Reconstitution through December 31, 1999.
Income tax expense is summarized as follows (amounts in thousands):
<TABLE>
<S> <C>
Total income tax expense......................................... $29,804
Less--tax benefit related to exercise of non-qualified stock
options......................................................... (2,678)
-------
Total deferred income taxes.................................... 27,126
Less current................................................... --
-------
Net deferred................................................... $27,126
=======
Variations from the federal statutory rate for activity since the
Reconstitution date are as follows:
Expected federal income tax benefit at statutory rate............ (35.0)%
Effect of net operating losses incurred prior to the
Reconstitution.................................................. 18.5
Effect of the initial deferred tax liability recorded at the time
of the Reconstitution........................................... 66.4
Effect of permanent differences.................................. 1.1
State income tax benefit, net of federal income tax benefit...... (2.1)
Other............................................................ 1.2
-------
Income tax expense............................................... 50.1%
=======
Significant components of the Company's net deferred tax liability at
December 31, 1999 are as follows (amounts in thousands):
Deferred tax assets:
Accrued expenses............................................... $ 4,933
Allowance for doubtful accounts................................ 3,159
Net operating losses since the Reconstitution.................. 5,869
-------
Total deferred tax assets.................................... 13,961
-------
Deferred tax liability--depreciation and amortization............ 41,087
-------
Net deferred tax liability................................... $27,126
=======
</TABLE>
At December 31, 1999, the Company has a net operating loss carryforward
since the Reconstitution for federal income tax purposes of approximately $14.6
million. The net operating loss carryforward is scheduled to expire in 2019.
8. Option Plans--Common Stock and Stock Options
Time Warner Telecom 1998 Option Plan
The Company maintains a stock option plan reserving 9,027,000 shares of
Class A Common Stock to be issued to officers and key employees under terms and
conditions to be set by the Company's board of directors.
F-16
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
Generally, the options vest over periods of up to four years and expire ten
years from the date of issuance. Such options have generally been granted to
employees of the Company at an estimated fair value at the date of grant, and
accordingly, no compensation cost has been recognized by the Company relating
to such option plan.
During 1999, the Company granted options to purchase 100,000 shares outside
of the option plan. Deferred compensation expense of $2.1 million was recorded
and will be amortized on a straight-line basis over the four-year vesting
period. In 1999, stock compensation expense of approximately $88,000 was
recorded for such options and are reported as a component of selling, general
and administrative expenses in the accompanying consolidated and combined
statements of operations.
The Company has elected to follow Accounting Principles Board Opinion No. 25
("APB 25"), "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its employee stock options. Under APB 25,
because the exercise price of the Company's employee stock options is generally
equal to the market price of the underlying stock on the date of the grant, no
compensation expense is recognized. SFAS No. 123, "Accounting and Disclosure of
Stock-Based Compensation," establishes an alternative method of expense
recognition for stock-based compensation awards to employees based on fair
values. The Company elected not to adopt SFAS No. 123 for expense recognition
purposes.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of SFAS
No. 123. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1998 and 1999, respectively: risk-free interest rate of 6.5%
during each period; dividend yield of 0.0% during each period; volatility
factor of the expected market price of the Company's common stock of 0.74 for
1999; and a weighted-average expected life of the option of five years during
each period.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
The weighted-average fair value of options granted during 1998 and 1999 was
$3.33 and $19.98, respectively. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The Company's pro forma net loss and pro forma net loss per
share applicable to Class A Common Stock as if the company had used the fair
value accounting provisions of SFAS No. 123 would be a loss of $103.1 million
and a loss per share of $1.07 for the year ended December 31, 1999. The
Company's shares were not publicly traded and no shares were exercisable as of
December 31, 1998.
F-17
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
A summary of the Company's stock option activity, and related information
for the year ended December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------------- ---------------------------
Weighted Average Weighted Average
Options Exercise Price Options Exercise Price
--------- ---------------- --------- ----------------
<S> <C> <C> <C> <C>
Options outstanding at
beginning of year...... 5,810,750 $12.00 -- $ --
Granted................. 2,950,750 29.90 6,115,250 12.00
Exercised............... (309,849) 12.00 -- --
Forfeited............... (277,594) 12.63 (304,500) 12.00
--------- ---------
Options outstanding at
end of year............ 8,174,057 18.44 5,810,750 12.00
========= =========
Exercisable at end of
year................... 1,784,036 $12.00 -- $12.00
========= =========
</TABLE>
Exercise prices for options outstanding as of December 31, 1999, are as
follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- --------------------------------
Number Weighted Number
Range of Outstanding as of Average Weighted Exercisable as of Weight
Exercise December 31, Remaining Average December 31, Average
Prices 1999 Contractual Life Exercise Price 1999 Exercise Price
-------- ----------------- ---------------- -------------- ----------------- --------------
<S> <C> <C> <C> <C> <C>
$12.00-12.00 5,465,557 8.64 $12.00 1,784,036 $12.00
14.00-34.00 662,250 9.51 21.38 0 0.00
34.50-34.50 2,000,000 9.88 34.50 0 0.00
35.75-48.13 46,250 9.96 43.02 0 0.00
--------- ---------
8,174,057 9.02 $18.44 1,784,036 $12.00
========= =========
</TABLE>
9. Commitments and Contingencies
The Company leases office space and furniture, switching facilities and
fiber optic use rights. Certain of these leases contain renewal clauses.
F-18
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
At December 31, 1999, commitments under capital and non-cancelable operating
leases with terms in excess of one year were as follows:
<TABLE>
<CAPTION>
Capital Operating
Leases Leases
----------- ------------
(amounts in thousands)
<S> <C> <C>
Year ended December 31:
2000............................................ $ 737 11,023
2001............................................ 736 9,152
2002............................................ 519 9,003
2003............................................ 433 8,804
2004............................................ 401 8,449
Thereafter...................................... 5,416 51,549
----------- ----------
Total minimum lease payments.................. 8,242 97,980
==========
Less amount representing interest................. (4,139)
-----------
Present value of obligations under capital
leases........................................... 4,103
Less current portion of obligations under capital
leases........................................... (476)
-----------
Obligations under capital leases, excluding
current portion.................................. $ 3,627
===========
</TABLE>
The obligations under capital leases have been discounted at an imputed
interest rate of 9.75%. Rental expense under operating leases, aggregated $9.4
million, $7.0 million and $5.4 million for 1999, 1998 and 1997, respectively.
Pending legal proceedings are substantially limited to litigation incidental
to the business of the Company. In the opinion of management, the ultimate
resolution of these matters will not have a material adverse effect on the
Company's financial statements.
10. Employee Benefit Plans
Effective January 1, 1999, the Company adopted the "TWTC 401(k) by Time
Warner Telecom" qualified retirement plan (the "401(k) Plan"). Employees who
meet certain eligibility requirements may contribute up to 15% of their
eligible compensation, subject to statutory limitations, to a trust for
investment in several diversified investment choices, as directed by the
employee. The Company made a matching contribution of 100% of each employee's
contribution up to a maximum of 5% of the employee's eligible compensation.
Contributions to the 401(k) Plan aggregated $3.3 million for 1999.
Effective January 1, 2000, the Company adopted the "Time Warner Telecom 2000
Qualified Stock Purchase Plan" (the "Stock Purchase Plan"). Employees who meet
certain eligibility requirements may elect to designate up to 15% of their
eligible compensation to be used to purchase shares of the Company's Class A
Common Stock, up to an annual limit of $25,000 in the Company's Class A Common
Stock, at a 15% discount to fair market value. Stock purchases occur twice a
year on January 1 and July 1, with the price per share equaling the lower of
85% of the market price at the beginning or end of the offering period. Subject
to stockholder approval at the Company's annual meeting, the Company is
authorized to issue a total of 750,000 shares of the Company's Class A Common
Stock to participants in the Stock Purchase Plan.
F-19
<PAGE>
TIME WARNER TELECOM INC.
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS--(Continued)
11. Quarterly Results of Operations (Unaudited)
The following summarizes the Company's unaudited quarterly results of
operations for 1999 and 1998:
<TABLE>
<CAPTION>
Three Months Ended
--------------------------------------------
March 31 June 30 September 30 December 31
-------- -------- ------------ -----------
(dollars in thousands, except per share
amounts)
<S> <C> <C> <C> <C>
Year Ended December 31, 1999
Total revenue(1)............ $ 47,589 $ 58,381 $ 71,315 $ 91,468
Operating income (loss)..... (15,536) (11,340) (8,561) 4,449
Net loss.................... (24,642) (53,178) (9,115) (2,330)
Basic and diluted loss per
common share............... (0.30) (0.57) (0.09) (0.02)
Year Ended December 31, 1998
Total revenue............... 22,048 27,047 32,686 40,091
Operating loss.............. (19,719) (19,407) (17,532) (16,741)
Net loss.................... (21,788) (22,135) (24,490) (24,326)
Basic and diluted loss per
common share............... $ (0.27) $ (0.27) $ (0.30) $ (0.30)
</TABLE>
- --------
(1) Total revenue for the quarter ended December 31, 1999 includes the
recognition of a non-recurring $7.6 million settlement of reciprocal
compensation.
The total net loss per share for the 1999 quarter does not equal net loss
per share for the respective year as the per share amounts for each quarter
and for the year are computed based on their respective discrete periods.
F-20
<PAGE>
TIME WARNER TELECOM INC.
SCHEDULE II--VALUATION OF QUALIFYING ACCOUNTS
Years Ended December 31, 1999, 1998 and 1997
<TABLE>
<CAPTION>
Additions/
Balance at Charges to Balance at
Beginning Costs and End of
Of Period Expenses Deductions Period
---------- ---------- ---------- ----------
(amounts in thousands)
<S> <C> <C> <C> <C>
For the Year ended December 31,
1999:
Allowance for doubtful accounts
receivable...................... $2,692 $6,735 $(1,570) $7,857
====== ====== ======= ======
For the Year ended December 31,
1998:
Allowance for doubtful accounts
receivable...................... 776 2,020 (104) 2,692
====== ====== ======= ======
For the Year ended December 31,
1997:
Allowance for doubtful accounts
receivable...................... $ 193 $1,213 $ (630) $ 776
====== ====== ======= ======
</TABLE>
F-21
<PAGE>
9,000,000 Shares
[LOGO OF TIME WARNER TELECOM]
Time Warner Telecom Inc.
Class A Common Stock
-----------
PROSPECTUS
April 26, 2000
-----------
Lehman Brothers Morgan Stanley Dean Witter
-----------
Bear, Stearns & Co. Inc.
Donaldson, Lufkin & Jenrette
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expenses payable by us in
connection with the registration of the offering of the shares. All expenses
other than the Securities and Exchange Commission registration fee, the NASD
filing fee and the Nasdaq National Market listing fee are estimates.
<TABLE>
<S> <C>
SEC Registration Fee............................................ $321,044
NASD Filing Fee................................................. $ 30,500
Nasdaq National Market Listing Fee.............................. $ 17,500
Accounting Fees and Expenses.................................... $ 75,000
Legal Fees and Expenses......................................... $ 80,000
Printing Expenses............................................... $200,000
Miscellaneous................................................... $ 5,956
--------
Total......................................................... $730,000
========
</TABLE>
The Company will pay all expenses of registration, issuance and distribution
of the shares being sold by the selling stockholder, excluding fees and
expenses of counsel to the selling stockholder and any underwriting commissions
and discounts, filing fees and transfer or other taxes, which shall be borne by
the selling stockholder.
ITEM 14. Indemnification of Directors and Officers.
Article VI of the Restated Certificate of Incorporation of Time Warner
Telecom Inc. (the "Company") provides that to the fullest extent permitted
under the General Corporation Law of the State of Delaware (the "DGCL"), a
director of the Company shall not be personally liable to the Company or its
stockholders for monetary damages for breach of fiduciary duty as a director.
Section 102(b)(7) of the DGCL provides that a corporation may eliminate or
limit the personal liability of a director (or certain persons who, pursuant to
the provisions of the certificate of incorporation, exercise or perform duties
conferred or imposed upon directors by the DGCL) to the corporation or its
stockholders for monetary damages for breach of fiduciary duty as a director,
provided that such provision shall not eliminate or limit the liability of a
director:
. for any breach of the director's duty of loyalty to the corporation or
its stockholders;
. for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. under Section 174 of the DGCL (providing for liability of directors for
unlawful payment of dividends or unlawful stock purchases or
redemptions); or
. for any transaction from which the director derived an improper personal
benefit.
Article VII of the By-laws of the Company provides that to the fullest
extent permitted under the DGCL, the Company will indemnify and hold harmless
any person that was or is made or threatened to be made a party or is otherwise
involved in any action, suit or proceeding by reason of the fact that such
person is or was a director or officer of the Company. Section 145 of the DGCL
provides that a corporation may indemnify directors and officers as well as
other employees and individuals against expenses (including attorneys' fees),
judgments, fines, and amounts paid in settlement in connection with specified
actions, suits or proceedings, whether civil, criminal, administrative or
investigative (other than an action by or in the right of the corporation--a
"derivative action"), if they acted in good faith and in a manner they
reasonably believed to be in or not opposed to the best interests of the
corporation and, with respect to any criminal action or proceedings, had no
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<PAGE>
reasonable cause to believe their conduct was unlawful. A similar standard is
applicable in the case of derivative actions, except that indemnification only
extends to expenses (including attorneys' fees) actually and reasonably
incurred in connection with the defense or settlement of such action, and the
statute requires court approval before there can be any indemnification where
the person seeking indemnification has been found liable to the corporation.
The statute provides that it is not exclusive of other indemnification that may
be granted by a corporation's charter, by-laws, disinterested director vote,
stockholder vote, agreement or otherwise. The Company also has obtained
insurance policies which provide coverage for the Company's directors and
officers in certain situations, including some situations where the Company
cannot directly indemnify the directors of officers.
Item 15. Recent Sales of Unregistered Securities.
During the past three years, except as set forth in the next four sentences,
the Company has not sold any securities without registration under the
Securities Act. Immediately prior to the date of the Company's Registration
Statement on Form S-1 dated May 11, 1999 (Registration No. 333-49439), the
Company issued 81,250,000 shares of its Class B Common Stock to the Class B
Stockholders, in a private placement under Section 4(2) of the Securities Act.
In April 1999, the Company issued 307,550 shares of Class A Common Stock in
connection with the Company's acquisition of Internet Connect, Inc. in a
private placement under Section 4(2) of the Securities Act. In March 1999, the
Company issued options to acquire Class A limited liability company interests
in TWT LLC which, in connection with the Reorganization, were converted into
options to acquire 41,667 shares of Class A Common Stock to its former
president and CEO, Steven McPhie, in a private placement under Section 4(2) of
the Securities Act. During the second quarter of 1999, the Company issued
2,190,308 shares of Class A Common Stock to the former partners of MetroComm in
a private placement under Section 4(2) of the Securities Act in connection with
the acquisition of the remaining 50% of MetroComm that the Company did not own.
ITEM 16. Exhibits and Financial Statement Schedules.
(a)(1), (2) The Financial Statements and Schedule II--Valuation and
Qualifying Accounts listed on the index on Page F-1 following are included
herein by reference. All other schedules are omitted, either because they are
not applicable or because the required information is shown in the financial
statements or the notes thereto.
(3) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<C> <S>
1.1 Underwriting Agreement**
2.1 Reorganization Agreement among Time Warner Companies, Inc., MediaOne
Group, Inc., Advance/Newhouse Partnership, Time Warner Entertainment
Company, L.P., and Time Warner Entertainment-Advance/Newhouse
Partnership (filed as Exhibit 2.1 to TWT LLC's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998)*
2.2 Merger Agreement among the Company, TWT LLC and TWT Inc. (filed as
Exhibit 2.2 to the Company's Registration Statement on Form S-1
(Registration No. 333-49439))*
3.1 Restated Certificate of Incorporation of the Company (filed as Exhibit
3.1 to the Company's Registration Statement on Form S-1 (Registration
No. 333-49439))*
3.2 Restated By-laws of the Company (filed as Exhibit 3.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333-40439))*
4.1 Stockholders Agreement, among the Company, Time Warner Companies,
Inc., American Television and Communications Corporation, MediaOne
Group, Inc., Multimedia Communications, Inc. and Advance/Newhouse
Partnership (filed as Exhibit 4.1 to the Company's Registration
Statement on Form S-1 (Registration No. 333-49439))*
4.2 Indenture, between TWT LLC, TWT Inc. and The Chase Manhattan Bank, as
Trustee (filed as Exhibit 4.1 to TWT LLC's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998)*
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
------- ----------------------
<C> <S>
5.1 Opinion of Cravath, Swaine & Moore**
10.1 Lease, between Quebec Court Joint Venture No. 2, Landlord, and
Intelligent Advanced Systems, Inc., Tenant, dated June 3, 1994 (filed
as Exhibit 10.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-53553))*
10.2 Agreement for Assignment of Lease, dated September 12, 1997, between
Ingram Micro Inc. and Time Warner Communications Holdings Inc. (filed
as Exhibit 10.2 to the Company's Registration Statement on Form S-1
(Registration No. 333-53553))*
10.3 First Amendment to Lease, dated October 15, 1997, by CarrAmerica
Realty, L.P. and Time Warner Communications Holdings Inc. (filed as
Exhibit 10.3 to the Company's Registration Statement on Form S-1
(Registration No. 333-53553))*
10.4 TWT LLC 1998 Option Plan as amended December 8, 1999 (filed as Exhibit
10.4 to the Company's Annual Report on Form 10-K for the year ended
December 31, 1999)*
10.5 Employment Agreement between the Company and Larissa L. Herda (filed
as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.6 Employment Agreement between the Company and Paul B. Jones (filed as
Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.7 Employment Agreement between the Company and A. Graham Powers (filed
as Exhibit 10.7 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999)*
10.8 Employment Agreement between the Company and David J. Rayner (filed as
Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.9 Employment Agreement between the Company and John T. Blount (filed as
Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.10 Employment Agreement between the Company and Michael Rouleau (filed as
Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.11 Employment Agreement between the Company and Julie Rich (filed as
Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.12 Employment Agreement between the Company and Raymond Whinery (filed as
Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1999)*
10.13 Capacity License Agreement (filed as Exhibit 10.3 to TWT LLC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998)*
10.14 Trade Name License Agreement (filed as Exhibit 10.4 to TWT LLC's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998)*
10.15 Agreement between AT&T Communications, Inc. and Time Warner
Communications, dated as of September 15, 1996, as amended on June 1,
1997 (filed as Exhibit 10.13 to the Company's Registration Statement
on Form S-1 (Registration No. 333-49439))*
21.1 Subsidiaries of the Company (filed as Exhibit 21 to the Company's
Registration Statement on Form S-1 (Registration No. 333-49439))*
23.1 Consent of Ernst & Young LLP, Independent Auditors
23.2 Consent of Cravath, Swaine & Moore (included in Exhibit 5)
24.1 Power of Attorney of the Company's Officers and Directors (included on
Signature Page)**
</TABLE>
- --------
*Incorporated by reference.
**Previously filed as part of this Registration Statement.
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<PAGE>
(b) Reports on Form 8-K.
None.
ITEM 17. Undertakings.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the provisions described under Item 14 above or otherwise, the
Company 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 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the Company
of expenses incurred or paid by a director, officer or controlling person of
the Company in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with the
securities being registered, the Company will, unless in the opinion of their
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
The Company hereby undertakes that:
1. For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as a part of this
Registration Statement in reliance upon Rule 430A and contained in the form
of prospectus filed by the Company pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed part of this Registration
Statement as of the time it was declared effective.
2. For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at such time shall be
deemed to be the initial bona fide offering thereof.
3. It will provide the underwriters at the closing specified in the
underwriting agreements certificates in such denominations and registered
in such names as required by the underwriters to permit prompt delivery to
each purchaser.
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<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, Time
Warner Telecom Inc. has duly caused Amendment No. 3 to this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, on April 26, 2000.
Time Warner Telecom Inc.
By: /s/ David J. Rayner
----------------------------------
Name: David J. Rayner
Title: Senior Vice President and
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
(i) Principal Executive Officer
<S> <C> <C>
* President and Chief April 26, 2000
___________________________________________ Executive Officer and
Larissa L. Herda Representative
(ii) Principal Financial Officer
/s/ David J. Rayner Senior Vice President and April 26, 2000
___________________________________________ Chief Financial Officer
David J. Rayner
(iii) Principal Accounting Officer
* Vice President, Accounting April 26, 2000
___________________________________________ and Finance and Chief
Jill R. Stuart Accounting Officer
(iv) Directors
* Director April 26, 2000
___________________________________________
Glenn A. Britt
* Director April 26, 2000
___________________________________________
Bruce Clafin
* Director April 26, 2000
___________________________________________
Richard J. Davies
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
* Director April 26, 2000
___________________________________________
Spencer B. Hays
* Director April 26, 2000
___________________________________________
Larissa L. Herda
* Director April 26, 2000
___________________________________________
Douglas Holmes
* Director April 26, 2000
___________________________________________
Lisa Hook
* Director April 26, 2000
___________________________________________
Robert J. Miron
* Director April 26, 2000
___________________________________________
Audley M. Webster, Jr.
/s/ James N. Zerefos Director April 26, 2000
___________________________________________
James N. Zerefos
/s/ David J. Rayner April 26, 2000
By: _______________________________________
Attorney-in-Fact
</TABLE>
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<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Selected
Consolidated and Combined Financial and Other Operating Data" and "Experts" and
to the use of our report dated February 4, 2000, in Amendment No. 3 to the
Registration Statement (Form S-1) and related Prospectus of Time Warner Telecom
Inc. for the registration of 9,500,000 shares of its Class A Common Stock.
/s/ ERNST & YOUNG LLP
Denver, Colorado
April 25, 2000
