<PAGE> 1
RULE 424(b)(3) AND (c)
REGISTRATION NO. 333-74771
PROSPECTUS SUPPLEMENT
(TO PROSPECTUS DATED MARCH 31, 1999)
ALLEGIANCE TELECOM, INC.
11 3/4% SENIOR DISCOUNT NOTES DUE 2008
ATTACHED HERETO AND INCORPORATED BY REFERENCE HEREIN IS THE ALLEGIANCE
TELECOM, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1999.
This Prospectus Supplement, together with the Prospectus, is to be used by
Morgan Stanley & Co. Incorporated ("Morgan Stanley") and Dean Witter Reynolds,
Inc. ("Dean Witter" and, together with Morgan Stanley, "Morgan Stanley Dean
Witter"), in connection with offers and sales of the 11 3/4% Senior Discount
Notes due 2008 of Allegiance Telecom, Inc. 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. Allegiance will receive no portion of the proceeds of such sales
of 11 3/4% notes and will bear the expenses incident to the registration
thereof. 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 11 3/4% notes because of the equity ownership of Allegiance by
certain private investment partnerships, which are affiliates of Morgan Stanley
Dean Witter. As of August 9, 1999, these investment partnerships owned in the
aggregate approximately 15.89% of Allegiance's outstanding common stock. 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 11 3/4% notes may, in part,
be dependent on the ability of Allegiance to maintain a current market-making
prospectus.
August 16, 1999
<PAGE> 2
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999.
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
COMMISSION FILE NUMBER: 0-24509
ALLEGIANCE TELECOM, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2721491
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1950 STEMMONS FREEWAY
SUITE 3026
DALLAS, TEXAS 75207
(Address of principal executive offices) (Zip Code)
(214) 261-7100
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
As of August 9, 1999, the registrant has 64,811,690 shares of common stock,
par value $0.01 per share outstanding.
================================================================================
<PAGE> 3
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
FORM 10-Q INDEX
<TABLE>
<CAPTION>
PAGE
NO.
----
PART I. FINANCIAL INFORMATION
<S> <C>
Item 1. Financial Statements........................................................... 3
Condensed Consolidated Balance Sheets as of June 30, 1999 and December 31, 1998... 3
Condensed Consolidated Statements of Operations for the three and six months
ended June 30, 1999 and 1998.................................................. 4
Condensed Consolidated Statements of Cash Flows for the six months ended June 30,
1999 and 1998................................................................. 5
Notes to Condensed Consolidated Financial Statements.............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk..................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................. 21
Item 2. Changes in Securities and Use of Proceeds...................................... 21
Item 3. Defaults Upon Senior Securities ............................................... 21
Item 4. Submission of Matters to a Vote of Security Holders............................ 21
Item 5. Other Information.............................................................. 22
Item 6. Exhibits and Reports on Form 8-K............................................... 22
Signatures............................................................................. 23
</TABLE>
2
<PAGE> 4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
ASSETS
JUNE 30, 1999 DECEMBER 31, 1998
------------- -----------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents .................................. $ 669,043 $ 262,502
Short-term investments ..................................... 37,607 143,390
Short-term investments, restricted ......................... 25,552 25,543
Accounts receivable (net of allowance for doubtful accounts
of $2,310 and $577, respectively) ........................ 17,322 6,186
Prepaid expenses and other current assets .................. 2,857 1,243
----------- -----------
Total current assets ............................... 752,381 438,864
PROPERTY AND EQUIPMENT (net of accumulated depreciation and
amortization of $25,988 and $9,015, respectively) .......... 283,835 144,860
OTHER NON-CURRENT ASSETS:
Deferred debt issuance costs (net of accumulated
amortization of $1,493 and $734, respectively) ........... 21,203 16,078
Goodwill (net of accumulated amortization of $100) ......... 33,494 --
Long-term investments, restricted .......................... 25,014 36,699
Other assets, net........................................... 7,426 1,373
----------- -----------
Total other non-current assets ..................... 87,137 54,150
----------- -----------
Total assets ....................................... $ 1,123,353 $ 637,874
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ........................................... $ 52,636 $ 20,981
Accrued liabilities and other .............................. 32,967 26,177
----------- -----------
Total current liabilities .......................... 85,603 47,158
LONG-TERM DEBT ............................................... 490,625 471,652
REDEEMABLE WARRANTS .......................................... -- 8,634
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock -- $.01 par value, 1,000,000 shares
authorized, no shares issued or outstanding at June 30,
1999 and December 31, 1998 ............................... -- --
Common stock -- $.01 par value, 150,000,000 authorized,
64,721,029 and 50,341,554 shares issued and 64,695,717
and 50,341,554 shares outstanding at June 30, 1999 and ... 646 503
December 31, 1998, respectively
Common stock in treasury, at cost, 25,312 and no shares at
June 30, 1999 and December 31, 1998, respectively ........ (5) --
Additional paid-in capital ................................. 943,389 416,730
Deferred compensation ...................................... (17,592) (14,617)
Deferred management ownership allocation charge ............ (14,969) (26,224)
Accumulated deficit ........................................ (364,344) (265,962)
----------- -----------
Total stockholders' equity ........................... 547,125 110,430
----------- -----------
Total liabilities and stockholders' equity ........... $ 1,123,353 $ 637,874
=========== ===========
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements.
3
<PAGE> 5
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1999 1998 1999 1998
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES................................................... $ 17,746 $ 1,212 $ 27,722 $ 1,415
OPERATING EXPENSES:
Network.................................................. 12,717 1,351 20,342 1,586
Selling, general and administrative...................... 30,652 8,075 58,236 12,776
Management ownership allocation charge................... 5,475 -- 11,255 --
Non-cash deferred compensation........................... 2,010 1,390 3,831 2,369
Depreciation and amortization............................ 9,920 1,005 17,137 1,213
------------ ------------ ------------ ------------
Total operating expenses......................... 60,774 11,821 110,801 17,944
------------ ------------ ------------ ------------
Loss from operations............................. (43,028) (10,609) (83,079) (16,529)
OTHER (EXPENSE) INCOME:
Interest income.......................................... 8,962 3,402 14,283 5,596
Interest expense......................................... (15,190) (7,229) (29,456) (11,898)
------------ ------------ ------------ ------------
Total other (expense) income..................... (6,228) (3,827) (15,173) (6,302)
------------ ------------ ------------ ------------
NET LOSS................................................... (49,256) (14,436) (98,252) (22,831)
ACCRETION OF REDEEMABLE PREFERRED STOCK AND WARRANT
VALUES .................................................. -- (6,454) (130) (11,719)
------------ ------------ ------------ ------------
NET LOSS APPLICABLE TO COMMON STOCK........................ $ (49,256) $ (20,890) $ (98,382) $ (34,550)
============ ============ ============ ============
NET LOSS PER SHARE, basic and diluted...................... $ (0.80) $ (49,037.56) $ (1.76) $ (81,103.29)
============ ============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING, basic
and diluted.............................................. 61,598,487 426 55,986,526 426
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements.
4
<PAGE> 6
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1999 JUNE 30, 1998
(UNAUDITED) (UNAUDITED)
------------- -------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss ................................................ $ (98,252) $ (22,831)
Adjustments to reconcile net loss to cash used in
operating activities--
Depreciation and amortization ......................... 17,137 1,213
Provision for uncollectible accounts receivable ....... 1,603 --
Accretion of investments .............................. (2,479) --
Accretion of senior discount notes .................... 16,839 11,646
Amortization of original issue discount ............... 387 --
Amortization of deferred debt issuance costs .......... 759 252
Amortization of management ownership allocation charge
and deferred compensation ........................... 15,086 2,369
Changes in assets and liabilities--
Increase in receivables ............................... (12,309) (1,675)
Increase in prepaid expenses and other current assets.. (1,473) (215)
Increase in other assets .............................. (165) (254)
Increase in accounts payable .......................... 1,270 1,085
Increase in accrued liabilities and other ............. 12,349 3,107
---------- ----------
Net cash used in operating activities ............. (49,248) (5,303)
Cash Flows from Investing Activities:
Purchases of property and equipment ..................... (134,142) (21,417)
Purchases of investments ................................ (47,717) (62,495)
Proceeds from redemption of investments ................. 167,655 --
Purchase of subsidiaries, net of cash acquired .......... (34,861) --
---------- ----------
Net cash used in investing activities ............. (49,065) (83,912)
Cash Flows from Financing Activities:
Proceeds from issuance of senior notes .................. -- 242,294
Proceeds from issuance of redeemable warrants ........... -- 8,184
Deferred debt issuance costs ............................ (6,362) (10,200)
Proceeds from issuance of redeemable preferred stock .... -- 62
Proceeds from secondary stock offering .................. 510,618 --
Preferred stock subscriptions receivable ................ -- 275
Proceeds from exercise of warrants ...................... 2 --
Proceeds from stock options exercised ................... 83 --
Proceeds from issuance of common stock under the
Employee Stock Discount Purchase Plan ................ 529 --
Proceeds from redeemable capital contributions .......... -- 20,543
Purchase of treasury stock .............................. (5) --
Other financing activities .............................. (11) --
---------- ----------
Net cash provided by financing activities ......... 504,854 261,158
---------- ----------
Net increase in cash and cash equivalents ......... 406,541 171,943
Cash and cash equivalents, beginning of period .... 262,502 5,726
---------- ----------
Cash and cash equivalents, end of period .......... $ 669,043 $ 177,669
========== ==========
</TABLE>
The accompanying notes are an integral part of
these condensed consolidated financial statements.
5
<PAGE> 7
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTHS ENDED JUNE 30, 1999 AND JUNE 30, 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
1. GENERAL:
Allegiance Telecom, Inc., a competitive local exchange carrier ("CLEC"),
seeks to become a leading provider of 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 development plan is focused on offering services in 24 of the
largest U.S. metropolitan areas. As of June 30, 1999, Allegiance is operational
in fifteen markets: Atlanta, Boston, Chicago, Dallas, Fort Worth, Houston, Los
Angeles, New York, Northern New Jersey, Oakland, Orange County, Philadelphia,
San Francisco, San Jose, and Washington, D.C.; and is in the process of
deploying networks in four other markets: San Diego, Long Island, Detroit, and
Baltimore.
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 intends to operate. The Company's
performance will further be affected by its ability to assess potential markets,
implement expanded interconnection and collocation with the facilities of
incumbent local exchange carriers ("ILECs"), lease adequate trunking capacity
from the ILECs or other CLECs, purchase and install switches in additional
markets, implement efficient operations support systems and other back office
systems, develop a sufficient customer base, and attract, retain, and motivate
qualified personnel. The Company's networks and the provisioning 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 location in which the
Company offers service until a sufficient customer base is established. It is
anticipated that obtaining a sufficient customer base will take a number of
years, and positive cash flows from operations are not expected in the near
future.
2. BASIS OF PRESENTATION:
The accompanying unaudited condensed consolidated financial statements have
been prepared by the Company in accordance with generally accepted accounting
principles for interim financial information and are in the form prescribed by
the Securities and Exchange Commission in instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The interim unaudited financial statements should be read
in conjunction with the audited financial statements of the Company as of and
for the year ended December 31, 1998. In the opinion of management, all
adjustments (consisting only of normal recurring adjustments) considered
necessary for a fair presentation have been included. Operating results for the
three and six months ended June 30, 1999 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1999.
Certain amounts in the prior period's consolidated financial statements
have been reclassified to conform with the current period presentation.
3. CHANGE IN ACCOUNTING POLICY:
In connection with the offering of the Series B 11 3/4% Notes due 2008,
445,000 Redeemable Warrants to purchase 1.45898399509 shares each, as adjusted
for a 426.2953905 for-one stock split (see Note 10), of the Company's common
stock at $.01 per share were issued. The Redeemable Warrants became exercisable
upon the Company's initial public offering on July 7, 1998, and will expire on
February 3, 2008.
6
<PAGE> 8
The Redeemable Warrants are redeemable for cash, upon the occurrence of a
repurchase event. A repurchase event is defined to occur when (i) the Company
consolidates 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
common stock thereafter issuable upon exercise of the Redeemable Warrants is not
registered under the Exchange Act, unless the consideration for such a
transaction is cash.
Through March 31, 1999, the Company was recognizing the future potential
redemption value of the Redeemable Warrants by recording accretion to their
estimated fair market value at February 3, 2008, using the effective interest
method. Accretion of $130 was recorded during the three months ended March 31,
1999, and accretion of $124 and $198 was recorded during the three and six
months ended June 30, 1998, respectively.
Effective April 1, 1999, the Company determined that accreting the
Redeemable Warrants to a future potential redemption value was no longer
applicable, as the redemption of the Redeemable Warrants for cash is no longer
beyond the control of the Company, and the redemption date and amount are not
reasonably determinable. Accordingly, the accreted value of the Redeemable
Warrants at April 1, 1999 was reclassified to stockholders' equity as warrants
(the "Warrants"), and no further accretion will be recorded.
If a repurchase event occurs in the future or becomes probable, the Company
will adjust the Warrants to the estimated redemption value at that time.
4. ACQUISITIONS:
During the three months ended June 30, 1999, the Company acquired certain assets
of ConnecTen, L.L.C. and the Internet service providers ConnectNet, Inc. and
Kivex, Inc. for cash. Summary information regarding the acquisitions is as
follows:
<TABLE>
<CAPTION>
BUSINESS NAME ACQUISITION DATE PERCENTAGE ACQUIRED PURCHASE PRICE
----------------- ---------------- ------------------- --------------
<S> <C> <C> <C>
ConnecTen, L.L.C. April 1, 1999 N/A $ 750
ConnectNet, Inc. April 28, 1999 100% $ 2,025
Kivex, Inc. June 30, 1999 100% $ 34,545
</TABLE>
Each of the acquisitions was accounted for using the purchase method of
accounting and, accordingly, the net assets and results of operations of the
acquired companies have been included in the Company's consolidated financial
statements since the acquisition dates. The purchase price of the acquisitions
was allocated to assets acquired, including intangible assets, and liabilities
assumed, based on their respective estimated fair values at the acquisition
dates. The Company's purchase price allocation of these acquisitions is
preliminary and may be adjusted as additional information is obtained. The
purchase price allocation for the acquired businesses is as follows:
<TABLE>
<CAPTION>
(unaudited)
------------
<S> <C>
Cash, receivables, and prepaids.... $ 3,030
Property and equipment............. 3,641
Other assets and intangibles....... 5,953
Goodwill .......................... 33,594
------------
46,218
Liabilities assumed ............... (8,898)
------------
$ 37,320
=============
</TABLE>
Goodwill and other intangibles are being amortized using the straight-line
method over a period of three years.
The following presents the unaudited pro forma results of operations of
the Company for the three and six months ended June 30, 1999 and 1998 as if the
acquisition of Kivex, Inc. had been consummated at the beginning of each of the
periods presented. The pro forma results of operations are prepared for
comparative purposes only and do not necessarily reflect the results that would
have occurred had the acquisition occurred at the beginning of the periods
presented or the results which may occur in the future. The pro forma results of
operations for ConnecTen, L.L.C. and ConnectNet, Inc. are not included in this
table as the results would not have been material to the Company's results of
operations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- ----------------------
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Revenues $ 19,872 $ 2,107 $ 31,660 $ 3,007
Net loss before extraordinary
items (51,423) (21,980) (102,984) (36,324)
Net loss applicable to
common stock (51,423) (21,980) (102,984) (36,324)
Net loss per share, basic
and diluted (0.83) (51,596.24) (1.84) (85,267.61)
</TABLE>
5. PROPERTY AND EQUIPMENT:
Property and equipment includes network equipment, leasehold improvements,
software, office equipment and other, furniture and fixtures, and
construction-in-progress. 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 three months ended June 30,
1999 and 1998, was $16,549 and $7,704, respectively, before the capitalization
of $1,359 and $475 of interest related to construction-in-progress for the three
months ended June 30, 1999 and 1998, respectively. Interest expense for the six
months ended June 30, 1999 and 1998, was $31,906 and $12,841, respectively,
before the capitalization of $2,450 and $943 of interest related to
construction-in-progress for the six months ended June 30, 1999 and 1998,
respectively. Repair and maintenance costs are expensed as incurred.
7
<PAGE> 9
Property and equipment at June 30, 1999 and December 31, 1998, consisted of
the following:
<TABLE>
<CAPTION>
USEFUL
JUNE 30, DECEMBER 31, LIVES
1999 1998 (IN YEARS)
--------- ------------ ----------
<S> <C> <C> <C>
Network equipment ...................... $ 176,247 $ 67,304 5-7
Leasehold improvements ................. 38,842 24,483 5-10
Software ............................... 17,559 7,840 3
Office equipment and other ............. 7,395 4,384 2
Furniture and fixtures ................. 4,317 2,420 5
--------- ---------
Property and equipment, in service ..... 244,360 106,431
Less: Accumulated depreciation ......... (25,988) (9,015)
--------- ---------
Property and equipment in service,
net .................................. 218,372 97,416
Construction-in-progress ............... 65,463 47,444
--------- ---------
Property and equipment, net... $ 283,835 $ 144,860
========= =========
</TABLE>
6. OTHER ASSETS
Other assets at June 30, 1999 and December 31, 1998 consisted of the
following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Acquired subscriber lists ............ $ 5,500 $ --
Acquired workforces .................. 205 --
Advanced payment on capital leases.... 248 --
Long-term deposits ................... 1,537 1,373
-------- ------------
Total other assets ................... 7,490 1,373
Less: Accumulated amortization ....... (64) (--)
-------- ------------
Other assets, net .................. $ 7,426 $ 1,373
======== ============
</TABLE>
Acquired subscriber lists and acquired workforces were obtained in
connection with the acquisitions (see Note 4) during the three months ended June
30, 1999. These assets are being amortized over their estimated useful lives of
three years using the straight-line method.
7. CAPITALIZATION:
Common Stock
In April 1999, under the Company's Employee Stock Discount Purchase Plan,
22,605 shares of common stock were issued for proceeds of $226.
In April 1999, the Company raised $533,041 of gross proceeds from the sale
of the Company's common stock (the "Secondary Equity Offering"). The Company
sold 14,027,400 shares at a price of $38.00 per share. Net proceeds from the
Secondary Equity Offering were $510,618.
Warrants
During the three months ended June 30, 1999, 175,139 Warrants, formerly
referred to as Redeemable Warrants (see Note 3), were exercised to purchase
255,493 shares of common stock. Fractional shares are not issued, cash payments
are made in lieu thereof, according to the terms of the Warrant Agreement. At
June 30, 1999 and December 31, 1998, 269,861 and 445,000 Warrants, respectively,
are outstanding.
8
<PAGE> 10
8. LONG-TERM DEBT:
Long-term debt consists of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Series B 11 3/4% Notes, face amount $445,000 due February 15,
2008, effective interest rate of 12.45%, at accreted value..... $287,636 $ 270,526
12 7/8% Senior Notes, face amount $205,000 due May 15,
2008, effective interest rate of 13.24%, at accreted value..... 201,135 201,019
Other ........................................................... 1,854 107
-------- ------------
Total long-term debt .................................. $490,625 $ 471,652
======== ============
</TABLE>
Included in accrued liabilities and other at June 30, 1999 is $1,957
currently payable under capital lease obligations.
Revolving Credit Facility
On April 1, 1999, the Company completed a $225 million senior secured
revolving credit facility maturing December 31, 2005 (the "Credit Facility").
The Credit Facility will be available, subject to satisfaction of certain terms
and conditions, to provide purchase money financing for the acquisition,
construction and improvement of telecommunications assets. Borrowings under the
Credit Facility will not be available until certain financial and operating
objectives are met. Additional funds will only be available to the extent
certain further objectives are met and certain other financial ratios and
covenants are maintained.
The Credit Facility is structurally senior to the Company's 12 7/8% Senior
Notes and Series B 11 3/4% Notes issued in 1998. The Credit Facility is secured
by substantially all of the Company's assets. Interest rates under the Credit
Facility are tied to the level of debt compared to consolidated EBITDA (earnings
before interest, income taxes, depreciation and amortization, management
ownership allocation charge and deferred compensation) and are initially
expected to be the London Interbank Offering Rate +3.75%. The quarterly
commitment fee is a maximum 1.50% of the total amount of the average daily
unused portion of the Credit Facility during the preceding quarter, with
step-downs based on utilization.
The Credit Facility carries certain restrictive covenants that, among other
things, limits 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, issue or sell stock of certain
subsidiaries, engage in transactions with stockholders and affiliates, and
requires the Company to maintain certain operating and financial performance
measures.
No advances have been made to the Company through the Credit Facility as of
June 30, 1999.
9. COMMITMENTS AND CONTINGENCIES:
The Company has entered into various operating lease agreements, with
expirations through 2009, for office space, equipment and network facilities.
Future minimum lease obligations related to the Company's operating leases as of
June 30, 1999 are as follows:
<TABLE>
<S> <C>
1999....................................... $ 9,426
2000....................................... 11,275
2001....................................... 10,394
2002....................................... 8,518
2003....................................... 8,054
2004....................................... 6,870
Thereafter................................. 36,517
</TABLE>
Total rent expense for the three months ended June 30, 1999 and 1998, and
the six months ended June 30, 1999 and 1998, was $2,091, $306, $3,826, and $760,
respectively.
9
<PAGE> 11
10. EARNINGS (LOSS) PER SHARE:
The net loss per share amounts included 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 of common stock on July 7, 1998. The redeemable preferred stock,
warrants and options are not included in the diluted net loss per share
calculation as the effect from the conversion would be antidilutive. The net
loss applicable to common stock includes the accretion of redeemable preferred
stock and warrant values of $0 and $6,454 for the three months ended June 30,
1999 and 1998, respectively, and $130 and $11,719 for the six months ended June
30, 1999 and 1998, respectively.
11. COMPREHENSIVE INCOME:
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income" (SFAS 130). SFAS 130 establishes reporting and disclosure
requirements for comprehensive income and its components within the financial
statements. The Company's comprehensive income components were immaterial for
the three and six months ending June 30, 1999 and 1998; therefore, comprehensive
income is the same as net income for all periods.
12. SEGMENT REPORTING:
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" (SFAS 131). SFAS 131 establishes how
public enterprise businesses determine operating segments and the financial and
descriptive information required to be disclosed relating to a company's
operating segments.
Management has determined that the adoption of SFAS 131 has no material
impact on the Company's current disclosures of its one operating segment,
providing telecommunication services.
13. RELATED PARTIES:
In connection with the Credit Facility and the Secondary Equity Offering,
the Company incurred approximately $1,032 and $3,898, respectively, in fees to
an affiliate of an investor in the Company.
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ITEM 2. 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.
We offer 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. Our principal competitors are incumbent local
exchange carriers ("ILECs"), such as the regional Bell operating companies and
GTE Corporation operating units.
We are developing networks throughout the United States using what we refer
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, we install our own switch in each market but then lease other
elements of the network from the ILECs. The smart build strategy specifically
involves:
o 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
o installing, or physically locating, transmission equipment in these
central offices to route customer traffic through them to our own
switch.
Locating equipment at ILEC facilities, also known as "collocation," is
central to the success of the smart build strategy. By collocating, we have the
ability to lease, on a monthly or long-term basis, local loop and other network
elements owned by the ILEC. This enables us to reach a wide range of customers
without having to build network connections to each one of them.
We believe that the smart build approach offers a number of competitive
advantages over the traditional build-out strategy by allowing us to:
o accelerate market entry by nine to eighteen months through eliminating
or at least deferring the need for city franchises, rights-of-way and
building access;
o reduce initial capital expenditures 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;
o improve return on capital by generating revenue with a smaller capital
investment;
o defer capital expenditures for network assets so that most of such
expenditures will be incurred when revenue generated by customer
demand is available to finance them; and
o address attractive service areas selectively throughout target markets
and not just in those areas where we own network transmission
facilities.
We believe that our smart build approach allows us to develop a market
network by making up-front capital expenditures of approximately 25% of the
total capital expenditures required to develop such a network as compared with
initial capital expenditures of approximately 50% made under traditional
build-out models. The level of up-front capital required to develop a network
will vary depending on a number of factors. These factors include:
o the size of the market,
o the cost of development of our network in each market,
o the degree of penetration of the market,
o the extent of price and service competition for telecommunications
services,
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o regulatory and technological developments; and
o our ability to negotiate favorable prices for purchases of equipment
and for capital leases of fiber networks.
Once traffic volume justifies further investment, we may lease unused fiber
to which we add our own electronic transmission equipment or construct our own
fiber network. This unused fiber is known as "dark fiber" because no light is
transmitted through it while it is unused. We believe that dark fiber is readily
available in most major markets and that additional fiber rings will be
constructed in all major markets.
We have rapidly deployed our networks since commencing service. We were
operating in fifteen markets across the United States as of June 30, 1999, and
we commenced operations in San Diego in July. We have had significant success in
selling services to customers, with approximately 192,400 lines sold since
beginning our sales efforts in January 1998. The table below provides selected
key operational data for the quarters ended:
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1999 1998
----------- ----------
<S> <C> <C>
Markets Served ....................... 15 3
Number Of Switches Deployed .......... 10 7
Central Office Collocations .......... 210 14
Addressable Market (Business Lines)... 7.0 million .3 million
Lines Sold ........................... 55,800 16,400
Lines Installed ...................... 41,200 8,000
Sales Force Employees ................ 552 96
Total Employees ...................... 1,243 256
</TABLE>
We believe in pre-funding each of our markets. Thus, we do not begin to
develop a new market until we have raised the capital that we project to be
necessary to build our network and operate that market to the point at which
operating cash flow from the market is sufficient to fund such market's
operating costs and capital expenditures.
RESULTS OF OPERATIONS -THREE AND SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH
THREE AND SIX MONTHS ENDED JUNE 30, 1998
We initiated service by buying phone lines at wholesale prices and then
reselling them to customers in Dallas during December 1997. We began providing
service using our own switch and transmission equipment in April 1998 to
customers in New York City. We generated revenues of $1.2 million during the
second quarter of 1998 and $1.4 million for the six months ended June 30, 1998.
Approximately 75% of such revenue was local service revenue, with the remainder
being long distance revenue. Total lines installed as of June 30, 1998 were
11,000 and we had sold a total of 21,100 lines as of that same date.
Throughout the remainder of 1998, we initiated facilities based services in
Atlanta, Boston, Chicago, Dallas, Fort Worth, Los Angeles, Oakland and San
Francisco. During 1999, we commenced operations in Philadelphia (in January
1999), in Washington, D.C., including suburban Maryland and Virginia, and San
Jose (each in March 1999), in Houston (in April 1999), in Northern New Jersey
(May 1999), in Orange County (June 1999) and in San Diego (in July 1999). We
plan to open three additional markets during 1999 for which we have already
raised the necessary capital, for a year-end total of 19 markets.
Although we initiated resale services in Dallas in 1997, resale service is
not our core focus and comprises a small percentage of our sales. We earn
significantly higher margins by providing facilities based services instead of
resale services and our sales teams have focused their efforts almost
exclusively on selling services that require the use of our facilities.
Facilities based lines represented 83% of all lines installed at June 30, 1999.
During the second quarter of 1999, we generated approximately $17.7 million
of revenue. For the six months ended June 30, 1999, we generated approximately
$27.7 million of revenue. Approximately $8.5 million and $13.9 million for the
three and six months ending June 30, 1999, respectively, was local service
revenue consisting of:
o the monthly recurring charge for basic service;
o usage based charges for local calls in certain markets;
o charges for services such as call waiting and call forwarding; and
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o to a lesser extent, non-recurring charges, such as charges for
additional lines for an existing customer.
Access charges and local interconnection charges, which we earn by
connecting our local service customers to their selected long distance carriers
for outbound calls or by delivering inbound local and long distance traffic to
our local service customers, including our Internet wholesale customer group,
accounted for $8.1 million of our second quarter 1999 revenues and $11.9 million
of our revenues for the first six months of 1999. 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. The FCC issued a Memorandum Opinion and Order on July 16, 1999 in
response to AT&T's complaint. In that order, the FCC directed AT&T to pay
properly tariffed access charges. AT&T does have regulatory and legal
opportunities to contest the FCC's decision, although AT&T has not initiated any
such action at this time, to the best of our knowledge. We cannot predict which,
if any, of these actions AT&T may pursue. 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.
As of June 30, 1999, approximately 27% of our local service customers had
chosen us as their long distance carrier. Long distance revenues during the
second quarter and first six months of 1999 amounted to $.3 million and $.8
million, respectively. For the three and six months ended June 30, 1998, we
earned $.1 million and $.2 million, respectively, in long distance revenue.
Internet access and other Internet revenues accounted for $.7 million and
$1.0 million of second quarter and year-to-date 1999 revenues, respectively. We
are using the purchase accounting method to account for the acquisitions of the
common stock of Kivex, Inc. and ConnectNet, Inc. and the acquisition of certain
assets of ConnectTen L.L.C. We have recognized the revenues earned since the
ConnectTen L.L.C. and ConnectNet, Inc. transactions, both of which closed in
April 1999, in our consolidated statement of operations for the period ending
June 30, 1999. Such revenues are not material to our quarterly revenues. The
acquisition of Kivex, Inc. occurred on June 30, 1999. Therefore, we have not
included any Kivex, Inc. revenues in our consolidated results of operations for
the three and six months ended June 30, 1999.
All other sources of revenue accounted for approximately $.1 million during
the second quarter of 1999 and $.1 million for the six months ending June 30,
1999, compared with $.1 million for both the three and six months ended June 30,
1998.
As described above, we have completed three acquisitions since the
beginning of the second quarter of 1999. Additional acquisitions during the
second half of 1999 may further increase revenues and revenue yield. We have had
discussions, and will continue to have discussions in the foreseeable future,
concerning other potential acquisitions of Internet service providers and other
providers of telecommunications services.
The systems that have historically been used to switch customers from their
existing carrier to Allegiance and to begin providing them service generally
required multiple entries of customer information by hand and were exchanged by
fax with the ILEC. In January 1999, we announced that we had successfully
achieved "electronic bonding" between our operations support systems and those
of Bell Atlantic in the New York City market with respect to processing local
service orders. Electronic bonding is a method by 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:
o errors in providing new service and billing;
o service interruptions;
o poor customer service; and
o increased customer turnover.
These problems create added expenses and decrease customer satisfaction.
Without electronic bonding, confirmation of receipt and installation of
orders has taken from two business days to one month. 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. We completed testing in the
second quarter of 1999 and are now electronically bonding with Bell Atlantic in
Boston and with Southwestern Bell in Dallas. We are currently testing electronic
bonding with Pacific Bell and Ameritech. If successful, we
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<PAGE> 15
expect to be electronically bonding with these companies during the third
quarter of 1999. We will begin testing with Bell Atlantic in their southern
region, with GTE and with BellSouth during the third quarter of 1999. Our plan
is to be electronically bonding with all of these companies in their respective
markets by the end of the current year.
We are also working towards the electronic bonding of that portion of the
billing process in which we gather customer specific information, including
their current service options, and the process of identifying and resolving
customer service problems. These additional "electronic bonding" initiatives
will require additional capital expenditures and should result in additional
efficiencies.
Network expenses increased to $12.7 million in the second quarter of 1999
from $1.4 million in the second quarter of 1998. For the six months ending June
30, 1999 and 1998, network expenses were $20.3 million and $1.6 million,
respectively. This sharp increase is consistent with the deployment of our
networks and initiation and growth of our services during 1999 and 1998. Network
expenses represent:
o the cost of leasing high capacity digital lines that interconnect our
network with ILEC networks;
o the cost of leasing high capacity digital lines that connect our
switching equipment to Allegiance transmission equipment located in
ILEC central offices;
o the cost of leasing local loop lines which connect our customers to
our network;
o the cost of leasing space in ILEC central offices for collocating
Allegiance transmission equipment; and
o the cost of leasing our 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. We believe that in many instances there are
multiple carriers in addition to the ILEC from which we can lease high capacity
lines, and that we can generally lease those lines at lower prices than are
charged by the ILEC. We expect that the costs associated with these leases will
increase with customer volume and will be a significant part of our ongoing cost
of services. The cost of leasing switch sites is also a significant part of our
ongoing cost of services.
In constructing switching and transmission equipment for a new market, we
capitalize as a component of property and equipment only the non-recurring
charges associated with our 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.
In an effort to reduce network expenses, we have moved to the next stage of
our smart build strategy in New York City and Dallas. In New York City, we
operate three rings of dark fiber in Manhattan with an extension into Brooklyn.
In the Dallas market, we have one ring of dark fiber in Dallas County. These
leases will be accounted for as capital leases. In July 1999, we entered into an
agreement to lease 12 dark fibers in the Houston market. This lease will also be
accounted for as a capital lease. We anticipate that any future dark fiber
leases will have roughly similar terms and conditions as the dark fiber leases
we currently have. Therefore, it is likely that such additional dark fiber
leases, if any, will also be accounted for as capital leases.
We incur "reciprocal compensation" costs in providing both voice and data
services and expect reciprocal compensation costs to be a major portion of our
cost of services. We must enter into an interconnection agreement with the ILEC
in each market to make widespread calling available to our 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 as our customers' outbound calling volume grows. We
expect, however, to generate increased revenue from the ILECs as inbound calling
volume to our customers increases. If 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.
The cost of securing long distance service capacity is a variable cost that
increases in direct relationship to increases in our customer base and their
long distance calling volumes. We believe that these costs, measured as a
percentage of long distance revenues, will be relatively consistent from period
to period. However, we do expect period over period growth in the absolute cost
of such capacity, and that the cost of long distance capacity will be a
significant portion of our cost of long distance services. We have
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<PAGE> 16
entered into one resale agreement with a long distance carrier to provide
Allegiance with the ability to provide our customers with long distance service.
We expect 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. Our existing resale agreement, however, does not contain a minimum
volume commitment. If we agree to minimum volume commitments and fail to meet
them, we 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.
We lease high capacity digital lines that comprise our Internet network,
and currently have servers in New York, Dallas and San Francisco. The absolute
costs of these lines will increase as we add customers, open new markets and
connect additional markets to our Internet network. However, these costs are
step variable and we expect that they will be relatively consistent from period
to period when measured as a percentage of revenues.
Selling, general and administrative expenses increased to $30.7 million in
the second quarter of 1999 from $8.1 million in the second quarter of 1998,
primarily due to the growth of our business. On a year-to-date basis, selling,
general and administrative expenses increased to $58.2 million for the first
half of 1999 from $12.8 million during the first half of 1998. Selling, general
and administrative expenses include salaries and related personnel costs,
facilities costs, legal and consulting fees. The number of employees increased
to 1,243 as of June 30, 1999, from 256 as of June 30, 1998. As of June 30, 1999,
the sales force, including sales managers and sales administrators had grown to
552. We had a sales force of 96 as of June 30, 1998. During the remainder of
1999, we expect the number of sales personnel to grow by approximately 150. We
currently do not use agents to sell services nor do we currently use any print
or other media advertising campaigns. As we continue to grow in terms of number
of customers and call volume, we expect that ongoing expenses for customer care
and billing will increase.
We amortized $5.5 million of the deferred management ownership allocation
charge, a non-cash charge to income, during the second quarter of 1999 and $11.3
million over the first six months of 1999. Our original private equity fund
investors and original management team investors owned 95.0% and 5.0%,
respectively, of the ownership interests of Allegiance Telecom, LLC, an entity
that owned substantially all of our outstanding capital stock prior to our
initial public offering of common stock. As a result of that offering, the
assets of Allegiance Telecom, LLC, which consisted almost entirely of such
capital stock, were distributed to the original fund investors and management
investors in accordance with the Allegiance Telecom, 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, we recorded the increase in the
assets of Allegiance Telecom, LLC allocated to the management investors as a
$193.5 million increase in additional paid-in capital. This transaction was
recorded during the third quarter of 1998. 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 $44.8
million of the deferred charge in 1998. We will further amortize this deferred
charge at $7.6 million, $7.2 million and $.2 million during the remainder of
1999, 2000 and 2001, respectively. This period is the time-frame over which we
have the right to repurchase a portion 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 Allegiance is terminated.
In addition to the above expenses, we recognized $2.0 million and $1.4
million of amortization of deferred stock compensation expense for the three
months ended June 30, 1999 and 1998, respectively, also non-cash charges. During
the first six months of 1999 and 1998, we recorded $3.8 million and $2.4 million
of amortization of deferred compensation expense, respectively. Such deferred
compensation was recorded in connection with membership units of Allegiance
Telecom, LLC sold to certain management employees and grants to employees under
our 1997 Stock Option Plan and 1998 Stock Incentive Plan.
Depreciation and amortization expense increased to $9.9 million in the
second quarter of 1999 from approximately $1.0 million in the second quarter of
1998, consistent with the deployment of our networks and initiation of services
in fifteen markets by June 30, 1999. For the first half of 1999, we recorded
$17.1 million of depreciation and amortization expense, compared with $1.2
million for the first half of 1998.
In connection with the acquisitions completed during the second quarter of
1999, we assigned $5.5 million of the purchase price to customer lists and $.2
million to workforces. We also recorded $33.6 million of goodwill. Each of these
intangible assets is being amortized over their estimated useful lives of three
years, beginning at the dates of the acquisitions, respectively. We recorded $.1
million of amortization for customer list and $.1 million of amortization for
goodwill during the second quarter of 1999.
Interest expense was $15.2 million and $29.5 million for the three and six
months ending June 30, 1999, respectively. For the
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<PAGE> 17
three and six months ending June 30, 1998, interest expense was $7.2 million
and $11.9 million, respectively. Interest expense recorded during 1999 reflects
the accretion of the Series B 11 3/4% Notes due 2008 and related amortization
of the original issue discount, and the amortization of the original issue
discount on the 12 7/8% Senior Notes due 2008. The 12 7/8% Senior Notes were
issued on July 1, 1998. We capitalize a portion of our interest costs as part of
the construction cost of our networks, in accordance with Statement of Financial
Accounting Standards No. 34. The amount of interest capitalized during the three
and six months ended June 30, 1999 was $1.4 million and $2.5 million,
respectively. For the same periods in 1998, the amounts were $.5 million and $.9
million, respectively. Interest income for the three and six month ending June
30, 1999 was $9.0 million and $14.3 million, respectively. Interest income for
the three and six months ending June 30, 1998 was $3.4 million and $5.6 million,
respectively. Interest income results 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. Interest income during 1999 is greater than for
the comparable periods in 1998 because we had additional cash generated from the
initial public offering of stock and 12 7/8% Senior Notes sale in July 1998, as
well as the follow-on sale of common stock during April 1999.
From February 1998 through March 1999, we recorded accretion of our
redeemable warrants to reflect the possibility that they would be redeemed at
fair market value in February 2008. Amounts were accreted using the effective
interest method and management's estimates of the future fair market value of
such warrants at the time redemption is permitted. Amounts accreted increased
the recorded value of such warrants on the balance sheet and resulted in
non-cash charges to increase the net loss applicable to common stock. Accretion
of $.1 million related to the redeemable warrants was recorded during the first
quarter of 1999. During the first quarter of 1998, we recorded accretion of
warrants totaling $.1 million, and a total of $.2 million for the six months
ending June 30, 1998. As the terms and conditions of the Warrant Agreement do
not specify a date certain for redemption of the warrants and the exchange of
warrants for cash is no longer beyond the control of management, we have ceased
accretion of the warrants and reclassified the accreted value of the redeemable
warrants at April 1, 1999 to the stockholders' equity section. If a repurchase
event occurs in the future or becomes probable, we will adjust the warrants to
the estimated redemption value at that time.
Until the consummation of our initial public offering of common stock in
July 1998, we also recorded the potential redemption values of redeemable
convertible preferred stock, in the event that those shares 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. Accretion related to the
redeemable convertible preferred stock of $6.4 million and $11.5 million was
recorded for the three and six months ending June 30, 1998, respectively.
Our net loss for the second quarter of 1999, after amortization of the
non-cash management allocation charge and amortization of deferred compensation,
was $49.3 million and it was $98.3 million for the six months ending June 30,
1999. Our net loss for the second quarter of 1998, after amortization of the
non-cash management allocation charge and amortization of deferred compensation,
but before the accretion of the redeemable convertible preferred stock and
redeemable warrants, was $14.4 million and it was $22.8 million for the six
months ending June 30, 1998. After deducting accretion of redeemable warrant
values, the net loss applicable to common stock was $49.3 million and $98.4
million for the three and six months ended June 30, 1999, respectively. After
deducting accretion of redeemable preferred stock and warrant values, the net
loss applicable to common stock was $20.9 million and $34.6 million for the
three and six months ended June 30, 1998, 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. We had EBITDA losses of $25.6
million and $50.9 million for the three months and six months ended June 30,
1999, respectively. For the three and six months ended June 30, 1998, we had
EBITDA losses of $8.2 million and $12.9 million. In calculating EBITDA, we also
exclude the non-cash charges to operations for management ownership allocation
charge and deferred stock compensation expense totaling $7.5 million and $15.1
million for the three and six months ended June 30, 1999, respectively. There
was no amortization of management ownership allocation charge for the three and
six months ended June 30, 1998; deferred stock compensation expense was $1.4
million and $2.4 million for the three and six months ended June 30, 1998.
We expect to continue to experience operating losses and negative EBITDA as
a result of our development and market expansion activities. We do not expect to
achieve positive EBITDA in any market until at least our second year of
operation in such market.
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LIQUIDITY AND CAPITAL RESOURCES
Our financing plan is predicated on the pre-funding of each market's
expansion to positive free cash flow. By using this approach, we avoid being in
the position of seeking additional capital to fund a market after we have
already made significant capital investment in that market. We believe that by
raising all required capital prior to making any commitments in a market, we can
raise capital on more favorable terms and conditions.
We plan to establish networks in the 24 largest U.S. metropolitan markets.
We estimate that we will need approximately $750 million to $850 million to
construct these networks and fund our operating losses in these markets to the
point of positive free cash flow. We have raised approximately $1.1 billion in
net capital since our inception. We, therefore, believe that we have raised
capital that is more than sufficient to fund such operating and capital
requirements in each of our 24 targeted markets. We have also completed a senior
secured revolving credit facility under which we may borrow up to $225 million,
subject to the satisfaction of certain terms and conditions.
Inasmuch as we have now raised, or have access to, more capital than is
estimated to be necessary to fund our 24 market business plan, we are currently
developing plans for the use of such additional capital. We may accelerate
construction of networks in certain of the 24 markets, we may expand
domestically beyond 24 markets, we may enter international markets or acquire
additional Internet service providers or other telecommunications services
providers or some combination of these alternatives.
The actual amount and timing of future capital requirements may differ
materially from our estimates as a result of, among other things:
o the cost of the development of our networks in each of our markets;
o a change in or inaccuracy of our development plans or projections that
leads to an alteration in the schedule or targets of our roll-out
plan;
o the extent of price and service competition for telecommunications
services in our markets;
o the demand for our services;
o regulatory and technological developments, including additional market
developments and new opportunities, in our industry;
o an inability to borrow under our senior credit facility; and
o the consummation of acquisitions.
Our cost of rolling out our networks and operating our business, as well as
our revenues, will depend on a variety of factors, including:
o our ability to meet our roll-out schedules;
o our ability to negotiate favorable prices for purchases of equipment;
o our ability to develop, acquire and integrate the necessary operations
support systems and other back office systems;
o the number of customers and the services for which they subscribe;
o the nature and penetration of new services that we may offer; and
o the impact of changes in technology and telecommunication regulations.
As such, actual costs and revenues may vary from expected amounts, possibly
to a material degree, and such variations are likely to affect our future
capital requirements.
We made capital expenditures of $73.5 million and $13.8 million during the
second quarters of 1999 and 1998, respectively, for
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property, plant, equipment, software and hardware necessary in deploying our
networks in our markets and providing operations and other support systems
necessary in conducting our business. For the six months ending June 30, 1999
and 1998, we made capital expenditures of $134.1 million and $21.4 million,
respectively. Also, in the second quarter of 1999, Allegiance used $34.9 million
of cash, net of cash acquired, to purchase assets or equity of three Internet
service providers. Inasmuch as these were our first acquisitions of other
companies, no similar amounts were expended during 1998. Allegiance also used
capital during these periods to fund our operations; excess cash was used to
purchase short-term investments and money market investments.
As of June 30, 1999, we had transmission equipment collocated in 210 ILEC
central offices. Under our current 24 market business plan, we plan to make
approximately $250 million in total capital expenditures in 1999, including
purchases of switching equipment, switch and sales facilities, transmission
equipment and collocation facilities. As noted previously, we are reviewing
alternatives for deploying the capital raised in excess of that required to fund
our 24 market plan. Capital expenditures during 1999 may increase above the $250
million planned currently, as we finalize plans to deploy such excess capital.
As of June 30, 1999, we had approximately $706.7 million of cash and
short-term investments. This amount excludes $50.6 million of restricted U.S.
Government securities that have been placed in a pledge account to fund interest
payments on our 12 7/8% notes through May 2001.
On April 1, 1999, we completed a $225 million senior secured revolving
credit facility maturing December 31, 2005 for a subsidiary of Allegiance
Telecom, Inc. This revolving facility will be available, subject to satisfaction
of certain terms and conditions, to provide purchase money financing for the
acquisition, construction and improvement of telecommunications assets by our
operating subsidiaries. Borrowings under the facility will not be available
until we reach certain financial and operating objectives, and then will only be
available to the extent we have achieved certain further objectives and have
maintained certain financial ratios and covenants. Based on our current business
plan, we do not expect to draw on this facility until 2000, if at all.
The credit facility is structurally senior to our 12 7/8% notes and Series
B 11 3/4% notes issued in 1998. The facility is secured by substantially all of
the assets of our subsidiaries and the stock of the Allegiance borrowing
subsidiary and is guaranteed by Allegiance Telecom, Inc. Interest rates under
the facility are tied to the level of debt compared to consolidated EBITDA and
is initially expected to be the London Interbank Offering Rate + 3.75%. The
current commitment fee on the undrawn portion of the facility is 1.50% of the
total amount of the facility, with step-downs based on utilization. The facility
also contains certain representations, warranties, covenants and events of
default customary for credit of this nature and otherwise agreed upon by the
parties.
On April 20, 1999, we completed the public offering of 11,826,000 new
shares of our common stock at a price of $38.00 per share, raising gross
proceeds of $449.4 million. After underwriters' fees and other expenses, we
realized net proceeds of approximately $430.3 million. On April 28, 1999, the
underwriters of this offering exercised an option to purchase an additional
2,201,400 shares of common stock at the same price per share. As a result, we
raised an additional $83.6 million of gross proceeds, or $80.3 million of net
proceeds, at that time.
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, we have identified two areas for year 2000
review: internal systems and operations, and external systems and services. As a
new enterprise, we do not have older systems that are not year 2000 ready. As we
develop network and support systems, we intend to ensure that all systems will
be year 2000 ready. We are purchasing our operations support systems with
express specifications, warranties and remedies that all systems be year 2000
ready. In addition, we require 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, we
intend to sell our telecommunications services to companies that may rely upon
computerized systems to make payments for such services, and to interconnect
certain portions of our network and systems with other companies' networks and
systems. These transactions and interactions could expose our operations to year
2000 problems.
We have completed a company-wide inventory of all computer systems on which
the company relies, both within and outside of
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Allegiance. We have concluded that our internal systems are year 2000 compliant.
We are using the inventory to contact our external suppliers, vendors and
providers to obtain information about their year 2000 readiness. Based on that
information, we 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 our operations in the event
that the systems fail to properly process date-sensitive transactions after
December 31, 1999.
Our assessment of our year 2000 readiness will be ongoing as we continue to
develop our own operations support systems and become reliant on the systems of
additional third parties as a result of the geographic expansion of our business
into additional markets. As a result, we 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 our business, financial
condition and results of operations.
Costs to Address Year 2000 Issues. We have used our internal information
technology and other personnel in identifying year 2000 issues. We do not
anticipate any significant costs to make our internal systems year 2000
compliant because we do not expect any remediation to be required.
We plan to engage a consultant during the third quarter of 1999 to review:
o the process that we have undertaken to determine the extent of our
year 2000 readiness,
o the results of our internal inventory of systems,
o our conclusions concerning the year 2000 readiness of our internal
systems, and
o responses we expect to receive from vendors and other third parties
regarding potential year 2000 exposure through our business
relationships with them.
We are estimating that such consultant's fees and expenses will not exceed
$200,000.
Because no material year 2000 issues have yet been identified in connection
with external sources, we cannot reasonably estimate costs that may be required
for remediation or for implementation of contingency plans. As we gather
information relating to external sources of year 2000 issues, we will reevaluate
our ability to estimate costs associated with year 2000 issues. There can be no
assurance that as additional year 2000 issues are addressed, our costs to
remediate such issues will be consistent with our historical costs.
Risks of Year 2000 Issues. We cannot reasonably ascertain the extent of the
risks involved in the event that any one system fails to process date-sensitive
calculations accurately because we have not identified any material year 2000
issues. Potential risks include:
o the inability to process customer billing accurately or in a timely
manner;
o the inability to provide accurate financial reporting to management,
auditors, investors and others;
o litigation costs associated with potential suits from customers and
investors;
o delays in implementing other information technology projects as a
result of work by internal personnel on year 2000 issues;
o delays in receiving payment or equipment from customers or suppliers
as a result of their systems' failure; and
o 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 our business, financial condition or results of
operations.
All of our information technology and non-information technology systems
and products relating to our external issues are manufactured or supplied by
other companies outside of our control. As a result, we cannot assure you that
the systems of any of those companies will be year 2000 ready. In particular, we
will be dependent upon other ILECs, long distance carriers and other companies
for interconnection and completion of off-network calls. These interconnection
arrangements are material to our ability to conduct our
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business and failure by any of these providers to be year 2000 ready may have a
material adverse effect on our business in the affected market. Moreover,
although we have taken every precaution to purchase our 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 our internal and
external systems fail or are not year 2000 ready in a timely manner, there could
be a material adverse effect on our business, financial condition or results of
operations.
Contingency Plans. Even though we have not identified any specific year
2000 issues, we believe that the design of our networks and support systems
could provide Allegiance with certain operating contingencies in the event
material external systems fail. In all of our markets, however, we have or
intend 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 we can do to mitigate the
impact of such a failure on our operations.
We have developed contingency plans for all of our operating support
systems. If we should experience year 2000 issues with any of these operating
support systems, we will have our personnel resort to the manual systems which
we used prior to implementing the operating support systems, during the period
that remediation efforts would be undertaken.
We have attempted to ensure that our own operating facilities and systems
are fully 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. We also have the
ability to relocate headquarters and administrative personnel to other
Allegiance facilities should power and other services at our Dallas headquarters
fail. Because of the inability of our 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 we will not experience
numerous disruptions that could have a material effect on our operations.
FORWARD-LOOKING STATEMENTS
Certain statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Allegiance intends that such forward-looking statements be subject
to the safe harbors created thereby. The words "believes," "expects,"
"estimates," "anticipates," "will be," "should" and similar words or expressions
identify forward-looking statements made by or on behalf of Allegiance. These
forward-looking statements are subject to many uncertainties and factors that
may cause Allegiance's actual results to be materially different from any future
results expressed or implied by such forward-looking statements. Examples of
such uncertainties and factors include, but are not limited to, Allegiance's
ability to (1) timely and effectively provision new customers, (2) interconnect
with and develop cooperative working relationships with ILECs, (3) develop
efficient operations support systems and other back office systems, (4) install
new switching facilities and other network equipment, (5) obtain leased fiber
optic line capacity, rights-of-way, building access rights and any required
governmental authorizations, franchises and permits, (6) electronically bond
with the ILECs, and (7) access necessary capital. Allegiance does not undertake
any obligation to update or revise any forward-looking statement made by it or
on its behalf, whether as a result of new information, future events or
otherwise. See our Annual Report on Form 10-K for the fiscal year ended December
31, 1998 for a discussion of the various risks relating to our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and Qualitative Disclosures about Market Risk
Our investment policy is limited by our existing bond indentures. We are
restricted to investing in financial instruments with a maturity of one year or
less. The indentures require investments in high quality instruments, such as
obligations of the U.S. Government or any agency thereof guaranteed by the
United States of America, money market deposits, and commercial paper with a
rating of A1/P1.
We are thus exposed to market risk related to changes in short-term U.S.
interest rates. We manage these risks by closely monitoring market rates and the
duration of our investments. We do not enter into financial or commodity
investments for speculation or trading purposes and are not a party to any
financial or commodity derivatives.
Interest income earned on our investment portfolio is affected by changes
in short-term interest rates. We believe that we are not exposed to significant
changes in fair value because of our conservative investment strategy. However,
the estimated interest income for the calendar year 1999, based on the average
1998 earned rate on investments and including in estimated average investments
the net proceeds realized from the common stock offering in April 1999, is $30.3
million. Assuming a 100 basis point drop in the average
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<PAGE> 22
rate, we would be exposed to a $5.5 million reduction in interest income for the
year. The following table illustrates this impact on a quarterly basis:
<TABLE>
<CAPTION>
QUARTER ENDING
------------------------------------------------
MARCH JUNE SEPTEMBER DECEMBER
1999 1999 1999 1999 TOTAL
------- ------- --------- -------- ------
($ IN MILLIONS)
<S> <C> <C> <C> <C> <C>
ESTIMATED AVERAGE INVESTMENTS............................... $ 367.4 $ 651.7 $ 649.8 $ 572.4
ESTIMATED INTEREST EARNED AT ESTIMATED RATE OF 5.4% AT
DECEMBER 31, 1998......................................... $ 5.0 $ 8.8 $ 8.8 $ 7.7 $ 30.3
ESTIMATED IMPACT OF INTEREST RATE DROP...................... $ 0.9 $ 1.6 $ 1.6 $ 1.4 $ 5.5
</TABLE>
We have outstanding long term, fixed rate notes, not subject to interest rate
fluctuations.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
We filed a registration statement on Form S-1 (File No. 333-74763) which
became effective on March 31, 1999, whereby 14,676,000 shares of our common
stock were sold at a price of $38.00 per share. Of the 14,676,000 shares of
common stock sold, 11,826,000 were sold by us and 2,850,000 were sold by selling
shareholders (Madison Dearborn Capital Partners II, L.P. sold 2,000,000 shares;
Frontenac VII Limited Partnership sold 809,524 shares; and Frontenac Masters VII
Limited Partnership sold 40,476 shares). We did not receive any of the proceeds
from the sale of shares by the selling shareholders. In addition, the
underwriters of this public offering, led by Salomon Smith Barney, Goldman,
Sachs & Co., Donaldson, Lufkin & Jenrette, Morgan Stanley Dean Witter and
Warburg Dillon Read, exercised an option to purchase 2,201,400 additional shares
of our common stock at the same price per share. Net proceeds to us from this
public offering totaled approximately $510.6 million, after deducting
underwriting discounts and other expenses aggregating approximately $22.4
million. We intend to use substantially all of the net proceeds from this
offering to fund our deployment in all 24 of our targeted markets, including but
not limited to, expenditures relating to the expansion of existing networks and
services, the development and acquisition of new networks and services and the
funding of operating losses and working capital. None of the proceeds from this
offering have been used as of June 30, 1999.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 1999 annual meeting of stockholders was held on May 12, 1999. The
number of shares of common stock present at the annual meeting in person or by
proxy and voting and withholding authority to vote in the election of directors
was 45,263,177 or 89.8% of the common stock of Allegiance outstanding on April
9, 1999, the record date for the annual meeting.
(b) The following nominees, having received the FOR votes set opposite
their respective names, constituting a plurality of the votes cast at the annual
meeting for the election of directors, were elected directors of Allegiance to
terms expiring in 2002.
<TABLE>
<CAPTION>
Directors For Withheld
---------------------------------------------------------------------
<S> <C> <C>
John J. Callahan 45,255,672 7,505
Paul D. Carbery 45,255,472 7,505
John B. Ehrenkranz 45,253,640 9,537
Paul J. Finnegan 45,253,740 9,437
</TABLE>
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(c) Stockholders ratified the appointment of Arthur Andersen LLP, as
independent public accountants, to audit the consolidated financial statements
for the current year ending December 31, 1999. The vote was 45,244,547 shares
FOR and 8,500 shares AGAINST such ratification, with 10,130 shares abstaining.
ITEM 5. OTHER INFORMATION
On August 4, 1999, Allegiance announced that it had signed an agreement
with Vulcan Ventures, Inc., the investment organization of Paul G. Allen. Vulcan
Ventures agreed to purchase 1.5 million shares of Allegiance common stock from
Allegiance's existing private equity investors at $50 per share upon receipt of
antitrust clearance. The agreement also grants Vulcan Ventures an option to
purchase up to an additional 5 million shares, at $56 per share, on or before
November 1, 1999, from existing private equity investors and certain other
investors. Allegiance will not receive any cash from either the 1.5 million
share transaction or the option transaction. In addition, after the closing of
this transaction, Vulcan Ventures has the right to appoint a director to the
board of Allegiance. If Vulcan Ventures acquires 2.5 million or more shares
under the option, Vulcan Venture will receive the right to appoint a second
director.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed with this report and made a part
hereof.
11.1 Statement regarding computation of per share loss for the
three and six months ended June 30, 1999
11.2 Statement regarding computation of per share loss for the
three and six months ended June 30, 1998
11.3 Statement regarding computation of per share loss for the
three months ended June 30, 1998
11.4 Statement regarding computation of per share loss for the
six months ended June 30, 1998
27.1 Financial Data Schedule
(b) We filed a Current Report on Form 8-K, dated April 8, 1999, to report
the closing of our senior secured revolving credit facility. At that time, we
also requested confidential treatment for certain portions of our credit and
guaranty agreement. We filed an amended Current Report on Form 8-K/A, dated July
20, 1999, to amend our request for confidential treatment regarding our credit
and guaranty agreement.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALLEGIANCE TELECOM, INC.
By: /s/ ROYCE J. HOLLAND
----------------------------------------
Name: Royce J. Holland
Title: Chairman and Chief Executive Officer
By: /s/ THOMAS M. LORD
----------------------------------------
Name: Thomas M. Lord
Title: Executive Vice President and Chief
Financial Officer
Dated: August 9, 1999
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