<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 3, 2000
REGISTRATION NO. 333-
- - - - - - - - - - --------------------------------------------------------------------------------
- - - - - - - - - - --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM S-3
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
ALLEGIANCE TELECOM, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 4832 75-2721491
(State or other jurisdiction of (Primary Standard Industrial (IRS Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
----------------------
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)
MARK B. TRESNOWSKI
SENIOR VICE PRESIDENT, SECRETARY AND GENERAL COUNSEL
ALLEGIANCE TELECOM, INC.
4 WESTBROOK CORPORATE CENTER, SUITE 400
WESTCHESTER, ILLINOIS 60154
(708) 836-5200
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies to:
<TABLE>
<S> <C>
GERALD T. NOWAK ANDREW R. SCHLEIDER
KIRKLAND & ELLIS SHEARMAN & STERLING
200 EAST RANDOLPH DRIVE 599 LEXINGTON AVENUE
CHICAGO, ILLINOIS 60601 NEW YORK, NEW YORK 10022
(312) 861-2000 (212) 848-4000
</TABLE>
----------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [ ]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(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. [ ]
----------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
- - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM
OF SECURITIES TO BE AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
REGISTERED REGISTERED(1) SHARE(2) PRICE REGISTRATION FEE
- - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, par value $.01
per share..................... 11,500,000 $79.25 $911,375,000 $240,603
- - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
- - - - - - - - - - ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Includes 1,500,000 shares of common stock that the Underwriters have an
option to purchase to cover over-allotments, if any.
(2) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) under the Securities Act of 1933 and based upon the
prices reported on the Nasdaq National Market on December 27, 1999.
----------------------
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 SEC, ACTING PURSUANT TO SAID SECTION 8(a), MAY
DETERMINE.
- - - - - - - - - - --------------------------------------------------------------------------------
- - - - - - - - - - --------------------------------------------------------------------------------
<PAGE> 2
THE INFORMATION IN THIS PRELIMINARY PROSPECTUS IS NOT COMPLETE AND MAY BE
CHANGED. THESE SECURITIES MAY NOT BE SOLD UNTIL THE REGISTRATION STATEMENT
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS
PRELIMINARY PROSPECTUS IS NOT AN OFFER TO SELL NOR DOES IT SEEK AN OFFER TO
BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED.
Subject to Completion. Dated January 3, 2000.
10,000,000 Shares
[ALLEGIANCE TELECOM LOGO]
Common Stock
----------------------
Allegiance Telecom, Inc. is offering 6,000,000 of the shares to be sold
in the offering. The selling stockholders identified in this prospectus are
offering an additional 4,000,000 shares. Allegiance will not receive any of the
proceeds from the sale of shares being sold by the selling stockholders.
The common stock is quoted on the Nasdaq National Market under the symbol
"ALGX". The last reported sale price of the common stock on December 31, 1999
was $92.25 per share.
See "Risk Factors" on page 8 to read about factors you should consider
before buying shares of the common stock.
----------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY
BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY
OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
----------------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Initial price to public..................................... $ $
Underwriting discount....................................... $ $
Proceeds, before expenses, to Allegiance.................... $ $
Proceeds, before expenses, to the selling stockholders...... $ $
</TABLE>
To the extent that the underwriters sell more than 10,000,000 shares of
common stock, the underwriters have the option to purchase up to an additional
1,500,000 shares from Allegiance at the initial price to public less the
underwriting discount.
----------------------
The underwriters expect to deliver the shares against payment in New York,
New York on , 2000.
Joint Book-Running Managers
GOLDMAN, SACHS & CO. SALOMON SMITH BARNEY
Joint Lead Manager
BEAR, STEARNS & CO. INC.
MORGAN STANLEY DEAN WITTER
DONALDSON, LUFKIN & JENRETTE
WARBURG DILLON READ LLC
ROBERTSON STEPHENS TD SECURITIES
---------------------
Prospectus dated , 2000.
<PAGE> 3
[Map Showing Current 19 Cities and Next 17 Cities]
<PAGE> 4
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 our common stock. You should read the entire prospectus
carefully.
ALLEGIANCE
Allegiance is a leading competitive provider of telecommunications services
to small and medium-sized business, government and other institutional users in
major metropolitan areas across the United States. We offer an integrated set of
telecommunications services including local exchange, local access, domestic and
international long distance, enhanced voice, data and a full suite of Internet
services. We were operating in the following 19 markets as of December 31, 1999:
Atlanta, Baltimore, Boston, Chicago, Dallas, Detroit, Fort Worth, Houston, Long
Island, Los Angeles, New York, Northern New Jersey, Oakland, Orange County,
Philadelphia, San Diego, San Francisco, San Jose and Washington, D.C.
Our initial business plan covered 24 of the largest metropolitan areas in
the United States. We have successfully raised the projected capital to build
our networks and operate in each of these markets to the point at which
operating cash flow from the market is sufficient to fund such market's ongoing
operating costs and capital expenditures.
In light of this progress, we have decided to expand our business plan in
three respects:
- First, we plan to increase the number of our target markets by 12, to a
total of 36 of the largest metropolitan markets in the United States. We
plan to have launched service in 27 markets by the end of 2000 and in an
additional nine markets by the end of 2001.
- Second, we plan to increase our collocation footprint by approximately
100 central offices in our initial 24 target markets.
- Third, we are moving to the next stage of our smart build strategy in
most of our existing markets by acquiring long-term rights to use dark
fiber rings that will connect many of the central offices at which we are
collocated. These dark fiber rings will replace the network elements that
we are leasing on a short-term basis from the incumbent local exchange
carriers and are expected to provide us with higher operating margins and
more reliable network services. We currently have dark fiber rings in
operation in New York City, Dallas and Houston and we have entered into
contracts for dark fiber rings in an additional 16 metropolitan markets,
all of which are expected to be in operation before the end of 2000. We
have also contracted for similar long-term arrangements for long-haul
fiber routes connecting our Boston, New York City and Washington, D.C.
networks.
By expanding our business plan in this manner, our total projected central
office collocations are expected to increase from 650 to 990 and the number of
nonresidential access lines covered by our projected collocation footprint is
expected to increase by approximately 33%. We believe that the new credit
facilities described below will provide the funding necessary for us to expand
into 30 of our target markets. We will need to complete this offering or obtain
additional financing to expand into our remaining six target markets.
BUSINESS STRATEGY
We have 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 competitive telecommunications
industry. Our Chairman
1
<PAGE> 5
and Chief Executive Officer, Royce J. Holland, has more than 25 years of
experience in the telecommunications and energy industries. He served as
President, Chief Operating Officer and co-founder of MFS Communications, one of
the first companies to compete with the incumbent local exchange carriers. Under
his leadership, MFS Communications grew from a start-up operation to become the
largest competitor to the incumbent local exchange carriers.
Target Customers 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, including local, long
distance, Internet services, digital subscriber line and Web hosting. To address
the expected demand by small and medium-sized business customers for Internet
based products and e-commerce solutions, we recently announced a comprehensive
Internet portal and small business resource center that we will offer to these
customers as a means of facilitating their entry into e-commerce.
Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. We pursue what we refer to as a "smart build" strategy. Under
this strategy, we purchase and install switches, locate our equipment in the
central office facilities of incumbent local exchange carriers and lease other
elements of their networks until growth justifies our ownership of additional
network assets. By using this strategy, we intend to reduce our initial capital
expenditures, reduce the time it takes to enter and expand in a geographic
market and generate higher returns on invested capital. The acquisition of dark
fiber capacity in 19 of our initial target markets is part of our smart build
strategy.
Achieve Broad Coverage of Attractive Areas within Each Targeted Market. We
intend to address the most attractive service areas throughout each of our
targeted 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 operating 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. We use a direct sales force
to sell directly to customers and provide them personalized customer care
through a single point of contact. By using this approach, we hope to maximize
our market share, particularly among small and medium-sized businesses.
Develop Efficient Automated Back Office Systems. We are automating most of
the processes involved in switching a customer to our networks. Our goal is to
decrease the time between customer order and service installation. To achieve
this goal, we are developing, acquiring and integrating information technology
systems to support our operations, and we are establishing an on-line and
real-time connection of our operations support systems with those of the
incumbent local exchange carriers, also referred to as "electronic bonding".
Expand Through Acquisitions. We plan to pursue strategic acquisitions to
expand our products and customer base and acquire additional experienced
management.
RECENT DEVELOPMENTS
On January 3, 2000, we announced a significant expansion of our business
plan as described above. On that date, we also announced that we had obtained a
commitment from Goldman Sachs Credit Partners L.P., Toronto Dominion (Texas),
Inc., BankBoston, N.A., Morgan Stanley Senior Funding, Inc. and various other
lenders to fully underwrite $500.0 million of senior
2
<PAGE> 6
secured credit facilities. The new credit facilities consist of a $350.0 million
revolving credit facility and a $150.0 million delayed draw term loan facility.
The new credit facilities are subject to customary conditions for a transaction
of this type, including completion of definitive documentation and finalization
of all terms and conditions. We expect to close these facilities in February
2000. The closing is not contingent on the completion of this offering. These
facilities will replace our existing senior secured revolving credit facility.
See "Description of Certain Indebtedness -- New Credit Facilities".
On September 13, 1999 and November 5, 1999, Vulcan Ventures Incorporated, a
Paul G. Allen investment vehicle, purchased an aggregate of four million shares
of Allegiance common stock from certain private equity investors and other
stockholders. As a result of such purchases, as of December 31, 1999, Vulcan
Ventures owned approximately 6% of the issued and outstanding stock of
Allegiance and joins Morgan Stanley Dean Witter Capital Partners and Madison
Dearborn Capital Partners as Allegiance's leading private equity sponsors. In
connection with the Vulcan Ventures investment, we began to develop a strategic
alliance with Go2Net, Inc., a Vulcan Ventures portfolio company. On December 16,
1999, we formally announced an alliance with Go2Net to jointly develop a
customized Internet portal and a customized small business resource center for
Allegiance customers as part of a larger effort by Allegiance to provide the
small and medium-sized business user with Internet based products and e-commerce
solutions that are typically available on a cost-effective basis only to large
organizations.
This customized Internet portal is designed to offer Allegiance customers
communications (calendar, e-mail, contacts, instant messenger), general
resources (search, weather/maps, yellow pages, knowledge links), community
resources (forums, discussion database), current information (news, stock
portfolio) and customer care (link to Allegiance's customer support). The
Allegiance customized small business resource center, which will be made
available through the customized portal, will allow Allegiance customers to gain
direct access to many resources that serve this segment of the business market,
including office supplies, information about incorporating, trademark
registration, chambers of commerce, communications services, financial services
and government agencies. The Allegiance customized small business resource
center will also connect customers to transaction services, such as real-time
credit card processing, on-line payroll and on-line educational courses.
Allegiance is independently working on expanding its Internet-based service
offering to include a web-based platform for software applications hosting.
Allegiance expects this aspect of its Internet initiative to provide its typical
small and medium-sized business customer with software applications at a more
affordable price.
In September 1999, we announced that we had completed deployment of
asymmetric digital subscriber line services in selected areas in Chicago, New
York, Philadelphia and Washington D.C., for a total of 19 collocations in
central offices, and that we had deployed what we believe to be the industry's
first commercial HDSL2 circuit, a new standard of high-bit rate digital
subscriber line. This new service requires only a single copper wire pair rather
than the two unbundled loops required for the older high-bit rate digital
subscriber line standard. Given the significant network technology advances and
economic efficiencies of HDSL2 and the added benefit of being able to carry
voice traffic on these lines, we plan to deploy HDSL2 capacity in all of our
existing and future collocations. This capability is now deployed in over 100 of
our collocations in central offices throughout our markets.
Based on preliminary information, we estimate that for the fourth quarter
and for the year ended December 31, 1999, we had consolidated revenues in the
range of $38.5 million to $40.0 million and $98.3 million to $99.8 million,
respectively; earnings before interest, income taxes, depreciation and
amortization, management ownership allocation charge and noncash deferred
compensation in the range of negative $26.0 million to negative $27.0 million
and negative $103.4 million to negative $104.4 million, respectively; capital
expenditures in the range of $55.0 million to $57.0 million and $270.9 million
to $272.9 million, respectively. Based on preliminary information, we estimate
that we sold between 73,000 and 75,000 lines and installed
3
<PAGE> 7
between 59,500 and 61,000 lines during the fourth quarter ended December 31,
1999 and that we have sold between 335,100 to 337,100 lines and have installed
between 240,900 to 242,400 lines to date.
Our principal executive offices are located at 1950 N. Stemmons Freeway,
Suite 3026, Dallas, Texas 75207 and our telephone number is (214) 261-7100.
4
<PAGE> 8
THE OFFERING
The following information assumes that the underwriters do not exercise the
option granted by Allegiance to purchase additional shares in the offering. See
"Underwriting".
Shares offered by
Allegiance................. 6,000,000 shares
Shares offered by selling
stockholders............. 4,000,000 shares
Common stock outstanding
after the offering....... 70,947,706 shares
Nasdaq National Market
symbol................... "ALGX"
Use of proceeds............ We intend to use the net proceeds from this
offering and our new credit facilities primarily to
fund the costs of our expanded business plan. We
may also use a portion of the net proceeds for
other general corporate purposes, which may include
acquisitions.
We will not receive any proceeds from the sale of
shares by the selling stockholders.
Dividend policy............ We do not anticipate paying any cash dividends in
the foreseeable future. Any future determination to
pay dividends will be at the discretion of our
board of directors and will be dependent upon then
existing conditions, including our financial
condition, results of operations, contractual
restrictions, capital requirements, business
prospects and other factors our board of directors
deems relevant.
If the underwriters exercise their over-allotment option in full,
72,447,706 shares of common stock will be outstanding after the offering.
The number of shares of common stock to be outstanding immediately after
the offering does not take into account 275,580 shares reserved for issuance
upon the exercise of outstanding warrants, 11,059,905 shares reserved under our
1997 Stock Option Plan and 1998 Stock Incentive Plan and 2,208,676 shares
reserved under our Employee Stock Discount Purchase Plan. See "Description of
Capital Stock" and "Management -- Stock Plans" in our Annual Report on Form 10-K
for the year ended December 31, 1998, which is incorporated by reference in this
prospectus.
RISK FACTORS
See "Risk Factors" for a discussion of certain factors relating to our
business and an investment in the common stock.
5
<PAGE> 9
SUMMARY FINANCIAL DATA
The summary consolidated financial data presented below for the year ended
December 31, 1998 was 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 summary consolidated financial data presented below as of and
for the nine months ended September 30, 1999 and 1998 were derived from the
unaudited condensed consolidated financial statements of Allegiance and the
notes thereto contained elsewhere in this prospectus.
The as adjusted balance sheet data is unaudited and gives effect to the
issuance of 6,000,000 shares of common stock by Allegiance in this offering as
if such transaction had occurred on September 30, 1999. Dollar amounts are in
thousands, except share amounts.
Allegiance has generated operating losses and negative cash flow from its
operating activities to date. The summary 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>
NINE MONTHS ENDED
--------------------------------------- YEAR ENDED
SEPTEMBER 30, 1999 SEPTEMBER 30, 1998 DECEMBER 31, 1998
------------------ ------------------ -----------------
(UNAUDITED) (AUDITED)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues...................................... $ 59,773 $ 4,201 $ 9,786
Operating expenses:
Network..................................... 38,626 4,506 9,529
Selling, general and administrative......... 98,539 26,076 46,089
Management ownership allocation charge(1)... 15,584 160,534 167,312
Non-cash deferred compensation.............. 5,841 3,759 5,307
Depreciation and amortization............... 35,085 3,705 9,003
----------- ----------- -----------
Total operating expenses.............. 193,675 198,580 237,240
----------- ----------- -----------
Loss from operations.......................... (133,902) (194,379) (227,454)
Interest income............................... 23,159 13,059 19,917
Interest expense.............................. (43,902) (25,278) (38,952)
----------- ----------- -----------
Net loss...................................... (154,645) (206,598) (246,489)
Accretion of redeemable convertible preferred
stock and warrant values.................... (130) (11,844) (11,971)
----------- ----------- -----------
Net loss applicable to common stock........... $ (154,775) $ (218,442) $ (258,460)
=========== =========== ===========
Net loss per share, basic and diluted......... $ (2.62) $ (13.02) $ (10.53)
=========== =========== ===========
Weighted average number of shares outstanding,
basic and diluted........................... 58,988,867 16,780,802 24,550,346
=========== =========== ===========
OTHER FINANCIAL DATA:
EBITDA(2)..................................... $ (77,392) $ (26,381) $ (45,832)
Net cash used in operating activities......... (64,308) (10,498) (17,270)
Net cash used in investing activities......... (120,255) (183,699) (319,170)
Net cash provided by financing activities..... 504,507 593,216 593,216
Capital expenditures.......................... 215,893 63,550 113,539
</TABLE>
6
<PAGE> 10
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
---------------------------
ACTUAL AS ADJUSTED(3)
------ --------------
(UNAUDITED)
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents, short-term investments, and
restricted short-term investments......................... $ 635,369 $1,166,613
Property and equipment, net................................. 345,130 345,130
Total assets................................................ 1,095,244 1,626,488
Long-term debt.............................................. 505,677 505,677
Total stockholders' equity.................................. 497,610 1,028,854
Total liabilities and stockholders' equity.................. 1,095,244 1,626,488
</TABLE>
<TABLE>
<CAPTION>
AS OF
AS OF DECEMBER 31,
SEPTEMBER 30, -------------------
1999 1998 1997
------------- ---- ----
<S> <C> <C> <C>
OTHER OPERATIONAL DATA:
Markets served.............................................. 17 9 0
Number of switches deployed................................. 13 7 0
Central office collocations................................. 260 101 0
Addressable market (business lines)......................... 8.4 million 3.6 million 0
Lines sold.................................................. 262,100 86,500 20
Lines installed............................................. 181,400 47,700 9
Sales force employees....................................... 608 295 0
Total employees............................................. 1,525 649 40
</TABLE>
- - - - - - - - - - ---------------
(1) In connection with the initial public offering of common stock, Allegiance
Telecom, 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 Allegiance
Telecom, LLC investors in accordance with its limited liability company
agreement. This 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 Telecom, 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 was recorded as deferred management ownership
allocation charge. The deferred charge was amortized at $44.8 million, $15.6
million and $38.0 million during the year ended December 31, 1998, and the
nine months ended September 30, 1999 and 1998, respectively. The deferred
charge will be further amortized at $3.2 million, $7.2 million and $0.2
million during the fourth quarter of 1999, and for the years 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" in our Annual Report on Form 10-K for the year ended December
31, 1998, which is incorporated by reference in this prospectus.
(2) 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.
(3) Reflects $531.2 million of net proceeds from the issuance of common stock by
Allegiance in this offering.
7
<PAGE> 11
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 our
common stock.
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 that you can use to evaluate our performance and determine
whether you should invest in our common stock.
IF WE DO NOT EFFECTIVELY MANAGE RAPID EXPANSION OF OUR BUSINESS, OUR FINANCIAL
CONDITION WILL SUFFER
We are rapidly expanding our operations and providing bundled
telecommunications services on a widespread basis. This continued 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.
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. The competition for
qualified personnel 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 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:
- we have and will likely continue to have difficulties in getting products
and services from our vendors delivered in a timely and effective manner,
at acceptable costs and at the service and performance level required;
- 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 not be able 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.
UNDER CERTAIN CIRCUMSTANCES WE MAY NEED ADDITIONAL CAPITAL TO EXPAND OUR
BUSINESS AND INCREASE REVENUE
We may need additional 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 estimate, based on our expanded
8
<PAGE> 12
business plan, that approximately $700.0 million to $860.0 million of additional
capital will be necessary to fund our expanded business plan. This amount
includes capital expenditures, working capital, cash flow deficits and debt
service.
We believe that the proceeds from this offering and borrowings expected to
be available under our new credit facilities, together with our cash on hand,
will be sufficient to pre-fund our expanded business plan. However, we will only
be able to borrow under these new credit facilities if they are successfully
closed and we are in compliance with the financial covenants and other
conditions. In the event we cannot borrow under these new credit facilities, we
may need to access alternative sources of capital. If we are unable to do so we
may not be able to expand as we expect, which may have an adverse effect on us.
The actual amount and timing of our future capital requirements may differ
materially from our estimates as a result of financial, business and other
factors, many of which are beyond our control, as well as prevailing economic
conditions. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources".
OUR SUBSTANTIAL INDEBTEDNESS COULD MAKE US UNABLE TO SERVICE INDEBTEDNESS AND
MEET OUR OTHER REQUIREMENTS AND COULD ADVERSELY AFFECT OUR FINANCIAL HEALTH
We have a significant amount of debt outstanding and plan to access
additional debt financing to fund our expanded business plan, including under
our new credit facilities that we expect to close in February 2000. See the
discussion of these new credit facilities in the section titled "Description of
Certain Indebtedness -- New Credit Facilities". On September 30, 1999, we had
$505.7 million of outstanding indebtedness and $497.6 million of stockholders'
equity.
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 who
do not have as much debt as we do;
- impair our ability to adjust rapidly to changing market conditions; and
- make us more vulnerable if there is a downturn in general economic
conditions or in our business.
Allegiance's earnings for the nine months ended September 30, 1999 and year
ended December 31, 1998 were insufficient to cover fixed charges by
approximately $158.8 million and $249.3 million, respectively. We cannot assure
you that we will be able to meet our working capital, capital expenditure and
debt service requirements.
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 our existing senior secured revolving credit facility
contain covenants that restrict our ability to:
- incur additional indebtedness;
- pay dividends and make other distributions;
9
<PAGE> 13
- 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 current and future financing arrangements, including the new credit
facilities discussed in the section titled "Description of Certain
Indebtedness -- New Credit Facilities," contain and will continue to contain
similar or more restrictive 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. If such a default occurs, 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 current and 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 our indebtedness,
meet our working capital or meet our capital expenditure requirements, 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.
WE MAY NOT HAVE THE FUNDS NECESSARY TO FINANCE THE CHANGE OF CONTROL OFFER WHICH
MAY BE REQUIRED BY OUR FINANCING AGREEMENTS
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.
Our existing senior secured revolving credit facility provides that upon a
change of control, we may be required to repay all of our obligations under this
credit facility. The new credit facilities will contain a similar requirement.
It is possible that we will not have sufficient funds at that time to repurchase
our notes or repay any debt outstanding under our new credit facilities.
IF WE DO NOT INTERCONNECT WITH OUR PRIMARY COMPETITORS, THE INCUMBENT LOCAL
EXCHANGE CARRIERS, OUR BUSINESS WILL BE ADVERSELY AFFECTED
Many new carriers, including Allegiance, have experienced difficulties in
working with the incumbent local exchange carriers (the "ILECs") with respect to
initiating, interconnecting, and implementing the systems used by these new
carriers to order and receive unbundled network elements and wholesale services
and locating the new carriers' equipment in the offices of the incumbent local
exchange carriers. 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
10
<PAGE> 14
ability to provide in-region long distance services until they have satisfied
statutory conditions designed to open their local markets to competition. The
FCC recently granted approval to Bell Atlantic to provide in-region long
distance service in New York. In addition, SBC has announced its intention to
file a petition to offer such service in Texas. Other regional Bell operating
companies in our markets may petition and receive approval from the FCC to offer
long distance services. These companies may not 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.
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 Internet service providers. In the past, 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. However, since 1997 UUNET Technologies, Inc., the largest Internet
service provider, has been greatly restricting the use of peering arrangements
with other providers and has been imposing charges for accepting traffic from
providers other than its "peers". Other major Internet service providers have
adopted similar policies. We do not currently have any peering arrangements and
cannot assure you that we will be able to negotiate "peer" status with any of
the major nationwide Internet service providers in the future, or that we will
be able to terminate traffic on Internet service providers' networks at
favorable prices.
OUR OFFERING OF LONG DISTANCE SERVICES IS AFFECTED BY OUR ABILITY TO ESTABLISH
EFFECTIVE RESALE AGREEMENTS
We offer long distance services as part of our "one-stop shopping" offering
of bundled telecommunications services to our customers. We have relied and will
continue to rely on other carriers to provide transmission and termination
services for all of our long distance traffic. We will continue to enter into
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
ILEC serving that area. These ILECs 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
11
<PAGE> 15
with federal and state regulatory authorities. FCC and state administrative
decisions and initiatives provide the incumbent local exchange carriers with
pricing flexibility for their:
- private lines, which are private, dedicated telecommunications
connections between customers;
- 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 access services, the FCC recently
approved incumbent local exchange carriers increased pricing flexibility and
deregulation for such access services 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 ("CLECs"), 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.
SIGNIFICANT COMPETITION IN PROVIDING LONG DISTANCE AND INTERNET SERVICES COULD
REDUCE THE DEMAND FOR AND PROFITABILITY OF OUR SERVICES
We also face significant competition in providing 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, MCI WorldCom and Sprint and many
smaller long distance carriers. Other competitors are likely to include regional
Bell operating companies providing long distance services outside of their local
service area and, with the removal of regulatory barriers, long distance
services within such local service areas, other competitive local exchange
carriers, microwave and satellite carriers and private networks owned by large
end users. The FCC has recently granted approval to Bell Atlantic to provide
in-region long distance service in New York and other regional Bell operating
companies may petition and be granted such approval in the future. 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 many of the charges
or fees that we have to pay.
The Internet services market is highly competitive and there are limited
barriers to entry. We expect that competition will continue to intensify. Our
competitors in this market include Internet
12
<PAGE> 16
service providers, other telecommunications companies, online service providers
and Internet software providers. Most of the regional Bell operating companies
and GTE Corporation operating units have announced plans to rapidly roll out
digital subscriber line ("DSL") services. Some of these entities, including SBC
Communications, US West and Bell Atlantic, have already commenced deployment of
DSL services in selected markets and may in the future deploy DSL services on a
widespread basis.
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 publicly available documents detailing our services and pricing, also known
as "tariffs," with the FCC for both international and domestic long-distance
services.
State regulatory commissions exercise jurisdiction over us because we
provide intrastate services. 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 ongoing 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, AND THE
RESOLUTION OF THESE UNCERTAINTIES COULD ADVERSELY AFFECT OUR BUSINESS
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 telecommunications industry. We cannot assure you that these
changes will not have a material adverse effect upon us.
THE REGULATION OF INTERCONNECTION WITH INCUMBENT LOCAL EXCHANGE CARRIERS
INVOLVES UNCERTAINTIES, AND THE RESOLUTION OF THESE UNCERTAINTIES COULD
ADVERSELY AFFECT OUR BUSINESS
Although the incumbent local exchange carriers are required under the
Telecommunications Act to unbundle and make available elements of their network
and permit us to purchase only the
13
<PAGE> 17
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.
A recent Supreme Court decision vacated a FCC rule determining which
network elements the incumbent local exchange carriers must provide to
competitors on an unbundled basis. On November 5, 1999, the FCC released an
order revising its unbundled network element rules to conform to the Supreme
Court's interpretation of the law, and reaffirmed the availability of the basic
network elements, such as loops and dedicated transport, used by Allegiance. It
is likely that this order may be subject to further agency reconsideration
and/or court review. While these court and FCC 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 any of these
agreements will be so renegotiated or whether Allegiance will be able to obtain
renewal of these agreements on favorable terms when they expire.
WE COULD LOSE REVENUE IF CALLS TO INTERNET SERVICE PROVIDERS ARE TREATED AS LONG
DISTANCE INTERSTATE CALLS
We believe that other 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. Reciprocal
compensation represents a material portion of our revenues. A majority of these
revenues are from Internet service providers. Decisions providing that other
carriers do not have to compensate us for these calls could limit our ability to
service this group of customers profitably.
For all other local 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 in its
Declaratory Ruling of February 26, 1999, determined that Internet service
provider traffic is interstate for jurisdictional purposes, but that its current
rules neither require nor prohibit the payment of reciprocal compensation for
such calls. In the absence of a federal rule, the FCC determined that state
commissions have authority to interpret and enforce the reciprocal compensation
provisions of existing interconnection agreements and to determine the
appropriate treatment of Internet service provider traffic in arbitrating new
agreements.
Currently, over 30 state commissions and several federal and state courts
have ruled that reciprocal compensation arrangements do apply to calls to
Internet service providers, while four jurisdictions have ruled to the contrary.
Certain of these rulings are subject to appeal. Additional disputes over the
appropriate treatments of Internet service provider traffic are pending in other
states.
In addition, we anticipate that the per minute reciprocal compensation rate
we receive from ILECs under our new interconnection agreements will be lower
than it was under our previous agreements. These reductions in reciprocal
compensation will have a material adverse effect on us if we are unable to
offset it with other revenues.
14
<PAGE> 18
THE REGULATION OF ACCESS CHARGES INVOLVES UNCERTAINTIES, AND THE RESOLUTION OF
THESE UNCERTAINTIES COULD ADVERSELY AFFECT OUR BUSINESS
To the extent we provide long-distance, often referred to as
"interexchange," telecommunications service, we are required to pay access
charges to other local exchange carriers when we use the facilities of those
companies to originate or terminate interexchange calls. As a competitive local
exchange carrier, we also 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.
Some interexchange carriers, including AT&T and Sprint, have challenged the
switched access rates of Allegiance and other CLECs and have withheld some or
all payments for the switched access services that they continue to receive.
Although no formal complaints have been filed against us, AT&T and other
interexchange carriers have asserted that they have not ordered switched access
service from us and/or that our charges for switched access services are higher
than those of the ILEC serving the same territory and are therefore unjust and
unreasonable. AT&T has refused to pay us any originating access charges at our
tariffed rates and other carriers are paying us less than our tariffed rates.
On July 5, 1999, the FCC issued a ruling to address this issue in the
context of a complaint case filed by MGC Communications, Inc., a CLEC that had
not been receiving payments from AT&T. In that ruling, the FCC stated that "AT&T
is liable to MGC, at MGC's tariffed rate, for the originating access service
that it received . . ." The FCC indicated that AT&T had no obligation to
purchase access from MGC based on the arguments that MGC had made, but the FCC
also made clear that there may be other requirements that could limit AT&T's
ability to not purchase such access from a CLEC. In response to that FCC
decision, AT&T filed a Petition for Review with the FCC, which was denied on
December 28, 1999. AT&T may pursue an appeal of this ruling.
Several states, including Colorado, Missouri, New York, Texas and Virginia,
have proposed or required that CLEC access charges be limited to those charged
by ILECs operating in the same area as the CLEC with respect to calls
originating or terminating in such area, except where the CLEC in question can
establish that its costs justify a higher access rate through a formal cost
proceeding. We believe that it is possible that other states will enact similar
requirements. We also believe, however, that it is more likely that many states
will use the same approach for intrastate long distance as the FCC ultimately
decides to use for interstate long distance.
It is our belief that the FCC's decision in the MGC/AT&T matter has
established the approach that will be applied for all similarly-situated CLECs
such as Allegiance. Further, the FCC is reviewing the switched access rate level
issue and related matters in its Access Charge Reform docket. In this docket,
the FCC has requested comment as to whether interexchange carriers may refuse to
purchase switched access services from particular carriers. Allegiance is an
active participant in that proceeding.
In light of the FCC's decision in the MGC/AT&T proceeding and the support
ILECs, including the large ILECs, have generally given to the principle that
interexchange carriers should not be permitted to refuse to purchase switched
access services from particular carriers, we believe that we will ultimately
receive payment owed to us from AT&T, Sprint and any other interexchange carrier
that withholds payment for switched access services that we provide. We cannot
provide any assurance, however, as to the amount of payments that we will
ultimately receive, the actual outcome of the FCC proceedings or the positions
various states will take on the similar issue of intrastate switched access
rates. Our switched access rates will have to be adjusted to comport
15
<PAGE> 19
with future decisions of the FCC or state commissions and these adjustments
could have a material adverse effect on Allegiance.
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.
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 the investment funds that provided our initial
equity hold a majority of our board seats and a significant amount of our common
stock and that as a result, our direction and future operations may be
controlled by these funds. For a discussion of the voting agreement among our
original fund and management investors regarding the election of nominees to the
board of directors, see the discussion under "Management and Directors". In
addition, Vulcan Ventures recently purchased four million shares of our common
stock from existing stockholders and in connection with that transaction,
Allegiance agreed to nominate two Vulcan Ventures designated directors to
Allegiance's board. As a result of these relationships, 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 our 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.
FUTURE SALES OF OUR STOCK BY EXISTING STOCKHOLDERS MAY ADVERSELY AFFECT OUR
STOCK PRICE
After this offering, we will have approximately 70.9 million shares of
common stock outstanding. While certain of these shares are "restricted
securities" under the federal securities laws, such shares are or will be
eligible for sale subject to restrictions as to timing, manner, volume, notice
and the availability of current public information regarding Allegiance. See
"Shares Eligible for Future Sale". Sales of substantial amounts of stock in the
public market, or the perception that sales could occur, could depress the
prevailing market price for our stock. Sales may also make it more difficult for
us to sell equity securities or equity-related securities in the future at a
time and price that we deem appropriate.
ANTI-TAKEOVER PROVISIONS IN ALLEGIANCE'S CHARTER AND BYLAWS COULD LIMIT OUR
SHARE PRICE AND DELAY A CHANGE OF MANAGEMENT
Our certificate of incorporation and by-laws contain provisions that could
make it more difficult or even prevent a third party from acquiring Allegiance
without the approval of our incumbent board of directors. See "Description of
Capital Stock".
16
<PAGE> 20
IF WE BECOME SUBJECT TO THE INVESTMENT COMPANY ACT, IT COULD ADVERSELY AFFECT
OUR FINANCING ACTIVITIES AND FINANCIAL RESULTS
Allegiance currently has substantial short-term investments, pending the
deployment of our capital in the pursuit of building our business and these will
increase if we complete this offering or borrow funds under our credit
facilities. This may result in Allegiance being treated as an "investment
company" under the Investment Company Act of 1940. This statute requires the
registration of, and imposes various substantive restrictions on, certain
companies that are, or hold themselves out as being, engaged primarily, or
propose to engage primarily in, the business of investing, reinvesting or
trading in securities, or that fail certain statistical tests regarding
composition of assets and sources of income and are not primarily engaged in
businesses other than investing, reinvesting, owning, holding or trading
securities.
Allegiance believes that it is primarily engaged in a business other than
investing, reinvesting, owning, holding or trading securities and, therefore, is
not an investment company within the meaning of this statute. While we believe
this means we are not an investment company within the meaning of the law, we
are currently relying on an exemption from these Investment Company Act
requirements. This exemption remains in effect until June 8, 2000.
If we were required to register as an investment company under the 1940
Act, we would become subject to substantial regulation with respect to our
capital structure, management, operations, transactions with affiliated persons
and other matters. To avoid having to register as an investment company, we may
have to seek an extension of the effectiveness of our exemption from the SEC or
we may have to invest a portion of our liquid assets in cash and demand deposits
instead of securities. The extent to which we will have to do so will depend on
the composition and value of our total assets on June 8, 2000. Having to
register as an investment company or having to invest a material portion of our
liquid assets in cash and demand deposits to avoid such registration, could have
a material adverse effect on our business, financial condition and results of
operations.
OUR FORWARD-LOOKING STATEMENTS MAY MATERIALLY DIFFER FROM ACTUAL EVENTS OR
RESULTS
This prospectus contains "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 by
this law. You generally can identify these statements by our use of
forward-looking words such as "believes," "expects," "may," "will," "should" or
"anticipates" or the negative or other variations of such terms or comparable
terminology, or by discussion of strategy that involve risks and uncertainties.
We often use these types of statements when discussing 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 or changes in
regulatory requirements and other statements contained in this prospectus
regarding matters that are not historical facts.
We caution you that these forward-looking statements are only predictions
and estimates regarding future events and circumstances. 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;
17
<PAGE> 21
- successfully and efficiently transfer new customers to our networks and
access new geographic markets;
- identify, finance and complete suitable acquisitions;
- close and borrow under our new credit facilities or borrow under
alternative financing sources;
- install new switching facilities and other network equipment;
- electronically bond with ILECs; 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.
USE OF PROCEEDS
The net proceeds to Allegiance from the sale of the 6,000,000 shares of
common stock in this offering at the assumed public offering price of $92.25 per
share are estimated to be approximately $531.2 million (approximately $664.4
million if the underwriters' over-allotment option is exercised in full), after
deducting underwriting discounts and commissions and estimated offering expenses
payable by Allegiance. We intend to use the net proceeds from this offering and
our new credit facilities primarily to fund the costs of our expanded business
plan. We may also use a portion of the net proceeds for other general corporate
purposes, which may include acquisitions. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources".
Allegiance will not receive any of the proceeds from the sale of common
stock by the selling stockholders.
DIVIDEND POLICY
We do not anticipate paying any cash dividends in the foreseeable future.
Any future determination to pay dividends will be at the discretion of our board
of directors and will be dependent upon then existing conditions, including our
financial condition, results of operations, contractual restrictions, capital
requirements, business prospects, and other factors our board of directors deems
relevant. In addition, our current financing agreements effectively prohibit us
from paying cash dividends for the foreseeable future.
18
<PAGE> 22
MARKET PRICE OF COMMON STOCK
Allegiance's common stock is traded on the Nasdaq National Market under the
symbol "ALGX". Allegiance completed the initial public offering of its common
stock on July 1, 1998. The following table sets forth, for the periods
indicated, the high and low sales prices for the common stock as reported by the
Nasdaq National Market.
<TABLE>
<CAPTION>
COMMON
STOCK PRICE
----------------
HIGH LOW
---- ---
<S> <C> <C>
Year ended December 31, 1998:
Third quarter............................................. $15.688 $6.250
Fourth quarter............................................ 13.375 5.000
Year ended December 31, 1999:
First quarter............................................. 31.000 11.563
Second quarter............................................ 58.500 25.375
Third quarter............................................. 65.250 40.000
Fourth quarter............................................ 92.250 57.250
</TABLE>
DILUTION
The net tangible book value of Allegiance as of September 30, 1999 was
approximately $461.7 million or $7.12 per share. Net tangible book value per
share represents the amount of Allegiance's total tangible assets less total
liabilities, divided by the total number of shares of common stock outstanding.
After giving effect to the sale by Allegiance of 6,000,000 shares of common
stock offered hereby at an assumed offering price of $92.25 per share and after
deducting underwriting discounts and commissions and estimated offering expenses
of $3.71 per share, the net tangible book value at September 30, 1999 would have
been approximately $992.9 million or $14.01 per share. This represents an
immediate increase in net tangible book value of $6.89 per share to existing
stockholders and an immediate dilution of $78.24 per share to new investors in
this offering, as illustrated by the following table:
<TABLE>
<S> <C> <C>
PER SHARE
--------------
Assumed public offering price per share..................... $92.25
Net tangible book value per share before the offering..... $7.12
Increase per share attributable to new investors.......... 6.89
Pro forma net tangible book value per share after the
offering.................................................. 14.01
Net tangible book value dilution per share to new
investors................................................. $78.24
======
</TABLE>
19
<PAGE> 23
CAPITALIZATION
The following table sets forth the capitalization of Allegiance as of
September 30, 1999 and as adjusted to reflect the sale of 6,000,000 shares of
common stock pursuant to this offering, assuming an offering price of $92.25 and
that the underwriters' over-allotment option is not exercised. This table should
be read in conjunction with the consolidated financial statements and related
notes and "Management's Discussion and Analysis of Financial Condition and
Results of Operations," appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
------------------------
ACTUAL AS ADJUSTED
---------- -----------
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash, cash equivalents and short-term investments........... $ 609,642 $1,140,886
Short-term investments, restricted.......................... 25,727 25,727
---------- ----------
Total cash, cash equivalents, short-term
investments and restricted short-term
investments..................................... $ 635,369 $1,166,613
========== ==========
Long-term debt:
11 3/4% senior discount notes, at accreted value.......... $ 295,470 $ 295,470
12 7/8% senior notes, at accreted value................... 201,196 201,196
Other..................................................... 9,011 9,011
---------- ----------
Total long-term debt.............................. $ 505,677 $ 505,677
========== ==========
Stockholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares
authorized, no shares issued and outstanding, actual
and as adjusted........................................ -- --
Common stock, $.01 par value, 150,000,000 shares
authorized, 64,890,147 and 70,890,147 shares issued and
64,864,835 and 70,864,835 shares outstanding, actual
and as adjusted, respectively.......................... 649 709
Common stock in treasury, at cost, 25,312 shares, actual and
as adjusted............................................... (5) (5)
Warrants.................................................... 3,896 3,896
Additional paid-in capital.................................. 940,029 1,471,213
Deferred compensation....................................... (15,583) (15,583)
Deferred management ownership allocation charge............. (10,640) (10,640)
Accumulated deficit......................................... (420,736) (420,736)
---------- ----------
Total stockholders' equity........................ 497,610 1,028,854
---------- ----------
Total capitalization.............................. $1,003,287 $1,534,531
========== ==========
</TABLE>
20
<PAGE> 24
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 consolidated
financial data presented below as of and for the nine months ended September 30,
1999 and 1998 were derived from the unaudited condensed consolidated financial
statements of Allegiance and the notes thereto contained elsewhere in this
prospectus. Dollar amounts are in thousands, except share amounts.
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>
PERIOD FROM
NINE MONTHS INCEPTION ON
ENDED APRIL 22, 1997
SEPTEMBER 30, YEAR ENDED THROUGH
------------------------- DECEMBER 31, DECEMBER 31,
1999 1998 1998 1997
---- ---- ------------ --------------
(UNAUDITED) (AUDITED) (AUDITED)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.................................. $ 59,773 $ 4,201 $ 9,786 $ --
Operating expenses:
Network................................. 38,626 4,506 9,529 151
Selling, general and administrative..... 98,539 26,076 46,089 3,426
Management ownership allocation
charge(1)............................. 15,584 160,534 167,312 --
Non-cash deferred compensation.......... 5,841 3,759 5,307 210
Depreciation and amortization........... 35,085 3,705 9,003 12
----------- ----------- ----------- -----------
Total operating expenses......... 193,675 198,580 237,240 3,799
----------- ----------- ----------- -----------
Loss from operations...................... (133,902) (194,379) (227,454) (3,799)
Interest income........................... 23,159 13,059 19,917 111
Interest expense.......................... (43,902) (25,278) (38,952) --
----------- ----------- ----------- -----------
Net loss.................................. (154,645) (206,598) (246,489) (3,688)
Accretion of redeemable convertible
preferred stock and warrant values...... (130) (11,844) (11,971) (3,814)
----------- ----------- ----------- -----------
Net loss applicable to common stock....... $ (154,775) $ (218,442) $ (258,460) $ (7,502)
=========== =========== =========== ===========
Net loss per share, basic and diluted..... $ (2.62) $ (13.02) $ (10.53) $(17,610.68)
=========== =========== =========== ===========
Weighted average number of shares
outstanding, basic and diluted.......... 58,988,867 16,780,802 24,550,346 426
=========== =========== =========== ===========
OTHER FINANCIAL DATA:
EBITDA(2)................................. $ (77,392) $ (26,381) $ (45,832) $ (3,577)
Net cash used in operating activities..... (64,308) (10,498) (17,270) (1,943)
Net cash used in investing activities..... (120,255) (183,699) (319,170) (21,926)
Net cash provided by financing
activities.............................. 504,507 593,216 593,216 29,595
Capital expenditures...................... 215,893 63,550 113,539 21,926
</TABLE>
21
<PAGE> 25
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, AS OF DECEMBER 31,
--------------------- -------------------
1999 1998 1998 1997
---- ---- ---- ----
(UNAUDITED) (AUDITED)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents, short-term investments, and
restricted short-term investments...................... $ 635,369 $477,096 $431,435 $ 5,726
Property and equipment, net.............................. 345,130 100,541 144,860 23,900
Total assets............................................. 1,095,244 646,772 637,874 30,047
Long-term debt........................................... 505,677 463,752 471,652 --
Redeemable cumulative convertible preferred stock, $.01
par value, 0 shares authorized and 0 shares issued and
outstanding at September 30, 1999, September 30, 1998
and December 31, 1998 and 40,498,062 shares authorized
and 40,498,062 shares issued and outstanding at
December 31, 1997...................................... -- -- -- 33,409
Redeemable warrants...................................... -- 8,507 8,634 --
Total stockholders' equity (deficit)..................... 497,610 142,121 110,430 (7,292)
Total liabilities and stockholders' equity............... 1,095,244 646,772 637,874 30,047
</TABLE>
- - - - - - - - - - ---------------
(1) In connection with the initial public offering of common stock, Allegiance
Telecom, 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 Allegiance
Telecom, LLC investors in accordance with its limited liability company
agreement. This 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 Telecom, 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 was recorded as deferred management
ownership allocation charge. The deferred charge was amortized at $44.8
million, $15.6 million and $38.0 million during the year ended December 31,
1998, and the nine months ended September 30, 1999 and 1998, respectively.
The deferred charge will be further amortized at $3.2 million, $7.2 million
and $0.2 million during the fourth quarter of 1999 and for the years 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" in our Annual Report on Form 10-K for the year ended
December 31, 1998, which is incorporated by reference in this prospectus.
(2) 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.
22
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Allegiance is a leading competitive provider of telecommunications services
to small and medium-sized business, government and other institutional users in
major metropolitan areas across the United States. Allegiance offers an
integrated set of telecommunications 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, 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:
- 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
- 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, also 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 a number of
competitive advantages over the traditional build-out strategy by allowing
Allegiance to:
- 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;
- 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 network assets to the time when 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 has constructed fiber
transmission facilities.
Allegiance believes that its smart build approach allows it to reduce its
up-front capital expenditures to approximately 25% of the total capital
expenditures required to develop such a network as compared with up-front
capital expenditures of approximately 50% under traditional build-out models.
The level of "up-front" capital required to be spent by Allegiance to develop a
network will vary depending on a number of factors. These factors include:
- the size and geography of the market;
- the cost of development of Allegiance's network in each market;
23
<PAGE> 27
- the degree of penetration of the market;
- the extent of price and service competition for telecommunications
services, regulatory and technological developments; and
- Allegiance's ability to negotiate favorable prices for purchases of
equipment.
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. 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 (January 1999), Washington, D.C., including suburban Maryland and
Virginia, and San Jose (March 1999), Houston (April 1999), Northern New Jersey
(May 1999), San Diego (July 1999), Long Island (August 1999), Orange County
(September 1999), Baltimore (October 1999), and Detroit (November 1999).
Although we initiated resale of local services in Dallas in 1997, reselling
local service is not our core focus and comprises a small percentage of our
sales. We now generally resell local services in order to provide a
comprehensive telecommunications solution to a customer that has a need for
local services both within and outside of our markets. In these cases, we resell
services to those locations that are not within markets where we have
facilities. We also resell services in certain cases where customers require
services that we do not currently provide on a facilities basis. We earn
significantly higher margins by providing facilities based services instead of
resale services and our sales teams have focused their efforts on selling
services that require the use of our facilities.
We may acquire unused fiber capacity to which Allegiance adds its own
electronic transmission equipment once traffic volume justifies this investment
or other factors make it attractive. This unused 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. We are
moving to the next stage of our smart build strategy in most of our existing
markets by acquiring dark fiber capacity to connect many of the central offices
at which we are located. These dark fiber rings will replace the network
elements that we are leasing on a short-term basis from the ILECs and are
expected to provide us with higher operating margins and more reliable network
services. We currently have dark fiber rings in operation in New York City,
Dallas and Houston and we have entered into contracts for dark fiber rings in an
additional 16 metropolitan markets, all of which are expected to be in operation
before the end of 2000. We have also contracted for similar long-term
arrangements for long-haul fiber routes connecting our Boston, New York City and
Washington, D.C. networks.
The table below provides selected key operational data:
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, DECEMBER 31,
---------------- -------------
1999 1998 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Markets served.................................... 17 6 9 0
Number of switches deployed....................... 13 5 7 0
Central office collocations....................... 260 54 101 0
Addressable market (business lines) (in
millions)....................................... 8.4 2.0 3.6 0
Lines sold........................................ 262,100 43,400 86,500 20
Lines installed................................... 181,400 25,900 47,700 9
Sales force employees............................. 608 195 295 0
Total employees................................... 1,525 462 649 40
</TABLE>
24
<PAGE> 28
Our initial business plan covered 24 of the largest metropolitan areas in
the United States. We have successfully raised the projected capital to build
our networks and operate in each of these markets to the point at which
operating cash flow from the market is sufficient to fund such market's
operating costs and capital expenditures. In light of this progress, we have
expanded our business plan as described under "Prospectus Summary".
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1998
For the nine months ended September 30, 1999 and 1998, we generated
revenues of $59.8 million and $4.2 million, respectively. As of September 30,
1999, we sold 262,100 lines and installed 181,400 lines. As of September 30,
1998, we sold 43,400 lines and installed 25,900 lines. Facilities based lines
represented 87% of all lines installed at September 30, 1999 as compared to 47%
at September 30, 1998.
Local service revenues for the nine months ended September 30, 1999 and
1998 were approximately $25.5 million and $3.5 million, respectively. Local
service revenues consisted of:
- the monthly recurring charge for basic service;
- usage based charges for local calls in certain markets;
- charges for 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.
We earn "access charges" revenue by connecting our local service customers
to their selected long distance carriers for outbound calls or by delivering
inbound long distance traffic to our local service customers. We earn
"reciprocal compensation" revenue by terminating on our network local calls that
originate on another carrier's network. Access charge revenue and reciprocal
compensation revenue accounted for $27.1 million of our revenues for the nine
months ended September 30, 1999 and $0.3 million of our revenues for the nine
months ended September 30, 1998. Our interstate access charges were filed
largely mirroring those used by the National Exchange Carrier Association
("NECA"), an association of independent local exchange carriers and our state
access charges were generally set the same as those of state associations
similar to NECA or of individual ILECs operating in other areas within the same
state. These charges are generally higher than those charged by the large ILECs
operating in the same areas as Allegiance because, for instance, these large
ILECs have many more customers and therefore have lower unit costs. Access
charges are intended to compensate the local exchange carrier for the costs
incurred in originating and terminating long distance calls on its network and
we believe our access charges are appropriately set at levels approximately the
same as those of the smaller ILECs. Access charge levels in general, and those
charged by CLECs in particular, are subject to various disputes and are under
review by the FCC. See "Risk Factors -- The Regulation of Access Charges
Involves Uncertainties, and the Resolution of These Uncertainties Could
Adversely Affect Our Business". Reciprocal compensation charges as they relate
to Internet service provider traffic are also subject to various disputes. See
"Risk Factors -- We Could Lose Revenue if Calls to Internet Service Providers
Are Treated As Long Distance Interstate Calls".
Long distance revenues for the nine months ended September 30, 1999 and
1998 were approximately $1.7 million and $0.4 million, respectively. Internet
access and other Internet revenues for the nine months ended September 30, 1999
were approximately $5.0 million.
25
<PAGE> 29
All other sources of revenue accounted for approximately $0.5 million for
the nine months ended September 30, 1999. Other revenues for the nine months
ended September 30, 1998 were immaterial.
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 ConnecTen, L.L.C. We have recognized the revenues earned since
the ConnecTen, L.L.C. and ConnectNet, Inc. transactions, both of which closed in
April 1999, and the Kivex, Inc. transaction which closed on June 30, 1999, in
our condensed consolidated statement of operations for the period ended
September 30, 1999. Kivex, Inc. revenues contributed approximately $2.4 million
to consolidated revenues for the third quarter of 1999. The other two companies'
revenues were immaterial to revenues for the period ended September 30, 1999. 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:
- errors in providing new service and billing;
- service interruptions;
- poor customer service; and
- 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.
In addition to Bell Atlantic in New York City, we are now electronically
bonding with Bell Atlantic in Boston and Long Island and with Southwestern Bell
in Dallas, Fort Worth, and Houston. Testing with SBC and Pacific Bell in
California was completed during the third quarter 1999 on the electronic data
interface which is now in use there. Local service requests for all Texas and
California markets are now processed electronically with SBC. We are currently
testing electronic bonding with Ameritech and expect to begin sending production
orders in January 2000. Electronic bonding with Bell Atlantic in their southern
region should also be completed by the end of the first quarter 2000. We plan on
testing with BellSouth and US West in the second quarter 2000. 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.
For the nine months ended September 30, 1999 and 1998, network expenses
were $38.6 million and $4.5 million, respectively. This sharp increase is
consistent with the deployment
26
<PAGE> 30
of our networks and initiation and growth of our services during 1999 and 1998.
Network expenses included:
- the cost of leasing high capacity digital lines that interconnect our
network with ILEC networks;
- the cost of leasing high capacity digital lines that connect our
switching equipment to Allegiance transmission equipment located in ILEC
central offices;
- the cost of leasing local loop lines which connect our customers to our
network;
- the cost of completing local and long distance calls originated by our
customers;
- the cost of leasing space in ILEC central offices for collocating
Allegiance transmission equipment; and
- 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.
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 other carrier's network. These reciprocal
compensation costs will grow as our customers' outbound calling volume grows.
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 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 types of
agreements, if a company underestimates its need for transmission
27
<PAGE> 31
capacity and exceeds the maximum amount agreed to under such agreements, it may
be required to obtain capacity through more expensive means.
We have developed a national Internet data network by connecting our cities
with leased high capacity digital lines. The costs of these lines will increase
as we increase capacity to address customer demand, open new markets and connect
additional markets to our Internet network.
For the nine months ended September 30, 1999, selling, general and
administrative expenses increased to $98.5 million from $26.1 million for the
nine months ended September 30, 1998. Selling, general and administrative
expenses include salaries and related personnel costs, facilities costs and
legal and consulting fees. The number of employees increased to 1,525 as of
September 30, 1999, from 462 as of September 30, 1998. As of September 30, 1999,
the sales force, including sales managers and sales administrators, had grown to
608, from 195 as of September 30, 1998. We currently do not have any print or
other media advertising campaigns. Although we currently do not use sales
agents, we may use agents in the future. 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 $15.6 million and $38.0 million of the deferred management
ownership allocation charge, a non-cash charge to income, for the nine months
ended September 30, 1999 and 1998, respectively. 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.
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 will further amortize this deferred charge at $3.2
million, $7.2 million and $0.2 million during the fourth quarter of 1999, and
for the years 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. For the nine
months ended September 30, 1999 and 1998, we recorded $5.8 million and $3.8
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.
For the nine months ended September 30, 1999 and 1998, we recorded $31.7
million of depreciation and amortization of property and equipment and $3.7
million, respectively. Such increase was consistent with the deployment of our
networks and initiation of services in seventeen markets by September 30, 1999.
In connection with the ConnecTen, ConnectNet and Kivex acquisitions
completed during the second quarter of 1999, we assigned an aggregate of $5.5
million of the purchase price to customer lists and $0.2 million to workforces.
We also recorded an aggregate of $33.7 million of goodwill. Each of these
intangible assets is being amortized over their estimated useful lives of three
years, beginning at their respective date of the acquisition. For the nine
months ended
28
<PAGE> 32
September 30, 1999, we recorded $2.9 million of amortization for goodwill and
$0.5 million of amortization of customer list and workforces.
For the nine months ended September 30, 1999 and 1998, interest expense was
$43.9 million and $25.3 million, respectively. Interest expense recorded during
the period ended September 30, 1999 reflects the accretion of the 11 3/4% notes
and related amortization of the original issue discount, and the amortization of
the original issue discount on the 12 7/8% notes. The 12 7/8% notes were issued
on July 1, 1998. The amount of interest capitalized for the nine months ended
September 30, 1999 and 1998 was $4.1 million and $1.8 million, respectively.
Interest income for the nine months ended September 30, 1999 and 1998 was $23.2
million and $13.1 million, respectively. Interest income results from the
investment of 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% notes. Interest income during 1999 is greater
than for the comparable periods in 1998 because we had additional cash generated
from our initial public offering of stock, sale of 11 3/4% notes in February
1998 and sale of 12 7/8% notes in July 1998, as well as the additional 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. 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 our 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 was $11.5 million for the nine months
ended September 30, 1998.
Our net loss for the nine months ended September 30, 1999, after
amortization of the non-cash management allocation charge and amortization of
deferred compensation, but before accretion of redeemable warrants, was $154.6
million. Our net loss for the nine months ended September 30, 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 $206.6 million. After deducting
accretion of redeemable warrant values, the net loss applicable to common stock
was $154.8 million for the nine months ended September 30, 1999. After deducting
accretion of redeemable preferred stock and warrant values, the net loss
applicable to common stock was $218.4 million for the nine months ended
September 30, 1998.
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 $77.4
million for the nine months ended September 30, 1999, and EBITDA losses of $26.4
million for the same period in 1998. In calculating EBITDA, we also exclude the
non-cash charges to operations for management ownership allocation charge
29
<PAGE> 33
and deferred stock compensation expense totaling $21.4 million for the nine
months ended September 30, 1999 and $164.3 million for the nine months ended
September 30, 1998.
We expect to continue to experience operating losses and negative EBITDA as
a result of our development and market expansion activities. We typically do not
expect to achieve positive EBITDA in any market until at least its third year of
operation.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO 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.
For the year ended December 31, 1998, we sold 67,100 facilities-based lines
and installed 30,500 lines. Resale lines sold during 1998 totaled 19,400, of
which 17,200 were installed. During 1998, Allegiance generated $9.8 million of
revenue. The majority, $6.9 million, was local service revenue. During 1998,
access charges accounted for $2.2 million of Allegiance's revenues and long
distance revenues accounted for $0.7 million of Allegiance's revenues. All other
sources of revenue accounted for approximately $10,000 during 1998. During 1998,
Allegiance recognized an insignificant amount of revenue from "reciprocal
compensation". Allegiance had no revenue from reciprocal compensation during
1997.
Network expenses increased to $9.5 million in 1998 from $0.2 million in
1997. This sharp increase was consistent with the deployment of our networks and
initiation and growth of our services during 1998.
Selling, general and administrative expenses increased to $46.1 million in
1998 from $3.4 million in 1997, which is primarily due to the growth of our
business. Selling, general and administrative expenses include salaries and
related personnel costs, facilities costs and legal and consulting fees.
As of December 31, 1998, we had 649 employees, compared to 40 as of
December 31, 1997. As of December 31, 1998, the sales force, including sales
managers and sales administrators, had grown to 295. Allegiance did not employ
any account executives, major account managers or sales engineers prior to
January 1998.
The magnitude of our net loss for 1998 is principally due to the management
ownership allocation charge, a non-cash charge to income. See "-- Nine Months
Ended September 30, 1999 Compared With Nine Months Ended September 30,
1998". Under generally accepted accounting principles, Allegiance recorded 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 $44.8 million of the deferred charge in 1998. In addition to these
expenses, Allegiance recognized $5.3 million and $0.2 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 Telecom, 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.
30
<PAGE> 34
Depreciation and amortization expense increased to approximately $9.0
million in 1998 from $13,000 in 1997, 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: the issuance on February 3, 1998, of 11 3/4% notes, and
the issuance on July 7, 1998, of 12 7/8% notes. See "Liquidity and Capital
Resources" for a discussion of these note offerings. 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 $0.1 million,
respectively, resulting from the investment of excess cash and from U.S.
government securities that we purchased and placed in a pledge account to secure
the semiannual payments of interest through May 2001 on the 12 7/8% notes.
Our net loss for the period ended December 31, 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.
Allegiance had negative EBITDA of $45.8 million and $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 $0.2 million for the year
ended December 31, 1998 and for the period from inception to December 31, 1997,
respectively.
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.
Under our old business plan, we planned to establish networks in 24 of the
largest U.S. metropolitan markets. On January 3, 2000, we announced a
significant expansion of our business plan which includes an additional 12
markets, for a total of 36 target markets and which:
- includes an increase in our collocation footprint by approximately 100
central offices in our initial 24 target markets, and
- provides for the acquisition of dark fiber capacity in an additional 16
of our target markets as well as in the Boston-New York-Washington D.C.
corridor.
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 in the market
to the point at which operating cash flow from the market is sufficient to fund
such market's ongoing operating costs and capital expenditures. All of our
initial 24 target markets are now fully funded in this manner. We believe that
the new credit facilities described in this prospectus will provide the funding
necessary for us to expand into 30 target markets. We will need to complete this
offering or obtain additional financing to expand into our remaining six target
markets.
31
<PAGE> 35
We may decide to seek additional capital in the future to expand our
business. Sources of additional financing may include 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 at all or on terms
acceptable to Allegiance, or that Allegiance's estimate of additional funds
required is accurate. The actual amount and timing of 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 that
leads to 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;
- an inability to borrow under our new credit facilities; and
- 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:
- our ability to meet our roll-out schedules;
- our ability to negotiate favorable prices for purchases of equipment;
- our 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 we may offer; and
- 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.
For the nine months ended September 30, 1999 and 1998, we made capital
expenditures of $215.9 million and $63.6 million, respectively. For the years
ended 1998 and 1997, we made capital expenditures of $113.5 million and $21.9
million, respectively. 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 September 30, 1999, we had transmission
equipment collocated in 260 ILEC central offices. Based on preliminary
information, we made capital expenditures of between $55.0 million and $57.0
million for the fourth quarter 1999, including purchases of switching equipment,
switch and sales facilities, transmission equipment and collocation facilities.
Under our expanded business plan, we expect to incur approximately $400.0
million of capital expenditures in 2000.
As of September 30, 1999, we had approximately $609.6 million of cash and
short-term investments. This amount excludes $51.2 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.
Allegiance initially raised approximately $50.1 million from certain
members of the Allegiance management team and from affiliates of four private
equity investment funds with extensive
32
<PAGE> 36
experience in financing telecommunications companies: Madison Dearborn Capital
Partners, Morgan Stanley Dean Witter Capital Partners, Frontenac Company and
Battery Ventures.
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. Net proceeds of approximately $240.7
million were received from that offering. The 11 3/4% notes have a principal
amount at maturity of $445.0 million and an effective interest rate of 12.21%.
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.
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 $137.8 million from its initial public
offering of common stock and approximately $124.8 million from the offering of
these notes. 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. The first interest payment was made in November 1998.
Such U.S. Government securities are reflected in the balance sheet as of
September 30, 1999, at an accreted value of approximately $51.2 million, $25.7
million of which we classified as current assets and $25.5 million of which we
classified as other non-current assets.
We completed a senior secured revolving credit facility under which we may
borrow up to $225.0 million, subject to the satisfaction of certain terms and
conditions, during the second quarter of 1999. 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. This existing credit facility is structurally senior to our 12 7/8%
notes and 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 Offered Rate + 3.75%. The
current commitment fee is 1.50% of the undrawn portion of the total 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 and $80.3 million of net
proceeds, at that time.
On January 3, 2000, we announced that we had obtained a commitment from
Goldman Sachs Credit Partners L.P., Toronto Dominion (Texas), Inc., BankBoston,
N.A., Morgan Stanley Senior Funding, Inc. and various other lenders to fully
underwrite $500.0 million of senior secured
33
<PAGE> 37
credit facilities. These new credit facilities would replace our existing senior
secured revolving credit facility. The new credit facilities consist of a $350.0
million revolving credit facility and a $150.0 million delayed draw term loan
facility. The new credit facilities are subject to conditions customary for
closing a transaction of this type, including completion of definitive
documentation and finalization of all terms and conditions. We expect to close
these facilities in February 2000. The closing is not contingent on the
completion of this offering. See "Description of Certain Indebtedness -- New
Credit Facilities".
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 we are operating in 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 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 have assessed and
will continue to 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.
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 engaged a consultant during the third quarter of 1999 to review:
- the process that we have undertaken to determine the extent of our year
2000 readiness;
- the results of our internal inventory of systems;
- our conclusions concerning the year 2000 readiness of our internal
systems;
- responses we received from vendors and other third parties regarding
potential year 2000 exposure through our business relationships with
them; and
- our company-wide contingency plans.
34
<PAGE> 38
We have paid an aggregate of $200,000 for this consultant and this
consultant has not identified any material issues.
Because no material year 2000 issues have been identified in connection
with external sources, we cannot reasonably estimate costs that may be required
for remediation or for implementation of contingency plans.
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:
- 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 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 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 or experienced 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
35
<PAGE> 39
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.
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 1999, based on the estimated average 1999
earned rate on investments is $28.4 million. Assuming a 100 basis point drop in
the estimated average 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
----- ---- --------- -------- -----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Estimated average investments..... $365.6 $645.7 $654.2 $562.9 --
Estimated average interest earned
at the estimated average rate of
5.1% for the year ended December
31, 1999........................ $ 4.7 $ 8.2 $ 8.3 $ 7.2 $28.4
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.
36
<PAGE> 40
BUSINESS
OVERVIEW
Allegiance is a leading competitive provider of telecommunications services
to small and medium-sized business, government and other institutional users in
major metropolitan areas across the United States. We offer an integrated set of
telecommunications services including local exchange, local access, domestic and
international long distance, enhanced voice, data and a full suite of Internet
services. We were operating in the following 19 markets as of December 31, 1999:
Atlanta, Baltimore, Boston, Chicago, Dallas, Detroit, Fort Worth, Houston, Long
Island, Los Angeles, New York, Northern New Jersey, Oakland, Orange County,
Philadelphia, San Diego, San Francisco, San Jose and Washington, D.C.
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, a 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
facilities-based competitive local exchange carriers like Allegiance that were
created after the enactment of this legislation and specifically designed to
take advantage of the opportunity it created. Most importantly, the
Telecommunications Act stated that competitive local exchange 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 switches with local and long
distance capability, and lease copper wires and fiber optic lines from the
ILECs, other CLECs, and other telecommunications companies, so that Allegiance
can directly serve its customers. Once traffic volume growth justifies further
capital investment, Allegiance leases dark fiber or otherwise acquires its own
fiber network.
Allegiance has developed procedures, together with its back office systems
vendors, including MetaSolv, DSET and Lucent, that it believes will provide it
with a 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.
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 2000. Allegiance has already achieved such bonding
with Bell Atlantic in Boston and Long Island and with Southwestern Bell in
Dallas, Fort Worth and Houston. Testing with SBC and Pacific Bell in California
was completed during the third quarter of 1999 on the electronic data interface
that is now in use there. We are currently testing electronic bonding with
Ameritech and expect to begin sending production orders in January 2000.
Electronic bonding with Bell Atlantic in their southern region should also be
completed by the end of the first quarter of 2000. We plan on testing with
BellSouth and US West in the second quarter of 2000. This electronic interface
allows 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 intends to continue network deployment of its 36 target markets.
With a strategy focusing on the central business districts and suburban
commercial districts in these areas,
37
<PAGE> 41
Allegiance plans to address a majority of the non-residential access lines in
most of its targeted markets.
BUSINESS STRATEGY
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. He
served as President, Chief Operating Officer and co-founder of MFS
Communications, one of the first companies to compete with the ILECs. Under his
leadership, MFS Communications grew from a start-up operation to become the
largest competitor to the 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
July 1997 to February 1998, and as President, Southwest Region of AT&T Wireless
Services, Inc. from June 1994 to July 1997. Thomas M. Lord, the Chief Financial
Officer of Allegiance is a former Managing Director of Bear, Stearns & Co. Inc.,
where he specialized in the telecommunications, information services and
technology industries and played a key role in the financing of many of the
first competitive local access providers. 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 Customers 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 interconnection;
- Internet services; and
- integrated services digital network trunking, an international standard
for voice and/or data transmission using digital signals.
In addition, we began to offer the following services in 1999:
- digital subscriber lines, which allow high speed digital connection for
carrying voice and data traffic over copper lines, and
- Web server hosting.
These comprehensive services are generally not available from the ILECs, or
available only at relatively higher prices. By offering a comprehensive package
of communications services together with traditional local and long distance
services, we believe that we can accelerate our
38
<PAGE> 42
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
focus primarily on capturing a significant portion of these customers' local
exchange, intraLATA toll, which are the calls that fall within a local service
area, 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.
To address the expected demand by small and medium-sized business customers
for Internet based products and e-commerce solutions, we recently announced a
comprehensive Internet portal and small business resource center that we will
offer to these customers as a means of facilitating their entry into e-commerce.
Utilize "Smart Build" Strategy to Maximize Speed to Market and Minimize
Investment Risk. We pursue what we refer to as a "smart build" strategy. Under
this strategy, we
- purchase and install switches;
- locate our equipment in the central office facilities of incumbent local
exchange carriers; and
- lease unbundled network elements from the incumbent local exchange
carriers until growth justifies our ownership of additional network
assets.
Once traffic volume justifies further investment, we may then lease dark
fiber or construct our own fiber network.
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 to 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 moving to the next stage of our smart build strategy in most of our
existing markets by acquiring long-term rights to use dark fiber rings that will
connect many of the central offices at which we are located. These dark fiber
rings will replace the network elements that we are leasing on a short-term
basis from the ILECs and are expected to provide us with higher operating
margins and more reliable network services. We currently have dark fiber rings
in operation in New York City, Dallas and Houston and we have entered into
contracts for dark fiber rings in an additional 16 metropolitan markets, all of
which are expected to be in operation before the end of 2000. We have also
contracted for similar long-term arrangements for long-haul fiber routes
connecting our Boston, New York City and Washington, D.C. networks.
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
39
<PAGE> 43
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
operating 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
generally resell ILEC services in order to provide comprehensive geographical
service coverage to customers with multiple sites where the customer is
physically connected to our switches and which can be addressed by our
facilities-based services, and a few off-switch sites, which can be addressed
only by reselling ILEC services. We also resell certain ILEC services that we do
not yet have available on a facilities basis.
Build Market Share by Focusing on Direct Sales. We use a direct sales force
to sell directly to customers and provide them personalized customer care
through a single point of contact. By using this approach, 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 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. We are automating most of
the processes involved in switching a customer to our networks. Our goal is to
decrease the time between customer order and service installation, reduce
overhead costs and improve customer service. To achieve this goal, we are
developing, acquiring and integrating information technology systems to support
our operations, and we are establishing electronic bonding arrangements with the
incumbent local exchange carriers. 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 and
Order Provisioning" for a discussion of electronic bonding.
40
<PAGE> 44
Expand Through Acquisitions. We plan to pursue strategic acquisitions to
accelerate our market penetration, expand our products and customer base, and
acquire additional experienced management. We purchased three Internet service
providers in the second quarter of 1999, including Kivex, Inc., a Maryland based
provider of DSL and other broadband Internet access services. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
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 1998 totaled approximately $285 billion in revenue. As depicted on
the chart below, wireline telecommunications services, other than Internet
access and content, purchased by non-residential users accounted for about 43%,
or approximately $122 billion, of the total U.S. market in 1998:
[GRAPH]
The major segments of the non-residential wireline telecommunications
services market, based on U.S. Census Bureau data, are as follows:
[GRAPH]
Traditional voice traffic accounted for the vast majority of
non-residential communications revenue in 1998, 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.
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-
41
<PAGE> 45
sized businesses, present 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 tailors 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 enable Allegiance to tailor its
service offerings to meet customers' needs and to creatively package its
services to provide "one-stop shopping" solutions for those customers.
Local Exchange Services. Allegiance offers local telephone services,
including local dial tone as well as other features such as:
- call forwarding;
- call waiting;
- caller number identification and/or calling name identification;
- call transfer;
- distinctive ringing;
- station-to-station four-digit dialing without a private branch exchange;
and
- voice mail.
By offering dial tone service, Allegiance also receives originating and
terminating access charges for interexchange calls placed or received by its
subscribers. Allegiance offers local voice services over unbundled local loops
as well as high capacity lines such as T-1 connections. Allegiance also combines
voice and data offerings over T-1 and digital subscriber line connections.
Allegiance believes that digital subscriber line technology offers an attractive
opportunity for offering local voice services at lower costs and higher gross
profit margins.
Integrated Services Digital Network, Digital Subscriber Line and Other 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
- 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 uses 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.
In 1999, Allegiance rolled out DSL services to its customers. DSL allows
high-speed digital connectivity over traditional copper telephone lines and
thereby provides an economic alternative to high-speed cable, T1 and integrated
service digital networks. Allegiance is now offering symmetric (equal download
and upload speeds) DSL service, facilitating the convergence of the customer's
voice, high-speed data and Internet traffic on one unbundled loop. Allegiance
has deployed DSL equipment to over 100 total collocations in central offices
throughout its operational markets. Allegiance has also deployed asymmetric DSL
equipment to collocations in Chicago, New York, Philadelphia and Washington,
D.C. Also, during
42
<PAGE> 46
the third quarter of 1999, Allegiance deployed what we believe to be the
industry's first commercial HDSL2 circuit, a new standard of high-bit-rate
digital subscriber line. HDSL2 allows the equivalent of 1.544 megabits T1
service over a single copper wire pair rather than the two unbundled loops
required under older high-bit rate digital subscriber line standards.
Many of Allegiance's current and target future small and medium-sized
business customers do not use data or Internet access services in their
businesses. It is expected that small and medium-sized businesses will
increasingly find the need to use these services as e-commerce and other
Internet-based products develop. To facilitate this expected trend and to assist
its customers in taking advantage of the opportunities offered by e-commerce and
related Internet developments, on December 16, 1999, Allegiance formally
announced the alliance with Go2Net, Inc. to jointly develop a customized
Internet portal and a customized small business resource center for Allegiance
customers .
The customized Internet portal is designed to offer Allegiance customers
communications (calendar, e-mail, contacts, instant messenger), general
resources (search, weather/maps, yellow pages, knowledge links), community
access (forums, discussion database), current information (news, stock
portfolio) and customer care (link to Allegiance's customer support). The
Allegiance customized small business resource center, which will be made
available through the customized portal, will allow Allegiance customers to gain
direct access to many resources that serve this segment of the business market,
including office supplies, information about incorporating, trademark
registration, chambers of commerce, communications services, financial services
and government agencies. The Allegiance customized small business resource
center will also connect customers to transaction services, such as real-time
credit card processing, on-line payroll and on-line educational courses.
Allegiance is independently working on expanding its Internet-based service
offering to include a web-based platform for software applications hosting.
Allegiance expects this aspect of its Internet initiative to provide its typical
small and medium-sized business customer with software applications at a more
affordable price.
Interexchange/Long Distance Services. Allegiance offers a full range of
domestic and international long distance services. These services include "1+"
outbound calling, inbound toll free service and such complementary services as
calling cards, operator assistance and conference calling.
Web Hosting Services. During 1999, Allegiance started offering Web site
hosting on its own computer servers to provide customers with a complete, easy
to use turnkey solution that gives them a presence on the World Wide Web.
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
supplements its core customer product offerings by providing a full array of
local services to Internet service providers, including telephone numbers,
managed modem switch ports 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, and a full suite
of Internet services to small and medium-sized businesses. Unlike large
corporate, government, or 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.
43
<PAGE> 47
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, and receives a material portion of its revenue from, large
business, government, and other institutional users, as well as to Internet
service providers. 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 and medium-sized businesses -- Allegiance uses direct sales with
sales forces based locally in each target market and plans to offer its
customized Internet portal and small business resource center to
facilitate Internet access sales to this market;
- Large business, government, and other institutional users -- Allegiance
uses account teams, established business relationships and applications
sales, and is an exhibitor at trade shows; and
- Wholesale carriers, primarily Internet service providers -- Allegiance
uses direct sales, established business relationships, competitive
pricing and integrated services.
Allegiance organizes account executives into teams of six to eight persons
with a team manager and a sales support specialist for each market. These teams
utilize telemarketing to "qualify" leads and set up initial appointments.
Allegiance closely manages the number of sales calls that account executives
make 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 Internet service providers are performed by
regional sales managers reporting to the director of wholesale accounts, who in
turn reports to the vice president of national accounts. 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 experienced national account managers with established business
relationships with large corporate accounts, supported by pre-sales engineers,
program managers and service coordinators. These individuals proactively manage
the account before and after the sale.
Allegiance has focused its efforts on developing a personalized customer
care program. Allegiance's customer service representatives are available seven
days a week, 24 hours a day. In addition, Allegiance has separate customer care
specialists to support its national accounts. Allegiance monitors and seeks to
continuously reduce the time to answer each call into its customer care
department. All customer service issues are tracked and escalated to appropriate
network personnel through software interfaces as well as personal management of
each issue by an Allegiance customer care representative.
INFORMATION SYSTEMS AND ORDER PROVISIONING
Allegiance is continuing to develop its customized 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. Allegiance believes that the ability
to successfully manage the process of converting customers from ILEC and other
networks to the Allegiance network, especially with respect to local loops
leased from ILECs, is one of the key functions required to succeed as a
competitive local exchange carrier. As a result, Allegiance has devoted
significant resources to this aspect of its operations and continues to develop
its information systems to facilitate this function. These
44
<PAGE> 48
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 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. Because Allegiance
does not have 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 free 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 and We May Have Difficulties in Developing These Systems".
Order Management. Allegiance has used MetaSolv's order management software
to develop processes that allow the sales team not only to enter customer orders
onsite, via computer and/or over the Internet, but also to monitor the status of
an order as it progresses through the service initiation process.
Provisioning Management. The licensed order management software, together
with the proprietary processes developed by Allegiance to optimize the
usefulness of this software, supports the design and management of the process
by which Allegiance converts a customer to the Allegiance network from the local
exchange network of an ILEC or other carrier, including circuit design and work
flow management. The system has been designed to permit programming into the
system of a standard schedule of tasks that must be accomplished 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. 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 third quarter of 1999
and are now electronically bonding with Bell Atlantic in Boston and Long Island
and with Southwestern Bell in Dallas, Fort Worth and Houston. Testing with SBC
and Pacific Bell in California was completed during the third quarter of 1999 on
the electronic data interface that is now in use there. Local service requests
for all of our three Texas markets and six California markets are now processed
electronically with SBC. We are currently testing electronic bonding with
Ameritech and expect to be sending production orders under this system in
January 2000. We also expect to complete electronic bonding with Bell Atlantic
in their southern region by the end of the first quarter 2000. We plan on
testing electronic bonding with BellSouth and US West in the second quarter
2000.
45
<PAGE> 49
In all of these markets, 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.
Electronic bonding allows 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.
Network Element Administration. Allegiance has automated each element of
its network. Allegiance continues to develop 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 service provider that
credits the collections made from Allegiance's lock-box. Customer information is
electronically interfaced with this provider from Allegiance's order management
system via a gateway, thereby integrating all repositories of information. We
are continuing to develop other enhancements to the gateway.
Billing Records. Local and intraLATA billing records are generated by our
Lucent Series 5ESS(R)-2000 switches to record customer calling activity. The
long distance carrier with whom Allegiance has a resale agreement generates
InterLATA billing records for Allegiance so that it can record customer calling
activity. The billing service provider will automatically process these records
in order to calculate and produce bills in a customer-specified billing format.
NETWORK DEPLOYMENT AND TRAFFIC MANAGEMENT
As of December 31, 1999, we were operating in 19 markets: Atlanta,
Baltimore, Boston, Chicago, Dallas, Detroit, Fort Worth, Houston, Long Island,
Los Angeles, New York, Northern New Jersey, Oakland, Orange County,
Philadelphia, San Diego, San Francisco, San Jose and Washington, D.C.
The following table sets forth the markets targeted by Allegiance and the
current buildout schedule. 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. Allegiance may also
elect not to deploy networks in each such market. Those markets designated for
deployment in 2001 are preliminary and one or more of these may be replaced by
other comparable markets.
46
<PAGE> 50
<TABLE>
<CAPTION>
ESTIMATED TOTAL % OF TOTAL U.S.
NON-RESIDENTIAL NON-RESIDENTIAL INITIAL FACILITIES BASED
MARKET ACCESS LINES(1) ACCESS LINES(2) SERVICE DATE(3)
- - - - - - - - - - ------ --------------- --------------- ------------------------
(IN 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
Washington, D.C. ........................ 871 1.8% March 1999
San Jose, CA............................. --(7) --(7) March 1999
Houston, TX.............................. 765 1.6% April 1999
Northern New Jersey...................... --(4) --(4) May 1999
San Diego, CA............................ 790 1.6% July 1999
Long Island, NY.......................... --(4) --(4) August 1999
Orange County, CA........................ --(6) --(6) September 1999
Baltimore, MD............................ 639 1.3% October 1999
Detroit, MI.............................. 821 1.7% November 1999
Denver, CO............................... 632 1.3% First Half 2000
St. Louis, MO............................ 449 0.9% First Half 2000
Seattle, WA.............................. 779 1.6% First Half 2000
Cleveland, OH............................ 654 1.3% First Half 2000
Miami, FL................................ 769 1.6% First Half 2000
Phoenix, AZ.............................. 466 1.0% Second Half 2000
Minneapolis, MN.......................... 562 1.1% Second Half 2000
Tampa, FL................................ 435 0.9% Second Half 2000
Pittsburgh, PA(8)........................ 512 1.0% 2001
Sacramento, CA(8)........................ 449 0.9% 2001
Portland, OR(8).......................... 408 0.8% 2001
Cincinnati, OH(8)........................ 381 0.8% 2001
Orlando, FL(8)........................... 367 0.7% 2001
Milwaukee, WI(8)......................... 355 0.7% 2001
Charlotte-Gastonia, NC(8)................ 327 0.7% 2001
Indianapolis, IN(8)...................... 292 0.6% 2001
San Antonio, TX(8)....................... 272 0.6% 2001
------ -----
Total.......................... 26,704 54.5%
====== =====
</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 expanded 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.
(8) Represents markets currently under evaluation for 2001. There can be no
assurance that we will actually initiate services in these markets; we may
select alternative markets. Under the terms of our new credit facilities, we
need to complete this offering to expand beyond our 30 target markets.
47
<PAGE> 51
In the majority of its targeted markets, Allegiance initially deploys
switches and collocates 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 does not initially deploy its own switch, but deploys
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. Given current traffic growth, Allegiance plans to deploy
additional switches in 2000 in the following existing Allegiance markets:
Northern New Jersey, Orange County and San Jose.
After the initial implementation activities are completed in a market,
Allegiance follows an ongoing 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.
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 market. As of December 31, 1999,
Allegiance had deployed 15 switches to serve nineteen markets. The switches are
located in: Dallas (two switches), New York City (two switches), Atlanta,
Baltimore, Boston, Chicago, Detroit, Houston, Los Angeles, Philadelphia, San
Diego, San Francisco and Washington, D.C. The Allegiance nationwide network is
controlled and monitored by a state of the art network operations control center
located in Dallas. Locally based switch engineers and technicians also manage
each switch.
Allegiance generally leases 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 is also 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 locates access equipment such as integrated digital loop
carriers and related equipment in each of the ILEC central offices in which it
is connected.
As each customer is signed up, service is provided by leasing unbundled
loops from the ILEC to connect Allegiance's integrated digital loop carriers
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 can be more cost-effective for
Allegiance to use leased ILEC or CLEC capacity in the 1.5 to 150 megabit range,
or 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 integrated digital loop carriers or other equipment in the customer's
building.
Although Allegiance initially leases its local network transmission
facilities from other carriers, Allegiance replaces leased capacity with its own
fiber optic facilities, such as dark fiber, 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. Allegiance
has already implemented this next phase by operating on fiber rings obtained
under long-term leases from Metropolitan Fiber Networks, Inc. in Dallas, Houston
and New York. On January 3, 2000, Allegiance announced that it had entered into
commitments to obtain similar fiber rings in 16 additional markets. These fiber
rings are expected to provide Allegiance with a reliable diverse connection to
most of its central office collocations throughout a market.
48
<PAGE> 52
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 California, Colorado, Florida, Georgia, Illinois, Maryland,
Massachusetts, Michigan, Missouri, New Jersey, New York, Pennsylvania, Texas,
Virginia, Washington, D.C., and Washington where Allegiance has obtained
certificates to provide local exchange and intrastate toll services. Allegiance
has similar applications pending in Arizona and Ohio.
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 United States
Supreme Court ruling, new entrants may adopt either all or portions of an
interconnection agreement already entered into by the ILEC and another carrier.
Such an approach is 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.
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 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.
Allegiance has entered into interconnection agreements with the ILECs in
each of the states in which its current geographic markets are located. In
Maryland, New Jersey, New York, Pennsylvania, Virginia and Washington, D.C.,
however, the original interconnection agreements have expired. Allegiance is
operating under the terms of these agreements while negotiating new
interconnection agreements.
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
49
<PAGE> 53
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 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.
50
<PAGE> 54
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 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. On November 5, 1999, the FCC
issued revised rules that largely reaffirmed, and in some respects expanded, the
duty of incumbent carriers to offer unbundled network elements. These rules may
be subject to further court appeals, and we cannot predict the outcome of such
proceedings. 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.
While these court and FCC 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.
On December 9, 1999, the FCC released an order requiring the incumbent
carriers to offer "line sharing" arrangements that will permit competitors like
Allegiance to offer DSL service over the same copper wires used by the incumbent
to provide voice service. The specific prices and terms of these arrangements
will be determined by future decisions of state utility commissions, and cannot
be predicted at this time. The FCC's ruling may also be challenged in court.
Allegiance expects, however, that this order, if implemented, will allow
Allegiance to offer DSL services at significantly lower cost than is now
possible.
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 permits 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.
The FCC recently granted approval to Bell Atlantic to provide in-region long
distance service in New York. In addition, SBC has announced its intention to
file a petition to offer such service in Texas. It is possible that other
regional Bell operating companies may petition and 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, other than
51
<PAGE> 55
Bell Atlantic in New York, 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 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 recently adopted 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. We estimate that our
contribution liability for 1999 will be immaterial. 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 federal regulators do not
effectively monitor this increased pricing flexibility, 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 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
52
<PAGE> 56
a material adverse effect on Allegiance's ability to compete in providing
interstate access services. Several parties appealed the May 16th order.
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 30 state commissions and several federal
and state courts have ruled that reciprocal compensation arrangements do apply
to calls to Internet service providers, while four jurisdictions have 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.
On February 26, 1999, the FCC released a Declaratory Ruling determining
that Internet service provider traffic is interstate for jurisdictional
purposes, but that its current rules neither require nor prohibit the payment of
reciprocal compensation for such calls. In the absence of a federal rule, the
FCC determined that state commissions have authority to interpret and enforce
the reciprocal compensation provisions of existing interconnection agreements,
and to determine the appropriate treatment of Internet service provider traffic
in arbitrating new agreements. The FCC also requested comment on alternative
federal rules to govern compensation for such calls in the future. In response
to the FCC ruling, some regional Bell operating companies have asked state
commissions to reopen previous decisions requiring the payment of reciprocal
compensation on Internet service provider calls. Some Bell companies have also
appealed the FCC's Declaratory Ruling to the United States Court of Appeals for
the District of Columbia Circuit, which recently heard oral arguments and is
expected to render a decision in the next several months.
Internet service providers are among Allegiance's target customers, and
adverse decisions in state proceedings could limit its ability to service this
group of customers profitably. 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 "Risk
Factors -- We Could Lose Revenue if Calls to Internet Service Providers Are
Treated As Long Distance Interstate Calls".
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 pro-competitive measures. Because the implementation of the
Telecommunications Act is subject to numerous state 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.
53
<PAGE> 57
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. If 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 are 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
depends 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 materially 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 that one of the objectives of the regional Bell operating companies is
to be able to offer long distance service in their 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
2000. On December 23, 1999, Bell Atlantic was granted permission by the FCC to
provide in region long distance service in New York. 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.
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.
54
<PAGE> 58
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 access services, the FCC recently adopted 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 such as AT&T, MCI WorldCom and
Sprint seeking to enter, reenter or expand entry into the local exchange market
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, merged with MCI and has agreed to merge
with Sprint. AT&T acquired Teleport Communications Group Inc., a CLEC, and
TeleCommunications, Inc., a cable, telecommunications and high-speed Internet
services provider. Ameritech Corporation has merged with SBC Communications.
Bell Atlantic has agreed to merge with GTE Corporation. These types of
consolidations and strategic alliances could put Allegiance at a competitive
disadvantage.
The Telecommunications Act includes provisions that 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 many existing competitive access providers and CLECs initially entered
the market providing dedicated access in the pre-1996 era, these companies had
to build a fiber infrastructure before offering services. Most competitive
access providers and CLECs added switches 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
and CLECs are 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 do not have to replicate existing facilities and
can be more opportunistic in designing and implementing networks.
A number of CLECs have entered or announced their intention to enter into
one or more of the same markets as Allegiance. Allegiance believes that not all
CLECs however, are pursuing the same target customers as Allegiance.
Demographically, business customers are commonly
55
<PAGE> 59
divided into three segments: small, medium and large. Targeted cities are
commonly 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 and selected "Tier 2" markets. To help
distinguish it 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:
- keep the regional Bell operating companies out of in-region long distance
as long as possible; and
- develop facilities-based and unbundled local service, an approach already
being pursued by MCI WorldCom with the acquisition of MFS Communications,
and by AT&T with its acquisitions of Teleport Communications and
TeleCommunications, Inc.
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. The FCC has recently granted approval to Bell
Atlantic to provide in-region long distance service in New York and other
regional Bell operating companies may petition and be granted such approval in
the future.
Data/Internet Service Providers. The Internet services market is highly
competitive and there are limited barriers to entry. Allegiance expects that
competition will continue to intensify. Allegiance's competitors in this market
will include Internet service providers, other telecommunications companies,
online service providers and Internet software providers. Most of the regional
Bell operating companies and GTE Corporation operating units have announced
plans to rapidly roll out DSL services. Some of these entities, including SBC,
US West and Bell Atlantic, have already commenced deployment of DSL services in
selected markets and may in the future deploy DSL services on a widespread
basis. Many of these competitors have greater financial, technological and
marketing resources than those available to Allegiance.
Competition from International Telecommunications Providers. Under the
recent World Trade Organization agreement on basic telecommunications services,
the United States and 72 other members of the World Trade Organization 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 of January 1998. Although Allegiance believes that this 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 this
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 World Trade
Organization agreement will not have a material adverse effect on Allegiance's
business, financial
56
<PAGE> 60
condition and results of operations or that members of the World Trade
Organization will implement the terms of this agreement.
EMPLOYEES
As of December 31, 1999, Allegiance had approximately 1,650 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 is currently represented by a collective
bargaining agreement. Allegiance believes that it enjoys good relationships with
its employees.
LEGAL PROCEEDINGS
Allegiance is not party to any 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.
57
<PAGE> 61
FACILITIES
Allegiance is headquartered in Dallas, Texas and leases offices and space
in each of its markets, primarily for sales offices and switch and other network
equipment installations. Allegiance has two leases of approximately 90,000
square feet and 77,000 square feet for its Dallas headquarters, with such leases
expiring February 2008 and June 2003, respectively. Allegiance's other leases
expire in years ranging from 2001 to 2010.
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.
58
<PAGE> 62
MANAGEMENT AND DIRECTORS
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, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
- - - - - - - - - - ---- --- -----------
<S> <C> <C>
Royce J. Holland...................... 51 Chairman of the Board and Chief
Executive Officer
C. Daniel Yost........................ 51 President and Chief Operating Officer
and Director
Thomas M. Lord........................ 43 Executive Vice President of Corporate
Development, Chief Financial Officer
and Director
Dana A. Crowne........................ 39 Senior Vice President and Chief
Technology Officer
Stephen N. Holland.................... 48 Senior Vice President of Research
Patricia E. Koide..................... 51 Senior Vice President of Human
Resources, Real Estate, Facilities
and Administration
Gregg A. Long......................... 46 Senior Vice President of Quality and
Audit
G. Clay Myers......................... 39 Senior Vice President, Finance and
Accounting
Anthony J. Parella.................... 40 Senior Vice President of Field Sales
and Customer Care and Director
Jerrold Sklar......................... 40 Senior Vice President of Operational
Support Systems and Customer
Implementation
Mark B. Tresnowski.................... 40 Senior Vice President, General Counsel
and Secretary
Paul D. Carbery....................... 38 Director
James E. Crawford, III................ 54 Director
John B. Ehrenkranz.................... 34 Director
Paul J. Finnegan...................... 46 Director
Richard D. Frisbie.................... 50 Director
Alan E. Goldberg...................... 45 Director
Reed E. Hundt......................... 51 Director
James N. Perry, Jr. .................. 39 Director
Dino Vendetti......................... 37 Director
</TABLE>
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. In December
1998, Mr. Holland was named Chairman of the Association for Local
Telecommunications Services, the industry trade organization for the competitive
local telephone sector. In November 1999, Mr. Holland was appointed by Texas
Governor George W. Bush to the Texas (Electronic) E-Government Task Force. Mr.
Holland also presently serves on the board of directors of CSG Systems, a
publicly
59
<PAGE> 63
held billing services company. Mr. Holland's brother, Stephen N. Holland, is
employed as Allegiance's Senior Vice President of Research.
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.
Dana A. Crowne, Allegiance's Senior Vice President and Chief Technology
Officer, joined Allegiance in August 1997 as its Senior Vice President and Chief
Engineer. 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, Allegiance's Senior Vice President of Research, joined
Allegiance in September 1997 as its Senior Vice President and Chief Information
Officer. 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.
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, Allegiance's Senior Vice President of Quality and Audit,
joined Allegiance in September 1997 as its Senior Vice President of Regulatory
and Development. Mr. Long spent
60
<PAGE> 64
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.
G. Clay Myers joined Allegiance as its Senior Vice President, Finance and
Accounting in December 1999. Prior to joining Allegiance, Mr. Myers was the Vice
President, Finance, Chief Financial Officer and Treasurer of PageMart Wireless,
Inc. Prior to joining PageMart, Mr. Myers was Senior Operations Manager for Dell
Computer Corporation from 1991 to 1993 and was with Ernst & Young, LLP from 1982
to 1991. Mr. Myers is a certified public accountant.
Anthony J. Parella, who joined Allegiance as its Regional Vice
President -- Central Division in August 1997, became its National Vice President
of Field Sales in August 1998 and became its Senior Vice President of Field
Sales and Customer Care in October 1999, has more than 10 years of experience in
the telecommunications industry. Mr. Parella became a member of the board of
directors in December 1999. 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.
Jerrold Sklar, Allegiance's Senior Vice President of Operation Support
Systems and Customer Implementation, joined Allegiance in January of 1998 as its
Vice President of Marketing, and has more than 17 years of experience in the
telecommunications industry. Prior to joining Allegiance, Mr. Sklar served as
Director of Strategic Sales and Director of Field Support for the Managed
Services Division of Octel Communications Corporation (now Lucent Technologies)
from October 1992 to December 1997. Prior to that time, Mr. Sklar managed the
OEM sales channel for VMX, Inc. from October 1989 to October 1992. Additionally
Mr. Sklar held various Sales and Sales Management positions with long distance
carrier, Sprint from July 1982 to September 1989.
Mark B. Tresnowski became Allegiance's Senior Vice President and General
Counsel in February 1999. Mr. Tresnowski has been Allegiance's Secretary since
September 1997. 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.
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
publicly traded CLEC that competes 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.
John B. Ehrenkranz, who was elected to Allegiance's board of directors in
March 1998, is a Managing Director 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
61
<PAGE> 65
held CLEC that may compete with Allegiance. Mr. Ehrenkranz is also a Managing
Director of Morgan Stanley Dean Witter Capital Partners.
Paul J. Finnegan, who was elected to Allegiance's board of directors in
August 1997, is a managing director 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 board of directors of Focal Communications Corporation, a publicly
traded CLEC that competes with Allegiance in certain markets.
Richard D. Frisbie, who was elected to Allegiance's board of directors in
August 1997, is a Managing Partner of Battery Partners IV, LLC which is the
general partner of Battery Venture IV, 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
Communications Corporation, a publicly traded CLEC that competes with Allegiance
in certain markets.
Alan E. Goldberg was elected to Allegiance's board of directors in March
1999. Mr. Goldberg has been Chairman, CEO and Director of Morgan Stanley Dean
Witter Capital Partners since February 1998. Prior to that time, he was co-head
of MSDW Capital Partners. He has been a Managing Director of Morgan Stanley &
Co. Incorporated since January 1988. Mr. Goldberg also serves as a director of
Catalytica, Inc., Smurfit-Stone Container Corporation, Equant, N.V., a provider
of international data network services, and several private companies.
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 Novell, Inc., a
publicly traded network software and Internet solutions provider, NorthPoint
Communications Group, Inc., a publicly traded CLEC that competes with Allegiance
in certain markets and Phone.Com, Inc., a publicly traded software provider for
wireless telephones. Prior to joining the FCC, Mr. Hundt was a partner at Latham
& Watkins, an international law firm.
James N. Perry, Jr., who was elected to Allegiance's board of directors in
August 1997, is a managing director 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 publicly
traded CLEC that competes with Allegiance in certain markets, as well as
Omnipoint Corporation, a publicly traded PCS provider, and Clearnet
Communications, a Canadian publicly traded PCS and enhanced specialized mobile
radio company.
Dino J. Vendetti was appointed to Allegiance's board of directors in
October 1999. Mr. Vendetti has managed investments in the telecommunications,
cable and data networking industries for Vulcan Ventures Incorporated since May
1998. From August 1997 until joining Vulcan Ventures, Mr. Vendetti was Vice
President and Research Analyst at Dain Rauscher covering the telecommunications
industry. From July 1996 to April 1997, Mr. Vendetti was Vice President of
Product Management at Metawave Communications Corporation. From October 1994 to
July 1996, Mr. Vendetti served as Director of Business Development and Product
Management for Qualcomm, Inc., where he was responsible for the global
infrastructure product line. Mr. Vendetti also presently serves on the board of
directors of NorthPoint Communications Group, Inc., a publicly traded CLEC that
competes with Allegiance in certain markets.
62
<PAGE> 66
ELECTION OF DIRECTORS; VOTING AGREEMENT
Allegiance's by-laws provide that the number of directors shall be
determined by resolution of the board of directors. The board currently consists
of 12 directors. Allegiance's by-laws provide that its directors will be elected
by plurality vote of Allegiance's stockholders, without cumulative voting. No
director may be removed from office without cause and without the vote of the
holders of a majority of the outstanding voting stock.
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. Lord, Yost,
Crawford, Frisbie and Vendetti are in the class of directors whose term expires
at the 2000 annual meeting of Allegiance's stockholders. Messrs. Holland, Hundt,
Perry and Goldberg are in the class of directors whose term expires at the 2001
annual meeting of Allegiance's stockholders. Messrs. Parella, Finnegan, Carbery
and Ehrenkranz are in the class of directors whose term expires at the 2002
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 Dean Witter Capital Partners,
and Frontenac Company each have the right to designate two directors; Battery
Ventures has the right to designate one director; the number of director(s) each
fund shall be entitled to designate will decrease as such fund's percentage
ownership of common stock decreases. In addition, Allegiance's Chief Executive
Officer has the right to serve as a director; our original management investors
have the right to designate three additional directors; and the final two
directorships may be filled by representatives designated by the fund investors
and acceptable to the management investors.
In connection with the purchase by Vulcan Ventures of an aggregate of four
million shares of Allegiance common stock in September and November 1999,
Allegiance agreed to use its best efforts to cause two designees nominated by
Vulcan Ventures to be appointed to the Board, so long as Vulcan Ventures
continues to hold at least four million shares (in each case as adjusted for
stock dividends, stock splits and other recapitalizations) of such stock. This
right to designate director nominees is not assignable by Vulcan Ventures.
COMMITTEES OF THE BOARD OF DIRECTORS
The board of directors currently has three committees:
- an Executive Committee;
- an Audit Committee; and
- a Compensation Committee.
The Executive Committee is currently comprised of Messrs. Holland,
Crawford, Goldberg, Perry and Vendetti. 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 and year 2000 issues.
The Compensation Committee is currently comprised of Messrs. Frisbie,
Crawford, Goldberg, Perry and Vendetti. The Compensation Committee is
responsible for reviewing, and as it deems
63
<PAGE> 67
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 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.
In December 1999, the Compensation Committee issued to each of Reed Hundt
and Dino Vendetti, stock options to purchase 25,000 shares of Allegiance common
stock at an exercise price of $75.00 per share. One-third of such options vest
on the first anniversary of the grant date, with 8.34% vesting every three
months thereafter. Other than these stock options issued to Mr. Hundt and Mr.
Vendetti, 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.
64
<PAGE> 68
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth the beneficial ownership of Allegiance's
common stock at December 28, 1999, by:
- each of the directors and the named executive officers of Allegiance;
- all directors and executive officers as a group;
- each selling stockholder; and
- each owner of more than 5% of the equity securities of Allegiance.
The percentages specified below are based on 64,947,706 shares of common
stock outstanding as of December 28, 1999 and on 70,947,706 shares of common
stock outstanding after the offering. Unless otherwise noted, the address for
each director and executive officer of Allegiance is c/o Allegiance Telecom,
Inc., 1950 N. Stemmons Freeway, Suite 3026, Dallas, Texas 75207.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO SHARES BENEFICIALLY
OFFERING OWNED AFTER OFFERING
----------------------- ----------------------
PERCENT OF SHARES TO BE PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER NUMBER CLASS SOLD IN OFFERING NUMBER CLASS
- - - - - - - - - - ------------------------------------ ------ ---------- ---------------- ------ ----------
<S> <C> <C> <C> <C> <C>
DIRECTORS AND EXECUTIVE OFFICERS:
Royce J. Holland(1)............................. 3,908,223 6.0% -- 3,908,223 5.5%
C. Daniel Yost.................................. 1,457,946 2.2% -- 1,457,946 2.1%
Thomas M. Lord(2)............................... 1,612,189 2.5% -- 1,612,189 2.3%
Anthony J. Parella(3)........................... 300,239 * -- 300,239 *
Mark B. Tresnowski(4)........................... 113,065 * -- 113,065 *
Paul D. Carbery(5).............................. 1,828,923 2.8% (7)
James E. Crawford, III(5)(6).................... 1,832,180 2.8% (7)
John B. Ehrenkranz(8)........................... -- -- -- -- --
Paul J. Finnegan(9)............................. -- -- -- -- --
Richard D. Frisbie(10).......................... 1,580,891 2.4% (11)
Alan E. Goldberg(12)............................ -- -- -- -- --
Reed E. Hundt(13)............................... 39,840 * -- 39,840 *
James N. Perry, Jr.(9).......................... -- -- -- -- --
Dino Vendetti(14)............................... 1,500 * -- 1,500 *
All directors and executive officers as a group
(13 persons).................................. 10,853,167 16.7% (7)(11)
SELLING STOCKHOLDERS:
Madison Dearborn Capital Partners(15)........... 6,157,612 9.5%
Morgan Stanley Dean Witter Capital
Partners(16).................................. 10,302,247 15.9%
Frontenac Company(17)........................... 1,821,829 2.8%
Battery Ventures(18)............................ 1,580,891 2.4%
OTHER 5% OWNERS:
Vulcan Ventures Incorporated.................... 4,000,000 6.2% -- 4,000,000 5.6%
Jennison Associates LLC(19)..................... 4,552,500 7.0% -- 4,552,500 6.4%
Putnam Investments, Inc.(20).................... 6,244,250 9.6% -- 6,244,250 8.8%
</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.
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 80% of
such shares of common stock having vested and an additional 20% vesting on
August 13, 2000.
65
<PAGE> 69
(2) Includes 806,095 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 80% of such shares of common stock having vested and an
additional 20% vesting on August 13, 2000.
(3) Mr. Parella owns 300,239 shares of common stock. In addition, Mr. Parella
has options to acquire an additional 200,000 shares of common stock at an
exercise price per share of $52.625, with one-third vesting on October 1,
2000, and 2.78% vesting each month thereafter.
(4) Includes options to acquire 110,000 shares of common stock on or after
February 1, 2000, at an exercise price per share of $1.00. In addition, Mr.
Tresnowski has options to acquire an additional 220,000 shares of common
stock at an exercise price per share of $1.00, with 2.78% vesting each
month after February 1, 2000.
(5) 1,821,829 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.
(6) Includes 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 700
shares Mr. Crawford disclaims beneficial ownership.
(7) Represents shares being sold by the Frontenac funds. Neither Mr. Carbery
nor Mr. Crawford are selling any shares in their individual capacity.
(8) Mr. Ehrenkranz is a Managing Director of Morgan Stanley Dean Witter Capital
Partners, the managing member of the general partner of the funds described
in footnote (16) below and their address is c/o Morgan Stanley Dean Witter
Capital Partners, 1221 Avenue of the Americas, New York, NY 10020.
(9) 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.
(10) All shares of common stock shown are owned by Battery Ventures IV, L.P. and
Battery Investment Partners IV, LLC. Mr. Frisbie is a member manager of
Battery Partners IV, LLC, the general partner of Battery Ventures IV, L.P.
and a member manager of Battery Investment Partners IV, LLC and his address
is c/o Battery Ventures, 20 William Street, Wellesley, MA 02181. He
disclaims beneficial ownership of these shares of common stock.
(11) Represents shares being sold by the Battery Ventures funds. Mr. Frisbie is
not selling any shares in his individual capacity.
(12) Mr. Goldberg is Chairman, CEO and Director of Morgan Stanley Dean Witter
Capital Partners, the managing member of the general partner of the funds
described in footnote (16) below and their address is c/o Morgan Stanley
Dean Witter Capital Partners, 1221 Avenue of the Americas, New York, NY
10020.
(13) In March 1998, Mr. Hundt was issued options to acquire 50,623 shares of
common stock, with an exercise price per share of $2.47. 58.33% of such
options are currently vested, and an additional 8.34% of such options will
vest on each of March 13, 2000, June 13, 2000, September 13, 2000, December
13, 2000 and March 13, 2001, when all such options become exercisable. In
December 1999, Mr. Hundt was issued options to acquire 25,000 shares of
common stock, at an exercise price per share of $75.00. One-third of these
options vest on December 8, 2000, with 8.34% vesting every three months
thereafter. Mr. Hundt owns 10,312 shares of common stock.
(14) In December 1999, Mr. Vendetti was issued options to acquire 25,000 shares
of common stock, at an exercise price per share of $75.00. One-third of
these options vest on December 8, 2000, with 8.34% vesting every three
months thereafter.
(15) These shares of common stock are owned by Madison Dearborn Capital Partners
II, L.P.
(16) 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.
(17) These shares of common stock are owned by Frontenac VII Limited Partnership
and Frontenac Masters VII Limited Partnership.
(18) These shares of common stock are owned by Battery Ventures IV, L.P. and
Battery Investment Partners IV, LLC.
(19) Of these shares, Jennison Associates LLC, a registered investment adviser
("Jennison"), has shared voting power as to 4,552,500 shares and sole
voting power as to 4,329,700 shares. Jennison is a wholly-owned subsidiary
of The Prudential Insurance Company of America. Jennison's address is 466
Lexington Avenue, New York, New York 10017. Information is as of May 6,
1999 and is derived from SEC filings.
(20) Of these shares, Putnam Investments, Inc., a registered investment adviser
("Putnam"), has shared voting power as to 198,546 shares and no voting
power as to 6,045,704 shares. Putnam is a wholly-owned subsidiary of
American Express Company. Putnam's address is One Post Office Square,
Boston, Massachusetts 02109. Information is as of July 8, 1999 and is
derived from SEC filings.
66
<PAGE> 70
DESCRIPTION OF CERTAIN INDEBTEDNESS
11 3/4% NOTES
On February 3, 1998, 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 cash 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 described below. 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% of their accreted
value on the redemption date. We may make this redemption only so long as at
least $289.3 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.
Events of default under the 11 3/4% notes indenture include, among other
things:
- payment defaults;
- covenant defaults;
- cross-defaults to certain other indebtedness;
- judgment defaults; and
- certain events of bankruptcy and insolvency.
67
<PAGE> 71
12 7/8% NOTES
On July 7, 1998, we issued $205.0 million aggregate principal amount at
maturity of 12 7/8% Senior Notes. They will mature on May 15, 2008.
Interest on the 12 7/8% notes accrues at the rate of 12 7/8% per annum,
payable semiannually on May 15 and November 15 of each year. Payment of interest
will be made to holders of record at the close of business on the May 1 or
November 1 immediately preceding the interest payment date.
In connection with the sale of the 12 7/8% notes, we purchased
approximately $69.0 million of U.S. Government 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.
The 12 7/8% notes are not secured by any of our assets other than the
pledge of the U.S. Government securities described above, and rank equally in
right of payment with all of our unsubordinated and unsecured indebtedness,
including the 11 3/4% notes described above. The 12 7/8% notes are senior in
right of payment to all of our future subordinated indebtedness.
We may redeem the 12 7/8% notes at our option, in whole or in part, at any
time on or after May 15, 2003. The initial redemption price is 106.438% 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 May 15, 2006. In addition, at any time on or
before May 15, 2001, we may redeem up to 35% of the aggregate principal amount
at maturity of the 12 7/8% notes with the proceeds of certain public equity
offerings at a redemption price equal to 112.875% of the principal amount plus
accrued interest. We may make this redemption only so long as at least $133.25
million aggregate principal amount at maturity of the 12 7/8% notes remains
outstanding immediately after such redemption.
The 12 7/8% notes indenture contains certain restrictive covenants and
events of default that are substantially similar to those contained in the
11 3/4% indenture.
EXISTING REVOLVING CREDIT FACILITY
On April 1, 1999, we entered into a credit agreement and related guaranty
agreement with Goldman Sachs Credit Partners L.P., TD Securities (USA) Inc.,
Morgan Stanley Senior Funding, Inc. and various other lenders that provides for
a $225 million senior secured revolving credit facility maturing December 31,
2005 for a subsidiary of Allegiance Telecom, Inc. This revolving facility is
available, subject to satisfaction of certain terms and conditions, to provide
purchase money financing for the acquisition, construction and improvement of
telecommunications assets by Allegiance's operating subsidiaries. Allegiance
intends to replace this facility with the one described below under "-- New
Credit Facilities". The following is a summary of material terms of the existing
revolving credit facility.
The borrower under the facility is Allegiance Finance Company, Inc., a
wholly owned subsidiary of Allegiance Telecom, Inc. that will own Allegiance's
operating subsidiaries. The facility is structurally senior to all of
Allegiance's 12 7/8% notes and 11 3/4% notes issued in 1998. The facility is
secured by substantially all of Allegiance's subsidiaries' assets and a pledge
of the stock of Allegiance Finance Company. The facility is guaranteed by
Allegiance Telecom, Inc. Interest rates under the facility are tied to the level
of debt compared to consolidated EBITDA and are initially expected to be the
London Interbank Offered Rate + 3.75%. The 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.
Allegiance's ability to borrow under the facility is dependent upon and
fluctuates according to Allegiance's ability to meet the financial covenants and
the ability of Allegiance's geographic markets to generate cash. Allegiance may
borrow under the facility at such time as Allegiance
68
<PAGE> 72
has invested a minimum of $250 million in the operations of the borrower and/or
its subsidiaries, and certifies that, in at least one market which operates as
an independent business unit, Allegiance has achieved positive earnings before
deducting interest, taxes, depreciation and amortization and before deducting
overhead charges and other non-cash items. The facility refers to this
measurement as "pre-overhead EBITDA". Allegiance must also certify that it
projects such market to remain pre-overhead EBITDA positive through the maturity
of the facility. The actual amount available under the initial availability test
is equal to one-third of the total amount of the facility, plus three times the
annualized pre-overhead EBITDA for such market. Thus, for example, if the
Allegiance Dallas market operations turn pre-overhead EBITDA positive for one
month and Allegiance projects that this market will remain positive through the
maturity of the facility on December 31, 2005, the initial availability under
the facility will be equal to one third of the total amount of the facility plus
three times the annualized pre-overhead EBITDA for the Dallas market. The
one-month results are annualized by multiplying these results by twelve.
Allegiance would not be able to borrow if the market fails to remain
pre-overhead EBITDA positive and is required to repay loans at such time in an
amount equal to the availability created by such market.
The availability derived from any single pre-overhead EBITDA positive
market, however, will not exceed $100 million.
The amount available will increase when two or more markets generate
positive pre-overhead EBITDA for a given month. This incremental availability
will equal three times the annualized pre-overhead EBITDA generated by each
market other than the first market.
The availability test also serves as a financial covenant, and Allegiance
is required to maintain levels of pre-overhead EBITDA from individual markets
that would support amounts outstanding under the facility. The commitments of
the lenders under the facility will reduce in twelve consecutive quarterly
installments, beginning on March 31, 2003, in annual amounts equal to the
following respective percentages of the initial amount of the facility:
<TABLE>
<CAPTION>
FACILITY
YEAR REDUCTION
- - - - - - - - - - ---- ---------
<S> <C>
2003.................................................... 20%
2004.................................................... 30%
2005.................................................... 50%
</TABLE>
A comprehensive covenant package as well as the availability tests described
above governs the facility. From April 1, 1999 through June 30, 2001, referred
to as Stage 1, Allegiance's performance will be tested by one set of covenants.
Another set of covenants will take effect July 1, 2001, referred to as Stage 2.
Allegiance must be in compliance with each covenant in order to borrow under the
facility and a failure to satisfy any of the covenants would enable the
69
<PAGE> 73
lender to declare outstanding amounts to be due and payable. The Stage 1 and
Stage 2 covenants include:
<TABLE>
<CAPTION>
STAGE 1 COVENANTS STAGE 2 COVENANTS
----------------- -----------------
<S> <C>
- - - - - - - - - - - Minimum Revenues - Senior Secured Debt to Annualized
Consolidated EBITDA
- - - - - - - - - - - Maximum Consolidated EBITDA Loss/ Minimum - Total Debt to Annualized Consolidated
Consolidated EBITDA EBITDA
- - - - - - - - - - - Senior Secured Debt to Total Capitalization - Annualized Consolidated EBITDA/Interest
Expense
- - - - - - - - - - - Maximum Unsecured Subordinated Debt - Annualized Pro Forma Consolidated
EBITDA/Pro Forma Debt Service
- - - - - - - - - - - Maximum Capital Expenditures - Maximum Capital Expenditures
</TABLE>
Allegiance has flexibility under the facility to make unlimited
acquisitions using equity consideration, including proceeds of equity issuances,
or if financed with indebtedness, acquisitions totaling up to $75 million. There
is an additional $25 million sub-limit with respect to acquisitions of entities
generating negative free cash flow for the trailing twelve-month period,
stepping up to $45 million at such time as the borrower generates positive
pre-overhead EBITDA in two or more markets, all of which limits are subject to
increase as additional equity is raised and contributed as common equity to the
borrower and its subsidiaries.
In addition, the borrower is subject to limitations, to be determined, with
respect to investments in more than 24 initial markets. The borrower is
permitted to make distributions to Allegiance Telecom, Inc. to enable the
payment of interest and principal on the existing indebtedness of Allegiance
Telecom, Inc.
The facility is also subject to certain representations, warranties,
covenants and events of default customary for credits of this nature and
otherwise agreed upon by the parties.
NEW CREDIT FACILITIES
We propose to replace the existing revolving credit facility with new
credit facilities in the aggregate amount of $500 million. We have obtained
commitments from Goldman Sachs Credit Partners L.P., Toronto Dominion (Texas),
Inc., BankBoston, N.A., Morgan Stanley Senior Funding, Inc. and various other
banks for the full amount of the new credit facilities. The new credit
facilities are subject to conditions customary for closing a transaction of this
type, including completion of definitive documentation and finalization of all
terms and conditions. We expect to close these facilities in February 2000. The
closing is not contingent on the completion of this offering.
The new credit facilities will consist of a $350 million revolving credit
facility and a $150 million delayed draw term loan facility, $100 million of
which must be drawn within 12 months of closing and the remaining $50 million of
which must be drawn within 18 months of closing. These facilities will mature on
December 31, 2006. The borrower under the new credit facilities will be
Allegiance Finance Company, Inc., a wholly-owned subsidiary of Allegiance
Telecom, Inc. The lenders will be secured by a first priority security interest
in substantially all of the assets of Allegiance's subsidiaries, including the
capital stock and assets of the borrower and all of its subsidiaries. Drawn
pricing on the new credit facilities will be tied to leverage and is initially
expected to be LIBOR + 3.25%. The commitment fee on the undrawn portion is
expected to be 1.50% initially, with step-downs based on utilization.
Allegiance will have the right, on or prior to the maturity date of the new
credit facilities, to establish a new tranche or to increase the amount of one
or more of the new credit facilities by
70
<PAGE> 74
requesting additional commitments from the lenders and/or by obtaining
commitments from new lenders. This incremental facility will be limited in size
to no more than $200 million and will be made available only upon the
satisfaction of the following conditions precedent: (i) the weighted average
life and final maturity of the incremental facility will be no shorter than the
weighted average life and final maturity of the other credit facilities, (ii)
the borrower will have received at least $300 million in gross proceeds from one
or more offerings of Allegiance common stock after January 1, 2000 and (iii)
immediately prior to and after giving effect to the incurrence of the
incremental facility, the Allegiance credit parties must be in full compliance
with the terms of the loan documents.
Commitments under this revolving credit facility and term loan facility
will amortize in 12 consecutive quarterly installments, commencing on March 31,
2004, in annual amounts equal to the following respective percentages of the
initial amount of each applicable facility:
<TABLE>
<CAPTION>
REDUCTION/
YEAR AMORTIZATION
- - - - - - - - - - ---- ------------
<S> <C>
2004................................................. 20%
2005................................................. 30%
2006................................................. 50%
</TABLE>
The new credit facilities will be supported by upstream secured guarantees
from all current and future subsidiaries, and a downstream secured guaranty from
Allegiance.
The new credit facilities will be governed by a comprehensive covenant
package. During the initial build-out phase from closing through December 31,
2002, Allegiance's performance will be measured against Stage 1 covenants. So
long as no loans have been made under the new credit facilities there shall be
no event of default even if Allegiance and its subsidiaries are not in
compliance therewith. However, no loans will be made if Allegiance and its
subsidiaries are not in compliance with such financial covenants. Stage 2
covenants will take effect on January 1, 2003. The Stage 1 and Stage 2 covenants
will include:
<TABLE>
<CAPTION>
STAGE 1 COVENANTS STAGE 2 COVENANTS
----------------- -----------------
<S> <C>
- - - - - - - - - - - Minimum Revenues - Senior Secured Debt to Annualized
Consolidated EBITDA
- - - - - - - - - - - Maximum Senior Secured Debt to Annualized - Total Debt to Annualized Consolidated
Adjusted EBITDA EBITDA
- - - - - - - - - - - Senior Secured Debt to Total Capitalization - Annualized Consolidated EBITDA/Interest
Expense
- - - - - - - - - - - Total Debt to Total Capitalization - Pro Forma Debt Service Coverage
- - - - - - - - - - - Maximum Capital Expenditures - Maximum Capital Expenditures
</TABLE>
Allegiance will have flexibility under the new credit facilities to make
unlimited acquisitions using equity consideration, including proceeds of equity
issuances, or if financed with indebtedness, acquisitions totaling up to $300
million in aggregate of entities generating positive consolidated EBITDA for the
trailing twelve-month period. There shall be an additional $150 million
sub-limit with respect to acquisitions of entities generating negative
consolidated EBITDA for the trailing twelve-month period. If the borrower does
not receive gross proceeds in excess of $300 million from the public issuance of
Allegiance common stock after January 1, 2000, however, such amounts financed
with indebtedness shall be limited to $100 million and $50 million,
respectively.
71
<PAGE> 75
Allegiance is limited to expanding into no more than 36 target markets
without obtaining consent under the new credit facilities. The failure to raise
more than $300 million in additional equity capital will also limit Allegiance's
ability to invest in more than 30 markets.
The borrower will be permitted to make distributions to Allegiance to
enable the payment of interest and principal on existing indebtedness.
72
<PAGE> 76
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. As of December 28, 1999,
64,947,706 shares of common stock were issued and outstanding and no shares of
preferred stock were 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 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 and Directors". 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
73
<PAGE> 77
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.
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
74
<PAGE> 78
- 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 has entered
into indemnification agreements with its current directors and anticipates
entering into such agreements with its executive officers and any new directors
or executive officers.
WARRANTS
In connection with the offering of our 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 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 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.
REGISTRATION RIGHTS
The fund investors, the management investors, Vulcan Ventures and
Allegiance are parties to an Amended and Restated Registration Agreement dated
as of September 13, 1999. Each of Morgan Stanley Dean Witter Capital Partners,
Madison Dearborn Capital Partners, and Frontenac Company is entitled to demand
two long-form registrations and unlimited short-form registrations, and each of
Vulcan Ventures and Battery Ventures is entitled to demand one long-form
registration, such as registration on Form S-1, and unlimited short-form
registrations, such as registration on Form S-3. In addition, the fund
investors, the management investors and Vulcan Ventures may "piggyback" on
primary or secondary registered public offerings of Allegiance's securities.
Allegiance has agreed to pay the registration expenses in connection with these
demand and "piggyback" registrations. Each investor is subject to holdback
restrictions in the event of a public offering of Allegiance securities. Vulcan
Ventures, the management investors and the fund investors who are not selling
stockholders in this offering have waived their piggyback rights in connection
with this offering.
75
<PAGE> 79
Allegiance, Morgan Stanley & Co. Incorporated, Salomon Brothers Inc, Bear,
Stearns & Co. Inc. and Donaldson Lufkin & Jenrette Securities Corporation are
parties to a Warrant Registration Rights Agreement dated as of February 3, 1998.
Allegiance has filed a shelf registration statement with respect to the issuance
of the common stock issuable upon exercise of the redeemable warrants; such
shelf registration statement was declared effective by the SEC on March 31,
1999. Allegiance is required to maintain the effectiveness of such registration
statement until all redeemable warrants have expired or been exercised.
Allegiance is required to pay the expenses associated with such registration.
SHARES ELIGIBLE FOR FUTURE SALE
After this offering, we will have 70,947,706 shares of common stock
outstanding, excluding 13,268,581 shares reserved for issuance under our stock
plans and 275,580 shares reserved for issuance upon the exercise of outstanding
warrants. All of the shares of common stock sold in this offering will be freely
tradeable under the Securities Act, unless held by our "affiliates," as that
term is defined by the SEC. In addition, approximately 11.7 million shares of
our common stock have been issued in transactions that were not registered with
the SEC and, thus, are "restricted securities," as that term is defined by the
SEC. Upon the expiration of the lock-up agreements between Allegiance, certain
stockholders, including the selling stockholders, management and the
underwriters, these shares of common stock will become eligible for sale,
subject to compliance with Rule 144 of the Securities Act as described below.
In general, under Rule 144 as currently in effect, a stockholder who has
beneficially owned restricted securities for at least one year, can sell in any
three-month period a number of shares that does not exceed the greater of:
- 1% of the number of shares of common stock then outstanding, or
- the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks immediately preceding the
date on which such sale is made.
Sales under Rule 144 are subject to certain requirements relating to manner
of sale, notice and availability of current public information about Allegiance.
A stockholder who is not deemed to have been an affiliate at any time during the
90 days immediately preceding the sale and who has beneficially owned restricted
securities for at least two years is entitled to sell such shares under Rule
144(k) without regard to the limitations and requirements described above.
Allegiance, its directors and certain of its officers and certain
stockholders, including the selling stockholders, have agreed with the
underwriters that, for a period of 90 days after the date of this prospectus,
they will not directly or indirectly, offer, pledge, sell, contract to sell,
sell any option or contract to purchase or otherwise dispose of any common stock
or any securities convertible into or exercisable or exchangeable for common
stock, or in any manner transfer all or a portion of the economic consequences
associated with the ownership of the common stock, or cause a registration
statement covering any shares of common stock to be filed, without the prior
written consent of Goldman, Sachs & Co., Salomon Smith Barney Inc. and Bear,
Stearns & Co. Inc., subject to certain limited exceptions, including, in the
case of Allegiance, the issuance of shares under the Employee Stock Discount
Purchase Plan and 1998 Stock Incentive Plan and grants of options pursuant to,
and issuance of shares upon exercise of options under, the 1997 Nonqualified
Stock Option Plan and the 1998 Stock Incentive Plan. The lock-up agreements
described above may be released at any time as to all or any portion of the
shares subject to such agreements at the sole discretion of Goldman, Sachs &
Co., Salomon Smith Barney Inc. and Bear, Stearns & Co. Inc.
76
<PAGE> 80
Allegiance has filed and will file registration statements on Form S-8
covering the sale of the shares of common stock reserved for issuance under the
1997 Nonqualified Stock Option Plan, the 1998 Stock Incentive Plan and the
Employee Stock Discount Purchase Plan. Accordingly, shares registered under such
registration statement will be available for sale in the public market upon
issuance of such shares pursuant to the respective stock plan, unless such
shares are subject to vesting restrictions and subject to limitations on resale
by "affiliates" pursuant to Rule 144 and under the lock-up agreements described
above.
Allegiance's shelf registration statement with respect to the issuance of
the common stock issuable upon exercise of the warrants was declared effective
on March 31, 1999. Allegiance is required to maintain the effectiveness of such
registration statement until all warrants have expired or been exercised.
77
<PAGE> 81
UNDERWRITING
Allegiance, the selling stockholders and the underwriters for the offering
(the "Underwriters") named below have entered into an underwriting agreement
with respect to the shares being offered. Subject to certain conditions, each
Underwriter has severally agreed to purchase the number of shares indicated in
the following table. Goldman, Sachs & Co., Salomon Smith Barney Inc. and Bear,
Stearns & Co. Inc. are the representatives of the Underwriters.
<TABLE>
<CAPTION>
Underwriters Number of Shares
------------ ----------------
<S> <C>
Goldman, Sachs & Co. .......................................
Salomon Smith Barney Inc. ..................................
Bear, Stearns & Co. Inc. ...................................
Morgan Stanley & Co. Incorporated...........................
Donaldson, Lufkin & Jenrette Securities Corporation.........
Warburg Dillon Read LLC.....................................
FleetBoston Robertson Stephens Inc. ........................
TD Securities (USA) Inc. ...................................
----------
Total............................................. 10,000,000
==========
</TABLE>
If the Underwriters sell more shares than the total number set forth in the
table above, the Underwriters have an option to buy up to an additional
1,500,000 shares from Allegiance to cover such sales. They may exercise that
option for 30 days. If any shares are purchased pursuant to this option, the
Underwriters will severally purchase shares in approximately the same proportion
as set forth in the table above.
The following table shows the per share and total underwriting discounts
and commissions to be paid to the Underwriters by Allegiance and the selling
stockholders. Such amounts are shown assuming both no exercise and full exercise
of the Underwriters' option to purchase additional shares.
<TABLE>
<CAPTION>
Paid by Allegiance
------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share............................................... $ $
Total................................................... $ $
</TABLE>
<TABLE>
<CAPTION>
Paid by the Selling
Stockholders
------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per Share............................................... $ $
Total................................................... $ $
</TABLE>
Shares sold by the Underwriters to the public will initially be offered at
the initial price to public set forth on the cover of this prospectus. Any
shares sold by the Underwriters to securities dealers may be sold at a discount
of up to $ per share from the initial price to public. Any such securities
dealers may resell any shares purchased from the Underwriters to certain other
brokers or dealers at a discount of up to $ per share from the initial price
to public. If all the shares are not sold at the initial price to public, the
representatives may change the offering price and the other selling terms.
Allegiance, Allegiance's executive officers and directors, the selling
stockholders, and certain existing stockholders of Allegiance have agreed that,
without the prior written consent of
78
<PAGE> 82
Goldman, Sachs & Co., Salomon Smith Barney Inc. and Bear, Stearns & Co. Inc. on
behalf of the Underwriters, they will not:
(1) offer, pledge, sell, contract to sell, sell any option or contract
to purchase, purchase any option or contract to sell, grant any option,
right or warrant to purchase, lend or otherwise transfer or dispose of,
directly or indirectly, any shares of common stock or any securities
convertible into or exercisable or exchangeable for common stock, or
(2) enter into any swap or similar arrangement that transfers to
another, in whole or in part, any of the economic consequences of ownership
of the common stock, whether any such transaction described in clause (1)
or (2) above is to be settled by delivery of the common stock or such other
securities, in cash or otherwise, for a period of 90 days after the date of
this prospectus. The restrictions described in clause (1) and (2) of this
paragraph shall not apply to:
(a) the common stock to be sold in this offering,
(b) the issuance by Allegiance of common stock upon the exercise of
an option or a warrant or the conversion of a security outstanding on
the date of this prospectus,
(c) the issuance by Allegiance of additional options to purchase
shares of common stock pursuant to Allegiance's existing stock option
plans,
(d) transactions relating to shares of common stock or other
securities acquired in open market transactions after the completion of
this offering, and
(e) certain other limited transactions.
In connection with the offering, the Underwriters may purchase and sell
shares of common stock in the open market. These transactions may include short
sales, stabilizing transactions and purchases to cover positions created by
short sales. Short sales involve the sale by the Underwriters of a greater
number of shares than they are required to purchase in the offering. Stabilizing
transactions consist of certain bids or purchases made for the purpose of
preventing or retarding a decline in the market price of the common stock while
the offering is in progress.
The Underwriters also may impose a penalty bid. This occurs when a
particular Underwriter repays to the Underwriters a portion of the underwriting
discount received by it because the representatives have repurchased shares sold
by or for the account of such Underwriter in stabilizing or short covering
transactions.
These activities by the Underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the open
market. If these activities are commenced, they may be discontinued by the
Underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
Allegiance estimates that its share of the total expenses of the offering,
excluding underwriting discounts and commissions, will be approximately
$1,500,000.
Allegiance and the selling stockholders have agreed to indemnify the
several Underwriters against certain liabilities, including liabilities under
the Securities Act of 1933.
Affiliates of each of Goldman, Sachs & Co., TD Securities (USA) Inc.,
Morgan Stanley & Co. Incorporated and BankBoston, N.A. are lenders under the
existing senior secured revolving credit facility and proposed lenders under the
new credit facilities discussed under "Description of Certain Indebtedness," for
which they have or will be paid customary compensation. Affiliates of Morgan
Stanley & Co. Incorporated are significant stockholders of Allegiance and have
two representatives serving on Allegiance's board of directors. See "Principal
and Selling Stockholders" and "Management and Directors".
79
<PAGE> 83
LEGAL MATTERS
The validity of the common stock offered hereby will be passed upon for
Allegiance by Kirkland & Ellis (a partnership including professional
corporations), Chicago, Illinois. Certain legal matters will be passed upon for
the underwriters by Shearman & Sterling, New York, New York.
EXPERTS
The consolidated balance sheets of Allegiance as of December 31, 1998 and
December 31, 1997, 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,
and Schedule II -- Valuation and Qualifying Accounts for the years ending
December 31, 1997 and 1998, included and incorporated by reference in this
prospectus and elsewhere in this registration statement, have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto and are included and incorporated by reference
herein in reliance upon the authority of said firm as experts in giving said
reports.
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 room in 450 Fifth Street, NW, Washington, D.C. 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.
We "incorporate by reference" into this prospectus the information we file
with the SEC, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
an important part of this prospectus and any information that we file
subsequently with the SEC will automatically update this prospectus. We
incorporate by reference:
- our Annual Report on Form 10-K for the year ended December 31, 1998;
- our Quarterly Reports on Form 10-Q for the quarters ended March 31, 1999,
June 30, 1999 and September 30, 1999;
- our Current Report on Form 8-K, as filed with the SEC on April 7, 1999,
as amended on July 20, 1999;
- our Current Report on Form 8-K, as filed with the SEC on September 22,
1999;
- the description of the Allegiance's Common Stock, par value $.01 per
share contained in its Registration Statement on Form 8-A; and
- any filings we make with the SEC under Sections 13(a), 13(c), 14, or
15(d) of the Securities Exchange Act of 1934 after the date of this
prospectus until the termination of the offering under this prospectus.
80
<PAGE> 84
You may request a copy of these filings (other than exhibits, unless that
exhibit is specifically incorporated by reference into that filing) at no cost,
by writing to or telephoning the following person:
Andrew Albrecht
Director of Investor Relations
Allegiance Telecom, Inc.
3500 Piedmont Road, Suite 340
Atlanta, GA 30305
Phone: (404) 760-4881
81
<PAGE> 85
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Condensed Consolidated Balance Sheets as of September 30,
1999 (Unaudited) and December 31, 1998...................... F-2
Condensed Consolidated Statements of Operations for the
three and nine months ended September 30, 1999 and 1998
(Unaudited)............................................... F-3
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 1999 and 1998 (Unaudited)...... F-4
Notes to Condensed Consolidated Financial Statements
(Unaudited)............................................... F-5
Report of Independent Public Accountants.................... F-11
Consolidated Balance Sheets as of December 31, 1998, and
December 31, 1997......................................... F-12
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-13
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-14
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-15
Notes to Consolidated Financial Statements.................. F-16
</TABLE>
F-1
<PAGE> 86
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED) (AUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents................................. $ 582,446 $ 262,502
Short-term investments.................................... 27,196 143,390
Short-term investments, restricted........................ 25,727 25,543
Accounts receivable (net of allowance for doubtful
accounts of $2,900 and $577, respectively)............. 23,762 6,186
Prepaid expenses and other current assets................. 6,390 1,243
---------- ---------
Total current assets.............................. 665,521 438,864
PROPERTY AND EQUIPMENT, NET................................. 345,130 144,860
OTHER NON-CURRENT ASSETS:
Deferred debt issuance costs (net of accumulated
amortization of $2,039 and $734, respectively)......... 20,973 16,078
Goodwill (net of accumulated amortization of $2,904)...... 30,748 --
Long-term investments, restricted......................... 25,513 36,699
Other assets, net......................................... 7,359 1,373
---------- ---------
Total other non-current assets.................... 84,593 54,150
---------- ---------
Total assets...................................... $1,095,244 $ 637,874
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable....................................... $ 49,466 $ 20,981
Accrued liabilities and other.......................... 42,491 26,177
---------- ---------
Total current liabilities......................... 91,957 47,158
LONG-TERM DEBT............................................ 505,677 471,652
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
September 30, 1999 and December 31, 1998.............. -- --
Common stock -- 64,890,147 and 50,341,554 shares issued
and 64,864,835 and 50,341,554 outstanding at September
30, 1999 and December 31, 1998, respectively.......... 649 503
Common stock in treasury, at cost, 25,312 and no shares
at September 30, 1999 and December 31, 1998........... (5) --
Warrants............................................... 3,896 --
Additional paid-in capital............................. 940,029 416,730
Deferred compensation.................................. (15,583) (14,617)
Deferred management ownership allocation charge........ (10,640) (26,224)
Accumulated deficit.................................... (420,736) (265,962)
---------- ---------
Total stockholders' equity........................ 497,610 110,430
---------- ---------
Total liabilities and stockholders' equity........ $1,095,244 $ 637,874
========== =========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
F-2
<PAGE> 87
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES............................ $ 32,051 $ 2,786 $ 59,773 $ 4,201
OPERATING EXPENSES:
Network........................... 18,284 2,920 38,626 4,506
Selling, general and
administrative................. 40,303 13,300 98,539 26,076
Management ownership allocation
charge......................... 4,329 160,534 15,584 160,534
Non-cash deferred compensation.... 2,010 1,390 5,841 3,759
Depreciation and amortization..... 17,948 2,492 35,085 3,705
----------- ----------- ----------- -----------
Total operating
expenses................ 82,874 180,636 193,675 198,580
----------- ----------- ----------- -----------
Loss from operations...... (50,823) (177,850) (133,902) (194,379)
OTHER (EXPENSE) INCOME:
Interest income................... 8,876 7,463 23,159 13,059
Interest expense.................. (14,446) (13,380) (43,902) (25,278)
----------- ----------- ----------- -----------
Total other (expense)
income.................. (5,570) (5,917) (20,743) (12,219)
NET LOSS............................ (56,393) (183,767) (154,645) (206,598)
ACCRETION OF REDEEMABLE PREFERRED
STOCK AND WARRANT VALUES.......... -- (125) (130) (11,844)
----------- ----------- ----------- -----------
NET LOSS APPLICABLE TO COMMON
STOCK............................. $ (56,393) $ (183,892) $ (154,775) $ (218,442)
=========== =========== =========== ===========
NET LOSS PER SHARE, basic and
diluted........................... $ (0.87) $ (3.69) $ (2.62) $ (13.02)
=========== =========== =========== ===========
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING, basic and diluted.... 64,800,773 49,794,368 58,988,867 16,780,802
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
F-3
<PAGE> 88
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998
----------------- -----------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss............................................... $(154,645) $(206,598)
Adjustments to reconcile net loss to cash used in
operating activities --
Depreciation and amortization....................... 35,085 3,705
Provision for uncollectible accounts receivable..... 2,193 153
Accretion of investments............................ (3,320) --
Accretion of senior discount notes.................. 24,523 20,114
Amortization of original issue discount............. 598 388
Amortization of deferred debt issuance costs........ 1,305 486
Amortization of management ownership allocation
charge and deferred compensation.................. 21,425 164,293
Changes in assets and liabilities --
Increase in receivables............................. (19,339) (2,181)
Increase in prepaid expenses and other current
assets............................................ (5,006) (1,466)
Increase in other assets............................ (574) (1,097)
Increase (decrease) in accounts payable............. 7,157 (1,454)
Increase in accrued liabilities and other........... 26,290 13,159
--------- ---------
Net cash used in operating activities.......... (64,308) (10,498)
Cash Flows from Investing Activities:
Purchases of property and equipment.................... (215,893) (63,550)
Purchases of investments............................... (61,467) (120,149)
Proceeds from redemption of investments................ 191,983 --
Purchase of subsidiaries, net of cash acquired......... (34,878) --
--------- ---------
Net cash used in investing activities.......... (120,255) (183,699)
Cash Flows from Financing Activities:
Proceeds from issuance of senior notes................. -- 443,212
Proceeds from issuance of redeemable warrants.......... -- 8,184
Deferred debt issuance costs........................... (6,679) (16,812)
Proceeds from issuance of redeemable preferred stock... -- --
Proceeds from initial public offering.................. -- 137,757
Proceeds from secondary stock offering................. 510,618 --
Proceeds from exercise of warrants..................... 3 --
Proceeds from stock options exercised.................. 263 --
Proceeds from issuance of common stock under the
Employee Stock Discount Purchase Plan............... 886 --
Proceeds from redeemable capital contributions......... -- 20,880
Purchase of treasury stock............................. (5) --
Other financing activities............................. (579) (5)
--------- ---------
Net cash provided by financing activities...... 504,507 593,216
--------- ---------
Net increase in cash and cash equivalents...... 319,944 399,019
Cash and cash equivalents, beginning of
period....................................... 262,502 5,726
--------- ---------
Cash and cash equivalents, end of period....... $ 582,446 $ 404,745
========= =========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
F-4
<PAGE> 89
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 AND SEPTEMBER 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 September 30, 1999, Allegiance is
operational in 17 markets: Atlanta, Boston, Chicago, Dallas, Fort Worth,
Houston, Long Island, Los Angeles, New York, Northern New Jersey, Oakland,
Orange County, Philadelphia, San Diego, San Francisco, San Jose, and Washington,
D.C.; and is in the process of deploying networks in two other markets: 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 and otherwise develop efficient and effective working relationships with
the ILECs and other carriers, 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 nine months ended September 30, 1999 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1999.
F-5
<PAGE> 90
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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 $125 and $323 was recorded during the three and nine
months ended September 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% $ 2,500
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
F-6
<PAGE> 91
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adjusted as additional information is obtained. 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 nine months ended September 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
1999 1998 1999 1998
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues.................................... $ 32,051 $ 3,837 $ 63,711 $ 6,844
Net loss before extraordinary items......... (56,393) (189,300) (165,501) (231,748)
Net loss applicable to common stock......... (56,393) (189,300) (165,501) (231,748)
Net loss per share, basic and diluted....... (0.87) (3.80) (2.81) (13.81)
</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 September
30, 1999 and 1998, was $16,145 and $14,231, respectively, before the
capitalization of $1,699 and $851 of interest related to
construction-in-progress for the three months ended September 30, 1999 and 1998,
respectively. Interest expense for the nine months ended September 30, 1999 and
1998, was $48,051 and $27,073, respectively, before the capitalization of $4,149
and $1,795 of interest related to construction-in-progress for the nine months
ended September 30, 1999 and 1998, respectively. Repair and maintenance costs
are expensed as incurred.
Property and equipment at September 30, 1999 and December 31, 1998,
consisted of the following:
<TABLE>
<CAPTION>
USEFUL
SEPTEMBER 30, DECEMBER 31, LIVES
1999 1998 (IN YEARS)
------------- ------------ ----------
<S> <C> <C> <C>
Network equipment............................. $221,116 $ 67,304 5-7
Leasehold improvements........................ 44,138 24,483 5-10
Software...................................... 23,215 7,840 3
Office equipment and other.................... 8,174 4,384 2
Furniture and fixtures........................ 6,635 2,420 5
-------- --------
Property and equipment, in service............ 303,278 106,431
Less: Accumulated depreciation................ (40,697) (9,015)
-------- --------
Property and equipment in service, net........ 262,581 97,416
Construction-in-progress...................... 82,549 47,444
-------- --------
Property and equipment, net................. $345,130 $144,860
======== ========
</TABLE>
F-7
<PAGE> 92
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. OTHER ASSETS:
Other assets at September 30, 1999 and December 31, 1998 consisted of the
following:
<TABLE>
<CAPTION>
SEPTEMBER 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....................................... 1,418 1,373
Other.................................................... 529 --
------ ------
Total other assets....................................... 7,900 1,373
Less: Accumulated amortization........................... (541) --
------ ------
Other assets, net.............................. $7,359 $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
During the three and nine months ended September 30, 1999, 15,828 and
83,057 shares of common stock were issued under the Company's Employee Stock
Discount Purchase Plan for proceeds of $357 and $886, respectively.
Warrants
During the three and nine months ended September 30, 1999, 72,000 and
247,139 Warrants, formerly referred to as Redeemable Warrants (see Note 3), were
exercised to purchase 105,045 and 360,538 shares of common stock, respectively.
Fractional shares are not issued, cash payments are made in lieu thereof,
according to the terms of the Warrant Agreement. At September 30, 1999 and
December 31, 1998, 197,861 and 445,000 Warrants, respectively, were outstanding.
8. LONG-TERM DEBT:
Long-term debt consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 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 12.21%, at accreted
value.................................................... $295,470 $270,526
12 7/8% Senior Notes, face amount $205,000 due May 15,
2008, effective interest rate of 13.24%, at accreted
value.................................................. 201,196 201,019
Other.................................................... 9,011 107
-------- --------
Total long-term debt........................... $505,677 $471,652
======== ========
</TABLE>
Included in accrued liabilities and other at September 30, 1999 is $1,795
currently payable under capital lease obligations.
F-8
<PAGE> 93
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Initial borrowings
under the Credit Facility will not be available until certain financial and
operating objectives are met. Further borrowings 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
September 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
September 30, 1999 are as follows:
<TABLE>
<S> <C>
1999...................................................... $ 4,173
2000...................................................... 16,873
2001...................................................... 15,939
2002...................................................... 13,099
2003...................................................... 10,134
2004...................................................... 6,508
Thereafter................................................ 21,355
</TABLE>
Total rent expense for the three months ended September 30, 1999 and 1998,
and the nine months ended September 30, 1999 and 1998, was $2,694, $815, $6,190,
and $1,576, respectively.
10. EARNINGS (LOSS) PER SHARE:
The net loss per share amounts included on the condensed consolidated
statements of operations and the number of shares outstanding on the condensed
consolidated balance sheets reflect a 426.2953905 for-one stock split, which
occurred in connection with the initial public
F-9
<PAGE> 94
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 $125 for the three months ended September 30,
1999 and 1998, respectively, and $130 and $11,844 for the nine months ended
September 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 nine months ending September 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.
F-10
<PAGE> 95
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.
ARTHUR ANDERSEN LLP
Dallas, Texas,
February 3, 1999
F-11
<PAGE> 96
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS -- DECEMBER 31, 1998 AND 1997
(in thousands, except share and per 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 (net of accumulated depreciation and
amortization of $9,015.4 and $12.7 at December 31, 1998
and 1997, respectively)................................... 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-12
<PAGE> 97
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>
REVENUE................................................... $ 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-13
<PAGE> 98
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
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
(in thousands, except share and per share data)
<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-14
<PAGE> 99
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
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
(in thousands)
<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 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-15
<PAGE> 100
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
was operational in nine markets: Atlanta, Boston, Chicago, Dallas, Fort Worth,
Los Angeles, New York City, Oakland and San Francisco and is in the process of
deploying networks in seven other markets: Houston, Northern New Jersey, Orange
County, Philadelphia, San Diego, San Jose and Washington, D.C.
Until December 16, 1997, the Company was in the development stage. From 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.
During 1998, the Company concentrated 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 by 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 sufficient customer base will take a number of
years, and positive cash flows from operations are not expected in the near
future.
F-16
<PAGE> 101
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 semiannual) 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.
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.
F-17
<PAGE> 102
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 the year ended December 31, 1998, and
$3,814.2 for the period from inception (April 22, 1997), through December 31,
1997.
F-18
<PAGE> 103
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The securities listed below were not included in the computation of diluted
loss per share, since 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......................... 886,127 189,127
1998 Stock Incentive Plan................................... 365,526 --
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 that start-up activities and
organization costs 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 effect 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
effect on the Company, inasmuch as the Company has historically not invested in
derivatives or participated 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.
F-19
<PAGE> 104
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, LLC ("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 as of 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
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.
F-20
<PAGE> 105
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 were issued and outstanding.
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 into 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 have 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.
F-21
<PAGE> 106
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 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
F-22
<PAGE> 107
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
after 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 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
F-23
<PAGE> 108
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
any such redemption at least 65% of the aggregate principal amount of the
12 7/8% Notes originally issued remains 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 to their capital stock, redeem capital stock,
make investments or certain other restricted payments, sell assets, 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 of each series of notes at December 31, 1998.
5. CAPITAL LEASES:
On May 29, 1998, the Company signed a capital lease agreement for three,
four-fiber rings, with a term of 10 years and a renewal term of 10 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 12
optical fibers configured in two separate rings, with a term of 15 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 on March 4, 1998. Thus, the
F-24
<PAGE> 109
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's counterclaim 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, the Fund Investors
and 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 sale of 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 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 that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events that 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
F-25
<PAGE> 110
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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 5.63% 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............ 259,796.6 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 17,634.27
</TABLE>
F-26
<PAGE> 111
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 1,037,474 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 3,655,778 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.
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........................ 848,347 2.76 189,127 2.47
Exercised...................... -- -- -- --
Forfeited...................... (151,347) 2.60 -- --
-------- -------
Outstanding, end of period..... 886,127 2.73 189,127 2.47
======== =======
Options exercisable at
period-end................... 44,481 --
======== =======
Weighted average fair value of
options granted.............. $ 2.82 $ 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.
F-27
<PAGE> 112
ALLEGIANCE TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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................................................... 399,974 10.21
Exercised................................................. -- --
Forfeited................................................. (34,448) 10.47
---------
Outstanding, end of period................................ 365,526 10.19
=========
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 have been
amortized to expense at 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-28
<PAGE> 113
------------------------------------------------------
------------------------------------------------------
No dealer, salesperson or other person is authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell only the shares offered hereby, but only under circumstances
and in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current only as of its date.
----------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary................... 1
Risk Factors......................... 8
Use of Proceeds...................... 18
Dividend Policy...................... 18
Market Price of Common Stock......... 19
Dilution............................. 19
Capitalization....................... 20
Selected Financial Data.............. 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 23
Business............................. 37
Management and Directors............. 59
Principal and Selling Stockholders... 65
Description of Certain
Indebtedness....................... 67
Description of Capital Stock......... 73
Shares Eligible for Future Sale...... 76
Underwriting......................... 78
Legal Matters........................ 80
Experts.............................. 80
Where You Can Find More Information.. 80
Index to Consolidated Financial
Statements......................... F-1
</TABLE>
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
10,000,000 Shares
allegiancetelecom, inc. logo
Common Stock
------------------------
PROSPECTUS
-----------------------
GOLDMAN, SACHS & CO.
SALOMON SMITH BARNEY
BEAR, STEARNS & CO. INC.
MORGAN STANLEY DEAN WITTER
DONALDSON, LUFKIN & JENRETTE
WARBURG DILLON READ LLC
ROBERTSON STEPHENS
TD SECURITIES
Representatives of the Underwriters
------------------------------------------------------
------------------------------------------------------
<PAGE> 114
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 14. 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>
Securities and Exchange Commission registration fee......... $ 240,603
NASD filing fee............................................. $ 30,500
Nasdaq National Market listing fee.......................... $ 17,500
Blue Sky fees and expenses (including attorneys' fees)...... $ 15,000
Printing expenses........................................... $ 150,000
Accounting fees and expenses................................ $ 100,000
Legal fees and expenses..................................... $ 150,000
Miscellaneous expenses...................................... $ 796,397
Total............................................. $1,500,000
</TABLE>
All amounts are estimated.
ITEM 15. 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 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
II-1
<PAGE> 115
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, BY-LAWS, INSURANCE POLICIES AND AGREEMENTS
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.
Allegiance and its directors have also entered into an Indemnification
Agreement.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
1.1** Form of Underwriting Agreement.
3.1 Amended and Restated Certificate of Incorporation of
Allegiance Telecom, Inc. (incorporated by reference to
Exhibit 3.1 to Allegiance Telecom's Form 10-Q for the period
ended June 30, 1998 (the "Form 10-Q")).
3.2 Certificate of Correction to Amended and Restated
Certificate of Incorporation (incorporated by reference to
Exhibit 3.2 to Allegiance Telecom, Inc.'s Form 10-K for the
period ended December 31, 1998 (the "1998 Form 10-K")).
3.3 Amended and Restated By-Laws of Allegiance Telecom, Inc.
(incorporated by reference to Exhibit 3.2 to the Form 10-Q).
5.1** Opinion of Kirkland & Ellis.
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).
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.
</TABLE>
- - - - - - - - - - ---------------
* Filed herewith
** To be filed by amendment
(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.
II-2
<PAGE> 116
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 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. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement; and
(iii) to include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement.
provided, however, that paragraphs (a)(i) and (a)(ii) do not apply if
the information required to be included in a post-effective amendment by
those paragraphs is contained in periodic reports filed with or
furnished to the Commission by the registrant pursuant to section 13 or
section 15(d) of the Securities Exchange Act of 1934 that are
incorporated by reference 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 this offering.
(4) For purposes of determining any liability under the Securities Act
of 1933, each filing of the registrant's annual report pursuant to section
13(a) or section 15(d) of the Securities Exchange Act of 1934 (and, where
applicable, each filing of an employee benefit plan's annual report
pursuant to section 15(d) of the Securities Exchange Act of 1934) that is
incorporated by reference in the registration statement shall be deemed to
be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
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
II-3
<PAGE> 117
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-4
<PAGE> 118
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Dallas, State of Texas, on January 3, 2000.
ALLEGIANCE TELECOM, INC.
By: /s/ ROYCE J. HOLLAND
----------------------------------
Royce J. Holland
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and Royce J. Holland, Mark B. Tresnowski and Thomas M. Lord
and each of them, his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any or all amendments (including
post-effective amendments) to this registration statement (and any registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933, as
amended, for the offerings which this Registration Statement relates), and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons on January 3,
2000 in the capacities indicated:
<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S>
/s/ ROYCE J. HOLLAND Chairman of the Board and Chief Executive
- - - - - - - - - - ----------------------------------------------------- Officer (Principal Executive Officer)
Royce J. Holland
/s/ C. DANIEL YOST President, Chief Operating Officer and
- - - - - - - - - - ----------------------------------------------------- Director
C. Daniel Yost
/s/ THOMAS M. LORD Executive Vice President, Chief Financial
- - - - - - - - - - ----------------------------------------------------- Officer and Director (Principal Financial
Thomas M. Lord Officer)
/s/ G. CLAY MYERS Senior Vice President of Finance and
- - - - - - - - - - ----------------------------------------------------- Accounting (Principal Accounting Officer)
G. Clay Myers
/s/ ANTHONY J. PARELLA Senior Vice President of Field Sales and
- - - - - - - - - - ----------------------------------------------------- Customer Care and Director
Anthony J. Parella
</TABLE>
II-5
<PAGE> 119
<TABLE>
<CAPTION>
SIGNATURE CAPACITY
--------- --------
<C> <S>
/s/ PAUL D. CARBERY Director
- - - - - - - - - - -----------------------------------------------------
Paul D. Carbery
/s/ JAMES E. CRAWFORD, III Director
- - - - - - - - - - -----------------------------------------------------
James E. Crawford, III
/s/ JOHN B. EHRENKRANZ Director
- - - - - - - - - - -----------------------------------------------------
John B. Ehrenkranz
/s/ PAUL J. FINNEGAN Director
- - - - - - - - - - -----------------------------------------------------
Paul J. Finnegan
/s/ RICHARD D. FRISBIE Director
- - - - - - - - - - -----------------------------------------------------
Richard D. Frisbie
/s/ REED E. HUNDT Director
- - - - - - - - - - -----------------------------------------------------
Reed E. Hundt
/s/ ALAN E. GOLDBERG Director
- - - - - - - - - - -----------------------------------------------------
Alan E. Goldberg
/s/ JAMES N. PERRY, JR. Director
- - - - - - - - - - -----------------------------------------------------
James N. Perry, Jr.
/s/ DINO VENDETTI Director
- - - - - - - - - - -----------------------------------------------------
Dino Vendetti
</TABLE>
II-6
<PAGE> 120
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
1.1** Form of Underwriting Agreement.
3.1 Amended and Restated Certificate of Incorporation of
Allegiance Telecom, Inc. (incorporated by reference to
Exhibit 3.1 to Allegiance Telecom's Form 10-Q for the period
ended June 30, 1998 (the "Form 10-Q")).
3.2 Certificate of Correction to Amended and Restated
Certificate of Incorporation (incorporated by reference to
Exhibit 3.2 to Allegiance Telecom, Inc.'s Form 10-K for the
period ended December 31, 1998 (the "1998 Form 10-K")).
3.3 Amended and Restated By-Laws of Allegiance Telecom, Inc.
(incorporated by reference to Exhibit 3.2 to the Form 10-Q).
5.1** Opinion of Kirkland & Ellis.
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).
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.
</TABLE>
- - - - - - - - - - ---------------
* Filed herewith
** To be filed by amendment
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our
report included in this registration statement and to the incorporation by
reference in this registration statement of our reports dated February 3, 1999,
included in and incorporated by reference in Allegiance Telecom, Inc.'s Form
10-K for the year ended December 31, 1998, and to all references to our Firm
included in this registration statement.
ARTHUR ANDERSEN LLP
Dallas, Texas
January 3, 2000
<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-BASIC> (10.53)
<EPS-DILUTED> (10.53)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AS OF DECEMBER 31, 1997 AND FOR THE
PERIOD FROM INCEPTION (APRIL 22, 1997) TO DECEMBER 31, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> APR-22-1997
<PERIOD-END> DEC-31-1997
<CASH> 5,726,359
<SECURITIES> 0
<RECEIVABLES> 4,310
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 5,975,821
<PP&E> 23,912,659
<DEPRECIATION> 12,639
<TOTAL-ASSETS> 30,047,014
<CURRENT-LIABILITIES> 3,929,700
<BONDS> 0
33,409,404
0
<COMMON> 0
<OTHER-SE> (7,292,090)
<TOTAL-LIABILITY-AND-EQUITY> 30,047,014
<SALES> 0
<TOTAL-REVENUES> 403
<CGS> 0
<TOTAL-COSTS> 151,269
<OTHER-EXPENSES> 12,639
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (7,502,150)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,502,150)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,502,150)
<EPS-BASIC> (17,610.68)
<EPS-DILUTED> (17,610.68)
</TABLE>
