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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 1, 1999
REGISTRATION NO. 333-69543
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
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ALLEGIANCE TELECOM, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 4832 75-2721491
(State or other jurisdiction (Primary Standard Industrial (IRS Employer
of incorporation or
organization) Classification Code Number) Identification Number)
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1950 STEMMONS FREEWAY
SUITE 3026
DALLAS, TEXAS 75207
TELEPHONE: (214) 261-7100
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
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ROYCE J. HOLLAND, CHAIRMAN AND
CHIEF EXECUTIVE OFFICER
Allegiance Telecom, Inc.
1950 Stemmons Freeway
Suite 3026
Dallas, Texas 75207
Telephone: (214) 261-7100
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
Copies to:
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MARK B. TRESNOWSKI
ANNIE S. TERRY
Allegiance Telecom, Inc. ANDREW R. SCHLEIDER
4 Westbrook Corporate Center Shearman & Sterling
Suite 400 599 Lexington Avenue
Westchester, Illinois 60154 New York, New York 10022
(708) 836-5200 (212) 848-4000
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: From time
to time after the effective date of this Registration Statement.
Pursuant to Rule 429 under the Securities Act of 1933, the prospectus
included in this Registration Statement relates to Registration No. 333-53479
filed by the Registrant and declared effective June 30, 1998. The Registrant is
registering an indeterminate amount of notes for which no filing fee is
required.
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: [X]
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 this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box: [ ]
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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 THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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PROSPECTUS
$205,000,000
[ALLEGINANCE TELECOM, INC., LOGO]
12 7/8% SENIOR NOTES DUE 2008
- - Mature May 15, 2008
- - Interest payable May 15 and November 15
- - We may redeem the 12 7/8% notes, in whole or in part, at any time on or after
May 15, 2003
- - $69.0 million of U.S. Treasury securities placed into a pledge account for the
payment in full of the first six scheduled interest payments of the 12 7/8%
notes
- - Except for the pledged securities, the 12 7/8% notes are not secured by any of
our assets and rank equally in right of payment with all of our unsecured and
unsubordinated indebtedness, including our 11 3/4% Senior Discount Notes due
2008
- - The 12 7/8% notes have been issued and are currently outstanding; this
prospectus will be used only for market-making transactions by Morgan Stanley
Dean Witter and we will not receive any proceeds from the sale of any 12 7/8%
notes by Morgan Stanley Dean Witter
There is currently no established market for the 12 7/8% notes and we do
not currently intend to apply for listing of the 12 7/8% notes on any securities
exchange or automated dealer quotation system.
See "Risk Factors" beginning on page 9 for information that should be
considered by prospective investors.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
MORGAN STANLEY DEAN WITTER
March , 1999
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TABLE OF CONTENTS
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Prospectus Summary.................. 4
Risk Factors........................ 9
Where You Can Find More
Information....................... 20
Use of Proceeds..................... 20
Selected Financial Data............. 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations..................... 26
Business............................ 40
Management.......................... 64
Certain Relationships and Related
Transactions...................... 75
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Security Ownership of Certain
Beneficial Owners and
Management........................ 77
Description of Certain
Indebtedness...................... 79
Description of the Notes............ 80
Description of Capital Stock........ 123
Certain United States Federal Tax
Considerations.................... 127
ERISA Considerations................ 132
Plan of Distribution................ 133
Legal Matters....................... 134
Experts............................. 134
Index to Consolidated Financial
Statements........................ F-1
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You should rely only on the information provided in this prospectus, any
supplement and the information set forth in the registration statement of which
this prospectus is a part. We have not authorized anyone else to provide you
with different information. We are not making an offer of these 12 7/8% notes in
any state where the offer is not permitted. You should not assume that the
information in this prospectus or any supplement is accurate as of any date
other than the date on the front of those documents.
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus. This
summary may not contain all of the information that you should consider before
purchasing the 12 7/8% notes. You should read the entire prospectus carefully.
ALLEGIANCE
Allegiance Telecom, Inc. seeks to be a premier provider of telecommunications
services to business, government and other institutional users in major
metropolitan areas across the United States. We offer an integrated set of
telecommunications products and services including local exchange, local access,
domestic and international long distance, enhanced voice, data and a full suite
of Internet services.
Our business plan covers 24 of the largest metropolitan areas in the U.S. We
estimate that these 24 markets include more than 21 million non-residential
access lines, representing about 44.7% of the total non-residential access lines
in the U.S. With a strategy focusing on the central business districts and
suburban commercial districts in these areas, we plan to address a majority of
the non-residential access lines in most of our targeted markets. As of March 1,
1999, we were operating in ten markets: New York City, Dallas, Atlanta, Fort
Worth, Chicago, Los Angeles, San Francisco, Boston, Oakland and Philadelphia. As
of that date we were in the process of deploying our networks in seven other
markets: Houston, Long Island, Washington D.C., Northern New Jersey, Orange
County, San Diego and San Jose.
Under the Telecommunications Act of 1996, we have the status of a competitive
local exchange carrier or "CLEC" and, as such, in each of our markets we compete
primarily with the existing or incumbent local exchange carrier or "ILEC." The
ILECs have historically enjoyed a monopoly in providing local phone service.
Our principal executive offices are located at 1950 Stemmons Freeway, Suite
3026, Dallas, Texas 75207 and our telephone number is (214) 261-7100.
BUSINESS STRATEGY
Our goal is to achieve significant market penetration and deliver superior
customer care while maximizing operating margins. The key components of our
strategy include the following:
Leverage Proven Management Team. Our Chairman and Chief Executive Officer, Royce
J. Holland, has more than 25 years of experience in the telecommunications and
energy industries, including as President, Chief Operating Officer, and
co-founder of MFS Communications, one of the first companies to compete with the
existing telephone companies that enjoyed a monopoly in providing local phone
service. Under his leadership, MFS Communications grew from a start-up operation
to become the largest competitor to the existing incumbent local exchange
carriers. It grew to approximately $1.1 billion in revenues before its
acquisition by WorldCom, Inc. in 1996. Our other key executives also have
significant industry experience.
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Target End Users with Integrated Service Offerings. We focus principally on
customers in the business, government and other institutional market segments.
The majority of our customers are small and medium-sized businesses, to which we
offer "one-stop shopping" by giving them the ability to purchase a comprehensive
package of communications services from a single supplier. We offer the
following services:
- - local and long distance services,
- - local area network interconnection,
- - frame relay, a high speed data service used to transmit data between
computers and designed to operate at higher speeds,
- - Internet services,
- - Integrated Services Digital Network, an internationally agreed upon standard
which, through special equipment, allows two-way, simultaneous voice and data
transmission in digital formats over the same transmission line,
- - Digital Subscriber Lines, which allow high speed digital connection for
carrying voice and data traffic over copper lines,
- - Web page design, and
- - Web server hosting.
By offering a comprehensive package of communications services together with
traditional local and long distance services, we believe that we can accelerate
our ability to establish new customer accounts and reduce the number of
customers who discontinue our services and switch to other telecommunications
providers.
Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. We will continue to pursue what we refer to as a "smart build"
strategy which entails purchasing and installing switches, locating our
equipment in the central office facilities of incumbent local exchange carriers
and leasing elements of the existing networks owned by the incumbent local
exchange carriers until growth justifies our ownership of additional network
assets. We believe this strategy reduces our initial capital expenditures,
reduces the time it takes to enter and expand in a geographic market and
generates higher returns on invested capital.
Achieve Broad Coverage of Attractive Areas within Each Targeted Market. As part
of our smart build strategy, we plan to continue to devote significant resources
to locating our equipment in the central office facilities of incumbent local
exchange carriers that we have selected to provide us with access to attractive
service areas. This will enable us to address the most attractive service areas
throughout each of our target markets, such as suburban business parks and
concentrated downtown areas, without having to construct our own fiber network
to the customer premises in each of these areas.
Maximize Operating Margins by Emphasizing Facilities-Based Services. We believe
that by using our own facilities to provide service, we should generate
significantly higher gross margins than we could obtain by reselling services
provided entirely on another carrier's facilities. As a result, we focus our
marketing activities on areas where we can serve customers through a direct
connection to our facilities.
Build Market Share by Focusing on Direct Sales. By using a direct sales force
which interacts directly with customers and provides them personalized customer
care through a
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single point of contact, we hope to maximize our market share, particularly
among small and medium-sized businesses.
Develop Efficient Automated Back Office Systems. By developing, acquiring and
integrating information technology systems to support our operations and by
establishing an electronic bonding arrangement with the incumbent local exchange
carriers that allow us to automate most of the processes involved in switching a
customer to our networks, we are working to minimize the time between customer
order and service installation. Automating the order processing function should
also help us reduce our overhead costs and improve customer service.
Expand Customer Base Through Potential Acquisitions. We plan to pursue strategic
acquisitions to expand our customer base and acquire additional experienced
management.
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THE NOTES
Total Amount of Notes
Offered...................... $205,000,000 aggregate principal amount of
12 7/8% Senior Notes due 2008.
Maturity..................... May 15, 2008.
Interest Payment Date........ Payable in cash on May 15 and November 15 of
each year, commencing November 15, 1998.
Optional Redemption of the
Notes...................... We may, at our option, redeem the 12 7/8% notes,
beginning on May 15, 2003. The initial
redemption price is 106.438% of their principal
amount, plus accrued interest. The redemption
price will decline each year and will be 100% of
their principal amount, plus accrued interest,
beginning on May 15, 2006.
In addition, before May 15, 2001, we may redeem
up to 35% of the aggregate principal amount of
the 12 7/8% notes with the proceeds of our
public equity offerings of equity, at 112.875%
of their principal amount, plus accrued
interest. We may make such redemption only if at
least 65% of the aggregate principal amount of
the 12 7/8% notes originally issued remains
outstanding.
Security for the Notes....... In connection with the sale of the 12 7/8%
notes, we purchased approximately $69.0 million
of U.S. Treasury securities and placed such
securities in a pledge account to be used for
payment in full of the first six scheduled
interest payments due on the 12 7/8% notes.
Change of Control of
Allegiance................. Upon a change of control of Allegiance, we will
be required to make an offer to purchase the
12 7/8% notes at a purchase price equal to 101%
of their principal amount plus accrued interest.
There can be no assurance that we will have
sufficient funds available at the time of any
change of control to make any required debt
repayment, including repurchases of the 12 7/8%
notes.
Ranking...................... The 12 7/8% notes:
- are not secured by any of our assets, other
than the pledge of the U.S. Treasury
securities described above; and
- rank equally in right of payment with all of
our unsubordinated and unsecured indebtedness,
including our 11 3/4% Senior Discount Notes
due 2008.
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At December 31, 1998, we had approximately
$471.7 million of indebtedness outstanding, all
of which was ranked equally in right of payment
with the 12 7/8% notes.
Restrictive Covenants........ The indenture under which the 12 7/8% notes have
been issued contains covenants that, among other
things, restrict our ability and the ability of
our subsidiaries to:
- incur additional indebtedness;
- create liens;
- engage in sale-leaseback transactions;
- pay dividends or make distributions in respect
of their capital stock;
- redeem capital stock;
- make investments or restricted payments;
- sell assets;
- issue or sell stock of our subsidiaries;
- enter into transactions with stockholders or
affiliates; or
- effect a consolidation or merger.
However, these limitations will be subject to a
number of important qualifications and
exceptions.
Use of Proceeds.............. We will not receive any proceeds from the sale
of any 12 7/8% notes by Morgan Stanley Dean
Witter.
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RISK FACTORS
You should carefully consider the following risk factors, as well as other
information in this prospectus, before you decide whether to invest in the
12 7/8% notes.
OUR LIMITED HISTORY OF OPERATIONS MAY NOT BE A RELIABLE BASIS FOR EVALUATING OUR
PROSPECTS
Because of our short operating history, you have limited operating and financial
data which you can use to evaluate our performance and determine whether you
should invest in the 12 7/8% notes. From our inception on April 22, 1997 through
December 16, 1997, we were in the development stage of operations. We have grown
rapidly since then and have demonstrated success in our early stages of
operations. As of December 31, 1998, we have sold approximately 86,500 lines to
customers, of which, 47,700 lines were installed.
IF WE DO NOT RAISE SIGNIFICANT ADDITIONAL CAPITAL, WE CANNOT EXECUTE ALL OF OUR
BUSINESS PLAN
We need significant capital to fund capital expenditures, working capital, debt
service and cash flow deficits during the period in which we are expanding and
developing our business and deploying our networks, services and systems. We
cannot assure you that the additional financing we are seeking will be available
on terms acceptable to us or at all. Our principal capital expenditure
requirements involve the purchase and installation of network switches and other
equipment. We estimate, based on our current business plan, that our aggregate
capital requirements to fund the deployment and operation of our networks in all
of our initial 24 markets to positive free cash flow will total about $750
million. This amount includes requirements to fund capital expenditures, working
capital and cash flow deficits, but excludes debt service. We believe, based on
our current business plan, that the net proceeds from our capital raising
activities completed to date and funding expected to be available from equipment
vendors, commercial banks or other available sources of capital will be
sufficient to pre-fund our market deployment in our initial 24 markets to the
point at which operating cash flow from the market is sufficient to fund such
market's operating costs and capital expenditures. If the additional financing
is not obtained in accordance with our plan, we intend to modify our deployment
schedule by developing only 18 of our initial markets through this positive free
cash flow point. In such case, we would delay deployment of networks in the
remaining six markets until we obtain additional financing on acceptable terms
and conditions.
The actual amount and timing of our future capital requirements may differ
materially from our estimates as a result of, among other things:
- - the cost of the development of our networks in each of our markets;
- - a change in or inaccuracy of our development plans or projections, such as an
alteration in the schedule or targets of our roll-out plan;
- - the extent of price and service competition for telecommunications services in
our markets;
- - the demand for our services;
- - regulatory and technological developments, including additional market
developments and new opportunities in our industry; and
- - our consummation of acquisitions.
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IF WE DO NOT EFFECTIVELY MANAGE RAPID EXPANSION OF OUR BUSINESS, OUR FINANCIAL
CONDITION WILL SUFFER
We are in the early stages of our operations and have only recently begun to
deploy networks in our first 17 target markets. If we are successful in the
implementation of our business plan, we will be rapidly expanding our operations
and providing bundled telecommunications services on a widespread basis. This
rapid expansion may place a significant strain on our management, financial and
other resources. If we fail to manage our growth effectively, we may not be able
to expand our customer base and service offerings as we have planned. Any
failure to successfully manage the growth of our business could have a material
adverse effect on us and on our ability to meet our obligations under the
12 7/8% notes.
Our ability to manage growth, should it occur, will depend upon our ability to:
- - develop efficient operations support systems and other back office systems;
- - monitor operations;
- - control costs;
- - maintain regulatory compliance;
- - maintain effective quality controls;
- - significantly expand our internal management, technical, information and
accounting systems; and
- - attract, assimilate and retain additional qualified personnel, especially
sales personnel.
We cannot assure you that we will successfully manage a developing and expanding
business in an evolving, highly regulated and increasingly competitive industry.
OUR SUCCESS DEPENDS ON OUR KEY PERSONNEL AND WE MAY NOT BE ABLE TO REPLACE KEY
EXECUTIVES WHO LEAVE
We are managed by a small number of key executive officers, most notably Royce
J. Holland, our Chairman and Chief Executive Officer. The loss of services of
one or more of these key individuals, particularly Mr. Holland, could materially
and adversely affect our business and our prospects. Most of our executive
officers do not have employment agreements, and we do not maintain key person
life insurance for any of our executive officers. Although we have been
successful in attracting and retaining qualified personnel, the competition for
qualified managers in the telecommunications industry is intense. For this
reason, we cannot assure you that we will be able to hire or retain necessary
personnel in the future.
WE ARE DEPENDENT ON EFFECTIVE BILLING, CUSTOMER SERVICE AND INFORMATION SYSTEMS
AND WE MAY HAVE DIFFICULTIES IN DEVELOPING THESE SYSTEMS
Sophisticated back office information and processing systems are vital to our
growth and our ability to monitor costs, bill customers, initiate, implement and
track customer orders
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and achieve operating efficiencies. We cannot assure you that these systems will
be successfully implemented on a timely basis or at all or will perform as
expected because:
- - our vendors may fail to deliver proposed products and services in a timely and
effective manner and at acceptable costs;
- - we may fail to adequately identify all of our information and processing
needs;
- - our processing or information systems may fail or be inadequate;
- - we may be unable to effectively integrate such products or services;
- - we may fail to upgrade systems as necessary; and
- - third party vendors may cancel or fail to renew license agreements that relate
to these systems.
WE MAY BE ADVERSELY IMPACTED BY YEAR 2000 ISSUES, MANY OF WHICH ARE BEYOND OUR
CONTROL
The "year 2000" issue generally describes the various problems that may result
from the improper processing of dates and date-sensitive transactions by
computers and other equipment as a result of computer hardware and software
using two digits to identify the year in a date. The failure to process dates
could result in network and system failures or miscalculations causing
disruptions in operations including, among other things, a temporary inability
to process transactions, send invoices or engage in other routine business
activities. A failure of our customers or vendors, including other
telecommunications operators, to cause their software and systems to be year
2000 compliant could have a material adverse effect on us and on our ability to
meet our obligations under the 12 7/8% notes. While we are taking steps to
ensure that our systems will be year 2000 compliant, until the year 2000 occurs,
we will not know for sure that all systems will then function adequately. In
addition, we are dependent upon third-party suppliers, including other
telecommunications operators, for the delivery of interconnection and other
services and on third-party customers for the purchase of our services. In many
cases, our services and operations require electronic interfacing with the
systems and networks of third-party telecommunication operators such as the
incumbent local exchange carriers.
WE FACE POTENTIAL CONFLICTS OF INTEREST CAUSED BY FUND INVESTOR CONTROL WHICH
COULD BE DETRIMENTAL TO HOLDERS OF OUR SECURITIES
You should be aware that over 50% of our outstanding voting stock is controlled
by the investment funds that provided our initial equity and that as a result,
our direction and future operations can be controlled by these funds. In
addition, decisions concerning our operations or financial structure may present
conflicts of interest between these investors and our management and other
holders of our securities, including the notes. In addition to their investments
in us, these investors or their affiliates currently have significant
investments in other telecommunications companies and may in the future invest
in other entities engaged in the telecommunications business or in related
businesses, including entities that compete with us. Conflicts may also arise in
the negotiation or enforcement of arrangements entered into by us and entities
in which these investors have an interest.
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OUR SUBSTANTIAL INDEBTEDNESS COULD MAKE US UNABLE TO SERVICE INDEBTEDNESS AND
COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH
We have a significant amount of debt outstanding and plan to obtain additional
debt financing to fund our business plan.
This level of debt could:
- - impair our ability to obtain additional financing for working capital, capital
expenditures, acquisitions or general corporate purposes;
- - require us to dedicate a substantial portion of our cash flow from operations
to the payment of principal and interest on our indebtedness, thereby reducing
the funds available for the growth of our networks;
- - place us at a competitive disadvantage with those of our competitors which do
not have as much debt as we do;
- - impair our ability to adjust rapidly to changing market conditions; and
- - make us more vulnerable in the event of a downturn in general economic
conditions or in our business.
We cannot assure you that we will be able to meet our debt service obligations.
LIMITATIONS IMPOSED BY RESTRICTIVE COVENANTS COULD LIMIT HOW WE CONDUCT BUSINESS
AND A DEFAULT UNDER OUR INDENTURES AND FINANCING AGREEMENTS COULD SIGNIFICANTLY
IMPACT OUR ABILITY TO REPAY OUR INDEBTEDNESS
Our indentures and the agreements entered into in connection with our initial
equity funding contain covenants that restrict our ability to:
- - incur additional indebtedness;
- - pay dividends and make other distributions;
- - prepay subordinated indebtedness;
- - make investments and other restricted payments;
- - enter into sale and leaseback transactions;
- - create liens;
- - sell assets; and
- - engage in certain transactions with affiliates.
Our future financing arrangements will most likely contain similar covenants, as
well as other covenants that will require us to maintain specified financial
ratios and satisfy financial tests. As a result of these restrictions, we are
limited in how we conduct business and we may be unable to raise additional debt
or equity financing to operate during general economic or business downturns, to
compete effectively or to take advantage of new business opportunities. This may
affect our ability to generate revenues and make profits. Without sufficient
revenues and cash, we may not be able to pay interest and principal on our
indebtedness.
Our failure to comply with the covenants and restrictions contained in our
indentures and other financing agreements could lead to a default under the
terms of these agreements. In
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the event of such a default, the other parties to such agreements could declare
all amounts borrowed and all amounts due under other instruments that contain
provisions for cross-acceleration or cross-default due and payable. In addition,
lenders under our future financing arrangements could terminate their
commitments to lend to us. If that occurs, we cannot assure you that we would be
able to make payments on the 12 7/8% notes or that we would be able to find
additional alternative financing. Even if we could obtain additional alternative
financing, we cannot assure you that it would be on terms that are favorable or
acceptable to us.
YOUR RIGHT TO RECEIVE PAYMENTS ON THE 12 7/8% NOTES IS EFFECTIVELY JUNIOR TO OUR
SENIOR INDEBTEDNESS AND POSSIBLY ALL FUTURE BORROWINGS
The 12 7/8% notes are not secured by any of our assets, other than the U.S.
Treasury securities placed in the pledge account for the payment in full of the
first six scheduled interest payments. We may pledge some or all of our assets
to secure other debt. The 12 7/8% notes rank equal in right of payment with all
of our existing and future unsecured and unsubordinated indebtedness. In
addition, all indebtedness, including trade payables, of our subsidiaries, will
have a claim to the assets of our subsidiaries that is senior to the claim of
the 12 7/8% notes.
WE MAY NOT HAVE THE FUNDS NECESSARY TO FINANCE THE CHANGE OF CONTROL OFFER WHICH
MAY BE REQUIRED BY OUR INDENTURES
Our indentures provide that upon a change of control, each note holder will have
the right to require us to purchase all or a portion of such holder's notes. We
would be required to purchase the notes at a purchase price of 101% of the
accreted value of the 11 3/4% notes and 101% of the principal amount of the
12 7/8% notes, plus any accrued and unpaid interest to the date of repurchase.
It is possible that we will not have sufficient funds at that time to repurchase
the notes.
THE REGULATION OF INTERCONNECTION WITH INCUMBENT LOCAL EXCHANGE CARRIERS
INVOLVES UNCERTAINTIES AND COULD ADVERSELY AFFECT OUR BUSINESS
Although the incumbent local exchange carriers are required under the
Telecommunications Act of 1996 to unbundle and make available elements of their
network and permit us to purchase only the origination and termination services
that we need, thereby decreasing our operating expenses, such unbundling may not
be done as quickly as we require and may be priced higher than we expect. This
is important because we rely on the facilities of these other carriers to
connect to our high capacity digital switches so that we can provide services to
our customers. Our ability to obtain these interconnection agreements on
favorable terms, and the time and expense involved in negotiating them, can be
adversely affected by legal developments.
In August 1996, the FCC released a decision implementing the interconnection
portions of the Telecommunications Act. This interconnection decision
establishes rules for negotiating interconnection agreements and guidelines for
review of such agreements by state public utilities commissions. On July 18,
1997, the United States Court of Appeals for the Eighth Circuit vacated certain
portions of this interconnection decision. On January 25, 1999, the United
States Supreme Court reversed the Eighth Circuit decision and reinstated most of
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the FCC's rules, but vacated a rule determining which network elements the
incumbent local exchange carriers must provide to competitors on an unbundled
basis. We expect that the FCC will conduct a rulemaking to adopt new standards
for unbundling of network elements in conformance with the Supreme Court
decision. These new rules, as well as the implementation of other FCC rules
reinstated by the Supreme Court, may well lead to further litigation. The
uncertainty created by ongoing changes in the regulatory environment may
complicate our interconnection negotiations, and may adversely affect the
financial and operational terms of these agreements.
OUR ABILITY TO PROVIDE SERVICES DEPENDS ON INTERCONNECTING WITH OUR PRIMARY
COMPETITORS, THE INCUMBENT LOCAL EXCHANGE CARRIERS
Many new carriers have experienced difficulties in working with the incumbent
local exchange carriers with respect to initiating, interconnection, collocation
and implementing the systems used by these new carriers to order and receive
unbundled network elements and wholesale services. As a new carrier, we must
coordinate with incumbent local exchange carriers so that we can provide local
service to customers on a timely and competitive basis. The Telecommunications
Act created incentives for regional Bell operating companies to cooperate with
new carriers and permit access to their facilities by denying such companies the
ability to provide in-region long distance services until they have satisfied
statutory conditions designed to open their local markets to competition. The
regional Bell operating companies in our markets are not yet permitted by the
FCC to offer long distance services and we cannot assure you that these regional
Bell operating companies will be accommodating to us once they are permitted to
offer long distance service. If we cannot obtain the cooperation of a regional
Bell operating company in a region, whether or not it has been authorized to
offer long distance service, our ability to offer local services in such region
on a timely and cost-effective basis will be adversely affected.
WE COULD LOSE REVENUE IF THE FCC DETERMINES THAT CALLS TO INTERNET SERVICE
PROVIDERS SHOULD BE TREATED AS LONG DISTANCE INTERSTATE CALLS
We believe that incumbent local exchange carriers should have to compensate us
when their customers place calls to Internet service providers who are our
customers. Most incumbent local exchange carriers disagree and the FCC's
position on this issue remains unclear. Internet service providers are among our
target customers, and decisions providing that other carriers do not have to
compensate us for calls to them could limit our ability to service this group of
customers profitably. For all other local intrastate calls, it is clear that the
telecommunications company whose customer calls a customer of a second
telecommunications company must compensate the second company. This is known as
reciprocal compensation. This rule does not apply to long distance interstate
calls and the FCC may determine that calls to an Internet service provider are
more like interstate calls and that reciprocal compensation does not apply to
such calls. Incumbent local exchange carriers around the country have been
making this argument.
IF WE DO NOT OBTAIN PEERING ARRANGEMENTS WITH INTERNET SERVICE PROVIDERS, THE
PROFITABILITY OF OUR INTERNET ACCESS SERVICES WILL SUFFER
The profitability of our Internet access services, and related services such as
Web site hosting, may be adversely affected if we are unable to obtain "peering"
arrangements with
14
<PAGE> 15
Internet service providers. In recent years, major Internet service providers
routinely exchanged traffic with other Internet service providers that met
technical criteria on a "peering" basis, meaning that each Internet service
provider accepted traffic routed to Internet addresses on their system from
their "peers" on a reciprocal basis, without payment of compensation. In 1997,
however, UUNET Technologies, Inc., the largest Internet service provider,
announced that it intends to greatly restrict the use of peering arrangements
with other providers, and would impose charges for accepting traffic from
providers other than its "peers." Other major Internet service providers have
reportedly adopted similar policies. We cannot assure you that we will be able
to negotiate "peer" status with any of the major nationwide Internet service
providers, or that we will be able to terminate traffic on Internet service
providers' networks at favorable prices.
OUR PROVISION OF LONG DISTANCE SERVICES IS AFFECTED BY OUR ABILITY TO ESTABLISH
EFFECTIVE RESALE AGREEMENTS
As part of our "one-stop shopping" offering of bundled telecommunications
services to our customers, we plan to offer long distance services to our
customers. 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
turnover rate, as customers frequently change long distance providers in
response to the offering of lower rates or promotional incentives by
competitors. We will initially rely on other carriers to provide transmission
and termination services for all of our long distance traffic. We will need
resale agreements with long distance carriers to provide us with transmission
services. Such agreements typically provide for the resale of long distance
services on a per-minute basis and may contain minimum volume commitments.
Negotiation of these agreements involves estimates of future supply and demand
for transmission capacity as well as estimates of the calling pattern and
traffic levels of our future customers. If we fail to meet our minimum volume
commitments, we may be obligated to pay underutilization charges and if we
underestimate our need for transmission capacity, we may be required to obtain
capacity through more expensive means.
OUR PRINCIPAL COMPETITORS FOR LOCAL SERVICES, THE INCUMBENT LOCAL EXCHANGE
CARRIERS, AND POTENTIAL ADDITIONAL COMPETITORS, HAVE ADVANTAGES THAT MAY
ADVERSELY AFFECT OUR ABILITY TO COMPETE WITH THEM
The telecommunications industry is highly competitive. Many of our current and
potential competitors in the local market have financial, technical, marketing,
personnel and other resources, including brand name recognition, substantially
greater than ours, as well as other competitive advantages over us. In each of
the markets targeted by us, we will compete principally with the incumbent local
exchange carrier serving that area and they enjoy advantages that may adversely
affect our ability to compete with them. Incumbent local exchange carriers are
established providers of local telephone services to all or virtually all
telephone subscribers within their respective service areas. Incumbent local
exchange carriers also have long-standing relationships with federal and state
regulatory authorities. While some FCC and state administrative decisions and
initiatives provide increased business opportunities to telecommunications
providers such as us, they also provide the incumbent local exchange carriers
with pricing flexibility for their:
- - private lines, which are private, dedicated telecommunications connections
between customers;
15
<PAGE> 16
- - special access services, which are dedicated lines from a customer to a long
distance company provided by the local phone company; and
- - switched access services, which refers to the call connection provided by the
local phone company's switch between a customer's phone and the long distance
company's switch.
In addition, with respect to competitive access services, such as special access
services as opposed to switched local exchange services, the FCC is considering
allowing incumbent local exchange carriers increased pricing flexibility and
deregulation for such access services either automatically or after certain
competitive levels are reached. If the incumbent local exchange carriers are
allowed by regulators to offer discounts to large customers through contract
tariffs, engage in aggressive volume and term discount pricing practices for
their customers, and/or seek to charge competitors excessive fees for
interconnection to their networks, competitors such as us could be materially
adversely affected. If future regulatory decisions afford the incumbent local
exchange carriers increased pricing flexibility or other regulatory relief, such
decisions could also have a material adverse effect on competitors such as us.
We also face, and expect to continue to face, competition in the local market
from other current and potential market entrants, including long distance
carriers seeking to enter, reenter or expand entry into the local exchange
marketplace such as AT&T, MCI WorldCom and Sprint, and from other competitive
local exchange carriers, resellers, competitive access providers, cable
television companies, electric utilities, microwave carriers, wireless telephone
system operators and private networks built by large end users. In addition, the
development of new technologies could give rise to significant new competitors
in the local market.
WE ALSO FACE SIGNIFICANT COMPETITION IN THE PROVISION OF LONG DISTANCE AND
INTERNET SERVICES
We also face significant competition in the provision of long distance and
Internet services. Many of these competitors have greater financial,
technological, marketing, personnel and other resources than those available to
us.
The long distance telecommunications market has numerous entities competing for
the same customers and a high average turnover rate, as customers frequently
change long distance providers in response to the offering of lower rates or
promotional incentives. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline. We face
competition from large carriers such as AT&T, Sprint, and MCI WorldCom and many
smaller long distance carriers. Other competitors are likely to include regional
Bell operating companies providing out-of-region and, with the removal of
regulatory barriers, in-region, long distance services, other competitive local
exchange carriers, microwave and satellite carriers and private networks owned
by large end users. We may also increasingly face competition from companies
offering local and long distance data and voice services over the Internet. Such
companies could enjoy a significant cost advantage because they do not currently
pay carrier access charges or universal service fees. In addition, in June 1998,
Sprint announced its intention to offer voice, data and video services over its
nationwide asynchronous transfer mode network, which Sprint anticipates will
significantly reduce its cost to provide such services. Sprint
16
<PAGE> 17
plans to bill its customers based upon the amount of traffic carried,
irrespective of the time required to send the traffic or the traffic's
destination.
The Internet services market is highly competitive and we expect that
competition will continue to intensify. Our competitors in this market include
Internet service providers, other telecommunications companies, online services
providers and Internet software providers.
OUR NEED TO COMPLY WITH EXTENSIVE GOVERNMENT REGULATION CAN INCREASE OUR COSTS
AND SLOW OUR GROWTH
Our networks and the provision of telecommunications services are subject to
significant regulation at the federal, state and local levels. Delays in
receiving required regulatory approvals or the enactment of new adverse
regulation or regulatory requirements may slow our growth and have a material
adverse effect upon us.
The FCC exercises jurisdiction over us with respect to interstate and
international services. We must obtain, and have obtained through our
subsidiary, Allegiance Telecom International, Inc., prior FCC authorization for
installation and operation of international facilities and the provision,
including by resale, of international long distance services. Additionally, we
file tariffs with the FCC for both international and domestic long-distance
services.
State regulatory commissions exercise jurisdiction over us to the extent we
provide intrastate services. As such a provider, we are required to obtain
regulatory authorization and/or file tariffs at state agencies in most of the
states in which we operate. If and when we seek to build our own network
segments, local authorities regulate our access to municipal rights-of-way.
Constructing a network is also subject to numerous local regulations such as
building codes and licensing. Such regulations vary on a city by city and county
by county basis.
Regulators at both the federal and state level require us to pay various fees
and assessments, file periodic reports, and comply with various rules regarding
the contents of our bills, protection of subscriber privacy, and similar matters
on an on-going basis.
We cannot assure you that the FCC or state commissions will grant required
authority or refrain from taking action against us if we are found to have
provided services without obtaining the necessary authorizations, or to have
violated other requirements of their rules and orders. Regulators or others
could challenge our compliance with applicable rules and orders. Such challenges
could cause us to incur substantial legal and administrative expenses.
DEREGULATION OF THE TELECOMMUNICATIONS INDUSTRY INVOLVES UNCERTAINTIES THAT MAY
BE RESOLVED ADVERSELY TO US
The Telecommunications Act provides for a significant deregulation of the
domestic telecommunications industry, including the local exchange, long
distance and cable television industries. The Telecommunications Act remains
subject to judicial review and additional FCC rulemaking, and thus it is
difficult to predict what effect the legislation will have on us and our
operations. There are currently many regulatory actions underway and being
contemplated by federal and state authorities regarding interconnection pricing
and other issues that could result in significant changes to the business
conditions in the
17
<PAGE> 18
telecommunications industry. We cannot assure you that these changes will not
have a material adverse effect upon us.
THE REGULATION OF ACCESS CHARGES INVOLVES UNCERTAINTIES THAT MAY BE RESOLVED
ADVERSELY TO US
To the extent we provide interexchange telecommunications service, we are
required to pay access charges to incumbent local exchange carriers when we use
the facilities of those companies to originate or terminate interexchange calls.
Also, as a competitive local exchange carrier, we provide access services to
other long distance service providers. The interstate access charges of
incumbent local exchange carriers are subject to extensive regulation by the
FCC, while those of competitive local exchange carriers are subject to a lesser
degree of FCC regulation, but remain subject to the requirement that all charges
be just, reasonable, and not unreasonably discriminatory. Disputes have arisen
regarding the regulation of access charges and these may be resolved adversely
to us.
In two orders released on December 24, 1996, and May 16, 1997, the FCC made
major changes in the interstate access charge structure. In the December 24th
order, the FCC removed restrictions on incumbent local exchange carriers'
ability to lower access prices and relaxed the regulation of new switched access
services in those markets where there are other providers of access services. If
this increased pricing flexibility is not effectively monitored by federal
regulators, it could have a material adverse effect on our ability to compete in
providing interstate access services. The May 16th order substantially increased
the costs that incumbent local exchange carriers subject to the FCC's price cap
rules recover through monthly, non-traffic-sensitive access charges and
substantially decreased the costs that these carriers recover through
traffic-sensitive access charges. In the May 16th order, the FCC also announced
its plan to bring interstate access rate levels more in line with cost. The plan
will include rules that may grant incumbent local exchange carriers increased
pricing flexibility upon demonstrations of increased competition or potential
competition in relevant markets. The manner in which the FCC implements this
approach to lowering access charge levels could have a material effect on our
ability to compete in providing interstate access services.
Also, some interexchange carriers, including AT&T, have asked the FCC to take
regulatory action to prevent competitive local exchange carriers from charging
allegedly "excessive" access charges. Although no complaints have been filed
against us, we do provide access service to interexchange carriers and we could
be subject in the future to allegations that our charges for this service are
unjust and unreasonable. In that event, we would have to provide the FCC with an
explanation of how we set our rates and justify them as reasonable. Although we
believe we can provide such an explanation and justification if required, we can
give no assurance that the FCC will accept our rates as reasonable. If our rates
are reduced by regulatory order, this could have a material adverse effect on
our profitability.
18
<PAGE> 19
IF WE DO NOT CONTINUALLY ADAPT TO TECHNOLOGICAL CHANGE, WE COULD LOSE CUSTOMERS
AND MARKET SHARE
The telecommunications industry is subject to rapid and significant changes in
technology, and we rely on outside vendors for the development of and access to
new technology. The effect of technological changes on our business cannot be
predicted. We believe our future success will depend, in part, on our ability to
anticipate or adapt to such changes and to offer, on a timely basis, services
that meet customer demands. We cannot assure you that we will obtain access to
new technology on a timely basis or on satisfactory terms. Any failure by us to
obtain new technology could cause us to lose customers and market share and
could have a material adverse effect on us and on our ability to meet our
obligations under the 12 7/8% notes.
OUR FORWARD-LOOKING STATEMENTS MAY PROVE TO BE INACCURATE
This prospectus contains "forward-looking statements," which generally can be
identified by the use of forward-looking terminology such as "believes,"
"expects," "may," "will," "should," or "anticipates" or the negative thereof or
other variations thereon or comparable terminology, or by discussion of strategy
that involve risks and uncertainties. We caution you that these forward-looking
statements, such as our plans and strategies, our anticipation of revenues from
designated markets, and statements regarding the development of our businesses,
the markets for our services and products, our anticipated capital expenditures,
operations support systems, changes in regulatory requirements and other
statements contained in this prospectus regarding matters that are not
historical facts, are only predictions and estimates regarding future events and
circumstances. We have disclosed cautionary statements in this prospectus,
especially under "Risk Factors." We cannot assure you that we will achieve the
future results reflected in these statements. The risks we face that could cause
us not to achieve these results include, but are not limited to our ability to
do the following in a timely manner, at reasonable costs and on satisfactory
terms and conditions:
- - successfully market our services to current and new customers;
- - interconnect with and develop cooperative working relationships with incumbent
local exchange carriers;
- - develop efficient operations support systems and other back office systems;
- - successfully and efficiently transfer new customers to our networks and access
new geographic markets;
- - identify, finance and complete suitable acquisitions;
- - install new switching facilities and other network equipment; and
- - obtain leased fiber optic line capacity, rights-of-way, building access rights
and any required governmental authorizations, franchises and permits.
Regulatory, legislative and judicial developments could also cause actual
results to differ materially from the future results reflected in such
forward-looking statements. You should consider all of our subsequent written
and oral forward-looking statements only in light of such cautionary statements.
You should not place undue reliance on these forward-looking statements and you
should understand that they speak only as of the dates we make them.
19
<PAGE> 20
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports and other information with the
SEC. You may read and copy any document we file at the SEC's public reference
rooms in Washington, D.C., New York, New York, and Chicago, Illinois. Please
call the SEC at 1-800-SEC-0330 for further information on the public reference
rooms. Our SEC filings are also available to the public on the SEC internet site
at http://www.sec.gov.
USE OF PROCEEDS
We raised approximately $124.8 million of net proceeds from the offering of the
12 7/8% notes, after deducting underwriting discounts and commissions and other
expenses payable by us, and approximately $137.8 million of net proceeds from
our initial public offering of common stock, after deducting underwriting
discounts and commissions and other expenses payable by us. At the closing of
the offering of the 12 7/8% notes, we purchased approximately $69.0 million of
U.S. treasury securities for purposes of funding the first six interest payments
on the 12 7/8% notes. We have used and intend to use the net proceeds from our
financing activities to date to fund the costs of deploying networks in our
first 18 markets to positive free cash flow, including the costs to develop,
acquire and integrate the necessary operations support and other back office
systems.
We will not obtain any proceeds in connection with the market-making activities
of Morgan Stanley Dean Witter from any sales of the 12 7/8% notes.
20
<PAGE> 21
SELECTED FINANCIAL DATA
The selected consolidated financial data presented below as of and for the year
ended December 31, 1998 and as of and for the period from inception on April 22,
1997 through December 31, 1997 were derived from the audited consolidated
financial statements of Allegiance and the notes thereto contained elsewhere in
this prospectus, which statements have been audited by Arthur Andersen LLP,
independent public accountants. The selected pro forma statements of operations
data set forth below is unaudited and gives effect to (a) Allegiance's offering
of the 12 7/8% notes, (b) its initial public offering of common stock, including
the conversion of the redeemable convertible preferred stock and the adjustments
to reflect the equity allocation as described in footnote (1), and (c) the unit
offering, consisting of the sale of 11 3/4% notes and redeemable warrants, as if
such transactions had occurred on April 22, 1997 for the period from inception
through December 31, 1997 and on January 1, 1998 for the year ended December 31,
1998. Operating results for the year ended December 31, 1998 are not necessarily
indicative of the results that may be expected for the entire year. Dollar
amounts are in thousands, except share and per share amounts.
From Allegiance's formation in April 1997 until December 16, 1997, Allegiance
was in the development stage. Allegiance has generated operating losses and
negative cash flow from its operating activities to date. The selected financial
data set forth below should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
consolidated financial statements, including the notes thereto, contained
elsewhere in this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
--------------------------------------------------
PRO FORMA
------------------------------------
AS ADJUSTED FOR
THE UNIT OFFERING,
COMMON STOCK
OFFERING AND
12 7/8% NOTES
ACTUAL ADJUSTMENTS OFFERING
----------- ----------- ------------------
(AUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues......................................... $ 9,786.2 $ -- $ 9,786.2
Operating expenses:
Network........................................ 9,528.8 -- 9,528.8
Selling, general and administrative............ 46,089.4 -- 46,089.4
Management ownership allocation charge......... 167,311.9 12,557.7(1) 179,869.6
Non-cash deferred compensation................. 5,307.2 -- 5,307.2
Depreciation and amortization.................. 9,002.8 -- 9,002.8
----------- ---------- -----------
Total operating expenses..................... 237,240.1 12,557.7 249,797.8
----------- ---------- -----------
Loss from operations............................. (227,453.9) (12,557.7) (240,011.6)
Interest income.................................. 19,917.4 --(2) 19,917.4
Interest expense................................. (38,951.7) (23,264.0)(3) (62,215.7)
----------- ---------- -----------
Net loss......................................... (246,488.2) (35,821.7) (282,309.9)
Accretion of redeemable convertible preferred
stock and warrant values....................... (11,971.4) (7.4)(4) (11,978.8)
----------- ---------- -----------
Net loss applicable to common stock.............. $(258,459.6) $(35,829.1) $(294,288.7)
=========== ========== ===========
Net loss per share, basic and diluted............ $ (10.53) $ (5.85)
=========== ===========
Weighted average number of shares outstanding,
basic and diluted.............................. 24,550,346 25,791,208(5) 50,341,554
=========== ========== ===========
<CAPTION>
PERIOD FROM INCEPTION ON APRIL 22, 1997
THROUGH DECEMBER 31, 1997
--------------------------------------------------
PRO FORMA
------------------------------------
AS ADJUSTED FOR
THE UNIT OFFERING,
COMMON STOCK
OFFERING AND
12 7/8% NOTES
ACTUAL ADJUSTMENTS OFFERING
----------- ----------- ------------------
(AUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues......................................... $ 0.4 $ -- $ 0.4
Operating expenses:
Network........................................ 151.2 -- 151.2
Selling, general and administrative............ 3,425.9 -- 3,425.9
Management ownership allocation charge......... -- 171,743.4(1) 171,743.4
Non-cash deferred compensation................. 209.9 -- 209.9
Depreciation and amortization.................. 12.7 -- 12.7
----------- ----------- -----------
Total operating expenses..................... 3,799.7 171,743.4 175,543.1
----------- ----------- -----------
Loss from operations............................. (3,799.3) (171,743.4) (175,542.7)
Interest income.................................. 111.4 --(2) 111.4
Interest expense................................. -- (41,212.5)(3) (41,212.5)
----------- ----------- -----------
Net loss......................................... (3,687.9) (212,955.9) (216,643.8)
Accretion of redeemable convertible preferred
stock and warrant values....................... (3,814.2) (288.6)(4) (4,102.8)
----------- ----------- -----------
Net loss applicable to common stock.............. $ (7,502.1) $(213,244.5) $(220,746.6)
=========== =========== ===========
Net loss per share, basic and diluted............ $(17,610.68) $ (4.37)
=========== ===========
Weighted average number of shares outstanding,
basic and diluted.............................. 426 50,498,062(5) 50,498,488
=========== =========== ===========
</TABLE>
21
<PAGE> 22
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
--------------------------------------------------
PRO FORMA
------------------------------------
AS ADJUSTED FOR
THE UNIT OFFERING,
COMMON STOCK
OFFERING AND
12 7/8% NOTES
ACTUAL ADJUSTMENTS OFFERING
----------- ----------- ------------------
(AUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
OTHER FINANCIAL DATA:
EBITDA(6)........................................ $ (45,832.0) --(1) $ (45,832.0)
Net cash used in operating activities............ (17,269.8) $(13,196.9)(7) (30,466.7)
Net cash used in investing activities............ (319,170.4) 13,196.9(7) (305,973.5)
Net cash provided by financing activities........ 593,215.5 -- 593,215.5
Capital expenditures(9).......................... 113,538.7 -- 113,538.7
Ratio of earnings to fixed charges(10)........... -- -- --
<CAPTION>
PERIOD FROM INCEPTION ON APRIL 22, 1997
THROUGH DECEMBER 31, 1997
--------------------------------------------------
PRO FORMA
------------------------------------
AS ADJUSTED FOR
THE UNIT OFFERING,
COMMON STOCK
OFFERING AND
12 7/8% NOTES
ACTUAL ADJUSTMENTS OFFERING
----------- ----------- ------------------
(AUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
OTHER FINANCIAL DATA:
EBITDA(6)........................................ $ (3,576.7) --(1) $ (3,576.7)
Net cash used in operating activities............ (1,942.9) $ (13,196.9)(7) (15,139.8)
Net cash used in investing activities............ (21,926.0) (55,836.5)(7) (77,762.5)
Net cash provided by financing activities........ 29,595.3 572,340.4(8) 601,935.7
Capital expenditures(9).......................... 21,926.0 -- 21,926.0
Ratio of earnings to fixed charges(10)........... -- -- --
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
BALANCE SHEET DATA: (AUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 262,501.7 $ 5,726.4
Short-term investments.................................... 143,389.7 --
Short-term investments, restricted........................ 25,542.8 --
Accounts receivable (net of allowance for doubtful
accounts of $577.2 and $0, respectively)................ 6,186.6 4.3
Prepaid expenses and other current assets................. 1,243.2 245.2
----------- ---------
Total current assets................................ 438,864.0 5,975.9
Property and Equipment:
Property and equipment.................................... 153,875.4 23,912.6
Accumulated depreciation and amortization................. (9,015.4) (12.7)
----------- ---------
Property and equipment, net......................... 144,860.0 23,899.9
Other Non-Current Assets:
Deferred debt issuance costs (net of accumulated
amortization of $733.7 and $0, respectively)............ 16,078.4 --
Long-term investments, restricted......................... 36,699.2 --
Other assets.............................................. 1,372.7 171.2
----------- ---------
Total other non-current assets...................... 54,150.3 171.2
----------- ---------
Total assets........................................ $ 637,874.3 $30,047.0
=========== =========
</TABLE>
22
<PAGE> 23
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
----------------- -----------------
BALANCE SHEET DATA: (AUDITED) (AUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable.......................................... $ 20,981.7 $ 2,261.7
Accrued liabilities and other............................. 26,176.8 1,668.0
----------- ---------
Total current liabilities........................... 47,158.5 3,929.7
Long-term Debt.............................................. 471,652.1 --
Redeemable Cumulative Convertible Preferred Stock -- 0 and
40,498,062 shares issued and outstanding at December 31,
1998 and December 31, 1997, respectively.................. -- 33,409.4
Redeemable Warrants......................................... 8,634.1 --
Commitments and Contingencies
Stockholders' Equity (Deficit):
Common stock-- 50,341,554 and 426 shares issued and
outstanding at December 31, 1998 and December 31, 1997,
respectively............................................ 503.4 --
Additional paid-in capital................................ 416,729.9 3,008.4
Deferred compensation..................................... (14,617.3) (2,798.4)
Deferred management ownership allocation charge........... (26,224.7) --
Accumulated deficit....................................... (265,961.7) (7,502.1)
----------- ---------
Total stockholders' equity (deficit)................ 110,429.6 (7,292.1)
----------- ---------
Total liabilities and stockholders' equity
(deficit)........................................... $ 637,874.3 $30,047.0
=========== =========
</TABLE>
- -------------------------
(1) In connection with the initial public offering of common stock, Allegiance
LLC, an entity that owned substantially all of Allegiance's outstanding
capital stock, was dissolved and its assets, which consisted almost
entirely of such capital stock, were distributed to the LLC investors in
accordance with the LLC Agreement, as defined under "Certain Relationships
and Related Transactions." The LLC Agreement provides that the equity
allocation between the original fund investors and the management investors
be 66.7% and 33.3%, respectively, based upon the valuation implied by the
initial public offering of common stock. Under generally accepted
accounting principles, upon consummation of the initial public offering of
common stock, Allegiance recorded the increase in the assets of Allegiance
LLC allocated to the management investors as a $193.5 million increase in
additional paid-in capital, of which $122.5 million was recorded as a
non-cash, non-recurring charge to operating expense and $71.0 million will
be recorded as deferred management ownership allocation charge. The
deferred charge was amortized at $38.0 million and $6.8 million during the
third and fourth quarters of 1998, respectively, and will be further
amortized at $18.8 million, $7.2 million and $.2 million during the years
1999, 2000 and 2001, respectively; this is the period over which Allegiance
has the right to repurchase the securities, at the lower of fair market
value or the price paid by the employee, in the event the management
employee's employment with Allegiance is terminated. See "Certain
Relationships and Related Transactions." The period from inception on April
22, 1997 through December 31, 1997 pro forma gives effect to the initial
$122.5 million non-cash, non-recurring charge to operating expense and the
related amortization of the deferred management ownership
23
<PAGE> 24
allocation charge for the period. The year ended December 31, 1998 pro forma
gives effect to the additional amortization of the deferred management ownership
allocation charge.
(2) Pro forma interest income excludes interest income that would have been
earned on the estimated $69.0 million of the proceeds from the offering of
the 12 7/8% notes required to be placed in a pledge account to secure and
fund the first six scheduled interest payments on the 12 7/8% notes.
(3) Reflects $19.8 million and $18.2 million of interest expense related to the
12 7/8% notes, $.2 million and $.1 million of amortization of the $4.1
million of original issuance discount, $.3 million and $.3 million of
amortization of the $7.0 million of deferred debt issuance cost related
thereto, $2.9 million and $22.1 million of interest expense related to the
accretion of the 11 3/4% notes and $.1 million and $.5 million of
amortization of the $9.8 million of deferred debt issuance cost related to
the 11 3/4% notes for the year ended December 31, 1998 and for the period
from inception on April 22, 1997 through December 31, 1997, respectively.
(4) Reflects the increase of $7,435 and $.3 million of accretion for the
redeemable warrants for the year ended December 31, 1998 and for the period
from inception on April 22, 1997 through December 31, 1997, respectively.
(5) The pro forma weighted average number of shares outstanding gives effect to
(a) Allegiance's common stock issued as a result of the initial public
offering of common stock and (b) the conversion of redeemable convertible
preferred stock to common stock.
(6) EBITDA represents earnings before interest, income taxes, depreciation and
amortization, management ownership allocation charge and non-cash deferred
compensation. EBITDA is not a measurement of financial performance under
generally accepted accounting principles, is not intended to represent cash
flow from operations, and should not be considered as an alternative to net
loss as an indicator of Allegiance's operating performance or to cash flows
as a measure of liquidity. Allegiance believes that EBITDA is widely used
by analysts, investors and other interested parties in the
telecommunications industry. EBITDA is not necessarily comparable with
similarly titled measures for other companies.
(7) Reflects the purchase of $69.0 million of U.S. government securities, which
securities were placed in a pledge account, to fund the first six scheduled
interest payments on the 12 7/8% notes. For the year ended December 31,
1998 and for the period from inception on April 22, 1997 through December
31, 1997, also reflects the $13.2 million cash interest payment on May 15
and November 15, respectively, on the 12 7/8% notes, which is funded
through a reduction of the pledge account.
(8) Reflects $193.8 million of net proceeds received from the offering of the
12 7/8% notes of which $69.0 million was required to be placed in a pledge
account to secure and fund the first six scheduled interest payments on the
12 7/8% notes, $137.8 million of net proceeds received from the initial
public offering of common stock, and $240.7 million of net proceeds from
the offering of the 11 3/4% notes and redeemable warrants.
(9) Reflects cash paid for capital expenditures.
(10) For purposes of calculating the ratio of earnings to fixed charges,
earnings is defined as net loss plus fixed charges, other than capitalized
interest. Fixed charges consist of
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interest and amortization of debt discount and debt issuance costs, whether
expensed or capitalized, and that portion of rental expense deemed to
represent interest, estimated to be 1/3 of such expense. Allegiance's
earnings for the year ended December 31, 1998 and for the period from
inception on April 22, 1997 through December 31, 1997 were insufficient to
cover fixed charges by approximately $249.3 million and $3.7 million,
respectively. After giving pro forma effect to the increase in interest
expense resulting from the issuance of the 12 7/8% notes and the 11 3/4%
notes and giving effect to $12.6 million and $171.7 million of management
ownership allocation charge to be recorded in connection with the initial
public offering of common stock, Allegiance's earnings would have been
insufficient to cover fixed charges by approximately $285.1 million and
$216.6 million, for the year ended December 31, 1998 and for the period
from inception on April 22, 1997 through December 31, 1997, respectively.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
Allegiance is a competitive local exchange carrier ("CLEC"), seeking to be a
premier provider of telecommunications services to business, government and
other institutional users in major metropolitan areas across the United States.
Allegiance offers an integrated set of telecommunications products and services
including local exchange, local access, domestic and international long
distance, data and a full suite of Internet services. Its principal competitors
are incumbent local exchange carriers ("ILECs"), such as the regional Bell
operating companies and GTE Corporation operating units.
Allegiance is developing its networks throughout the United States using what it
refers to as a "smart build" approach. In contrast to the traditional network
build-out strategy under which carriers install their own telecommunications
switch in each market and then construct their own fiber optic networks to reach
customers, Allegiance installs its own switch in each market but then leases
other elements of the network from the ILECs. The smart-build strategy
specifically involves (a) leasing existing ILEC copper wire connections
throughout a local market area, also called the "local loop," which connect
customers to the central offices or "hubs" of an ILEC network, and (b)
installing, or physically locating, transmission equipment in these central
offices to route customer traffic through them to Allegiance's own switch.
Locating equipment at ILEC facilities in this manner, known as "collocation," is
central to the success of the smart build strategy. By collocating, Allegiance
has the ability to lease, on a monthly or long-term basis, local loop and other
network elements owned by the ILEC. This enables Allegiance to reach a wide
range of customers without having to build network connections to each one of
them. Management believes that the smart build approach offers it a number of
competitive advantages over the traditional build-out strategy by allowing
Allegiance to:
- - accelerate market entry nine to eighteen months by eliminating or at least
deferring the need for city franchises, rights-of-way and building access;
- - reduce initial capital expenditures in each market, allowing Allegiance to
focus its initial capital resources on the critical areas of sales, marketing,
and operations support systems, instead of on constructing extensive fiber
optic networks to each customer;
- - improve return on capital by generating revenue with a smaller capital
investment;
- - defer capital expenditures for more extensive investment in network assets to
the time revenue generated by customer demand is available to finance such
expenditures; and
- - address attractive service areas selectively throughout target markets and not
just in those areas where Allegiance owns network transmission facilities.
Once traffic volume growth justifies further capital investment Allegiance may
lease unused fiber to which Allegiance adds its own electronic transmission
equipment. This fiber is known as "dark fiber" because no light is transmitted
through it while it is unused. Allegiance believes that dark fiber is readily
available in most major markets.
Allegiance has rapidly deployed its networks since commencing service in
December 1997 and was operating in nine markets across the United States as of
the end of 1998, and ten as of January 31, 1999. Allegiance has had significant
success in selling its services to
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customers, with approximately 86,500 lines sold during 1998. The table below
provides selected key operational data:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1998 1997
----------- ----
<S> <C> <C>
Markets Served.............................................. 9 0
Number Of Switches Deployed................................. 7 0
Central Office Collocations................................. 101 0
Addressable Market (Business Lines)......................... 3.6 million 0
Lines Sold.................................................. 86,500 9
Lines Installed............................................. 47,700 20
Sales Force Employees....................................... 295 0
Total Employees............................................. 649 40
</TABLE>
Allegiance does not begin to develop a new market until it has raised the
capital necessary to build its network and operate such market to the point at
which operating cash flow from the market is sufficient to fund such market's
operating costs and capital expenditures. We have raised enough capital to allow
us to develop our first 18 markets through this positive free cash flow point.
Allegiance is currently in the process of securing the additional capital
financing required for the remaining six markets in its business plan.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
Allegiance commenced operations in August 1997. During the period from August to
December 1997, Allegiance did not sell any services or open any markets.
Instead, substantial effort was devoted to developing business plans, initiating
applications for governmental authorizations, hiring management and other key
personnel, working on the design and development of local exchange telephone
networks and operations support systems, acquiring equipment and facilities, and
negotiating interconnection agreements. Allegiance initiated service by buying
phone lines at wholesale prices and then reselling them to nine "beta" customers
in Dallas during December 1997, generating only $400 of revenue for that period.
Given that Allegiance has significantly increased its customer base and
geographic markets from the commencement of operations in Dallas during 1997,
comparisons of 1998 results with those of 1997 are not meaningful.
Allegiance first provided service using its own switch and transmission
equipment in April 1998 to customers in New York City. Throughout the remainder
of 1998, it initiated this facilities based service in Atlanta, Boston, Chicago,
Dallas, Fort Worth, Los Angeles, Oakland and San Francisco. In January 1999,
Allegiance announced that it was operational in Philadelphia. Allegiance expects
to become operational in Washington, D.C. (including suburban Maryland and
Virginia) and Northern New Jersey during the first quarter of 1999. Allegiance
plans to open five additional markets during 1999 for which it has already
raised the necessary capital. Allegiance plans to open two more markets during
1999 if it can obtain the necessary additional financing.
Since the initiation of resale services in Dallas in 1997, Allegiance sales
teams have focused their efforts almost exclusively on selling services that
require the use of
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Allegiance facilities. Allegiance earns significantly higher margins by
providing facilities based services instead of resale services. During the
fourth quarter of 1998, facilities based lines represented 91% of all lines sold
and 83% of all lines installed. For the full year, 67,100 facilities based lines
were sold, and 30,500 of those were installed. Resale lines sold during 1998
totaled 19,400, of which 17,200 were installed. Allegiance continues to
emphasize the sale of facilities based services and lines. We estimate that the
proportion of customer lines for which we simply resell service provided by
other carriers will continue to decline to the point that no more than 5% of all
lines Allegiance sells will be resale lines.
During 1998, Allegiance generated $9.8 million of revenue. The majority, $6.9
million, was local service revenue consisting of:
- - the monthly recurring charge for basic service;
- - usage based charges for local calls in certain markets;
- - charges for vertical services such as call waiting and call forwarding; and
- - to a lesser extent, non-recurring charges, such as charges for additional
lines for an existing customer.
Access charges, which we earn by connecting Allegiance local service customers
to their selected long distance carriers for outbound calls or by delivering
inbound long distance traffic to Allegiance local service customers, accounted
for $2.2 million of Allegiance's 1998 revenues. Approximately 20% of
Allegiance's local service customers have chosen Allegiance as their long
distance carrier. Long distance revenues during 1998 amounted to $.7 million.
All other sources of revenue accounted for approximately $10,000 during 1998.
During 1998, Allegiance recognized an insignificant amount of revenue from
"reciprocal compensation" generated by having customers of other local exchange
carriers calling Internet service providers which are Allegiance customers.
Allegiance had no revenue from reciprocal compensation during 1997. Given the
uncertainty as to whether reciprocal compensation should be payable in
connection with calls to Internet service providers, Allegiance recognizes such
revenue only when realization of it is certain, which in most cases will be upon
receipt of cash. See "Business -- Federal Regulation" for a discussion of
reciprocal compensation.
The revenue yield, or revenue generated per line per month, was approximately
$56.00 for all of 1998. The revenue yield during the fourth quarter of 1998 was
approximately $61.00. Allegiance expected this increase as its sales teams
concentrated their efforts on selling more features along with access lines.
Allegiance received a significant order for lines from one of the United States'
top tier Internet service providers during the fourth quarter of 1998. As these
lines are installed, the current mix between end-user retail lines and Internet
service provider wholesale lines will change, however, the switch ports utilized
for the Internet service provider lines will be well below Allegiance's policy
limit of 20%. Internet service provider wholesale lines generate approximately
half the revenue yield, excluding the reciprocal compensation component of
revenue, of that provided by an end-user retail line. The revenue yield may
decline during the first quarter of 1999 as a result of the change in the mix.
However, data and Internet services such as frame relay, dedicated and dial-up
access to the Internet,
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web page design, e-mail and domain name service, which we introduced during
December 1998, may partially, or perhaps completely, offset the reduction
anticipated from the receipt of that order.
Although our primary focus is on serving higher margin, higher revenue
generating end-user lines, significant Internet wholesale line orders, such as
that received during the fourth quarter of 1998, contribute positively to gross
margin again excluding the reciprocal compensation component of revenue. For
this reason, we will accept such orders in the future but do not plan to allow
the installation of such lines to constitute more than 20% of our switch port
capacity.
During 1998, Allegiance had no sales of or revenue from installation of customer
premise equipment, no revenue from system integration activities, no wireless
revenue and no data or internet services revenue. Allegiance does not plan to
sell wireless services in the foreseeable future.
Acquisitions during 1999 may increase revenues and revenue yield. Allegiance has
had discussions, and will continue to have discussions in the foreseeable
future, concerning potential acquisitions of Internet service providers and
other providers of telecommunication services.
In January 1999, Allegiance announced that it had successfully achieved
"electronic bonding" between its operating support systems and those of Bell
Atlantic relating to the New York City market. The systems that we currently use
to switch customers from their existing carrier to Allegiance and to begin
providing them service generally require multiple entries of customer
information by hand and exchanged by fax with the ILEC. Electronic bonding is a
method in which manual processing and faxing of information is replaced with
electronic processing where our computer systems and those of other carriers
communicate directly. The manual approach which we must use in the absence of
electronic bonding is not only labor intensive, but also creates numerous
opportunities for:
- - errors in providing new service and billing,
- - service interruptions,
- - poor customer service, and
- - increased customer turnover.
These problems create significant added expenses and decrease customer
satisfaction.
Without electronic bonding, confirmation of receipt and completeness of previous
orders has taken from three to four hours to as long as several days or weeks.
Electronic bonding is expected to improve productivity by decreasing the period
between the time of sale and the time a customer's line is installed in the
Allegiance network. During 1999, Allegiance expects to electronically bond with
Bell Atlantic in other markets and with other ILECs and extend the functionality
of the electronic bond to pre-ordering, billing and trouble ticketing processes.
Currently, Allegiance and Bell Atlantic are testing electronic bonding in
Boston. Allegiance and Southwestern Bell are now in the process of testing an
electronic bond in the Dallas market. The early results of these efforts have
been encouraging. For example, so far electronic bonding with Southwestern Bell
has required a change to only about 10% of the software coding written on behalf
of Allegiance for the Bell Atlantic
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electronic bond. Allegiance and Pacific Bell are discussing the possibility of
using this same template to pass service requests between these parties.
Ameritech has also requested the initiation of a project to electronically bond
with Allegiance.
Network expenses increased from $.2 million in 1997 to $9.5 million in 1998.
This sharp increase is consistent with the deployment of our networks and
initiation and growth of our services during 1998. Network expenses represent:
- - the cost of leasing high capacity digital lines that interconnect Allegiance's
network with ILEC networks;
- - the cost of leasing high capacity digital lines that connect Allegiance's
switching equipment to Allegiance transmission equipment located in ILEC
central offices;
- - the cost of leasing local loop lines which connect Allegiance's customers to
Allegiance's network;
- - the monthly cost of leasing space in ILEC central offices for collocating
Allegiance transmission equipment; and
- - the cost of leasing Allegiance's nationwide Internet network.
The costs to lease local loop lines and high capacity digital lines from the
ILECs vary by ILEC and are regulated by state authorities under the
Telecommunications Act of 1996. Allegiance believes that in many instances,
there are multiple carriers in addition to the ILEC from which it can lease the
high capacity lines, and that Allegiance can generally lease those lines at
lower prices than are charged by the ILEC. Allegiance expects that the costs
associated with these leases will increase with customer volume and will be a
significant part of its ongoing cost of services. The cost of leasing switch
sites are also a significant part of Allegiance's ongoing cost of services.
In constructing its initial switching and transmission equipment for a new
market, Allegiance capitalizes only the non-recurring charges associated with
its initial network facilities and the monthly recurring costs of those network
facilities until the switching equipment begins to carry revenue producing
traffic. Typically, the charges for just one to two months are capitalized. We
expense the monthly recurring and non-recurring costs resulting from the growth
of existing collocation sites, and the costs related to expansion of the network
to additional collocation sites in operational markets as we incur these
charges.
At December 31, 1998, Allegiance transmission equipment was collocated in 101
ILEC central offices. Allegiance anticipates adding approximately 175
collocations during 1999 and expects that by the end of 1999, it will have
achieved collocation in approximately 275 ILEC central offices.
Allegiance is moving to the next stage of its smart build strategy in New York
City and Dallas by entering into leases for dark fiber to which Allegiance is
installing its own electronic equipment. These leases are accounted for as
capital leases. In New York City, Allegiance has entered into a lease agreement
with Metromedia Fiber Network, Inc. for three dark fiber rings in Manhattan with
an extension into Brooklyn. In the Dallas market, Allegiance has reached an
agreement with Communications Systems Development, Inc. for the lease of a dark
fiber ring in Dallas County. Allegiance anticipates that any future
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dark fiber leases will have roughly similar terms and conditions, and therefore
it is likely that such additional dark fiber leases, if any, will also be
accounted for as capital leases.
Allegiance must enter into an interconnection agreement with the ILEC in each
market to make ubiquitous calling available to Allegiance's customers. These
agreements typically set the cost per minute to be charged by each party for the
calls that are exchanged between the two carriers' networks. Generally, a
carrier must compensate another carrier when a local call by the first carrier's
customer terminates on the second carrier's network. These "reciprocal
compensation" costs will grow for Allegiance as its customers' outbound call
volume grows. We expect these costs to be a major portion of our cost of
services. We expect, however, to generate increased revenue from the ILECs as
inbound calling volume to our customers increases. To the extent that our
customers' outbound call volume is equivalent to their inbound call volume, our
interconnection costs paid to the ILECs will be substantially offset by the
interconnection revenues we receive from them.
Allegiance has entered into one resale agreement with a long distance carrier to
provide Allegiance with the ability to provide our customers with long distance
service. Allegiance expects to enter into resale agreements for long distance
service with other carriers in the future. Such agreements typically provide for
the resale of long distance services on a per-minute basis and may contain
minimum volume commitments. Allegiance's existing resale agreement, however,
does not contain a minimum volume commitment. If Allegiance agrees to minimum
volume commitments and fails to meet them, it may be obligated to pay
underutilization charges. Under most of these agreements, if a company
underestimates its need for transmission capacity and exceeds the maximum amount
agreed to under such agreements, it may be required to obtain capacity through
more expensive means. The cost of securing long distance service capacity will
increase as Allegiance's customers long distance calling volume increases.
Allegiance expects that these costs will be a significant portion of its cost of
long distance services.
Allegiance leases high capacity digital lines which comprise its nationwide
Internet backbone network. These costs will increase as Allegiance opens new
markets, and adds connections to those markets to its Internet backbone network.
Consistent with the growth in our business, selling, general and administrative
expenses increased to $46.1 million in 1998 from just $3.4 million in 1997.
Selling, general and administrative expenses include salaries and related
personnel costs, facilities costs, legal and consulting fees. The number of
employees increased to 649 as of December 31, 1998 from 40 as of December 31,
1997. As of December 31, 1998, the sales force, including sales managers, had
grown to 295. Allegiance did not employ any account executives, major account
managers or sales engineers prior to January 1998. During 1999, Allegiance
expects the number of its sales personnel to grow to approximately 570.
Allegiance currently does not use agents to sell its services nor does it
currently use any print or other media advertising campaigns.
As Allegiance continues to grow in terms of number of customers and call volume,
we expect that development costs for information systems and ongoing expenses
for customer care and billing will increase.
Allegiance is not party to any pending legal proceedings that it believes would,
individually or in the aggregate, have a material adverse effect on its
financial condition or results of operations.
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The magnitude of our net loss for 1998 is principally due to the management
ownership allocation charge, a non-cash charge to income. Allegiance's original
private equity fund investors and its original management team investors owned
95.0% and 5.0%, respectively, of the ownership interests of Allegiance Telecom,
LLC ("Allegiance LLC"), an entity that owned substantially all of Allegiance's
outstanding capital stock prior to Allegiance's initial public offering of its
common stock. As a result of this offering, the assets of Allegiance LLC, which
consisted almost entirely of such capital stock, were distributed to the
original fund investors and management investors in accordance with the
Allegiance LLC limited liability company agreement. This agreement provided that
the equity allocation between the fund investors and management investors would
be 66.7% and 33.3%, respectively, based upon the valuation implied by the
initial public offering. Under generally accepted accounting principles,
Allegiance recorded the increase in the assets of Allegiance LLC allocated to
the management investors as a $193.5 million increase in additional paid-in
capital. Of this charge, we recorded $122.5 million as a non-cash, non-
recurring charge to operating expense and $71.0 million as a deferred management
ownership allocation charge. We amortized the deferred charge at $38.0 million
and $6.8 million during the third and fourth quarters of 1998, respectively. We
will further amortize this deferred charge at $18.8 million, $7.2 million and
$.2 million during 1999, 2000, 2001, respectively. This period is the time frame
over which Allegiance has the right to repurchase the securities, at the lower
of fair market value or the price paid by the employee, in the event the
management employee's employment with Allegiance is terminated.
In addition to the above expenses, Allegiance recognized $5.3 million and $.2
million amortization of deferred stock compensation expense for the years ended
December 31, 1998 and 1997, respectively, also non-cash charges. Such deferred
compensation was recorded in connection with membership units of Allegiance LLC
sold to certain management employees and grants to employees under Allegiance's
1997 Stock Option Plan made prior to Allegiance's initial public offering of
common stock.
Depreciation expense increased from approximately $13,000 in 1997 to $9.0
million in 1998, consistent with the completion of Allegiance's networks and
initiation of services in nine markets by December 31, 1998.
Interest expense for the year ended December 31, 1998 was $39.0 million. There
was no interest expense incurred during 1997. Interest expense recorded during
1998 reflects: (a) the issuance on February 3, 1998 of 11 3/4% Senior Discount
Notes due 2008, and (b) the issuance on July 8, 1998 of 12 7/8% Senior Notes due
2008. See "-- Liquidity and Capital Resources" below for a discussion of these
note offerings. Allegiance capitalizes a portion of its interest costs as part
of the construction cost of its networks, in accordance with Statement of
Financial Accounting Standards No. 34. The amount of interest capitalized during
1998 was $2.8 million. No interest was capitalized during 1997. Interest income
during 1998 and 1997 was $19.9 million and $.1 million, respectively, resulting
from the investment of excess cash and from U.S. government securities which we
purchased and placed in a pledge account to secure the semi-annual payments of
interest through May 2001 on the 12 7/8% Senior Notes due 2008.
Allegiance has recorded the potential redemption value of its redeemable
warrants in the event that they are redeemed at fair market value in February
2008. Amounts are accreted using the effective interest method and management's
estimates of the future fair market
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value of such warrants when redemption is first permitted. Amounts accreted
increase the recorded value of such warrants on the balance sheet and result in
a non-cash charge to increase the net loss applicable to Allegiance's common
stock. Accretion of $.5 million related to the redeemable warrants has been
recorded for the year ending December 31, 1998.
Until the consummation of Allegiance's initial public offering of common stock,
Allegiance also recorded the potential redemption values of its redeemable
convertible preferred stock, in the event that they would be redeemed at fair
market value in August 2004. At the time of the initial public offering, such
preferred stock was converted into common stock. Accordingly, the amounts
accreted for the redeemable convertible preferred stock were reclassified as an
increase to additional paid-in capital in the stockholders' equity section of
the balance sheet, and there has been, and will be, no additional accretion of
redeemable convertible preferred stock values beyond that point in time.
Accretion related to the redeemable convertible preferred stock of $11.5 million
was recorded for the year ending December 31, 1998 and $3.8 million was recorded
for the year ending December 31, 1997.
Our net loss for 1998, after the non-cash, one-time management allocation charge
and amortization of deferred compensation and a portion of the deferred
management allocation charge, but before the accretion of the redeemable
convertible preferred stock and redeemable warrants, was $246.5 million and was
$3.7 million for the period from inception to December 31, 1997. After deducting
accretion of preferred stock and warrant values, the net loss applicable to
common stock was $258.5 million and $7.5 million for the year ended December 31,
1998 and for the period from inception to December 31, 1997, respectively.
Many securities analysts use the measure of earnings before deducting interest,
taxes, depreciation and amortization, also commonly referred to as "EBITDA," as
a way of evaluating a company. Allegiance had EBITDA of negative $45.8 million
and negative $3.6 million for the year ended December 31, 1998 and for the
period from inception to December 31, 1997, respectively. In calculating EBITDA,
Allegiance also excludes the non-cash charges to operations for management
ownership allocation charge and deferred stock compensation expense totaling
$172.6 million and $.2 million for the years ended December 31, 1998 and 1997,
respectively.
Allegiance expects to continue to experience increasing operating losses and
negative EBITDA as a result of its development activities and as it expands its
operations. Allegiance does not expect to achieve positive EBITDA in any market
until at least its second year of operation in such market.
FINANCIAL CONDITION
As a result of: (a) its offering of the 11 3/4% notes and redeemable warrants,
(b) its initial public offering of common stock, and (c) its issuance of the
12 7/8% notes (see "-- Liquidity and Capital Resources" below), Allegiance has
reflected on its balance sheet at December 31, 1998 additional cash,
unrestricted short-term investments, short-term and long-term restricted
investments, deferred debt issuance costs, long-term debt, redeemable warrants
and stockholders' equity, compared to its December 31, 1997 balance sheet. In
accordance with the terms of the 12 7/8% notes, Allegiance purchased, and placed
in a pledge account, U.S. government securities which will be used solely to pay
the first three
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years' interest payments on these notes. Such securities are reflected in the
balance sheet as of December 31, 1998, at accreted value of approximately $62.2
million, $25.5 million of which we classified as current assets, and $36.7
million of which we classified in other non-current assets.
Accounts receivable increased during the same period, as Allegiance's first nine
markets became operational.
Property and equipment, net of accumulated depreciation, increased between
December 31, 1997 and December 31, 1998 from capital expenditures incurred in
building out Allegiance's networks, from developing operations support and other
systems required to effectively manage the business and to provide general
office space and equipment for employees.
Accounts payable and accrued liabilities have increased consistent with
operations and Allegiance's policy to make use of working capital in funding
network construction and operations.
The increase in accumulated deficit is consistent with the net loss for the year
ending December 31, 1998. There have been no dividends declared from inception
to date and Allegiance does not expect that it will declare any dividends in the
foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
Allegiance plans to establish networks in the 24 largest U.S. metropolitan
markets. We estimate that we will need approximately $750 million to construct
these networks and fund our operating losses in these markets to the point of
positive free cash flow.
In October 1997, Allegiance entered into a five-year agreement with Lucent
Technologies establishing terms and conditions for the purchase of Lucent
products, services and licensed materials. The agreement includes a three-year
exclusivity commitment for the purchase of products and services related to new
switches. The agreement does not contain minimum purchase requirements. We are
in the process of re-negotiating this agreement and we expect that changes in
the agreement will be reflective of our successful initiation of service in our
operational markets to date, and result in more favorable terms and conditions
than is contained in the current agreement. Allegiance expects to increase the
capacity of its switches, and may add additional switches in its current markets
as demand warrants.
Allegiance's financing plan is predicated on the pre-funding of each market's
expansion to positive free cash flow. By using this approach, Allegiance avoids
being in the position of seeking additional capital to fund a market after
Allegiance has already made significant capital investment in that market. When
we raise all required capital prior to making any commitments in a market, we
can be opportunistic and raise capital on more favorable terms and conditions.
Allegiance initially raised approximately $50.1 million from affiliates of four
private equity investment funds with extensive experience in financing
telecommunications companies, Madison Dearborn Capital Partners, Morgan Stanley
Capital Partners, Frontenac Company, and Battery Ventures, and from certain
members of the Allegiance management team.
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On February 3, 1998, Allegiance raised gross proceeds of approximately $250.5
million in an offering of 445,000 units, each unit consisting of one 11 3/4%
note and one redeemable warrant to purchase .0034224719 shares of common stock
at an exercise price of $.01 per share, subject to certain antidilution
provisions. Of the gross proceeds, $242.3 million was allocated to the value of
the 11 3/4% notes and $8.2 million was allocated to the redeemable warrants. The
redeemable warrants became exercisable in connection with Allegiance's initial
public offering of common stock in July 1998, and each redeemable warrant may
now purchase 1.45898399509 shares of common stock at an exercise price of $.01
per share, giving effect to the 426.2953905-for-one stock split in connection
with such initial public offering.
The 11 3/4% notes have a principal amount at maturity of $445.0 million and an
effective interest rate of 12.45%. The 11 3/4% notes mature on February 15,
2008. From and after February 15, 2003, interest on such notes will be payable
semi-annually in cash at the rate of 11 3/4% per annum. The accretion of
original issue discount will cause an increase in indebtedness from December 31,
1998 to February 15, 2008 of $174.5 million. The net proceeds of approximately
$240.7 million from the sale of the 11 3/4% notes and redeemable warrants have
been, and are continuing to be, used to fund the completion of networks in
Allegiance's initial 12 target markets.
Following completion of the offering of the units described above, Allegiance
increased the scope of its business plan to, among other things, accommodate:
- - an expansion of its network buildout in the New York, Chicago, Los Angeles and
San Francisco markets to include additional central offices, thereby giving
Allegiance access to a larger number of potential customers in those markets,
- - an accelerated and expanded deployment of data, Internet and enhanced services
in all markets, and
- - the acceleration of network deployment in its target markets.
To fund these activities, Allegiance completed the initial public offering of
its common stock and the offering of the 12 7/8% notes early in the third
quarter of 1998. Allegiance raised net proceeds of approximately $124.8 million
from the offering of these notes and approximately $137.8 million from its
initial public offering of common stock, bringing its total capital raised since
inception and which is available to build networks and operate markets to
approximately $553.7 million.
The 12 7/8% notes mature on May 15, 2008. Interest on these notes is payable in
cash semi-annually, commencing November 15, 1998. The 12 7/8% notes were sold at
less than par, resulting in an effective rate of 13.24%, and the value of the
12 7/8% notes is being accreted, using the effective interest method, from the
$200.9 million gross proceeds realized at the time of the sale to the aggregate
value at maturity, $205.0 million, over the period ending May 15, 2008. In
connection with the sale of the 12 7/8% notes, Allegiance purchased U.S.
government securities for approximately $69.0 million and placed them in a
pledge account to fund interest payments for the first three years the 12 7/8%
notes are outstanding.
Allegiance expended $21.9 million and $113.5 million during 1997 and 1998,
respectively, for property, plant, equipment, software and hardware necessary in
deploying its networks in nine markets and providing operations and other
support systems necessary in
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conducting its business. Allegiance also used capital during 1998 to fund its
operations; excess cash was used to purchase short-term investments and money
market investments.
As of December 31, 1998, Allegiance had approximately $405.9 million of cash and
short-term investments. This amount excludes the restricted U.S. Government
securities that have been placed in a pledge account. Allegiance believes, based
on its business plan, that the net proceeds from the capital raising activities
completed to date will be sufficient to pre-fund its market deployment in its
initial 18 markets to the point of positive free cash flow in each of these
markets. Allegiance estimates that it will require up to an estimated additional
$200 million to completely fund its remaining six target markets. Allegiance
does not plan to expend any funds, other than minimum amounts required to
incorporate and become certified to do business, for the unfunded six markets,
until permanent financing required to develop the network and fund the
operations in each of those markets to positive free cash flow is obtained.
Allegiance has had significant discussions with commercial banks for the
purposes of raising an additional $150 to $200 million in financing. Allegiance
is seeking to obtain such financing during the first half of 1999. Sources of
additional financing may include commercial bank borrowings, vendor financing
and/or the private or public sale of Allegiance's equity or debt securities. We
cannot assure you, however, that such financing will be available on terms
acceptable to Allegiance or at all, or that Allegiance's estimate of additional
funds required is accurate.
The actual amount and timing of Allegiance's future capital requirements may
differ materially from its estimates as a result of, among other things:
- - the cost of the development of its networks in each of its markets;
- - a change in or inaccuracy of its development plans or projections that leads
to an alteration in the schedule or targets of its roll-out plan;
- - the extent of price and service competition for telecommunications services in
its markets;
- - the demand for its services;
- - regulatory and technological developments, including additional market
developments and new opportunities, in Allegiance's industry; and
- - the consummation of acquisitions.
Allegiance's cost of rolling out its networks and operating its business, as
well as its revenues, will depend on a variety of factors, including:
- - its ability to meet its roll-out schedules;
- - its ability to negotiate favorable prices for purchases of equipment;
- - its ability to develop, acquire and integrate the necessary operations support
systems and other back office systems;
- - the number of customers and the services for which they subscribe;
- - the nature and penetration of new services that Allegiance may offer; and
- - the impact of changes in technology and telecommunication regulations.
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As such, actual costs and revenues may vary from expected amounts, possibly to a
material degree, and such variations are likely to affect Allegiance's future
capital requirements.
IMPACT OF THE YEAR 2000
The "year 2000" issue generally describes the various problems that may result
from the improper processing of dates and date-sensitive transactions by
computers and other equipment as a result of computer hardware and software
using two digits to identify the year in a date. If a computer program or other
piece of equipment fails to properly process dates including and after the year
2000, date-sensitive calculations may be inaccurate. The failure to process
dates could result in network and system failures or miscalculations causing
disruptions in operations including, among other things, a temporary inability
to process transactions, send invoices or engage in other routine business
activities.
State of Readiness. Generally, Allegiance has identified two areas for year 2000
review: internal systems and operations, and external systems and services. As a
new enterprise, Allegiance does not have older systems that are not year 2000
ready. As it develops its network and support systems, Allegiance intends to
ensure that all systems will be year 2000 ready. Allegiance is purchasing its
operations support systems with express specifications, warranties and remedies
that all systems be year 2000 ready. In addition, Allegiance requires all
vendors supplying third party software and hardware to warrant year 2000
readiness. However, there can be no assurance until the year 2000 that all
systems will then function adequately. Also, Allegiance intends to sell its
telecommunications services to companies that may rely upon computerized systems
to make payments for such services, and to interconnect certain portions of its
network and systems with other companies' networks and systems. These
transactions and interactions could expose Allegiance to year 2000 problems.
Allegiance is in the process of conducting a company-wide inventory of all
computer systems on which the company relies, both within and outside of
Allegiance. This inventory is scheduled to be completed by the end of May 1999.
Allegiance will use this inventory to contact its external suppliers, vendors
and providers to obtain information about their year 2000 readiness and, based
on that information, will assess the extent to which these external information
technology and non-information technology systems, including embedded
technology, could cause a material adverse effect on Allegiance's operations in
the event that the systems fail to properly process date-sensitive transactions
after December 31, 1999.
Allegiance's assessment of its year 2000 readiness will be ongoing as it
continues to develop its own operations support system and becomes reliant on
the systems of additional third parties as a result of the geographic expansion
of its business into additional markets. As a result, Allegiance may in the
future identify a significant internal or external year 2000 issue which, if not
remedied in a timely manner, could have a material adverse effect on
Allegiance's business, financial condition and results of operations.
Costs to Address Year 2000 Issues. Other than time spent by Allegiance's
internal information technology and other personnel, Allegiance has not incurred
any significant costs in identifying year 2000 issues. Allegiance does not
anticipate any significant costs to make its internal systems year 2000
compliant because it does not expect any remediation to be required and does not
expect to make material expenditures for outside consultants to assist
Allegiance in its effort to address Year 2000 issues. Because no material
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year 2000 issues have yet been identified in connection with external sources,
Allegiance cannot reasonably estimate costs that may be required for remediation
or for implementation of contingency plans. As Allegiance gathers information
relating to external sources of year 2000 issues, Allegiance will reevaluate its
ability to estimate costs associated with year 2000 issues. There can be no
assurance that as additional year 2000 issues are addressed, Allegiance's costs
to remediate such issues will be consistent with its historical costs.
Risks of Year 2000 Issues. Allegiance cannot reasonably ascertain the extent of
the risks involved in the event that any one system fails to process
date-sensitive calculations accurately because it has not identified any
material year 2000 issues. Potential risks include:
- - the inability to process customer billing accurately or in a timely manner;
- - the inability to provide accurate financial reporting to management, auditors,
investors and others;
- - litigation costs associated with potential suits from customers and investors;
- - delays in implementing other information technology projects as a result of
work by internal personnel on year 2000 issues;
- - delays in receiving payment or equipment from customers or suppliers as a
result of their systems' failure; and
- - the inability to occupy and operate in a facility.
Any one of these risks, if they materialize, could individually have a material
adverse effect on Allegiance's business, financial condition or results of
operations.
As all of Allegiance's information technology and non-information technology
systems and products relating to Allegiance's external issues are manufactured
or supplied by other companies outside of Allegiance's control, there can be no
assurance that the systems of any of those companies will be year 2000 ready. In
particular, Allegiance will be dependent upon other ILECs, long distance
carriers and others on whose services Allegiance depends for interconnection and
completion of off-network calls. These interconnection arrangements are material
to Allegiance's ability to conduct its business and failure by any of these
providers to be year 2000 ready may have a material adverse effect on
Allegiance's business in the affected market. Moreover, although Allegiance has
taken every precaution to purchase its internal systems to be fully year 2000
ready, there can be no assurance that every vendor will fully comply with the
contract requirements. If some or all of Allegiance's internal and external
systems fail or are not year 2000 ready in a timely manner, there could be a
material adverse effect on Allegiance's business, financial condition or results
of operations.
Contingency Plans. Even though Allegiance has not identified any specific year
2000 issues, Allegiance believes that the design of its networks and support
systems could provide Allegiance with certain operating contingencies in the
event material external systems fail. In all of its markets, however, Allegiance
has or intends to establish interconnection agreements with the ILECs and other
regional and international carriers. If one of these carriers fails for any
reason, including year 2000 problems, there may be little Allegiance can do to
mitigate the impact of such a failure on Allegiance's operations. Allegiance has
attempted to ensure that its own operating facilities and systems are fully
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backed up with auxiliary power generators capable of operating all equipment and
systems for indeterminate periods should power supplies fail, subject to the
availability of fuel to run these generators. Allegiance also has the ability to
relocate headquarters and administrative personnel to other Allegiance
facilities should power and other services at its Dallas headquarters fail.
Because of the inability of Allegiance's contingency plans to eliminate the
negative impact that disruptions in ILEC service or the service of other
carriers would create, there can be no assurance that Allegiance will not
experience numerous disruptions that could have a material effect on
Allegiance's operations and its ability to service its indebtedness.
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BUSINESS
OVERVIEW
Allegiance seeks to be a premier provider of telecommunications services to
business, government and other institutional users in 24 of the largest major
metropolitan areas across the United States. Allegiance offers an integrated set
of telecommunications products and services including local exchange, local
access, domestic and international long distance, enhanced voice, data and a
full suite of Internet services. Allegiance generally prices these services at a
discount of 5% to 15% below the prices charged by the incumbent local exchange
carriers. Allegiance was founded in April 1997 by a management team led by Royce
J. Holland, the former President, Chief Operating Officer and co-founder of MFS
Communications, and Thomas M. Lord, former Managing Director of Bear, Stearns &
Co. Inc., where he specialized in the telecommunications, information services
and technology industries.
Allegiance believes that the Telecommunications Act, by opening the local
exchange market to competition, has created an attractive opportunity for new
facilities-based competitive local exchange carriers like Allegiance. Most
importantly, the Telecommunications Act stated that these carriers, known as
CLECs, should be able to lease the various elements of the ILECs' networks,
which are necessary for the cost-effective provision of service. This aspect of
the Telecommunications Act, which is referred to as "unbundling" the ILEC
networks, has enabled Allegiance to deploy digital switching platforms with
local and long distance capability and lease fiber optic lines from the ILECs,
other CLECs, and other telecommunications companies to connect Allegiance's
switch with its transmission equipment located in ILEC central offices. Once
traffic volume growth justifies further capital investment, Allegiance may lease
unused fiber to which Allegiance adds its own electronic transmission equipment.
Allegiance has developed procedures together with its back office systems
vendors, MetaSolv, DSET, Lucent and Intertech, that it believes will provide it
with a significant competitive advantage in terms of reducing costs, processing
large order volumes and providing customer service. Back office systems enable a
phone company to enter, schedule and track a customer's order from the point of
sale to the installation and testing of service. These systems also include or
interface with trouble management, inventory, billing, collection and customer
service systems. The existing systems currently employed by many carriers were
developed prior to the passage of the Telecommunications Act and generally
require multiple entries of customer information to accomplish order management,
provisioning, switch administration and billing. This process is not only labor
intensive, but it also creates numerous opportunities for errors in providing
new service and billing, service interruptions, poor customer service, and
increased customer turnover. These problems create significant added expenses
due to duplicated efforts and decreased customer satisfaction.
To address these problems, Allegiance is determined to achieve electronic
bonding, the on-line and real-time connection of Allegiance's operations support
systems with those of the ILECs, with each of the incumbent telecommunications
companies in most of its markets by the end of 1999. On January 8, 1999,
Allegiance and Bell Atlantic became the first major facilities-based CLEC and
ILEC to formally engage in electronic bonding after working since April 1998 to
develop the necessary software and processes. This will allow
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Allegiance to create service requests on-line, leading to faster installations
of customer orders through a reduction in errors associated with multiple manual
inputs. Allegiance expects electronic bonding to improve productivity by
decreasing the period between the time of sale and the time a customer's line is
installed in the Allegiance network. In addition, Allegiance expects that the
simplified process will reduce selling, general and administrative costs.
Allegiance believes that it will be some time before many other CLECs and
telecommunications service companies will be able to implement similar
electronic bonding systems. Unlike Allegiance, which is a new company designing
its systems specifically for electronic bonding, most of these other carriers
have systems that have been in place for years and already support a large
number of customers with ongoing service. Updating these systems can therefore
disrupt service and be much more costly and time consuming.
Allegiance intends to continue network deployment of its initial 24 markets.
Allegiance estimates that these 24 markets will include more than 21 million
non-residential access lines. According to Allegiance estimates, this represents
approximately 44.7% of the total non-residential access lines in the U.S. With a
strategy focusing on the central business districts and suburban commercial
districts in these areas, Allegiance plans to address a majority of the
non-residential access lines in most of its targeted markets.
As of February 9, 1999, Allegiance was operational in ten markets: New York
City, Dallas, Atlanta, Fort Worth, Chicago, Los Angeles, San Francisco, Boston,
Oakland and Philadelphia. As of such date, Allegiance was in the process of
deploying networks in seven other markets: Houston, Long Island, Washington,
D.C., Northern New Jersey, Orange County, San Diego, and San Jose.
BUSINESS STRATEGY
To accomplish its goal of becoming a premier provider of telecommunications
services to business, government, and other institutional users in U.S.
metropolitan areas, Allegiance has developed a customer-focused business
strategy designed to achieve significant market penetration and deliver superior
customer care while maximizing operating margins. The key components of this
strategy include the following:
Leverage Proven Management Team. Allegiance's veteran management team has
extensive experience and past successes in the CLEC industry. Allegiance
believes that its ability to combine and draw upon the collective talent and
expertise of its senior management gives it a competitive advantage in the
effective and efficient execution of network deployment, sales, provisioning,
service installation, billing and collection, and customer service functions.
Allegiance's Chairman and Chief Executive Officer, Royce J. Holland, has more
than 25 years of experience in the telecommunications and energy industries,
including as President, Chief Operating Officer, and co-founder of MFS
Communications, one of the first companies to compete with the existing
telephone companies that enjoyed a monopoly in providing local phone service.
Under his leadership, MFS Communications grew from a start-up operation to
become the largest competitor to the existing incumbent local exchange carriers.
It grew to $1.1 billion in revenues before its acquisition by WorldCom, Inc. in
1996. Dan Yost, the President and Chief Operating Officer of Allegiance, has
more than 26 years of telecommunications industry experience, including
experience as President and Chief Operating Officer of Netcom On-Line
Communications Services, Inc. from
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July 1997 to February 1998, and as President, Southwest Region of AT&T Wireless
Services, Inc. from June 1994 to July 1997. Other key Allegiance executives have
significant experience in the critical functions of network operations, sales
and marketing, back office and operations support systems, finance and
regulatory affairs.
Target End Users with Integrated Service Offerings. Allegiance focuses
principally on customers in the business, government and other institutional
market segments. The majority of our customers are small and medium-sized
businesses, to which we offer "one-stop shopping" by giving them the ability to
purchase a comprehensive package of communications services from a single
supplier. We also offer convenient integrated billing and a single point of
contact for sales and service. We offer the following services:
- - local and long distance services,
- - local area network ("LAN") interconnection,
- - frame relay,
- - Internet services,
- - Integrated Services Digital Network ("ISDN"),
- - Digital Subscriber Lines ("DSL"),
- - Web page design, and
- - Web server hosting.
These comprehensive services are generally not available from the ILECs, or
available only at high prices. By offering a comprehensive package of
communications services together with traditional local and long distance
services, we believe that we can accelerate our ability to establish new
customer accounts and reduce the number of customers who discontinue our
services and switch to other telecommunications providers. For large businesses
and government and other institutional users, which typically obtain
telecommunications services from a variety of suppliers, we will focus primarily
on capturing a significant portion of these customers' local exchange, intraLATA
toll, and data traffic. Although we will principally target end-users in markets
where we believe we can achieve significant market penetration by providing
superior customer care at competitive prices, we may augment our core business
strategy by selectively supplying wholesale services including equipment
collocation and facilities management services to Internet service providers.
Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. We will continue to pursue what we refer to as a "smart build"
strategy which entails:
- - purchasing and installing switches;
- - locating our equipment in the central office facilities of incumbent local
exchange carriers; and
- - leasing unbundled network elements from the incumbent local exchange carriers
until growth justifies our ownership of additional network elements.
Once traffic volume justifies further investment, we may then lease dark fiber
or construct our own fiber network.
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We believe that this smart build strategy offers a number of economic benefits.
First, the strategy allows us to enter into a new market in a six- to nine-month
time frame, less than half the 18-24 months generally required under the
traditional "build first, sell later" approach required before the
Telecommunications Act established a framework for CLECs to acquire unbundled
network elements. We believe that this smart build strategy has the additional
advantage of reducing initial capital requirements in each market, allowing us
to focus our initial capital resources on the critical areas of sales, marketing
and operations support systems, instead of on constructing extensive fiber optic
networks to each customer.
We are currently implementing this smart build strategy in all of our networks
where we lease high capacity circuits to connect the central office facilities
of incumbent local exchange carriers with our switches. In New York City, we are
moving to the next stage of our smart build strategy, by leasing a thirty-mile
dark fiber ring in Manhattan which extends into Brooklyn. We are in the process
of leasing a dark fiber ring in the Dallas market.
Achieve Broad Coverage of Attractive Areas within Each Targeted Market. As a
result of the substantial up-front capital requirements necessary to construct
metropolitan area fiber networks, CLECs have traditionally limited their initial
networks to highly concentrated downtown areas, which limits their ability to
provide service to customers in other attractive, but geographically dispersed,
markets. We prepare a detailed, "bottoms-up" analysis of a market's local
exchange areas using FCC and demographic data. We use this analysis, together
with estimates of the costs and potential benefits of addressing particular
service areas to:
- - identify attractive markets;
- - determine the optimal concentration of areas to be served; and
- - develop our schedule for deploying and expanding our network.
This will enable us to address the most attractive service areas throughout each
of our target markets, such as suburban business parks and concentrated downtown
areas, without having to construct our own fiber network to the customer
premises in each of these areas.
Maximize Operating Margins by Emphasizing Facilities-Based Services. We believe
that by using our own facilities to provide local exchange, local access, and
long distance service, we should generate significantly higher gross margins
than we could obtain by reselling services provided entirely on another
carrier's facilities. As a result, we focus our marketing activities on areas
where we can serve customers through a direct connection using unbundled loops
or high capacity circuits connected to our facilities. We plan to resell ILEC
services only in order to provide comprehensive geographical service coverage to
customers with multiple on-switch sites, which can be addressed by our
facilities-based services, and a few off-switch sites, which can be addressed
only by our reselling ILEC services.
Build Market Share by Focusing on Direct Sales. By using a direct sales force
which interacts directly with customers and provides them personalized customer
care through a single point of contact, we hope to maximize our market share,
particularly among small and medium-sized businesses. We believe that ILECs have
generally neglected to target small and medium-sized business customers with
direct sales efforts. Our sales
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management team is composed of executives with experience in managing a large
number of direct sales specialists in the telecommunications and data networking
industries. Additionally, we believe that we can attract and retain highly
qualified sales and support personnel by offering them the opportunity to:
- - work with an experienced and success-proven management team in building a
developing, entrepreneurial company;
- - market a comprehensive set of products and services and customer care options;
and
- - participate in the potential economic returns made available through a
results-oriented compensation package emphasizing sales commissions and stock
options.
Develop Efficient Automated Back Office Systems. By developing, acquiring and
integrating information technology systems to support our operations and by
establishing an electronic bonding arrangement with the incumbent local exchange
carriers that allow us to automate most of the processes involved in switching a
customer to our networks, we will accelerate the time between customer order and
service installation. Automating the order processing function should also help
us reduce our overhead costs and improve customer service. To address these
critical issues, we have hired an experienced team of engineering and
information technology professionals. This team is working to develop, with the
assistance of key third party vendors, operations support systems that
synchronize multiple tasks such as provisioning, customer service and billing
and provide management with timely operating and financial data to most
efficiently direct network, sales and customer service resources. In addition,
with electronic bonding, we should be able to provide better customer care since
we will be able to more readily pinpoint any problems with a customer's order.
See "-- Information Systems" for a discussion of electronic bonding.
Expand Customer Base Through Potential Acquisitions. We plan to pursue strategic
acquisitions to accelerate our market penetration, expand our customer base, and
acquire additional experienced management.
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MARKET OPPORTUNITY
U.S. Census Bureau data indicates that the United States communications services
market, including cable television, but excluding Internet access and content,
in 1997 totaled approximately $256 billion in annual revenue. As depicted on the
chart below, wireline telecommunications services, other than Internet access
and content, purchased by non-residential users accounted for about 44%, or
approximately $113 billion, of the total U.S. market in 1997:
[US COMMUNICATIONS MARKET GRAPH]
The major segments of the non-residential wireline telecommunications services
market, based on U.S. Census Bureau data, are as follows:
[NON-RESIDENTIAL WIRELINE TELECOMMUNICATIONS MARKET GRAPH]
Traditional voice traffic accounted for the vast majority of non-residential
communications revenue in 1997, with local exchange and exchange access
accounting for over half of the total non-residential wireline
telecommunications market, excluding Internet access and content. Due to its
rapid growth, estimates of data and Internet services revenue are not as well
established as those relating to traditional voice traffic communications.
However, Allegiance believes that a significant market opportunity exists for
providers of non-residential Internet services.
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Allegiance believes that the rapid opening of the local market to competition,
accelerated growth rates in local traffic related to increases in Internet
access, the desire for multiple suppliers by large businesses, and the desire
for "one-stop shopping" by small and medium-sized businesses and consumers,
presents an opportunity for new entrants to achieve product differentiation and
significant penetration into this very large, established market. Success in
this environment will, in the opinion of management, depend primarily on
speed-to-market, marketing creativity, superior customer service, and a CLEC's
ability to provide competitively priced services rapidly and accurately and to
issue concise, accurate integrated billing statements.
ALLEGIANCE'S TELECOMMUNICATIONS SERVICES
Allegiance intends to tailor its service offerings to meet the specific needs of
the business, government, and other institutional customers in its target
markets. Management believes that Allegiance's close contact with customers from
its direct sales force and customer care personnel will enable it to tailor its
service offerings to meet customers' needs and to creatively package its
services to provide "one-stop shopping" solutions for those customers.
Allegiance plans to offer the following services:
Local Exchange Services. Allegiance plans to offer in all of its target markets,
local telephone services, including local dial tone as well as enhanced features
such as:
- - call forwarding;
- - call waiting;
- - dial back;
- - caller ID; and
- - voice mail.
By offering dial tone service, Allegiance will also receive originating and
terminating access charges for interexchange calls placed or received by its
subscribers.
Private Branch Exchange/Shared Tenant Services. In areas where telephone density
is high and most telephone customers desire similar services, such as office
buildings, apartments, condominiums or campus-type environments, a private
branch exchange or services such as Centrex are among the most efficient means
of providing telephone services. A private branch exchange, also known as "PBX,"
is a switching system located within an office building and owned by a customer
which allows calls from the outside to be routed directly to the individual
instead of through a central number. PBX also allows for calling within an
office by way of four digit extensions. Centrex is a service that offers
features similar to those of a PBX, except that the switching equipment is
located at the telephone carrier's premises and not at the customer's premises.
The use of the Centrex service eliminates the need for large capital
expenditures on a PBX. Allegiance intends to offer these services in areas where
market potential warrants.
Integrated Services Digital Network and High Speed Data Services. Allegiance
offers high speed data transmission services, such as:
- - wide area network interconnection, which are remote computer communications
systems that allow file sharing among geographically distributed workgroups;
wide area networks typically use links provided by local telephone companies;
and
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- - broadband Internet access, also known as "wideband," which allows large
quantities of data to be transmitted simultaneously.
These services may be provided via frame relay and dedicated point-to-point
connections. In order to provide these services, Allegiance intends to utilize
leased high capacity connections, such as multiple DS-1, DS-3, T1 or T3
connections, to medium- and large-sized business, government, and other
institutional customers. Allegiance may also employ DSL and/or ISDN connections
over unbundled copper wire connections to smaller business users whose
telecommunications requirements may not justify such high capacity connections
or which are located in areas where T1 connections are not available.
Interexchange/Long Distance Services. Allegiance will offer a full range of:
- - domestic long distance services, such as: (a) interLATA, which are calls that
pass one "Local Access and Transport Area" or "LATA" to another, and such
calls must be carried across the LATA boundary by a long-distance carrier; and
(b) intraLATA, which is a call that falls within the local service area of a
single local telephone company; and
- - international long distance services.
These services will include "1+" outbound calling, inbound toll free service,
and such complementary services as calling cards, operator assistance, and
conference calling.
Enhanced Internet Services. Allegiance will offer dedicated and dial-up high
speed Internet access services via conventional modem connections, ISDN, DSL,
and T1 and higher speed dedicated connections. Dedicated services are
telecommunications lines dedicated or reserved for use by particular customers.
Web Site Design and Hosting Services. Allegiance offers Web site design services
and Web site hosting on its own computer servers to provide customers with a
complete, easy to use key solution that gives them a presence on the World Wide
Web.
Facilities and Systems Integration Services. Allegiance assists individual
customers with the design and implementation of complete, easy to use solutions
in order to meet their specific needs, including the selection of the customer's
premises equipment, interconnection of local area networks and wide area
networks, and implementation of virtual private networks. Virtual private
networks simulate private line networks without actually building a private
network and offer special services such as abbreviated dialing, where a customer
can call between offices in different area codes without having to dial all
eleven digits.
Wholesale Services to Internet Service Providers. Allegiance believes that with
the recent growth in demand for Internet services, numerous Internet service
providers are unable to obtain network capacity rapidly enough to meet customer
demand and eliminate network congestion problems. Allegiance plans to supplement
its core customer product offerings by providing a full array of local services
to Internet service providers, including telephone numbers and switched and
dedicated access to the Internet.
SALES AND CUSTOMER SUPPORT
Allegiance offers an integrated package of local exchange, local access,
domestic and international long distance, enhanced voice, data transmission, and
a full suite of Internet services to small and medium-sized businesses. Unlike
large corporate, government, or
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other institutional users, small and medium-sized businesses often have no
in-house telecommunications manager. Based on management's previous experience,
Allegiance believes that a direct sales and customer care program focusing on
complete, "one-stop shopping" solutions will have a competitive advantage in
capturing this type of customer's total telecommunications traffic.
Although the vast majority of Allegiance's sales force is focused primarily on
the small and medium-sized business segment, Allegiance also provides services
to large business, government, and other institutional users, as well as to
Internet service providers, and expects that a significant portion of its
initial revenue will come from these segments. Therefore, Allegiance has
organized its sales and customer care organizations to serve each of these three
market segments. Sales and marketing approaches in the telecommunications market
are market-segment specific, and Allegiance believes the following are the most
effective approaches with respect to its three targeted market segments:
- - Small/medium business -- Allegiance uses direct sales.
- - Large business, government, and other institutional users -- Allegiance uses
account teams, established business relationships, applications sales, is an
exhibitor at trade shows, and technical journal articles.
- - Wholesale carriers, primarily Internet service providers -- Allegiance uses
direct sales, established business relationships, and competitive pricing.
Allegiance organizes account executives into teams of six to eight persons with
a team manager and a sales support specialist. These teams utilize telemarketing
to "qualify" leads and set up initial appointments. Allegiance closely manages
account executives with regard to the number of sales calls per week, with the
goal of eventually calling on every prospective business customer in an account
executive's sales territory. Allegiance uses commission plans and incentive
programs to reward and retain the top performers and encourage strong customer
relationships. The sales team managers for each market report to a city sales
vice president who in turn reports to a regional vice president.
Allegiance's wholesale sales to local and regional Internet service providers
are performed by account executives reporting to the vice president of national
accounts. Account executives reporting to the vice president of national
accounts will handle large national Internet service providers. The vice
president of national accounts also has responsibility for large corporate,
government, and other institutional accounts, with designated national account
managers and sales support personnel assigned to the major accounts. Unlike the
small and medium-sized business segment, the national account program is being
built by recruiting national account managers with established business
relationships with large corporate accounts, supported by technical applications
personnel and customer care specialists.
INFORMATION SYSTEMS
Allegiance is currently developing tailored information systems and procedures
for operations support and other back-office systems that it believes will
provide a significant competitive advantage in terms of cost, processing large
order volumes, and customer service. These systems are required to enter,
schedule, provision, and track a customer's order from the point of sale to the
installation and testing of service and also include or interface with trouble
management, inventory, billing, collection and customer service
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systems. The existing systems currently employed by most ILECs, CLECs and long
distance carriers, which were developed prior to the passage of the
Telecommunications Act, generally require multiple entries of customer
information to accomplish order management, provisioning, switch administration
and billing. This process is not only labor intensive, but it creates numerous
opportunities for errors in provisioning service and billing, delays in
installing orders, service interruptions, poor customer service, increased
customer turnover, and significant added expenses due to duplicated efforts and
decreased customer satisfaction.
Allegiance believes that the practical problems and costs of upgrading existing
systems are often prohibitive for companies whose existing systems support a
large number of customers with ongoing service. Unburdened by having to work
with existing systems designed prior to the expanded interaction between CLECs
and ILECs introduced by the Telecommunications Act, Allegiance's team of
engineering and information technology professionals experienced in the CLEC
industry is working to develop operations support and other back office systems
designed to facilitate a smooth, efficient order management, provisioning,
trouble management, billing and collection, and customer care process. See "Risk
Factors -- We Are Dependent on Effective Billing, Customer Service and
Information Systems."
Order Management. Allegiance has signed a contract with MetaSolv to license its
order management software. This product allows the sales team not only to enter
customer orders onsite, via computer and/or over the Internet, but also to
monitor the status of the order as it progresses through the service initiation
process.
Provisioning Management. The licensed order management software also supports
the design and management of the provisioning process, including circuit design
and work flow management. The system has been designed to permit programming
into the system of a standard schedule of tasks which must be accomplished in
order to initiate service to a customer, as well as the standard time intervals
during which each such task must be completed. This way, when a standard order
is selected in the system, each required task in the service initiation process
can be efficiently managed to its assigned time interval.
External Interfaces. Several external interfaces are required to initiate
service for a customer. While some of these are automated via gateways from the
order management software, the most important interfaces, those to the ILEC,
have generally been accomplished via fax or e-mail. In an effort to make this
process more efficient, Allegiance and Bell Atlantic announced on January 8,
1999, the first implementation of electronic bonding between the operations
support system of a facilities-based CLEC and an ILEC. Electronic bonding will
allow Allegiance to access data from the ILEC, submit service requests
electronically, and more quickly attend to errors in the local service request
form because an order is bounced back immediately if the ILEC determines that
there is a mistake. As a result, Allegiance expects to be able to eventually
reduce the time frame required to switch service to Allegiance from
approximately 25 business days to as low as five business days, as compared to
three days currently required to switch to a new long distance carrier.
Electronic bonding should also enable Allegiance to improve its ability to
provide better customer care since Allegiance will more readily be able to
pinpoint where any problems may have occurred with a customer's order.
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Network Element Administration. Allegiance has signed a contract with a
third-party vendor to license their network element administration software.
Allegiance is currently developing an interface between its order management
system and the network element manager to integrate data integrity and eliminate
redundant data entry.
Customer Billing. Allegiance has selected a billing services provider which
credits the collections made to Allegiance's lock-box. Customer information will
be electronically interfaced with this provider from Allegiance's order
management system via a gateway being developed, thereby integrating all
repositories of information.
Billing Records. Local and intraLATA billing records are generated by the Lucent
Series 5ESS(R)-2000 switches to record customer calling activity. InterLATA
billing records are generated by the long distance carrier with whom Allegiance
has a resale agreement, to record customer calling activity. These records will
be automatically processed by the billing services provider in order to
calculate and produce bills in a customer-specified billing format.
NETWORK DEPLOYMENT
As of March 1, 1999, Allegiance was operational in ten markets: New York City,
Dallas, Atlanta, Fort Worth, Chicago, Los Angeles, San Francisco, Boston,
Oakland and Philadelphia. As of such date, Allegiance was in the process of
deploying networks in seven other markets: Houston, Long Island, Washington,
D.C., Northern New Jersey, Orange County, San Diego, and San Jose.
The following table sets forth the initial markets targeted by Allegiance and
Allegiance's current buildout schedule, although the order and timing of network
deployment may vary and will depend on a number of factors, including recruiting
city management, the regulatory environment, Allegiance's results of operations
and the existence of specific market opportunities, such as acquisitions, and no
assurance can be given that Allegiance will deploy networks in each such market:
MARKET SIZE AND BUILDOUT SCHEDULE
<TABLE>
<CAPTION>
ESTIMATED TOTAL NON- % OF TOTAL U.S. NON- INITIAL FACILITIES-
MARKET RESIDENTIAL ACCESS LINES(1) RESIDENTIAL ACCESS LINES(2) BASED SERVICE DATE(3)
------ --------------------------- --------------------------- ---------------------
(THOUSANDS)
<S> <C> <C> <C>
New York City......... 3,298(4) 6.7%(4) March 1998
Dallas, TX............ 867(5) 1.8%(5) April 1998
Atlanta, GA........... 612 1.2% April 1998
Fort Worth, TX........ --(5) --(5) July 1998
Chicago, IL........... 1,951 4.0% September 1998
Los Angeles, CA....... 3,430(6) 7.0%(6) October 1998
San Francisco, CA..... 2,148(7) 4.4%(7) November 1998
Boston, MA............ 649 1.3% December 1998
Oakland, CA........... --(7) --(7) December 1998
Philadelphia, PA...... 1,754 3.6% February 1999
</TABLE>
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<PAGE> 51
<TABLE>
<CAPTION>
ESTIMATED TOTAL NON- % OF TOTAL U.S. NON- INITIAL FACILITIES-
MARKET RESIDENTIAL ACCESS LINES(1) RESIDENTIAL ACCESS LINES(2) BASED SERVICE DATE(3)
------ --------------------------- --------------------------- ---------------------
(THOUSANDS)
<S> <C> <C> <C>
Northern New Jersey... --(4) --(4) 1999
Washington, D.C....... 871 1.8% 1999
Houston, TX........... 765 1.6% 1999
Orange County, CA..... --(6) --(6) 1999
San Jose, CA.......... --(7) --(7) 1999
San Diego, CA......... 790 1.6% 1999
Long Island, NY....... --(4) --(4) 1999
Baltimore, MD......... 639 1.3% 1999
Detroit, MI........... 821 1.7% 1999
Denver, CO............ 632 1.3% 2000
Seattle, WA........... 779 1.6% 2000
Cleveland, OH......... 654 1.3% 2000
Miami, FL............. 769 1.6% 2000
St. Louis, MO......... 449 0.9% 2000
------ -----
Total....... 21,878 44.7%
</TABLE>
- -------------------------
(1) Data as of December 31, 1996.
(2) Based on an estimated 49.0 million U.S. non-residential access lines as of
December 31, 1996.
(3) Refers to the first month during which Allegiance could offer
facilities-based service or the year during which Allegiance expects to be
able to offer facilities-based service based on its current business plan.
(4) Data for New York City also includes Northern New Jersey and Long Island,
NY.
(5) Data for Dallas, TX also includes Fort Worth, TX.
(6) Data for Los Angeles, CA also includes Orange County, CA.
(7) Data for San Francisco, CA also includes San Jose, CA and Oakland, CA.
In the majority of its targeted markets, Allegiance will initially deploy
switches and collocate transmission equipment in ILEC central offices with heavy
concentrations of non-residential access lines. Over time, Allegiance plans to
expand its networks throughout the metropolitan areas to address the majority of
the business market in each area. In some markets, such as Northern New Jersey,
Allegiance will not initially deploy its own switch, but will deploy
transmission equipment in major central offices and route traffic to an existing
Allegiance switch until traffic growth warrants the addition of a switch to
service that market.
NETWORK ARCHITECTURE
An important element of Allegiance's smart build strategy is the installation of
Lucent Series 5ESS(R)-2000 digital switches and related equipment at a central
location in each
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market. As of March 1, 1999, Allegiance had deployed 8 switches to serve 10
markets: New York City, Dallas, Atlanta, Chicago, Los Angeles, San Francisco,
Fort Worth, Oakland, Boston and Philadelphia. As of such date, Allegiance was
installing additional switches in each of Washington, D.C., Houston and San
Diego. Initially, Allegiance intends to lease local network trunking facilities
from the ILEC and/or one or more CLECs in order to connect Allegiance's switch
to major ILEC central offices serving the central business district and outlying
areas of business concentrations in each market. The switch will also be
connected to ILEC tandem switches and certain interexchange carrier
points-of-presence, the equivalent of a local phone company's central office. To
access the largest number of customers possible without having to lay fiber to
each of their premises, Allegiance will also locate access equipment such as
integrated digital loop carriers ("IDLCs") and related equipment in each of the
ILEC central offices in which it is connected. As each customer is signed up,
service will be provisioned by leasing unbundled loops from the ILEC to connect
Allegiance's IDLC located in the serving central office to the customer premise
equipment. For large business, government, or other institutional customers or
for numerous customers located in large buildings, it may be more cost-
effective for Allegiance to use leased ILEC or CLEC capacity in the 1.5 to 150
megabit range, or perhaps a wireless local loop leased from one of the emerging
wireless CLECs, to connect the customer(s) to the Allegiance network. In this
case, Allegiance will locate its IDLC or other equipment in the customer's
building.
Although Allegiance will initially lease its local network transmission
facilities, Allegiance plans to replace leased capacity with its own fiber optic
facilities as and when it experiences sufficient traffic volume growth between
its switch and specific ILEC central offices or as other factors make these
arrangements more attractive.
IMPLEMENTATION OF SERVICES
To offer services in a market, Allegiance generally must secure certification
from the state regulator and typically must file tariffs or price lists for the
services that it will offer. The certification process varies from state to
state; however, the fundamental requirements are largely the same. State
regulators require new entrants to demonstrate that they have secured adequate
financial resources to establish and maintain good customer service. New
entrants must also show that they possess the knowledge and ability required to
establish and operate a telecommunications network. Allegiance has made such
demonstrations in Texas, Georgia, California, Illinois, Maryland, New York, New
Jersey, Virginia and Massachusetts, where Allegiance has obtained certificates
to provide local exchange and intrastate toll services. Applications for such
authority are pending in Colorado, the District of Columbia, Pennsylvania (where
Allegiance has obtained interim operating authority), Michigan and Washington.
Allegiance intends to file similar applications in the near future in Ohio,
Missouri and Florida.
Before providing local service, a new entrant must negotiate and execute an
interconnection agreement with the ILEC. While such agreements can be voluminous
and may take months to negotiate, most of the key interconnection issues have
now been thoroughly addressed and commissions in most states have ruled on
arbitrations between the ILECs and new entrants. However, interconnection rates
and conditions may be subject to change as the result of future commission
actions or other changes in the regulatory environment. Under a recent United
States Supreme Court ruling, new entrants may adopt either all or
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portions of an interconnection agreement already entered into by the ILEC and
another carrier. Such an approach will be selectively adopted by Allegiance to
enable it to enter markets quickly while at the same time preserving its right
to replace the adopted agreement with a customized interconnection agreement
that can be negotiated once service has already been established. For example,
Allegiance has adopted the interconnection agreement entered into between
Southwestern Bell and WinStar Wireless of Texas, Inc. in Texas and has begun to
negotiate enhancements to that agreement for ultimate inclusion in Allegiance's
customized agreement with Southwestern Bell.
While such interconnection agreements include key terms and prices for
interconnection, a significant joint implementation effort must be made with the
ILEC in order to establish operationally efficient and reliable traffic
interchange arrangements. Such interchange arrangements must include those
between the new entrant's network and the facilities of other service providers
as well as public service agencies. For example, Allegiance worked closely with
Southwestern Bell in order to devise and implement an efficient 911 call routing
plan that will meet the requirements of each individual 911 service bureau in
Southwestern Bell areas that Allegiance will serve using its own switches.
Allegiance meets with key personnel from 911 service bureaus to obtain their
acceptance and to establish dates for circuit establishment and joint testing.
Other examples of traffic interchange and interconnection arrangements utilizing
the ILEC's network include connectivity to its out-of-band signaling facilities,
interconnectivity to the ILEC's operator services and directory assistance
personnel, and access through the ILEC to the networks of wireless companies and
interexchange carriers.
After the initial implementation activities are completed in a market,
Allegiance follows an on-going capacity management plan to ensure that adequate
quantities of network facilities, such as interconnection trunks are in place,
and a contingency plan must be devised to address spikes in demand caused by
events such as a larger-than-expected customer sale in a relatively small
geographic area.
REGULATION
Allegiance's telecommunications services business is subject to federal, state
and local regulation.
FEDERAL REGULATION
The FCC regulates interstate and international telecommunications services,
including the use of local telephone facilities to originate and terminate
interstate and international calls. Allegiance provides such services on a
common carrier basis. The FCC imposes certain regulations on common carriers
such as the ILECs that have some degree of market power. The FCC imposes less
regulation on common carriers without market power including, to date, CLECs
like Allegiance. The FCC requires common carriers to receive an authorization to
construct and operate telecommunications facilities, and to provide or resell
telecommunications services, between the United States and international points.
Under the Telecommunications Act, any entity, including cable television
companies and electric and gas utilities, may enter any telecommunications
market, subject to reasonable state regulation of safety, quality and consumer
protection. Because implementation of the Telecommunications Act is subject to
numerous federal and state policy rulemaking
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proceedings and judicial review there is still uncertainty as to what impact
such legislation will have on Allegiance.
The Telecommunications Act is intended to increase competition. The act opens
the local services market by requiring ILECs to permit interconnection to their
networks and establishing ILEC obligations with respect to:
Reciprocal Compensation. Requires all local exchange carriers to complete calls
originated by competing local exchange carriers under reciprocal arrangements at
prices based on tariffs or negotiated prices.
Resale. Requires all ILECs and CLECs to permit resale of their
telecommunications services without unreasonable restrictions or conditions. In
addition, ILECs are required to offer wholesale versions of all retail services
to other telecommunications carriers for resale at discounted rates, based on
the costs avoided by the ILEC in the wholesale offering.
Interconnection. Requires all ILECs and CLECs to permit their competitors to
interconnect with their facilities. Requires all ILECs to permit interconnection
at any technically feasible point within their networks, on nondiscriminatory
terms, at prices based on cost, which may include a reasonable profit. At the
option of the carrier seeking interconnection, collocation of the requesting
carrier's equipment in the ILECs' premises must be offered, except where an ILEC
can demonstrate space limitations or other technical impediments to collocation.
Unbundled Access. Requires all ILECs to provide nondiscriminatory access to
unbundled network elements including, network facilities, equipment, features,
functions, and capabilities, at any technically feasible point within their
networks, on nondiscriminatory terms, at prices based on cost, which may include
a reasonable profit.
Number Portability. Requires all ILECs and CLECs to permit users of
telecommunications services to retain existing telephone numbers without
impairment of quality, reliability or convenience when switching from one
telecommunications carrier to another.
Dialing Parity. Requires all ILECs and CLECs to provide "1+" equal access to
competing providers of telephone exchange service and toll service, and to
provide nondiscriminatory access to telephone numbers, operator services,
directory assistance, and directory listing, with no unreasonable dialing
delays.
Access to Rights-of-Way. Requires all ILECs and CLECs to permit competing
carriers access to poles, ducts, conduits and rights-of-way at regulated prices.
ILECs are required to negotiate in good faith with carriers requesting any or
all of the above arrangements. If the negotiating carriers cannot reach
agreement within a prescribed time, either carrier may request binding
arbitration of the disputed issues by the state regulatory commission. Where an
agreement has not been reached, ILECs remain subject to interconnection
obligations established by the FCC and state telecommunication regulatory
commissions.
In August 1996, the FCC released a decision establishing rules implementing the
ILEC interconnection obligations described above. On July 18, 1997, the Eighth
Circuit vacated certain portions of this decision and narrowly interpreted the
FCC's power to prescribe and enforce rules implementing the Telecommunications
Act. On January 25, 1999, the United
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States Supreme Court reversed the Eighth Circuit decision and reaffirmed the
FCC's broad authority to issue rules implementing the Telecommunications Act,
although it did vacate a rule determining which network elements the incumbent
local exchange carriers must provide to competitors on an unbundled basis.
Allegiance, however, leases only the basic unbundled network elements from the
ILEC and therefore does not expect reconsideration of the unbundling rules to
have an adverse effect on its smart build strategy.
Nevertheless, the FCC likely will conduct additional rulemaking proceedings to
conform to the Supreme Court's interpretation of the law, and these proceedings
may result in further judicial review. While these court proceedings were
pending, Allegiance entered into interconnection agreements with a number of
ILECs through negotiations or, in some cases, adoption of another CLEC's
approved agreement. These agreements remain in effect, although in some cases
one or both parties may be entitled to demand renegotiation of particular
provisions based on intervening changes in the law. However, it is uncertain
whether Allegiance will be able to obtain renewal of these agreements on
favorable terms when they expire.
The Telecommunications Act codifies the ILECs' equal access and
nondiscrimination obligations and preempts inconsistent state regulation. The
Telecommunications Act also contains special provisions that replace prior
antitrust restrictions that prohibited the regional Bell operating companies
from providing long distance services and engaging in telecommunications
equipment manufacturing. The Telecommunications Act permitted the regional Bell
operating companies to enter the out-of-region long distance market immediately
upon its enactment. Further, provisions of the Telecommunications Act permit a
regional Bell operating company to enter the long distance market in its
in-region states if it satisfies several procedural and substantive
requirements, including:
- - obtaining FCC approval upon a showing that the regional Bell operating company
has entered into interconnection agreements or, under some circumstances, has
offered to enter into such agreements in those states in which it seeks long
distance relief;
- - the interconnection agreements satisfy a 14-point "checklist" of competitive
requirements; and
- - the FCC is satisfied that the regional Bell operating company's entry into
long distance markets is in the public interest.
To date, several petitions by regional Bell operating companies for such entry
have been denied by the FCC, and none have been granted. However, it is likely
that additional petitions will be filed in 1999 and it is possible that regional
Bell operating companies may receive approval to offer long distance services in
one or more states. This may have an unfavorable effect on Allegiance's
business. Allegiance is legally able to offer its customers both long distance
and local exchange services, which the regional Bell operating companies
currently may not do. This ability to offer "one-stop shopping" gives Allegiance
a marketing advantage that it would no longer enjoy. See "-- Competition."
On May 8, 1997, the FCC released an order establishing a significantly expanded
federal universal service subsidy regime. For example, the FCC established new
subsidies for telecommunications and information services provided to qualifying
schools and libraries with an annual cap of $2.25 billion and for services
provided to rural health care providers with an annual cap of $400 million. The
FCC also expanded the federal subsidies for local
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exchange telephone services provided to low-income consumers. Providers of
interstate telecommunications service, such as Allegiance must pay for a portion
of these programs. Allegiance's share of these federal subsidy funds will be
based on its share of certain defined telecommunications end user revenues.
Currently, the FCC is assessing such payments on the basis of a provider's
revenue for the previous year. The FCC announced that it intends, effective July
1, 1999, to revise its rules for subsidizing service provided to consumers in
high cost areas, which may result in further substantial increases in the
overall cost of the subsidy program. Several parties have appealed the May 8th
order. Such appeals have been consolidated and transferred to the United States
Court of Appeals for the Fifth Circuit where they are currently pending.
For the first half of 1999, Allegiance expects to incur a contribution liability
equal to approximately 1.5% of its 1998 operating revenues. With respect to
subsequent periods, however, Allegiance is currently unable to quantify the
amount of subsidy payments that it will be required to make or the effect that
these required payments will have on its financial condition.
Under authority granted by the FCC, Allegiance will resell the international
telecommunications services of other common carriers between the United States
and international points. In connection with such authority, Allegiance's
subsidiary, Allegiance Telecom International, Inc., has filed tariffs with the
FCC stating the rates, terms and conditions for its international services.
With respect to its domestic service offerings, various subsidiaries of
Allegiance have filed tariffs with the FCC stating the rates, terms and
conditions for their interstate services. Allegiance's tariffs are generally not
subject to pre-effective review by the FCC, and can be amended on one day's
notice. Allegiance's interstate services are provided in competition with
interexchange carriers and, with respect to access services, the ILECs. With
limited exceptions, the current policy of the FCC for most interstate access
services dictates that ILECs charge all customers the same price for the same
service. Thus, the ILECs generally cannot lower prices to those customers likely
to contract for their services without also lowering charges for the same
service to all customers in the same geographic area, including those whose
telecommunications requirements would not justify the use of such lower prices.
The FCC may, however, alleviate this constraint on the ILECs and permit them to
offer special rate packages to very large customers, as it has done in a few
cases, or permit other forms of rate flexibility. The FCC has adopted some
proposals that significantly lessen the regulation of ILECs that are subject to
competition in their service areas and provide such ILECs with additional
flexibility in pricing their interstate switched and special access on a central
office specific basis; and, as discussed in the following paragraph, is
considering expanding such flexibility.
In two orders released on December 24, 1996, and May 16, 1997, the FCC made
major changes in the interstate access charge structure. In the December 24th
order, the FCC removed restrictions on ILECs' ability to lower access prices and
relaxed the regulation of new switched access services in those markets where
there are other providers of access services. If this increased pricing
flexibility is not effectively monitored by federal regulators, it could have a
material adverse effect on Allegiance's ability to compete in providing
interstate access services. The May 16th order substantially increased the costs
that ILECs subject to the FCC's price cap rules recover through monthly,
non-traffic sensitive access charges and substantially decreased the costs that
these carriers recover
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through traffic sensitive access charges. In the May 16th order, the FCC also
announced its plan to bring interstate access rate levels more in line with
cost. The plan will include rules that may grant these carriers increased
pricing flexibility upon demonstrations of increased competition or potential
competition in relevant markets. The manner in which the FCC implements this
approach to lowering access charge levels could have a material effect on
Allegiance's ability to compete in providing interstate access services. Several
parties appealed the May 16th order. On August 19, 1998, the May 16th order was
affirmed by the Eighth Circuit U.S. Court of Appeals. The FCC is now considering
public comments on pricing flexibility proposals submitted by two regional Bell
operating companies and on changing the productivity factor (currently 6.5%),
which is applied annually to reduce ILECs' price cap indices.
ILECs around the country have been contesting whether the obligation to pay
reciprocal compensation to competitive local exchange carriers should apply to
local telephone calls from an ILEC's customers to Internet service providers
served by competitive local exchange carriers. The ILECs claim that this traffic
is interstate in nature and therefore should be exempt from compensation
arrangements applicable to local, intrastate calls. Competitive local exchange
carriers have contended that the interconnection agreements provide no exception
for local calls to Internet service providers and reciprocal compensation is
therefore applicable. Currently, over 25 state commissions and several federal
and state courts have ruled that reciprocal compensation arrangements do apply
to calls to Internet service providers, and no jurisdiction has ruled to the
contrary. Certain of these rulings are subject to appeal. Additional disputes
over the appropriate treatment of Internet service provider traffic are pending
in other states. The National Association of Regulatory Utility Commissioners
adopted a resolution in favor of applying reciprocal compensation to calls to
Internet service providers. Allegiance anticipates that Internet service
providers will be among its target customers, and adverse decisions in these
proceedings could limit its ability to service this group of customers
profitably.
The FCC recently held that GTE Corporation's Asymmetric Digital Subscriber Line
service, also known as "ADSL", which permits an Internet service provider to
provide its end user with high-speed access to the Internet, is a special access
service with more than a small amount of interstate traffic. This order
determined that GTE's ADSL service is properly tariffed at the federal level but
if GTE or any other ILECs were to offer an ADSL service that is intrastate in
nature, that service should be tariffed at the state level. The FCC made clear
that its GTE ADSL order did not determine whether reciprocal compensation is
owed under existing interconnection agreements, state arbitration decisions and
federal court decisions. The FCC indicated that it intends to issue a separate
order specifically addressing reciprocal compensation issues, and we expect that
this order may be released in early 1999. No assurance can be given that the FCC
order will be consistent with previous state decisions or that it will be
favorable to Allegiance's interests.
STATE REGULATION
The Telecommunications Act is intended to increase competition in the
telecommunications industry, especially in the local exchange market. With
respect to local services, ILECs are required to allow interconnection to their
networks and to provide unbundled access to network facilities, as well as a
number of other procompetitive measures. Because the implementation of the
Telecommunications Act is subject to numerous state
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rulemaking proceedings on these issues, it is currently difficult to predict how
quickly full competition for local services, including local dial tone, will be
introduced.
State regulatory agencies have regulatory jurisdiction when Allegiance
facilities and services are used to provide intrastate services. A portion of
Allegiance's current traffic may be classified as intrastate and therefore
subject to state regulation. Allegiance expects that it will offer more
intrastate services, including intrastate switched services, as its business and
product lines expand and state regulations are modified to allow increased local
services competition. To provide intrastate services, Allegiance generally must
obtain a certificate of public convenience and necessity from the state
regulatory agency and comply with state requirements for telecommunications
utilities, including state tariffing requirements.
State agencies, like the FCC, require Allegiance to file periodic reports, pay
various fees and assessments, and comply with rules governing quality of
service, consumer protection, and similar issues. Although the specific
requirements vary from state to state, they tend to be more detailed than the
FCC's regulation because of the strong public interest in the quality of basic
local exchange service. Allegiance intends to comply with all applicable state
regulations, and as a general matter does not expect that these requirements of
industry-wide applicability will have a material adverse effect on its business.
However, no assurance can be given that the imposition of new regulatory burdens
in a particular state will not affect the profitability of Allegiance's services
in that state.
LOCAL REGULATION
Allegiance's networks are subject to numerous local regulations such as building
codes and licensing. Such regulations vary on a city by city and county by
county basis. To the extent Allegiance decides in the future to install its own
fiber optic transmission facilities, it will need to obtain rights-of-way over
private and publicly owned land. There can be no assurance that such
rights-of-way will be available to Allegiance on economically reasonable or
advantageous terms.
COMPETITION
The telecommunications industry is highly competitive. Allegiance believes that
the principal competitive factors affecting its business will be pricing levels
and clear pricing policies, customer service, accurate billing and, to a lesser
extent, variety of services. The ability of Allegiance to compete effectively
will depend upon its continued ability to maintain high quality, market-driven
services at prices generally equal to or below those charged by its competitors.
To maintain its competitive posture, Allegiance believes that it must be in a
position to reduce its prices in order to meet reductions in rates, if any, by
others. Any such reductions could adversely affect Allegiance. Many of
Allegiance's current and potential competitors have financial, personnel and
other resources, including brand name recognition, substantially greater than
those of Allegiance, as well as other competitive advantages over Allegiance.
Local Exchange Carriers. In each of the markets targeted by Allegiance,
Allegiance will compete principally with the ILEC serving that area, such as
Ameritech, BellSouth, Southwestern Bell, Bell Atlantic or US West. Allegiance
believes the regional Bell operating companies' primary agenda is to be able to
offer long distance service in their
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<PAGE> 59
service territories. The independent telephone companies have already achieved
this goal with good early returns. Many experts expect the regional Bell
operating companies to be successful in entering the long distance market in a
few states sometime in 1999. Allegiance believes the regional Bell operating
companies expect to offset share losses in their local markets by capturing a
significant percentage of the in-region long distance market, especially in the
residential segment where the regional Bell operating companies' strong regional
brand names and extensive advertising campaigns may be very successful. See
"-- Regulation."
As a recent entrant in the integrated telecommunications services industry,
Allegiance has not achieved and does not expect to achieve a significant market
share for any of its services. In particular, the ILECs have long-standing
relationships with their customers, have financial, technical and marketing
resources substantially greater than those of Allegiance, have the potential to
subsidize competitive services with revenues from a variety of businesses and
currently benefit from certain existing regulations that favor the ILECs over
Allegiance in certain respects. While recent regulatory initiatives, which allow
CLECs such as Allegiance to interconnect with ILEC facilities, provide increased
business opportunities for Allegiance, such interconnection opportunities have
been and likely will continue to be accompanied by increased pricing flexibility
for and relaxation of regulatory oversight of the ILECs.
ILECs have long-standing relationships with regulatory authorities at the
federal and state levels. While recent FCC administrative decisions and
initiatives provide increased business opportunities to telecommunications
providers such as Allegiance, they also provide the ILECs with increased pricing
flexibility for their private line and special access and switched access
services. In addition, with respect to competitive access services as opposed to
switched local exchange services, the FCC recently proposed a rule that would
provide for increased ILEC pricing flexibility and deregulation for such access
services either automatically or after certain competitive levels are reached.
If the ILECs are allowed by regulators to offer discounts to large customers
through contract tariffs, engage in aggressive volume and term discount pricing
practices for their customers, and/or seek to charge competitors excessive fees
for interconnection to their networks, the income of competitors to the ILECs,
including Allegiance, could be materially adversely affected. If future
regulatory decisions afford the ILECs increased access services pricing
flexibility or other regulatory relief, such decisions could also have a
material adverse effect on competitors to the ILEC, including Allegiance.
Competitive Access Carriers/Competitive Local Exchange Carriers/Interexchange
Carriers/ Other Market Entrants. Allegiance also faces, and expects to continue
to face, competition from other current and potential market entrants, including
long distance carriers seeking to enter, reenter or expand entry into the local
exchange market such as AT&T, MCI WorldCom, and Sprint, and from other CLECs,
resellers of local exchange services, competitive access providers, cable
television companies, electric utilities, microwave carriers, wireless telephone
system operators and private networks built by large end users. In addition, a
continuing trend toward consolidation of telecommunications companies and the
formation of strategic alliances within the telecommunications industry, as well
as the development of new technologies, could give rise to significant new
competitors to Allegiance. For example, WorldCom acquired MFS Communications in
December 1996, acquired another CLEC, Brooks Fiber Properties, Inc. in 1997, and
recently merged with MCI. AT&T recently acquired Teleport Communications Group
Inc. Ameritech Corpora-
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<PAGE> 60
tion has agreed to merge with SBC Communications; and Bell Atlantic has agreed
to merge with GTE Corporation. On June 24, 1998, AT&T announced that it had
entered into a merger agreement with Tele-Communications, Inc., a cable,
telecommunications, and high-speed Internet services provider. These types of
consolidations and strategic alliances could put Allegiance at a competitive
disadvantage. The Telecommunications Act includes provisions which impose
certain regulatory requirements on all local exchange carriers, including
competitors such as Allegiance, while granting the FCC expanded authority to
reduce the level of regulation applicable to any or all telecommunications
carriers, including ILECs. The manner in which these provisions of the
Telecommunications Act are implemented and enforced could have a material
adverse effect on Allegiance's ability to successfully compete against ILECs and
other telecommunications service providers. Allegiance also competes with
equipment vendors and installers, and telecommunications management companies
with respect to certain portions of its business.
The changes in the Telecommunications Act radically altered the market
opportunity for traditional competitive access providers and CLECs. Due to the
fact that most existing competitive access providers/CLECs initially entered the
market providing dedicated access in the pre-1996 era, these companies had to
build a fiber infrastructure before offering services. Switches were added by
most competitive access providers/CLECs in the last year to take advantage of
the opening of the local market. With the Telecommunications Act requiring
unbundling of the local exchange carrier networks, competitive access
providers/CLECs will now be able to more rapidly enter the market by installing
switches and leasing trunk and loop capacity until traffic volume justifies
building facilities. New CLECs will not have to replicate existing facilities
and can be more opportunistic in designing and implementing networks.
As of December 31, 1998, over 20 CLECS have entered or announced their intention
to enter into one or more of the same markets as Allegiance. Not all CLECS
however, are pursuing the same target customers as Allegiance. Demographically,
business customers are divided into three segments: small, medium and large.
Targeted cities are divided into three segments by population: Tier 1, Tier 2
and Tier 3. As would be expected, each CLEC may focus on different combinations
of primary and secondary target customers.
Allegiance has chosen to focus primarily on small and medium-sized business
customers in large "Tier 1" markets. To help distinguish itself from other
competitors who have adopted a similar strategy, Allegiance uses a direct sales
approach to offer potential customers "one-stop shopping" services through a
single point of contact. In addition, Allegiance is actively pursuing
collocations throughout all of its target markets which, in combination with its
smart build strategy, is expected to allow Allegiance to access its markets and
provide a greater array of services more quickly than if it were able to use a
traditional build approach.
Allegiance believes the major interexchange carriers, such as AT&T, MCI WorldCom
and Sprint, have a two pronged strategy: (1) keep the regional Bell operating
companies out of in-region long distance as long as possible, and (2) develop
facilities-based and unbundled local service, an approach already being pursued
by MCI WorldCom with the acquisition of MFS Communications, and more recently by
AT&T with its acquisition of Teleport Communications.
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<PAGE> 61
Competition for Provision of Long Distance Services. The long distance
telecommunications industry has numerous entities competing for the same
customers and a high average turnover rate, as customers frequently change long
distance providers in response to the offering of lower rates or promotional
incentives by competitors. Prices in the long distance market have declined
significantly in recent years and are expected to continue to decline.
Allegiance expects to increasingly face competition from companies offering long
distance data and voice services over the Internet. Such companies could enjoy a
significant cost advantage because they do not currently pay carrier access
charges or universal service fees.
Data/Internet Service Providers. The Internet services market is highly
competitive, and Allegiance expects that competition will continue to intensify.
Allegiance's competitors in this market will include Internet service providers,
other telecommunications companies, online services providers and Internet
software providers. Many of these competitors have greater financial,
technological and marketing resources than those available to Allegiance.
Competition from International Telecommunications Providers. Under the recent
WTO agreement on basic telecommunications services, the United States and 72
other members of the WTO committed themselves to opening their respective
telecommunications markets and/or foreign ownership and/or to adopting
regulatory measures to protect competitors against anticompetitive behavior by
dominant telecommunications companies, effective in some cases as early as
January 1998. Although Allegiance believes that the WTO agreement could provide
Allegiance with significant opportunities to compete in markets that were not
previously accessible and to provide more reliable services at lower costs than
Allegiance could have provided prior to implementation of the WTO agreement, it
could also provide similar opportunities to Allegiance's competitors and
facilitate entry by foreign carriers into the U.S. market. There can be no
assurance that the pro-competitive effects of the WTO agreement will not have a
material adverse effect on Allegiance's business, financial condition and
results of operations or that members of the WTO will implement the terms of the
WTO agreement.
EMPLOYEES
As of December 31, 1998, Allegiance had approximately 649 full-time employees.
Allegiance believes that its future success will depend on its continued ability
to attract and retain highly skilled and qualified employees. None of
Allegiance's employees are currently represented by a collective bargaining
agreement. Allegiance believes that it enjoys good relationships with its
employees.
LEGAL PROCEEDINGS
On August 29, 1997, WorldCom sued Allegiance and two of its Senior Vice
Presidents. In its complaint, WorldCom alleges that these employees violated
noncompete and nonsolicitation agreements by accepting employment with
Allegiance and by soliciting then-current WorldCom employees to leave WorldCom's
employment and join Allegiance. In addition, WorldCom claims that Allegiance
tortiously interfered with WorldCom's relationships with its employees, and that
Allegiance's behavior constituted unfair competition. WorldCom seeks injunctive
relief, including barring two of Allegiance's executives from continued
employment with Allegiance, and monetary damages, although
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<PAGE> 62
it has filed no motion for a temporary restraining order or preliminary
injunction. Allegiance denies all claims and is vigorously defending itself.
Allegiance does not expect the ultimate outcome of this matter to have a
material adverse effect on the results of operations or financial condition of
Allegiance.
On October 7, 1997, Allegiance filed a counterclaim against WorldCom for, among
other things, attempted monopolization of the "one-stop shopping"
telecommunications market, abuse of process, and unfair competition. WorldCom
did not move to dismiss the attempted monopolization claim, but moved to dismiss
the abuse of process and unfair competition claims. On March 4, 1998, the court
dismissed the claim for unfair competition.
Allegiance is not party to any other pending legal proceedings that Allegiance
believes would, individually or in the aggregate, have a material adverse effect
on Allegiance's financial condition or results of operations.
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<PAGE> 63
FACILITIES
Allegiance is headquartered in Dallas, Texas and leases offices and space in a
number of locations, primarily for sales offices and network equipment
installations. The table below lists Allegiance's current leased facilities:
<TABLE>
<CAPTION>
LEASE APPROXIMATE
LOCATION EXPIRATION SQUARE FOOTAGE
-------- -------------- --------------
<S> <C> <C>
Dallas, TX...................................... February 2008 76,000
Atlanta, GA..................................... February 2003 7,400
Atlanta, GA..................................... November 2001 7,300
Boston, MA...................................... September 2003 12,000
Boston, MA...................................... September 2008 18,000
Chicago, IL..................................... March 2009 11,000
Chicago, IL..................................... July 2008 14,000
Fort Worth, TX.................................. June 2003 3,900
Houston, TX..................................... December 2005 11,700
Houston, TX..................................... November 2008 18,000
Los Angeles, CA................................. June 2008 11,700
Los Angeles, CA................................. June 2008 14,585
New York, NY.................................... August 2006 8,700
New York, NY.................................... March 2008 19,500
New York, NY.................................... June 2008 12,400
Oakland, CA..................................... December 2006 2,000
Philadelphia, PA................................ April 2002 8,900
Philadelphia, PA................................ October 2008 18,000
San Diego, CA................................... March 2008 14,000
San Francisco, CA............................... April 2002 8,100
San Francisco, CA............................... June 2008 16,000
San Jose........................................ February 2004 4,500
Washington, DC.................................. November 2008 15,000
Washington, DC.................................. November 2006 8,200
Westchester, IL................................. January 2001 10,700
Westchester, IL................................. April 2001 5,700
</TABLE>
Allegiance believes that its leased facilities are adequate to meet its current
needs in the markets in which it has begun to deploy networks, and that
additional facilities are available to meet its development and expansion needs
in existing and projected target markets for the foreseeable future.
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<PAGE> 64
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND OTHER KEY EMPLOYEES
The following table sets forth information concerning the directors, executive
officers and other key personnel of Allegiance, including their ages as of
December 31, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
---- --- -----------
<S> <C> <C>
Royce J. Holland(1)..... 50 Chairman of the Board and Chief Executive
Officer
C. Daniel Yost.......... 50 President and Chief Operating Officer, and
Director
Thomas M. Lord.......... 42 Executive Vice President of Corporate
Development, Chief Financial Officer, and
Director
John J. Callahan........ 48 Senior Vice President of Sales and Marketing,
and Director
Dana A. Crowne.......... 37 Senior Vice President and Chief Engineer
Stephen N. Holland...... 46 Senior Vice President and Chief Information
Officer
Patricia E. Koide....... 50 Senior Vice President of Human Resources, Real
Estate, Facilities and Administration
Gregg A. Long........... 44 Senior Vice President of Development and
Regulatory
Mark B. Tresnowski...... 39 Senior Vice President and General Counsel
Anthony J. Parella...... 38 National Vice President of Sales
Paul D. Carbery......... 37 Director
James E. Crawford,
III(1)................ 52 Director
John B. Ehrenkranz...... 33 Director
Paul J. Finnegan........ 45 Director
Richard D. Frisbie...... 49 Director
Reed E. Hundt........... 49 Director
Robert H. Niehaus(1).... 43 Director
James N. Perry,
Jr.(1)................ 37 Director
</TABLE>
- -------------------------
(1) Member of the Board's Executive Committee.
Royce J. Holland, Allegiance's Chairman of the Board and Chief Executive
Officer, has more than 25 years of experience in the telecommunications,
independent power and engineering/construction industries. Prior to founding
Allegiance in April 1997, Mr. Holland was one of several co-founders of MFS
Communications, where he served as President and Chief Operating Officer from
April 1990 until September 1996 and as Vice Chairman from September 1996 to
February 1997. In January 1993, Mr. Holland was appointed by President George
Bush to the National Security Telecommunications Advisory Committee. Mr. Holland
was recently named the head of the Association for Local Telecommunications
Services, the industry trade organization for the competitive telephone sector.
Mr. Holland also presently serves on the Board of Directors of CSG Systems, a
publicly held billing services company. Mr. Holland's brother, Stephen N.
Holland, is employed as Allegiance's Senior Vice President and Chief Information
Officer.
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<PAGE> 65
C. Daniel Yost, who joined Allegiance as President and Chief Operating Officer
in February 1998, was elected to Allegiance's Board of Directors in March 1998.
Mr. Yost has more than 26 years of experience in the telecommunications
industry. From July 1997 until he joined Allegiance, Mr. Yost was the President
and Chief Operating Officer for U.S. Operations of Netcom On-Line Communications
Services, Inc., a leading Internet service provider. Mr. Yost served as the
President, Southwest Region of AT&T Wireless Services, Inc. from June 1994 to
July 1997. Prior to that, from July 1991 to June 1994, Mr. Yost was the
President, Southwest Region of McCaw Cellular Communications/LIN Broadcasting.
Thomas M. Lord, a co-founder and Director of Allegiance and its Executive Vice
President of Corporate Development and Chief Financial Officer, is responsible
for overseeing Allegiance's mergers and acquisitions, corporate finance and
investor relations functions. Mr. Lord is an 18-year veteran in investment
banking, securities research and portfolio management, including serving as a
managing director of Bear, Stearns & Co. Inc. from January 1986 to December
1996. In the five-year period ending December 1996, Mr. Lord oversaw 43
different transactions valued in excess of $6.2 billion for the
telecommunications, information services and technology industries.
John J. Callahan, who joined Allegiance as Senior Vice President of Sales and
Marketing in December 1997, has more than 18 years of experience in the
telecommunications industry. Most recently, Mr. Callahan was President of the
Western Division for MFS Communications from December 1991 to November 1997,
where he was responsible for the company's sales and operations in Arizona,
California, Georgia, Florida, Illinois, Michigan, Missouri, Ohio, Oregon, Texas
and Washington. Prior to joining MFS Communications, Mr. Callahan was Vice
President and General Manager, Southwest Division for Sprint. Mr. Callahan also
held sales positions with Data Switch and North American Telecom. Mr. Callahan
was elected to Allegiance's Board of Directors in March 1998.
Dana A. Crowne became Allegiance's Senior Vice President and Chief Engineer in
August 1997. Prior to joining Allegiance, Mr. Crowne held various management
positions at MFS Communications from the time of its founding in 1988, where his
responsibilities included providing engineering support and overseeing budgets
for the construction of MFS Communications' networks. Mr. Crowne ultimately
became Vice President, Network Optimization for MFS Communications from January
1996 to May 1997 and managed the company's network expenses and planning and its
domestic engineering functions. Prior to joining MFS Communications, Mr. Crowne
designed and installed fiber optic transmission systems for Morrison-Knudsen and
served as a consultant on the construction of private telecommunications
networks with JW Reed and Associates.
Stephen N. Holland joined Allegiance as its Senior Vice President and Chief
Information Officer in September 1997. Prior to that time, Mr. Holland held
several senior level positions involving management of or consulting on
information systems, accounting, taxation and finance. Mr. Holland's experience
includes serving as Practice Manager and Information Technology Consultant for
Oracle Corporation from June 1995 to September 1997, as Chief Financial Officer
of Petrosurance Casualty Co. from September 1992 to June 1995, as Manager of
Business Development for Electronic Data Systems, and as a partner of Price
Waterhouse. Mr. Holland's brother, Royce J. Holland, presently serves as
Allegiance's Chairman of the Board and Chief Executive Officer.
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<PAGE> 66
Patricia E. Koide has been Allegiance's Senior Vice President of Human
Resources, Real Estate, Facilities and Administration since August 1997. Before
then, Ms. Koide was Vice President of Corporate Services, Facilities and
Administration for WorldCom from March 1997 to August 1997. Ms. Koide also held
various management positions within MFS Communications and its subsidiaries
since 1989, including Senior Vice President of Facilities, Administration and
Purchasing for MFS Communications North America from 1996 to 1997, Senior Vice
President of Human Resources, Facilities and Administration for MFS
Communications Telecom from 1994 to 1996, and Vice President of Human Resources
and Administration for MFS Communications North America from 1989 to 1993. Prior
to MFS Communications, Ms. Koide was with Sprint for eight years where she
managed the company's human resources, real estate and facilities for the
Midwest.
Gregg A. Long, who became Allegiance's Senior Vice President of Regulatory and
Development in September 1997, spent 11 years at Destec Energy, Inc. as Project
Development Manager -- Partnership Vice President and Director. In that
position, he was responsible for the development of gas-fired power plants from
conceptual stages through project financing. Prior to joining Destec, Mr. Long
was Manager of Project Finance at Morrison-Knudsen, where he was responsible for
analyzing and arranging finance packages for various industrial, mining and
civil projects and also served as financial consultant and analyst.
Mark B. Tresnowski became Allegiance's Senior Vice President and General Counsel
in February 1999. Mr. Tresnowski practiced law at Kirkland & Ellis for 13 years
and was a partner of that firm from October 1992 to January 1999. In private
practice, Mr. Tresnowski specialized in private and public financings, mergers
and acquisitions and securities law.
Anthony J. Parella, who joined Allegiance as its Regional Vice President
-- Central Division in August 1997 and became its National Vice President of
Sales in August 1998, has more than 10 years of experience in the
telecommunications industry. Prior to joining Allegiance, Mr. Parella was Vice
President and General Manager for MFS Intelenet, Inc., an operating unit of MFS
Communications, from February 1994 to January 1997, where he was responsible for
the company's sales and operations in Texas. Mr. Parella also served as Director
of Commercial Sales for Sprint from 1991 to January 1994.
Paul D. Carbery, who was elected to Allegiance's Board of Directors in August
1997, is a general partner of Frontenac Company, a Chicago-based private equity
investing firm, where he specializes in investing in companies in the
telecommunications and technology industries. Mr. Carbery also presently serves
on the boards of directors of Whittman Hart, Inc., a publicly traded information
services company.
James E. Crawford, III, who was elected to Allegiance's Board of Directors in
August 1997, is a general partner of Frontenac Company, a Chicago-based private
equity investing firm, where he specializes in investing in companies in the
telecommunications and technology industries. Mr. Crawford also presently serves
on the boards of directors of Focal Communications Corporation, a privately held
CLEC that will compete with Allegiance, as well as of Optika Incorporated, a
publicly held imaging software document company, and Input Software
Incorporated, a publicly held document imaging software company.
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<PAGE> 67
John B. Ehrenkranz, who was elected to Allegiance's Board of Directors in March
1998, is a Principal of Morgan Stanley & Co. Incorporated where he has been
employed since 1987. Mr. Ehrenkranz also presently serves on the board of
directors of Choice One, a privately held CLEC that may compete with Allegiance.
Mr. Ehrenkranz is also a Principal of Morgan Stanley Capital Partners III, Inc.
Paul J. Finnegan, who was elected to Allegiance's Board of Directors in August
1997, is a vice president of Madison Dearborn Partners, Inc., a Chicago-based
private equity investing firm, where he specializes in investing in companies in
the telecommunications industry. Mr. Finnegan also presently serves on the
boards of directors of Focal Communications Corporation, a privately held CLEC
that will compete with Allegiance, and Omnipoint Corporation, a publicly traded
PCS provider.
Richard D. Frisbie, who was elected to Allegiance's Board of Directors in August
1997, is a Managing Partner of Battery Ventures, a Boston-based private equity
investing firm, where he specializes in investing in companies in the
telecommunications industry. Mr. Frisbie also presently serves on the board of
directors of Focal, a privately held CLEC that will compete with Allegiance.
Reed E. Hundt was elected to Allegiance's Board of Directors in March 1998. Mr.
Hundt served as chairman of the Federal Communications Commission from 1993 to
1997. He currently serves as chairman of The Forum on Communications and Society
at The Aspen Institute, is a senior advisor on information industries to
McKinsey & Company, a worldwide management consulting firm, and a special
advisor to Madison Dearborn Partners, Inc., a Chicago-based private equity
investing firm. Mr. Hundt is a venture partner at Benchmark Capital, a venture
capital firm and a principal of Charles Ross Partners, LLC, a consulting firm.
Mr. Hundt also presently serves on the boards of directors of Ascend
Communications, Inc., a manufacturer of wide area networking solutions, and
Novell, Inc., a network software and Internet solutions provider. Prior to
joining the FCC, Mr. Hundt was a partner at Latham & Watkins, an international
law firm.
Robert H. Niehaus, who was elected to Allegiance's Board of Directors in August
1997, is a Managing Director of Morgan Stanley & Co. Incorporated where he has
been employed since 1982. Mr. Niehaus also presently serves on the boards of
directors of numerous companies including PageMart Wireless, Inc., Silgan
Holdings Inc., Waterford Wedgewood, plc. and Choice One, a privately held CLEC
that may compete with Allegiance. Mr. Niehaus is also a Managing Director and a
Director of Morgan Stanley Capital Partners III, Inc.
James N. Perry, Jr., who was elected to Allegiance's Board of Directors in
August 1997, is a vice president of Madison Dearborn Partners, Inc., a
Chicago-based private equity investing firm, where he specializes in investing
in companies in the telecommunications industry. Mr. Perry also presently serves
on the boards of directors of Focal Communications Corporation, a privately held
CLEC that will compete with Allegiance, as well as Omnipoint Corporation, a
publicly traded PCS provider, and Clearnet Communications, a Canadian publicly
traded PCS and enhanced specialized mobile radio company.
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<PAGE> 68
ELECTION OF DIRECTORS; VOTING AGREEMENT
Allegiance's bylaws establish the size of Allegiance's Board of Directors at 13
Directors; there is presently one vacancy. Allegiance anticipates that one
additional director not otherwise affiliated with Allegiance or any of its
stockholders will be elected by the Board of Directors. Allegiance's charter and
by-laws provide that its Directors will be appointed and may be removed by
majority vote of Allegiance's stockholders, without cumulative voting.
At present all directors are elected annually and serve until the next annual
meeting of stockholders, or until the election and qualification of their
successors. The Board of Directors is divided into three classes, as nearly
equal in number as possible, with each Director serving a three year term and
one class being elected at each year's annual meeting of stockholders. Messrs.
Callahan, Finnegan, Carbery, and Ehrenkranz are in the class of directors whose
term expires at the 1999 annual meeting of Allegiance's stockholders. Messrs.
Lord, Yost, Crawford, Frisbie and the additional director anticipated to be
appointed by the Board of Directors are in the class of directors whose term
expires at the 2000 annual meeting of Allegiance's stockholders. Messrs.
Holland, Hundt, Perry, and Niehaus are in the class of directors whose term
expires at the 2001 annual meeting of Allegiance's stockholders. At each annual
meeting of Allegiance's stockholders, successors to the class of directors whose
term expires at such meeting will be elected to serve for three-year terms and
until their successors are elected and qualified.
Certain of Allegiance's stockholders have each agreed to vote all of their
shares in such a manner as to elect the following persons to serve as Directors:
Madison Dearborn Capital Partners, Morgan Stanley Capital Partners, and
Frontenac Company each have the right to designate two Directors; Battery
Ventures has the right to designate one Director; Allegiance's Chief Executive
Officer has the right to serve as a Director; the Management Investors have the
right to designate three Directors; and the final two directorships may be
filled by representatives designated by the Fund Investors and acceptable to the
Management Investors.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors currently has three committees: (a) an Executive
Committee, (b) an Audit Committee, and (c) a Compensation Committee.
The Executive Committee is authorized, subject to certain limitations, to
exercise all of the powers of the Board of Directors during periods between
Board meetings.
The Audit Committee is currently comprised of Messrs. Yost, Hundt, Carbery,
Ehrenkranz and Finnegan. The Audit Committee is responsible for making
recommendations to the Board of Directors regarding the selection of independent
auditors, reviewing the results and scope of the audit and other services
provided by Allegiance's independent accountants and reviewing and evaluating
Allegiance's audit and control functions.
The Compensation Committee is currently comprised of Messrs. Holland, Frisbie,
Crawford, Niehaus and Perry. The Compensation Committee is responsible for
reviewing, and as it deems appropriate, recommending to the Board of Directors,
policies, practices and procedures relating to the compensation of the officers
and other managerial employees of Allegiance and the establishment and
administration of employee benefit
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<PAGE> 69
plans. The Compensation Committee exercises all authority under any stock option
or stock purchase plans of Allegiance, unless the Board appoints any other
committee to exercise such authority, and advises and consults with the officers
of Allegiance as may be requested regarding managerial personnel policies.
COMPENSATION OF DIRECTORS
Allegiance will reimburse the members of its Board of Directors for their
reasonable out-of-pocket expenses incurred in connection with attending Board or
committee meetings. Additionally, Allegiance is obligated to maintain its
present level of directors' and officers' insurance. Members of Allegiance's
Board of Directors receive no other compensation for services provided as a
Director or as a member of any Board committee.
EXECUTIVE COMPENSATION
The following table sets forth compensation paid to the Chief Executive Officer
and the four other executive officers of Allegiance who, based on salary and
bonus compensation from Allegiance, were the most highly compensated officers of
Allegiance for the year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
-------------------------------------------
OTHER ANNUAL ALL OTHER
COMPENSATION COMPENSATION
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) ($)(A) ($)
- --------------------------- ---- --------- -------- ------------- ------------
<S> <C> <C> <C> <C> <C>
Royce J. Holland............ 1998 $207,690 $150,000 $ -- $ --
Chairman of the Board and
Chief Executive Officer
C. Daniel Yost.............. 1998 $165,380 $100,000 $ -- $ --
President and Chief
Operating Officer
Thomas M. Lord.............. 1998 $181,730 $150,000 $ -- $ --
Executive Vice President
of Corporate Development
and Chief Financial
Officer
John J. Callahan............ 1998 $181,730 $ 70,000 $ -- $ --
Senior Vice President of
Sales and Marketing
Stephen N. Holland.......... 1998 $129,810 $ 40,000 $ -- $ --
Senior Vice President and
Chief Information Officer
</TABLE>
- -------------------------
(a) Includes perquisites and other benefits paid to the named executive officer
in excess of 10% of the total annual salary and bonus received by the named
executive officer during the last fiscal year.
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<PAGE> 70
Prior to April 1998, the Board did not have a Compensation Committee and
decisions concerning the compensation of executive officers and other key
employees of Allegiance were determined by Allegiance's Board of Directors.
STOCK PLANS
1997 NONQUALIFIED STOCK OPTION PLAN
On November 13, 1997, Allegiance's Board of Directors adopted the 1997
Nonqualified Stock Option Plan (the "Option Plan"), under which Allegiance may
issue to Directors, consultants, and executive and other key employees of
Allegiance, stock options exercisable for shares of Allegiance's common stock.
Options to acquire an aggregate of 1,030,559 shares of common stock have been
granted under such Option Plan and Allegiance will not grant options for any
additional shares under the Option Plan. The Option Plan is administered by the
Compensation Committee. The Option Plan authorizes the Compensation Committee to
issue Options in such forms and amounts and on such terms as determined by the
Compensation Committee. The per-share exercise price for Options is set by the
Compensation Committee, but may not be less than the fair market value of a
share of Allegiance's common stock on the date of grant, as determined in good
faith by the Compensation Committee. The Compensation Committee has issued
Options under the Option Plan to employees other than the Management Investors
(as defined under "-- Executive Agreements Entered into by Other Management
Investors"), and has set the number of Options issued as an annual component of
such employee's compensation package. The terms of the options issued under the
Option Plan to date are summarized below.
Three years' amount of options will be issued on the first business day of the
quarter succeeding the date which a participant joins Allegiance. Such options
will vest over a three-year period, with 1/3 "cliff" vesting on the first
anniversary of the date of grant and 1/12 vesting on each of the first eight
quarter-ends thereafter. Subject to available options under the Option Plan, one
year's amount of options will be issued on each anniversary of the initial
grant, and such options will vest in the third year after grant, with 1/4
vesting on each of the 27-, 30-, 33-, and 36-month anniversaries of the date of
grant. Through this mechanism, a participant will at any given time have three
years' amount of options unvested. Vesting is accelerated 100% upon an
employee's death or permanent physical disability. If there is a sale of
Allegiance and the participant is terminated or constructively terminated within
the two-year period following the sale, vesting is accelerated 100% upon such
termination. Options expire if not exercised within six years after the date of
grant. If a participant is terminated for any reason, all unvested options
immediately expire and all vested options must be exercised within 90 days after
termination. Options are nontransferable during the life of the participant.
Shares of common stock issued upon exercise of options are subject to various
restrictions on transferability, holdback periods in the event of a public
offering of Allegiance's securities and provisions requiring the holder of such
shares to approve and, if requested by Allegiance, sell its shares in any sale
of Allegiance that is approved by the Board.
1998 STOCK INCENTIVE PLAN
Prior to the closing of the 12 7/8% notes offering, the Board and stockholders
of Allegiance approved Allegiance's 1998 Stock Incentive Plan (the "1998 Stock
Plan"). The 1998
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<PAGE> 71
Stock Plan is administered by the Compensation Committee. Certain employees,
directors, advisors and consultants of Allegiance will be eligible to
participate in the 1998 Stock Plan. The Compensation Committee is authorized
under the 1998 Stock Plan to select the participants and determine the terms and
conditions of the awards under the 1998 Stock Plan. The 1998 Stock Plan provides
for the issuance of the following types of incentive awards: stock options,
stock appreciation rights, restricted stock, performance grants and other types
of awards that the Compensation Committee deems consistent with the purposes of
the 1998 Stock Plan. An aggregate of 3,662,693 shares of common stock of
Allegiance have been reserved for issuance under the 1998 Stock Plan, subject to
certain adjustments reflecting changes in Allegiance's capitalization.
Options granted under the 1998 Stock Plan may be either incentive stock options
or such other forms of non-qualified stock options as the Compensation Committee
may determine. Incentive stock options are intended to qualify as "incentive
stock options" within the meaning of Section 422 of the Internal Revenue Code of
1986, as amended (the "Code"). The exercise price of (a) an incentive stock
option granted to an individual who owns shares possessing more than 10% of the
total combined voting power of all classes of stock of Allegiance (a "10%
Owner") will be at least 110% of the fair market value of a share of common
stock on the date of grant, and (b) an incentive stock option granted to an
individual other than a 10% Owner and a non-qualified stock option will be at
least 100% of the fair market value of a share of common stock on the date of
grant.
Options granted under the 1998 Stock Plan may be subject to time vesting and
certain other restrictions at the sole discretion of the Compensation Committee.
Subject to certain exceptions, the right to exercise an option generally will
terminate at the earlier of (a) the first date on which the initial grantee of
such option is not employed by Allegiance for any reason other than termination
without cause, death or permanent disability or (b) the expiration date of the
option. If the holder of an option dies or suffers a permanent disability while
still employed by Allegiance, the right to exercise all unexpired installments
of such option will be accelerated and will vest as of the latest of the date of
such death, the date of such permanent disability and the date of the discovery
of such permanent disability, and such option will be exercisable, subject to
certain exceptions, for 180 days after such date. If the holder of an option is
terminated without cause, to the extent the option has vested, such option will
be exercisable for 30 days after such date.
All outstanding awards under the 1998 Stock Plan will terminate immediately
prior to consummation of a liquidation or dissolution of Allegiance, unless
otherwise provided by the Board. In the event of the sale of all or
substantially all of the assets of Allegiance or the merger of Allegiance with
another corporation, all restrictions on any outstanding awards will terminate
and participants will be entitled to the full benefit of their awards
immediately prior to the closing date of such sale or merger, unless otherwise
provided by the Board.
The Board generally will have the power and authority to amend the 1998 Stock
Plan at any time without approval of Allegiance's stockholders, subject to
applicable federal securities and tax laws limitations and to the regulations of
the Nasdaq National Market.
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STOCK PURCHASE PLAN
Allegiance's Employee Stock Discount Purchase Plan (the "Stock Purchase Plan")
was approved by the Board and stockholders prior to the consummation of the
12 7/8% notes offering. The Stock Purchase Plan is intended to give employees
desiring to do so a convenient means of purchasing shares of common stock
through payroll deductions. The Stock Purchase Plan is intended to provide an
incentive to participate by permitting purchases at a discounted price.
Allegiance believes that ownership of stock by employees will foster greater
employee interest in the success, growth and development of Allegiance.
Subject to certain restrictions, each employee of Allegiance who is a U.S.
resident or a U.S. citizen temporarily on location at a facility outside of the
United States will be eligible to participate in the Stock Purchase Plan if he
or she has been employed by Allegiance for more than three months. Participation
will be discretionary with each eligible employee. Allegiance will reserve
2,305,718 shares of common stock for issuance in connection with the Stock
Purchase Plan. Elections to participate and purchases of stock will be made on a
quarterly basis. Each participating employee contributes to the Stock Purchase
Plan by choosing a payroll deduction in any specified amount, with a specified
minimum deduction per payroll period. A participating employee may increase or
decrease the amount of such employee's payroll deduction, including a change to
a zero deduction as of the beginning of any calendar quarter. Elected
contributions will be credited to participants' accounts at the end of each
calendar quarter.
Each participating employee's contributions will be used to purchase shares for
the employee's share account as promptly as practicable after each calendar
quarter. The cost per share will be 85% of the lower of the closing price of
Allegiance's common stock on the Nasdaq National Market on the first or the last
day of the calendar quarter. The number of shares purchased on each employee's
behalf and deposited in his/her share account will be based on the amount
accumulated in such participant's cash account and the purchase price for shares
with respect to any calendar quarter. Shares purchased under the Stock Purchase
Plan carry full rights to receive dividends declared from time to time. Under
the Stock Purchase Plan, any dividends attributable to shares in the employee's
share account will be automatically used to purchase additional shares for such
employee's share account. Share distributions and share splits will be credited
to the participating employee's share account as of the record date and
effective date, respectively. A participating employee will have full ownership
of all shares in such employee's share account and may withdraw them for sale or
otherwise by written request to the Compensation Committee following the close
of each calendar quarter. Subject to applicable federal securities and tax laws,
the Board will have the right to amend or to terminate the Stock Purchase Plan.
Amendments to the Stock Purchase Plan will not affect a participating employee's
right to the benefit of the contributions made by such employee prior to the
date of any such amendment. In the event the Stock Purchase Plan is terminated,
the Compensation Committee will be required to distribute all shares held in
each participating employee's share account plus an amount of cash equal to the
balance in each participating employee's cash account.
401(k) PLAN
Allegiance has adopted a tax-qualified employee savings and retirement plan
covering all of Allegiance's full-time employees. Under the 401(k) Plan,
employees may elect to reduce
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their current compensation up to the statutorily prescribed annual limit and
have the amount of such reduction contributed to the 401(k) Plan. The 401(k)
Plan is intended to qualify under Section 401 of the Code so that contributions
by employees to the 401(k) Plan, and income earned on plan contributions, are
not taxable to employees until withdrawn from the 401(k) Plan. The trustees
under the 401(k) Plan, at the direction of each participant, invest such
participant's assets in the 401(k) Plan in selected investment options.
EXECUTIVE AGREEMENTS
ROYCE J. HOLLAND EXECUTIVE AGREEMENT
In August 1997, Allegiance, Allegiance LLC, and Mr. Holland entered into an
Executive Purchase Agreement (the "Holland Executive Agreement"), including,
among others, the following terms:
Vesting. The Allegiance LLC securities purchased by Mr. Holland, as well as any
Allegiance securities distributed with respect to such Allegiance LLC securities
(collectively, the "Holland Executive Securities") are subject to vesting over a
four-year period, with 20.0% vesting on the date of grant and 20.0% vesting on
each of the first four anniversaries thereof. Vesting was accelerated by one
year upon the consummation of the initial public offering of common stock, and
will be accelerated 100.0% in the event of Mr. Holland's death or disability,
and 100.0% upon a sale of Allegiance where at least 50.0% of the consideration
for such sale is cash or marketable securities.
Repurchase of Securities. If Mr. Holland's employment is terminated for any
reason other than a termination by Allegiance without cause, Allegiance LLC and
Allegiance will have the right to repurchase all vested Holland Executive
Securities at fair market value, and all unvested Holland Executive Securities
at the lesser of fair market value and original cost.
Restrictions on Transfer; Holdback and "Drag Along" Agreements. The Holland
Executive Securities are subject to various restrictions on transferability,
holdback periods in the event of a public offering of Allegiance's securities
and provisions requiring the holder of such shares to approve and, if requested
by Allegiance, sell its shares in any sale of Allegiance that is approved by the
Board.
Terms of Employment. Mr. Holland is an "at will" employee of Allegiance and,
thus, may be terminated by Allegiance at any time and for any reason. Mr.
Holland is not entitled to receive any severance payments upon any such
termination, other than payments in consideration of the noncompetition and
nonsolicitation agreements discussed below.
Noncompetition and Nonsolicitation Agreements. During the Noncompete Period (as
defined below), Mr. Holland may not hire or attempt to induce any employee of
Allegiance to leave Allegiance's employ, nor attempt to induce any customer or
other business relation of Allegiance to cease doing business with Allegiance,
nor in any other way interfere with Allegiance's relationships with its
employees, customers, and other business relations. Also, during the Noncompete
Period, Mr. Holland may not participate in any business engaged in the provision
of telecommunications services in any Covered Market.
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As used in the Holland Executive Agreement, the "Noncompete Period" means the
period of employment and the following additional period: (a) if Mr. Holland is
terminated prior to August 13, 2000, the period ending on the later of August
13, 2001 and the second anniversary of termination; (b) if Mr. Holland is
terminated at any time on or after August 13, 2000 but prior to August 13, 2001,
the period ending on August 13, 2002; and (c) if Mr. Holland is terminated at
any time on or after August 13, 2001, the one-year period following termination.
However, the "Noncompete Period" ends if at any time Allegiance ceases to pay
Mr. Holland his base salary and benefits in existence at the time of
termination. As used in the Holland Executive Agreement, "Covered Market" means:
(a) any market in which Allegiance is conducting business or preparing under a
business plan approved by the Board of Directors to conduct business; (b)
Dallas, New York City, Atlanta, Chicago, Los Angeles and 15 additional markets;
and (c) any market for which Allegiance has prepared a business plan unless such
business plan has been rejected by the Board of Directors.
C. DANIEL YOST EXECUTIVE AGREEMENT
In February 1998, Allegiance, Allegiance LLC, and Mr. Yost entered into an
Executive Purchase Agreement, containing the same terms as the Holland Executive
Agreement described above.
THOMAS M. LORD EXECUTIVE AGREEMENT
In August 1997, Allegiance, Allegiance LLC, and Mr. Lord entered into an
Executive Purchase Agreement, containing the same terms as the Holland Executive
Agreement described above.
EXECUTIVE AGREEMENTS ENTERED INTO BY OTHER MANAGEMENT INVESTORS
Each of the original management investors (the "Management Investors") has
entered into an Executive Purchase Agreement, including, among others, the
following terms:
Vesting. The Allegiance LLC securities purchased by a Management Investor, as
well as any securities distributed with respect to such Allegiance LLC
securities (collectively, the "Executive Securities") are subject to vesting
over a four-year period, with 25.0% vesting on each of the first four
anniversaries of the grant date. Vesting was accelerated by one year upon the
consummation of the initial public offering of common stock, and will be
accelerated 100.0% in the event of such Management Investor's death or
disability, and 100.0% upon a sale of Allegiance where at least 50.0% of the
consideration for such sale is cash or marketable securities.
Repurchase of Securities. If a Management Investor's employment is terminated
for any reason, Allegiance LLC and Allegiance will have the right to repurchase
all such Management Investor's vested Executive Securities at fair market value,
and all unvested Executive Securities at the lesser of fair market value and
original cost.
Restrictions on Transfer; Holdback and "Drag Along" Agreements. The Executive
Securities are subject to various restrictions on transferability, holdback
periods in the event of a public offering of Allegiance's securities and
provisions requiring the holder of
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such shares to approve and, if requested by Allegiance, sell its shares in any
sale of Allegiance that is approved by the Board.
Terms of Employment. Each Management Investor is an "at will" employee of
Allegiance and, thus, may be terminated by Allegiance at any time and for any
reason. No Management Investor is entitled to receive any severance payments
upon any such termination.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to April 1998, Allegiance did not have a Compensation Committee and the
compensation of executive officers and other key employees of Allegiance was
determined by its Board of Directors. Royce J. Holland, Allegiance's Chairman
and Chief Executive Officer, Thomas M. Lord, Allegiance's Executive Vice
President of Corporate Development and Chief Financial Officer, C. Daniel Yost,
Allegiance's President and Chief Operating Officer, and John J. Callahan,
Allegiance's Senior Vice President of Sales and Marketing, are all currently
members of Allegiance's Board of Directors. The Board of Directors has
established a Compensation Committee, which is responsible for decisions
regarding salaries, incentive compensation, stock option grants and other
matters regarding executive officers and key employees of Allegiance. See
"-- Committees of the Board of Directors."
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
LIMITED LIABILITY COMPANY AGREEMENT
On August 13, 1997, the original fund investors (the "Fund Investors") and the
Management Investors entered into a limited liability company agreement (the
"LLC Agreement") in order to govern the affairs of Allegiance LLC, which
immediately prior to the 12 7/8% notes offering, held the one outstanding share
of Allegiance's common stock and substantially all of the outstanding shares of
Allegiance's preferred stock.
Upon consummation of Allegiance's initial public offering of common stock,
Allegiance LLC dissolved and its assets, which consisted almost entirely of
Allegiance stock, were distributed to the Fund Investors and the Management
Investors in accordance with the LLC Agreement. Under the terms of the LLC
Agreement, the equity allocation between the Fund Investors and the Management
Investors would range between 95.0%/5.0% and 66.7%/33.3% based upon the
valuation of Allegiance's common stock implied by the initial public offering of
common stock. Based upon the valuation of Allegiance's common stock implied by
the initial public offering of common stock, the equity allocation was 66.7% to
the Fund Investors and 33.3% to the Management Investors. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations."
SECURITYHOLDERS AGREEMENT
The Fund Investors, the Management Investors, Allegiance, and Allegiance LLC are
parties to the Securityholders Agreement dated as of August 13, 1997. Under the
terms of the Securityholders Agreement, in the event of an approved sale of
Allegiance, each of the
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Fund Investors and their transferees agrees to approve and, if requested, to
sell its shares in such sale of Allegiance. The Securityholders Agreement, apart
from certain provisions thereof, terminated upon the consummation of the initial
public offering of common stock.
REGISTRATION AGREEMENT
The Fund Investors, the Management Investors, and Allegiance are parties to the
Registration Agreement dated as of August 13, 1997. See "Description of Capital
Stock -- Registration Rights."
VOTING AGREEMENT
Certain of Allegiance's stockholders have each agreed to vote all of their
shares in such a manner as to elect the following persons to serve as Directors:
Madison Dearborn Capital Partners, Morgan Stanley Capital Partners, and
Frontenac Company each have the right to designate two Directors; Battery
Ventures has the right to designate one Director; Allegiance's Chief Executive
Officer has the right to serve as a Director; the Management Investors have the
right to designate three Directors; and the final two directorships may be
filled by representatives designated by the Fund Investors and acceptable to the
Management Investors.
OTHER
Morgan Stanley & Co. Incorporated, an affiliate of Morgan Stanley Capital
Partners, one of the Fund Investors, acted as a placement agent in connection
with Allegiance's offering of the 11 3/4% notes and redeemable warrants and
received fees of approximately $4.4 million. In addition, Morgan Stanley & Co.
Incorporated was one of the Underwriters in Allegiance's initial public offering
of common stock and 12 7/8% notes offering and received fees of approximately
$6.9 million in connection with each of such offerings.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the outstanding common stock of Allegiance as of December 31, 1998
by: (a) each of the directors and the executive officers of Allegiance; (b) all
directors and executive officers as a group, and (c) each owner of more than 5%
of the equity securities of Allegiance. Unless otherwise noted, the address for
each director and executive officer of Allegiance is c/o Allegiance Telecom,
Inc., 1950 Stemmons Freeway, Suite 3026, Dallas, Texas 75207.
<TABLE>
<CAPTION>
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER PERCENT
- ------------------------------------ ---------- -------
<S> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS:
Royce J. Holland(1)....................................... 3,904,685 7.8%
C. Daniel Yost............................................ 1,619,940 3.2
Thomas M. Lord(2)......................................... 1,822,432 3.6
John J. Callahan.......................................... 607,477 1.2
Stephen N. Holland........................................ 430,296 *
Paul D. Carbery(3)........................................ 4,262,999 8.5
James E. Crawford, III(3)(4).............................. 4,274,499 8.5
John B. Ehrenkranz........................................ -- --
Paul J. Finnegan(5)....................................... -- --
Richard D. Frisbie(6)..................................... 2,131,499 4.2
Reed E. Hundt(7).......................................... 101,246 *
Robert H. Niehaus(8)...................................... -- --
James N. Perry, Jr.(5).................................... -- --
All directors and executive officers as a group (12
persons)................................................ 14,892,074 29.6
5% OWNERS:
Madison Dearborn Capital Partners(9)...................... 10,302,247 20.5
Morgan Stanley Capital Partners(10)....................... 10,302,247 20.5
Frontenac Company(11)..................................... 4,262,999 8.5
</TABLE>
- -------------------------
* Denotes less than one percent.
(1) Includes 1,940,552 shares of common stock owned by the Royce J. Holland
Family Limited Partnership, of which Royce J. Holland is the sole general
partner, 1,000 shares of common stock owned by Mr. Holland's wife, 2,600
shares of common stock held by Mr. Holland as custodian for his children,
as to which 2,600 shares Mr. Holland disclaims beneficial ownership
thereof. 3,881,105 of the shares of common stock owned by Mr. Holland and
the Royce J. Holland Family Limited Partnership are subject to vesting,
with 20% of such shares of common stock vested on August 13, 1997, 20%
vested upon the consummation of the initial public offering of common stock
and an additional 20% vesting on each of August 13, 1998, 1999 and 2000.
See "Management -- Executive Agreements."
(2) Includes 911,216 shares of common stock owned by Mr. Lord's wife and
children, as to which Mr. Lord disclaims beneficial ownership. All of the
shares of common stock owned by Mr. Lord and his family are subject to
vesting with 20% of such shares of
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common stock vested on August 13, 1997, 20% vested upon the consummation of
the initial public offering of common stock and an additional 20% vesting
on each of August 13, 1998, 1999 and 2000. See "Management -- Executive
Agreements."
(3) 4,262,999 shares of common stock shown are owned by Frontenac VII Limited
Partnership and Frontenac Masters VII Limited Partnership. Messrs. Carbery
and Crawford are members of Frontenac Company, VII, L.L.C., the general
partner of Frontenac VII Limited Partnership and Frontenac Masters VII
Limited Partnership and their address is c/o Frontenac Company, 135 S.
LaSalle Street, Suite 3800, Chicago, IL 60603. They disclaim beneficial
ownership of these shares of common stock.
(4) Includes 500 shares of Common Stock owned by Mr. Crawford's spouse, 100
shares of Common Stock owned by Mr. Crawford's son, and 600 shares held by
Mr. Crawford as custodian for his son, as to which 600 shares Mr. Crawford
disclaims beneficial ownership thereof.
(5) Messrs. Finnegan and Perry are managing directors of Madison Dearborn
Partners, Inc., the general partner of the general partner of Madison
Dearborn Capital Partners II, L.P. and their address is c/o Madison
Dearborn Partners, Inc., Three First National Plaza, Suite 3800, Chicago,
IL 60602.
(6) All shares of Common Stock shown are owned by Battery Ventures IV, L.P. and
Battery Investment Partners IV, LLC. Mr. Frisbie is a managing partner of
Battery Ventures, the general partner of these funds and his address is c/o
Battery Ventures, 20 William Street, Wellesley, MA 02181. He disclaims
beneficial ownership of these shares of common stock.
(7) Mr. Hundt owns options to acquire 50,623 shares of common stock and Charles
Ross Partners, LLC, a Delaware limited liability company, of which Mr.
Hundt is a member, owns 50,623 shares of common stock.
(8) Mr. Niehaus is a managing director and director of Morgan Stanley Capital
Partners III, Inc., the general partner of the general partner of the funds
described in footnote (10) below and their address is c/o Morgan Stanley
Capital Partners, 1221 Avenue of the Americas, New York, NY 10020.
(9) These shares of common stock are owned by Madison Dearborn Capital Partners
II, L.P.
(10) These shares of common stock are owned by Morgan Stanley Capital Partners
III, L.P., MSCP III 892 Investors, L.P. and Morgan Stanley Capital
Investors, L.P.
(11) These shares of common stock are owned by Frontenac VII Limited Partnership
and Frontenac Masters VII Limited Partnership.
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DESCRIPTION OF CERTAIN INDEBTEDNESS
The 11 3/4% notes were issued under an indenture, dated as of February 3, 1998,
between The Bank of New York, the trustee, and us. This indenture is governed by
the Trust Indenture Act of 1939, as amended. The following description of the
Allegiance 11 3/4% notes is a summary. If you would like to read the indenture
setting forth the terms of the Allegiance 11 3/4% notes, we have filed a copy
with the SEC.
11 3/4% NOTES
We issued $445.0 million aggregate principal amount at maturity of 11 3/4%
Senior Discount Notes. They will mature on February 15, 2008. The 11 3/4% notes
were issued in units, with each unit consisting of one 11 3/4% note and one
redeemable warrant.
No interest is payable on the 11 3/4% notes prior to August 15, 2003. From and
after February 15, 2003, interest on the 11 3/4% notes will accrue at the rate
of 11 3/4% per annum. Interest on the 11 3/4% notes is payable semiannually on
February 15 and August 15 of each year, commencing August 15, 2003. Payment of
interest will be made to holders of record at the close of business on the
February 1 or August 1 immediately preceding the interest payment date.
The 11 3/4% notes are not secured by any of our assets and rank equally in right
of payment with all of our unsubordinated and unsecured indebtedness, including
the 12 7/8% notes. The 11 3/4% notes are senior in right of payment to all of
our future subordinated indebtedness.
We may redeem the 11 3/4% notes at our option, in whole or in part, at any time
on or after February 15, 2003. The initial redemption price is 105.8750% of
their principal amount at maturity, plus accrued interest. The redemption price
will decline each year and will be 100% of their principal amount at maturity,
plus accrued interest, beginning on February 15, 2006. In addition, at any time
on or before February 15, 2001, we may redeem up to 35% of the aggregate
principal amount at maturity of the 11 3/4% notes with the proceeds of certain
public equity offerings at a redemption price equal to 111.75%, expressed as a
percentage of the accreted value of the 11 3/4% notes on the redemption date. We
may make this redemption only so long as at least $289.25 million aggregate
principal amount at maturity of the 11 3/4% notes remains outstanding
immediately after such redemption.
The 11 3/4% notes indenture contains certain restrictive covenants, including
among others, limitations on the ability of Allegiance and its restricted
subsidiaries to incur indebtedness, pay dividends, prepay subordinated
indebtedness, repurchase capital stock, make investments, engage in transactions
with affiliates, create liens, sell assets and engage in mergers and
consolidations and certain other events which could cause an event of default.
These covenants are substantially the same as those relating to the 12 7/8%
notes. See "Description of the Notes."
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DESCRIPTION OF THE NOTES
The 12 7/8% notes were issued under an indenture, dated as of July 7, 1998,
between The Bank of New York, the trustee, and us. This indenture is governed by
the Trust Indenture Act of 1939, as amended.
The following description of the terms of the indenture is a summary. It does
not restate the indenture and excludes certain of the definitions and complex
legal terminology contained in the indenture. While we believe this summary
contains the information about the indenture which is important to your decision
to purchase the 12 7/8% notes it does not include all of the provisions of the
indenture that you may feel are important. The indenture, and not this summary,
defines your rights as a note holder. If you would like to read the indenture,
we have filed a copy as an exhibit to the registration statement.
GENERAL
We issued $205.0 million aggregate principal amount of notes. They will mature
on May 15, 2008. Each note bears interest at 12 7/8% per annum. This interest is
paid semiannually to holders of record at the close of business on the May 1 or
November 1 immediately preceding the interest payment date on May 15 and
November 15 of each year. Interest is computed on the basis of a 360-day year of
twelve 30-day months.
The notes are issued only in fully registered form, without coupons, in
denominations of $1,000 of principal amount and any integral multiple thereof.
The notes were initially represented by one or more global notes and deposited
with, or on behalf of, The Depository Trust Company (the "Depositary"), and
registered in the name of a nominee of the Depositary. Except as set forth under
"Book-Entry; Delivery and Form," owners of beneficial interests in these global
notes will not be entitled to have notes registered in their names, will not
receive or be entitled to receive physical delivery of notes in definitive form
and will not be considered the owners or holders of notes under the indenture.
See "Book-Entry; Delivery and Form." No service charge will be made for any
registration of transfer or exchange of notes, but we may require that you pay a
sum sufficient to cover any transfer tax or other similar governmental charge
that must be paid in connection with any such registration.
Subject to the covenants described below under "Covenants" and applicable law,
we may issue additional notes under the indenture. The notes offered by this
prospectus and any additional notes that we subsequently issue would be treated
as a single class for all purposes under the indenture.
OPTIONAL REDEMPTION
We can redeem the notes at our option, in whole or in part, at any time or from
time to time, on or after May 15, 2003 and prior to maturity. To redeem the
notes, we must give you not less than 30 nor more than 60 days' prior notice
which we must mail to you by first class mail to your last address as it appears
in the Security Register, at the redemption prices, expressed in percentages of
principal amount, set forth below, plus accrued and unpaid interest to the
redemption date, subject to the right of holders of record on the relevant
regular record date that is on or prior to the redemption date to
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receive interest due on an interest payment date, if redeemed during the
12-month period commencing May 15 of the years set forth below:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
- ---- ----------------
<S> <C>
2003.......................................... 106.438%
2004.......................................... 104.292
2005.......................................... 102.146
2006 and thereafter........................... 100.000%
</TABLE>
In addition, prior to May 15, 2001, we may on one or more occasions redeem up to
35% of the principal amount of the notes originally issued with the proceeds of
one or more public equity offerings at a redemption price of 112.875% of the
principal amount of the notes plus accrued and unpaid interest to the redemption
date. However, at least 65% of the aggregate principal amount of notes
originally issued must remain outstanding after each such redemption. Notice of
any such redemption must be mailed within 60 days after such public equity
offering.
SELECTION AND NOTICE OF REDEMPTION
In the case of any partial redemption, the trustee will select the notes for
redemption in compliance with the requirements of the principal national
securities exchange, if any, on which the notes are listed or, if the notes are
not listed on a national securities exchange, by lot or by such other method as
the trustee in its sole discretion will deem to be fair and appropriate. No note
of $1,000 in principal amount or less will be redeemed in part. If any note is
to be redeemed in part only, the notice of redemption relating to such note will
state the portion of the principal amount thereof to be redeemed. A new note in
principal amount equal to the unredeemed portion of a note will be issued in the
name of the holder of the note upon cancellation of the original note.
SINKING FUND
There will be no sinking fund payments for the notes.
SECURITY
In connection with the sale of the notes, we purchased approximately $69.0
million of U.S. Treasury securities and placed them in a pledge account to be
used for payment in full of the first six scheduled interest payments due on the
notes.
We pledged these securities to the trustee for the benefit of the holders of the
notes under the Pledge Agreement. The trustee will hold these securities in the
pledge account. Under the pledge agreement, immediately prior to an interest
payment date, we may either deposit cash with the trustee sufficient to pay the
interest scheduled to be paid on such date or we may direct the trustee to
release from the pledge account proceeds sufficient to pay interest then due on
the notes. If we exercise the former option, we may direct the trustee to
release a like amount of proceeds from the pledge account. A failure to pay
interest on the notes in a timely manner through the first six scheduled
interest payment dates will constitute an immediate event of default under the
indenture, with no grace or
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cure period. The pledged securities and pledge account will also secure the
repayment of the principal amount and premium on the notes.
Once we make the first six scheduled interest payments on the notes, all of the
remaining pledged securities, if any, will be released from the pledge account
and the notes will then be unsecured.
RANKING
The indebtedness evidenced by the notes are unsubordinated obligations of
Allegiance and have the same right of payment as all other existing and future
unsubordinated indebtedness of Allegiance, including our 11 3/4% Senior Discount
Notes due 2008. The notes are senior in right of payment to all subordinated
indebtedness of Allegiance. At December 31, 1998, Allegiance had approximately
$471.7 million of indebtedness outstanding. All of this debt is unsubordinated
and unsecured. In addition, all existing and future liabilities, including trade
payables, of our subsidiaries will effectively rank senior in right of payment
to the notes.
CERTAIN DEFINITIONS
The following are material terms defined in the indenture. You should review the
indenture to see full disclosure of all terms that are defined in the indenture.
"Acquired Indebtedness" means Indebtedness of a person existing at the time such
person becomes a Restricted Subsidiary or assumed in connection with an Asset
Acquisition by a Restricted Subsidiary and not incurred in connection with, or
in anticipation of, such person becoming a Restricted Subsidiary or such Asset
Acquisition.
"Adjusted Consolidated Net Income" means, for any period, the aggregate net
income or loss of Allegiance Telecom, Inc. and its Restricted Subsidiaries for
such period determined in conformity with GAAP. However, the following items are
excluded in computing Adjusted Consolidated Net Income:
(1) the net income (or loss) of any person that is not a Restricted
Subsidiary, except:
(a) with respect to net income, to the extent of the amount of dividends
or other distributions actually paid to Allegiance Telecom, Inc. or
any of its Restricted Subsidiaries by such person during such
period, and
(b) with respect to net losses, to the extent of the amount of
Investments made by Allegiance Telecom, Inc. or any Restricted
Subsidiary in such person during such period;
(2) solely for the purposes of calculating the amount of Restricted
Payments that may be made under clause (3) of the second paragraph of
the "Limitation on Restricted Payments" covenant described below, and
in such case, except to the extent includable under clause (1) above,
the net income or loss of any person accrued prior to the date it
becomes a Restricted Subsidiary or is merged into or consolidated with
Allegiance Telecom, Inc. or any of its Restricted Subsidiaries or all
or substantially all of the property and assets of such person are
acquired by Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries;
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(3) the net income of any Restricted Subsidiary to the extent that the
declaration or payment of dividends or similar distributions by such
Restricted Subsidiary of such net income is not at the time permitted
by the operation of the terms of its charter or any agreement,
instrument, judgment, decree, order, statute, rule or governmental
regulation applicable to such Restricted Subsidiary;
(4) any gains or losses, on an after-tax basis, attributable to Asset
Sales;
(5) except for purposes of calculating the amount of Restricted Payments
that may be made under clause (3) of the second paragraph of the
"Limitation on Restricted Payments" covenant described below, any
amount paid or accrued as dividends on preferred stock of Allegiance
Telecom, Inc. or any Restricted Subsidiary owned by persons other than
Allegiance Telecom, Inc. and any of its Restricted Subsidiaries;
(6) all extraordinary gains and extraordinary losses; and
(7) any compensation expense paid or payable solely with Capital Stock,
other than Disqualified Stock, of Allegiance Telecom, Inc. or any
options, warrants or other rights to acquire Capital Stock, other than
Disqualified Stock, of Allegiance Telecom, Inc.
"Adjusted Consolidated Net Tangible Assets" means the total amount of assets of
Allegiance Telecom, Inc. and its Restricted Subsidiaries, less applicable
depreciation, amortization and other valuation reserves, except to the extent
resulting from write-ups of capital assets other than write-ups in connection
with accounting for acquisitions in conformity with GAAP, after deducting from
such assets:
(1) all current liabilities of Allegiance Telecom, Inc. and its Restricted
Subsidiaries, excluding intercompany items, and
(2) all goodwill, trade names, trademarks, patents, unamortized debt
discount and expense and other like intangibles, all as set forth on
the most recent quarterly or annual consolidated balance sheet of
Allegiance Telecom, Inc. and its Restricted Subsidiaries, prepared in
conformity with GAAP and filed with the Commission or provided to the
trustee under the "Commission Reports and Reports to Holders" covenant.
"Affiliate" means, as applied to any person, any other person directly or
indirectly controlling, controlled by, or under direct or indirect common
control with, such person. For purposes of this definition, "control" and the
correlative meanings of the terms "controlling," "controlled by" and "under
common control with", as applied to any person, means the possession, directly
or indirectly, of the power to direct or cause the direction of the management
and policies of such person, whether through the ownership of voting securities,
by contract or otherwise.
"Asset Acquisition" means:
(1) an investment by Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries in any other person after which such person becomes a
Restricted Subsidiary or is merged into or consolidated with Allegiance
Telecom, Inc. or any of its Restricted Subsidiaries, but only if such
person's primary business is related,
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ancillary or complementary to the businesses of Allegiance Telecom,
Inc. and its Restricted Subsidiaries on the date of such investment; or
(2) an acquisition by Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries of the property and assets of any person other than
Allegiance Telecom, Inc. or any of its Restricted Subsidiaries that
constitute substantially all of a division or line of business of such
person, but only if the property and assets acquired are related,
ancillary or complementary to the businesses of Allegiance Telecom,
Inc. and its Restricted Subsidiaries on the date of such acquisition.
"Asset Disposition" means the sale or other disposition by Allegiance Telecom,
Inc. or any of its Restricted Subsidiaries, other than to Allegiance Telecom,
Inc. or another Restricted Subsidiary, of all or substantially all of the
Capital Stock of any Restricted Subsidiary or all or substantially all of the
assets that constitute a division or line of business of Allegiance Telecom,
Inc. or any of its Restricted Subsidiaries.
"Asset Sale" means any sale, transfer or other disposition, including by way of
merger, consolidation or sale-leaseback transaction in one transaction or a
series of related transactions by the Allegiance Telecom, Inc. or any of its
Restricted Subsidiaries to any person other than to Allegiance Telecom, Inc. or
any of its Restricted Subsidiaries of:
(1) all or any of the Capital Stock of any Restricted Subsidiary;
(2) all or substantially all of the property and assets of an operating
unit or business of Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries; or
(3) any other property and assets, other than the Capital Stock or other
Investment in an Unrestricted Subsidiary, of Allegiance Telecom, Inc.
or any of its Restricted Subsidiaries outside the ordinary course of
business that is not governed by the provisions of the indenture
applicable to mergers, consolidations and sales of all or substantially
all of the assets of Allegiance Telecom, Inc.
For purposes of this definition, the term "Asset Sale" does not include:
(1) sales or other dispositions of inventory, receivables and other current
assets;
(2) sales, transfers or other dispositions of assets constituting a
Restricted Payment permitted to be made under the "Limitation on
Restricted Payments" covenant;
(3) sales, transfers or other dispositions of assets with a fair market not
in excess of $1 million in any transaction or series of related
transactions; or
(4) sales or other dispositions of assets for consideration at least equal
to the fair market value of the assets sold or disposed of, to the
extent that the consideration received would constitute property or
assets of the kind described in clause (1)(b) of the second paragraph
of the "Limitation on Asset Sales" covenant.
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"Average Life" means, at any date of determination with respect to any debt
security, the quotient obtained by dividing:
(1) the sum of the products of the number of years from such date of
determination to the dates of each successive scheduled principal
payment of such debt security and the amount of such principal payment
by
(2) the sum of all such principal payments.
"Capital Stock" means, with respect to any person, any and all shares,
interests, participations or other equivalents, however designated, whether
voting or non-voting, in equity of such person, whether outstanding on the
Closing Date or issued after the Closing Date, including all Common Stock and
Preferred Stock.
"Capitalized Lease" means, as applied to any person, any lease of any property,
whether real, personal or mixed, of which the discounted present value of the
rental obligations of such person as lessee, in conformity with GAAP, is
required to be capitalized on the balance sheet of such person.
"Capitalized Lease Obligations" means the discounted present value of the rental
obligations under a Capitalized Lease.
"Change of Control" means such time as:
(1) a "person" or "group" within the meaning of Sections 13(d) and 14(d)(2)
of the Exchange Act becomes the ultimate beneficial owner of more than
35% of the total voting power of the Voting Stock of Allegiance
Telecom, Inc. on a fully diluted basis and such ownership represents a
greater percentage of the total voting power of the Voting Stock of
Allegiance Telecom, Inc., on a fully diluted basis, than is held by the
Existing Stockholders on such date; or
(2) individuals who on the Closing Date constitute the Board of Directors
cease for any reason to constitute a majority of the members of the
Board of Directors then in office. For purposes of this definition, a
director will be treated as being on the Board of Directors on the
Closing Date if such directors election by the Board of Directors or
whose nomination by the Board of Directors for election by stockholders
of Allegiance Telecom, Inc. was approved by a vote of at least two-
thirds of the members of the Board of Directors then in office who
either were members of the Board of Directors on the Closing Date or
whose election or nomination for election was previously so approved.
"Closing Date" means July 7, 1998.
"Consolidated EBITDA" means, for any period, Adjusted Consolidated Net Income
for such period plus, to the extent such amount was deducted in calculating such
Adjusted Consolidated Net Income,
(1) Consolidated Interest Expense,
(2) income taxes, other than income taxes, either positive or negative,
attributable to extraordinary and non-recurring gains or losses or
sales of assets,
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(3) depreciation expense,
(4) amortization expense, and
(5) all other non-cash items reducing Adjusted Consolidated Net Income
other than items that will require cash payments and for which an
accrual or reserve is, or is required by GAAP to be, made,
less all non-cash items increasing Adjusted Consolidated Net Income, all as
determined on a consolidated basis for Allegiance Telecom, Inc. and its
Restricted Subsidiaries in conformity with GAAP. However, if any Restricted
Subsidiary is not a wholly owned Restricted Subsidiary, Consolidated EBITDA will
be reduced, to the extent not otherwise reduced in accordance with GAAP, by an
amount equal to:
(1) the amount of the Adjusted Consolidated Net Income attributable to such
Restricted Subsidiary multiplied by
(2) the percentage ownership interest in the income of such Restricted
Subsidiary not owned on the last day of such period by Allegiance
Telecom, Inc. or any of its Restricted Subsidiaries.
"Consolidated Interest Expense" means, for any period, the aggregate amount of
interest in respect of Indebtedness and all but the principal component of
rentals in respect of Capitalized Lease Obligations paid, accrued or scheduled
to be paid or to be accrued by Allegiance Telecom, Inc. and its Restricted
Subsidiaries during such period. This amount includes:
(1) amortization of original issue discount on any Indebtedness and the
interest portion of any deferred payment obligation, calculated in
accordance with the effective interest method of accounting;
(2) all commissions, discounts and other fees and charges owed with respect
to letters of credit and bankers' acceptance financing;
(3) the net costs associated with Interest Rate Agreements; and
(4) interest in respect of Indebtedness that is Guaranteed or secured by
Allegiance Telecom, Inc. or any of its Restricted Subsidiaries.
But this amount excludes:
(1) any amount of such interest of any Restricted Subsidiary if the net
income of such Restricted Subsidiary is excluded in the calculation of
Adjusted Consolidated Net Income under clause (3) of the definition
thereof, but only in the same proportion as the net income of such
Restricted Subsidiary is excluded from the calculation of Adjusted
Consolidated Net Income under clause (3) of the definition thereof; and
(2) any premiums, fees and expenses, and any amortization thereof, payable
in connection with the Allegiance initial public offering of common
stock and the notes offering, all as determined on a consolidated
basis, without taking into account Unrestricted Subsidiaries, in
conformity with GAAP.
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"Consolidated Leverage Ratio" means, on any Transaction Date, the ratio of the
aggregate amount of Indebtedness of Allegiance Telecom, Inc. and its Restricted
Subsidiaries on a consolidated basis outstanding on such Transaction Date to the
aggregate amount of Consolidated EBITDA for the then most recent four fiscal
quarters for which financial statements of Allegiance Telecom, Inc. have been
filed with the Commission or provided to the trustee under the "Commission
Reports and Reports to Holders" covenant described below. Such four fiscal
quarter period is referred to as the "Four Quarter Period". However, in making
the foregoing calculation,
(1) pro forma effect will be given to any Indebtedness to be incurred or
repaid on the Transaction Date;
(2) pro forma effect will be given to Asset Dispositions and Asset
Acquisitions, including giving pro forma effect to the application of
proceeds of any Asset Disposition, that occur from the beginning of the
Four Quarter Period through the Transaction Date (the "Reference
Period"), as if they had occurred and such proceeds had been applied on
the first day of such Reference Period;
(3) pro forma effect will be given to asset dispositions and asset
acquisitions, including giving pro forma effect to the application of
proceeds of any asset disposition, that have been made by any person
that has become a Restricted Subsidiary or has been merged with or into
Allegiance Telecom, Inc. or any Restricted Subsidiary during such
Reference Period and that would have constituted Asset Dispositions or
Asset Acquisitions had such transactions occurred when such person was
a Restricted Subsidiary as if such asset dispositions or asset
acquisitions were Asset Dispositions or Asset Acquisitions that
occurred on the first day of such Reference Period; but to the extent
that clause (2) or (3) of this sentence requires that pro forma effect
be given to an Asset Acquisition or Asset Disposition, such pro forma
calculation will be based upon the four full fiscal quarters
immediately preceding the Transaction Date of the person, or division
or line of business of the person, that is acquired or disposed of for
which financial information is available; and
(4) the aggregate amount of Indebtedness outstanding as of the end of the
Reference Period will be deemed to include the total amount of funds
outstanding and/or available on the Transaction Date under any
revolving credit or similar facilities of Allegiance Telecom, Inc. or
its Restricted Subsidiaries.
"Consolidated Net Worth" means, at any date of determination, stockholders'
equity as set forth on the most recently available quarterly or annual
consolidated balance sheet of Allegiance Telecom, Inc. and its Restricted
Subsidiaries. Such balance sheet must be as of a date not more than 90 days
prior to the date of such computation and it cannot take into account
Unrestricted Subsidiaries. For purposes of this definition, such stockholders'
equity will be reduced by:
(1) any amounts attributable to Disqualified Stock or any equity security
convertible into or exchangeable for Indebtedness;
(2) the cost of treasury stock; and
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(3) the principal amount of any promissory notes receivable from the sale
of the Capital Stock of Allegiance Telecom, Inc. or any of its
Restricted Subsidiaries.
Each item must be determined in conformity with GAAP excluding the effects of
foreign currency exchange adjustments under Financial Accounting Standards Board
Statement of Financial Accounting Standards No. 52.
"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement or arrangement.
"Default" means any event that is, or after notice or passage of time or both
would be, an Event of Default.
"Disqualified Stock" means any class or series of Capital Stock of any person
that by its terms or otherwise is:
(1) required to be redeemed prior to the Stated Maturity of the notes;
(2) redeemable at the option of the holder of such class or series of
Capital Stock at any time prior to the Stated Maturity of the notes; or
(3) convertible into or exchangeable for Capital Stock referred to in
clause (1) or (2) above or Indebtedness having a scheduled maturity
prior to the Stated Maturity of the notes.
However, any Capital Stock that constitutes Disqualified Stock only because it
gives the holders of such stock the right to require such person to repurchase
or redeem such Capital Stock upon the occurrence of an "asset sale" or "change
of control" occurring prior to the Stated Maturity of the notes will not
constitute Disqualified Stock if:
(1) the "asset sale" or "change of control" provisions applicable to such
Capital Stock are no more favorable to the holders of such Capital
Stock than the provisions contained in "Limitation on Asset Sales" and
"Repurchase of notes upon a Change of Control" covenants described
below; and
(2) such Capital Stock, or the agreements or instruments governing the
redemption rights thereof, specifically provides that such person will
not repurchase or redeem any such stock under such provision prior to
Allegiance Telecom, Inc.'s repurchase of such notes as are required to
be repurchased under the "Limitation on Asset Sales" and "Repurchase of
Notes upon a Change of Control" covenants described below.
"Existing Stockholders" means Madison Dearborn Partners, Inc., Morgan Stanley
Capital Partners III, Inc., Frontenac Company, Battery Partners IV, L.P. and
Battery Investment Partners IV, LLC and their respective Affiliates.
"GAAP" means generally accepted accounting principles in the United States of
America as in effect as of the Closing Date, including, without limitation,
those set forth in the opinions and pronouncements of the Accounting Principles
Board of the American Institute of Certified Public Accountants and statements
and pronouncements of the Financial Accounting Standards Board or in such other
statements by such other entity as
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approved by a significant segment of the accounting profession. All ratios and
computations contained or referred to in the indenture will be computed in
conformity with GAAP applied on a consistent basis, except that calculations
made for purposes of determining compliance with the terms of the covenants and
with other provisions of the indenture will be made without giving effect to the
amortization of any expenses incurred in connection with the Allegiance initial
public offering of common stock and the notes offering and, except as otherwise
provided, the amortization of any amounts required or permitted by Accounting
Principles Board Opinion Nos. 16 and 17.
"Guarantee" means any obligation, contingent or otherwise, of any person
directly or indirectly guaranteeing any Indebtedness of any other person. This
terms includes, for example, any obligation, direct or indirect, contingent or
otherwise, of such person:
(1) to purchase or pay or advance or supply funds for the purchase or
payment of such Indebtedness of such other person, whether arising by
virtue of partnership arrangements, or by agreements to keep-well, to
purchase assets, goods, securities or services unless such purchase
arrangements are on arm's-length terms and are entered into in the
ordinary course of business, to take-or-pay, or to maintain financial
statement conditions or otherwise; or
(2) entered into for purposes of assuring in any other manner the obligee
of such Indebtedness of the payment thereof or to protect such obligee
against loss in respect thereof in whole or in part.
However, the term "Guarantee" does not include endorsements for collection or
deposit in the ordinary course of business. The term "Guarantee" used as a verb
has a corresponding meaning.
"Indebtedness" means, with respect to any person at any date of determination
without duplication:
(1) all indebtedness of such person for borrowed money;
(2) all obligations of such person evidenced by bonds, debentures, notes or
other similar instruments;
(3) all obligations of such person in respect of letters of credit or other
similar instruments, including reimbursement obligations with respect
thereto, but excluding obligations with respect to letters of credit,
including trade letters of credit, securing obligations, other than
obligations described in (1) or (2) above or (5), (6) or (7) below,
entered into in the ordinary course of business of such person to the
extent such letters of credit are not drawn upon or, if drawn upon, to
the extent such drawing is reimbursed no later than the third Business
Day following receipt by such person of a demand for reimbursement;
(4) all obligations of such person to pay the deferred and unpaid purchase
price of property or services, which purchase price is due more than
six months after the date of placing such property in service or taking
delivery and title thereto or the completion of such services, except
Trade Payables;
(5) all Capitalized Lease Obligations of such person;
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(6) all Indebtedness of other persons secured by a Lien on any asset of
such person, whether or not such Indebtedness is assumed by such person
but the amount of such Indebtedness will be the lesser of the fair
market value of such asset at such date of determination and the amount
of such Indebtedness;
(7) all Indebtedness of other persons Guaranteed by such person to the
extent such Indebtedness is Guaranteed by such person; and
(8) to the extent not otherwise included in this definition, obligations
under Currency Agreements and Interest Rate Agreements.
The amount of Indebtedness of any person at any date will be the outstanding
balance at such date or, in the case of a revolving credit or other similar
facility, the total amount of funds outstanding and/or available on the date of
determination, of all unconditional obligations as described above and, with
respect to contingent obligations, the maximum liability upon the occurrence of
the contingency giving rise to the obligation. However,
(1) the amount outstanding at any time of any Indebtedness issued with
original issue discount is the face amount of such Indebtedness less
the remaining unamortized portion of the original issue discount of
such Indebtedness at the time of its issuance as determined in
conformity with GAAP,
(2) money borrowed and set aside at the time of the incurrence of any
Indebtedness to pre-fund the payment of the interest on such
Indebtedness will not be deemed to be "Indebtedness" so long as such
money is held to secure the payment of such interest, and
(3) Indebtedness will not include any liability for federal, state, local
or other taxes.
"Interest Rate Agreement" means any interest rate protection agreement, interest
rate future agreement, interest rate option agreement, interest rate swap
agreement, interest rate cap agreement, interest rate collar agreement, interest
rate hedge agreement, option or future contract or other similar agreement or
arrangement.
"Investment" in any person means:
(1) any direct or indirect advance, loan or other extension of credit,
including by way of Guarantee or similar arrangement; but excluding
advances to customers in the ordinary course of business that are, in
conformity with GAAP, recorded as accounts receivable on the balance
sheet of Allegiance Telecom, Inc. or its Restricted Subsidiaries; or
(2) capital contribution by means of any transfer of cash or other property
to others or any payment for property or services for the account or
use of others to, or any purchase or acquisition of Capital Stock,
bonds, notes, debentures or other similar instruments issued by, such
person.
The term "Investment" also includes:
(1) the designation of a Restricted Subsidiary as an Unrestricted
Subsidiary; and
(2) the fair market value of the Capital Stock or any other Investment held
by Allegiance Telecom, Inc. or any of its Restricted Subsidiaries, of
or in any person
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that has ceased to be a Restricted Subsidiary, including without
limitation, by reason of any transaction permitted by clause (3) of the
"Limitation on the Issuance and Sale of Capital Stock of Restricted
Subsidiaries" covenant. However, the fair market value of the
Investment remaining in any person that has ceased to be a Restricted
Subsidiary will not exceed the aggregate amount of Investments
previously made in such person valued at the time such Investments were
made less the net reduction of such Investments.
For purposes of the definition of "Unrestricted Subsidiary" and the "Limitation
on Restricted Payments" covenant described below:
(1) "Investment" will include the fair market value of the assets net of
liabilities, other than liabilities to Allegiance Telecom, Inc. or any
of its Restricted Subsidiaries, of any Restricted Subsidiary at the
time that such Restricted Subsidiary is designated an Unrestricted
Subsidiary;
(2) the fair market value of the assets net of liabilities, other than
liabilities to Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries, of any Unrestricted Subsidiary at the time that such
Unrestricted Subsidiary is designated a Restricted Subsidiary will be
considered a reduction in outstanding Investments; and
(3) any property transferred to or from an Unrestricted Subsidiary will be
valued at its fair market value at the time of such transfer.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind, including any conditional sale or other title retention
agreement or lease in the nature thereof or any agreement to give any security
interest.
"Net Cash Proceeds" means:
(1) with respect to any Asset Sale, the proceeds of such Asset Sale in the
form of cash or cash equivalents, including payments in respect of
deferred payment obligations, to the extent corresponding to the
principal, but not interest, component thereof, when received in the
form of cash or cash equivalents, except to the extent such obligations
are financed or sold with recourse to Allegiance Telecom, Inc. or any
Restricted Subsidiary, and proceeds from the conversion of other
property received when converted to cash or cash equivalents, net of:
(a) brokerage commissions and other fees and expenses related to such
Asset Sale, including fees and expenses of counsel and investment
bankers;
(b) provisions for all taxes, whether or not such taxes will actually be
paid or are payable, as a result of such Asset Sale without regard
to the consolidated results of operations of Allegiance Telecom,
Inc. and its Restricted Subsidiaries, taken as a whole;
(c) payments made to repay Indebtedness or any other obligation
outstanding at the time of such Asset Sale that either is secured by
a Lien on the property or assets sold or is required to be paid as a
result of such sale; and
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(d) appropriate amounts to be provided by Allegiance Telecom, Inc. or
any Restricted Subsidiary as a reserve against any liabilities
associated with such Asset Sale, including, without limitation,
pension and other post-employment benefit liabilities, liabilities
related to environmental matters and liabilities under any
indemnification obligations associated with such Asset Sale, all as
determined in conformity with GAAP; and
(2) with respect to any issuance or sale of Capital Stock, the proceeds of
such issuance or sale in the form of cash or cash equivalents,
including payments in respect of deferred payment obligations, to the
extent corresponding to the principal, but not interest, component
thereof, when received in the form of cash or cash equivalents, except
to the extent such obligations are financed or sold with recourse to
Allegiance Telecom, Inc. or any Restricted Subsidiary, and proceeds
from the conversion of other property received when converted to cash
or cash equivalents, net of attorney's fees, accountants' fees,
underwriters' or placement agents' fees, discounts or commissions and
brokerage, consultant and other fees incurred in connection with such
issuance or sale and net of taxes paid or payable as a result thereof.
"Offer to Purchase" means an offer to purchase notes by Allegiance Telecom, Inc.
from the holders commenced by mailing a notice to the trustee and each holder
stating:
(1) the covenant under which the offer is being made and that all notes
validly tendered will be accepted for payment on a pro rata basis;
(2) the purchase price and the date of purchase, which will be a Business
Day no earlier than 30 days nor later than 60 days from the date such
notice is mailed (the "Payment Date");
(3) that any note not tendered will continue to accrue interest under its
terms;
(4) that, unless Allegiance Telecom, Inc. defaults in the payment of the
purchase price, any note accepted for payment under the Offer to
Purchase will cease to accrue interest on and after the Payment Date;
(5) that holders electing to have a note purchased under the Offer to
Purchase will be required to surrender the note, together with the form
entitled "Option of the Holder to Elect Purchase" on the reverse side
of the note completed, to the Paying Agent at the address specified in
the notice prior to the close of business on the Business Day
immediately preceding the Payment Date;
(6) that holders will be entitled to withdraw their election if the Paying
Agent receives, not later than the close of business on the third
Business Day immediately preceding the Payment Date, a telegram,
facsimile transmission or letter setting forth the name of such holder,
the principal amount of notes delivered for purchase and a statement
that such holder is withdrawing his election to have such notes
purchased; and
(7) that holders whose notes are being purchased only in part will be
issued new notes equal in principal amount to the unpurchased portion
of the notes surrendered.
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Each note purchased and each new note issued will be in a principal amount of
$1,000 or an integral multiple thereof. On the Payment Date, Allegiance Telecom,
Inc. will accept for payment on a pro rata basis notes or portions thereof
tendered under an Offer to Purchase; deposit with the Paying Agent money
sufficient to pay the purchase price of all notes or portions thereof so
accepted; and deliver, or cause to be delivered, to the trustee all notes or
portions thereof so accepted together with an Officers' Certificate specifying
the notes or portions thereof accepted for payment by Allegiance Telecom, Inc.
The Paying Agent will promptly mail to the holders of notes so accepted payment
in an amount equal to the purchase price, and the trustee will promptly
authenticate and mail to such holders a new note equal in principal amount to
any unpurchased portion of the note surrendered. Each note purchased and each
new note issued will be in a principal amount of $1,000 or an integral multiple
thereof. Allegiance Telecom, Inc. will publicly announce the results of an Offer
to Purchase as soon as practicable after the Payment Date. The trustee will act
as the Paying Agent for an Offer to Purchase. Allegiance Telecom, Inc. will
comply with Rule 14e-1 under the Exchange Act and any other securities laws and
regulations thereunder to the extent such laws and regulations are applicable,
if Allegiance Telecom, Inc. is required to repurchase notes under an Offer to
Purchase.
"Permitted Investment" means:
(1) an Investment in Allegiance Telecom, Inc. or a Restricted Subsidiary or
a person which will, upon the making of such Investment, become a
Restricted Subsidiary or be merged or consolidated with or into or
transfer or convey all or substantially all its assets to, Allegiance
Telecom, Inc. or a Restricted Subsidiary, but such person's primary
business must be related, ancillary or complementary to the businesses
of Allegiance Telecom, Inc. and its Restricted Subsidiaries on the date
of such Investment;
(2) Temporary Cash Investments;
(3) payroll, travel and similar advances to cover matters that are expected
at the time of such advances ultimately to be treated as expenses in
accordance with GAAP;
(4) stock, obligations or securities received in satisfaction of judgments;
(5) Investments in prepaid expenses, negotiable instruments held for
collection and lease, utility and worker's compensation, performance
and other similar deposits;
(6) Interest Rate Agreements and Currency Agreements designed solely to
protect Allegiance Telecom, Inc. or its Restricted Subsidiaries against
fluctuations in interest rates or foreign currency exchange rates; and
(7) loans or advances to officers or employees of Allegiance Telecom, Inc.
or any Restricted Subsidiary that do not in the aggregate exceed $2
million at any time outstanding.
"Permitted Liens" means:
(1) Liens for taxes, assessments, governmental charges or claims that are
being contested in good faith by appropriate legal proceedings promptly
instituted and diligently conducted and for which a reserve or other
appropriate provision, if any, as will be required in conformity with
GAAP will have been made;
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(2) statutory and common law Liens of landlords and carriers, warehousemen,
mechanics, suppliers, materialmen, repairmen or other similar Liens
arising in the ordinary course of business and with respect to amounts
not yet delinquent or being contested in good faith by appropriate
legal proceedings promptly instituted and diligently conducted and for
which a reserve or other appropriate provision, if any, as will be
required in conformity with GAAP will have been made;
(3) Liens incurred or deposits made in the ordinary course of business in
connection with workers' compensation, unemployment insurance and other
types of social security;
(4) Liens incurred or deposits made to secure the performance of tenders,
bids, leases, statutory or regulatory obligations, bankers'
acceptances, surety and appeal bonds, government contracts, performance
and return-of-money bonds and other obligations of a similar nature
incurred in the ordinary course of business, exclusive of obligations
for the payment of borrowed money;
(5) easements, rights-of-way, municipal and zoning ordinances and similar
charges, encumbrances, title defects or other irregularities that do
not materially interfere with the ordinary course of business of
Allegiance Telecom, Inc. or any of its Restricted Subsidiaries;
(6) Liens, including extensions and renewals thereof, upon real or personal
property acquired after the Closing Date so long as:
(a) such Lien is created solely for the purpose of securing Indebtedness
incurred, in accordance with the "Limitation on Indebtedness"
covenant described below, to finance the cost of the item of
property or assets subject thereto and such Lien is created prior
to, at the time of or within six months after the later of the
acquisition, the completion of construction or the commencement of
full operation of such property,
(b) the principal amount of the Indebtedness secured by such Lien does
not exceed 100% of such cost, and
(c) any such Lien will not extend to or cover any property or assets
other than such item of property or assets and any improvements on
such item;
(7) leases or subleases granted to others that do not materially interfere
with the ordinary course of business of Allegiance Telecom, Inc. and
its Restricted Subsidiaries, taken as a whole;
(8) Liens encumbering property or assets under construction arising from
progress or partial payments by a customer of Allegiance Telecom, Inc.
or its Restricted Subsidiaries relating to such property or assets;
(9) any interest or title of a lessor in the property subject to any
Capitalized Lease or operating lease;
(10) Liens arising from filing Uniform Commercial Code financing statements
regarding leases;
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(11) Liens on property of, or on shares of Capital Stock or Indebtedness
of, any person existing at the time such person becomes, or becomes a
part of, any Restricted Subsidiary so long as such Liens do not extend
to or cover any property or assets of Allegiance Telecom, Inc. or any
Restricted Subsidiary other than the property or assets acquired;
(12) Liens in favor of Allegiance Telecom, Inc. or any Restricted
Subsidiary;
(13) Liens arising from the rendering of a final judgment or order against
Allegiance Telecom, Inc. or any Restricted Subsidiary that does not
give rise to an Event of Default;
(14) Liens securing reimbursement obligations with respect to letters of
credit that encumber documents and other property relating to such
letters of credit and the products and proceeds thereof;
(15) Liens in favor of customs and revenue authorities arising as a matter
of law to secure payment of customs duties in connection with the
importation of goods;
(16) Liens encumbering customary initial deposits and margin deposits, and
other Liens that are within the general parameters customary in the
industry and incurred in the ordinary course of business, in each
case, securing Indebtedness under Interest Rate Agreements and
Currency Agreements and forward contracts, options, future contracts,
futures options or similar agreements or arrangements designed solely
to protect Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries from fluctuations in interest rates, currencies or the
price of commodities;
(17) Liens arising out of conditional sale, title retention, consignment or
similar arrangements for the sale of goods entered into by Allegiance
Telecom, Inc. or any of its Restricted Subsidiaries in the ordinary
course of business in accordance with the past practices of Allegiance
Telecom, Inc. and its Restricted Subsidiaries prior to the Closing
Date;
(18) Liens on or sales of receivables; and
(19) Liens that secure Indebtedness with an aggregate principal amount not
in excess of $5 million at any time outstanding.
"Pledge Account" means an account established with the trustee under the terms
of the Pledge Agreement for the deposit of the Pledged Securities to be
purchased by Allegiance Telecom, Inc. with the net proceeds from the sale of the
notes.
"Pledge Agreement" means the Collateral Pledge and Security Agreement, dated as
of the Closing Date, made by Allegiance Telecom, Inc. in favor of the trustee,
governing the disbursement of funds from the Pledge Account, as such agreement
may be amended, restated, supplemented or otherwise modified from time to time.
"Pledged Securities" means the U.S. government securities purchased by
Allegiance Telecom, Inc. and held in the Pledge Account in accordance with the
Pledge Agreement.
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"Restricted Subsidiary" means any subsidiary of Allegiance Telecom, Inc. other
than an Unrestricted Subsidiary.
"Significant Subsidiary" means, at any date of determination, any Restricted
Subsidiary that, together with its Subsidiaries, (1) for the most recent fiscal
year of Allegiance Telecom, Inc., accounted for more than 10% of the
consolidated revenues of Allegiance Telecom, Inc. and its Restricted
Subsidiaries or (2) as of the end of such fiscal year, was the owner of more
than 10% of the consolidated assets of Allegiance Telecom, Inc. and its
Restricted Subsidiaries, all as set forth on the most recently available
consolidated financial statements of Allegiance Telecom, Inc. for such fiscal
year.
"Stated Maturity" means (1) with respect to any debt security, the date
specified in such debt security as the fixed date on which the final installment
of principal of such debt security is due and payable and (2) with respect to
any scheduled installment of principal of or interest on any debt security, the
date specified in such debt security as the fixed date on which such installment
is due and payable.
"Strategic Subordinated Indebtedness" means Indebtedness of Allegiance Telecom,
Inc. incurred to finance the acquisition of a person engaged in a business that
is related, ancillary or complementary to the business conducted by Allegiance
Telecom, Inc. or any of its Restricted Subsidiaries. The Indebtedness by its
terms, or by the terms of any agreement or instrument under which such
Indebtedness is incurred, however, must be expressly made subordinate in right
of payment to the notes and provides that no payment of principal, premium or
interest on, or any other payment with respect to, such Indebtedness may be made
prior to the payment in full of all of Allegiance Telecom, Inc.'s obligations
under the notes. However, such Indebtedness may provide for and be repaid at any
time from the proceeds of a capital contribution or the sale of Capital Stock
(other than Disqualified Stock) of Allegiance Telecom, Inc. after the incurrence
of such Indebtedness.
"Temporary Cash Investment" means any of the following:
(1) direct obligations of the United States of America or any agency
thereof or obligations fully and unconditionally guaranteed by the
United States of America or any agency thereof;
(2) time deposit accounts, certificates of deposit and money market
deposits maturing within one year of the date of acquisition thereof
issued by a bank or trust company which is organized under the laws of
the United States of America, any state thereof or any foreign country
recognized by the United States of America, and which bank or trust
company has capital, surplus and undivided profits aggregating in
excess of $50 million, or the foreign currency equivalent thereof, and
has outstanding debt which is rated "A" or such similar equivalent
rating or higher by at least one nationally recognized statistical
rating organization, as defined in Rule 436 under the Securities Act,
or any money-market fund sponsored by a registered broker dealer or
mutual fund distributor;
(3) repurchase obligations with a term of not more than 30 days for
underlying securities of the types described in clause (1) above
entered into with a bank meeting the qualifications described in clause
(2) above;
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(4) commercial paper, maturing not more than one year after the date of
acquisition, issued by a corporation, other than an Affiliate of
Allegiance Telecom, Inc., organized and in existence under the laws of
the United States of America, any state thereof or any foreign country
recognized by the United States of America with a rating at the time as
of which any investment therein is made of "P-1" or higher according to
Moody's, or "A-1" or higher according to S&P; and
(5) securities with maturities of six months or less from the date of
acquisition issued or fully and unconditionally guaranteed by any
state, commonwealth or territory of the United States of America, or by
any political subdivision or taxing authority thereof, and rated at
least "A" by S&P or Moody's.
"Trade Payables" means, with respect to any person, any accounts payable or any
other indebtedness or monetary obligation to trade creditors created, assumed or
Guaranteed by such person or any of its Subsidiaries arising in the ordinary
course of business in connection with the acquisition of goods or services.
"Transaction Date" means, with respect to the incurrence of any Indebtedness by
Allegiance Telecom, Inc. or any of its Restricted Subsidiaries, the date such
Indebtedness is to be incurred and, with respect to any Restricted Payment, the
date such Restricted Payment is to be made.
"Unrestricted Subsidiary" means any subsidiary of Allegiance Telecom, Inc. that
at the time of determination will be designated an Unrestricted Subsidiary by
the Board of Directors in the manner provided below and any subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Restricted
Subsidiary, including any newly acquired or newly formed subsidiary of
Allegiance Telecom, Inc., to be an Unrestricted Subsidiary unless such
subsidiary owns any Capital Stock of, or owns or holds any Lien on any property
of, Allegiance Telecom, Inc. or any Restricted Subsidiary. However,
(1) any Guarantee by Allegiance Telecom, Inc. or by any Restricted
Subsidiary of any Indebtedness of the subsidiary being so designated
will be deemed an "incurrence" of such Indebtedness and an "Investment"
by Allegiance Telecom, Inc. or such Restricted Subsidiary, or both, if
applicable, at the time of such designation;
(2) either the subsidiary to be so designated must have total assets of
$1,000 or less or if such subsidiary has assets greater than $1,000,
such designation must be permitted under the "Limitation on Restricted
Payments" covenant described below; and
(3) If applicable, the incurrence of Indebtedness and the Investment
referred to in clause (1) of this sentence would be permitted under the
"Limitation on Indebtedness" and "Limitation on Restricted Payments"
covenants described below.
The Board of Directors may designate any Unrestricted Subsidiary to be a
Restricted Subsidiary so long as no Default or Event of Default will have
occurred and be continuing at the time of or after giving effect to such
designation and all Liens and Indebtedness of such Unrestricted Subsidiary
outstanding immediately after such designation would, if
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incurred at such time, have been permitted to be incurred and will be deemed to
have been incurred for all purposes of the indenture. Any such designation by
the Board of Directors will be evidenced to the trustee by promptly filing with
the trustee a copy of the Board Resolution giving effect to such designation and
an Officers' Certificate certifying that such designation complied with the
foregoing provisions.
"Voting Stock" means with respect to any person, Capital Stock of any class or
kind ordinarily having the power to vote for the election of directors, managers
or other voting members of the governing body of such person.
COVENANTS
SUMMARY
In the indenture, Allegiance Telecom, Inc. agreed to certain restrictions that
limit its and its Restricted Subsidiaries' ability, among other things, to:
- incur indebtedness
- pay dividends
- repurchase capital stock or subordinated indebtedness
- make investments
- limit the ability of any Restricted Subsidiary to pay dividends or
otherwise provide funds to Allegiance Telecom, Inc.
- issue capital stock of Restricted Subsidiaries
- have Restricted Subsidiaries issue guarantees
- engage in transactions with stockholders and affiliates
- incur liens
- engage in sale-leaseback transactions
- sell assets
- effect mergers.
In addition, if a Change of Control occurs, each holder of notes will have the
right to required Allegiance Telecom, Inc. to repurchase all or part of such
holder's notes at a price equal to 101% of the principal amount of those notes
plus accrued interest to the date of purchase.
LIMITATION ON INDEBTEDNESS
(a) Allegiance Telecom, Inc. will not, and will not permit any of its Restricted
Subsidiaries to, incur any Indebtedness, other than the notes and Indebtedness
existing on the Closing Date except that Allegiance Telecom, Inc. may incur
Indebtedness if, after giving effect to the incurrence of such Indebtedness and
the receipt and application of the proceeds therefrom, the Consolidated Leverage
Ratio would be greater than zero and less than 6:1.
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This restriction does not apply, however, to the following:
(1) Indebtedness outstanding at any time in an aggregate principal amount
not to exceed $100 million, less any amount of such Indebtedness
permanently repaid as provided under the "Limitation on Asset Sales"
covenant described below;
(2) Indebtedness owed (a) to Allegiance Telecom, Inc. evidenced by a
promissory note or (b) to any Restricted Subsidiary, however, any event
which results in any such Restricted Subsidiary ceasing to be a
Restricted Subsidiary or any subsequent transfer of such Indebtedness,
other than to Allegiance Telecom, Inc. or another Restricted
Subsidiary, will be deemed, in each case, to constitute an incurrence
of such Indebtedness not permitted by this clause (2);
(3) Indebtedness issued in exchange for, or the net proceeds of which are
used to refinance or refund, then outstanding Indebtedness, other than
Indebtedness incurred under clause (1), (2), (3), (4), (5) or (6) of
this paragraph, and any refinancings thereof in an amount not to exceed
the amount so refinanced or refunded, plus premiums, accrued interest,
fees and expenses; however, Indebtedness the proceeds of which are used
to refinance or refund the notes or Indebtedness that is has the same
seniority as, or subordinated in right of payment to, the notes will
only be permitted under this clause (3) if
(a) in case the notes are refinanced in part or the Indebtedness to be
refinanced has the same seniority as the notes, such new
Indebtedness, by its terms or by the terms of any agreement or
instrument under which such new Indebtedness is outstanding, is
expressly made to have the same seniority as, or subordinate in
right of payment to, the remaining notes,
(b) in case the Indebtedness to be refinanced is subordinated in right
of payment to the notes, such new Indebtedness, by its terms or by
the terms of any agreement or instrument under which such new
Indebtedness is issued or remains outstanding, is expressly made
subordinate in right of payment to the notes at least to the extent
that the Indebtedness to be refinanced is subordinated to the notes
and
(c) such new Indebtedness, determined as of the date of incurrence of
such new Indebtedness, does not mature prior to the Stated Maturity
of the Indebtedness to be refinanced or refunded, and the Average
Life of such new Indebtedness is at least equal to the remaining
Average Life of the Indebtedness to be refinanced or refunded, but
in no event may Indebtedness of Allegiance Telecom, Inc. be
refinanced by means of any Indebtedness of any Restricted Subsidiary
under this clause (3);
(4) Indebtedness
(a) in respect of performance, surety or appeal bonds provided in the
ordinary course of business,
(b) under Currency Agreements and Interest Rate Agreements so long as
such agreements (A) are designed solely to protect Allegiance
Telecom, Inc. or its Restricted Subsidiaries against fluctuations in
foreign currency exchange rates or interest rates and (B) do not
increase the Indebtedness of the
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obligor outstanding at any time other than as a result of
fluctuations in foreign currency exchange rates or interest rates or
by reason of fees, indemnities and compensation payable thereunder;
and
(c) arising from agreements providing for indemnification, adjustment of
purchase price or similar obligations, or from Guarantees or letters
of credit, surety bonds or performance bonds securing any
obligations of Allegiance Telecom, Inc. or any of its Restricted
Subsidiaries under such agreements, in any case incurred in
connection with the disposition of any business, assets or
Restricted Subsidiary, other than Guarantees of Indebtedness
incurred by any person acquiring all or any portion of such
business, assets or Restricted Subsidiary for the purpose of
financing such acquisition, in a principal amount not to exceed the
gross proceeds actually received by Allegiance Telecom, Inc. or any
Restricted Subsidiary in connection with such disposition;
(5) Indebtedness of Allegiance Telecom, Inc., to the extent the net
proceeds thereof are promptly (a) used to purchase notes tendered in an
Offer to Purchase made as a result of a Change in Control or (b)
deposited to defease the notes as described below under "Defeasance";
(6) Guarantees of the notes and Guarantees of Indebtedness of Allegiance
Telecom, Inc. by any Restricted Subsidiary provided the Guarantee of
such Indebtedness is permitted by and made in accordance with the
"Limitation on Issuance of Guarantees by Restricted Subsidiaries"
covenant described below;
(7) Indebtedness, including Guarantees, incurred to finance the cost,
including the cost of design, development, acquisition, construction,
installation, improvement, transportation or integration, to acquire
equipment, inventory or network assets, including acquisitions by way
of Capitalized Lease and acquisitions of the Capital Stock of a person
that becomes a Restricted Subsidiary to the extent of the fair market
value of the equipment, inventory or network assets so acquired, by
Allegiance Telecom, Inc. or a Restricted Subsidiary after the Closing
Date;
(8) Indebtedness of Allegiance Telecom, Inc. not to exceed, at any one time
outstanding, two times
(a) the Net Cash Proceeds received by Allegiance Telecom, Inc. after
February 3, 1998 as a capital contribution or from the issuance and
sale of its Capital Stock, other than Disqualified Stock, to a
person that is not a subsidiary of Allegiance Telecom, Inc., to the
extent:
(A) such capital contribution or Net Cash Proceeds have not been
used under clause (3)(b) of the second paragraph or clause (3),
(4), (6), (7), or (8) of the third paragraph of the "Limitation
on Restricted Payments" covenant described below to make a
Restricted Payment,
(B) if such capital contribution or Net Cash Proceeds are used to
consummate a transaction under which Allegiance Telecom, Inc.
incurs Acquired Indebtedness, the amount of such Net Cash
Proceeds exceeds one-half of the amount of Acquired
Indebtedness so incurred, and
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(b) 80% of the fair market value of property, other than cash and cash
equivalents, received by Allegiance Telecom, Inc. after February 3,
1998 from the sale of its Capital Stock, other than Disqualified
Stock, to a person that is not a subsidiary of Allegiance Telecom,
Inc., to the extent:
(A) such capital contribution or sale of Capital Stock has not been
used under clause (3), (4), (6) or (7) of the third paragraph
of the "Limitation on Restricted Payments" covenant described
below to make a Restricted Payment and
(B) if such capital contribution or Capital Stock is used to
consummate a transaction under which Allegiance Telecom, Inc.
incurs Acquired Indebtedness, 80% of the fair market value of
the property received exceeds one-half of the amount of
Acquired Indebtedness so incurred so long as such Indebtedness
does not mature prior to the Stated Maturity of the notes and
has an Average Life longer than the notes;
(9) Acquired Indebtedness;
(10) Strategic Subordinated Indebtedness; and
(11) in addition to the Indebtedness permitted under clauses (1) through
(10), subordinated Indebtedness of Allegiance Telecom, Inc. in an
aggregate principal amount outstanding at any time not to exceed $100
million, less any amount of such Indebtedness permanently repaid in
the manner described under the "Limitation on Asset Sales" covenant
described below.
(b) The maximum amount of Indebtedness that Allegiance Telecom, Inc. or
a Restricted Subsidiary may incur under this "Limitation on
Indebtedness" covenant will not be deemed to be exceeded with
respect to any outstanding Indebtedness due solely to the result of
fluctuations in the exchange rates of currencies.
(c) For purposes of determining the amount of any particular
Indebtedness under this "Limitation on Indebtedness" covenant, (1)
Guarantees, Liens or obligations with respect to letters of credit
supporting Indebtedness otherwise included in the determination of
such particular amount will not be included and (2) any Liens
granted under the equal and ratable provisions referred to in the
"Limitation on Liens" covenant described below will not be treated
as Indebtedness. For purposes of determining compliance with this
"Limitation on Indebtedness" covenant, in the event that an item of
Indebtedness meets the criteria of more than one of the types of
Indebtedness described in the above clauses, Allegiance Telecom,
Inc., in its sole discretion, will classify, and from time to time
may reclassify, such item of Indebtedness and only be required to
include the amount and type of such Indebtedness in one of such
clauses.
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LIMITATION ON RESTRICTED PAYMENTS
"Restricted Payment" under the indenture is any payment or other action taken,
directly or indirectly, by Allegiance Telecom, Inc. or any Restricted Subsidiary
whereby Allegiance Telecom, Inc. or any Restricted Subsidiary,
(1) declares or pays any dividend or makes any distribution on or with
respect to its Capital Stock that is held by persons other than
Allegiance Telecom, Inc. or any of its Restricted Subsidiaries, other
than:
(a) dividends or distributions payable solely in shares of its Capital
Stock, other than Disqualified Stock, or in options, warrants or
other rights to acquire shares of such Capital Stock, and
(b) pro rata dividends or distributions on Common Stock of Restricted
Subsidiaries held by minority stockholders;
(2) purchases, redeems, retires or otherwise acquires for value (a) any
shares of Capital Stock of Allegiance Telecom, Inc. or an Unrestricted
Subsidiary, including options, warrants or other rights to acquire such
shares of Capital Stock, held by any person or (b) any shares of
Capital Stock of a Restricted Subsidiary, including options, warrants
or other rights to acquire such shares of Capital Stock, held by any
Affiliate of Allegiance Telecom, Inc., other than an Affiliate that is
a wholly owned Restricted Subsidiary, or held by any holder, or any
Affiliate of such holder, of 5% or more of the Capital Stock of
Allegiance Telecom, Inc.;
(3) makes any voluntary or optional principal payment, or voluntary or
optional redemption, repurchase, defeasance, or other acquisition or
retirement for value, of Indebtedness of Allegiance Telecom, Inc. that
is subordinated in right of payment to the notes; or
(4) makes any Investment in any person, other than a Permitted Investment.
Allegiance Telecom, Inc. will not, and will not permit any Restricted Subsidiary
to make any Restricted Payment if at the time of and after giving effect to the
proposed Restricted Payment:
(1) a Default or Event of Default will have occurred and be continuing;
(2) Allegiance Telecom, Inc. could not incur at least $1.00 of Indebtedness
under the first paragraph of the "Limitation on Indebtedness" covenant;
or
(3) the aggregate amount of all Restricted Payments made after the Closing
Date will exceed the sum of
(a) 50% of the aggregate amount of the Adjusted Consolidated Net Income
or, if the Adjusted Consolidated Net Income is a loss, minus 100% of
the amount of such loss, determined by excluding income resulting
from transfers of assets by Allegiance Telecom, Inc. or a Restricted
Subsidiary to an Unrestricted Subsidiary, accrued on a cumulative
basis during the period, taken as one accounting period, beginning
on April 1, 1998 and ending on the last day of the last fiscal
quarter preceding the Transaction Date for
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which reports have been filed with the Commission or provided to the
trustee under the "Commission Reports and Reports to Holders"
covenant plus
(b) the aggregate Net Cash Proceeds received by Allegiance Telecom, Inc.
after February 3, 1998 as a capital contribution or from the
issuance and sale permitted by the indenture of its Capital Stock to
a person who is not a subsidiary of Allegiance Telecom, Inc.,
including an issuance or sale permitted by the indenture of
Indebtedness of Allegiance Telecom, Inc. for cash subsequent to
February 3, 1998 upon the conversion of such Indebtedness into
Capital Stock of Allegiance Telecom, Inc., or from the issuance to a
person who is not a subsidiary of Allegiance Telecom, Inc. of any
options, warrants or other rights to acquire Capital Stock of
Allegiance Telecom, Inc., in each case,
(A) excluding any Disqualified Stock or any options, warrants or
other rights that are redeemable at the option of the holder,
or are required to be redeemed, prior to the Stated Maturity of
the notes,
(B) except to the extent such Net Cash Proceeds are used to incur
Indebtedness under clause (3) of the second paragraph under the
"Limitation on Indebtedness" covenant, plus
(c) an amount equal to the net reduction in Investments, other than
reductions in Permitted Investments, in any person resulting
(A) from payments of interest on Indebtedness, dividends,
repayments of loans or advances, or other transfers of assets,
in each case to Allegiance Telecom, Inc. or any Restricted
Subsidiary, except to the extent any such proceeds are included
in the calculation of Adjusted Consolidated Net Income, or
(B) from the Net Cash Proceeds from the sale of any such
Investment, except to the extent any such payment is included
in the calculation of Adjusted Consolidated Net Income not to
exceed the amount of Investments previously made by Allegiance
Telecom, Inc. or any Restricted Subsidiary in such person, or
(C) from redesignations of Unrestricted Subsidiaries as Restricted
Subsidiaries valued as provided in the definition of
"Investments", not to exceed the amount of Investments
previously made by Allegiance Telecom, Inc. or any Restricted
Subsidiary in such Unrestricted Subsidiary.
The foregoing provision will not be violated by reason of:
(1) the payment of any dividend within 60 days after the date of
declaration thereof if, at said date of declaration, such payment would
comply with the foregoing paragraph;
(2) the redemption, repurchase, defeasance or other acquisition or
retirement for value of Indebtedness that is subordinated in right of
payment to the notes
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including premium, if any, and accrued and unpaid interest, with the
proceeds of, or in exchange for, Indebtedness incurred under clause (3)
of the second paragraph of part (a) of the "Limitation on Indebtedness"
covenant;
(3) the repurchase, redemption or other acquisition of Capital Stock of
Allegiance Telecom, Inc. or an Unrestricted Subsidiary, or options,
warrants or other rights to acquire such Capital Stock, in exchange
for, or out of the proceeds of a capital contribution or a
substantially concurrent offering of, shares of Capital Stock, other
than Disqualified Stock, of Allegiance Telecom, Inc. or options,
warrants or other rights to acquire such Capital Stock;
(4) the making of any principal payment or the repurchase, redemption,
retirement, defeasance or other acquisition for value of Indebtedness
of Allegiance Telecom, Inc. which is subordinated in right of payment
to the notes in exchange for, or out of the proceeds of a capital
contribution or a substantially concurrent offering of, shares of the
Capital Stock, other than Disqualified Stock, of Allegiance Telecom,
Inc., or options, warrants or other rights to acquire such Capital
Stock;
(5) payments or distributions, to dissenting stockholders under applicable
law, under or in connection with a consolidation, merger or transfer of
assets that complies with the provisions of the indenture applicable to
mergers, consolidations and transfers of all or substantially all of
the property and assets of Allegiance Telecom, Inc.;
(6) Investments in any person the primary business of which is related,
ancillary or complementary to the business of Allegiance Telecom, Inc.
and its Restricted Subsidiaries on the date of such Investments so long
as the aggregate amount of Investments made under this clause (6) does
not exceed the sum of:
(a) $20 million, plus
(b) the amount of Net Cash Proceeds received by Allegiance Telecom, Inc.
after February 3, 1998 as a capital contribution or from the sale of
its Capital Stock, other than Disqualified Stock, to a person who is
not a subsidiary of Allegiance Telecom, Inc., except to the extent
such Net Cash Proceeds are used to incur Indebtedness under clause
(8) under the "Limitation on Indebtedness" covenant or to make
Restricted Payments under clause (3)(b) of the second paragraph, or
clauses (3), (4) or (8) of this paragraph, of this "Limitation on
Restricted Payments" covenant, plus
(c) the net reduction in Investments made under this clause (6)
resulting from distributions on or repayments of such Investments or
from the Net Cash Proceeds from the sale of any such Investment, in
each case other than to the extent any such payment or proceeds is
included in the calculation of Adjusted Consolidated Net Income, or
from such person becoming a Restricted Subsidiary, valued in each
case as provided in the definition of "Investments", but the net
reduction in any Investment cannot exceed the amount of such
Investment;
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(7) Investments acquired in exchange for Capital Stock, other than
Disqualified Stock, of Allegiance Telecom, Inc.;
(8) the declaration or payment of dividends on Capital Stock, other than
Disqualified Stock, of Allegiance Telecom, Inc. in an aggregate annual
amount not to exceed 6% of the Net Cash Proceeds received by Allegiance
Telecom, Inc. from the sale of such Capital Stock after the Closing
Date;
(9) repurchases of warrants under a Repurchase Offer;
(10) any purchase of any fractional share of Common Stock, or other Capital
Stock of Allegiance Telecom, Inc. issuable upon exercise of the
warrants, in connection with an exercise of the warrants; and
(11) other Restricted Payments in an aggregate amount not to exceed $2
million so long as no Default or Event of Default will have occurred
and be continuing or occur as a consequence of the actions or payments
set forth therein other than a Restricted Payment under clauses (1) or
(3) above.
Each Restricted Payment permitted under the preceding paragraph will be included
in calculating whether the conditions of clause (3) of the second paragraph of
this "Limitation on Restricted Payments" covenant have been met with respect to
any subsequent Restricted Payments, except that such calculation will not
include
- the amount of any Restricted Payments permitted under in clause (2) of
the preceding paragraph,
- an exchange of Capital Stock for Capital Stock or Indebtedness referred
to in clause (3) or (4) of the preceding paragraph,
- an Investment referred to in clause (6) of the preceding paragraph, and
- the Net Cash Proceeds from any capital contribution or any issuance of
Capital Stock referred to in clauses (3), (4) and (6)of such second
paragraph.
In the event the proceeds of an issuance of Capital Stock of Allegiance Telecom,
Inc. are used for the redemption, repurchase or other acquisition of the notes,
or Indebtedness that has the same seniority as the notes, then the Net Cash
Proceeds of such issuance will be included in clause (3) of the second paragraph
of this "Limitation on Restricted Payments" covenant only to the extent such
proceeds are not used for such redemption, repurchase or other acquisition of
Indebtedness.
LIMITATION ON DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING RESTRICTED
SUBSIDIARIES
Allegiance Telecom, Inc. will not, and will not permit any Restricted Subsidiary
to, create or otherwise cause or suffer to exist or become effective any
consensual encumbrance or restriction of any kind on the ability of any
Restricted Subsidiary to:
(1) pay dividends or make any other distributions permitted by applicable
law on any Capital Stock of such Restricted Subsidiary owned by
Allegiance Telecom, Inc. or any other Restricted Subsidiary;
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(2) pay any Indebtedness owed to Allegiance Telecom, Inc. or any other
Restricted Subsidiary;
(3) make loans or advances to Allegiance Telecom, Inc. or any other
Restricted Subsidiary; or
(4) transfer any of its property or assets to Allegiance Telecom, Inc. or
any other Restricted Subsidiary.
The foregoing provisions will not restrict any encumbrances or restrictions:
(1) existing on the Closing Date in the indenture or any other agreements
in effect on the Closing Date, and any extensions, refinancings,
renewals or replacements of such agreements so long as the encumbrances
and restrictions in any such extensions, refinancings, renewals or
replacements are no less favorable in any material respect to the
holders than those encumbrances or restrictions that are then in effect
and that are being extended, refinanced, renewed or replaced;
(2) existing under or by reason of applicable law;
(3) existing with respect to any person or the property or assets of such
person acquired by Allegiance Telecom, Inc. or any Restricted
Subsidiary, existing at the time of such acquisition and not incurred
in contemplation thereof, which encumbrances or restrictions are not
applicable to any person or the property or assets of any person other
than such person or the property or assets of such person so acquired;
(4) in the case of clause (4) of the first paragraph of this "Limitation on
Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries" covenant,
(a) that restrict in a customary manner the subletting, assignment or
transfer of any property or asset that is a lease, license,
conveyance or contract or similar property or asset,
(b) existing by virtue of any transfer of, agreement to transfer, option
or right with respect to, or Lien on, any property or assets of
Allegiance Telecom, Inc. or any Restricted Subsidiary not otherwise
prohibited by the indenture, or
(c) arising or agreed to in the ordinary course of business, not
relating to any Indebtedness, and that do not, individually or in
the aggregate, detract from the value of property or assets of
Allegiance Telecom, Inc. or any Restricted Subsidiary in any manner
material to Allegiance Telecom, Inc. or any Restricted Subsidiary;
(5) with respect to a Restricted Subsidiary and imposed under an agreement
that has been entered into for the sale or disposition of all or
substantially all of the Capital Stock of, or property and assets of,
such Restricted Subsidiary; or
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(6) contained in the terms of any Indebtedness or any agreement under which
such Indebtedness was issued if
(a) the encumbrance or restriction applies only in the event of a
payment default or a default with respect to a financial covenant
contained in such Indebtedness or agreement,
(b) the encumbrance or restriction is not materially more
disadvantageous to the holders of the notes than is customary in
comparable financings as determined by Allegiance Telecom, Inc., and
(c) Allegiance Telecom, Inc. determines that any such encumbrance or
restriction will not materially affect Allegiance Telecom, Inc.'s
ability to make principal or interest payments on the notes.
Nothing contained in this "Limitation on Dividend and Other Payment Restrictions
Affecting Restricted Subsidiaries" covenant will prevent Allegiance Telecom,
Inc. or any Restricted Subsidiary from (1) creating, incurring, assuming or
suffering to exist any Liens otherwise permitted in the "Limitation on Liens"
covenant or (2) restricting the sale or other disposition of property or assets
of Allegiance Telecom, Inc. or any of its Restricted Subsidiaries that secure
Indebtedness of Allegiance Telecom, Inc. or any of its Restricted Subsidiaries.
LIMITATION ON THE ISSUANCE AND SALE OF CAPITAL STOCK OF RESTRICTED SUBSIDIARIES
Allegiance Telecom, Inc. will not sell, and will not permit any Restricted
Subsidiary, directly or indirectly, to issue or sell, any shares of Capital
Stock of a Restricted Subsidiary, including options, warrants or other rights to
purchase shares of such Capital Stock, except:
(1) to Allegiance Telecom, Inc. or a wholly owned Restricted Subsidiary;
(2) issuances of director's qualifying shares or sales to foreign nationals
of shares of Capital Stock of foreign Restricted Subsidiaries, to the
extent required by applicable law;
(3) if, immediately after giving effect to such issuance or sale, such
Restricted Subsidiary would no longer constitute a Restricted
Subsidiary and any Investment in such person remaining after giving
effect to such issuance or sale would have been permitted to be made
under the "Limitation on Restricted Payments" covenant if made on the
date of such issuance or sale; or
(4) issuances or sales of Common Stock of a Restricted Subsidiary, provided
that Allegiance Telecom, Inc. or such Restricted Subsidiary applies the
Net Cash Proceeds, if any, of any such sale in accordance with clauses
(1)(a) or (b) of the "Limitation on Asset Sales" covenant described
below.
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LIMITATION ON ISSUANCES OF GUARANTEES BY RESTRICTED SUBSIDIARIES
Allegiance Telecom, Inc. will not permit any Restricted Subsidiary, directly or
indirectly, to Guarantee any Indebtedness of Allegiance Telecom, Inc. which has
the same seniority as or subordinate in right of payment to the notes
("Guaranteed Indebtedness"), unless:
(1) such Restricted Subsidiary simultaneously executes and delivers a
supplemental indenture to the indenture providing for a Guarantee (a
"Subsidiary Guarantee") of payment of the notes by such Restricted
Subsidiary; and
(2) such Restricted Subsidiary waives and will not in any manner whatsoever
claim or take the benefit or advantage of, any rights of reimbursement,
indemnity or subrogation or any other rights against Allegiance
Telecom, Inc. or any other Restricted Subsidiary as a result of any
payment by such Restricted Subsidiary under its Subsidiary Guarantee.
However, this paragraph will not be applicable to any Guarantee of any
Restricted Subsidiary that existed at the time such person became a Restricted
Subsidiary and was not incurred in connection with, or in contemplation of, such
person becoming a Restricted Subsidiary. If the Guaranteed Indebtedness (1) has
the same seniority as the notes, then the Guarantee of such Guaranteed
Indebtedness will have the same seniority as, or subordinated to, the Subsidiary
Guarantee or (2) is subordinated to the notes, then the Guarantee of such
Guaranteed Indebtedness will be subordinated to the Subsidiary Guarantee at
least to the extent that the Guaranteed Indebtedness is subordinated to the
notes.
Any Subsidiary Guarantee by a Restricted Subsidiary may provide by its terms
that it will be automatically and unconditionally released and discharged upon
(1) any sale, exchange or transfer, to any person not an Affiliate of Allegiance
Telecom, Inc., of all of Allegiance Telecom, Inc.'s and each Restricted
Subsidiary's Capital Stock in, or all or substantially all the assets of, such
Restricted Subsidiary or (2) the release or discharge of the Guarantee which
resulted in the creation of such Subsidiary Guarantee, except a discharge or
release by or as a result of payment under such Guarantee.
LIMITATION ON TRANSACTIONS WITH SHAREHOLDERS AND AFFILIATES
Allegiance Telecom, Inc. will not, and will not permit any Restricted Subsidiary
to, directly or indirectly, enter into, renew or extend any transaction,
including the purchase, sale, lease or exchange of property or assets, or the
rendering of any service, with any holder, or any Affiliate of such holder, of
5% or more of any class of Capital Stock of Allegiance Telecom, Inc. or with any
Affiliate of Allegiance Telecom, Inc. or any Restricted Subsidiary, except upon
fair and reasonable terms no less favorable to Allegiance Telecom, Inc. or such
Restricted Subsidiary than could be obtained, at the time of such transaction
or, if such transaction is under a written agreement, at the time of the
execution of the agreement providing therefor, in a comparable arm's-length
transaction with a person that is not such a holder or an Affiliate.
The foregoing limitation does not limit, and will not apply to:
(1) transactions approved by a majority of the disinterested members of the
Board of Directors or for which Allegiance Telecom, Inc. or a
Restricted Subsidiary
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delivers to the trustee a written opinion of a nationally recognized
investment banking firm stating that the transaction is fair to
Allegiance Telecom, Inc. or such Restricted Subsidiary from a financial
point of view;
(2) any transaction solely between Allegiance Telecom, Inc. and any of its
wholly owned Restricted Subsidiaries or solely between wholly owned
Restricted Subsidiaries;
(3) the payment of reasonable and customary regular fees to directors of
Allegiance Telecom, Inc. who are not employees of Allegiance Telecom,
Inc.;
(4) any payments or other transactions under any tax-sharing agreement
between Allegiance Telecom, Inc. and any other person with which
Allegiance Telecom, Inc. files a consolidated tax return or with which
Allegiance Telecom, Inc. is part of a consolidated group for tax
purposes; or
(5) any Restricted Payments not prohibited by the "Limitation on Restricted
Payments" covenant.
However, any transaction or series of related transactions covered by the first
paragraph of this "Limitation on Transactions with Shareholders and Affiliates"
covenant and not covered by clauses (2) through (5) of this paragraph, the
aggregate amount of which exceeds $1 million in value, must be approved or
determined to be fair in the manner provided for in clause (1) above.
LIMITATION ON LIENS
Allegiance Telecom, Inc. will not, and will not permit any Restricted Subsidiary
to, create, incur, assume or suffer to exist any Lien on any of its assets or
properties of any character or any shares of Capital Stock or Indebtedness of
any Restricted Subsidiary without making effective provision for all of the
notes and all other amounts due under the indenture to be directly secured
equally and ratably with, or, if the obligation or liability to be secured by
such Lien is subordinated in right of payment to the notes, prior to, the
obligation or liability secured by such Lien.
The foregoing limitation does not apply to
(1) Liens existing on the Closing Date;
(2) Liens granted after the Closing Date on any assets or Capital Stock of
Allegiance Telecom, Inc. or its Restricted Subsidiaries created in
favor of the holders;
(3) Liens with respect to the assets of a Restricted Subsidiary granted by
such Restricted Subsidiary to Allegiance Telecom, Inc. or a wholly
owned Restricted Subsidiary to secure Indebtedness owing to Allegiance
Telecom, Inc. or such other Restricted Subsidiary;
(4) Liens securing Indebtedness which is incurred to refinance secured
Indebtedness which is permitted to be incurred under clause (3) of the
second paragraph of the "Limitation on Indebtedness" covenant so long
as such Liens do not extend to or cover any property or assets of
Allegiance Telecom, Inc. or any Restricted
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Subsidiary other than the property or assets securing the Indebtedness
being refinanced;
(5) Liens on the Capital Stock of, or any property or assets of, a
Restricted Subsidiary securing Indebtedness of such Restricted
Subsidiary permitted under the "Limitation on Indebtedness" covenant;
(6) Liens on the Capital Stock of Restricted Subsidiaries securing up to
$100.0 million of Indebtedness incurred under clause (7) of the second
paragraph of the "Limitation on Indebtedness" covenant; or
(7) Permitted Liens.
LIMITATION ON SALE-LEASEBACK TRANSACTIONS
Allegiance Telecom, Inc. will not, and will not permit any Restricted Subsidiary
to, enter into any sale-leaseback transaction involving any of its assets or
properties whether now owned or hereafter acquired, whereby Allegiance Telecom,
Inc. or a Restricted Subsidiary sells or transfers such assets or properties and
then or thereafter leases such assets or properties or any part thereof or any
other assets or properties which Allegiance Telecom, Inc. or such Restricted
Subsidiary, as the case may be, intends to use for substantially the same
purpose or purposes as the assets or properties sold or transferred.
The foregoing restriction does not apply to any sale-leaseback transaction if:
(1) the lease is for a period, including renewal rights, of not in excess
of three years;
(2) the lease secures or relates to industrial revenue or pollution control
bonds;
(3) the transaction is solely between Allegiance Telecom, Inc. and any
wholly owned Restricted Subsidiary or solely between wholly owned
Restricted Subsidiaries; or
(4) Allegiance Telecom, Inc. or such Restricted Subsidiary, within 12
months after the sale or transfer of any assets or properties is
completed, applies an amount not less than the net proceeds received
from such sale in accordance with clause (1) or (2) of the second
paragraph of the "Limitation on Asset Sales" covenant described below.
LIMITATION ON ASSET SALES
Allegiance Telecom, Inc. will not, and will not permit any Restricted Subsidiary
to, consummate any Asset Sale, unless:
(1) the consideration received by Allegiance Telecom, Inc. or such
Restricted Subsidiary is at least equal to the fair market value of the
assets sold or disposed of; and
(2) at least 75% of the consideration received consists of cash or
Temporary Cash Investments, but this clause (2) will not apply to
long-term assignments in capacity in a telecommunications network.
In the event and to the extent that the Net Cash Proceeds received by Allegiance
Telecom, Inc. or any of its Restricted Subsidiaries from one or more Asset Sales
occurring
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on or after the Closing Date in any period of 12 consecutive months exceed 10%
of Adjusted Consolidated Net Tangible Assets, determined as of the date closest
to the commencement of such 12-month period for which a consolidated balance
sheet of Allegiance Telecom, Inc. and its Subsidiaries has been filed with the
Commission under the "Commission Reports and Reports to Holders" covenant, then
Allegiance Telecom, Inc. will or will cause the relevant Restricted Subsidiary
to:
(1) within 12 months after the date Net Cash Proceeds so received exceed
10% of Adjusted Consolidated Net Tangible Assets (a) apply an amount
equal to such excess Net Cash Proceeds to permanently repay
unsubordinated Indebtedness of Allegiance Telecom, Inc., or any
Restricted Subsidiary providing a Subsidiary Guarantee under the
"Limitation on Issuances of Guarantees by Restricted Subsidiaries"
covenant described above or Indebtedness of any other Restricted
Subsidiary, in each case owing to a person other than Allegiance
Telecom, Inc. or any of its Restricted Subsidiaries or (b) invest an
equal amount, or the amount not so applied under clause (a), or enter
into a definitive agreement committing to so invest within 12 months
after the date of such agreement, in property or assets, other than
current assets, of a nature or type or that are used in a business, or
in a company having property and assets of a nature or type, or engaged
in a business, similar or related to the nature or type of the property
and assets of, or the business of, Allegiance Telecom, Inc. and its
Restricted Subsidiaries existing on the date of such investment; and
(2) apply no later than the end of the 12-month period referred to in
clause (1) such excess Net Cash Proceeds to the extent not applied
under clause (1) as provided in the following paragraph of this
"Limitation on Asset Sales" covenant. The amount of such excess Net
Cash Proceeds required to be applied, or to be committed to be applied,
during such 12-month period as set forth in clause (1) of the preceding
sentence and not applied as so required by the end of such period will
constitute "Excess Proceeds."
If, as of the first day of any calendar month, the aggregate amount of Excess
Proceeds not theretofore subject to an Offer to Purchase under this "Limitation
on Asset Sales" covenant totals at least $5 million, Allegiance Telecom, Inc.
must commence, not later than the fifteenth Business Day of such month, and
consummate an Offer to Purchase from the holders on a pro rata basis an
aggregate principal amount of notes equal to the Excess Proceeds on such date,
at a purchase price equal to 100% of the principal amount of the notes, plus
accrued interest to the Payment Date.
REPURCHASE OF NOTES UPON A CHANGE OF CONTROL
Allegiance Telecom, Inc. must commence, within 30 days of the occurrence of a
Change of Control, and consummate an Offer to Purchase for all notes then
outstanding, at a purchase price equal to 101% of the principal amount thereof,
plus accrued interest to the Payment Date.
There can be no assurance that Allegiance Telecom, Inc. will have sufficient
funds available at the time of any Change of Control to make any debt payment,
including repurchases of notes, required by the foregoing covenant as well as
may be contained in
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other securities of Allegiance Telecom, Inc. which might be outstanding at the
time. The above covenant requiring Allegiance Telecom, Inc. to repurchase the
notes will, unless consents are obtained, require Allegiance Telecom, Inc. to
repay all indebtedness then outstanding which by its terms would prohibit such
note repurchase, either prior to or concurrently with such note repurchase.
COMMISSION REPORTS AND REPORTS TO HOLDERS
Whether or not Allegiance Telecom, Inc. is then required to file reports with
the Commission, Allegiance Telecom, Inc. will file with the Commission all such
reports and other information as it would be required to file with the
Commission by Sections 13(a) or 15(d) under the Securities Exchange Act of 1934
if it were subject thereto. Allegiance Telecom, Inc. will supply the trustee and
each holder or will supply to the trustee for forwarding to each such holder,
without cost to such holder, copies of such reports and other information.
EVENTS OF DEFAULT
The following events will be defined as "Events of Default" in the indenture:
(1) default in the payment of principal of, or any premium on, any note
when the same becomes due and payable at maturity, upon acceleration,
redemption or otherwise;
(2) default in the payment of interest on any note when the same becomes
due and payable, and such default continues for a period of 30 days;
however, a failure to make any of the first six scheduled interest
payments on the notes on the applicable Interest Payment Date will
constitute an Event of Default with no grace or cure period;
(3) default in the performance or breach of the provisions of the indenture
applicable to mergers, consolidations and transfers of all or
substantially all of the assets of Allegiance Telecom, Inc. or the
failure to make or consummate an Offer to Purchase in accordance with
the "Limitation on Asset Sales" or "Repurchase of Notes upon a Change
of Control" covenant;
(4) Allegiance Telecom, Inc. defaults in the performance of or breaches any
other covenant or agreement of Allegiance Telecom, Inc. in the
indenture or under the notes, other than a default specified in clause
(1), (2) or (3) above) and such default or breach continues for a
period of 30 consecutive days after written notice by the trustee or
the holders of 25% or more in aggregate principal amount of the notes;
(5) there occurs with respect to any issue or issues of Indebtedness of
Allegiance Telecom, Inc. or any Significant Subsidiary having an
outstanding principal amount of $5 million or more in the aggregate for
all such issues of all such persons, whether such Indebtedness now
exists or will hereafter be created,
(a) an event of default that has caused the holder thereof to declare
such Indebtedness to be due and payable prior to its Stated Maturity
and such
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Indebtedness has not been discharged in full or such acceleration
has not been rescinded or annulled within 30 days of such
acceleration and/or
(b) the failure to make a principal payment at the final, but not any
interim, fixed maturity and such defaulted payment will not have
been made, waived or extended within 30 days of such payment
default;
(6) any final judgment or order not covered by insurance for the payment of
money in excess of $5 million in the aggregate for all such final
judgments or orders against all such persons, treating any deductibles,
self-insurance or retention as not so covered, will be rendered against
Allegiance Telecom, Inc. or any Significant Subsidiary and will not be
paid or discharged, and there will be any period of 30 consecutive days
following entry of the final judgment or order that causes the
aggregate amount for all such final judgments or orders outstanding and
not paid or discharged against all such persons to exceed $5 million
during which a stay of enforcement of such final judgment or order, by
reason of a pending appeal or otherwise, will not be in effect;
(7) a court having jurisdiction in the premises enters a decree or order
for
(a) relief in respect of Allegiance Telecom, Inc. or any Significant
Subsidiary in an involuntary case under any applicable bankruptcy,
insolvency or other similar law now or hereafter in effect,
(b) appointment of a receiver, liquidator, assignee, custodian, trustee,
sequestrator or similar official of Allegiance Telecom, Inc. or any
Significant Subsidiary or for all or substantially all of the
property and assets of Allegiance Telecom, Inc. or any Significant
Subsidiary or
(c) the winding up or liquidation of the affairs of Allegiance Telecom,
Inc. or any Significant Subsidiary and, in each case, such decree or
order will remain in effect for a period of 30 consecutive days
without being stayed or put on hold by a court;
(8) Allegiance Telecom, Inc. or any Significant Subsidiary
(a) commences a voluntary case under any applicable bankruptcy,
insolvency or other similar law now or hereafter in effect, or
consents to the entry of an order for relief in an involuntary case
under any such law,
(b) consents to the appointment of or taking possession by a receiver,
liquidator, assignee, custodian, trustee, sequestrator or similar
official of Allegiance Telecom, Inc. or any Significant Subsidiary
or for all or substantially all of the property and assets of
Allegiance Telecom, Inc. or any Significant Subsidiary or
(c) effects any general assignment for the benefit of creditors; or
(9) the Pledge Agreement will cease to be in full force and effect or
enforceable in accordance with its terms, other than in accordance with
its terms.
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If an Event of Default other than one specified in clause (7) or (8) above that
occurs with respect to Allegiance Telecom, Inc. occurs and is continuing under
the indenture, the trustee or the holders of at least 25% in aggregate principal
amount of the notes, then outstanding, by written notice to Allegiance Telecom,
Inc. and to the trustee if such notice is given by the holders, may, and the
trustee at the request of such holders will, declare the principal of, premium,
if any, and accrued interest on the notes to be immediately due and payable.
Upon a declaration of acceleration, such principal of, premium, if any, and
accrued interest will be immediately due and payable.
In the event of a declaration of acceleration because an Event of Default set
forth in clause (5) above has occurred and is continuing, such declaration of
acceleration will be automatically rescinded and annulled if the event of
default triggering such Event of Default under clause (5) will be remedied or
cured by Allegiance Telecom, Inc. or the relevant Significant Subsidiary or
waived by the holders of the relevant Indebtedness within 60 days after the
declaration of acceleration with respect thereto.
If an Event of Default specified in clause (7) or (8) above occurs with respect
to Allegiance Telecom, Inc., the principal of, premium, if any, and accrued
interest on the notes then outstanding will automatically become and be
immediately due and payable without any declaration or other act on the part of
the trustee or any holder. The holders of at least a majority in principal
amount of the outstanding notes by written notice to Allegiance Telecom, Inc.
and to the trustee, may waive all past defaults and rescind and annul a
declaration of acceleration and its consequences if (a) all existing Events of
Default, other than the nonpayment of the principal of, premium, if any, and
interest on the notes that have become due solely by such declaration of
acceleration, have been cured or waived and (b) the rescission would not
conflict with any judgment or decree of a court of competent jurisdiction. For
information as to the waiver of defaults, see "-- Modification and Waiver."
The holders of at least a majority in aggregate principal amount of the
outstanding notes may direct the time, method and place of conducting any
proceeding for any remedy available to the trustee or exercising any trust or
power conferred on the trustee. However, the trustee may refuse to follow any
direction that conflicts with law or the indenture, that may involve the trustee
in personal liability, or that the trustee determines in good faith may be
unduly prejudicial to the rights of holders of notes not joining in the giving
of such direction and may take any other action it deems proper that is not
inconsistent with any such direction received from holders of notes.
A holder may not pursue any remedy with respect to the indenture or the notes
unless:
(1) the holder gives the trustee written notice of a continuing Event of
Default;
(2) the holders of at least 25% in aggregate principal amount of
outstanding notes make a written request to the trustee to pursue the
remedy;
(3) such holder or holders offer the trustee indemnity satisfactory to the
trustee against any costs, liability or expense;
(4) the trustee does not comply with the request within 60 days after
receipt of the request and the offer of indemnity; and
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(5) during such 60-day period, the holders of a majority in aggregate
principal amount of the outstanding notes do not give the trustee a
direction that is inconsistent with the request.
However, such limitations do not apply to the right of any holder of a note to
receive payment of the principal of, premium, if any, or interest on, such note
or to bring suit for the enforcement of any such payment, on or after the due
date expressed in the notes, which right will not be impaired or affected
without the consent of the holder.
The indenture requires certain officers of Allegiance Telecom, Inc. to certify,
on or before a date not more than 90 days after the end of each fiscal year,
that a review has been conducted of the activities of Allegiance Telecom, Inc.
and its Restricted Subsidiaries and Allegiance Telecom, Inc.'s and its
Restricted Subsidiaries' performance under the indenture and that Allegiance
Telecom, Inc. has fulfilled all obligations thereunder, or, if there has been a
default in the fulfillment of any such obligation, specifying each such default
and the nature and status thereof. Allegiance Telecom, Inc. will also be
obligated to notify the trustee of any default or defaults in the performance of
any covenants or agreements under the indenture.
CONSOLIDATION, MERGER AND SALE OF ASSETS
Allegiance Telecom, Inc. will not consolidate with, merge with or into, or sell,
convey, transfer, lease or otherwise dispose of all or substantially all of its
property and assets to any person or permit any person to merge with or into
Allegiance Telecom, Inc. unless:
(1) Allegiance Telecom, Inc. will be the continuing person, or the person,
if other than Allegiance Telecom, Inc., formed by such consolidation or
into which Allegiance Telecom, Inc. is merged or that acquired or
leased such property and assets of Allegiance Telecom, Inc. will be a
corporation organized and validly existing under the laws of the United
States of America or any jurisdiction thereof and will expressly
assume, by a supplemental indenture, executed and delivered to the
trustee, all of the obligations of Allegiance Telecom, Inc. on all of
the notes and under the indenture;
(2) immediately after giving effect to such transaction, no Default or
Event of Default will have occurred and be continuing;
(3) immediately after giving effect to such transaction on a pro forma
basis, Allegiance Telecom, Inc. or any person becoming the successor
obligor of the notes will have a Consolidated Net Worth equal to or
greater than the Consolidated Net Worth of Allegiance Telecom, Inc.
immediately prior to such transaction;
(4) immediately after giving effect to such transaction on a pro forma
basis Allegiance Telecom, Inc., or any person becoming the successor
obligor of the notes, as the case may be, could incur at least $1.00 of
Indebtedness under the first paragraph of the "Limitation on
Indebtedness" covenant, however, this clause (4) will not apply to:
(a) a consolidation, merger or sale of all but not less than all of the
assets of Allegiance Telecom, Inc. if all Liens and Indebtedness of
Allegiance
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Telecom, Inc. or any person becoming the successor obligor on the
notes, as the case may be, and its Restricted Subsidiaries
outstanding immediately after such transaction would, if incurred at
such time, have been permitted to be incurred, and all such Liens
and Indebtedness, other than Liens and Indebtedness of Allegiance
Telecom, Inc. and its Restricted Subsidiaries outstanding
immediately prior to the transaction, will be deemed to have been
incurred, for all purposes of the indenture; or
(b) a consolidation, merger or sale of all or substantially all of the
assets of Allegiance Telecom, Inc. if immediately after giving
effect to such transaction on a pro forma basis, Allegiance Telecom,
Inc. or any person becoming the successor obligor of the notes will
have a Consolidated Leverage Ratio equal to or less than the
Consolidated Leverage Ratio of Allegiance Telecom, Inc. immediately
prior to such transaction; and
(c) Allegiance Telecom, Inc. delivers to the trustee an Officers'
Certificate and Opinion of Counsel, in each case stating that such
consolidation, merger or transfer and such supplemental indenture
complies with this provision and that all conditions precedent
provided for herein relating to such transaction have been complied
with.
However, clauses (3) and (4) above do not apply if, in the good faith
determination of the Board of Directors of Allegiance Telecom, Inc the principal
purpose of such transaction is to change the state of incorporation of
Allegiance Telecom, Inc. so long as any such transaction will not have as one of
its purposes the evasion of the foregoing limitations.
DEFEASANCE
Defeasance and Discharge. The indenture provides that Allegiance Telecom, Inc.
will be deemed to have paid and will be discharged from any and all obligations
in respect of the notes on the 123rd day after the deposit referred to below,
and the provisions of the indenture will no longer be in effect with respect to
the notes, except for, among other matters, certain obligations to register the
transfer or exchange of the notes, to replace stolen, lost or mutilated notes,
to maintain paying agencies and to hold monies for payment in trust, if, among
other things:
(1) Allegiance Telecom, Inc. has deposited with the trustee, in trust,
money and/or U.S. Government Obligations that through the payment of interest
and principal in respect thereof in accordance with their terms will provide
money in an amount sufficient to pay the principal of, premium, if any, and
accrued interest on the notes on the Stated Maturity of such payments in
accordance with the terms of the indenture and the notes;
(2) Allegiance Telecom, Inc. has delivered to the trustee
(a) either (A) an Opinion of Counsel to the effect that holders will not
recognize income, gain or loss for federal income tax purposes as a
result of Allegiance Telecom, Inc.'s exercise of its option under
this "Defeasance" provision and will be subject to federal income
tax on the same amount and in the same manner and at the same times
as would have been the case if such deposit, defeasance and
discharge had not occurred, which Opinion of
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Counsel must be based upon and accompanied by a copy of a ruling of
the Internal Revenue Service to the same effect unless there has
been a change in applicable federal income tax law after the Closing
Date such that a ruling is no longer required or (B) a ruling
directed to the trustee received from the Internal Revenue Service
to the same effect as the aforementioned Opinion of Counsel, and
(b) an Opinion of Counsel to the effect that the creation of the
defeasance trust does not violate the Investment Company Act of 1940
and after the passage of 123 days following the deposit, the trust
fund will not be subject to the effect of Section 547 of the United
States Bankruptcy Code or Section 15 of the New York Debtor and
Creditor Law;
(3) immediately after giving effect to such deposit on a pro forma basis,
no Event of Default, or event that after the giving of notice or lapse
of time or both would become an Event of Default, will have occurred
and be continuing on the date of such deposit or during the period
ending on the 123rd day after the date of such deposit, and such
deposit will not result in a breach or violation of, or constitute a
default under, any other agreement or instrument to which Allegiance
Telecom, Inc. or any of its Subsidiaries is a party or by which
Allegiance Telecom, Inc. or any of its Subsidiaries is bound; and
(4) if at such time the notes are listed on a national securities exchange,
Allegiance Telecom, Inc. has delivered to the trustee an Opinion of
Counsel to the effect that the notes will not be delisted as a result
of such deposit, defeasance and discharge.
Defeasance of Certain Covenants and Certain Events of Default. The indenture
further provides that the provisions of the indenture will no longer be in
effect with respect to clauses (3) and (4) under "Consolidation, Merger and Sale
of Assets" and all the covenants described herein under "Covenants," clause (3)
under "Events of Default" with respect to such clauses (3) and (4) under
"Consolidation, Merger and Sale of Assets," clause (4) under "Events of Default"
with respect to such other covenants and clauses (5) and (6) under "Events of
Default" will be deemed not to be Events of Default upon, among other things,
the deposit with the trustee, in trust, of money and/or U.S. Government
Obligations that through the payment of interest and principal in respect
thereof in accordance with their terms will provide money in an amount
sufficient to pay the principal of, premium, if any, and accrued interest on the
notes on the Stated Maturity of such payments in accordance with the terms of
the indenture and the notes, the satisfaction of the provisions described in
clauses (2)(b), (3) and (4) of the preceding paragraph and the delivery by
Allegiance Telecom, Inc. to the trustee of an Opinion of Counsel to the effect
that, among other things, the holders will not recognize income, gain or loss
for federal income tax purposes as a result of such deposit and defeasance of
certain covenants and Events of Default and will be subject to federal income
tax on the same amount and in the same manner and at the same times as would
have been the case if such deposit and defeasance had not occurred.
Defeasance and Certain Other Events of Default. In the event Allegiance Telecom,
Inc. exercises its option to omit compliance with certain covenants and
provisions of the indenture with respect to the notes as described in the
immediately preceding paragraph
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and the notes are declared due and payable because of the occurrence of an Event
of Default that remains applicable, the amount of money and/or U.S. Government
Obligations on deposit with the trustee will be sufficient to pay amounts due on
the notes at the time of their Stated Maturity but may not be sufficient to pay
amounts due on the notes at the time of the acceleration resulting from such
Event of Default. However, Allegiance Telecom, Inc. will remain liable for such
payments.
MODIFICATION AND WAIVER
Modifications and amendments of the indenture may be made by Allegiance Telecom,
Inc. and the trustee with the consent of the holders of not less than a majority
in aggregate principal amount of the outstanding notes. However, no such
modification or amendment may, without the consent of each holder affected
thereby;
(1) change the Stated Maturity of the principal of, or any installment of
interest on, any note;
(2) reduce the principal of, or premium, if any, or interest on, any note;
(3) change the place or currency of payment of principal of, or premium, if
any, or interest on, any note;
(4) impair the right to institute suit for the enforcement of any payment
of any note on or after the Stated Maturity or, in the case of a
redemption, on or after the Redemption Date;
(5) reduce the above-stated percentage of outstanding notes the consent of
whose holders is necessary to modify or amend the indenture;
(6) waive a default in the payment of principal of, premium, if any, or
interest on the notes; or
(7) reduce the percentage or aggregate principal amount of outstanding
notes the consent of whose holders is necessary for waiver of
compliance with certain provisions of the indenture or for waiver of
certain defaults.
NO PERSONAL LIABILITY OF INCORPORATORS, STOCKHOLDERS, OFFICERS, DIRECTORS, OR
EMPLOYEES
The indenture provides that no recourse for the payment of the principal of,
premium, if any, or interest on any of the notes or for any claim based thereon
or otherwise in respect thereof, and no recourse under or upon any obligation,
covenant or agreement of Allegiance Telecom, Inc. in the indenture, or in any of
the notes or because of the creation of any Indebtedness represented thereby,
will be had against any incorporator, stockholder, officer, director, employee
or controlling person of Allegiance Telecom, Inc. or of any successor person
thereof. Each holder, by accepting the notes, waives and releases all such
liability.
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CONCERNING THE TRUSTEE
The indenture provides that, except during the continuance of a Default, the
trustee will not be liable, except for the performance of such duties as are
specifically set forth in such indenture. If an Event of Default has occurred
and is continuing, the trustee will use the same degree of care and skill in its
exercise of the rights and powers vested in it under the indenture as a prudent
person would exercise under the circumstances in the conduct of such person's
own affairs.
The indenture and provisions of the Trust Indenture Act of 1939, as amended,
incorporated by reference therein contain limitations on the rights of the
trustee, should it become a creditor of Allegiance Telecom, Inc., to obtain
payment of claims in certain cases or to realize on certain property received by
it in respect of any such claims, as security or otherwise. The trustee is
permitted to engage in other transactions but if it acquires any conflicting
interest, it must eliminate such conflict or resign.
The trustee is also the trustee under the 11 3/4% notes indenture.
BOOK-ENTRY; DELIVERY AND FORM
The notes were initially represented by one or more global notes issued in the
form of fully registered global notes, which were deposited with, or on behalf
of, the Depositary and registered in the name of a nominee of the Depositary.
Transfers between participants in the Depositary will be effected in the
ordinary way in accordance with the Depositary's rules and will be settled in
same-day funds.
The Depositary has advised Allegiance Telecom, Inc. that the Depositary intends
to follow the procedures described below:
The Depositary will act as securities depository for the global notes. The
global notes will be issued as a fully registered security registered in
the name of Cede & Co., the Depositary's nominee.
The Depositary is a limited-purpose trust company organized under the New
York Banking Law, a "banking organization" within the meaning of the New
York Banking Law, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code,
and a "clearing agency" registered under the Provisions of Section 17A of
the Exchange Act. The Depositary holds securities that its participants
deposit with the Depositary. The Depositary also facilitates the settlement
among participants of securities transactions, such as transfers and
pledges, in deposited securities through electronic computerized book-
entry changes in participants' accounts, thereby eliminating the need for
physical movement of securities certificates. Direct participants include
securities brokers and dealers, banks, trust companies, clearing
corporations, and certain other organizations. The Depositary is owned by a
number of its direct participants and by the New York Stock Exchange, Inc.,
the AMEX and the National Association of Securities Dealers, Inc. Access to
the Depositary's system is also available to others such as securities
brokers and dealers, banks, and trust companies that clear through or
maintain a custodial relationship with a direct participant, either
directly or indirectly. The Rules applicable to the Depositary and its
participants are on file with the Commission.
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Purchases of notes must be made by or through direct participants, which
will receive a credit for the notes on the Depositary's records. The
ownership interest of each actual purchaser of each note ("Beneficial
Owner") is in turn recorded on the direct and indirect participant's
records. Transfers of ownership interests in the notes are to be
accomplished by entries made on the books of participants acting on behalf
of Beneficial Owners. Beneficial Owners will not receive certificates
representing their ownership interests in the notes, except in the event
that use of the book-entry system for the notes is discontinued.
Conveyance of notes and other communications by the Depositary to direct
participants, by direct participants to indirect participants, and direct
participants and indirect participants to Beneficial Owners are governed by
arrangements among them, subject to any statutory or regulatory
requirements as may be in effect from time to time.
Redemption notices will be sent to Cede & Co. If less than all of the notes
are being redeemed, the Depositary's practice is to determine by lot the
amount of the interest of each direct participant in such issue to be
redeemed.
Neither the Depositary nor Cede & Co. will consent or vote with respect to
the notes. Under its usual procedures, the Depositary mails an Omnibus
Proxy to the issuer as soon as possible after the record date. The Omnibus
Proxy assigns Cede & Co.'s consenting or voting rights to those direct
participants to whose accounts the notes are credited on the record date,
identified in a listing attached to the Omnibus Proxy.
Principal, any premium, and interest payments on the notes will be made to
the Depositary. The Depositary's practice is to credit direct participants'
accounts on the payable date in accordance with their respective holdings
shown on the Depositary's records unless the Depositary has reason to
believe that it will not receive payment on the payable date. Payments by
participants to Beneficial Owners will be governed by standing instructions
and customary practices, as is the case with securities held for the
accounts of customers in bearer form or registered in "street name," and
will be the responsibility of such participant and not of the Depositary,
the Paying Agent, or Allegiance Telecom, Inc., subject to any statutory or
regulatory requirements as may be in effect from time to time. Payment to
the Depositary of principal, any premium, and interest on the notes are the
responsibility of Allegiance Telecom, Inc. or the Paying Agent,
disbursement of such payments to direct participants will be the
responsibility of the Depositary, and disbursement of such payments to the
Beneficial Owners will be the responsibility of direct and indirect
participants.
The information in this section concerning the Depositary and the Depositary's
book-entry system has been obtained from sources that Allegiance Telecom, Inc.
believes to be reliable, but Allegiance Telecom, Inc. takes no responsibility
for the accuracy thereof.
So long as the Depositary for the global notes, or its nominee, is the
registered owner of the global notes, the Depositary or its nominee, as the case
may be, will be considered the sole owner or holder of the notes represented by
the global notes for all purposes under the indenture. Except as set forth
below, owners of beneficial interests in such global notes will not be entitled
to have notes represented by such global notes registered in their names, will
not receive or be entitled to receive physical delivery of notes in definitive
form and will not be considered the owners or holders thereof under the
indenture. Accordingly,
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each person owning a beneficial interest in global notes must rely on the
procedures of the Depositary and, if such person is not a participant, those of
the participant through which such person owns its interests, in order to
exercise any rights of a holder under the indenture or such note.
The indenture provides that the Depositary, as a holder, may appoint agents and
otherwise authorize participants to give or take any request, demand,
authorization, direction, notice, consent, waiver or other action which a holder
is entitled to give or take under the indenture, including the right to sue for
payment of principal or interest under Section 316(b) of the Trust Indenture Act
of 1939, as amended. Allegiance Telecom, Inc. understands that under existing
industry practices, when Allegiance Telecom, Inc. requests any action of holders
or when a Beneficial Owner desires to give or take any action which a holder is
entitled to give or take under the indenture, the Depositary generally will give
or take such action, or authorize the relevant participants to give or take such
action, and such participants would authorize Beneficial Owners owning through
such participants to give or take such action or would otherwise act upon the
instructions of Beneficial Owners owning through them.
Allegiance Telecom, Inc. has been informed by the Depositary that the Depositary
will assist its participants and their customers (Beneficial Owners) in taking
any action a holder is entitled to take under the indenture or exercise any
rights available to Cede & Co., as the holder of record of the notes and
including the right to demand acceleration of the notes upon an Event of Default
or to institute suit for the enforcement of payment or interest under Section
316(b) of the Trust Indenture Act of 1939, as amended. The Depositary has
advised Allegiance Telecom, Inc. that it will act with respect to such matters
upon written instructions from a participant to whose account with the
Depositary the relevant beneficial ownership in the notes is credited.
Allegiance Telecom, Inc. understands that a participant will deliver such
written instructions to the Depositary upon itself receiving similar written
instructions from either indirect participants or Beneficial Owners, as the case
may be. Under Rule 6 of the rules and procedures filed by the Depositary with
the Commission under Section 17 of the Exchange Act, participants are required
to indemnify the Depositary against all liability the Depositary may sustain,
without fault on the part of the Depositary or its nominee, as a result of any
action they may take under the instructions of the participant in exercising any
such rights.
The laws of some jurisdictions require that certain purchasers of securities
take physical delivery of such securities in definitive form. Such limits and
such laws may impair the ability to transfer beneficial interests in the global
notes.
Principal, premium, if any, and interest payments on notes registered in the
name of or held by the Depositary or its nominee will be made to the Depositary
or its nominee, as the case may be, as the registered owner or the holder of the
global notes representing such notes. Neither Allegiance Telecom, Inc. nor the
trustee will have any responsibility or liability for any aspect of the records
relating to or payments made on account of beneficial ownership interests in the
global notes or for maintaining, supervising or reviewing any records relating
to such beneficial ownership interests.
If the Depositary is at any time unwilling, unable or ineligible to continue as
depositary and a successor depositary is not appointed by Allegiance Telecom,
Inc. within 60 days or, if an Event of Default under the indenture has occurred
and is continuing, Allegiance
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Telecom, Inc. will issue notes in definitive registered form, without coupons,
in denominations of $1,000 of principal amount and any integral multiple
thereof, in exchange for the global notes representing such notes. In addition,
Allegiance Telecom, Inc. may at any time and in its sole discretion determine
not to have any notes in registered form represented by the global notes and, in
such event, will issue notes or in definitive registered form in exchange for
the global notes representing such notes. In any such instance, an owner of a
beneficial interest in a global note will be entitled to physical delivery in
definitive form of notes registered in its name. Upon the exchange of the global
notes for notes in definitive form, the global notes will be cancelled by the
trustee.
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DESCRIPTION OF CAPITAL STOCK
GENERAL MATTERS
The total amount of authorized capital stock of Allegiance consists of
150,000,000 shares of common stock, par value $.01 per share, and 1,000,000
shares of preferred stock, par value $.01 per share. 50,341,554 shares of common
stock are currently issued and outstanding and no shares of preferred stock are
currently issued and outstanding. The following discussion describes
Allegiance's capital stock, its charter and by-laws. This summary describes all
material provisions of Allegiance's charter and by-laws. If you would like to
read copies of these documents, we have filed copies with the SEC.
Allegiance's charter and by-laws contain certain provisions that are intended to
enhance the likelihood of continuity and stability in the composition of the
Board of Directors. These provisions may have the effect of delaying, deferring
or preventing a future takeover or change in control of Allegiance unless the
takeover or change in control is approved by the Board of Directors.
COMMON STOCK
Subject to the prior rights of the holders of any preferred stock, the holders
of outstanding shares of common stock are entitled to receive dividends out of
assets legally available at such time and in such amounts as the Board of
Directors may from time to time determine. The shares of common stock are not
convertible and the holders have no preemptive or subscription rights to
purchase any securities of Allegiance. Upon liquidation, dissolution or winding
up of Allegiance, the holders of common stock are entitled to receive pro rata,
the assets of Allegiance which are legally available for distribution, after
payment of all debts and other liabilities and subject to the prior rights of
any holders of preferred stock then outstanding. Each outstanding share of
common stock is entitled to one vote on all matters submitted to a vote of
stockholders. There is no cumulative voting.
PREFERRED STOCK
Allegiance's Board of Directors may, without further action by Allegiance's
stockholders, from time to time, direct the issuance of shares of preferred
stock in series and may, at the time of issuance, determine the rights,
preferences and limitations of each series. Satisfaction of any dividend
preferences of outstanding shares of preferred stock would reduce the amount of
funds available for the payment of dividends on shares of common stock. Holders
of shares of preferred stock may be entitled to receive a preference payment in
the event of any liquidation, dissolution or winding-up of Allegiance before any
payment is made to the holders of shares of common stock. Under certain
circumstances, the issuance of shares of preferred stock may render more
difficult or tend to discourage a merger, tender offer or proxy contest, the
assumption of control by a holder of a large block of Allegiance's securities or
the removal of incumbent management. Upon the affirmative vote of a majority of
the total number of directors then in office, the Board of Directors of
Allegiance, without stockholder approval, may issue shares of preferred stock
with voting and conversion rights which could adversely affect the holders of
shares of
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common stock. There are no shares of preferred stock currently outstanding, and
Allegiance has no present intention to issue any shares of preferred stock.
CERTAIN PROVISIONS OF ALLEGIANCE'S CHARTER AND BY-LAWS
Allegiance's charter provides for the Board of Directors to be divided into
three classes, as nearly equal in number as possible, serving staggered terms.
Approximately one-third of the Board of Directors will be elected each year. See
"Management." Under the Delaware General Corporation Law, directors serving on a
classified board can only be removed for cause. The provision for a classified
board could prevent a party who acquires control of a majority of the
outstanding voting stock from obtaining control of the Board of Directors until
the second annual stockholders meeting following the date the acquiror obtains
the controlling stock interest. The classified board provision could have the
effect of discouraging a potential acquiror from making a tender offer or
otherwise attempting to obtain control of Allegiance and could increase the
likelihood that incumbent directors will retain their positions.
Allegiance's charter provides that stockholder action can be taken only at an
annual or special meeting of stockholders and cannot be taken by written consent
in lieu of a meeting. Allegiance's charter and the by-laws provides that, except
as otherwise required by law, special meetings of the stockholders can only be
called under a resolution adopted by a majority of the Board of Directors or by
the Chief Executive Officer of Allegiance. Stockholders will not be permitted to
call a special meeting or to require the Board of Directors to call a special
meeting.
Allegiance's by-laws establish an advance notice procedure for stockholder
proposals to be brought before an annual meeting of stockholders of Allegiance,
including proposed nominations of persons for election to the Board of
Directors.
Stockholders at an annual meeting may only consider proposals or nominations
specified in the notice of meeting or brought before the meeting by or at the
direction of the Board of Directors or by a stockholder who was a stockholder of
record on the record date for the meeting, who is entitled to vote at the
meeting and who has given to Allegiance's Secretary timely written notice, in
proper form, of the stockholder's intention to bring that business before the
meeting. Although the by-laws do not give the Board of Directors the power to
approve or disapprove stockholder nominations of candidates or proposals
regarding other business to be conducted at a special or annual meeting, the
by-laws may have the effect of precluding the conduct of certain business at a
meeting if the proper procedures are not followed or may discourage or defer a
potential acquiror from conducting a solicitation of proxies to elect its own
slate of directors or otherwise attempting to obtain control of Allegiance.
Allegiance's charter and by-laws provide that the affirmative vote of holders of
at least 66 2/3% of the total votes eligible to be cast in the election of
directors is required to amend, alter, change or repeal certain of their
provisions. This requirement of a super-majority vote to approve amendments to
its charter and by-laws could enable a minority of Allegiance's stockholders to
exercise veto power over any such amendments.
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CERTAIN PROVISIONS OF DELAWARE LAW
Allegiance is subject to the "Business Combination" provisions of the Delaware
General Corporation Law. In general, such provisions prohibit a publicly held
Delaware corporation from engaging in various "business combination"
transactions with any "interested stockholder" for a period of three years after
the date of the transaction which the person became an "interested stockholder,"
unless:
- - the transaction is approved by the Board of Directors prior to the date the
"interested stockholder" obtained such status;
- - upon consummation of the transaction which resulted in the stockholder
becoming an "interested stockholder," the "interested stockholder," owned at
least 85% of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned by (a) persons who are directors and
also officers and (b) employee stock plans in which employee participants do
not have the right to determine confidentially whether shares held subject to
the plan will be tendered in a tender or exchange offer; or
- - on or subsequent to such date the "business combination" is approved by the
Board of Directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of at least 66 2/3% of the outstanding
voting stock which is not owned by the "interested stockholder."
A "business combination" is defined to include mergers, asset sales and other
transactions resulting in financial benefit to a stockholder. In general, an
"interested stockholder" is a person who, together with affiliates and
associates, owns or within three years did own, 15% or more of a corporation's
voting stock. The statute could prohibit or delay mergers or other takeover or
change in control attempts with respect to Allegiance and, accordingly, may
discourage attempts to acquire Allegiance.
LIMITATIONS ON LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
Allegiance's charter limits the liability of Directors to the fullest extent
permitted by the Delaware General Corporation Law. In addition, the charter
provides that Allegiance will indemnify Directors and officers of Allegiance to
the fullest extent permitted by such law. Allegiance anticipates entering into
indemnification agreements with its current Directors and executive officers and
any new Directors or executive officers.
WARRANTS
In connection with the offering of the 11 3/4% notes, Allegiance issued 445,000
redeemable warrants under the Warrant Agreement between Allegiance and The Bank
of New York.
Each redeemable warrant is exercisable to purchase 1.45898399509 shares of
common stock at an exercise price of $.01 per share, subject to adjustment. The
redeemable warrants may be exercised at any time on or after February 3, 1999
and prior to February 3, 2008. Upon the occurrence of a merger with a person
that does not have a class of equity securities registered under the Securities
Exchange Act of 1934, as amended (the "Exchange Act") in connection with which
the consideration to stockholders of Allegiance is not all cash, Allegiance or
its successor by merger or consolidation will be required to offer to repurchase
the redeemable warrants. All such
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repurchases will be at the market price of the common stock or other securities
issuable upon exercise of the redeemable warrants or, if the common stock or
such other securities are not registered under the Exchange Act, the value of
the common stock or other securities as determined by an independent financial
expert, less the exercise price thereof.
REGISTRATION RIGHTS
The Fund Investors, the Management Investors, and Allegiance are parties to a
Registration Agreement dated as of August 13, 1997. Each of Morgan Stanley
Capital Partners, Madison Dearborn Capital Partners, and Frontenac Company is
entitled to demand two long-form registrations and unlimited short-form
registrations, and Battery Ventures is entitled to demand one long-form
registration and unlimited short-form registrations. In addition, the Fund
Investors and the Management Investors may "piggyback" on primary or secondary
registered public offerings of Allegiance's securities. Each Fund Investor and
Management Investor is subject to holdback restrictions in the event of a public
offering of Allegiance securities. The parties to the Registration Agreement
have agreed to permit the holders of redeemable warrants to "piggyback" on any
registrations under the Registration Agreement.
Allegiance and The Bank of New York are parties to a Warrant Registration Rights
Agreement dated as of February 3, 1998. The holders of the redeemable warrants
are entitled to "piggyback" registration rights in connection with certain
public offerings of the common stock. In addition, Allegiance is required to use
its best efforts to cause to become effective under the Securities Act, within
180 days after the closing of the initial public offering of common stock, a
shelf registration statement with respect to the issuance of the common stock
issuable upon exercise of the redeemable warrants; except that such shelf
registration statement may not be declared effective prior to the first
anniversary of the issuance of the redeemable warrants. Once the shelf
registration statement is declared effective, Allegiance is required to maintain
the effectiveness of such registration statement until all redeemable warrants
have expired or been exercised.
126
<PAGE> 127
CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS
The following is a general discussion of the principal United States federal
income tax consequences of the purchase, ownership and disposition of the
12 7/8% notes to both initial and subsequent purchasers of the 12 7/8% notes.
This discussion is based on currently existing provisions of the Code, existing,
temporary and proposed Treasury regulations issued by the IRS, and
administrative and judicial interpretations thereof, all as in effect or
proposed on the date of this prospectus and all of which are subject to change,
possibly with retroactive effect, or different interpretations. This discussion
is limited to purchasers who hold the 12 7/8% notes as capital assets, within
the meaning of section 1221 of the Code and is for general information only and
does not address all of the tax consequences that may be relevant to particular
purchasers in light of their personal circumstances or to certain types of
initial purchasers, such as certain financial institutions, insurance companies,
tax-exempt entities, dealers in securities, certain U.S. expatriates, persons
who have hedged the risk of owning a 12 7/8% note or holders whose "functional
currency" is not the U.S. dollar. Moreover, the effect of any applicable foreign
taxes and any applicable federal state, local, gift, estate or other tax laws is
generally not discussed.
As used in this prospectus, the term "U.S. Holder" means an initial or
subsequent purchaser of a 12 7/8% note that is, for United States federal income
tax purposes,
(a) a citizen or individual resident of the United States, or one treated as a
citizen or resident under the Code,
(b) a corporation, partnership or other entity created or organized in or under
the laws of the United States or any political subdivision of the United States,
or an entity treated as created or organized in or under the laws of the United
States or any political subdivision of the United States,
(c) an estate the income of which is subject to United States federal income
taxation regardless of source, or
(d) a trust subject to the primary supervision of a court within the United
States and the control of a United States person, as described in the Code. An
individual may, subject to certain exceptions, be deemed to be a United States
resident (as opposed to a non-resident alien) by virtue of being present in the
United States on at least 31 days in the calendar year and for an aggregate of
at least 183 days during a three-year period ending in the current calendar year
(counting for such purposes all of the days present in the current year,
one-third of the days present in the immediately preceding year, and one-sixth
of the days present in the second preceding year). Resident aliens are subject
to U.S. federal tax as if they were U.S. citizens. As used in this prospectus, a
"Non-U.S. Holder" is a holder that is not a U.S. Holder.
ALL PROSPECTIVE PURCHASERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE
PARTICULAR TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION
OF THE NOTES, INCLUDING THE APPLICABILITY OF ANY FEDERAL TAX LAWS OR ANY STATE,
LOCAL OR FOREIGN TAX LAWS, AND ANY CHANGES (OR PROPOSED CHANGES) IN APPLICABLE
TAX LAWS OR INTERPRETATIONS THEREOF.
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<PAGE> 128
UNITED STATES FEDERAL INCOME TAXATION OF UNITED STATES HOLDERS
Interest. Stated interest paid on a 12 7/8% note generally will be taxable to a
U.S. Holder as ordinary interest income as it accrues or is received, in
accordance with such U.S. Holder's method of accounting for United States
federal income tax purposes. U.S. Holders of the 12 7/8% notes will not be
required to include any original issue discount ("OID") in gross income for U.S.
federal income tax purposes as a consequence of the issuance of the 12 7/8%
notes at an approximately 2% discount from their principal amount because the
amount of OID created by such discount will not exceed the de minimis threshold
as determined under Section 1273(a)(3) of the Code and thus will be treated as
zero.
Optional Redemption. The 12 7/8% notes may be redeemed prior to their stated
maturity at the option of Allegiance. For purposes of computing the yield of
such instruments, Allegiance will be deemed to exercise or not exercise its
option to redeem the 12 7/8% notes in a manner that minimizes the yield on the
12 7/8% notes. In the event Allegiance were deemed to exercise its option to
redeem, for purposes of determining whether the 12 7/8% notes were issued with
OID, the 12 7/8% notes' yield to maturity would be computed by treating the
deemed redemption date as the maturity date of the 12 7/8% notes and the amount
payable on redemption as the principal amount of the 12 7/8% notes. It is not
anticipated that Allegiance's option to redeem the 12 7/8% notes prior to stated
maturity will be treated as exercised.
Redemption, Sale, Exchange or Retirement of the 12 7/8% Notes. In general, a
U.S. Holder will recognize gain or loss on the redemption, sale, exchange or
retirement of the 12 7/8% notes equal to the difference between the amount
realized on the redemption, sale, exchange or retirement (reduced by any amounts
attributable to accrued but unpaid interest, which will be taxable as ordinary
interest income) and such U.S. Holder's adjusted tax basis in the 12 7/8% note.
A U.S. Holder's adjusted tax basis in the 12 7/8% note generally will be its
cost to such U.S. Holder. As a general rule, such gain or loss recognized on the
redemption, sale, exchange or retirement of the 12 7/8% notes will be capital
gain or loss. With respect to individuals, gain is subject to reduced rates of
tax if the 12 7/8% note was held for more than twelve months as of the date of
redemption, sale, exchange or retirement.
Market Discount -- Applicable For Subsequent Purchasers. If a U.S. Holder
purchases a 12 7/8% note for an amount that is less than such 12 7/8% note's
stated redemption price at maturity (i.e., in this case the 12 7/8% note's face
amount), the amount of the difference will be treated as "market discount" for
federal income tax purposes, unless such difference is less than .25% multiplied
by the complete number of years to maturity, after its acquisition by the U.S.
Holder. All prospective purchasers should consult their own tax advisors
regarding the application of the market discount rules, which in certain cases
can require a U.S. Holder to treat any principal payments on, or any gain on the
sale, exchange, retirement or other disposition of, a 12 7/8% note as ordinary
income to the extent of the market discount that has not previously been
included in income, including the effect of
(a) the market discount rules on the interest deductibility of any indebtedness
incurred or continued to purchase or carry such 12 7/8% note,
(b) certain available elections for U.S. Holder's to elect (1) to accrue market
discount on a constant interest method rather than ratably or (2) to accrue
market discount into income currently, and
128
<PAGE> 129
(c) President Clinton's Fiscal Year 2000 Budget which includes a proposal that,
if enacted, would require holders that use an accrual method of accounting to
include market discount in income as it accrues.
Amortizable Bond Premium -- Applicable For Subsequent Purchasers. A U.S. Holder
that purchases a 12 7/8% note for an amount in excess of the sum of all amounts
payable on the 12 7/8% note, other than stated interest, after the initial
purchase date of the 12 7/8% note will be considered to have purchased the
12 7/8% note at a "premium." All prospective purchasers should consult their own
tax advisors regarding the application of the market premium rules, including
the effect of certain available elections for U.S. Holder's to elect to amortize
market premium on a constant yield method. If such an election is made, the
amount amortized in any year will be treated as a reduction of the U.S. Holder's
interest income from the 12 7/8% note.
UNITED STATES FEDERAL INCOME TAXATION OF NON-U.S. HOLDERS
Under present U.S. federal income and estate tax law and subject to the
discussion of backup withholding below:
(a) payments of principal, premium (if any) and interest on a 12 7/8% note
by Allegiance or any agent of Allegiance to any Non-U.S. Holder will not be
subject to withholding of U.S. federal income tax, provided that, in the
case of interest (1) the Non-U.S. Holder does not actually or
constructively own 10% or more of the total combined voting power of all
classes of stock of Allegiance entitled to vote, (2) the Non-U.S. Holder is
not (x) a controlled foreign corporation that is related to Allegiance
through stock ownership, or (y) a bank receiving interest described in
Section 881(c)(3)(A) of the Code, and (3) the beneficial owner of the
12 7/8% note certifies to Allegiance or its agent, under penalties of
perjury, that it is not a "United States person" (as defined in the Code)
and provides its name and address, and (A) such beneficial owner files the
Form W-8 with the withholding agent or (B) in the case of a securities
clearing organization, bank or other financial institution that holds
customers' securities in the ordinary course of its trade or business (a
"financial institution") and holds the 12 7/8% note on behalf of the
beneficial owner, such financial institution certifies to Allegiance or its
agent under penalties of perjury that such statement has been received from
the beneficial owner and furnishes the payor with a copy thereof;
(b) a Non-U.S. Holder will not be subject to U.S. federal income tax on
gain realized on the sale, exchange, redemption, retirement at maturity or
other disposition of a 12 7/8% note unless (1) such holder is an individual
who is present in the United States for 183 days or more during the taxable
year and certain other conditions are met, or (2) the gain is effectively
connected with a U.S. trade or business of the holder, and if an income tax
treaty applies, is generally attributable to a U.S. "permanent
establishment" maintained by the holder;
(c) a 12 7/8% note held by an individual who at the time of death is not a
citizen or resident of the United States will not be subject to U.S.
federal estate tax as a result of such individual's death if, at the time
of such death, (1) the individual did not actually or constructively own 10
percent or more of the total combined voting power of all classes of stock
of Allegiance entitled to vote, and (2) the income on the 12 7/8% note
would not have been effectively connected with the conduct of a trade or
business by the individual in the United States; and
129
<PAGE> 130
If a Non-U.S. Holder is engaged in a trade or business in the United States, and
interest on the 12 7/8% note or gain realized on the sale, exchange or other
disposition of the 12 7/8% note is effectively connected with the conduct of
such trade or business (and, if an income tax treaty applies, the Non-U.S.
Holder maintains a U.S. "permanent establishment" to which the interest or gain
is attributable), the Non-U.S. Holder, although exempt from the withholding tax
provided the requirements discussed in the preceding paragraph (a) are met
(provided that such holder furnishes a properly executed Internal Revenue
Service ("IRS") Form 4224 or successor form on or before any payment date to
claim such exemption), generally will be subject to U.S. federal income tax on
such interest or gain on a net basis in the same manner as if it were a U.S.
Holder.
In addition, a foreign corporation that is a Non-U.S. Holder may be subject to a
branch profits tax equal to 30% of its effectively connected earnings and
profits for the taxable year, subject to certain adjustments, unless it
qualifies for a lower rate under an applicable tax treaty. For this purpose,
interest on a 12 7/8% note or gain on the disposition of a 12 7/8% note will be
included in earnings and profits if such interest or gain is effectively
connected with the conduct by the foreign corporation of a trade or business in
the United States.
Recently finalized Treasury regulations pertaining to U.S. federal withholding
tax, generally effective for payments made after December 31, 1999 (the "Final
Withholding Tax Regulations"), will provide alternative methods for satisfying
the certification requirement described in paragraph (a)(3) above and will
require a Non-U.S. Holder that provides an IRS Form 4224 or successor form (as
discussed above) to also provide its U.S. taxpayer identification number. The
Final Withholding Tax Regulations generally also will require, in the case of a
12 7/8% note held by a foreign partnership, that (x) the certification described
in paragraph (i)(3) above be provided by the partners rather than the
partnership and (y) the partnership provide certain information, including a
U.S. taxpayer identification number. A look-through rule will apply in the case
of tiered partnerships.
Non-U.S. Holders should consult with their tax advisors regarding U.S. and
foreign tax consequences with respect to the 12 7/8% notes.
INFORMATION REPORTING AND BACKUP WITHHOLDING
In general, information reporting requirements will apply to certain payments
made in respect of a 12 7/8% note made to U.S. Holders other than certain exempt
recipients (such as corporations). A 31% backup withholding tax will apply to
such payments if the U.S. Holder fails to provide a correct taxpayer
identification number or certification of exempt status or, with respect to
certain payments, the U.S. Holder fails to report in full all dividend and
interest income and the IRS notifies the payor of such underreporting.
Under current Treasury Regulations, backup withholding and information reporting
will not apply to payments made by Allegiance or any agent thereof (in its
capacity as such) to a Non-U.S. Holder of a 12 7/8% note if such holder has
provided the required certification that it is not a United States person as set
forth in paragraph (i) under "United States Federal Income Taxation of Foreign
Holders," provided that neither Allegiance nor its agent has actual knowledge
that the holder is a United States person. Allegiance or its agent may, however,
report (on IRS Form 1042S) payments of interest on the 12 7/8% notes.
130
<PAGE> 131
Payment of the proceeds from the disposition of a 12 7/8% note made to or
through a foreign office of a broker will not be subject to information
reporting or backup withholding, except that if the broker is a United States
person, a controlled foreign corporation for U.S. tax purposes or a foreign
person 50% or more of whose gross income from all sources for the three-year
period ending with the close of its taxable year preceding the payment was
effectively connected with a U.S. trade or business, information reporting may
apply to such payments. Payments of the proceeds from a disposition of a 12 7/8%
note made to or through the U.S. office of a broker is subject to information
reporting and backup withholding unless the holder or beneficial owner certifies
as to its taxpayer identification number or otherwise establishes an exemption
from information reporting and backup withholding.
In general, the Final Withholding Tax Regulations do not significantly alter the
current substantive backup withholding and information reporting requirements,
but unify current certification procedures and clarify reliance standards. Under
the Final Withholding Tax Regulations, special rules apply which permit the
shifting of primary responsibility for withholding to certain financial
intermediaries acting on behalf of beneficial owners. A holder of a 12 7/8% note
should consult with its tax advisor regarding the application of the backup
withholding rules to its particular situation, the availability of an exemption
therefrom, the procedure for obtaining such an exemption, if available, and the
impact of the Final Withholding Tax Regulations on payments made with respect to
12 7/8% notes after December 31, 1999.
Any amounts withheld under the backup withholding rules from a payment to a
holder would be allowed as a refund or a credit against such holder's U.S.
federal income tax liability, provided the required information is timely
furnished to the IRS.
131
<PAGE> 132
ERISA CONSIDERATIONS
A fiduciary of a pension, profit-sharing, retirement, or other employee benefit
plan ("Plan") subject to Title I of ERISA, should consider the fiduciary
standards under ERISA in the context of the Plan's particular circumstances
before authorizing an investment of a portion of such Plan's assets in the
12 7/8% notes. Accordingly, such fiduciary should consider whether:
- - the investment satisfies the diversification requirements of Section
404(a)(1)(C) of ERISA;
- - the investment is in accordance with the documents and instruments governing
the Plan as required by Section 404(a)(1)(D) of ERISA; and
- - the investment is prudent under ERISA.
In addition to the imposition of general fiduciary standards of investment
prudence and diversification, ERISA and the corresponding provisions of the Code
prohibit a wide range of transactions involving the assets of a Plan or a plan
subject to Section 4975 of the Code (such plans are collectively referred to as
"ERISA Plans") and persons who have certain specified relationships to the ERISA
Plan ("parties in interest" within the meaning of ERISA, and "disqualified
persons" within the meaning of the Code). A prohibited transaction described in
Section 406 of ERISA or Section 4975 of the Code could arise if Allegiance were,
or were to become, a party in interest or a disqualified person with respect to
an ERISA Plan purchasing the 12 7/8% notes. Certain exemptions from the
prohibited transaction rules could be applicable to the purchase of the 12 7/8%
notes by an ERISA Plan depending on the type and circumstances of the fiduciary
of the ERISA Plan making the decision to acquire the 12 7/8% notes. Included
among these exemptions are: Prohibited Transaction Class Exemption ("PTCE")
90-1, regarding investments by insurance company pooled separate accounts; PTCE
91-38, regarding investments by bank collective investment funds; PTCE 84-14,
regarding transactions effected by a qualified professional asset manager; PTCE
95-60, regarding investments by insurance company general amounts; and PTCE
96-23, regarding transactions effected by an in-house asset manager. Thus, a
fiduciary of an ERISA Plan considering an investment in the 12 7/8% notes also
should consider whether the acquisition or the continued holding of the 12 7/8%
notes might constitute or give rise to a non-exempt prohibited transaction. No
ERISA Plan with respect to which Allegiance is a party in interest or a
disqualified person may purchase the 12 7/8% notes, unless a statutory or
administrative exemption is available.
Certain employee benefit plans, such as governmental plans and church plans, if
no election has been made under Section 410(d) of the Code, are not subject to
the restrictions of ERISA, and assets of such Plans may be invested in the
12 7/8% notes without regard to the ERISA considerations described above. The
investment in the 12 7/8% notes by such employee benefit plans may, however, be
subject to other applicable federal and state laws, which should be carefully
considered by such employee benefit plans before investing in the 12 7/8% notes.
Every ERISA Plan investor considering the acquisition of the 12 7/8% notes
should consult with its counsel with respect to the potential applicability of
ERISA and Section 4975 of the Code to such investment, and whether any
prohibited transaction exemption would be applicable.
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<PAGE> 133
PLAN OF DISTRIBUTION
This prospectus is to be used by Morgan Stanley Dean Witter, in connection with
offers and sales of the 12 7/8% notes in market-making transactions at
negotiated prices related to prevailing market prices at the time of sale.
Morgan Stanley Dean Witter may act as principal or as agent in such
transactions. If Morgan Stanley Dean Witter conducts any market-making
activities, it may be required to deliver a "market-making prospectus" when
effecting offers and sales in the 12 7/8% notes because of the equity ownership
of Allegiance by certain private investment partnerships, which are affiliates
of Morgan Stanley Dean Witter. For as long as a market-making prospectus is
required to be delivered, the ability of Morgan Stanley Dean Witter to make a
market in the 12 7/8% notes may, in part, be dependent on the ability of
Allegiance to maintain a current market-making prospectus. Morgan Stanley Dean
Witter has no obligation to make a market in the 12 7/8% notes, and may
discontinue its market-making activities at any time without notice, at its sole
discretion.
There is currently no established public market for the 12 7/8% notes.
Allegiance does not currently intend to apply for listing of the 12 7/8% notes
on any securities exchange. Therefore, any trading that does develop will occur
on the over-the-counter market. Allegiance has been advised by Morgan Stanley
Dean Witter that it intends to make a market in the 12 7/8% notes but it has no
obligation to do so and any market-making may be discontinued at any time. No
assurance can be given that an active public market for the 12 7/8% notes will
develop.
Morgan Stanley Dean Witter acted as an "Underwriter" in connection with the
initial public offering of Allegiance's common stock and the public offering of
the 12 7/8% notes and received aggregate commissions and fees of $6.9 million in
connection with such offerings. Morgan Stanley also acted as an "Initial
Purchaser" in connection with the original offering of the 11 3/4% notes and
redeemable warrants and received approximately $4.4 million in fees in
connection with such offering. Morgan Stanley Dean Witter is affiliated with
entities that beneficially own approximately 20.5% of the outstanding common
stock as of December 31, 1998. Robert H. Niehaus and John B. Ehrenkranz,
directors of Allegiance, are officers of Morgan Stanley. For further information
regarding the involvement of affiliates of Morgan Stanley Dean Witter in the
management of Allegiance and their equity ownership, see "Risk Factors -- We
Face Potential Conflicts of Interest Caused by Fund Investor Control,"
"Management" and "Security Ownership of Certain Beneficial Owners and
Management."
Although there are no agreements to do so, Morgan Stanley Dean Witter, as well
as others, may act as broker or dealer in connection with the sale of the
12 7/8% notes contemplated by this prospectus and may receive fees or
commissions in connection therewith.
Allegiance has agreed to indemnify Morgan Stanley Dean Witter against certain
liabilities under the Securities Act or to contribute to payment that Morgan
Stanley Dean Witter may be required to make in respect of such liabilities.
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<PAGE> 134
LEGAL MATTERS
The validity of the 12 7/8% notes offered hereby have been passed upon for
Allegiance by Kirkland & Ellis, a partnership including professional
corporations, Chicago, Illinois.
EXPERTS
The consolidated balance sheets of Allegiance as of December 31, 1998 and
December 31, 1997, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for the year ended December 31,
1998 and for the period from inception on April 22, 1997 to December 31, 1997,
have been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their report with respect thereto and are included in this
prospectus in reliance upon the authority of said firm as experts in giving said
report.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets as of December 31, 1998, and
December 31, 1997......................................... F-3
Consolidated Statements of Operations for the year ended
December 31, 1998, and for the Period from Inception
(April 22, 1997) through December 31, 1997................ F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the year ended December 31, 1998, and for the Period
from Inception (April 22, 1997) through December 31,
1997...................................................... F-5
Consolidated Statements of Cash Flows for the year ended
December 31, 1998, and for the Period from Inception
(April 22, 1997) through December 31, 1997................ F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 136
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Allegiance Telecom, Inc.:
We have audited the accompanying consolidated balance sheets of Allegiance
Telecom, Inc. (a Delaware corporation) and subsidiaries (the "Company") as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for the year ended
December 31, 1998, and for the period from inception (April 22, 1997), to
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Allegiance Telecom, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for the year ended December 31, 1998, and for
the period from inception (April 22, 1997), to December 31, 1997, in conformity
with generally accepted accounting principles.
Dallas, Texas, ARTHUR ANDERSEN LLP
February 3, 1999
F-2
<PAGE> 137
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -- DECEMBER 31, 1998 AND 1997
(In thousands, except share data)
<TABLE>
<CAPTION>
1998 1997
----------- ---------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 262,501.7 $ 5,726.4
Short-term investments.................................... 143,389.7 --
Short-term investments, restricted........................ 25,542.8 --
Accounts receivable (net of allowance for doubtful
accounts of $577.2 and $0, at December 31, 1998 and
1997, respectively)..................................... 6,186.6 4.3
Prepaid expenses and other current assets................. 1,243.2 245.2
----------- ---------
Total current assets................................ 438,864.0 5,975.9
PROPERTY AND EQUIPMENT:
Property and equipment.................................... 153,875.4 23,912.6
Accumulated depreciation and amortization................. (9,015.4) (12.7)
----------- ---------
Property and equipment, net......................... 144,860.0 23,899.9
OTHER NONCURRENT ASSETS:
Deferred debt issuance costs (net of accumulated
amortization of $733.7 and $0, at December 31, 1998 and
1997, respectively)..................................... 16,078.4 --
Long-term investments, restricted......................... 36,699.2 --
Other assets.............................................. 1,372.7 171.2
----------- ---------
Total other noncurrent assets....................... 54,150.3 171.2
----------- ---------
Total assets........................................ $ 637,874.3 $30,047.0
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable.......................................... $ 20,981.7 $ 2,261.7
Accrued liabilities and other current liabilities......... 26,176.8 1,668.0
----------- ---------
Total current liabilities........................... 47,158.5 3,929.7
LONG-TERM DEBT.............................................. 471,652.1 --
REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK:
$.01 par value, 0 and 40,498,062 shares authorized, 0 and
40,498,062 shares issued and outstanding at December 31,
1998 and 1997, respectively............................. -- 33,409.4
REDEEMABLE WARRANTS......................................... 8,634.1 --
COMMITMENTS AND CONTINGENCIES (see Notes 6 and 8)
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $.01 par value, 1,000,000 and 0 shares
authorized, no shares issued or outstanding at December
31, 1998 and 1997, respectively......................... -- --
Common stock, $.01 par value, 150,000,000 and 42,629,965
shares authorized, 50,341,554 and 426 shares issued and
outstanding at December 31, 1998 and 1997,
respectively............................................ 503.4 --
Additional paid-in capital................................ 416,729.9 3,008.4
Deferred compensation..................................... (14,617.3) (2,798.4)
Deferred management ownership allocation charge........... (26,224.7) --
Accumulated deficit....................................... (265,961.7) (7,502.1)
----------- ---------
Total stockholders' equity (deficit)................ 110,429.6 (7,292.1)
----------- ---------
Total liabilities and stockholders' equity
(deficit)........................................... $ 637,874.3 $30,047.0
=========== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 138
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
PERIOD FROM
INCEPTION
(APRIL 22, 1997),
YEAR ENDED THROUGH
DECEMBER 31, DECEMBER 31,
1998 1997
------------ -----------------
<S> <C> <C>
REVENUES........................................... $ 9,786.2 $ 0.4
OPERATING EXPENSES:
Network.......................................... 9,528.8 151.2
Selling, general, and administrative............. 46,089.4 3,425.9
Management ownership allocation charge........... 167,311.9 --
Noncash deferred compensation.................... 5,307.2 209.9
Depreciation and amortization.................... 9,002.8 12.7
----------- -----------
Total operating expenses................. 237,240.1 3,799.7
----------- -----------
Loss from operations..................... (227,453.9) (3,799.3)
OTHER (EXPENSE) INCOME:
Interest income.................................. 19,917.4 111.4
Interest expense................................. (38,951.7) --
----------- -----------
Total other (expense) income............. (19,034.3) 111.4
----------- -----------
NET LOSS........................................... (246,488.2) (3,687.9)
ACCRETION OF REDEEMABLE PREFERRED STOCK AND WARRANT
VALUES........................................... (11,971.4) (3,814.2)
----------- -----------
NET LOSS APPLICABLE TO COMMON STOCK................ $(258,459.6) $ (7,502.1)
=========== ===========
NET LOSS PER SHARE, basic and diluted.............. $ (10.53) $(17,610.68)
=========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING,
basic and diluted................................ 24,550,346 426
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 139
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands, except share data)
For the Year Ended December 31, 1998, and for
the Period from Inception (April 22, 1997), Through December 31, 1997
<TABLE>
<CAPTION>
DEFERRED
PREFERRED STOCK COMMON STOCK MANAGEMENT
-------------------- ------------------- ADDITIONAL OWNERSHIP
NUMBER OF NUMBER OF PAID-IN DEFERRED ALLOCATION ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION CHARGE DEFICIT
--------- -------- ---------- ------ ---------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, April 22, 1997
(date of inception)....... -- $ -- -- $ -- $ -- $ -- $ -- $ --
Issuance of common stock
at $.23 per share....... -- -- 426 -- 0.1 -- -- --
Accretion of redeemable
preferred stock and
warrant values.......... -- -- -- -- -- -- -- (3,814.2)
Deferred compensation..... -- -- -- -- 3,008.3 (3,008.3) -- --
Amortization of deferred
compensation............ -- -- -- -- -- 209.9 -- --
Net loss.................. -- -- -- -- -- -- -- (3,687.9)
------- -------- ---------- ------ ---------- ---------- ----------- -----------
BALANCE, December 31,
1997...................... -- -- 426 -- 3,008.4 (2,798.4) -- (7,502.1)
Accretion of redeemable
preferred stock and
warrant values.......... -- -- -- -- -- -- -- (11,971.4)
Initial public offering... -- -- 10,000,000 100.0 137,656.8 -- -- --
Conversion of redeemable
preferred stock......... -- -- 40,341,128 403.4 65,402.0 -- -- --
Deferred compensation..... -- -- -- -- 210,662.7 (17,126.1) (193,536.6) --
Amortization of deferred
compensation............ -- -- -- -- -- 5,307.2 167,311.9 --
Net loss.................. -- -- -- -- -- -- -- (246,488.2)
------- -------- ---------- ------ ---------- ---------- ----------- -----------
BALANCE, December 31,
1998...................... -- $ -- 50,341,554 $503.4 $416,729.9 $(14,617.3) $ (26,224.7) $(265,961.7)
======= ======== ========== ====== ========== ========== =========== ===========
<CAPTION>
TOTAL
-----------
<S> <C>
BALANCE, April 22, 1997
(date of inception)....... $ --
Issuance of common stock
at $.23 per share....... 0.1
Accretion of redeemable
preferred stock and
warrant values.......... (3,814.2)
Deferred compensation..... --
Amortization of deferred
compensation............ 209.9
Net loss.................. (3,687.9)
-----------
BALANCE, December 31,
1997...................... (7,292.1)
Accretion of redeemable
preferred stock and
warrant values.......... (11,971.4)
Initial public offering... 137,756.8
Conversion of redeemable
preferred stock......... 65,805.4
Deferred compensation..... --
Amortization of deferred
compensation............ 172,619.1
Net loss.................. (246,488.2)
-----------
BALANCE, December 31,
1998...................... $ 110,429.6
===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 140
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Year Ended December 31, 1998, and for
The Period From Inception (April 22, 1997), Through December 31, 1997
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(246,488.2) $ (3,687.9)
Adjustments to reconcile net loss to cash used in
operating activities --
Depreciation and amortization........................... 9,002.8 12.7
Provision for uncollectible accounts receivable......... 577.2 --
Accretion of senior discount notes...................... 27,762.7 --
Amortization of original issue discount................. 569.9 --
Amortization of deferred debt issuance costs............ 733.7 --
Amortization of management ownership allocation charge
and deferred compensation.............................. 172,619.1 209.9
Changes in assets and liabilities --
Accounts receivable................................... (6,759.5) (4.3)
Prepaid expenses and other current assets............. (998.0) (245.2)
Other assets.......................................... (1,201.5) (171.2)
Accounts payable...................................... 4,703.9 275.1
Accrued liabilities and other current liabilities..... 22,208.1 1,668.0
----------- ----------
Net cash used in operating activities.............. (17,269.8) (1,942.9)
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (113,538.7) (21,926.0)
Purchases of investments.................................. (294,688.8) --
Proceeds from redemption of investments................... 89,057.1 --
----------- ----------
Net cash used in investing activities.............. (319,170.4) (21,926.0)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from senior discount notes....................... 443,212.1 --
Proceeds from issuance of redeemable warrants............. 8,183.5 --
Deferred debt issuance costs.............................. (16,812.1) --
Proceeds from issuance of redeemable preferred stock...... -- 5,000.0
Proceeds from redeemable capital contributions............ 20,875.2 24,595.2
Proceeds from issuance of common stock.................... -- 0.1
Proceeds from initial public offering..................... 137,756.8 --
----------- ----------
Net cash provided by financing activities.......... 593,215.5 29,595.3
----------- ----------
INCREASE IN CASH AND CASH EQUIVALENTS....................... 256,775.3 5,726.4
CASH AND CASH EQUIVALENTS, beginning of period.............. 5,726.4 --
----------- ----------
CASH AND CASH EQUIVALENTS, end of period.................... $ 262,501.7 $ 5,726.4
=========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for --
Interest................................................ $ 9,384.4 $ --
=========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 141
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
(In thousands, except share and per share data)
1. GENERAL:
Allegiance Telecom, Inc., a competitive local exchange carrier (CLEC), was
incorporated on April 22, 1997, as a Delaware corporation, for the purpose of
providing voice, data, and Internet services to business, government, and other
institutional users in major metropolitan areas across the United States.
Allegiance Telecom, Inc. and its subsidiaries are referred to herein as the
"Company."
The Company's business plan is focused on offering services in 24 of the largest
metropolitan areas in the United States. As of December 31, 1998, the Company is
operational in nine markets: New York City, Dallas, Fort Worth, Atlanta, Boston,
Chicago, Los Angeles, San Francisco, and Oakland; and is in the process of
deploying networks in seven other markets: Philadelphia, Houston, Washington
D.C., Northern New Jersey, San Jose, Orange County, and San Diego.
Until December 16, 1997, the Company was in the development stage. Since its
inception on April 22, 1997 through December 31, 1997, the Company's principal
activities included developing its business plans, procuring governmental
authorizations, raising capital, hiring management and other key personnel,
working on the design and development of its local exchange telephone networks
and operations support systems (OSS), acquiring equipment and facilities, and
negotiating interconnection agreements. Also, the Company initiated resale
services to customers in the Dallas market in December 1997. During 1998, the
Company began providing facilities-based services to customers in its markets.
The Company has concentrated its effort during 1998 on building out the markets
it is currently operating in as well as developing its future markets.
Accordingly, the Company has incurred substantial operating losses and operating
cash flow deficits.
The Company's success will be affected by the problems, expenses, and delays
encountered in connection with the formation of any new business, and the
competitive environment in which the Company operates. The Company's performance
will further be affected by its ability to assess potential markets, secure
financing or raise additional capital, implement expanded interconnection and
collocation with incumbent local exchange carrier (ILEC) facilities, lease
adequate trunking capacity from ILECs or other CLECs, purchase and install
switches in additional markets, implement efficient OSS and other back office
systems, develop a sufficient customer base, and attract, retain, and motivate
qualified personnel. The Company's networks and the provisions of
telecommunications services are subject to significant regulation at the
federal, state, and local levels. Delays in receiving required regulatory
approvals or the enactment of new adverse regulation or regulatory requirements
may have a material adverse effect upon the Company. Although management
believes that the Company will be able to successfully mitigate these risks,
there is no assurance that the Company will be able to do so or that the Company
will ever operate profitably.
Expenses are expected to exceed revenues in each market in which the Company
offers service until a sufficient customer base is established. It is
anticipated that obtaining a
F-7
<PAGE> 142
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
sufficient customer base will take a number of years, and positive cash flows
from operations are not expected in the near future.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CONSOLIDATION
The accompanying financial statements include the accounts of Allegiance
Telecom, Inc. and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, the Company includes as cash and cash
equivalents, cash, marketable securities, and commercial paper with original
maturities of three months or less at date of purchase.
SHORT-TERM INVESTMENTS
Short-term investments consist primarily of commercial paper with original
maturities at date of purchase beyond three months and less than 12 months. Such
short-term investments are carried at their accreted value, which approximates
fair value, due to the short period of time to maturity.
RESTRICTED INVESTMENTS
Restricted investments consist primarily of U.S. government securities purchased
in connection with the Company's outstanding 12 7/8% Notes (see Note 4) to
secure the first three years' (six semi-annual) interest payments on the 12 7/8%
Notes. Such investments are stated at their accreted value, which approximates
fair value, and are shown in both current and other noncurrent assets, based
upon the maturity dates of each of the securities at the balance sheet date.
Restricted investments also includes $787.2 in certificates of deposit held as
collateral for letters of credit issued on behalf of the Company. These
investments are classified as other noncurrent assets.
ACCOUNTS RECEIVABLE
Accounts receivable consist of end-user receivables, interest receivable, and at
December 31, 1997, a receivable from an employee.
PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of prepaid rent, prepaid
insurance, and refundable deposits. Prepayments are expensed on a straight-line
basis over the life of the underlying agreements.
F-8
<PAGE> 143
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment includes network equipment, leasehold improvements,
software, office equipment, furniture and fixtures, construction-in-progress,
and other. These assets are stated at cost, which includes direct costs and
capitalized interest and are depreciated once placed in service using the
straight-line method. Interest expense for the year ended December 31, 1998, was
$41,749.9 before the capitalization of $2,798.2 of interest related to
construction-in-progress. No interest expense was incurred during the period
ended December 31, 1997. Repair and maintenance costs are expensed as incurred.
Property and equipment at December 31, 1998 and 1997, consist of the following:
<TABLE>
<CAPTION>
USEFUL
LIVES
1998 1997 (IN YEARS)
---------- --------- ----------
<S> <C> <C> <C>
Network equipment............................ $ 67,303.8 $ -- 5-7
Leasehold improvements....................... 24,483.2 37.5 5-10
Software..................................... 7,840.0 -- 3
Office equipment and other................... 4,384.3 89.9 2
Furniture and fixtures....................... 2,419.6 150.2 5
---------- ---------
Property and equipment, in service........... 106,430.9 277.6
Less: Accumulated depreciation............... (9,015.4) (12.7)
---------- ---------
Property and equipment, in service, net...... 97,415.5 264.9
Construction-in-progress..................... 47,444.5 23,635.0
---------- ---------
Property and equipment, net.................. $144,860.0 $23,899.9
========== =========
</TABLE>
REVENUE RECOGNITION
Revenue is recognized in the month in which the service is provided, except for
reciprocal compensation generated by calls placed to Internet service providers
connected to the Company's network. The propriety of CLECs (such as the Company)
to earn local reciprocal compensation is the subject of numerous regulatory and
legal challenges. Until this issue is ultimately resolved, the Company has
determined to recognize this revenue only when realization of it is certain,
which in most cases will be upon receipt of cash.
COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 130 (SFAS 130), "Reporting
Comprehensive Income." SFAS 130 established reporting and disclosure
requirements for comprehensive income and its components within the financial
statements. The Company's comprehensive income components were immaterial as of
December 31, 1998, and the
F-9
<PAGE> 144
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company had no comprehensive income components as of December 31, 1997;
therefore, comprehensive income/loss is the same as net income/loss for both
periods.
LOSS PER SHARE
The Company calculates net loss per share under the provisions of SFAS No. 128,
"Earnings per Share." The net loss per share amounts reflected on the statements
of operations and the number of shares outstanding on the balance sheets reflect
a 426.2953905-for-one stock split, which occurred in connection with the initial
public offering (see Note 3). The net loss applicable to common stock includes
the accretion of redeemable cumulative convertible preferred stock and warrant
values of $11,971.4 for year ended December 31, 1998, and $3,814.2 for the year
ended December 31, 1997.
The securities listed below were not included in the computation of diluted loss
per share, as the effect from the conversion would be antidilutive.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1997
-------- -----------
<S> <C> <C>
Redeemable Cumulative Convertible Preferred Stock....... $ -- $40,498,062
Redeemable Warrants..................................... 649,248 --
1997 Nonqualified Stock Option Plan..................... 883,937 189,127
1998 Stock Incentive Plan............................... 369,517 --
Employee Stock Discount Purchase Plan................... 44,624 --
</TABLE>
RECOGNITION OF THE COST OF START-UP ACTIVITIES
On April 3, 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-5 (SOP 98-5), "Reporting on the Costs of Start-up
Activities." SOP 98-5 requires start-up activities and organization costs to be
expensed as incurred and that start-up costs capitalized prior to the adoption
of SOP 98-5 be reported as a cumulative effect of a change in accounting
principle. The Company adopted SOP 98-5 during the second quarter of 1998.
Adoption of SOP 98-5 did not have an affect on the Company, inasmuch as the
Company had previously expensed all such costs.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 requires that all
derivatives be recognized at fair value as either assets or liabilities. SFAS
133 also requires an entity that elects to apply hedge accounting to establish
the method to be used in assessing the effectiveness of the hedging derivatives
and the measurement approach for determining the ineffectiveness of the hedge at
the inception of the hedge. The methods chosen must be consistent with the
entity's approach to managing risk. The Company adopted SFAS 133 at the
beginning of the fourth quarter of 1998. Adoption of SFAS 133 did not have an
F-10
<PAGE> 145
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
effect on the Company, inasmuch as the Company has historically not invested in
derivatives or participate in hedging activities.
USE OF ESTIMATES IN FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of expenses during the reporting period. Actual results
could differ from those estimates.
RECLASSIFICATIONS
Certain amounts in the prior period's consolidated financial statements have
been reclassified to conform with the current period presentation.
3. CAPITALIZATION:
In connection with its initial public offering of common stock (the "IPO") on
July 7, 1998, (see below) the Company effected a 426.2953905-for-one stock split
which is retroactively reflected within these financial statements.
STOCK PURCHASE AGREEMENT AND SECURITY HOLDERS AGREEMENT
On August 13, 1997, the Company entered into a stock purchase agreement with
Allegiance Telecom, L.L.C. ("Allegiance LLC") (see Note 7). Allegiance LLC
purchased 40,498,062 shares of 12% redeemable cumulative convertible preferred
stock ("Redeemable Preferred Stock"), par value $.01 per share, for aggregate
consideration of $5,000.0 (the "Initial Closing"). Allegiance LLC agreed to make
additional contributions as necessary to fund expansion into new markets
("Subsequent Closings"). In order to obtain funds through Subsequent Closings,
the Company submitted a proposal to Allegiance LLC detailing the funds necessary
to build out the Company's business in a new market. Allegiance LLC was not
required to make any contributions until it approved the proposal. The maximum
commitment of Allegiance LLC was $100,000.0. No capital contributions were
required to be made after the Company consummated an initial public offering of
its stock (which occurred on July 7, 1998).
Allegiance LLC contributed a total of $50,132.9 and $29,595.2 prior to the
Company's initial public offering and December 31, 1997, respectively. Each
security holder in Allegiance LLC had the right to require Allegiance LLC to
repurchase all of the outstanding securities held by such security holder at the
greater of the original cost (including interest at 12% per annum) for such
security or the fair market value, as defined in the security holders agreement,
at any time and from time to time after August 13, 2004, but not after the
consummation of a public offering or sale of the Company. If repurchase
provisions had been exercised, the Company had agreed, at the request and
direction of Allegiance LLC, to take any and all actions necessary, including
F-11
<PAGE> 146
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
declaring and paying dividends and repurchasing preferred or common stock, to
enable Allegiance LLC to satisfy its repurchase obligations.
Because of the redemption provisions, the Company has recognized the accretion
of the value of the Redeemable Preferred Stock to reflect management's estimate
of the potential future fair market value of the Redeemable Preferred Stock
payable in the event the repurchase provisions were exercised. Amounts were
accreted using the effective interest method assuming the Redeemable Preferred
Stock is redeemed at a redemption price based on the estimated potential future
fair market value of the equity of the Company in August 2004. The accretion was
recorded each period as an increase in the balance of Redeemable Preferred Stock
outstanding and a noncash increase in the net loss applicable to common stock.
In connection with the IPO, the Redeemable Preferred Stock was converted into
common stock, and the amounts accreted were reclassified as a component of
additional paid-in capital. In addition, the redemption provisions and the
obligation of Allegiance LLC to make additional contributions to the Company
(and the obligation of the members of Allegiance LLC to make capital
contributions) have terminated.
REDEEMABLE CUMULATIVE CONVERTIBLE PREFERRED STOCK
Each share of the Company's Redeemable Preferred Stock was convertible into
shares of the Company's common stock (the "Common Stock") on a one-for-one
basis, subject to certain antidilution provisions. No dividends were declared in
1998 or 1997.
In 1998, prior to the conversion of the Redeemable Preferred Stock, the Company
recorded accretion of $11,520.8. Accretion recorded in the period ended December
31, 1997, was $3,814.2.
Capital contributed in the Subsequent Closings occurring in October 1997 and
January 1998 and other capital contributions totaled approximately $45,132.9.
In February and March 1998, the Company issued 273,361.92 shares of Redeemable
Preferred Stock for aggregate consideration of $337.5.
In connection with the consummation of the IPO, the outstanding shares of the
Redeemable Preferred Stock were converted into 40,341,128 shares of Common
Stock. Upon the conversion of the Redeemable Preferred Stock, the obligation of
the Company to redeem the Redeemable Preferred Stock also terminated and,
therefore, the accretion of the Redeemable Preferred Stock value recorded to the
date of the IPO, $15,335.0 was reclassified to additional paid-in capital along
with $50,470.4 proceeds from the issuance of the Redeemable Preferred Stock and
redeemable capital contributions.
PREFERRED STOCK
In connection with the IPO, the Company authorized 1,000,000 shares of preferred
stock ("Preferred Stock") with a $.01 par value. At December 31, 1998, no shares
of Preferred Stock are issued and outstanding.
F-12
<PAGE> 147
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
COMMON STOCK
On July 7, 1998, the Company raised $150,000.0 of gross proceeds in the
Company's IPO. The Company sold 10,000,000 shares of its Common Stock at a price
of $15 per share. In connection with the IPO, the outstanding shares of
Redeemable Preferred Stock were converted in to 40,341,128 shares of Common
Stock and the Company increased the number of authorized Common Stock to
150,000,000. At December 31, 1998, 50,341,554 shares were issued and
outstanding. Of the authorized but unissued Common Stock, 6,998,970 shares are
reserved for issuance upon exercise of options issued under the Company's stock
option, stock incentive and stock purchase plans (see Note 10) and 649,248
shares are reserved for issuance, sale, and delivery upon the exercise of
warrants (see Note 4).
DEFERRED COMPENSATION
Allegiance LLC sold to certain management investors (the "Management Investors")
membership units of Allegiance LLC at amounts less than their estimated fair
market value; therefore, the Company has recognized deferred compensation of
$10,090.2 and $977.6 at December 31, 1998 and 1997, respectively, of which
$2,726.1 and $40.7 has been amortized to expense at December 31, 1998 and 1997,
respectively. In connection with the IPO, the Redeemable Preferred Stock was
converted into Common Stock and Allegiance LLC was dissolved. The deferred
compensation charge is amortized based upon the period over which the Company
has the right to repurchase certain of the securities (at the lower of fair
market value or the price paid by the employee) in the event the management
employee's employment with the Company is terminated.
DEFERRED MANAGEMENT OWNERSHIP ALLOCATION CHARGE
On July 7, 1998, in connection with the IPO, certain venture capital investors
(the "Fund Investors") and certain Management Investors owned 95.0% and 5.0%,
respectively, of the ownership interests of Allegiance LLC, which owned
substantially all of the Company's outstanding capital stock. As a result of the
successful IPO, Allegiance LLC was dissolved and its assets (which consisted
almost entirely of such capital stock) have been distributed to the Fund
Investors and Management Investors in accordance with the Allegiance LLC's
Limited Liability Company Agreement (the "LLC Agreement"). The LLC Agreement
provided that the equity allocation between the Fund Investors and the
Management Investors be 66.7% and 33.3%, respectively, based upon the valuation
implied by the IPO. Under generally accepted accounting principles, the Company
recorded the increase in the assets of Allegiance LLC allocated to the
Management Investors as a $193,536.6 increase in additional paid-in capital, of
which $122,475.5 was recorded as a noncash, nonrecurring charge to operating
expense and $71,061.1 was recorded as a deferred management ownership allocation
charge. The deferred charge was amortized at $44,836.4 as of December 31, 1998,
and will be further amortized at $18,870.2, $7,175.7, and $178.8 during the
years 1999, 2000 and 2001, respectively, which is the period over which the
Company has the right to repurchase certain of the securities (at the lower of
fair market
F-13
<PAGE> 148
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
value or the price paid by the employee) in the event the management employee's
employment with the Company is terminated.
4. LONG-TERM DEBT:
Long-term debt consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
---------- -------
<S> <C> <C>
Series B 11 3/4% Notes, face amount $445,000.0 due
February 15, 2008, effective interest rate of 12.45%,
at accreted value...................................... $270,526.1 $ --
12 7/8% Senior Notes, face amount $205,000.0 due May 15,
2008, effective interest rate of 13.24%, at accreted
value.................................................. 201,018.6
Other.................................................... 107.4 --
---------- -------
Total long-term debt........................... $471,652.1 $ --
========== =======
</TABLE>
On February 3, 1998, the Company raised gross proceeds of approximately
$250,477.1 in an offering of 445,000 Units (the "Unit Offering"), each of which
consists of one 11 3/4% Senior Discount Note due 2008 of the Company (the
"11 3/4% Notes") and one warrant to purchase .0034224719 shares of Common Stock
(the "Redeemable Warrants") at an exercise price of $.01 per share, subject to
certain antidilution provisions. Of the gross proceeds, $242,293.6 was allocated
to the 11 3/4% Notes and $8,183.5 was allocated to the Redeemable Warrants. The
Redeemable Warrants became exercisable in connection with the IPO (see Note 3)
in July 1998, and each warrant may now purchase 1.45898399509 shares of Common
Stock as a result of the stock split (see Note 3).
A Registration Statement on Form S-4 (File No. 333-49013) registering the
Company's 11 3/4% Notes, and offering to exchange (the "Exchange Offer") any and
all of the outstanding 11 3/4% Notes for Series B 11 3/4% Notes due 2008 (the
"Series B Notes"), was declared effective by the Securities and Exchange
Commission on May 22, 1998. The Exchange Offer terminated on June 23, 1998,
after substantially all of the outstanding 11 3/4% Notes were exchanged. The
terms and conditions of the Series B Notes are identical to those of the 11 3/4%
Notes in all material respects.
The Series B Notes have a principal amount at maturity of $445,000.0 and an
effective interest rate of 12.45%. The Series B Notes mature on February 15,
2008. From and after February 15, 2003, interest on the Series B Notes will be
payable semi-annually in cash at the rate of 11 3/4% per annum.
The Company must make an offer to purchase the Redeemable Warrants for cash at
the Relevant Value upon the occurrence of a Repurchase Event. A Repurchase Event
is defined to occur when (i) the Company consolidates with or merges into
another person if the Common Stock thereafter issuable upon exercise of the
Redeemable Warrants is not registered under the Securities Exchange Act of 1934,
as amended (the "Exchange Act") or (ii) the Company sells all or substantially
all of its assets to another person, if the
F-14
<PAGE> 149
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Common Stock thereafter issuable upon the exercise of the Redeemable Warrants is
not registered under the Exchange Act, unless the consideration for such a
transaction is cash. The Relevant Value is defined to be the fair market value
of the Common Stock as determined by the trading value of the securities if
publicly traded or at an estimated fair market value without giving effect to
any discount for lack of liquidity, lack of registered securities, or the fact
that the securities represent a minority of the total shares outstanding. As a
result of the warrant redemption provisions, the Company is recognizing the
potential future redemption value of the Redeemable Warrants by recording
accretion of the Redeemable Warrants to their estimated fair market value at
February 3, 2008, using the effective interest method. Accretion recorded in the
year ended December 31, 1998, was $450.6.
The Series B Notes are redeemable by the Company, in whole or in part, anytime
on or after February 15, 2003, at 105.875% of their principal amount at
maturity, plus accrued and unpaid interest, declining to 100% of their principal
amount at maturity, plus accrued and unpaid interest on and after February 15,
2006. In addition, at any time prior to February 15, 2001, the Company may, at
its option, redeem up to 35% of the principal amount at maturity of the Series B
Notes in connection with one or more public equity offerings at 111.750% of the
accreted value on the redemption date, provided that at least $289,250.0
aggregate principal amount at maturity of the Series B Notes remains outstanding
after such redemption.
On July 7, 1998, the Company raised approximately $200,918.5 of gross proceeds
from the sale of its 12 7/8% Senior Notes due 2008 (the "12 7/8% Notes") of
which approximately $69,033.4 was used to purchase U.S. government securities,
which were placed in a pledged account to secure and fund the first six
scheduled payments of interest on the notes (see Note 2).
The 12 7/8% Notes have a principal amount at maturity of $205,000.0 and an
effective interest rate of 13.24%. The 12 7/8% Notes mature on May 15, 2008.
Interest on the 12 7/8% Notes is payable semi-annually in cash at the rate of
12 7/8% on May 15 and November 15 of each year. As of December 31, 1998, the
Company has recorded accrued interest associated with the 12 7/8% Notes of
$3,470.2, which is included in other current liabilities.
The 12 7/8% Notes are redeemable by the Company, in whole or in part, at any
time on or after May 15, 2003, at 106.438% of their principal amount, declining
to 100% of their principal amount, plus accrued interest, on or after May 15,
2006. In addition, prior to May 15, 2001, the Company may redeem up to 35% of
the aggregate principal amount of the 12 7/8% Notes with the proceeds of one or
more public offerings (as defined in the indenture relating to the 12 7/8%
Notes) at 112.875% of their principal amount, plus accrued interest, provided,
however, that after any such redemption at least 65% of the aggregate principal
amount of the 12 7/8% Notes originally issued remain outstanding.
The Series B and the 12 7/8% Notes carry certain restrictive covenants that,
among other things, limit the ability of the Company to incur indebtedness,
create liens, engage in sale-leaseback transactions, pay dividends or make
distributions in respect of their capital stock, redeem capital stock, make
investments or certain other restricted payments, sell assets,
F-15
<PAGE> 150
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
issue or sell stock of restricted subsidiaries (as defined in the indentures
relating to the Series B Notes and the 12 7/8% Notes), enter into transactions
with any holder of 5% or more of any class of capital stock of the Company, or
effect a consolidation or merger. In addition, upon a change of control, the
Company is required to make an offer to purchase each series of notes at a
purchase price of 101% of the accreted value thereof (in the case of the Series
B Notes) and 101% of the principal amount thereof (in the case of the 12 7/8%
Notes), together with accrued interest, if any. However, these limitations are
subject to a number of qualifications and exceptions (as defined in the
indentures relating to each series of notes). The Company was in compliance with
all such restrictive covenants since issuance of each series of notes.
5. CAPITAL LEASES:
On May 29, 1998, the Company signed a capital lease agreement for three,
four-fiber rings, with a term of ten years and a renewal term of ten years, at
an expected total cost of $3,485.0; $871.3 was paid as of December 31, 1998. The
remainder is expected to be paid in 1999 and is not reflected in the financial
statements, since the payment is contingent upon the timing of completion of
network segments.
On December 4, 1998, the Company signed a capital lease agreement for twelve
optical fibers configured in two separate rings, with a term of fifteen years
and two renewal terms of five years each. Total cost associated with the capital
lease is dependent upon the timing of completion of connectivity of the optical
fibers with the Company's network, which is to be completed in two phases. The
Company will incur recurring monthly charges of $29.4 after the completion of
phase one. After completion of phase two, the Company will pay a one-time fee of
$76.5 and the recurring monthly charge will increase to $76.5. This capital
lease is not reflected in the financial statements, since the total cost and
timing of payments are contingent upon the timing of completion of the phases.
6. LEGAL MATTERS:
On August 29, 1997, WorldCom, Inc. ("WorldCom") sued the Company and two
individual employees. In its complaint, WorldCom alleges that these employees
violated certain noncompete and nonsolicitation agreements by accepting
employment with the Company and by soliciting then current WorldCom employees to
leave WorldCom's employment and join the Company. In addition, WorldCom claims
that the Company tortiously interfered with WorldCom's relationships with its
employees, and that the Company's behavior constituted unfair competition.
WorldCom seeks injunctive relief and damages, although it has filed no motion
for a temporary restraining order or preliminary injunction. The Company denies
all claims and will vigorously defend itself. An estimate of possible loss
cannot be made at this time.
On October 7, 1997, the Company filed a counterclaim against WorldCom for, among
other things, attempted monopolization of the "one-stop shopping"
telecommunications market, abuse of process, and unfair competition. WorldCom
moved to dismiss the abuse of process and unfair competition claims. The court
dismissed the unfair competition claim
F-16
<PAGE> 151
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on March 4, 1998. Thus, the Company's counter claim for attempted monopolization
and abuse of power are still being litigated.
7. RELATED PARTIES:
From inception (April 22, 1997) through July 7, 1998, the Company was a wholly
owned subsidiary of Allegiance LLC. On July 7, 1998, certain venture capital
investors in Allegiance LLC ("the Fund Investors") and certain management
investors in Allegiance LLC ("the Management Investors") owned 95.0% and 5.0%,
respectively, of the ownership interest of Allegiance LLC, which owned
substantially all of the Company's outstanding capital stock. As a result of the
successful IPO (see Note 3), Allegiance LLC was dissolved and its assets (which
consisted almost entirely of such capital stock) have been distributed to the
Fund Investors and the Management Investors in accordance with the LLC Agreement
(see Note 3).
As of July 7, 1998 and 1997, Allegiance LLC had made aggregate capital
contributions to the Company of approximately $50,132.9 and $29,595.2,
respectively.
During 1998 and 1997, the Company paid all organizational and legal fees of
Allegiance LLC, the amount of which was not material. No amounts are due from
Allegiance LLC at December 31, 1998, or December 31, 1997.
In connection with the Unit Offering (see Note 4), the IPO (see Note 3), and the
12 7/8% Notes (see Note 4), the Company incurred approximately $11,331.5 in fees
to an affiliate of an investor in the Company.
8. COMMITMENTS AND CONTINGENCIES:
The Company has entered into various operating lease agreements, with
expirations through 2009, for network facilities, office space, and equipment.
Future minimum lease obligations related to the Company's operating leases as of
December 31, 1998, are as follows:
<TABLE>
<S> <C>
1999............................... $10,984.8
2000............................... 11,201.6
2001............................... 10,436.7
2002............................... 8,600.8
2003............................... 7,940.7
Thereafter......................... 30,083.5
</TABLE>
Total rent expense for the year ended December 31, 1998, was $2,991.8 and for
the period from inception (April 22, 1997) through December 31, 1997, was
$212.1.
In October 1997, the Company entered into a five-year general agreement with
Lucent Technologies, Inc. ("Lucent") establishing terms and conditions for the
purchase of Lucent products, services, and licensed materials. This agreement
includes a three-year
F-17
<PAGE> 152
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exclusivity commitment for the purchase of products and services related to new
switches. The agreement contains no minimum purchase requirements.
9. FEDERAL INCOME TAXES:
The Company accounts for income tax under the provisions of SFAS No. 109,
"Accounting for Income Taxes" (SFAS 109). SFAS 109 requires an asset and
liability approach which requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events which have been
recognized in the Company's financial statements. The Company had approximately
$53,572.5 and $460.5 of net operating loss carryforwards for federal income tax
purposes at December 31, 1998 and 1997, respectively. The net operating loss
carryforwards will expire in the years 2012 and 2018 if not previously utilized.
The Company has recorded a valuation allowance equal to the net deferred tax
assets at December 31, 1998 and 1997, due to the uncertainty of future operating
results. The valuation allowance will be reduced at such time as management
believes it is more likely than not that the net deferred tax assets will be
realized. Any reductions in the valuation allowance will reduce future
provisions for income tax expense.
The Company's deferred tax assets and liabilities and the changes in those
assets are:
<TABLE>
<CAPTION>
1997 CHANGE 1998
--------- ---------- ----------
<S> <C> <C> <C>
Start-up costs capitalized for tax
purposes.................................. $ 1,025.9 $ (213.7) $ 812.2
Net operating loss carryforward............. 156.6 18,058.1 18,214.7
Amortization of original issue discount..... -- 9,663.6 9,663.6
Depreciation................................ -- (2,392.4) (2,392.4)
Valuation allowance......................... (1,182.5) (25,115.6) (26,298.1)
--------- ---------- ----------
$ -- $ -- $ --
========= ========== ==========
</TABLE>
Amortization of the original issue discount on the Series B Notes and 12 7/8%
Notes as interest expense is not deductible in the income tax return until paid.
Under existing income tax law, all operating expenses incurred prior to a
company commencing its principal operations are capitalized and amortized over a
five-year period for tax purposes.
10. STOCK OPTION/STOCK INCENTIVE/STOCK PURCHASE PLANS:
At December 31, 1998, the Company had three stock-based compensation plans, the
1997 Nonqualified Stock Option Plan (the "1997 Option Plan"), the 1998 Stock
Incentive Plan and the Employee Stock Discount Purchase Plan (the "Stock
Purchase Plan"). The Company applies the provisions of Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" and the related
interpretations in accounting for the Company's plans. Had compensation cost for
the Company's plans been determined based on the fair value of the options as of
the grant dates for awards under
F-18
<PAGE> 153
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the plans consistent with the method prescribed in SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net loss applicable to common stock and
net loss per share would have increased to the pro forma amounts indicated
below. The Company utilized the following assumptions in calculating the
estimated fair value of each option on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions for grants
in 1998 and 1997: dividend yield of 0%, expected volatility of 89.1%, and
expected lives of six years for both years: risk-free interest rates of 5.60% in
1998 and 6.06% in 1997 for the 1997 Option Plan and 4.70% in 1998 for the 1998
Stock Incentive Plan.
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Net loss applicable to common stock -- As reported..... $258,459.6 $ 7,502.1
Net loss applicable to common stock -- Pro forma....... $259,789.3 $ 7,512.2
Net loss per share, basic and diluted -- As reported... $ 10.53 $17,610.68
Net loss per share, basic and diluted -- Pro forma..... $ 10.58 $17,634.28
</TABLE>
As the 1998 Stock Incentive Plan and the Stock Purchase Plan were adopted in
1998, the December 31, 1997, pro forma balances do not include expenses for
these plans.
1997 OPTION PLAN AND 1998 STOCK INCENTIVE PLAN
Under the 1997 Option Plan, the Company granted options to key employees, a
director, and a consultant of the Company for an aggregate of 1,030,559 shares
of the Company's Common Stock. The Company will not grant options for any
additional shares under the 1997 Option Plan.
Under the 1998 Stock Incentive Plan, the Company may grant options to certain
employees, directors, advisors, and consultants of the Company. The 1998 Stock
Incentive Plan provides for issuance of the following types of incentive awards:
stock options, stock appreciation rights, restricted stock, performance grants,
and other types of awards that the Compensation Committee of the Board of
Directors (the "Compensation Committee") deems consistent with the purposes of
the 1998 Stock Incentive Plan. The Company has reserved 3,662,693 shares of
Common Stock for issuance under the 1998 Stock Incentive Plan.
Options granted under both plans have a term of six years and vest over a
three-year period and the Compensation Committee administers both option plans.
F-19
<PAGE> 154
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the 1997 Option Plan as of December 31, 1998 and
1997, is presented in the table below:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
--------------------------- --------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- ---------------- ------- ----------------
<S> <C> <C> <C> <C>
Outstanding, beginning of
period................... 189,127 $2.47 -- $ --
Granted.................... 843,457 2.79 189,127 2.47
Exercised.................. -- -- -- --
Forfeited.................. (148,647) 2.66 -- --
-------- -------
Outstanding, end of
period................... 883,937 2.74 189,127 2.47
======== =======
Options exercisable at
period-end............... 41,109 --
======== =======
Weighted average fair value
of options granted....... $ 2.74 $ 0.68
======== =======
</TABLE>
As of December 31, 1998 and 1997, options outstanding under the 1997 Option Plan
have a weighted average remaining contractual life of 5.2 and 5.8 years,
respectively.
A summary of the status of the 1998 Stock Incentive Plan as of December 31,
1998, is presented in the table below:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------------
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
------- ----------------
<S> <C> <C>
Outstanding, beginning of period...................... -- $ --
Granted............................................... 400,349 10.21
Exercised............................................. -- --
Forfeited............................................. (30,832) 10.03
-------
Outstanding, end of period............................ 369,517 10.22
=======
Options exercisable at period-end..................... --
=======
Weighted average fair value of options granted........ $ 10.22
=======
</TABLE>
As of December 31, 1998, options outstanding under the 1998 Stock Incentive Plan
have a weighted average remaining contractual life of 5.7 years.
As the estimated fair market value of the Company's Common Stock (as implied by
the IPO price) exceeded the exercise price of the options granted, the Company
has recognized deferred compensation of $7,635.0 and $2,030.7 at December 31,
1998 and 1997, respectively, of which $2,581.1 and $169.2 has been amortized to
expense at
F-20
<PAGE> 155
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1998 and 1997, respectively, over the vesting period of the
options. As of December 31, 1998, the Company has reversed $599.1 of unamortized
deferred compensation related to options forfeited.
STOCK PURCHASE PLAN
The Company's Stock Purchase Plan is intended to give employees a convenient
means of purchasing shares of Common Stock through payroll deductions. Each
participating employee's contributions will be used to purchase shares for the
employee's share account as promptly as practicable after each calendar quarter.
The cost per share will be 85% of the lower of the closing price of the
Company's Common Stock on the Nasdaq National Market on the first or the last
day of the calendar quarter. The Company has reserved 2,305,718 shares of Common
Stock for issuance under the Stock Purchase Plan. As of December 31, 1998, no
shares have been issued under the Stock Purchase Plan; however, participants
have contributed $303.4 and will be issued 44,624 shares of Common Stock in
January 1999. The Compensation Committee administers the Stock Purchase Plan.
F-21
<PAGE> 156
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following is a statement of estimated expenses, to be paid solely by
Allegiance, in connection with the distribution of the securities being
registered:
<TABLE>
<S> <C>
Printing expenses........................................... $ 75,000
Accounting fees and expenses................................ $140,000
Legal fees and expenses..................................... $ 30,000
Miscellaneous expenses...................................... $ 5,000
--------
Total............................................. $250,000
========
</TABLE>
- -------------------------
All amounts are estimated.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
GENERAL CORPORATION LAW
Allegiance is incorporated under the laws of the State of Delaware. Section 145
("Section 145") of the General Corporation Law of the State of Delaware, as the
same exists or may hereafter be amended (the "General Corporation Law"), among
other things, provides that a Delaware corporation may indemnify any persons who
were, are or are threatened to be made, parties to any threatened, pending or
completed action, suit or proceeding, whether civil, criminal, administrative or
investigative, other than an action by or in the right of such corporation, by
reason of the fact that such person is or was an officer, director, employee or
agent of such corporation, or is or was serving at the request of such
corporation as a director, officer employee or agent of another corporation or
enterprise. The indemnity may include expenses (including attorneys' fees),
judgments, fines and amounts paid in settlement actually and reasonably incurred
by such person in connection with such action, suit or proceeding, so long as
such person acted in good faith and in a manner he reasonably believed to be in
or not opposed to the corporation's best interests and, with respect to any
criminal action or proceeding, had no reasonable cause to believe that his
conduct was illegal. A Delaware corporation may indemnify any persons who are,
were or are threatened to be made, a party to any threatened, pending or
completed action or suit by or in the right of the corporation by reasons of the
fact that such person was a director, officer, employee or agent of such
corporation, or is or was serving at the request of such corporation as a
director, officer, employee or agent of another corporation or enterprise. The
indemnity may include expenses (including attorneys' fees) actually and
reasonably incurred by such person in connection with the defense or settlement
of such action or suit, so long as such person acted in good faith and in a
manner he reasonably believed to be in or not opposed to the corporation's best
interests, except that no indemnification is permitted without judicial approval
if the officer, director, employee or agent is adjudged to be liable to the
corporation. Where an officer, director, employee or agent is successful on the
merits or otherwise in the defense
II-1
<PAGE> 157
of any action referred to above, the corporation must indemnify him against the
expenses which such officer or director has actually and reasonably incurred.
Section 145 further authorizes a corporation to purchase and maintain insurance
on behalf of any person who is or was a director, officer, employee or agent of
the corporation, or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation or enterprise,
against any liability asserted against him and incurred by him in any such
capacity, arising out of his status as such, whether or not the corporation
would otherwise have the power to indemnify him under Section 145.
CERTIFICATE OF INCORPORATION
Allegiance's charter and by-laws provides for the indemnification of officers
and directors to the fullest extent permitted by the General Corporation Law.
All of Allegiance's directors and officers are covered by insurance policies
maintained by it against certain liabilities for actions taken in their
capacities as such, including liabilities under the Securities Act.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Since its inception, Allegiance has issued the following securities without
registration under the Securities Act (the number of shares set forth below does
not give effect to the stock split of Allegiance's common stock in the initial
public offering of common stock).
On August 13, 1997, in connection with Allegiance's formation, Allegiance issued
one share of common stock to Allegiance LLC for consideration of $1,000.
On August 13, 1997, Allegiance issued 95,000 shares of redeemable convertible
preferred stock to Allegiance LLC for an aggregate initial purchase price of
approximately $5 million.
On February 25, 1998, Allegiance issued: (a) 71.25 shares of redeemable
convertible preferred stock to Richard Fields for an aggregate initial purchase
price of $37,500; (b) 95 shares of redeemable convertible preferred stock to
Roger Curry for an aggregate initial purchase price of $50,000; (c) 23.75 shares
of redeemable convertible preferred stock to Northwestern University for an
aggregate initial purchase price of $12,500; (d) 237.5 shares of redeemable
convertible preferred stock to MKW Partners, L.P. for an aggregate initial
purchase price of $125,001; (e) 47.5 shares of redeemable convertible preferred
stock to Tom Shattan for an aggregate initial purchase price of $25,000; (f)
28.5 shares of redeemable convertible preferred stock to Greg Mendel for an
aggregate initial purchase price of $15,000; and (g) 19 shares of redeemable
convertible preferred stock to Kevin Fechtmeyer for an aggregate initial
purchase price of $10,000.
On March 13, 1998, Allegiance issued 118.75 shares of redeemable convertible
preferred stock to Charles Ross Partners, LLC for an aggregate initial purchase
price of $62,500.
The above-described transactions were exempt from registration under the
Securities Act under Section 4(2) of the Securities Act, as transactions not
involving any public offering.
On February 3, 1998, Allegiance issued 445,000 units, with each unit consisting
of one 11 3/4% Senior Discount Note due 2008 and one redeemable warrant to
purchase
II-2
<PAGE> 158
.0034224719 shares of Allegiance's common stock. Allegiance received
approximately $240.7 million of net proceeds, after deducting underwriting
discounts and commissions of approximately $8.75 million and other expenses
payable by Allegiance of approximately $1.0 million, from the issuance of the
units. Such units were issued to (a) "qualified institutional buyers" (as
defined in Rule 144A of the Securities Act), (b) other institutional "accredited
investors" (as defined in Rule 501(a) of the Securities Act), and (c) outside
the United States in compliance with Regulation S under the Securities Act, and
therefore, the issuance of such units was exempt from registration under the
Securities Act. Morgan Stanley & Co. Incorporated, Salomon Brothers Inc, Bear,
Stearns & Co. Inc. and Donaldson, Lufkin & Jenrette Securities Corporation were
the initial purchasers of the units.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
1.1 Form of Underwriting Agreement (incorporated by reference to
Exhibit 1.1 to Allegiance Telecom, Inc.'s Registration
Statement on Form S-1 (Registration No. 333-53479), filed on
May 22, 1998 and amended on June 5, 1998 and June 30, 1998
(the "Form S-1 Registration Statement")).
3.1 Amended and Restated Certificate of Incorporation of
Allegiance Telecom, Inc. (incorporated by reference to
Exhibit 3.1 to Allegiance's Form 10-Q for the period ended
June 30, 1998 (the "Form 10-Q")).
3.2 Amended and Restated By-Laws of Allegiance Telecom, Inc.
(incorporated by reference to Exhibit 3.2 to the Form 10-Q).
**4.1 Indenture, dated as of July 7, 1998, by and between the
Company and The Bank of New York, as trustee (including the
Form of Notes).
4.2 Indenture, dated as of February 3, 1998, by and between the
Company and The Bank of New York, as trustee (incorporated
by reference to Exhibit 4.2 to Allegiance Telecom, Inc.'s
Registration Statement on Form S-4 (Registration No.
333-49013), filed on March 31, 1998 and amended on May 6,
1998, May 15, 1998 and May 22, 1998 (the "Form S-4
Registration Statement")).
4.3 Form of 11 3/4% Senior Discount Notes (incorporated by
reference to Exhibit 4.3 to the Form S-4 Registration
Statement).
**4.4 Collateral Pledge and Security Agreement, dated as of July
7, 1998, by and between Allegiance and The Bank of New York,
as trustee.
**5.1 Opinion of Kirkland & Ellis.
10.1 Stock Purchase Agreement, dated August 13, 1997, between
Allegiance LLC and Allegiance (incorporated by reference to
Exhibit 10.1 to the Form S-4 Registration Statement).
</TABLE>
II-3
<PAGE> 159
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
10.2 Securityholders Agreement, dated August 13, 1997, among
Allegiance LLC, the Fund Investors, the Management Investors
and Allegiance (incorporated by reference to Exhibit 10.2 to
the Form S-4 Registration Statement).
10.3 Registration Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors and Allegiance
(incorporated by reference to Exhibit 10.3 to the Form S-4
Registration Statement).
10.4 Warrant Registration Rights Agreement, dated as of January
29, 1998, by and among Allegiance and Morgan Stanley & Co.
Incorporated, Salomon Brothers Inc, Bear, Stearns & Co. Inc.
and Donaldson, Lufkin & Jenrette Securities Corporation, as
initial purchasers of the 11 3/4% Senior Discount Notes
(incorporated by reference to Exhibit 10.11 to the Form S-4
Registration Statement).
10.5 Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the Form S-4
Registration Statement).
10.6 Allegiance Telecom, Inc. 1998 Stock Incentive Plan
(incorporated by reference to Exhibit 10.6 to the Form S-1
Registration Statement).
10.7 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance LLC, Allegiance and Royce J. Holland
(incorporated by reference to Exhibit 10.5 to the Form S-4
Registration Statement).
10.8 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance LLC, Allegiance and Thomas M. Lord (incorporated
by reference to Exhibit 10.6 to the Form S-4 Registration
Statement).
10.9 Executive Purchase Agreement, dated January 28, 1998, among
Allegiance LLC, Allegiance and C. Daniel Yost (incorporated
by reference to Exhibit 10.7 to the Form S-4 Registration
Statement).
10.10 Form of Executive Purchase Agreement among Allegiance LLC,
Allegiance and each of the other Management Investors
(incorporated by reference to Exhibit 10.8 to the Form S-4
Registration Statement).
10.11 Warrant Agreement, dated February 3, 1998, by and between
Allegiance and The Bank of New York, as Warrant Agent
(including the form of the Warrant Certificate)
(incorporated by reference to Exhibit 10.9 to the Form S-4
Registration Statement).
10.12 General Agreement, dated October 16, 1997, as amended,
between Allegiance and Lucent Technologies Inc.
(incorporated by reference to Exhibit 10.10 to the Form S-4
Registration Statement).
10.13 Form of Indemnification Agreement by and between Allegiance
and its directors and officers (incorporated by reference to
Exhibit 10.13 to the Form S-1 Registration Statement).
*11.1 Statement Regarding Computation of Per Share Earnings (Loss)
for the year ended December 31, 1998.
*11.2 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the year ended December 31, 1998.
</TABLE>
II-4
<PAGE> 160
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
*11.3 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the period from inception (April 22,
1997) through December 31, 1997.
*12.1 Statement Regarding Computation of Ratios of Earnings (Loss)
to Fixed Charges.
21.1 Subsidiaries of Allegiance (incorporated by reference to
Exhibit 21.1 to the Form S-1 Registration Statement).
*23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Kirkland & Ellis (included in Exhibit 5.1).
24.1 Powers of Attorney (included in Part II to the Registration
Statement).
25.1 Statement of Eligibility of Trustee on Form T-1
(incorporated by reference to Exhibit 25.1 to the Form S-1
Registration Statement).
*27.1 Financial Data Schedule for the year ended December 31,
1998.
27.2 Financial Data Schedule for the period from inception (April
22, 1997) through December 31, 1997 (incorporated by
reference to Exhibit 27.2 to the Form S-4 Registration
Statement).
</TABLE>
- -------------------------
* Filed herewith
** Previously filed
(b) FINANCIAL STATEMENT SCHEDULES.
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required
under the related instructions, are inapplicable or not material, or the
information called for thereby is otherwise included in the financial
statements and therefore has been omitted.
ITEM 17. UNDERTAKINGS.
The undersigned registrant hereby undertakes to provide to the underwriter at
closing specified in the underwriting agreement certificates in such
denominations and registered in such names as requested by the underwriter to
permit prompt delivery to each purchaser.
The undersigned registrant hereby undertakes:
(1) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of
this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For purposes of determining any liability under the Securities Act of
1933, 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
II-5
<PAGE> 161
such securities at that time shall be deemed to be the initial bona fide
offering thereof.
(3) (a) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement; and
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or
any material change to such information in the registration statement.
(b) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination
of the offering.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question 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.
II-6
<PAGE> 162
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant has
duly caused this amendment to the Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Dallas,
State of Texas, on March 1, 1999.
ALLEGIANCE TELECOM, INC.
By: /s/ ROYCE J. HOLLAND
--------------------------------------
Royce J. Holland
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this amendment to
the Registration Statement has been signed by the following persons on March 1,
1999, in the capacities indicated:
<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S> <C>
/s/ ROYCE J. HOLLAND Chairman of the Board
- ------------------------------------------------ and Chief Executive
Royce J. Holland Officer (Principal
Executive Officer)
* President, Chief
- ------------------------------------------------ Operating Officer
C. Daniel Yost and Director
* Executive Vice
- ------------------------------------------------ President, Chief
Thomas M. Lord Financial Officer,
and Director
(Principal
Financial Officer)
/s/ DENNIS M. MAUNDER Vice President and
- ------------------------------------------------ Controller
Dennis M. Maunder (Principal
Accounting Officer)
* Senior Vice President
- ------------------------------------------------ of Sales and
John J. Callahan Marketing and
Director
* Director
- ------------------------------------------------
Paul D. Carbery
</TABLE>
II-7
<PAGE> 163
<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S> <C>
* Director
- ------------------------------------------------
James E. Crawford, III
* Director
- ------------------------------------------------
John B. Ehrenkranz
* Director
- ------------------------------------------------
Paul J. Finnegan
* Director
- ------------------------------------------------
Richard D. Frisbie
* Director
- ------------------------------------------------
Reed E. Hundt
* Director
- ------------------------------------------------
Robert H. Niehaus
* Director
- ------------------------------------------------
James N. Perry, Jr.
- ------------------
* The undersigned, by signing his name hereto, does sign and execute this amendment to
Registration Statement on behalf of the above named officers and directors of Allegiance
Telecom, Inc. pursuant to the Power of Attorney executed by such officers and directors
and previously filed with the Securities and Exchange Commission.
/s/ DENNIS M. MAUNDER
- ------------------------------------------------
Dennis M. Maunder
Attorney-in-Fact
</TABLE>
II-8
<PAGE> 164
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
1.1 Form of Underwriting Agreement (incorporated by reference to
Exhibit 1.1 to Allegiance Telecom, Inc.'s Registration
Statement on Form S-1 (Registration No. 333-53479), filed on
May 22, 1998 and amended on June 5, 1998 and June 30, 1998
(the "Form S-1 Registration Statement")).
3.1 Amended and Restated Certificate of Incorporation of
Allegiance Telecom, Inc. (incorporated by reference to
Exhibit 3.1 to Allegiance's Form 10-Q for the period ended
June 30, 1998 (the "Form 10-Q")).
3.2 Amended and Restated By-Laws of Allegiance Telecom, Inc.
(incorporated by reference to Exhibit 3.2 to the Form 10-Q).
**4.1 Indenture, dated as of July 7, 1998, by and between the
Company and The Bank of New York, as trustee (including the
Form of Notes).
4.2 Indenture, dated as of February 3, 1998, by and between the
Company and The Bank of New York, as trustee (incorporated
by reference to Exhibit 4.2 to Allegiance Telecom, Inc.'s
Registration Statement on Form S-4 (Registration No.
333-49013), filed on March 31, 1998 and amended on May 6,
1998, May 15, 1998 and May 22, 1998 (the "Form S-4
Registration Statement")).
4.3 Form of 11 3/4% Senior Discount Notes (incorporated by
reference to Exhibit 4.3 to the Form S-4 Registration
Statement).
**4.4 Collateral Pledge and Security Agreement, dated as of July
7, 1998, by and between Allegiance and The Bank of New York,
as trustee.
**5.1 Opinion of Kirkland & Ellis.
10.1 Stock Purchase Agreement, dated August 13, 1997, between
Allegiance LLC and Allegiance (incorporated by reference to
Exhibit 10.1 to the Form S-4 Registration Statement).
10.2 Securityholders Agreement, dated August 13, 1997, among
Allegiance LLC, the Fund Investors, the Management Investors
and Allegiance (incorporated by reference to Exhibit 10.2 to
the Form S-4 Registration Statement).
10.3 Registration Agreement, dated August 13, 1997, among the
Fund Investors, the Management Investors and Allegiance
(incorporated by reference to Exhibit 10.3 to the Form S-4
Registration Statement).
10.4 Warrant Registration Rights Agreement, dated as of January
29, 1998, by and among Allegiance and Morgan Stanley & Co.
Incorporated, Salomon Brothers Inc, Bear, Stearns & Co. Inc.
and Donaldson, Lufkin & Jenrette Securities Corporation, as
initial purchasers of the 11 3/4% Senior Discount Notes
(incorporated by reference to Exhibit 10.11 to the Form S-4
Registration Statement).
10.5 Allegiance Telecom, Inc. 1997 Nonqualified Stock Option Plan
(incorporated by reference to Exhibit 10.4 to the Form S-4
Registration Statement).
</TABLE>
<PAGE> 165
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
10.6 Allegiance Telecom, Inc. 1998 Stock Incentive Plan
(incorporated by reference to Exhibit 10.6 to the Form S-1
Registration Statement).
10.7 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance LLC, Allegiance and Royce J. Holland
(incorporated by reference to Exhibit 10.5 to the Form S-4
Registration Statement).
10.8 Executive Purchase Agreement, dated August 13, 1997, among
Allegiance LLC, Allegiance and Thomas M. Lord (incorporated
by reference to Exhibit 10.6 to the Form S-4 Registration
Statement).
10.9 Executive Purchase Agreement, dated January 28, 1998, among
Allegiance LLC, Allegiance and C. Daniel Yost (incorporated
by reference to Exhibit 10.7 to the Form S-4 Registration
Statement).
10.10 Form of Executive Purchase Agreement among Allegiance LLC,
Allegiance and each of the other Management Investors
(incorporated by reference to Exhibit 10.8 to the Form S-4
Registration Statement).
10.11 Warrant Agreement, dated February 3, 1998, by and between
Allegiance and The Bank of New York, as Warrant Agent
(including the form of the Warrant Certificate)
(incorporated by reference to Exhibit 10.9 to the Form S-4
Registration Statement).
10.12 General Agreement, dated October 16, 1997, as amended,
between Allegiance and Lucent Technologies Inc.
(incorporated by reference to Exhibit 10.10 to the Form S-4
Registration Statement).
10.13 Form of Indemnification Agreement by and between Allegiance
and its directors and officers (incorporated by reference to
Exhibit 10.13 to the Form S-1 Registration Statement).
*11.1 Statement Regarding Computation of Per Share Earnings (Loss)
for the year ended December 31, 1998.
*11.2 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the year ended December 31, 1998.
*11.3 Statement Regarding Computation of Pro Forma Per Share
Earnings (Loss) for the period from inception (April 22,
1997) through December 31, 1997.
*12.1 Statement Regarding Computation of Ratios of Earnings (Loss)
to Fixed Charges.
21.1 Subsidiaries of Allegiance (incorporated by reference to
Exhibit 21.1 to the Form S-1 Registration Statement).
*23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Kirkland & Ellis (included in Exhibit 5.1).
24.1 Powers of Attorney (included in Part II to the Registration
Statement).
25.1 Statement of Eligibility of Trustee on Form T-1
(incorporated by reference to Exhibit 25.1 to the Form S-1
Registration Statement).
*27.1 Financial Data Schedule for the year ended December 31,
1998.
</TABLE>
<PAGE> 166
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
27.2 Financial Data Schedule for the period from inception (April
22, 1997) through December 31, 1997 (incorporated by
reference to Exhibit 27.2 to the Form S-4 Registration
Statement).
</TABLE>
- -------------------------
* Filed herewith
** Previously filed
<PAGE> 1
EXHIBIT 11.1
ALLEGIANCE TELECOM, INC.
COMPUTATION OF PER SHARE EARNINGS (LOSS)
Year Ended December 31, 1998
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
Number of Shares Percent Outstanding Equivalent Shares
---------------- ------------------- -----------------
<S> <C> <C> <C>
Prior to Initial Public Offering
1997 Common Stock Offering 426 51.23% 218
After Initial Public Offering
1997 Common Stock Offering 426 48.77% 208
1998 Common Stock Offering 10,000,000 48.77% 4,876,712
Preferred Stock Converted to Common Stock 40,341,128 48.77% 19,673,208
--------------
24,550,346
WEIGHTED AVERAGE SHARES OUTSTANDING 24,550,346
NET LOSS APPLICABLE TO COMMON STOCK $ (258,459.6)
NET LOSS PER SHARE, BASIC AND DILUTED $ (10.53)
==============
</TABLE>
<PAGE> 1
EXHIBIT 11.2
ALLEGIANCE TELECOM, INC.
COMPUTATION OF PRO FORMA PER SHARE EARNINGS (LOSS)
Year Ended December 31, 1998
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
PRO FORMA NET LOSS PER SHARE,
-----------------------------------------------------------
Number of Shares Percent Outstanding Equivalent Shares
---------------- ------------------- -----------------
<S> <C> <C> <C>
COMMON STOCK
1997 Common Stock Offering 426 100.00% 426
1998 Common Stock Offering 10,000,000 100.00% 10,000,000
Preferred Stock Converted to Common Stock 40,341,128 100.00% 40,341,128
-------------- --------------
50,341,554 50,341,554
WEIGHTED AVERAGE SHARES OUTSTANDING 50,341,554
NET LOSS APPLICABLE TO COMMON STOCK $ (294,288.7)
NET LOSS PER SHARE, BASIC AND DILUTED $ (5.85)
==============
</TABLE>
<PAGE> 1
EXHIBIT 11.3
ALLEGIANCE TELECOM, INC.
COMPUTATION OF PRO FORMA PER SHARE EARNINGS (LOSS)
Period From Inception (April 22, 1997) Through December 31, 1997
(In thousands, except share and per share amounts)
<TABLE>
<CAPTION>
PRO FORMA NET LOSS PER SHARE
---------------------------------------------------------
Number of Shares Percent Outstanding Equivalent Shares
---------------- ------------------- -----------------
<S> <C> <C> <C>
COMMON STOCK
1997 Common Stock Offering 426 100.00% 426
1998 Common Stock Offering 10,000,000 100.00% 10,000,000
Preferred Stock Converted to Common Stock 40,498,062 100.00% 40,498,062
-------------- --------------
50,498,488 50,498,488
WEIGHTED AVERAGE SHARES OUTSTANDING 50,498,488
NET LOSS APPLICABLE TO COMMON STOCK $ (220,746.6)
NET LOSS PER SHARE, BASIC AND DILUTED $ (4.37)
==============
</TABLE>
<PAGE> 1
EXHIBIT 12.1
ALLEGIANCE TELECOM, INC.
COMPUTATION OF RATIOS OF EARNINGS (LOSS) TO FIXED CHARGES
(In thousands)
<TABLE>
<CAPTION>
PERIOD FROM INCEPTION
YEAR ENDED (APRIL 22, 1997)
DECEMBER 31, 1998 THROUGH DECEMBER 31, 1997
----------------------------- ---------------------------
PRO FORMA PRO FORMA
AS ADJUSTED FOR AS ADJUSTED FOR
THE IPO AND THE IPO AND
ACTUAL DEBT OFFERINGS ACTUAL DEBT OFFERINGS
----------- --------------- --------- ---------------
<S> <C> <C> <C> <C>
Earnings:
Net loss $(246,488.2) $ (282,309.9) $(3,687.9) $(216,643.8)
Add: Fixed charges 39,949.1 63,213.1 -- 41,212.5
----------- ------------- --------- -----------
(206,539.1) (219,096.8) (3,687.9) (175,431.3)
Fixed charges:
Interest in
indebtedness 40,446.4 63,138.6 -- 39,946.7
Amortization of debt
discount and debt
issuance costs 1,303.6 1,875.4 -- 1,265.8
Interest portion of
rental and lease
expense 997.3 997.3 -- --
----------- ------------- --------- -----------
42,747.3 66,011.3 -- 41,212.5
Deficiency of earnings
available to cover fixed
charges $(249,286.4) $ (285,108.1) $(3,687.9) $(216,643.8)
=========== ============= ========= ===========
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
(and to all references to our Firm) included in or made a part of this
Registration Statement File No. 333-69543.
ARTHUR ANDERSEN LLP
Dallas, Texas
March 1, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1998 AND FROM THE
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
CONSOLIDATED FINANCIAL STATEMENT.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 262,502
<SECURITIES> 143,390
<RECEIVABLES> 6,764
<ALLOWANCES> 577
<INVENTORY> 0
<CURRENT-ASSETS> 438,864
<PP&E> 153,875
<DEPRECIATION> 9,015
<TOTAL-ASSETS> 637,874
<CURRENT-LIABILITIES> 47,159
<BONDS> 471,545
0
0
<COMMON> 503
<OTHER-SE> 109,926
<TOTAL-LIABILITY-AND-EQUITY> 637,874
<SALES> 0
<TOTAL-REVENUES> 9,786
<CGS> 0
<TOTAL-COSTS> 9,529
<OTHER-EXPENSES> 181,622
<LOSS-PROVISION> 577
<INTEREST-EXPENSE> 38,952
<INCOME-PRETAX> (258,460)
<INCOME-TAX> 0
<INCOME-CONTINUING> (258,460)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (258,460)
<EPS-PRIMARY> (10.53)
<EPS-DILUTED> (10.53)
</TABLE>
