SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
[ x ] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended June 30, 1998 or [ ] Transition report
pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 for the
transition period from _________ to _________.
Commission File Number: 333-50049
DTI HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Missouri 43-1828147
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8112 Maryland Ave, 4th Floor, St. Louis, Missouri 63105
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (314) 253-6600
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [x]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
No non-affiliates of the registrant own common stock of the registrant.
Documents Incorporated By Reference
None
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TABLE OF CONTENTS
Page
Part I.
Item 1. Business 4
Item 2. Properties 20
Item 3. Legal Proceedings 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Part II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 21
Item 6. Selected Financial Data 22
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk 32
Item 8. Financial Statements and Supplementary Data 32
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 32
Part III.
Item 10. Directors and Executive Officers of the Registrant 33
Item 11. Executive Compensation 35
Item 12. Security Ownership of Certain Beneficial Owners and
Management 39
Item 13. Certain Relationships and Related Transactions 40
Part IV.
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 41
Signatures
Exhibit Index
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Actof 1995 that include,
among others, statements by the Company with respect to (i) projected capital
expenditures and costs and the timing thereof, (ii) projected dates of
construction or acquisition of routes, commencement of service and completion of
the DTI network, (iii) assumptions about the pricing of telecommunications
services and (iv) assumptions about the cost and availability of the Company's
telecommunications equipment. These forward-looking statements are subject to
risks and uncertainties that could cause actual events or results to differ
materially from those expressed or implied by the statements. The most important
factors that could prevent the Company from achieving its stated goals include,
but are not limited to, (a) failure to obtain substantial amounts of additional
financing at reasonable costs and on acceptable terms, (b) failure to
effectively and efficiently manage the expansion and construction of the
Company's network, (c) failure to enter into additional indefeasible rights to
use ("IRUs") and/or wholesale network capacity agreements, (d) failure to obtain
and maintain sufficient rights-of-way, (e) intense competition and pricing
decreases, (f) potential for rapid and significant changes in telecommunications
technology and their effect on the Company's business, and (g) adverse changes
in the regulatory environment. These cautionary statements should be considered
in connection with any subsequent written or oral forward-looking statements
that may be issued by the Company or on its behalf and a discussion of certain
risks relating to the Company and its business set forth in "Risk Factors"
included as an exhibit to this Annual Report of Form 10-K.
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Part I.
Item 1. Business
OVERVIEW
DTI is a facilities-based communications company that is creating an
approximately 18,500 route mile digital fiber optic network comprised of 19
regional rings interconnecting primary, secondary and tertiary cities in 37
states. By providing high-capacity voice and data transmission services to and
from secondary and tertiary cities, the Company intends to become a leading
wholesale provider of regional communications transport services to
interexchange carriers ("IXCs") and other communications companies ("carrier's
carrier services"). DTI currently provides carrier's carrier services under
contracts with AT&T, Sprint, MCI WorldCom, Ameritech Cellular and IXC
Communications. The Company also provides private line services to targeted
business and governmental end-user customers ("end-user services"). DTI is
50%-owned by an affiliate of Kansas City Power & Light Company, which has agreed
to be acquired by Western Resources, Inc.
BUSINESS STRATEGY
The Company intends to:
Leverage Integrated Long-Haul Routes, Regional Rings and Local Network
Design. The Company believes that the strategic design of the DTI network will
allow it to offer reliable, high-capacity transmission services on a
region-by-region basis to carrier and end-user customers who seek a competitive
alternative to incumbent providers of such services. The regional and local
SONET rings in the DTI network will interconnect primary, secondary and tertiary
markets, major interexchange carrier ("IXC") points of presence ("POPs") and
incumbent local exchange carrier ("ILEC") access tandems and, in selected
metropolitan areas, potential end-user customers. This design will permit the
Company to provide its carrier customers with reliable transmission capacity
between the carrier's network and access tandems serving a significant number of
end-users in each region. Using a technologically advanced design, the DTI
network will provide rapid rerouting of calls in the event of a fiber cut and,
in many cases, will permit DTI's customers to allocate, manage and monitor the
capacity they lease from DTI from within the customer's own network operations
center.
Strategically Locate and Expand its Network Through Regional Rings. The
Company is expanding the DTI network through the creation of additional regional
rings outside the core central region in the Midwest in which the Company had
previously focused its network buildout because it believes that substantial
demand for additional IXC capacity exists in secondary and tertiary markets
located around the country. DTI intends to construct or obtain IRUs for other
facilities to create regional rings and connect secondary and tertiary cities.
Completing the DTI network in this manner will help the Company to offer
reliable connectivity on a regional basis and high-capacity service
cost-effectively to secondary and tertiary markets.
Develop A Low-Cost Network. The Company will strive to develop a low-cost
network by (i) taking advantage of the potential cost efficiencies of the DTI
network design, (ii) continuing to deploy advanced fiber optic network
technology, which the Company believes lowers construction, operating and
maintenance costs, and (iii) realizing cost efficiencies through existing and
additional fiber optic long term IRU and swap agreements with other
telecommunications companies and rights-of-way agreements with governmental
authorities. The Company believes that its approach will allow it to offer
carrier customers regional transport on a more economical basis than is
currently available to such customers.
Selectively Pursue Local Switched Services Opportunities. DTI believes its
network design will allow it to cost-effectively pursue local switched services
opportunities by creating regional and local fiber optic rings along its
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long-haul routes and by leveraging the technical capabilities and high-bandwidth
capacity of the DTI network. The Company intends to provide local switched
service capacity to its carrier customers and to other facilities-based and
non-facilities-based telecommunications companies on a wholesale basis. The DTI
network's design will also provide the Company with sufficient long-haul
capacity to offer local switched services to targeted end-user customers in
primary, secondary and tertiary cities on the Company's regional rings.
Leverage Experienced Management Team. The Company's management team
includes individuals with significant experience in the deployment and marketing
of telecommunications services. Prior to founding DTI in 1989, Richard D.
Weinstein, President and Chief Executive Officer of DTI, owned and managed
Digital Teleresources, Inc., a firm which designed, engineered and installed
telecommunications systems for large telecommunications companies, including SBC
Communications, Inc. ("SBC"), and other Fortune 500 companies. H.P. Scott, the
Company's Senior Vice President, has over 35 years of telecommunications
industry experience, having spent eighteen years with MCI Communications, Inc.
("MCI") and IXC Carrier, Inc., where he held positions of senior responsibility
for the design and construction of their coast-to-coast fiber optic
telecommunications networks. Prior to joining DTI as Senior Vice President,
Finance and Administration and Chief Financial Officer, Gary W. Douglass was the
Executive Vice President and Chief Financial Officer of publicly-held Roosevelt
Financial Group, Inc., which was acquired by Mercantile Bancorporation in 1997,
and had previously spent 23 years at Deloitte & Touche LLP. Jerry W. Murphy, the
Company's Vice President, Network Operations, spent 18 years with MCI, having
spent the last 11 years in senior positions in engineering, network
implementation and network operations positions. Jerome W. Sheehy, DTI's Vice
President, Regulatory-Industry Affairs, has over 42 years' experience in the
telecommunications industry, including 20 years at GTE Corporation ("GTE").
The DTI Network
General. The DTI network is an exclusively fiber optic cable communications
system substantially all of which employs self-healing, SONET ring architecture
to minimize downtime in the event of a cut in a fiber ring. The Company has
installed its first switch on the DTI network and expects that it will be fully
operational by the end of 1998. DTI expects that more than 90% of the fiber in
the DTI network will be installed underground, typically 36 to 48 inches under
the surface, providing protection from weather and other environmental hazards
affecting reliability of communication connections. The Company expects to
construct approximately half of the DTI network, and to obtain indefeasible
rights to use fiber optic facilities of other carriers for the other half. On
routes which the Company constructs, and on most routes which it acquires from
other carriers, the Company will employ SMF-28A fiber optic cable composed of
Corning glass fiber. The Company has entered into a two year agreement with
Pirelli Cable and Systems LLC ("Pirelli") pursuant to which the Company agreed
to purchase all of its fiber optic cable from Pirelli. All routes in the DTI
network constructed by DTI are comprised of at least 48 strands. In addition, in
St. Louis and Kansas City, DTI is installing 216 and 288 fiber strands,
respectively. On routes that the Company does not build, the Company expects to
obtain IRUs for between two and 12 optical fibers. On certain strategic routes
which it constructs, the DTI network will also include one or two empty
innerducts for maintenance and future growth purposes. As part of its design,
the Company typically retains 50% or more of the capacity on each DTI network
route for its own use.
The Company currently has approximately 2,000 route miles of fiber optic
cable in place in Missouri and Arkansas, of which approximately 1,500 route
miles represent long-haul segments, and approximately 500 route miles represent
local loop networks in the St. Louis and Kansas City metropolitan areas, as well
as in Jefferson City, Columbia, Mexico and Fulton, Missouri. DTI currently
provides services over 900 route miles of its network.
Network Electronics. Long-haul routes on the DTI network will generally
utilize dense wavelength division ("DWDM") equipment. DWDM equipment provides
individual wavelength-specific circuits of OC-48 capacity optical windows. The
Company has entered into a three-year agreement with Pirelli pursuant to which
the Company agreed to purchase from Pirelli at least 80% of its needs for DWDM
equipment. All DTI network DWDM equipment will initially be equipped to enable
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the Company to provide the equivalent of eight dedicated, ring redundant,
optical windows. Such equipment will have the ability to be expanded to offer
additional optical windows as the need for capacity on the DTI network
increases. The DWDM equipment will permit the Company to offer to its carrier
customers optical windows on regional rings providing a dedicated, virtual
circuit that can interconnect any two points on that regional ring. The DWDM
equipment, with the accompanying optical add/drop multiplexing ("OADM")
equipment, also will permit the Company to efficiently provide high capacity
telecommunications services to secondary and tertiary markets that the Company
believes are currently underserved. The Company's use of open architecture, DWDM
equipment conforming to SONET standards on its regional rings and long-haul
routes will also give the DTI network the ability to interoperate with its
carrier customers' existing fiber optic transmission systems, which have a broad
range of transmission speeds and signal formats, without the addition of
expensive conversion equipment by those carriers. The Company believes that the
network's current and planned system architecture, with minor additions or
modifications, will accommodate ATM and frame relay transmission methods and
emerging Internet Protocol technologies.
On all routes throughout the DTI network, whether constructed by DTI or
purchased, leased or swapped from another carrier, the Company will install
centrally controllable high-bit-rate transmission electronics. The Company
believes the use of such fiber optical terminal equipment will provide DTI's
customers the ability to monitor, in their own network control centers, the
optical windows on the regional rings that they utilize. This equipment should
also permit DTI's customers to utilize their own network control centers to add
and remove services on the optical windows serving that carrier. The DTI network
design will permit carriers to utilize the DTI network as a means to efficiently
expand their networks to areas not previously served, to provide redundancy to
their networks or to upgrade the technology in areas already served by such
networks. The DTI network will also be capable of providing services to carriers
and end-users in increments of less than a full OC-48 optical window, from
OC-12s to DS-3s.
The Company believes that the DTI network design standards give it
sufficient transmission capacity to meet anticipated future increases in call
volume and the development of more bandwidth-intensive voice, data and video
telecommunication uses. The DTI network's capacity also will allow the Company
to deploy fewer high cost switches by facilitating the transport of rural
switched calls to and from distant centralized switching facilities. All network
operations are currently controlled from a single network control center in
suburban St. Louis, Missouri. The Company is currently constructing a second
control center in Kansas City, Missouri that can serve as a backup network
control center for the entire DTI network.
Network Design. The DTI network is designed to include high-capacity (i)
long-haul routes between large metropolitan areas, (ii) regional rings
connecting primary, secondary and tertiary metropolitan areas to one another and
(iii) local rings in selected metropolitan areas along the regional rings. The
long-haul route portions of the DTI network will generally be located to allow
the Company to more easily interconnect with major IXC POPs and ILEC access
tandems in a region. Any major ILEC access tandem along a regional ring not
physically interconnected through facilities owned or used pursuant to a
long-term IRU by DTI will be interconnected through leased lines until there are
sufficient customers to make construction of a DTI-owned route to these access
tandems economically feasible. Local network portions of the DTI network in
metropolitan areas are generally routed near major business telecommunications
users, metropolitan ILEC access tandems and major ILEC central offices. DTI
believes the different elements of the DTI network complement each other and
will create certain construction, operating and maintenance synergies. DTI also
believes its integrated long-haul route, regional ring and local ring design
will allow the Company to offer its carrier and end-user customers private line
and local switched services at a lower cost by reducing the Company's use of
ILEC and IXC facilities to provide services to its customers.
Switching Capacity. The Company intends to install high-capacity switches
in strategically located, geographically diverse metropolitan areas to balance
the expected traffic throughout the DTI network. When coupled with its
integrated network design, this switch placement will give DTI the ability to
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offer local switched service and long-haul service to many end-user customers
along its regional rings. By using the expected excess capacity on the DTI
network, calls from diverse geographic regions in the DTI network can be routed
long distances from the originating point to one of the Company's switches and
on to their destination, reducing the number of switches required and decreasing
the cost and complexity of constructing, operating and maintaining the DTI
network. In addition, the strategic deployment of switches is expected to enable
the Company to (i) allow the Company to offer switched services on a more
economical basis, (ii) offer custom calling features and billing enhancements to
all of its customers without involving the ILEC, and (iii) allow the Company to
sell its local switched service capacity to other carriers on a wholesale basis.
The Company's first switch has been installed in St. Louis, and the Company
expects that it will be fully operational by the end of 1998.
Highway and Utility Rights-Of-Way. Much of the currently completed DTI
network is located in rights-of-way obtained by DTI through strategic
relationships with utilities, state transportation departments and other
governmental authorities. The Company currently has built or has rights-of-way
to build approximately 2,400 route miles of the 9,800 route miles that it plans
to construct on the DTI network and has preliminary or definitive agreements for
IRUs and short-term leases covering approximately 8,600 additional route miles.
To build the long-haul portions of the DTI network between population centers in
Missouri, the Company has generally used rights-of-way in the median of and
along the interstate highway system. The Company will seek to obtain the
rights-of-way that it needs for the expansion of its network in areas where it
will construct network rather than purchase, lease or swap fiber optic strands
by entering into agreements with other state highway departments, utilities or
pipeline companies and it may enter into joint ventures or other "in-kind"
transfers in order to obtain such rights. In addition, the Company believes that
public rights-of-way for a substantial portion of the remainder of the planned
DTI network will be available in the event that it is unable to obtain
rights-of-way from third parties.
Build-Out Plan. The Company currently plans to deploy a fiber optic network
in 37 states and the District of Columbia that will consist of approximately
18,500 route miles of fiber optic cable, DWDM and other signal transmission
equipment, and high-capacity switches strategically located in larger
metropolitan areas. The Company expects to construct approximately half of such
network and to obtain IRUs for fiber optic facilities of other carriers for the
remainder of the network. The Company has construction projects underway in
Missouri, Arkansas, Kansas and Tennessee.
In addition to routes that it will construct, the Company expects to (i)
purchase, for cash, indefeasible rights to use fiber optic facilities of other
telecommunications companies and (ii) exchange indefeasible rights to use the
Company's fiber optic facilities for the indefeasible right to use the fiber
optic facilities of other telecommunications companies. In this manner, the
Company believes that it would be able to establish telecommunications
facilities along the DTI network routes more quickly than by constructing all of
its own facilities. The Company has entered into definitive agreements for
long-term IRUs for fiber optic strands and related facilities along routes from
Chicago to near Cleveland and from near Indianapolis to New York City,
preliminary agreements for long-term IRUs along routes from Washington D.C. to
Texas, from Des Moines to Minneapolis and from Portland to Salt Lake City to Los
Angeles, and a short-term lease agreement along routes from Los Angeles to
Joplin, Missouri, from near St. Louis, Missouri to near Indianapolis and from
near Indianapolis to Chicago. These routes include an aggregate of approximately
8,600 route miles (including 2,800 route miles under the short-term lease), for
an aggregate cash consideration of up to approximately $133 million, plus
recurring maintenance and building space fees. The short-term leases of fiber
along planned routes were executed in order to provide services prior to the
construction of, or the execution of long-term IRUs for, planned DTI network
routes through the end of 2000. DTI has also recently entered into a long-term
IRU and fiber swap agreement, in which DTI will obtain access to dark fiber and
receive approximately $5 million in cash in exchange for providing dark fiber
along DTI's network.
The Company has entered into certain agreements that require it to
construct its network facilities. The MHTC Agreement requires the Company to
build approximately 1,200 miles of fiber optic network along Missouri's
interstate highway system by the end of 1998, certain portions of which must be
built prior to such time. The Company must also complete construction of an
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additional 800 miles by the end of 1999 to maintain its rights to such
additional routes. Over 1,700 route miles of the entire 2,000-mile network have
been completed; however, the Company did not meet an intermediate construction
deadline for the construction of approximately 30 miles but has received from
MHTC a waiver of such construction delay and an extension of the 30-mile
completion date to October 1, 1998. The Company expects to complete such
construction prior to such date except where delayed by unattained permits. The
Company must complete construction on an additional 800 miles by the end of 1999
to maintain its rights to such routes. The Company may lose its exclusive rights
under the MHTC Agreement only in the event of its breach and failure to timely
exercise its right to cure within 60 days of notice of any such breach, which
would allow MHTC to terminate the MHTC Agreement. As of September 30, 1998, the
Company has not received any notice of breach that has not been waived or cured.
An agreement between the Company and Union Electric requires it to construct a
fiber optic network linking Union Electric's 80-plus sites throughout the states
of Missouri and Illinois. As of June 30, 1998, the Company had completed
approximately 85% of the sites required for Union Electric and expects to
complete all such construction by the end of 1998.
During the balance of calendar 1998 and all of calendar 1999, the Company
anticipates its build-out plan priorities will be focused principally on
expanding from its existing Missouri/Arkansas base by building additional
regional rings adjacent to existing rings where one side already exists. In
addition, the Company intends to light those portions of routes that close
regional rings that adjoin existing rings and those that initiate new rings in
areas in which strong carrier interest has been expressed. The Company
anticipates that its existing financial resources will be adequate to fund the
abovementioned priorities and its existing capital commitments, principally
payments required under existing preliminary and definitive IRU and short-term
lease agreements, totaling $133 million which are payable in varying
installments over the period through December 31, 1999. In addition, the Company
had a commitment at June 30, 1998 for eight telecommunications switches totaling
$15 million, which is cancelable upon the payment of a cancellation fee of
$42,000 for each of the remaining eight unpurchased switches.
Products and Services
Carrier's Carrier Services
"Carrier's carrier services" are generally the high capacity transmission
services used by IXCs, ILECs and CLECs to transmit telecommunications traffic.
Customers using carrier's carrier services include (i) facilities-based carriers
that require transmission capacity where they have geographic gaps in their
facilities, need additional capacity or require alternative routing and (ii)
non-facilities-based carriers requiring transmission capacity to carry their
customers' telecommunications traffic. Carrier's carrier service is a wholesale
pricing business characterized by net margins that are higher than the Company
could typically achieve through end-user services. This is primarily because
these services can be marketed more quickly and at a lower cost than is
generally necessary with end-user services. The Company currently provides
carrier's carrier services through IRUs and wholesale network capacity
agreements. The Company's present and planned carrier's carrier services are set
forth below.
Optical Windows. DTI plans to offer its carrier customers dedicated,
virtual circuits through the exclusive use of an OC-48 capacity, ring redundant
wavelength of light, or optical window, on the regional rings in the DTI
network. DTI intends to supply all fiber optic electronic equipment necessary to
transmit telecommunications traffic along the regional ring. The Company plans
to enter into agreements for the provision of optical windows for a term of
years with fixed monthly payments over the term of the agreement, regardless of
the level of usage. Uses of optical windows by an IXC can include
point-to-point, dedicated data and voice circuit communications connections, as
well as redundancy and overflow capacity for existing facilities of the IXC.
Possible uses of optical windows by ILECs include connection of its central
offices to other central offices or access tandems. An ILEC may also use such
agreements as a cost-effective way to upgrade its network facilities. A CLEC may
use optical window agreements as a way of "filling out" its network.
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The Company also will offer its carrier customers the use of an OC-48
optical window to create a high quality, ring redundant means to efficiently
deliver its calls to a significant number of end-users along these rings and
aggregate, for further long haul transport, the outgoing calls of that carrier's
customers along such rings to a regional points of interconnection between the
carrier's network and DTI's network. DTI will be able to offer this service
because (i) its network will be physically interconnected with major IXC POPs in
a region, (ii) the DTI network will typically be interconnected through its own
or leased facilities to major ILEC access tandems in a region, and (iii) the DTI
network will integrate high capacity switches. Currently, IXCs have to provide
for the transport between each of their POPs and from each of those POPs to each
of the access tandems in the areas adjacent to such POPs, which can involve the
use of multiple networks and carriers. DTI believes that its method of
transporting an IXC's traffic directly to access tandems would be attractive to
an IXC because it should (i) reduce the administrative burden on the IXC of
terminating such calls, because the IXC will have to contract with only one
carrier to reach the ILEC access tandems, (ii) result in greater reliability,
because the calls are transported over a newer system, with fewer potential
points of failure, and (iii) result in greater accountability, because fewer
telecommunications companies may be involved in the delivery of such traffic.
The Company expects that it would charge the IXC on a per-optical window,
per-mile basis.
Dedicated Bandwidth Services. Through its other wholesale network capacity
agreements, also referred to as dedicated bandwidth agreements, the Company
provides carriers with bandwidth capacity on the DTI network in increments of
less than a full OC-48 optical window, such as a DS-3. The carrier customer in a
dedicated bandwidth agreement does not have exclusive use of any particular
strand of fiber or wavelength, but instead has the right to transmit a certain
amount of bandwidth between two points along the DTI network. The carrier
customer provides a telecommunications signal to DTI, and DTI provides all fiber
and electronic equipment necessary to transmit the signal to the end point. This
capacity may or may not be along a DTI regional ring providing redundancy.
Dedicated bandwidth agreements typically have terms ranging from five to 20
years, require the customer to pay for such capacity regardless of the level of
usage, and require fixed monthly payments or a combination of advance payments
and subsequent monthly payments over the term of the agreement. DTI offers some
customers the right to switch their service from dedicated bandwidth agreements
to IRUs. DTI customers with dedicated bandwidth agreements include AT&T, MCI
WorldCom and Ameritech Cellular.
IRUs. Through IRUs, the Company provides carrier customers specified
strands of optical fiber, (which are used exclusively by the carrier customer),
while the carrier customers are responsible for providing the electronic
equipment necessary to transmit communications along the fiber. IRUs, which are
accounted for as operating leases, typically have terms of 10 to 20 years and
require substantial advance payments and additional fixed annual maintenance
payments over the term of the agreement. Uses of IRUs by an IXC are the same as
those for optical windows or dedicated bandwidth agreements, but permit a
customer to use its own electronic equipment to light up the fibers at any level
of capacity it chooses. DTI's IRU customers include IXC Communications,
Sprint/United Telephone and MCI WorldCom.
Other Wholesale Services. DTI offers its end-user services on a wholesale
basis to other carriers for resale. For example, a private line could be leased
to an IXC to transmit the traffic of its large business customers, which are
located on, or near the DTI network from the premises of such customers to the
IXC's POPs, using the DTI network exclusively. In addition, upon the
installation of its high-capacity switches at strategic points on the DTI
network, the Company in the future will have the capacity to provide wholesale
local switched services to its carrier customers.
End-User Services. End-user services are telecommunications services
provided to business and governmental end-users. The Company currently provides
private line services connecting certain points on a given end-user's private
telecommunications network and in the past has established connections between
such private network and the facilities of that end-user's long distance service
provider.
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Private Line Services. A private line is an unswitched, generally
non-exclusive, lighted telecommunications transmission circuit used to transport
data, voice and video communications. The customer may use a private line for
communications between otherwise unconnected points on its internal network or
to connect its facilities to a switched IXC. Private line calls are generally
routed by a customer through the customer's Private Branch Exchange ("PBX")
facilities to a receiving terminal on DTI's network. DTI then transmits the
signals over the DTI network to the customer's terminal in the call recipient's
area or to the POP for the customer's long distance provider. For example, the
Company has established private line bypass services for a major hospital in the
St. Louis metropolitan area. The Company's current private line service
agreements have terms ranging from three to 40 years and typically require a
one-time installation charge as well as fixed monthly payments throughout the
term of the agreement regardless of level of usage.
Sales and Marketing
The Company's sales and marketing staff is currently organized into two
groups: carrier's carrier services and end-user services. DTI currently has one
person focusing solely on carrier's carrier services and two direct sales and
marketing personnel pursuing sales of end-user services. Sales personnel are
compensated through a combination of salary and commissions. The Company plans
to significantly expand its sales and marketing activities. The Company
currently has sales offices in St. Louis and Springfield. DTI also plans to hire
additional personnel (not including additional carrier's carrier and end-user
sales personnel) to form a separate marketing force to implement its marketing
strategies.
Carrier's Carrier Services. DTI's carrier's carrier services are marketed
and sold to facilities-based and nonfacilities-based carriers that require
capacity in the form of IRUs and wholesale network capacity agreements to
provide added capacity in markets they currently serve, bridge geographic gaps
in their facilities or require geographically different routing of their long
distance or local traffic. The Company relies on direct selling to other
carriers on a wholesale basis. DTI's sales efforts also emphasize providing
continued customer support services to its existing customers. The Company
intends to distinguish itself in the carrier's carrier market on the basis of
pricing, quality, availability of capacity and flexibility and range of
services.
End-User Services. Through its direct sales personnel, DTI markets and
sells its end-user services to business and governmental end-users that require
private line services among multiple office sites or data centers and between
the end-user's private network and its long distance provider. End-user sales
generally are project-driven and typically involve sales cycles of two to six
months. For customers that are not located on the local rings of the DTI
network, the Company will consider leasing circuits from the local ILEC or other
telecommunications company or, if necessary, build out its network directly to
such customers. DTI does not currently anticipate offering switched long
distance services under a Company brand. The Company intends to distinguish
itself to end-users on the basis of pricing, customer responsiveness and
creative product implementation.
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Competition
The telecommunications industry is highly competitive. The Company competes
and, as it expands its network, expects to continue to compete with numerous
established facilities-based IXCs, ILECs and CLECs. Many of these competitors
have substantially greater financial and technical resources, long-standing
relationships with their customers and the potential to subsidize competitive
services from less competitive service revenues. DTI is aware that other
facilities-based providers of local and long distance telecommunications
services are planning and constructing additional networks that, if and when
completed, could employ advanced fiber optic technology similar to, or more
advanced than, the DTI network. Such competing networks may also have operating
capability similar to, or more advanced than, that of the DTI network and be
positioned geographically to compete directly with the DTI network for many of
the same customers along a significant portion of the same routes. Unlike
certain of the Company's competitors, who are constructing or have announced
plans to construct nationwide fiber optic networks, DTI is deploying a network
design that it believes will allow it to address secondary and tertiary markets
located along the DTI network's regional rings, which markets the Company
believes are underserved by existing carriers and are not expected to be the
primary targets of such newly constructed long distance networks.
The Company competes primarily on the basis of price, transmission quality,
reliability and customer service and support. Prices have been declining and are
expected to continue to do so. The Company's competitors in carrier's carrier
services include many large and small IXCs including AT&T, MCI WorldCom, Sprint,
IXC Communications, Qwest and McLeod. The Company competes with both LECs and
IXCs in its end-user business. In the end-user private line services market, the
Company's principal competitors are SBC, GTE and Sprint/United Telephone. In the
local exchange market, the Company expects to face competition from ILECs and
other competitive providers, including non-facilities based providers, and, as
the local markets become opened to IXCs under the Telecom Act, from long
distance providers. See "--Regulatory Matters."
Some major long distance and local telecommunications service providers
have also recently indicated a willingness to consolidate their operations to
offer a joint long distance and local package of telecommunications services.
MCI WorldCom, together with its wholly-owned subsidiaries MFS, Brooks Fiber, and
MCImetro, currently provides both local exchange and long distance
telecommunications services throughout the United States. Unlike MCI WorldCom,
however, DTI's network is designed to reach secondary and tertiary markets,
which are substantially bypassed by MCI WorldCom's long-haul and local exchange
networks. Qwest, a communications provider building a coast-to-coast fiber optic
network in the United States, completed its merger with LCI International, Inc.,
a retail long distance provider, becoming the nation's fourth largest long
distance company. In addition, AT&T announced its agreement to acquire TCG, a
facilities-based CLEC with networks in operation in 57 markets in the United
States, and SBC has announced agreements to acquire Ameritech, one of the
original seven RBOCs, and SNET. Bell Atlantic Corporation has also announced its
agreement to acquire GTE. Further, Qwest, a communications provider building a
18,449-mile fiber optic network in the United States, announced its agreement to
acquire LCI International Inc., a retail long distance provider, which
acquisition would create the nation's fifth largest long distance company. The
Company also believes that high initial network cost and low marginal costs of
carrying long distance traffic have led to a trend among non-facilities-based
carriers to consolidate in order to achieve economies of scale. Such
consolidation among significant telecommunications carriers could result in
larger, better-capitalized competitors that can offer a "one-stop shopping"
combination of long distance and local switched services in many of DTI's target
markets
Certain companies, such as Level 3 Communications, Inc., have recently
announced efforts to use Internet technologies to supply telecommunications
services, potentially leading to a lower cost of supplying these services and
therefore increased pressure on IXCs and other telecommunications companies to
reduce their prices. There can be no assurance that the Company's IXC and other
carrier customers will not experience substantial decreases in call volume or
pricing due to competition from Internet-based telecommunications, which could
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lead to a decreased need for the Company's services, or a reduction in the
amount these companies are willing or able to pay for the Company's services.
There can also be no assurance that the Company will be able to offer its
telecommunications services to end-users at a price that is competitive with the
Internet-based telecommunications services offered by these companies. The
Company does not currently market to ISPs and therefore may not realize any
revenues from the Internet-based telecommunications market. If the Company does
commence marketing to ISPs there can be no assurance that it will be able to do
so successfully, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
In addition to IXCs and LECs, entities potentially capable of offering
local switched services in competition with the DTI network include cable
television companies, such as Tele-Communications, Inc. ("TCI") which is the
second largest cable television company in the United States and has agreed to
be acquired by AT&T, electric utilities, microwave carriers, wireless telephone
system operators and large subscribers who build private networks. Previous
impediments to certain utility companies entering telecommunications markets
under the Public Utility Holding Company Act of 1935 were also removed by the
Telecom Act, at the same time creating both a new competitive threat and a
source of strategic business and customer relationships for DTI.
In the future, the Company may be subject to more intense competition due
to the development of new technologies, an increased supply of transmission
capacity, the consolidation in the industry among local and long distance
service providers and the effects of deregulation resulting from the Telecom
Act. The telecommunications industry is experiencing a period of rapid
technological evolution, marked by the introduction of new product and service
offerings and increasing satellite transmission capacity for services similar to
those provided by the Company. For instance, recent technological advances
permit substantial increases in transmission capacity of both new and existing
fiber, and certain companies have begun to deploy and use ATM network backbones
for both data and packetized voice transmission and announced plans to transport
interstate long distance calls via such voice-over-data technology. The
introduction of such new products or emergence of such new technologies may
reduce the cost or increase the supply of certain services similar to those
provided by the Company. The Company cannot predict which of many possible
future product and service offerings will be crucial to maintain its competitive
position or what expenditures will be required to profitably develop and provide
such products and services.
The Company believes its existing and planned rights-of-way along
interstate highway systems and public utility infrastructures have played and
could continue to play a significant role in achieving its business objectives.
However, there can be no assurance that competitors will not obtain rights to
use the same or similar rights-of-way for expansion of their communications
networks.
Many of the Company's competitors and potential competitors have financial,
personnel, marketing and other resources significantly greater than those of the
Company, as well as other competitive advantages. A continuing trend toward
business combinations and alliances in the telecommunications industry may
increase the resources available to DTI's competitors and create significant new
competitors. The ability of DTI to compete effectively will depend upon, among
other things, its ability to deploy the planned DTI network and to maintain high
quality services at prices equal to or below those charged by its competitors.
There can be no assurance that the Company will be able to compete successfully
with existing competitors or new entrants in the markets for carrier's carrier
and end-user services and any of the other services DTI plans to offer in the
future. Failure of the Company to do so would have a material adverse effect on
the Company's business, financial condition, results of operations and business
prospects.
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Regulatory Matters
General Regulatory Environment. The Company's operations are subject to
extensive Federal and state regulation. Carrier's carrier and end-user services
are subject to the provisions of the Communications Act of 1934, as amended,
including the Telecom Act, and the FCC regulations thereunder, as well as the
applicable laws and regulations of the various states, including regulation by
public utility commissions and other state agencies. Federal laws and FCC
regulations apply to interstate telecommunications, while state regulatory
authorities have jurisdiction over telecommunications both originating and
terminating within the state. The regulation of the telecommunications industry
is changing rapidly, and the regulatory environment varies substantially from
state to state. Moreover, as deregulation at the Federal level occurs, some
states are reassessing the level and scope of regulation that may be applicable
to telecommunications service providers, such as the Company. All of the
Company's operations are also subject to a variety of environmental, safety,
health and other governmental regulations. There can be no assurance that future
regulatory, judicial or legislative activities will not have a material adverse
effect on the Company, or that domestic regulators or third parties will not
raise material issues with regard to the Company's compliance or noncompliance
with applicable regulations.
A recent Federal legislative change, the Telecom Act, may have potentially
significant effects on the operations of the Company. The Telecom Act, among
other things, allows the RBOCs to enter the long distance business after meeting
certain competitive market conditions, and enables other entities, including
entities affiliated with power utilities and ventures between ILECs and cable
television companies, to provide an expanded range of telecommunications
services. The General Telephone Operating Companies may enter the long distance
markets without meeting these FCC criteria. Entry of such companies into the
long distance business would result in substantial competition for carrier's
carrier service customers, and may have a material adverse effect on the Company
and such customers. However, the Company believes the RBOCs' and other
companies' participation in the market will provide opportunities for the
Company to lease dark fiber or sell wholesale network capacity.
Under the Telecom Act, the RBOCs may immediately provide long distance
service outside those states in which they provide local exchange service
("out-of-region" service), and long distance service within the regions in which
they provide local exchange service ("in-region" service) upon meeting certain
conditions. The General Telephone Operating Companies may enter the long
distance market without regard to limitations by region. The Telecom Act does,
however, impose certain restrictions on, among others, the RBOCs and General
Telephone Operating Companies in connection with their provision of long
distance services. Out-of-region services by RBOCs are subject to receipt of any
necessary state and/or Federal regulatory approvals that are otherwise
applicable to the provision of intrastate and/or interstate long distance
service. In-region services by RBOCs are subject to specific FCC approval and
satisfaction of other conditions, including a checklist of pro-competitive
requirements.
On December 31, 1997, the United States District Court for the Northern
District of Texas (the "SBC Court"), overturned as unconstitutional the
provisions of the Telecom Act which prohibited RBOCs from providing inter-LATA
long distance services within their own region without demonstrating that the
local exchange market was opened to local competition. The decision, however,
affected only SBC Communications, Inc. and U.S. West, Inc. On January 2, 1998,
AT&T, MCI and other intervenors in the SBC Court proceeding filed a petition for
stay with the SBC Court. On January 5, 1997, the FCC also filed a petition for
stay of the decision in the SBC Court. On February, 11, 1998, the SBC Court
temporarily stayed its December 31st decision which stay placed those provisions
of the Telecom Act which had been found unconstitutional back into effect and
foreclosed, temporarily, the RBOCs from providing inter-LATA long distance
service within their own service regions without FCC approval. On September 4,
1998, the U.S. Court of Appeals for the Fifth Circuit ("Fifth Circuit Court")
found that Section 271 through 275 of the Telecom Act were constitutional, and
reversed the SBC Court's ruling. SBC has not decided whether to appeal the
ruling to the U.S. Supreme Court.
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On March 20, 1998, on reconsideration, the U.S. Court of Appeals for the
District of Columbia Circuit ("D.C. Circuit") upheld the FCC's ruling which
rejected the application of SBC Communications to offer long-distance in-region
service. The FCC also has rejected Ameritech's request to provide long-distance
in-region service in Michigan and BellSouth's requests to provide long-distance
in-region service in South Carolina and Louisiana. On July 9, 1998, BellSouth
re-filed its request to provide long distance in-region service in Louisiana,
which request remains pending before the FCC. On September 25, 1998, a
three-judge panel of the D.C. Circuit heard argument challenging the FCC's
denial of Bell South Corp.'s to provide interLATA service in South Carolina. In
addition, in response to petitions of mandamus filed by the Iowa Utilities Board
and other petitioners, the U.S. Court of Appeals for the Eighth Circuit (the
"Eighth Circuit"), on January 22, 1998, ordered the FCC to abide by the SBC
Court's mandate and refrain from subsequent attempts to apply either directly or
indirectly the FCC's vacated pricing policies and to confine its consideration
of whether a RBOC has complied with the pricing methodology and rules adopted by
state commission and in effect in the respective states in which such RBOC seeks
to provide in-region, interLATA services for Section 271 purposes.
On September 28, 1998, the FCC barred U S West and Ameritech from marketing
long distance service on behalf of Qwest Communications, Inc. ("Qwest"). The FCC
found that the arrangements which permitted the RBOCs to collect fees for
referring customers to Qwest violated the Telecom Act. U S West stated that it
will appeal the FCC's ruling. Ameritech has not determined its course of action.
The RBOCs may provide in-region long distance services only through
separate subsidiaries with separate books and records, financing, management and
employees, and all affiliate transactions must be conducted on an arm's length
and nondiscriminatory basis. The RBOCs are also prohibited from jointly
marketing local and long distance services, equipment and certain information
services unless competitors are permitted to offer similar packages of local and
long distance services in their market. Further, the RBOCs must obtain in-region
long distance authority before jointly marketing local and long distance
services in a particular state. Additionally, AT&T and other major carriers
serving more than 5% of presubscribed long distance access lines in the United
States are also restricted from packaging other long distance services and local
services provided over RBOC facilities. The General Telephone Operating
Companies are subject to the provisions of the Telecom Act that impose
interconnection and other requirements on ILECs. General Telephone Operating
Companies providing long distance services must obtain regulatory approvals
otherwise applicable to the provision of long distance services.
Federal Regulation. The FCC classifies the Company as a non-dominant
carrier. Generally, the FCC has chosen not to exercise its statutory power to
closely regulate the charges, practices or classifications of non-dominant
carriers. However, the FCC has the power to impose more stringent regulation
requirements on the Company and to change its regulatory classification. In the
current regulatory atmosphere, the Company believes the FCC is unlikely to do so
with respect to the Company's service offerings.
The FCC regulates many of the charges, practices and classifications of
dominant carriers to a greater degree than non-dominant carriers. Among domestic
carriers, large ILECs and the RBOCs are currently considered dominant carriers
for the provision of interstate access services, while all other interstate
service providers are considered non-dominant carriers. On April 18, 1997, the
FCC ordered that the RBOCs and independent CLECs offering domestic interstate
inter-LATA services, in-region or out-of-region, be regulated as non-dominant
carriers. However, such services offered in-region must be offered in compliance
with the structural separation requirements mentioned above. AT&T was classified
as a dominant carrier, but AT&T successfully petitioned the FCC for non-dominant
status in the domestic interstate interexchange market in October 1995 and in
the international market in May 1996. Therefore, certain pricing restrictions
that once applied to AT&T have been eliminated. A number of parties have,
however, sought the FCC's reconsideration of AT&T's status. The Company is
unable to predict the outcome of these proceedings on its operations.
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As a non-dominant carrier, the Company may install and operate wireline
facilities for the transmission of domestic interstate communications without
prior FCC authorization, but must obtain all necessary authorizations from the
FCC for use of any radio frequencies. Non-dominant carriers are required to
obtain prior FCC authorization to provide international telecommunications;
however the Company currently does not and has no intent to provide
international services. The FCC also must provide prior approval of certain
transfers of control and assignments of operating authorizations. Non-dominant
carriers are required to file periodic reports with the FCC concerning their
interstate circuits and deployment of network facilities. The Company is
required to offer its interstate services on a nondiscriminatory basis, at just
and reasonable rates, and is subject to FCC complaint procedures. While the FCC
generally has chosen not to exercise direct oversight over cost justification or
levels of charges for services of non-dominant carriers, the FCC acts upon
complaints against such carriers for failure to comply with statutory
obligations or with the FCC's rules, regulations and policies. The Company could
be subject to legal actions seeking damages, assessment of monetary forfeitures
and/or injunctive relief filed by any party claiming to have been injured by the
Company's practices. The Company cannot predict either the likelihood of the
filing of any such complaints or the results if filed.
Under existing regulations, non-dominant carriers are required to file with
the FCC tariffs listing the rates, terms and conditions of both interstate and
international services provided by the carrier. On October 29, 1996, the FCC
adopted an order in which it eliminated, as of September 1997, the requirement
that non-dominant interstate carriers such as the Company maintain tariffs on
file with the FCC for domestic interstate services, and in fact prohibited the
filing of such tariffs. Such carriers were given the option to cease filing
tariffs during a nine-month transition period that concluded on September 22,
1997. The FCC's order was issued pursuant to authority granted to the FCC in the
Telecom Act to "forbear" from regulating any telecommunications service provider
if the FCC determines that the public interest will be served. However, on
February 19, 1997, the D.C. Circuit suspended the FCC's order pending further
expedited judicial review and/or FCC reconsideration. In August 1997, the FCC
issued an order on reconsideration in which it affirmed its decision to impose
complete or mandatory detariffing, although it decided to allow optional or
permissive tariffing in certain limited circumstances (including interstate,
domestic, interexchange dial-around services, which end-users access by dialing
a carrier's 10XXX access code). Several parties filed petitions for further
consideration and three parties have filed petitions for review of order on
reconsideration in the D.C. Circuit. This order also remains subject to the D.C.
Circuit's stay pending further judicial review. The Company cannot predict the
ultimate outcome of this or other proceedings on its service offerings or
operations.
On May 8, 1997, the FCC released an order intended to reform its system of
interstate access charges to make that regime compatible with the
pro-competitive deregulatory framework of the Telecom Act. Access service is the
use of local exchange facilities for the origination and termination of
interexchange communications. The FCC's historic access charge rules were
formulated largely in anticipation of the 1984 divestiture of AT&T and the
emergence of long distance competition, and were designated to replace piecemeal
arrangements for compensating ILECs for use of their networks for access, to
ensure that all long distance companies would be able to originate and terminate
long distance traffic at just, reasonable, and non-discriminatory rates, and to
ensure that access charge revenues would be sufficient to provide certain levels
of subsidy to local exchange service. While there has been pressure on the FCC
historically to revisit its access pricing rules, the Telecom Act has made
access reform timely. The FCC's recent access reform order adopts various
changes to its rules and policies governing interstate access service pricing
designed to move access charges, over time, to more economically efficient
levels and rate structures. Among other things, the FCC modified rate structures
for certain non-traffic sensitive access rate elements, moving some costs from a
per-minute-of-use basis to flat-rate recovery, including one new flat rate
element; changed its structure for interstate transport services; and affirmed
that ISPs may not be assessed interstate access charges. In response to claims
that existing access charge levels are excessive, the FCC stated that it would
rely on market forces first to drive prices for interstate access to levels that
would be achieved through competition but that a "prescriptive" approach,
specifying the nature and timing of changes to existing access rate levels,
might be adopted in the absence of competition. On August 19, 1998, the Eighth
Circuit upheld the FCC's decision in regard to interstate access charges. Though
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the Company believes that access reform through lowering and/or eliminating
excessive access services charges will have a positive effect on its services
offerings and operations, it cannot predict how or when such benefits may
present themselves, or the outcome of additional judicial appeals or pending
petitions for FCC reconsideration.
On August 1, 1996, the FCC adopted an order in which it attempted to adopt
a framework of minimum, national rules to enable the states and the FCC to
implement the local competition provisions of the Telecom Act. This order
included pricing rules that apply to state commissions when they are called on
to arbitrate rate disputes between ILECs and entities entering the local
telephone market. The order also included rules addressing the three paths of
entry into the local telephone market. Several parties filed appeals of the
order, which were consolidated in the Eighth Circuit. On October 15, 1996, the
U.S. Court of Appeals for the Eighth Circuit issued a stay of the implementation
of certain of the FCC's rules and on July 18, 1997, the Court issued its
decision finding that the FCC lacked statutory authority under the Telecom Act
for certain of its rules. In particular, the Court found that the FCC was not
empowered to establish the pricing standards governing unbundled local network
elements or wholesale local services of the ILECs. The Court also struck down
other FCC rules, including one that would have enabled new entrants to "pick and
choose" from provisions of established interconnection agreements between the
ILECs and other carriers. The Court rejected certain other objections to the FCC
rules brought by the ILECs or the states, including challenges to the FCC's
definition of unbundled elements, and to the FCC's rules allowing new
competitors to create their own networks by combining ILEC network elements
together without adding additional facilities of their own. On October 14, 1997,
the Eighth Circuit ruled in favor of those ILECs and substantially modified its
July 18, 1997 decision. The Eighth Circuit ruled that ILECs cannot be compelled
to "combine" two or more unbundled elements into "platforms" or combinations,
finding that IXCs must either combine the elements themselves, or purchase
entire retail services at the applicable wholesale discounts if they wish to
offer local services to their customers. The latter omission was the subject of
petitions for reconsideration filed with the Eighth Circuit by ILECs. On August
10, 1998, the Eighth Circuit upheld the FCC's determination that ILECs have the
duty to provide unbundled access to "shared transport" as a network element. On
September 24, 1998, GTE Corporation, SBC Communications, Inc., Ameritech
Corporation, Bell Atlantic Corporation, and U.S. West, among others, asked the
Eighth Circuit to reconsider its August 10, 1998 ruling.
The overall impact of the Eighth Circuit's decisions is to materially
reduce the role of the FCC in fostering local competition, including its ability
to take enforcement action if the Telecom Act is violated, and increase the role
of state utility commissions. The Supreme Court recently announced that it would
review the Eighth Circuit's decision. Meanwhile, certain state commissions have
asserted that they will be active in promoting local telephone competition using
the authority they have under the ruling, lessening the significance of the
reduced FCC role. At this time the impact of the Eighth Circuit's decisions
cannot be evaluated, but there can be no assurance that the Eighth Circuit's
decisions and related developments will not have a material adverse effect on
the Company. Furthermore, other FCC rules related to local telephone competition
remain the subject of legal challenges, and there can be no assurance that
decisions affecting those rules will not be adverse to companies seeking to
enter the local telephone market.
The FCC also released a companion order on universal service reform on May
8, 1997. The universal availability of basic telecommunications service at
affordable prices has been a fundamental element of U.S. telecommunications
policy since enactment of the Communications Act of 1934. The current system of
universal service is based on the indirect subsidization of ILEC pricing, funded
as part of a system of direct charges on some ILEC customers, including
interstate telecommunications carriers such as the Company, and above-cost
charges for certain ILEC services such as local business rates and access
charges. In accordance with the Telecom Act, the FCC adopted plans to implement
the recommendations of a Federal-State Joint Board to preserve universal
service, including a definition of services to be supported, and defining
carriers eligible for contributing to and receiving from universal service
subsidies. The FCC ruled, among other things, that: contributions to universal
service funding be based on all interstate telecommunications carriers' gross
revenues from both interstate and international telecommunications services;
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only common carriers providing a full complement of defined local services be
eligible for support; and up to $2.25 billion in new annual subsidies for
discounted telecommunications services used by schools, libraries, and rural
health care providers be funded by an assessment on total interstate and
intrastate revenues of all interstate telecommunications carriers. The FCC,
however, for the period January 1, 1998 through June 30, 1999, has placed a
$1.925 billion cap on funds to be collected and disbursed with no carryover of
unused funding authority to subsequent fiscal years. The FCC has initiated a
proceeding to obtain comments on the mechanism for continued support of
universal service in high cost areas in a subsequent proceeding. The Company is
unable to predict the outcome of these proceedings or of any judicial appeal or
petition for FCC reconsideration on its operations.
On April 11, 1997, the FCC released an order requiring that all carriers
transition from three-digit to four-digit Carrier Identification Codes ("CICs")
by January 1, 1998. CICs are the suffix of a carrier's Carrier Access Code
("CAC"), and the transition will expand CACs from five (10XXX) to seven digit
(101XXXX). These codes permit customers to reach their carrier of choice from
any telephone. In response to petitions for reconsideration of this design,
arguing in part that this short transition (following the FCC's proposal for a
six year transition) does not permit carriers sufficient time to make necessary
hardware and software upgrades or to educate their customers regarding the need
to dial additional digits to reach their carrier of choice, on October 20, 1997,
the FCC modified its decision. The FCC created a "two step" end to the
transaction in which three and four digit Feature Group D CICs co-exist. By
January 1, 1998, all LECs that provide equal access must have completed switch
changes to recognize four digit CICs (First Phase). The second phase ended June
30, 1998 on which date only four digit CICs and seven digit CACs will be
recognized. The FCC, however, released a declaratory ruling on May 1, 1998 which
clarified that blocking of three-digit CICs must not begin until July 1, 1998
and granted all LECs a waiver to permit the phase-in of three-digit CICs over
two months beginning July 1, 1998 and ending September 1, 1998.
On October 25, 1994, Congress enacted the Communications Assistance for Law
Enforcement Act ("CALEA"), which requires telecommunications carriers to modify
their equipment, facilities and services to ensure that they are able to comply
with authorized electronic surveillance. On March 3, 1998, the Federal Bureau of
Investigation issued its Final Notice of Capacity. Actual carrier capacity
compliance is mandated as of October 25, 1998, with maximum carrier capacity
compliance is effective March 12, 2001. For wireline carriers, counties have
been selected as the appropriate geographic basis for expressing interception
capacity requirements for telecommunications carriers offering local exchange
service. Over 66 percent of all counties have an actual capacity requirement of
two, and a maximum capacity requirement of three, simultaneous interceptions.
Approximately 90 percent of all counties have an actual capacity requirement of
12 or less, and a maximum capacity requirement of 16, simultaneous interceptions
or less. Telecommunications carriers may be reimbursed by the government for
certain reasonable costs directly associated with achieving CALEA. The FCC has
not taken final action in the CALEA proceeding and the Company is unable to
predict the outcome to the proceeding on its operations.
The FCC also recently has commenced a proceeding to determine methods by
which Telecommunications Relay Services ("TRS") for persons with hearing and
speech disabilities may be improved. Currently, interstate common carriers are
required to contribute to the TRS fund for provision of services to hearing and
speech disabled persons. The FCC tentatively concluded that within two years of
the publications of the final rules in the proceeding, all common carriers
providing voice transmission services must ensure that speech-to-speech relay
services are available to callers with speech disabilities in their service
areas. The Company is unable to predict the outcome to the proceeding on its
operations.
As a facilities-based, switched LEC, the Company will be required to comply
with local number portability rules and regulations. Compliance may require
changes in the Company's business processes and support systems and may impact
its call processing.
State Regulation. The Company is also subject to various state laws and
regulations. Most public utilities commissions require providers such as the
Company to obtain authority from the commission prior to the initiation of
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service. In most states, the Company also is required to file tariffs setting
forth the terms, conditions and prices for services that are classified as
intrastate and, in some cases, interstate. The Company also is required to
update or amend its tariffs when it adjusts its rates or adds new products, and
is subject to various reporting and record-keeping requirements.
Many states also require prior approval for transfers of control of
certified carriers, corporate reorganizations, acquisitions of
telecommunications operations, assignment of carrier assets, carrier stock
offerings and incurrence by carriers of significant debt obligations.
Certificates of authority can generally be conditioned, modified, canceled,
terminated or revoked by state regulatory authorities for failure to comply with
state law and/or the rules, regulations and policies of state regulatory
authorities. Fines or other penalties also may be imposed for such violations.
There can be no assurance that state utilities commissions or third parties will
not raise issues with regard to the Company's compliance with applicable laws or
regulations.
The Company has all necessary authority to offer local and interstate and
intrastate long-haul services in Missouri. The Company is authorized to provide
intrastate long-haul service in Illinois. The Company has been deemed to be a
"telecommunications utility" in Kentucky, and expects to receive authority to
offer local and interstate and intrastate long haul services in Arkansas, Iowa,
Kansas, and Oklahoma within the next 90 to 120 days. The Company will seek
authority in other states as and when needed as a result of its network
build-out.
Many issues remain open regarding how new local telephone carriers will be
regulated at the state level. For example, although the Telecom Act preempts the
ability of states to forbid local service competition, the Telecom Act preserves
the ability of states to impose reasonable terms and conditions of service and
other regulatory requirements. However, these statutes and related questions
arising from the Telecom Act will be elaborated through rules and policy
decisions made by PUCs in the process of addressing local service competition
issues.
The Company also will be heavily affected by state PUC decisions related to
the ILECs. For example, PUCs have significant responsibility under the Telecom
Act to oversee relationships between ILEC's and their new competitors with
respect to such competitors' use of the ILEC's network elements and wholesale
local services. PUCs arbitrate interconnection agreements between the ILECs and
new competitors such as the Company when necessary. PUCs are considering ILEC
pricing issues in major proceedings now underway. PUCs will also determine how
competitors can take advantage of the terms and conditions of interconnection
agreements that ILECs reach with other carriers. It is too early to evaluate how
these matters will be resolved, or their impact on the ability of the Company to
pursue its business plan.
States also regulate the intrastate carrier's carrier services of the
ILECs. The Company is required to pay such access charges to originate and
terminate its intrastate long distance traffic. The Company could be adversely
affected by high access charges, particularly to the extent that the ILECs do
not incur the same level of costs with respect to their own intrastate long
distance services. A related issue is use by certain ILECs, with the approval of
PUCs, of extended local area calling that converts otherwise competitive
intrastate toll service to local service. States also are or will be addressing
various intraLATA dialing parity issues that may affect competition. It is
unclear whether state utility commissions will adopt changes in their rules
governing intrastate access charges similar to those recently approved by the
FCC for interstate access or whether the outcome of currently pending litigation
will give PUCs the power to set such access charges. The Company's business
could be adversely affected by such changes.
The Company also will be affected by how states regulate the retail prices
of the ILECs with which it competes. The Company believes that, as the degree of
intrastate competition increases, the states will offer the ILECs increasing
pricing flexibility. This flexibility may present the ILECs with an opportunity
to subsidize services that compete with the Company's services with revenues
generated from non-competitive services, thereby allowing ILECs to offer
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<PAGE>
competitive services at lower prices than they otherwise could. The Company
cannot predict the extent to which this may occur or its impact on the Company's
business.
Those states that permit the offering of intrastate/intra-LATA service by
IXCs generally require that end-users desiring to use such services dial special
access codes. Regulatory agencies in a number of states have issued decisions
that would permit the Company and other IXCs to provide intra-LATA calling on a
1 + basis. Further, the Telecom Act requires in most cases that the RBOCs
provide such dialing parity coincident to their providing in-region inter-LATA
services. The Company expects to benefit from the ability to offer 1 +
intra-LATA services in states that allow this type of dialing parity.
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<PAGE>
Item 2. Properties
The Company's network in progress and its fiber optic cable, transmission
equipment and other component assets are the principal properties owned by the
Company. The Company's installed fiber optic cable is laid under the various
rights-of-way held by the Company. Other fixed assets are located at various
leased locations in geographic areas served by the Company. The Company believes
that its existing properties are adequate to meet its anticipated needs in the
markets in which it has deployed or begun to deploy the DTI network and that
additional facilities are and will be available to meet its development and
expansion needs in existing and planned markets for the foreseeable future.
The Company's principal executive offices and its Network Operations Center
are located at 8112 Maryland Avenue, 4th Floor, St. Louis, Missouri 63105, and
its telephone number is (314) 253-6600. The Company also leases additional
office and equipment space in St. Louis, Missouri from Mr. Weinstein at market
rates under an agreement that expires on December 31, 1998. See "Certain
Relationships and Related Transactions." The Company is also constructing
network operations facilities in Kansas City, Missouri.
Item 3. Legal Proceedings
On June 20, 1995, the Company and Mr. Weinstein were named as defendants in
a suit brought in the Circuit Court of St. Louis County, Missouri, in a matter
styled Alfred H. Frank v. Richard D. Weinstein and Digital Teleport, Inc. The
plaintiff alleges that (i) he entered into an oral contract with the defendants
pursuant to which he was to receive 40% of the Common Stock, (ii) he provided
services to DTI, for which he was not and should be compensated, and (iii) the
defendants misrepresented certain facts to the plaintiff in order to induce him
to loan money and provide services to the defendants. Based on these
allegations, the plaintiff is suing for breach of contract, quantum meruit and
fraud and is seeking actual monetary damages, punitive damages and a percentage
of the common stock of the Company. The Company and Mr. Weinstein believe the
plaintiff's claims are without merit and intend to defend themselves vigorously.
It is not possible to determine what impact, if any, an unfavorable outcome
in the Frank litigation would have on the financial condition, results of
operations or cash flows of the Company. Mr. Weinstein has agreed personally to
indemnify DTI against any and all losses resulting from any judgments and awards
rendered against the Company in this litigation. Mr. Weinstein has also agreed
personally to indemnify KLT against any and all losses resulting from any
judgments and awards rendered against the Company in this litigation and has
pledged his Common Stock in the Company in favor of KLT to secure such
obligation. See "Certain Relationships and Related Transactions."
From time to time, the Company is named as a defendant in routine lawsuits
incidental to its business. Based on the information currently available, the
Company believes that none of such current proceedings, individually or in the
aggregate, will have a material adverse effect on the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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<PAGE>
Part II.
Item 5. Market for the Registrant's Common Stock and Related Shareholders
Matters
There is no existing trading market for the Company's common stock. As of
June 30, 1998, there was one holder of the Company's common stock. The Company
has never declared or paid cash dividends on its common stock. It is the
Company's present intention to retain all future earnings for use in its
business and, therefore, it does not expect to pay cash dividends on the common
stock in the foreseeable future. The declaration and payment of dividends on the
common stock is restricted by the terms of the Company's indebtedness under the
indenture pursuant to which the Company issued its Senior Discount Notes.
On February 23, 1998, the Company consummated a private placement in
reliance upon the exemption from registration under Section 4(2) of the
Securities Act of 1933, as amended (the "Securities Act"), pursuant to which the
Company issued and sold 506,000 units (the "Units") consisting of $506 million
aggregate principal amount at maturity of Senior Discount Notes and warrants to
purchase 3,926,560 shares of Common Stock (the "Warrants"). The Senior Discount
Notes were sold at an aggregate price of $275.2 million, and the Company
received approximately $264.7 million net proceeds, after deductions for
offering expenses. The Warrants were allocated a value of $10 million. The
Senior Discount Notes were initially purchased by Merrill Lynch, Pierce, Fenner
& Smith Incorporated, and TD Securities USA Inc and were resold in accordance
with Rule 144A and Regulation S under the Securities Act. On September 15, 1998,
the Company completed an exchange offering registered under the Securities Act,
of Series B Senior Discount Notes due 2008 in exchange for all outstanding
Senior Discount Notes. The form and terms of the Series B Senior Discount Notes
are identical in all material respects to those of the Senior Discount Notes,
except for certain transfer restrictions and registration rights relating to the
privately placed Senior Discount Notes and except for certain interest
provisions related to such registration rights. Together the Series B Senior
Discount Notes and the privately placed Senior Discount Notes are referred to
herein as the "Senior Discount Notes."
The Company used approximately $19 million of the $264.7 million net
proceeds of the Senior Discount Notes for construction of its fiber optic
telecommunications network and purchase of IRUs, with the remaining net proceeds
temporarily invested in certain short-term investment grade securities.
Through September 30, 1998, under its Incentive Award Plan, the Company
granted or became obligated to grant options to purchase an aggregate of
1,325,000 shares (net of 600,000 forfeited shares) of its Common Stock to
certain of its directors and key employees at exercise prices ranging from $2.60
to $6.66 per share. Such transactions were completed without registration under
the Securities Act in reliance on the exemption provided by Section 4(2) of the
Securities Act.
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<PAGE>
Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data presented below for each of the
four years in the period ended June 30, 1998 have been derived from the audited
consolidated financial statements of the Company. The selected consolidated
financial data as of and for the year ended June 30, 1994 has been derived from
the unaudited consolidated financial statements of the Company, which have been
prepared on the same basis as the audited consolidated financial statements of
the Company and, in the opinion of management, reflect all normal recurring
adjustments necessary for a fair presentation of the financial position and
results of operations as of the end of and for such periods. The information set
forth below should be read in conjunction with the discussion under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", "Business" and the audited consolidated financial statements of the
Company and notes thereto and other information included herein.
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<PAGE>
<TABLE>
Fiscal Year Ended June 30,
<S> <C> <C> <C> <C> <C>
1994(a) 1995(a) 1996(a) 1997 1998
Operating Statement Data:
Total revenues......................... $ 35,463 $ 199,537 $ 676,801 $ 2,033,990 $ 3,542,771
Operating expenses:
Telecommunication services........... -- 165,723 296,912 1,097,190 2,294,181
Other services....................... -- -- -- 364,495 --
Selling, general and administrative.. 15,781 240,530 548,613 868,809 3,668,540
Depreciation and amortization........ -- 70,500 425,841 757,173 2,030,789
Total operating expenses 15,781 476,753 1,271,366 3,087,667 7,993,510
Income (loss) from operations.......... 19,682 (277,216) (594,565) (1,053,677) (4,450,739)
Interest income (expense) - net........ (588) (9,516) (191,810) (798,087) (6,991,773)
Income (loss) before income tax benefit 19,094 (286,732) (786,375) (1,851,764) (11,442,512)
Income tax benefit..................... -- -- -- 1,214,331 2,020,000
Net income (loss) (e).................. $ 19,094 $ (286,732) $ (786,375) $ (637,433) $ (9,422,512)
Balance Sheet Data:
Cash and cash equivalents.............. $ 10,512 $ 140,220 $ 817,391 $ 4,366,906 $251,057,274
Network and equipment, net............. 39,032 6,788,582 13,064,169 34,000,634 77,771,527
Total assets........................... 57,844 11,983,497 15,025,758 39,849,136 342,865,160
Long-term debt......................... -- -- -- -- 277,455,859
Deferred revenues...................... 37,750 5,027,963 6,734,728 9,679,904 16,814,488
Redeemable Convertible Preferred Stock -- -- -- 28,889,165 --
(b)
Stockholders' equity (deficit) (b).... 19,094 (237,638) (1,100,703) (4,729,867) 41,958,122
Other Financial Data:
Cash flows from operations............. $ 49,544 $ 6,903,884 $ 299,710 $ 7,674,272 $ 10,555,957
Cash flows from investing activities (39,032) (11,804,176) (1,122,569) (19,417,073) (45,800,682)
Cash flows from financing activities... -- 5,030,000 1,500,030 15,292,316 281,935,093
EBITDA (c)............................. 19,682 (206,716) (168,724) (259,068) (2,419,950)
Capital expenditures................... 39,032 6,804,176 5,663,047 19,876,595 45,800,682
Ratio of earnings to fixed charges (d). -- -- -- -- --
</TABLE>
(a) Through June 30, 1996, the Company was considered a development stage
enterprise focused on developing the DTI network and customer base.
(b) On February 13, 1998, in conjunction with the Senior Discount Notes
Offering, the Company amended the terms of the Series A Preferred Stock to
provide that it is no longer mandatorily redeemable, and, as a result, the
Series A Preferred Stock has been classified with stockholders' equity.
(c) EBITDA represents net loss before interest income (expense), loan
commitment fees, income tax benefit, depreciation and amortization. EBITDA
is included because the Company understands that such information is
commonly used by investors in the telecommunications industry as an
additional basis on which to evaluate the Company's ability to pay
interest, repay debt and make capital expenditures. Excluded from EBITDA
are interest income (expense), loan commitment fees, income taxes,
depreciation and amortization, each of which can significantly affect the
Company's results of operations and liquidity and should be considered in
evaluating the Company's financial performance. EBITDA is not intended to
represent, and should not be considered more meaningful than, or an
alternative to, measures of operating performance determined in accordance
with generally accepted accounting principles ("GAAP"). Additionally,
EBITDA should not be used as a comparison between companies, as it may not
be calculated in a similar manner by all companies.
(d) For purposes of calculating the ratio of earnings to fixed charges: (i)
earnings consist of loss before income tax benefit, plus fixed charges
excluding capitalized interest; and (ii) fixed charges consist of interest
expenses and capitalized costs, amortization of deferred financing costs,
plus the portion of rentals considered to be representative of the interest
factor (one-third of lease payments). For the ended June 30, 1995, 1996 and
1997, and 1998 the Company's earnings were insufficient to cover fixed
charges by approximately $296,000, $2.0 million, $2.4 million, $2.5 million
and $11.4 million, respectively.
(e) Net loss attributable to Common Stock, loss per share data and weighted
average number of share outstanding are not meaningful as there was only
one common shareholder and no class of securities was registered.
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<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and the notes thereto and the
other financial data appearing elsewhere in this Prospectus.
Overview
DTI is a facilities-based communications company that is creating an
approximately 18,500 route mile digital fiber optic network comprised of 19
regional rings interconnecting primary, secondary and tertiary cities in 37
states. By providing high-capacity voice and data transmission services to and
from secondary and tertiary cities, the Company intends to become a leading
wholesale provider of regional communications transport services to IXCs and
other communications companies. DTI currently provides carrier's carrier
services under contracts with AT&T, Sprint, MCI WorldCom, Ameritech Cellular and
IXC Communications. The Company also provides private line services to targeted
business and governmental end-user customers. DTI is 50% owned by an affiliate
of Kansas City Power & Light Company ("KCPL"), which has agreed to be acquired
by Western Resources, Inc.
DTI was incorporated in June 1989. Until 1994, the Company was engaged
primarily in developing its business plan, planning its activities, and bidding
for and negotiating the following agreements with St. John's Hospital in St.
Louis, Missouri ("St. John's"), MHTC and Union Electric. Pursuant to a February
1994 agreement with St. John's, DTI commenced construction of a fiber optic
network to provide data communications services between St. John's facilities
within the St. Louis area. The Company subsequently established its network
control center in suburban St. Louis, which was then interconnected with the St.
John's routes. Following the execution of agreements with the MHTC in September
1994 and with Union Electric in October 1994, DTI began construction of a
long-haul route between St. Louis and Jefferson City, Missouri. This long-haul
route and its local portions enabled DTI to begin providing long haul and local
carrier's carrier services in 1996 to certain IXCs, including MCI and WorldCom.
During fiscal 1995 and 1996, DTI continued construction of its network,
primarily along the Missouri highway system to Kansas City and other Missouri
locations. DTI also entered into agreements with St. Louis metropolitan
municipalities and other secondary Missouri cities to obtain rights-of-way and
construct local loops in such areas. In July 1996, pursuant to its joint venture
agreement with KLT Telecom, Inc. ("KLT"), a subsidiary of KCPL, DTI commenced
construction of a fiber optic network in the Kansas City metropolitan area.
Since then the Company has been developing and executing its business plan
focusing on regional connectivity with access to secondary and tertiary markets,
in addition to certain primary markets.
Revenues. The Company derives revenues principally from (i) the sale of
wholesale telecommunications services, primarily through IRUs and wholesale
network capacity agreements, to IXCs, such as the Tier 1 carriers, and other
telecommunications entities and (ii) the sale of telecommunications services
directly to business and governmental end-users. For the year ended June 30,
1998, the Company derived approximately 87% and 13% of its total revenues from
carrier's carrier services and end-user services, respectively. Of the Company's
total carrier's carrier service revenues, approximately 82% and 18% related to
wholesale network capacity services and IRU agreements, respectively.
During the past several years, market prices for many telecommunications
services have been declining, which is a trend the Company believes will likely
continue. This decline has had and will continue to have a negative effect on
the Company's gross margin, which may not be offset by decreases in the
Company's cost of services. However, the Company believes that such decreases in
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<PAGE>
prices may be partially offset by increased demand for DTI's telecommunications
services as it expands the DTI network and introduces new services.
Carrier's carrier services are generally high capacity, private line
telecommunications services provided over the Company's owned facilities and
facilities obtained through long-term IRUs and, in locations where the DTI
network has not been extended or completed, over leased line capacity. Carrier's
carrier services generally are provided to (i) facilities-based carriers that
require transmission capacity where they have geographic gaps in their
facilities, need additional capacity or require alternative routing and (ii)
non-facilities-based carriers requiring transmission capacity. Carrier's carrier
is a wholesale business characterized by higher net margins than are typically
realized through end-user services primarily because carrier's carrier services
can be established more quickly and at a lower marketing cost than end-user
services.
DTI derives carrier's carrier services revenues from IRUs and wholesale
network capacity agreements. IRUs typically have a term of 10 to 20 years. The
Company provides wholesale network capacity services through service agreements
for terms of one year or longer which typically require customers to pay for
such capacity regardless of level of usage. IRUs, which are accounted for as
operating leases, generally require substantial advance payments and periodic
maintenance fees over the terms of the agreements. Advance payments are recorded
by the Company as deferred revenue and are then recognized on a straight-line
basis over the terms of the IRU agreements, as the Company has continuing
obligations to guarantee the performance of the fibers under such agreements.
These costs are potentially significant, and the Company cannot reasonably
estimate such costs over the terms of the IRU agreements due principally to the
limited history of operations of the Company to date, the long-term nature of
the agreements and the various possible causes of service disruption that the
Company must remedy pursuant to the agreements. Fixed periodic maintenance
payments are also recognized on a straight-line basis over the term of the
agreements as ongoing maintenance services are provided. Wholesale network
capacity agreements generally provide for a fixed monthly payment based on the
capacity and length of circuit provided and sometimes require substantial
advance payments. Advance payments and fixed monthly service payments are
recognized on a straight-line basis over the terms of the agreements, which
represent the periods during which services are rendered. For the years ended
June 30, 1997 and 1998, the Company's three largest carrier customers combined
accounted for an aggregate of 70% and 74%, respectively, of carrier's carrier
services revenues, or 28% and 65%, respectively, of total revenues. The terms of
these agreements are such that there are no stated obligations to return any of
the advance payments. The Company's contracts do provide for reduced future
payments and varying penalties for late delivery of route segments, and allow
the customers, after expiration of grace periods, to delete such non-delivered
segment from the system route to be delivered.
End-user services are telecommunications services provided directly to
businesses and governmental end-users. The Company currently provides private
line services to end-users to connect certain points on an end-user's private
telecommunications network as well as to bypass the applicable ILEC in accessing
such end-user's long distance provider. DTI end-user services agreements to date
have generally provided for services for a term of one year or longer and for a
fixed monthly payment based on the capacity and length of circuit provided,
regardless of level of usage. As of June 30, 1998, the Company has received
aggregate advance payments of approximately $18.1 million from certain of its
customers. Revenues from end-user services and carrier's carrier services are
recognized monthly as the services are provided, except with respect to advance
payments, for which revenues are deferred and recognized over the life of the
agreement on a straight-line basis. Upon expiration, such agreements may be
renewed or services may be provided on a month-to-month basis. For the year
ended June 30, 1997 and 1998, four customers accounted for all of DTI's end-user
services revenue, or an aggregate of 25% and 13%, respectively, of total
revenues.
In fiscal 1997, at the request of a specific carrier customer, the Company
designed, constructed and installed innerduct for such customer's own fiber
optic network. While the Company does not presently consider the provision of
such services to be part of its business strategy, it will consider such
opportunities as they arise. The Company expects that future revenues, if any,
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<PAGE>
from network construction services will not be a significant contributor to the
Company's overall revenues or results of operations.
Operating Expenses. The Company's principal operating expenses consist of
the cost of telecommunications services, selling, general and administrative
("SG&A") expenses, depreciation and amortization, and, in fiscal 1997, costs of
network construction services performed for a third party.
The cost of telecommunications services consists primarily of the cost of
leased line facilities and capacity, and operating costs in connection with its
owned facilities. Because the Company currently provides carrier's carrier and
end-user services principally over its own network, the cost of providing these
services includes a minor amount of leased space (in the form of physical
collocation at ILEC access tandems and IXC POPs) and leased line capacity (to
fill requirements of a customer contract which are otherwise substantially met
on the DTI network and typically where the Company plans to expand the DTI
network) and no ILEC access charges. However, leased space and maintenance costs
are expected to increase significantly as the Company intends to enter into
long-term IRUs to acquire certain routes in the planned DTI network. Further,
leased line capacity costs and access charges are expected to increase
significantly because the Company expects to obtain access to a greater number
of ILEC facilities through leased lines in order to reach end-users and access
tandems that cannot be cost-effectively connected to the DTI network in a given
local market. Operating costs include, but are not limited to, costs of managing
DTI's network facilities, technical personnel salaries and benefits,
rights-of-way fees, locating installed fiber to minimize the risk of fiber cuts
and property taxes.
SG&A expenses include the cost of salaries, benefits, occupancy costs,
sales and marketing expenses and administrative expenses. Selling expenses
include commissions for the Company's sales programs, which consist of a
percentage of a customer's initial billing, plus a residual percentage of
ongoing monthly revenues. The Company plans to add sales offices in selected
markets as additional segments of the DTI network become operational.
Depreciation and amortization are primarily related to fiber optic cable plant,
electronic terminal equipment and network buildings, and are expected to
increase as the Company incurs substantial capital expenditures to build and
acquire the components of the DTI network and begins to install its own
switches. In general, SG&A expenses have increased significantly as the Company
has developed and expanded the DTI network. The Company expects to incur
significant increases in SG&A expenses to realize the anticipated growth in
revenue for carrier's carrier services and end-user services. In addition, SG&A
expenses will increase as the Company continues to recruit experienced personnel
to implement the Company's business strategy.
Operating Losses. As a result of development and operating expenses, the
Company has incurred significant operating and net losses to date. Losses from
operations in fiscal 1996, 1997 and 1998 were $595,000, $1.1 million and $4.5
million, respectively. DTI may incur significant and possibly increasing
operating losses and expects to generate negative net cash flows after capital
expenditures during at least the next two years of the Company's expansion of
the DTI network. There can be no assurance that the Company will achieve or
sustain profitability or generate sufficient positive cash flow to meet its debt
service obligations and working capital requirements. If the Company cannot
achieve operating profitability or positive cash flows from operating
activities, it may not be able to service the Senior Discount Notes or to meet
its other debt service or working capital requirements, which could have a
material adverse effect on the Company.
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<PAGE>
Results of Operations
The table set forth below summarizes the Company's percentage of revenue by
source and operating expenses as a percentage of total revenues:
Fiscal Year Ended June 30,
1996 1997 1998
---------- --------- -------
Revenue:
Carrier's carrier services............. 27.8% 39.7% 86.8%
End-user services...................... 72.2 25.3 13.2
----- ----- --------
100.0 65.0 100.0
Other services......................... -- 35.0 --
------ ----- --------
Total revenue....................... 100.0% 100.0% 100.0%
===== ===== ========
Operating Expenses:
Telecommunications services............ 43.9% 54.0% 64.8%
Other services......................... -- 17.9 --
Selling, general and administrative... 81.0 42.7 103.6
Depreciation and amortization.......... 62.9 37.2 57.3
----- ----- --------
Total operating expenses............ 187.8% 151.8% 225.7%
===== ===== ========
Fiscal Year Ended June 30, 1997 Compared to Fiscal Year Ended June 30, 1998
Revenue. Total revenue increased 74.1% from $2.0 million in 1997 to $3.5
million in 1998 principally due to increased revenue from carrier's carrier
services. Revenue from carrier's carrier services increased 280.9% from $807,000
in 1997 to $3.1 million in 1998. This increase resulted principally from the
completion of additional network segments, as well as from adding traffic on the
existing DTI network. End-user revenues decreased 9.4% from $516,000 in 1997 to
$467,000 in 1998. This decrease was attributable to the expiration of a
customer's contract.
Operating Expenses. Operating expenses increased 158.9% from $3.1 million
in 1997 to $8.0 million in 1998, due primarily to increases in
telecommunications services, selling, general and administrative expenses and
depreciation and amortization. Telecommunications services expenses increased
109.1% from $1.1 million in 1997 to $2.3 million in 1998 due to increased
personnel to support the expansion of the DTI network, as well as increased
costs related to property taxes and other costs in connection with obtaining
leased capacity to support customers in areas not yet reached by the DTI
network. Selling, general and administrative expenses increased 322.2%, from
$869,000 in 1997 to $3.7 million in 1998, in order to support the expansion of
the DTI network, which includes an increase in administrative and sales
personnel and the related expenses of supporting these personnel, as well as
increased legal fees. Depreciation and amortization increased 168.2%, from
$757,000 in 1997 to $2.0 million in 1998 due to higher amounts of plant and
equipment being in service in 1998 versus 1997. The Company expects that
significant additional amounts of plant and equipment will be placed in service
throughout fiscal 1999 and fiscal 2000. As a result, depreciation and
amortization is expected to increase significantly.
Other Income (Expenses). Net interest and other income (expense) increased
from a net expense of $798,000 in 1997 to net expense of $7.0 million in 1998.
Interest income increased from $102,000 in 1997 to $5.1 million in 1998 due to
the investment of the proceeds from the Senior Discount Notes. Similarly, as a
result of the Senior Discount Notes, interest expense increased from $153,000 in
1997 to $12.1 million in 1998. Loan commitment fees decreased from $785,000 in
1997 to $-0- in 1998. These fees represented a one-time charge for a loan
commitment which was not used.
Income Taxes. An income tax benefit of $1.0 million and $2.0 million was
recorded in fiscal 1997 and 1998, respectively, as management believes it is
more likely than not that the Company will generate taxable income sufficient to
realize certain of the tax benefit associated with future deductible temporary
differences and net operating loss carryforwards prior to their expiration.
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<PAGE>
Net Loss. Net loss for the fiscal year ended 1997 was $637,000 compared to
$9.4 million for the fiscal year ended 1998.
Fiscal Year Ended June 30, 1996 Compared to Fiscal Year Ended June 30, 1997
Revenue. Revenue increased 200.5%, from $677,000 in 1996 to $2.0 million in
1997. This increase was due primarily to increased revenue from carrier's
carrier services, as well as significant income from other services. Revenue
from carrier's carrier services increased 328.5%, from $188,000 in 1996 to
$807,000 in 1997. This increase resulted principally from completion and
activation of additional route miles of the DTI network, which allowed the
Company to begin recognizing revenue under certain deferred agreements as assets
were placed in service for several IXCs and to sell additional capacity.
End-user services revenue increased 5.6%, from $488,000 in 1996 to $516,000 in
1997. Other services revenue of $711,000 in fiscal 1997 represented a single
contract for installation of innerduct for one of the Company's carrier
customers along the Company's right-of-way. The Company recorded $0 in other
service revenues in fiscal 1996, and other services are not expected to be a
recurring source of revenue for the Company in the future. However, the Company
will consider similar opportunities, should they become available in the future,
principally as a means of lowering the cost of expanding its network.
Operating Expenses. Operating expenses increased 142.9%, from $1.3 million
in 1996 to $3.1 million in 1997, due primarily to increases in
telecommunications services expenses, SG&A expenses, other services expenses,
and depreciation and amortization. Telecommunications services expenses
increased 270.0%, from $297,000 in 1996 to $1.1 million in 1997 due to the
expansion of the network and increased revenues from carrier's carrier services.
SG&A expenses increased 58.4%, from $549,000 in 1996 to $869,000 in 1997 to
support the Company's expansion. Other services expenses of $364,000 in 1997
represent the costs associated with a contract for the installation of innerduct
for one of the Company's carrier customers.
Depreciation and amortization increased 77.8%, from $426,000 in 1996 to
$757,000 in 1997 primarily due to additional plant and equipment being placed
into service. As of June 30, 1997, the Company had gross plant and equipment of
$35.2 million, of which $19.0 million (54%) consisted of construction in
progress that was not subject to depreciation.
Other Income (Expenses). Net interest and other expenses increased
$606,000, from $192,000 in 1996 to $798,000 in 1997. This increase was primarily
attributable to loan commitment fees of $785,000 incurred in connection with a
bridge loan commitment made available to the Company but not utilized as a
result of KLT's investment in the Company. Interest income decreased from
$193,000 in 1996 to $102,000 in 1997 because the Company carried smaller average
cash balances. Interest expense decreased from $385,000 in 1996 to $153,000 in
1997, as the Company issued its Series A Preferred Stock to finance, in part,
its network construction. The Company reported equity in earnings of a joint
venture of $37,000 in 1997. This joint venture was formed and its operations and
assets were combined with the Company's during the year ended June 30, 1997 in
connection with the issuance of Series A Preferred Stock to KLT.
Income Taxes. The Company incurred $0 of income taxes from July 1, 1994
through June 30, 1997 as a result of generating net operating losses for tax
purposes. An income tax benefit of $1.2 million was recorded in fiscal 1997, as
the Company believes that it is more likely than not that it will generate
taxable income sufficient to realize the tax benefits associated with future
deductible temporary differences and net operating loss carryforwards prior to
their expiration. This belief is based primarily upon changes in operations over
the last year which include the equity investment by KLT (see Note 5 to the
financial statements), which allowed the Company to significantly expand its
fiber optic network, deferred revenues of the Company which have been collected
under certain IRUs and end-user service agreements, future payments due under
existing contracts, and available tax-planning strategies.
Net Loss. The Company's net loss decreased 18.9% from $786,000 in 1996 to
$637,000 in 1997.
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<PAGE>
Liquidity and Capital Resources
The Company has funded its capital expenditures, working capital and debt
requirements and operating losses through a combination of advance payments for
future telecommunications services received from certain major customers, debt
and equity financing and external borrowings. In addition to utilizing the net
proceeds of the Senior Discount Notes, DTI intends to finance its capital
expenditures, working capital requirements, operating losses and debt service
requirements through advance payments under existing and additional agreements
for IRUs or wholesale capacity and available cash flow from operations, if any.
In addition, the Company may seek borrowings under bank credit facilities and
additional debt or equity financing.
The net cash provided by operating activities for the years ended June 30,
1997 and 1998 totaled $7.7 million and $10.6 million, respectively. During the
year ended June 30, 1997, cash provided by operating activities came principally
from increases in accounts payable of $3.4 million, deferred revenues of $2.9
million and other liabilities of $1.5 million. The increase in accounts payable
in fiscal 1997 reflects the increase in liabilities under DTI's supply contracts
in connection with the buildout of the DTI network. Deferred revenues in fiscal
1997 principally reflect advance payments received from carrier customers under
agreements for IRUs and wholesale network capacity. During fiscal 1998, net cash
provided by operating activities resulted principally from an increase in
deferred revenues of $7.1 million relating to advanced payments received under
IRUs, wholesale network capacity agreements and end-user agreements. As of June
30, 1998, advance payments of approximately $19.2 million will become due over
the next five years under existing agreements with certain major customers upon
DTI's meeting its obligations under certain agreements, which require the
Company to provide telecommunications services or dark fiber capacity.
In January 1998, Digital Teleport entered into a $30.0 million bank credit
facility (the "Credit Facility") with certain commercial lending institutions
and Toronto Dominion (Texas), Inc., as administrative agent for the lenders, to
fund its working capital requirements until consummation of the Private
Offering. Certain covenants under the Credit Facility required that all
outstanding borrowings be repaid upon the consummation of the Private Offering
and effectively precluded any additional borrowings under the Credit Facility
after such amounts were so repaid. The Company has repaid all borrowings under
and has terminated the Credit Facility. The Company intends to pursue a new
long-term bank credit facility.
On February 23, 1998 the Company completed the issuance and sale of the
Senior Discount Notes, from which the Company received proceeds, net of
underwriting discounts and expenses, totaling approximately $264.7 million. The
Company is using the net proceeds (i) to fund additional capital expenditures
required for the completion of the DTI network, (ii) to expand its management,
operations and sales and marketing infrastructure and (iii) for additional
working capital and other general corporate purposes. The Company may incur
significant and possibly increasing operating losses and expects to generate
negative net cash flows after capital expenditures during at least the next two
years as the Company continues to invest substantial funds to complete the DTI
network and develop and expand its telecommunications services and customer
base. Accordingly, if the Company cannot achieve operating profitability or
positive cash flows from operating activities, it may not be able to service the
Senior Discount Notes or to meet its other debt service or working capital
requirements, which would have a material adverse effect on the Company.
At June 30, 1998, the Company had a working capital surplus of $245.0
million, which represents an improvement of $246.5 million compared to the
working capital deficit of $1.5 million at June 30, 1997. This improvement is
primarily attributable to the issuance of the Senior Discount Notes discussed
above. The fiscal 1997 working capital deficit resulted primarily from growth
experienced by the Company and DTI's substantial investment in network and
equipment.
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<PAGE>
The Company's investing activities used cash of $19.4 million for the year
ended June 30, 1997 and $45.8 million for the year ended June 30, 1998. During
the year ended June 30, 1997, the Company invested $19.9 million in network and
equipment and reduced restricted cash by $460,000 to repay borrowings under
DTI's former credit facility. During the year ended June 30, 1998, the Company
invested $45.8 million in network and equipment.
Cash provided by financing activities was $15.3 million for the year ended
June 30, 1997 and $281.9 million for the year ended June 30, 1998. During the
year ended June 30, 1997, the Company borrowed $8.0 million under a loan
agreement with KLT, bringing the total borrowings under that agreement to $14.0
million. These total borrowings were converted into Series A Preferred Stock,
and additional cash proceeds in the amount of $10.5 million were received
pursuant to the KLT Agreement (as defined herein). Cash was used to make
principal payments on a bank loan of $500,000 and to repurchase common stock
warrants for $2.7 million granted to a customer (in connection with a bridge
financing provided by such customer to the Company, which bridge financing was
satisfied and terminated by the Company in April 1996). During fiscal 1998, the
Company received $17.3 million in proceeds from the issuance of Series A
Preferred Stock to KLT, $3 million under the Credit Facility and $275.2 million
from the Private Offering. The proceeds of the Private Offering were used to pay
off the $3 million on the Credit Facility and $10.5 million in financing costs.
To achieve its business plan, DTI will need significant financing to fund
its capital expenditure, working capital and debt service requirements and its
anticipated future operating losses. The Company's estimated capital
requirements primarily include the estimated cost of (i) constructing
approximately half of the planned DTI network routes, (ii) purchasing, for cash,
fiber optic facilities pursuant to long-term IRUs for planned routes that the
Company will neither construct nor acquire through swaps with other
telecommunication carriers, and (iii) additional network expansion activities,
including the construction of additional local loops in secondary and tertiary
cities as network traffic volume increases. The Company estimates that total
capital expenditures necessary to complete the DTI network will be approximately
$780 million, of which the Company had expended $81 million as of June 30, 1998.
During the balance of calendar 1998 and all of calendar 1999, the Company
anticipates its capital expenditure priorities will be focused principally on
expanding from its existing Missouri/Arkansas base by building additional
regional rings that adjoin existing rings and those that initiate new rings in
areas in which strong carrier interest has been expressed. The Company
anticipates that its existing financial resources will be adequate to fund the
abovementioned priorities and its existing capital commitments, principally
payments required under existing preliminary and definitive IRU and short-term
lease agreements, totaling $133 million which are payable in varying
installments over the period through December 31, 1999. In addition, the Company
has a commitment at June 30, 1998 for eight telecommunications switches totaling
$15 million which is cancelable upon the payment of a cancellation fee of
$42,000 for each of the remaining unpurchased switches. The Company also may
require additional capital in the future to fund operating deficits and net
losses and for potential strategic alliances, joint ventures and acquisitions.
These activities could require significant additional capital not included in
the foregoing estimated capital requirements.
As of June 30, 1998, DTI had $251.1 million of cash and cash equivalents.
Such amount is expected to provide sufficient liquidity to meet the Company's
operating and capital requirements through approximately December 31, 1999.
Subsequent to such date, DTI's operating and capital requirements are expected
to be funded, in large part, out of additional debt or equity financing, advance
payments under IRUs and wholesale network capacity agreements, and available
cash flow from operations, if any. The Company is exploring the possibility of
an additional high yield debt offering, a commercial credit facility and equity
sales, but has no specific plans at this time. The Company is in various stages
of discussions with potential customers for IRUs, wholesale network capacity
agreements and regional ring service agreements. There can be no assurance,
however, that the Company will continue to obtain advance payments from
customers prior to commencing construction of, or obtaining IRUs for, planned
routes, that it will be able to obtain financing under any credit facility or
that other sources of capital will be available on a timely basis or on terms
that are acceptable to the Company and within the restrictions under the
Company's existing financing arrangements, or at all. If the Company fails to
obtain the capital required to complete the DTI network, the Company could
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<PAGE>
modify, defer or abandon plans to build or acquire certain portions of the DTI
network. The failure of the Company, however, to raise the substantial capital
required to complete the DTI network could have a material adverse effect on the
Company. The actual amount and timing of DTI's capital requirements may differ
materially from those estimates depending on demand for the Company's services,
and the Company's ability to implement its current business strategy as a result
of regulatory, technological and competitive developments (including market
developments and new opportunities) in the telecommunications industry.
Subject to the Indenture provisions that limit restrictions on the ability
of any of the Company's Restricted Subsidiaries to pay dividends and make other
payments to the Company, future debt instruments of Digital Teleport may impose
significant restrictions that may affect, among other things, the ability of
Digital Teleport to pay dividends or make loans, advances or other distributions
to the Company. The ability of Digital Teleport to pay dividends and make other
distributions also will be subject to, among other things, applicable state laws
and regulations. Although the Senior Discount Notes do not require cash interest
payments until September 1, 2003, at such time the Senior Discount Notes will
require annual cash interest payments of $63.25 million. In addition, the Senior
Discount Notes mature on March 1, 2008. The Company currently expects that the
earnings and cash flow, if any, of Digital Teleport will be retained and used by
such subsidiary in its operations, including servicing its own debt obligations.
The Company does not anticipate that it will receive any material distributions
from Digital Teleport prior to September 1, 2003. Even if the Company determined
to pay a dividend on or make a distribution in respect of the capital stock of
Digital Teleport, there can be no assurance that Digital Teleport will generate
sufficient cash flow to pay such a dividend or distribute such funds to the
Company or that applicable state law and contractual restrictions, including
negative covenants contained in any future debt instruments of Digital Teleport,
will permit such dividends or distributions. The failure of Digital Teleport to
pay, or to generate sufficient earnings or cash flow to distribute, any cash
dividends or make any loans, advances or other payments of funds to the Company
would have a material adverse effect on the Company's ability to meet its
obligations on the Senior Discount Notes. Further, there can be no assurance
that the Company will have available, or will be able to acquire from
alternative sources of financing, funds sufficient to repurchase the Senior
Discount Notes in the event of a Change of Control.
The Company has received notice from a customer that it intends to set off
against amounts payable to the Company $15,000 per month, which as of June 30,
1998 totaled approximately $90,000 (in addition to $400,000 previously set off
against other payments) as damages and penalties under the Company's contract
with that customer due to the failure by the Company to meet certain
construction deadlines, and such customer reserved its rights to seek other
remedies under the contract. The Company believes that if such $90,000 setoff
were to be made, it would not be material to the Company's business, financial
position or results of operations. The Company is behind schedule with respect
to such contract as a result of such customer's not obtaining on behalf of the
Company certain rights-of-way required for completion of certain network
facilities, and the Company's limitations on its financial and human resources,
particularly prior to the Senior Discount Notes Offering. The Company has
obtained alternative rights-of-way and hired additional construction supervisory
personnel to accelerate the completion of such construction. Upon completion and
turn-up of services, such customer is contractually required to pay the Company
a lump sum of approximately $4.2 million for the Company's telecommunications
services over its network
Inflation
The Company does not believe that inflation has had a significant impact on
the Company's consolidated results of operations.
Year 2000
While the Company believes that its existing systems and software
applications are Year 2000 compliant, there can be no assurance until the year
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<PAGE>
2000 that all of the Company's systems and software applications then in place
will function adequately. The failure of the Company's systems or software
applications to accommodate the year 2000 could have a material adverse effect
on its business, financial condition and results of operations and its ability
to meet its obligations on the Senior Discount Notes. Further, if the systems or
software applications of telecommunications equipment suppliers, ILECs, IXCs or
others on whose services or products the Company depends or with whom the
Company's systems must interface are not Year 2000 compliant, it could have a
material adverse effect on the Company's business, financial condition and
results of operations and its ability to meet its obligations on the Senior
Discount Notes. The Company intends to continue to monitor the performance of
its accounting, information and processing systems and software applications and
those of its third-party constituents to identify and resolve any Year 2000
issues. To the extent necessary, the Company may need to replace, upgrade or
reprogram certain systems to ensure that all interfacing applications will be
Year 2000 compliant when operating jointly. Based on current information, the
Company does not expect that the costs of such replacements, upgrades and
reprogramming will be material to its business, financial condition or results
of operations. Most major domestic carriers have announced that they expect to
achieve Year 2000 compliance for their networks and support systems by mid-1999;
however, other domestic and international carriers and other third-party
constituents may not be Year 2000 compliant, and failures on their networks and
systems could adversely affect the operation of the Company's networks and
support systems and have a material adverse effect on the Company's business,
financial condition and results of operations. The Company has not developed a
contingency plan with respect to the failure of its systems or the systems of
its suppliers or other carriers to achieve year 2000 compliance.
New Accounting Standards
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income,"
and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information." These statements, which are effective for fiscal years beginning
after December 15, 1997, expand or modify disclosures and, the Company believes,
will not have a material impact on the Company's consolidated financial
position, results of operations or cash flows.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
None.
Item 8. Financial Statements and Supplementary Data
Reference is made to the Index to Consolidated Financial Statements on Page
F-1 of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
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<PAGE>
Part III.
Item 10. Directors and Executive Officers of the Company
The following table sets forth certain information concerning directors and
executive officers of the Company as of July 31, 1998.
Name Age Position(s) With The Company
Richard D. Weinstein(1) 46 President, Chief Executive Officer
and Secretary; Director
Gary W. Douglass 47 Senior Vice President, Finance and
Administration and Chief Financial Officer
H.P. Scott 61 Senior Vice President
Jerry W. Murphy 40 Vice President, Network Operations
Jerome W. Sheehy 67 Vice President, Regulatory -- Industry
Affairs; Director
Ronald G. Wasson(1) 53 Director
Bernard J. Beaudoin 58 Director
James V. O'Donnell 48 Director
Kenneth V. Hager 47 Director
- -------------------------
(1) Member of Compensation Committee
Richard D. Weinstein is President, Chief Executive Officer and Secretary of
the Company, which he founded in 1989. Prior to 1989, Mr. Weinstein owned and
managed Digital Teleresources, Inc., a firm which consulted, designed,
engineered and installed telecommunications systems. That company focused on
providing private microwave networks for ILEC bypass purposes to Fortune 500
companies such as General Dynamics, May Department Stores and Boatmen's
Bancshares (now NationsBank), as well as various cellular and health care firms.
In this capacity, Mr. Weinstein worked closely with SBC's deregulated marketing
subsidiary. Prior to 1984, Mr. Weinstein's consulting efforts were focused on
early wireless services, particularly paging and mobile telephone providers and
end-users. Mr. Weinstein also owned and operated a distributor of Motorola
microwave equipment from 1986 to 1991.
Gary W. Douglass became the Senior Vice President, Finance and
Administration and Chief Financial Officer, of DTI in July 1998. From March 1995
to December 1997, Mr. Douglass was Executive Vice President and Chief Financial
Officer of Roosevelt Financial Group, Inc., a banking corporation that merged
with Mercantile Bancorporation Inc. in July 1997. Prior to joining Roosevelt
Financial, Mr. Douglass was a partner with Deloitte & Touche LLP, a "Big Six"
international accounting firm where he was in charge of the accounting and
auditing function and financial institution practice of the firm's St. Louis
office.
H.P. Scott joined the Company May 1998 as Senior Vice President. From May
1997 to May 1998, Mr. Scott was Vice President of Business Development of IXC
Carrier, Inc. ("IXC Carrier") of Austin, Texas. From May 1996 to May 1997, Mr.
Scott was Vice President of Engineering and Construction of IXC Carrier, from
January 1994 to October 1995, Mr. Scott was Vice President of Engineering and
Construction with MCImetro Access Transmission Services, Inc. ("MCImetro"), a
wholly-owned subsidiary of MCI. From January 1990 to January 1994, Mr. Scott was
President of Western Union ATS, a wholly-owned subsidiary of MCI. Prior to 1990,
Mr. Scott had spent over 11 years in positions of senior responsibility for the
design and construction of MCI's coast-to-coast fiber optic telecommunications
networks. Prior to joining MCI, Mr. Scott spent 20 years with Collins Radio and
Microwave Associates.
Jerry W. Murphy became Vice President, Network Operations, in June 1998.
From October 1996 to December 1997, Mr. Murphy was the Director of Construction
Support of MCImetro. Mr. Murphy was MCImetro's Director of Engineering and
Construction from January 1994 to October 1996, and was Vice President of
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<PAGE>
Engineering and Construction of Advanced Transmissions Systems, Inc., a
wholly-owned subsidiary of MCI, from January 1990 to January 1995. Prior to such
time, Mr. Murphy spent over 10 years with MCI in various engineering, network
implementation and network operations positions.
Jerome W. Sheehy has been the Company's Vice President, Regulatory --
Industry Affairs, since November 1997 and Vice President, Inter-Carrier Support,
from February 1997 to November 1997. Mr. Sheehy has also been a director of DTI
since September 1997. Prior to joining DTI, Mr. Sheehy was employed in the
telecommunications industry for 42 years, of which 20 years were spent with GTE
in many capacities including installation, sales, public relations, and manager
of carrier markets support.
Ronald G. Wasson has been a director of DTI since March 1997. He is
currently President and Director of KLT Inc., a wholly-owned subsidiary of
Kansas City Power & Light Company. He is also President of KLT Gas and KLT
Telecom Inc., and serves as director of KLT Power and KLT Energy Services, all
of which are subsidiaries of KLT Inc. Mr. Wasson joined KCPL in 1966 as Power
Sales Engineer and held various positions in marketing, engineering, corporate
planning and economic controls until 1977. After working briefly for R.W. Beck
and Associates as a Principal Engineer, he rejoined KCPL in 1979 in the
Operational Analysis and Development Department as a Management Analyst. In
1980, he was appointed Manager of Fossil Fuels, became Vice President of
Purchasing in 1983, Vice President of Administrative Services in 1986 and Senior
Vice President of Administration and Technical Services in 1991. Effective
January 1995, he transferred to KLT Inc. as Executive Vice President until he
was named to his current position as President in November 1996. Mr. Wasson also
serves on the Board of Directors of Junior Achievement of Mid-America and the
Board of Governors for the American Royal Association in Kansas City, Missouri.
Bernard J. Beaudoin has been a director of DTI since October 1997. He is
currently the Executive Vice President and Chief Financial Officer of KCPL. KLT
is an indirect wholly-owned subsidiary of KCPL. Mr. Beaudoin joined KCPL in 1980
as Manager of Corporate Planning. Previously he was with the New England
Electric System, where he was Director of Economic Planning. At KCPL, he was
named director of Corporate Planning and Finance in 1983 and promoted to Vice
President of Finance in 1984. He became Chief Financial Officer in 1989, Senior
Vice President in 1991 and Senior Vice President -- Finance and Business
Development in 1994. Effective January 1995, he transferred to full-time KLT
Inc. employment as President. He was named to his current position with KCPL in
1996. Mr. Beaudoin also serves as Chairman of the Board of Directors of
Carondelet Health, a holding company for a variety of health provider services.
James V. O'Donnell has been a director of DTI since November 1997. Since
1988, he has been the President of Bush-O'Donnell & Co., Inc., a funds
management and investment banking firm. Prior to 1988, Mr. O'Donnell served as a
Vice President of Goldman, Sachs & Co. Mr. O'Donnell serves as Chairman of the
Board of The Benjamin Ansehl Company of St. Louis and as President of National
Automobile and Casualty Insurance Company of Pasadena, California. He is also a
director of certain privately held companies and serves on the Board of Trustees
of Washington University in St. Louis.
Kenneth V. Hager has been a director of DTI since November 1997. Mr. Hager
has been employed by DST Systems, Inc. since 1988 and is currently its Vice
President, Chief Financial Officer and Treasurer. DST Systems, Inc. is a
provider of information processing and computer software services and products,
primarily to mutual funds, insurance companies, banks and other financial
services organizations. Since 1980, Mr. Hager has been a member of the Board of
Directors of the American Cancer Society -- Kansas City Unit, and is the current
Chairman of the Society's Metropolitan Kansas City Coordinating Council. Mr.
Hager also serves on the Board of Directors of the Greater Kansas City Sports
Commission and is a member of the Accounting and Information Systems Advisory
Council for the University of Kansas School of Business.
Officers are elected by and serve at the discretion of the Board of
Directors. There are no family relationships among the directors and executive
officers of the Company.
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<PAGE>
The Board of Directors has a Compensation Committee comprised of Messrs.
Wasson (Chairman) and Weinstein.
A Shareholders' Agreement among the Company, Mr. Weinstein and KLT (as
amended, the "Shareholders' Agreement"), provides for a Board of Directors
consisting of six directors, at least two of whom must not be affiliated with
either the Company or KLT. Pursuant to the Shareholders' Agreement, Mr.
Weinstein and KLT will each have the right to designate three directors. At the
present time there are no vacancies. Mr. Weinstein has served as a director
since the formation of the Company in June 1989. Messrs. Wasson and Sheehy have
served as directors since March 1997 and September, 1997, respectively. Mr.
Beaudoin has served as a director since October 1997. Messrs. O'Donnell and
Hager have served as directors since November 1997. The current directors have
been elected to serve until the expiration of the term to which they have been
elected and until their respective successors are elected and qualified or until
the earlier of their death, resignation or removal.
Pursuant to the Shareholders' Agreement, Messrs. O'Donnell and Hager, as
directors who are not affiliates (as defined in the Shareholders' Agreement and
as set forth in the Glossary included as Annex A hereto) of either Mr.
Weinstein, the Company or KLT are paid a $20,000 annual retainer fee payable in
quarterly installments. All directors are reimbursed for expenses incurred in
connection with attending Board and committee meetings. The Company has also
granted options to purchase 150,000 shares under the Plan to each of Messrs.
O'Donnell and Hager, its non-affiliated directors.
Item 11. Executive Compensation
The following table sets forth all compensation awarded, earned or paid
during the last three fiscal years to or by: (i) the Chief Executive Officer of
the Company and (ii) the three most highly compensated executive officers in
fiscal 1998 other than the Chief Executive Officer, including two former
executive officers who were no longer employed by the Company at the end of
fiscal 1998 (collectively, the "Named Executive Officers").
<TABLE>
Summary Compensation Table
<CAPTION>
Long-Term
Compensation
------------
Annual Compensation Other Annual Securities All Other
Name and Compensation Underlying Compensation
Principal Position Year Salary($) Bonus($) ($) Options(#) ($)
------------------------ ------- ------------- ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Richard D. Weinstein,... 1998 $150,000 -- -- -- --
President, Chief 1997 69,231 -- -- -- --
Executive
Officer and Secretary 1996 -- -- -- -- --
H.P. Scott, Senior Vice 1998 28,800 $100,000 -- -- --
President
1997 -- -- -- -- --
1996 -- -- -- -- --
T. George Hess, former 1998 108,242 81,000 -- -- $120,577(1)
Chief Operating Officer
1997 -- -- -- -- --
1996 -- -- -- -- --
Robert F. McCormick, 1998 142,741 81,000 -- -- 250,000(1)
former Chief Financial
Officer
1997 -- -- -- -- --
1996 -- -- -- -- --
</TABLE>
(1) Such amounts reflect severance payments made in connection with the
resignations of such former executive officers. During fiscal 1998,
such former executive officers were also granted stock options under
the Company's Incentive Award Plan, which options were terminated
during fiscal 1998 in connection with their resignations.
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<PAGE>
Employment And Consulting Agreements
Weinstein Employment Agreement. As a condition of the KLT Investment, the
Company and Mr. Weinstein entered into an employment agreement (the "Weinstein
Employment Agreement"), which provides that Mr. Weinstein will serve as the
Company's President and Chief Executive Officer and in such other capacities as
the Board may determine through January 1, 2000. For the duration of the lease
of the Company's headquarters entered into as of December 31, 1996 by and among
Mr. Weinstein, his wife and the Company (as amended, the "Lease Agreement"), Mr.
Weinstein will be compensated at the rate of $150,000 per year (which is in
addition to payments made to Mr. Weinstein under the Lease Agreement), and
$200,000 per year after the termination of such Lease Agreement, in addition to
group health or other benefits generally provided to other Company employees.
The Weinstein Employment Agreement may be terminated in connection with the
disability of Mr. Weinstein, for "cause" as defined therein or by either party
upon 90 days prior written notice; provided that if the Weinstein Employment
Agreement is terminated by the Company upon 90 days notice to Mr. Weinstein, Mr.
Weinstein shall thereafter receive his annual base salary for the remainder of
the employment period (but no Company-paid medical or other benefits), offset by
any compensation received by Mr. Weinstein if and when he obtains subsequent
employment. During its term and for two years thereafter, the Weinstein
Employment Agreement restricts the ability of Mr. Weinstein to compete with the
Company as an employee of or investor in another company in a 14 state region in
the Midwest. The Weinstein Employment Agreement also imposes on Mr. Weinstein
certain non-solicitation restrictions with respect to Company employees,
customers and clients. Unless extended by mutual agreement of the parties
thereto, the Lease Agreement will terminate on December 31, 1998.
Douglass Employment Agreement. In July 1998, Digital Teleport and Mr.
Douglass entered into an employment agreement (the "Douglass Agreement"), which
provides that Mr. Douglass will serve in a full-time capacity as Senior Vice
President, Finance and Administration and Chief Financial Officer, of both
Digital Teleport and the Company for a term of three years for a minimum base
compensation of $200,000 per year, in addition to group health or other benefits
generally provided to other Digital Teleport employees. Moreover, Mr. Douglass
will receive guaranteed incentive compensation of $66,666 for fiscal year 1999,
and is eligible for discretionary incentive compensation of up to one-third of
his annual base compensation for the following two fiscal years.
In addition to his cash compensation, before December 1998 the Company is
obligated to grant Mr. Douglass (i) 200,000 shares of restricted stock of the
Company's Common Stock (which restricted stock will not carry voting rights and
will vest in equal portions for each of the three years of the term of the
Douglass Agreement, subject to certain acceleration events) and (ii)
nonqualified options to purchase 200,000 shares of the Company's Common Stock at
$6.66 per share. The Company has a right to call the vested restricted nonvoting
shares in the event that Mr. Douglass is no longer employed by the Company for
any reason at a price equal to the greater of $1.00 per share or the per share
book value of the Company; provided that such call right lapses upon a "Change
of Control" (as defined in the Douglass Agreement) or the consummation of an
initial public offering of the Company's Common Stock. In the event that Mr.
Douglass is terminated for any reason other than for cause at any time following
a Change of Control, Mr. Douglass may put his shares to the Company at fair
market value (determined in accordance with the Douglass Agreement); provided
that such put right terminates upon consummation of an initial public offering
of the Company's Common Stock. The Company has agreed to make a three-year loan
at the applicable minimum federal interest rate to Mr. Douglass to enable him to
pay tax on income recognized as a result of the restricted stock grants. This
loan will be forgiven upon the earliest of the expiration of the three year
period, Mr. Douglass' termination without cause or a Change in Control, and the
Company will pay Mr. Douglass additional cash in an amount sufficient to pay
federal and state income taxes on the ordinary income recognized as a result of
such loan forgiveness.
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<PAGE>
The options include a put right similar to that attendant to the restricted
nonvoting shares, except that the price that the Company must pay is equal to
fair market value reduced by the exercise price and further that "fair market
value" for such purpose is no less than $12.16 per share. The stock option put
right terminates upon consummation of an initial public offering of the
Company's Common Stock; provided that the option put right does not terminate
unless the Company's Common Stock is listed on a national stock exchange or on
the Nasdaq National Market and has an average closing price of at least $12.16
for the 90 day period prior to the expiration of such lock-up period. In order
to allow Mr. Douglass to meet his tax obligations arising from the option
grants, the Company has agreed to pay him cash in such amounts as are sufficient
to pay federal and state income taxes on the ordinary income (up to a maximum of
$1.1 million of ordinary income) required to be recognized in the event of any
exercise of such options.
The Douglass Agreement restricts the ability of Mr. Douglass to compete
with Digital Teleport during the term thereof and for up to one year thereafter
as a principal, employee, partner, consultant, agent or otherwise in any region
in which Digital Teleport does business at such time. The Douglass agreement
also imposes on Mr. Douglass certain confidentiality obligations and proprietary
and non-solicitation restrictions with respect to Digital Teleport employees,
customers and clients.
Scott Consulting Agreement. In May 1998, the Company and Mr. H.P. Scott
entered into a consulting agreement (the "Scott Agreement"), which provides that
Mr. Scott will serve as a Senior Vice President of the Company for a term of one
year, providing such consulting services as the Company requests, in the areas
of carrier's carrier sales, fiber swaps and any other services as mutually
agreed. For the duration of the Scott Agreement, Mr. Scott will be compensated
at a rate of $800 per day for such consulting services, and currently the
Company and Mr. Scott expect that he will spend approximately 15 days per month
providing such services, though neither he nor the Company is obligated by such
expectation.
Mr. Scott also will receive, with respect to sales which were substantially
negotiated during the consulting term and with which Mr. Scott was substantively
involved, a commission equal to the following: (i) 1% of any cash payments
received for sales of dark fiber to telecommunications companies, which payments
are within five (5) years of the completion of the term of the Scott Agreement
(ii) $200 per route mile of dark fiber received by the Company pursuant to a
swap for dark fiber owned by the Company; (iii) 1% of any cash payments received
by the Company from sales of lighted bandwidth capacity at a rate of DS-3 or
above to telecommunications companies, which payments are within five (5) years
of the completion of such term; and (iv) 1% of the value of any bandwidth
received by the Company in exchange for bandwidth capacity at a rate of DS-3 or
above of the Company, which commission shall be paid for up to five years
following the completion of such term, reduced on a pro rata basis by any cash
paid by the Company pursuant to such exchange. Mr. Scott may elect, in his sole
discretion, to receive up to 50% of any such commission in the form of Common
Stock at fair market value. Upon execution of the Scott Agreement, the Company
paid Mr. Scott $100,000, and he is eligible for reimbursement of certain
expenses.
The Scott Agreement restricts the ability of Mr. Scott to compete with the
Company during the term thereof and for up to one year thereafter as a
principal, employee, partner or consultant in any region in which the Company
does business at such time. The Scott Agreement also imposes on Mr. Scott
certain confidentiality obligations and proprietary and non-solicitation
restrictions with respect to Company employees, customers and clients.
-37-
<PAGE>
Incentive Award Plan
The Company's 1997 Long-Term Incentive Award Plan (the "Plan") was adopted
by the Company's Board of Directors in December 1997. A total of 3,000,000
shares of Common Stock of the Company have been reserved for issuance under the
Plan. The Company has granted or is obligated to grant options to purchase an
aggregate of 1,025,000 shares of Common Stock to certain of its key employees at
an exercise price equal to the fair market value of the Common Stock on the
applicable date of grant. The Company also has granted options to purchase
150,000 shares of Common Stock to each of the Company's non-affiliated directors
(i.e., Messrs. O'Donnell and Hager) at an exercise price equal to the fair
market value of the Common Stock on the date of grant. The Company is also
obligated to issue 200,000 shares of restricted stock to an employee under the
Plan. No other options or other awards are outstanding under the Plan. The Plan
will terminate in December 2007, unless sooner terminated by the Board of
Directors.
The Plan provides for grants of "incentive stock options," within the
meaning of Section 422 of the Internal Revenue Code of 1986, as amended, to
employees (including employee directors) and grants of nonqualified options to
employees and directors. The Plan also allows for the grant of stock
appreciation rights, restricted shares and performance shares to employees. The
Plan is administered by a committee designated by the Board of Directors.
Messrs. Wasson and Weinstein comprise the current committee. The exercise price
of incentive stock options granted under the Plan must not be less than the fair
market value of the Common Stock on the date of grant. With respect to any
optionee who owns stock representing more than 10% of the voting power of all
classes of the Company's outstanding capital stock, the exercise price of any
incentive stock option must be equal to at least 110% of the fair market value
of the Common Stock on the date of grant, and the term of the option must not
exceed five years. The terms of all other options may not exceed ten years. To
the extent that the aggregate fair market value of Common Stock (determined as
of the date of the option grant) for options which would otherwise be incentive
stock options may for the first time become exercisable by any individual in any
calendar year exceeds $100,000, such options shall be non-qualified stock
options.
-38-
<PAGE>
Item 12. Security Ownership Of Certain Beneficial Owners And Management
The following table sets forth certain information regarding the beneficial
ownership of the outstanding Common Stock of DTI as of June 30, 1998 by each
person or entity who is known by the Company to beneficially own 5% or more of
the Common Stock, which includes the Company's President and Chief Executive
Officer, each of the Company's directors and all of the Company's directors and
executive officers as a group.
Number Of Shares Percent Of
Beneficially Common Stock
Name Of Beneficial Owner Owned Outstanding(a)
- ------------------------ ---------------- --------------
Richard D. Weinstein....................... 30,000,000 50.0%
8112 Maryland Avenue, 4th Floor
St. Louis, Missouri 63105
KLT Telecom Inc.(b)........................ 30,000,000 50.0%
1201 Walnut Avenue
Kansas City, Missouri 64141
Ronald G. Wasson(b)........................ 30,000,000 50.0%
Bernard J. Beaudoin(b)..................... 30,000,000 50.0%
James V. O'Donnell......................... -- --
Jerome W. Sheehy........................... -- --
Kenneth V. Hager........................... -- --
Directors and executive officers
as a group (8 persons)................. 60,000,000 100.0%
-------------------------
(a) Reflects Common Stock outstanding after giving effect to the conversion of
all outstanding shares of the Series A Preferred Stock into Common Stock. KLT
owns 30,000 shares of the Series A Preferred Stock, which constitutes 100% of
such stock. Each such share of Series A Preferred Stock is convertible into
1,000 shares of Common Stock of the Company.
(b) All of the shares shown as owned by each of Messrs. Wasson and Beaudoin are
the shares of Series A Preferred Stock owned by KLT. KLT is a wholly-owned
subsidiary of KLT Inc., a wholly-owned subsidiary of KCPL. Mr. Wasson is the
President of KLT Inc. and KLT. Mr. Beaudoin is the Executive Vice President and
Chief Financial Officer of KCPL. Each of Messrs. Wasson and Beaudoin disclaims
beneficial ownership of such shares held by KLT.
KLT owns 100% of the Series A Preferred Stock. Except for any amendment
affecting the rights and obligations of holders of Series A Preferred Stock or
as otherwise provided by law, holders of Series A Preferred Stock vote together
with the holders of Common Stock as a single class. The holders of the Series A
Preferred Stock vote separately as a class with respect to any amendment
affecting the rights and obligations of holders of Series A Preferred Stock and
as otherwise required by law.
-39-
<PAGE>
Item 13. Certain Relationships And Related Transactions
On December 31, 1996, Mr. Weinstein, Mr. Weinstein's wife and the Company
formalized a lease with respect to the offices and equipment space for the
Company (the "Lease Agreement"). The lease pertains to 10,000 of the 14,400
square feet available in such building and provides for monthly lease payments
of $6,250, terminating on December 31, 1998. The Company believes that the terms
of the current Lease Agreement are comparable to those which would be available
to an unaffiliated entity on the basis of an arm's-length negotiation. The
Shareholders' Agreement also requires that if Mr. Weinstein proposes to build or
obtain ownership of a new building to house the operations of the Company, Mr.
Weinstein will first offer to the Company the opportunity to build or own such
building. If the Company declines to exercise this right, then the rent the
Company would pay for occupying such building would be 80% of the market
appraised rate for such space.
Effective July 1996, the Company formed a joint venture with KLT to
develop, construct and operate a network in the Kansas City metropolitan area,
using in part the electrical duct system and certain other real estate owned by
KCPL and licensed to the joint venture. In March 1997, KLT became a strategic
investor in DTI when it entered into an agreement with DTI (the "KLT Agreement")
pursuant to which KLT committed to make an equity investment of up to $45.0
million in preferred stock of the Company. On March 12, 1997, pursuant to the
KLT Agreement, the Company issued 15,100 shares of Series A Preferred Stock to
KLT in exchange for the retirement of the then-outstanding indebtedness of the
Company to KLT, KLT's interest in the joint venture and cash, which
consideration was valued in the aggregate at approximately $21.9 million, net of
transactions costs. In June 1997, DTI issued an additional 3,400 shares of
Series A Preferred Stock to KLT for a cash payment of $5.1 million. In September
and October 1997, DTI issued the remaining 11,500 shares of Series A Preferred
Stock to KLT for aggregate cash payments of approximately $17.3 million. See
Note 5 of the notes to the consolidated financial statements. Each share of
Series A Preferred Stock of the Company is entitled to the number of votes equal
to the number of shares into which such share of Series A Preferred Stock is
convertible with respect to any and all matters presented to the stockholders of
the Company for their action or consideration. Except for any amendments
affecting the rights and obligations of holders of Series A Preferred Stock,
with respect to which such holders vote separately as a class, or as otherwise
provided by law, holders of Series A Preferred Stock vote together with the
holders of the Common Stock as a single class. Pursuant to the KLT Agreement,
KLT has the right of first offer concerning energy services rights and contracts
involving DTI. In connection with the issuance of the Series A Preferred Stock,
Mr. Weinstein has guaranteed to KLT the performance by the Company of its
obligations under the KLT Agreement, including without limitation,
representations and warranties under such agreement. Mr. Weinstein has pledged
his Common Stock to secure such guarantee. Such obligations to KLT are
subordinated to Mr. Weinstein's obligations to hold the Company and KLT harmless
for any losses resulting from judgments and awards rendered against Digital
Teleport or the Company in the matter of Alfred H. Frank v. Richard D. Weinstein
and Digital Teleport, Inc. See "Legal Proceedings." Mr. Weinstein has pledged
his shares of Common Stock to KLT, which has agreed to reimburse the Company and
Digital Teleport for losses incurred by them in connection with the Frank
litigation to the extent of any proceeds KLT receives from Weinstein pursuant to
such pledge, less KLT's costs in pursuing such claim against Weinstein. KLT has
also agreed to bear one-half of any such losses. After such claims related to
the Frank litigation are resolved, KLT may exercise on the pledge of Weinstein's
shares to fulfill any amounts owing to KLT pursuant to Weinstein's guarantee of
the Company's obligations under the KLT Agreement. Mr. Beaudoin is the Executive
Vice President and Chief Financial Officer of KCPL. Mr. Wasson is the President
and a director of KLT Inc., a wholly-owned subsidiary of KCPL and parent
corporation of KLT.
-40-
<PAGE>
Part IV.
Item 14. Exhibits, Financial Statement Schedules And Reports On Form 8-K
(a)(1) Financial statements
See index to Consolidated Financial Statements
(a)(2) Financial statement schedules
None.
(a)(3) Exhibits required by Item 601 of Regulation S-K
See Exhibit Index for the exhibits filed as part of or incorporated by reference
into this Report.
(b) Reports on Form 8-K
None.
-41-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
DTI HOLDINGS, INC.
BY: /S/ GARY W. DOUGLASS
Gary W. Douglass
Senior Vice President, Finance and
Administration and Chief Financial
Officer (principal financial and
accounting officer)
September 30, 1998
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, this report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
/S/ RICHARD D. WEINSTEIN President, Chief Executive Officer, September 30, 1998
Richard D. Weinstein Secretary and Director (Principal
Executive Officer)
/S/ GARY W. DOUGLASS Senior Vice President, Finance and September 30, 1998
Gary W. Douglass Administration and Chief Financial
Officer (Principal Financial and
Accounting Officer)
/S/ JEROME W. SHEEHY Vice President -- Regulatory AffairsSeptember 30, 1998
Jerome W. Sheehy and Director
/S/ RONALD G. WASSON Director September 30, 1998
Ronald G. Wasson
/S/ BERNARD J. BEAUDOIN Director September 30, 1998
Bernard J. Beaudoin
/S/ JAMES V. O'DONNELL Director September 30, 1998
James V. O'Donnell
/S/ KENNETH V. HAGER Director September 30, 1998
Kenneth V. Hager
-42-
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
DTI HOLDINGS, INC. AND SUBSIDIARY
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report................................................F-2.
Consolidated Balance Sheets as of June 30, 1997 and 1998....................F-3.
Consolidated Statements of Operations for the years
ended June 30, 1996, 1997 and 1998....................................... F-4.
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended June 30, 1996, 1997 and 1998......................... F-5.
Consolidated Statements of Cash Flows for the years
ended June 30, 1996, 1997 and 1998 .................................... F-6.
Notes to Consolidated Financial Statements..................................F-7.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of DTI Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of DTI
Holdings, Inc., and subsidiary (the "Company") as of June 30, 1997 and 1998 and
the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for each of the three years in the period ended June
30, 1998. 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, such consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of June 30, 1997
and 1998 and the results of its operations and its cash flows for each of the
three years in the period ended June 30, 1998 in conformity with generally
accepted accounting principles.
Deloitte & Touche LLP
St. Louis, Missouri
September 25, 1998
F-2
<PAGE>
DTI HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---------------- ----------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents.................................................. $ 4,366,906 $ 251,057,274
Accounts receivable, less allowance for doubtful accounts of $48,000
in 1997 (Note 13)..................................................... 159,268 501,612
Prepaid and other current assets........................................... 23,764 69,635
-------------- ---------------
Total current assets.................................................. 4,549,938 251,628,521
Network and equipment, net (Note 3).......................................... 34,000,634 77,771,527
Deferred financing costs, net of amortization of $509,869 in 1998
(Note 4).................................................................. -- 10,028,558
Deferred tax asset (Note 9).................................................. 1,214,331 3,234,331
Other assets................................................................. 84,233 202,223
-------------- ---------------
Total................................................................. $ 39,849,136 $ 342,865,160
============== ===============
Liabilities and stockholders' equity (deficit) Current liabilities:
Accounts payable........................................................... $ 5,086,830 $ 4,722,418
Taxes payable (other than income taxes).................................... 923,104 1,830,668
Other current liabilities.................................................. -- 83,605
-------------- ---------------
Total current liabilities............................................. 6,009,934 6,636,691
Deferred revenues (Note 7)................................................... 9,679,904 16,814,488
Senior discount notes, net of unamortized discount of $9,465,882
in 1998 (Note 4).......................................................... -- 277,455,859
-------------- ---------------
Total liabilities..................................................... 15,689,838 300,907,038
Commitments and contingencies (Notes 10, 11 and 12)
Redeemable Convertible Series A Preferred Stock $0.01 par
value, 30,000 shares authorized, 18,500 shares issued and
outstanding in 1997 (Notes 5 and 8)........................................ 28,889,165 --
Stockholders' equity (deficit):
Preferred stock, $.01 par value, 20,000,000 shares authorized, no
shares issued and outstanding........................................... -- --
Convertible series A preferred stock, $.01 par value, (aggregate liquidation
preference of $45,000,000) 30,000 shares authorized, 30,000 issued and
outstanding in 1998 (Notes 5 and 8)..................................... -- 300
Common stock, $.01 par value, 100,000,000 shares authorized,
30,000,000 shares issued and outstanding (Note 6)....................... 300,000 300,000
Additional paid-in capital (Note 5)........................................ -- 44,013,063
Common stock warrants (Notes 4 and 6)...................................... 450,000 10,421,336
Accumulated deficit........................................................ (5,479,867) (12,776,577)
--------------- ----------------
Total stockholders' equity (deficit).............................. (4,729,867) 41,958,122
--------------- ---------------
Total........................................................................ $ 39,849,136 $ 342,865,160
============== ===============
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
DTI HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
1996 1997 1998
-------------- -------------- ---------------
<S> <C> <C> <C>
REVENUES:
Telecommunications services:
Carrier's carrier services......................... $ 188,424 $ 807,347 $ 3,075,527
End-user services.................................. 488,377 515,637 467,244
-------------- -------------- ---------------
676,801 1,322,984 3,542,771
Other services....................................... -- 711,006 --
-------------- -------------- ---------------
Total revenues.................................. 676,801 2,033,990 3,542,771
-------------- -------------- ---------------
OPERATING EXPENSES:
Telecommunications services........................ 296,912 1,097,190 2,294,181
Other services..................................... -- 364,495 --
Selling, general and administrative................ 548,613 868,809 3,668,540
Depreciation and amortization...................... 425,841 757,173 2,030,789
-------------- -------------- ---------------
Total operating expenses........................ 1,271,366 3,087,667 7,993,510
-------------- -------------- ---------------
Loss from operations............................ (594,565) (1,053,677) (4,450,739)
OTHER INCOME (EXPENSES):
Interest income.................................... 193,049 101,914 5,063,655
Interest expense................................... (384,859) (152,937) (12,055,428)
Loan commitment fees (Note 6)...................... -- (784,500) --
Equity in earnings of joint venture (Note 8)....... -- 37,436 --
-------------- -------------- ---------------
Loss before income tax benefit.................. (786,375) (1,851,764) (11,442,512)
INCOME TAX BENEFIT (Note 9).......................... -- 1,214,331 2,020,000
-------------- -------------- ---------------
NET LOSS............................................. $ (786,375) $ (637,433) $ (9,422,512)
-============= ============== ===============
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
DTI HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF
STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
Convertible Total
Series A Additional Common Stockholders'
Preferred Preferred Common Paid-in Stock Accumulated Equity
Stock Stock Stock Capital Warrants Deficit (Deficit)
--------- ----- --------- ---------- ----------------------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JULY 1, 1995....... $ -- $ -- $ -- $ 30,000 $ -- $ (267,638) $ (237,638)
Issuance of common stock
(Note 6)............... -- -- 300,000 (30,000) -- (269,970) 30
Accretion of put value of
common stock warrants (Note 4) -- -- -- -- -- (76,720) (76,720)
Net loss for the year.... -- -- -- -- -- (786,375) (786,375)
----- ----- -------- ----------- ----------- ------------- ------------
BALANCE, JUNE 30, 1996...... $ -- $ -- $300,000 $ -- $ -- $ (1,400,703) $(1,100,703)
Accretion/repurchase of
common stock warrants
(Note 4)............... -- -- -- -- -- (1,585,899) (1,585,899)
Accretion of redeemable
convertible preferred
stock to redemption
price (Note 5)......... -- -- -- -- -- (1,855,832) (1,855,832)
Common stock warrants
(Note 6)............... -- -- -- -- 450,000 -- 450,000
Net loss for the year.... -- -- -- -- -- (637,433) (637,433)
----- ----- -------- ----------- ----------- ------------- -----------
BALANCE, JUNE 30, 1997...... -- -- 300,000 -- 450,000 (5,479,867) (4,729,867)
Accretion of redeemable
convertible preferred
stock to redemption price
(Note 5).............. -- -- -- -- -- (4,985,442) (4,985,442)
Reclassification of redeem-
able convertible stock to
convertible series A
preferred stock and re-
versal of related
accretion
(Note 5).............. -- 300 -- 44,283,033 -- 6,841,274 51,124,607
Reclassification to additional
paid-in capital of charge to
accumulated deficit to
effect the 1,000 to 1
stock splits (Note 6). -- -- -- (269,970) -- 269,970 --
Allocation of proceeds from
senior discount notes
offering to related
warrants (Note 4)..... -- -- -- -- 9,971,336 -- 9,971,336
Net loss for the year..... -- -- -- -- -- (9,422,512) (9,422,512)
----- ----- -------- ----------- ----------- ---------- -----------
BALANCE, JUNE 30, 1998 ..... $ --- $ 300 $300,000 $44,013,063 $10,421,336 $(12,776,577) $41,958,122
===== ===== ======== =========== =========== ============= ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
DTI HOLDINGS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.............................................. $ (786,375) $ (637,433) $ (9,422,512)
Adjustments to reconcile net loss to cash provided
by operating activities:
Depreciation and amortization.................... 425,841 757,173 2,030,789
Accretion of senior discount notes............... -- -- 12,203,675
Amortization of deferred financing costs......... -- -- 509,869
Deferred income taxes............................ -- (1,214,331) (2,020,000)
Loan commitment fees related to common stock
Warrants...................................... -- 450,000 --
Changes in assets and liabilities:
Accounts receivable........................... (60,740) (81,278) (342,344)
Prepayments to suppliers...................... (554,261) 554,261 --
Other assets.................................. (15,980) (56,572) (164,861)
Accounts payable.............................. (516,051) 3,427,994 (364,412)
Other current liabilities..................... 100,511 -- 83,605
Taxes payable (other than income taxes)....... -- 1,529,282 907,564
Deferred revenues............................. 1,706,765 2,945,176 7,134,584
-------------- -------------- ---------------
Net cash flows provided by operating activities......... 299,710 7,674,272 10,555,957
-------------- -------------- ---------------
Cash flows from investing activities:
Increase in network and equipment..................... (5,663,047) (19,876,595) (45,800,682)
Change in restricted cash............................. 4,540,478 459,522 --
-------------- -------------- ---------------
Net cash used in investing activities.............. (1,122,569) (19,417,073) (45,800,682)
-------------- -------------- ---------------
Cash flows from financing activities:
Proceeds from issuance of senior discount notes and
attached warrants................................... -- -- 275,223,520
Deferred financing costs.............................. -- -- (10,538,427)
Proceeds from issuance of redeemable convertible
preferred stock, including cash from
contributed joint venture of $2,253,045 in 1997.... -- 10,492,316 17,250,000
Repurchase of common stock warrants granted to
a customer........................................ -- (2,700,000) --
Proceeds from notes payable........................... 10,403,305 8,000,000 --
Payment of notes payable.............................. (8,903,305) (500,000) --
Proceeds from issuance of common stock................ 30 -- --
Proceeds from credit facility......................... -- -- 3,000,000
Principal payments on credit facility................. -- -- (3,000,000)
-------------- -------------- ----------------
Net cash provided by financing activities.... 1,500,030 15,292,316 281,935,093
-------------- -------------- ---------------
Net increase in cash and cash equivalents............. 677,171 3,549,515 246,690,368
Cash and cash equivalents, beginning of period........ 140,220 817,391 4,366,906
-------------- -------------- ---------------
Cash and cash equivalents, end of period.............. $ 817,391 $ 4,366,906 $ 251,057,274
============== ============== ================
Supplemental cash flow statement information:
Non-cash consideration for issuance of redeemable
convertible preferred stock:........................
Outstanding principal of KLT Loan................ $ -- $ 14,000,000 $ --
Accrued interest payable on KLT Loan............. -- 794,062 --
Assets of contributed joint venture.............. -- 1,816,043 --
Liabilities assumed of contributed joint venture -- 69,088 --
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
DTI HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED JUNE 30, 1996, 1997 AND 1998
1. Description of Business
DTI Holdings, Inc. (the "Company" or "DTI") was incorporated in December
1997 as part of the reorganization (the "Reorganization") of Digital Teleport,
Inc., a wholly-owned subsidiary of DTI ("Digital Teleport"). Pursuant to the
Reorganization, the outstanding shares of common and preferred stock of Digital
Teleport were exchanged for the number of shares of common and preferred stock
of DTI having the same relative rights and preferences as such exchanged shares.
The Reorganization was required in connection with the establishment of the
Credit Facility (see Note 4). The business operations, name, charter, by-laws
and board of directors of the Company are identical in all material respects to
those of Digital Teleport, which did not change as a result of the
Reorganization. Accordingly, the consolidated financial statements have been
presented as if Digital Teleport had always been a wholly-owned subsidiary of
DTI. DTI is a holding company and, as such, has no operations other than its
ownership interest in Digital Teleport, its wholly-owned subsidiary, and
maintains only nominal other assets.
Digital Teleport was incorporated in June 1989 and was certified as a
telecommunications company in Missouri by the Missouri Public Service Commission
in 1992. DTI commenced construction of its long-haul network in fiscal year
1995, following an agreement with the Missouri Highway and Transportation
Commission ("MHTC"), which granted to DTI the exclusive right to build in the
interstate highway systems in Missouri. DTI is a facilities-based provider of
non-switched interexchange and local network telecommunications services to
interexchange carriers ("IXCs"), and business and governmental end-users. DTI's
network is designed to include high-capacity (i) interexchange long-haul routes
between the larger metropolitan areas in the region, (ii) local networks in such
larger metropolitan areas, and (iii) local networks in secondary and tertiary
markets located along the long-haul routes.
Prior to July 1, 1996, the Company was considered to be a development stage
enterprise focusing on developing its digital fiber optic telecommunications
network and customer base. All of the Company's operations are subject to
federal and state regulation.
At June 30, 1998, activities were primarily located in the State of Missouri
providing interexchange end-user and carrier's carrier services. Carrier's
carrier services are provided through wholesale network capacity agreements
("WNCAs") and indefeasible rights to use ("IRU") agreements. Wholesale network
capacity agreements provide carriers with virtual circuits or bandwidth capacity
on DTI's network for terms specified in the agreements, ranging from 5 to 20
years. The carrier customer in a WNCA does not have exclusive use of any
particular strand of fiber, but instead has the right to transmit along a
virtual circuit or a certain amount of bandwidth along DTI's network. These
agreements require the customer to pay for such capacity regardless of the level
of usage, and generally require fixed monthly payments over the term of the
agreement. In an IRU agreement the Company grants indefeasible rights to use
specified strands of optical fiber (which are used exclusively by the carrier
customer), while the carrier customer is responsible for providing the
electronic equipment necessary to transmit communications along the fiber. IRUs
generally require substantial advance payments and additional fixed annual
maintenance payments over the terms of the agreements, which range from 14 to 40
years. End-user services are telecommunications services provided to business
and governmental end-users and typically require a combination of advanced
payments and fixed monthly payments throughout the term of the agreement
regardless of the level of usage. In all cases, title to the optical fiber is
retained by the Company and the Company is generally obligated for all costs of
ongoing maintenance and repairs, unless such repairs are necessitated by acts or
omissions of the customer. The terms of these agreements are such that there are
no stated obligations to return any of the advanced payments. Generally, the
F-7
<PAGE>
agreements may be terminated upon the mutual written consent of both parties;
however, certain of the agreements may be terminated by the customer subject to
acceleration of all payments due thereunder.
2. Summary of Significant Accounting Policies
Principles of Consolidation -- The consolidated financial statements include
the accounts of DTI and its wholly-owned subsidiary, Digital Teleport. In
addition, the financial statements include an entity acquired during the year
ended June 30, 1997. The Company previously held a 50% interest in this entity
which was accounted for under the equity method. The acquisition of the
remaining 50% interest was accounted for as a purchase. Accordingly, the
purchase consideration was allocated to the assets and liabilities acquired
based on their fair values as of the date of acquisition. All significant
intercompany transactions and balances have been eliminated.
Revenues -- The Company recognizes revenue under its various agreements as
follows:
Wholesale network capacity agreements -- All revenues are deferred by
the Company until related route segments are ready for service. Advance
payments and fixed monthly service payments are then recognized on a
straight-line basis over the terms of the agreements which represent the
periods during which services are provided. One-time installation fees are
recognized upon completion of the installation if non-refundable or, if
refundable, as the performance requirements are met.
IRU Agreements -- These agreements are accounted for as operating
leases. All revenues are deferred until specified route segments are
completed and accepted by the customer. Advance payments are then recognized
on a straight-line basis over the terms of the agreements, as the Company
has continuing obligations to guarantee the performance of the fibers under
such agreements. These costs are potentially significant, and the Company
cannot reasonably estimate such costs over the terms of the IRU agreements
due principally to the limited history of operations of the Company to date,
the long-term nature of the agreements and the various possible causes of
service disruption that the Company must remedy pursuant to the agreements.
Fixed periodic maintenance payments are also recognized on a straight-line
basis over the terms of the agreements as ongoing maintenance services are
provided.
End-user Service Agreements -- All revenues are deferred until related
route segments are available for service. Advance payments and fixed monthly
payments are then recognized on a straight-line basis over the terms of the
agreements which represent the periods during which services are provided.
Other Services Revenue -- This category consists of work related to the
design and installation of inner-duct for a customer who was constructing
fiber optic cable facilities. For this agreement, revenue was recognized
upon completion of the facilities under the completed contract method of
accounting. Title to the fiber optic cable under this agreement was retained
by the customer.
Cash and Cash Equivalents -- The Company considers all highly liquid
investments with original maturities of three months or less to be cash
equivalents.
F-8
<PAGE>
Network and Equipment -- Network and equipment are stated at cost. Costs of
construction are capitalized, including interest costs on funds borrowed to
finance the construction. Maintenance and repairs are charged to operations as
incurred. Fiber optic cable plant includes primarily costs of cable, inner duct
and related installation charges. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets as follows:
Fiber optical cable plant....................... 25 years
Network buildings............................... 15 years
Leasehold improvements.......................... 10 years
Fiber optic terminal equipment.................. 8 years
Furniture, office equipment and other........... 5 years
The carrying value of long-lived assets is periodically evaluated by
management for impairment. Upon indication of an impairment, the Company will
record a loss on its long-lived assets if the discounted cash flows estimated to
be generated by those assets are less than the related carrying amount of the
assets.
Income Taxes -- The Company accounts for income taxes utilizing the
asset/liability method, and deferred taxes are determined based on the estimated
future tax effects of differences between the financial statement and tax bases
of assets and liabilities given the provisions of the enacted tax laws.
Deferred Financing Costs -- Deferred financing costs are stated at cost and
amortized over the life of the related debt using the effective interest method.
Amortization of deferred financing costs is included in interest expense.
Stock-Based Compensation -- The Company accounts for its stock based
incentive plan in accordance with the provisions of Accounting Principles Board
(APB) Option No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense is recorded on the date of grant
only if the then current market price of the underlying stock exceeded the
exercise price. The Company has also adopted Statement of Financial Accounting
Standards ("SFAS") 123, Accounting for Stock-Based Compensation, which permits
entities to recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant. Alternatively, SFAS 123 allows entities
to apply the provisions of APB Opinion No. 25 and provide pro forma net income
for employee stock option grants made in 1996 and future years as if the
fair-value-based method defined in SFAS 123 had been applied. The Company has
elected to apply the provisions of APB Opinion No. 25.
Fair Value of Financial Instruments -- The carrying amounts of cash and
cash equivalents and other short term financial instruments approximate fair
value because of the short-term maturity of these instruments. As of June 30,
1998, the fair value of debt was $273.2 million compared to its carrying value
of $277.5 million. The fair value of debt instruments as of June 30, 1998 was
determined based on quoted market prices.
New Accounting Standards -- In 1997, the Financial Accounting Standards
Board issued SFAS 130, Reporting Comprehensive Income, and SFAS 131, Disclosures
About Segments of an Enterprise and Related Information. These statements, which
are effective for fiscal years beginning after December 15, 1997, expand or
modify disclosures and, the Company believes, will have no impact on the
Company's consolidated financial position, results of operations or cash flows.
Management Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires that
management make certain 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. The reported amounts of
revenues and expenses during the reporting period may also be affected by the
estimates and assumptions management is required to make. Actual results may
differ from those estimates.
F-9
<PAGE>
Concentrations of Risk -- The Company currently operates in the
telecommunications industry within the States of Missouri and Arkansas. See Note
7 regarding concentration of credit risk associated with deferred revenues and
revenues. Additionally, the Company is dependent upon single or limited source
suppliers for its fiber optic cable and for the electrical equipment used in its
network.
Reclassifications -- Certain amounts for prior years have been reclassified
to conform to the 1998 presentation.
3. Network and Equipment
Network and equipment consists of the following as of June 30:
1997 1998
---- ----
Fiber optic cable plant................... $ 28,498,465 $ 52,619,430
Fiber optic terminal equipment............ 5,757,270 24,970,648
Network buildings......................... 757,680 2,591,326
Leasehold improvements.................... 131,611 390,186
Furniture, office equipment and other..... 91,248 465,367
--------- ---------
35,236,274 81,036,957
Less-- accumulated depreciation........... 1,235,640 3,265,430
--------- ---------
Network and equipment, net $ 34,000,634 $ 77,771,527
============ ============
At June 30, 1997 and 1998, fiber optic cable plant, fiber optic terminal
equipment and network buildings include $19,027,585 and $37,752,267 of
construction in progress, respectively, that was not in service and,
accordingly, has not been depreciated. Also, during the years ended June 30,
1996, 1997 and 1998 $1,227,149, $562,750 and $848,000 of interest costs were
capitalized.
4. Borrowing Arrangements
Senior Discount Notes -- On February 23, 1998, the Company issued 506,000
Units consisting of $506.0 million aggregate principal amount at maturity of 12
1/2% Senior Discount Notes (effective interest rate 12.9%) due March 1, 2008 and
warrants to purchase 3,926,560 shares of Common Stock, for which the Company
received proceeds, net of underwriting discounts and expenses (deferred
financing costs), of approximately $264.7 million. Of the $275.2 million gross
proceeds from the issuance of the Units, $265.2 million was allocated to the
Senior Discount Notes and $10.0 million was allocated to warrants included in
stockholders' equity, based on the fair market value of the warrants as
determined by the Company and the initial purchasers of the Units utilizing the
Black-Scholes method. The Senior Discount Notes are senior unsecured obligations
of the Company and may be redeemed at the option of the Company, in whole or in
part, on or after March 1, 2003 at a premium declining to zero in 2006. At any
time and from time to time on or prior to March 1, 2001, the Company may redeem
an aggregate of up to 33 1/3% of the aggregate principal amount at maturity of
the originally issued Senior Discount Notes within 60 days of one or more public
equity offerings with the net proceeds of such offerings, at a redemption price
of 112.5% of the accreted value (determined at the redemption date). The
discount on the Senior Discount Notes accrues from the date of the issue until
March 1, 2003 at which time cash interest on the Senior Discount Notes accrues
at a rate of 12 1/2% per annum and is payable semi-annually in arrears on March
1 and September 1, commencing September 1, 2003.
In the event of a "Change of Control" (as defined in the Indenture pursuant
to which the Senior Discount Notes were issued), holders of the Senior Discount
Notes may require the Company to offer to repurchase all outstanding Senior
Discount Notes at a price equal to 101% of the accreted value thereof, plus
accrued interest, if any, to the date of redemption. The Senior Discount Notes
also contain certain covenants that restrict the ability of the Company and its
Restricted Subsidiaries (as defined in the Indenture) to incur certain
indebtedness, pay dividends and make certain other restricted payments, create
liens, permit other restrictions on dividends and other payments by Restricted
Subsidiaries, issue and sell capital stock of its Restricted Subsidiaries,
F-10
<PAGE>
guarantee certain indebtedness, sell assets, enter into transactions with
affiliates, merge, consolidate or transfer substantially all of the assets of
the Company and make any investments in any Unrestricted Subsidiary (as defined
in the Indenture). The issuance of the Senior Discount Notes does not constitute
a "qualified public offering" within the meaning of the Company's Articles of
Incorporation and, therefore, did not effect the conversion of the Series A
Preferred Stock into common stock (see Note 5).
On April 14, 1998, the Company filed a Registration Statement on Form S-4
(subsequently amended and registered) relating to an offer to exchange, under
substantially similar terms, the Company's 12 1/2% Series B Senior Discount
Notes due March 1, 2008 for its outstanding Senior Discount Notes (the "Exchange
Offer"). The Exchange Offer did not constitute a "qualified public offering"
within the meaning of the Company's Articles of Incorporation and, therefore,
did not effect the conversion of the Series A Preferred Stock into common stock
(see Note 5).
Credit Facility -- In January 1998, Digital Teleport entered into a $30.0
million bank credit facility (the "Credit Facility") with certain commercial
lending institutions and Toronto Dominion (Texas), Inc., as administrative agent
for the lenders, to fund its working capital requirements. At February 23, 1998,
Digital Teleport had drawn $3.0 million principal amount under the Credit
Facility which was repaid with the net proceeds of the Senior Discount Notes
discussed above and then cancelled.
KLT Loan -- Effective April 30, 1996, and as subsequently amended, the
Company entered into a loan agreement with KLT Telecom Inc. ("KLT"), a
wholly-owned subsidiary of Kansas City Power and Light Company ("KCPL"), to
provide borrowings for the expansion of the Company's network not to exceed
$14,000,000 bearing interest at 3% above the prime interest rate (the "KLT
Loan"). A total of $14,000,000 had been borrowed under this facility as of March
12, 1997. The outstanding principal of the KLT Loan, plus accrued interest, was
contributed on March 12, 1997 as consideration under the Stock Purchase
Agreement referred to in Note 5.
Customer Loan -- In connection with the issuance of a $3,200,000 note
payable to a major customer effective February 20, 1996, approximately
$1,037,000 of the proceeds from the note payable was allocated to a warrant
which was also granted to the customer. The warrant represented the right to
purchase 5% of the common stock of the Company for a nominal amount. The Company
also executed an amendment to the contract with the major customer to provide an
additional $1,200,000 in telecommunication services and modify certain
completion dates in the original contract. The note was paid in full in April
1996. The carrying amount of the warrant was being accreted from the date of
issuance until February 1997, the initial date at which the Company could have
been required to repurchase the warrants for $1,250,000. In February 1997, the
Company repurchased the warrant from the holder for the amount of $2,700,000
which was stipulated in a repurchase right included in the customer contract and
available to the Company for the period from note issuance through February 19,
1997.
5. Convertible Series A Preferred Stock
During fiscal 1997, the Company amended its Articles of Incorporation to
provide for 50,000 authorized shares of preferred stock, $0.01 par value. On
December 31, 1996, the Company entered into a Stock Purchase Agreement (the
"Stock Purchase Agreement") with KLT to sell 30,000 shares of redeemable
convertible preferred stock (designated "Series A Preferred Stock") for
$45,000,000. At the closing date of the Stock Purchase Agreement on March 12,
1997, 15,100 shares of Series A Preferred Stock were issued to KLT with the
remaining 14,900 shares of Series A Preferred Stock to be issued as additional
capital as required by the Company upon twenty days notice by DTI to KLT and
verification by KLT as to the use of the monies pursuant to the terms of the
Stock Purchase Agreement. The consideration for the 15,100 shares of Series A
Preferred Stock was calculated as follows:
F-11
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Outstanding principal of KLT Loan.............................$ 14,000,000
Accrued interest on the KLT Loan at March 11, 1997............ 794,062
KLT investment in KCDT LLC (Note 8)........................... 4,000,000
Cash.......................................................... 3,855,938
---------
Total consideration for 15,100 shares
of Series A preferred Stock .......................... 22,650,000
Less: transaction costs....................................... 716,667
---------
Net consideration for 15,100 shares of
Series A preferred Stock ..............................$ 21,933,333
============
</TABLE>
Series A Preferred Stock shareholders are entitled to one common vote for
each share of common stock that would be issuable upon conversion of the Series
A Preferred Stock. Each share of Series A Preferred Stock is convertible into
one-thousand shares (after giving effect to the stock splits discussed in Note 6
and the Reorganization discussed in Note 1) of common stock (the "Conversion
Shares") under the terms of the Stock Purchase Agreement and is entitled to the
number of votes equal to the number of Conversion Shares into which such shares
of Series A Preferred Stock is convertible with respect to any and all matters
presented to the shareholders of the Company for their action or consideration.
The Series A Preferred Stock shares will automatically convert into common stock
upon the sale of shares of common stock or debt securities of the Company in a
"qualified public offering" within the meaning of the Company's Articles of
Incorporation and subject to the satisfaction of certain net proceed dollar
thresholds. Series A Preferred Stock shareholders rank senior to common
shareholders in the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Company. Series A Preferred Stock shareholders
are entitled to receive such dividends as would be declared and paid on each
share of common stock.
On June 27, 1997, an additional 3,400 shares of Series A Preferred Stock
were issued for a cash payment of $5,100,000. At June 30, 1997, Series A
Preferred Stock issued and outstanding was as follows:
Series A Preferred Stock, $0.01 par value, 30,000 shares designated,
18,500 shares issued and outstanding......... $ 185
Additional paid-in capital...................... 27,033,148
Accumulated accretion to redemption price....... 1,855,832
----------
Total carrying value....................... $ 28,889,165
============
During fiscal 1998, the remaining 11,500 shares of Series A Preferred Stock
were issued for cash payments of $17,250,000.
In conjunction with the Stock Purchase Agreement, the Company entered into a
Shareholders' Agreement whereby the Series A Preferred Stock shareholders will
designate half of the directors of the Company's Board of Directors.
On February 13, 1998, in connection with the Company's offering of Senior
Discount Notes (See Note 4), the Company amended its Articles of Incorporation
amending the terms of the Series A Preferred Stock such that the Series A
Preferred Stock is no longer redeemable. The Series A Preferred Stock, as a
result of such amendment, is now classified with stockholders' equity subsequent
to such date.
6. Equity Transactions
Stock Splits -- On August 22, 1997 and on February 17, 1998, the Company
approved stock splits in the form of stock dividends of 99 shares and 999
shares, respectively, of common stock for each one share of common stock
outstanding. Effective October 17, 1997 and February 18, 1998, the Company's
Articles of Incorporation were amended to increase the number of authorized
shares of common stock to 100,000 and 100,000,000, respectively, and the stock
dividends were issued to the Company's stockholders. All share information
included in the accompanying financial statements, and in the discussion below,
has been retroactively adjusted to give effect to the stock splits. In order to
effect the 999 for 1 stock split on February 17, 1998, $269,970 was charged to
accumulated deficit. The Company recorded an entry in the third quarter of
fiscal 1998 to reclassify this amount from accumulated deficit to additional
paid-in capital recorded in conjunction with the reclassification of Series A
Preferred Stock on February 13, 1998 (see Note 5).
F-12
<PAGE>
Common Stock -- As of June 30, 1995, the Company had authorized 30,000,000
shares of common stock, par value $1.00 per share, and obtained contributed
capital of $30,000. In April 1996, the Company authorized 20,000,000 additional
shares of common stock, and changed the par value of the common stock to $.01
par value per share. At such time the Company made its initial share issuance of
30,000,000 shares of common stock as "founder's shares" to the founder,
President and Chief Executive Officer of the Company. These shares were
attributable to the initial contributed services of the founder for services
performed from the inception of the Company through June 30, 1995 and his
capital contribution of $30,000 in 1995. In February 1997, the Company
authorized 50,000,000 additional shares of common stock.
Warrant to Third Party -- In connection with a loan commitment from a
strategic third party lender which became effective December 24, 1996, the
Company agreed to issue a warrant representing the right to purchase 1% of the
common stock of the Company for $0.01 per share. Effective December 31, 1996,
the Company reached an agreement with respect to the sale of its Series A
Preferred Stock (see Note 5), and, as a result, the commitment from the
strategic third party lender was terminated in January 1997. Accordingly, the
Company has recorded the fair value of this warrant as an equity instrument and
the related loan commitment fee as an expense. The fair value of the warrant was
determined based upon an independent valuation utilizing the Black-Scholes
method. The warrant is exercisable at the option of the holder and expires in
the year 2007. Also in connection with this transaction, cash expenses
consisting of legal and other fees of $334,500 were incurred by the Company.
Stock Based Compensation -- On August 22, 1997, the Company adopted a
Long-Term Incentive Award Plan (the "Plan"). A total of 3,000,000 shares of
common stock of the Company have been reserved for issuance under the Plan. The
employees' options vest 100% after three to five years from the date of grant,
subject to certain acceleration events. The directors' options vest 25% per year
beginning one year from the date of grant. The exercise prices per share of such
options are based on fair market value as determined in good faith by the Board
of Directors. The Board reviewed a combination of detailed financial analyses,
as well as information derived from discussions with outside financial advisors.
For purposes of the pro forma disclosures required by SFAS 123, the fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for fiscal 1998: risk-free interest rate of 5.6%; no dividend yield;
volatility factor of the expected market price of the Company's common stock of
.678; and a weighted-average expected life of the options of approximately 10
years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
1998
----
Loss applicable to common stockholders:
As reported...................................... $ 9,422,512
===========
Pro Forma........................................ $ 9,516,824
===========
F-13
<PAGE>
A summary of the Company's stock option activity, and related
information for the years ended June 30, 1998 follows:
1998
----------------------------------
Weighted Average
Options Exercise Price
------- --------------
Outstanding - beginning of year....... -
Granted............................... 1,175,000 $ 2.99
Exercised............................. -
Forfeited............................. (600,000) 1.50
--------- ---------
Outstanding - end of year............. 575,000 $ 4.54
========= =========
Exercisable - end of year............. -
========= =========
The following table summarizes outstanding options at June 30, 1998 by price
range:
Outstanding
-------------------------------------------------------------------------------
Weighted Average Weighted Average
Number of Options Range of Exercise Remaining Contractual
Exercise Price Price Life of Options
300,000 $ 2.60 $ 2.60 9.6
275,000 6.66 6.66 10.0
------- ---- ---- ----
575,000 $ 2.60 to $ 6.66 $ 4.54 9.8
======= =================== =========== ===
In July 1998, in conjunction with the execution of an officer's employment
agreement the Company became obligated to grant 200,000 shares of restricted
stock. These shares do not carry voting rights and will vest over the three-year
term of the agreement. Additionally, the Company through September, 1998 has
become obligated to grant an additional 750,000 options under terms similar to
those above to new employees of the Company.
7. Customer Contracts
The Company enters into agreements with unrelated third parties whereby the
Company will provide IRUs in multiple fibers along certain routes, WNCAs or
end-user service agreements for a minimum purchase price paid in advance or over
the life of the contract. These amounts are then recognized over the terms of
the related agreements, which range from 3 to 40 years on a straight-line basis.
The Company has various contracts related to IRUs that provide for advanced
payments, which are detailed below, with no monthly payments. The Company also
has various WNCA and end-user contracts that provide for a combination of
advance payments, which are detailed below, and monthly payments. The following
schedule details the advanced payments received or to be received under IRU,
WNCA and end-user service agreements and the components of deferred revenue at
June 30:
<TABLE>
<CAPTION>
1997
----
End-user
IRUs WNCAs Services Total
<S> <C> <C> <C> <C>
Total contract amounts....................$ 22,578,380 $ 1,539,750 $ 11,445,250 $ 35,563,380
Less: future payments due under
Contracts................................ 18,575,205 1,500,000 5,390,000 25,465,205
----------- --------- --------- ----------
Total amounts collected to date............ 4,003,175 39,750 6,055,250 10,098,175
Less: total amounts recognized as
revenues to date.......................... 141,914 -- 276,357 418,271
------- --------- ------- -------
Deferred revenue........................... 3,861,261 39,750 5,778,893 9,679,904
Less: amounts to be recognized within
12 months.................................. 77,796 -- 181,884 259,680
- -- ------ --------- ------- -------
$ 3,783,465 $ 39,750 $ 5,597,009 $ 9,420,224
============ ============ ============ ============
</TABLE>
F-14
<PAGE>
<TABLE>
<CAPTION>
1998
----
End-user
IRUs WNCAs Services Total
---- ----- -------- -----
<S> <C> <C> <C> <C>
Total contract amounts....................$24,470,380 $ 1,539,750 $ 11,278,288 $ 37,288,418
Less: future payments due under
Contracts............................... 14,979,500 -- 4,190,000 19,169,500
---------- ----------- --------- ----------
Total amounts collected to date........... 9,490,880 1,539,750 7,088,288 18,118,918
Less: total amounts recognized as
revenues to date.......................... 703,480 114,750 486,200 1,304,430
------- ------- ------- ---------
Deferred revenue.......................... 8,787,400 1,425,000 6,602,088 16,814,488
Less: amounts to be recognized within
12 months................................. 893,868 75,000 162,954 1,131,822
------- ------ ------- ---------
$ 7,893,532 $ 1,350,000 $ 6,439,134 $ 15,682,666
=========== =========== ============ ============
</TABLE>
Future minimum rentals due over the next five years under the IRU agreements
accounted for as operating leases are generally receivable upon completion of
related routes and are as follows as of June 30, 1998:
1999............................. $ 2,662,000
2000............................. 3,030,000
2001............................. 3,030,000
2002............................. 3,030,000
2003............................. 3,030,000
Thereafter....................... 197,500
---------
Total...................... $ 14,979,500
===========
The total costs of fiber optic cable plant for the route segments completed
to date are allocated to property subject to lease under IRU agreements based on
the percentage of fiber strands under lease to total fiber count in the related
route segments and amount to approximately $4,988,000 at June 30, 1998.
Additional route segments related to the IRU agreements are in process or
planned for construction under timelines established in the IRU agreements. The
IRU agreements also provide for the receipt of periodic maintenance payments,
which are recognized on a straight-line basis over the periods covered by the
agreement.
The Company has substantial business relationships with several large
customers. Four customers accounted for 39%, 31%, 24% and 5% of deferred
revenues at June 30, 1998. Additionally, three of these four customers accounted
for 69%, 22%, and 9% of amounts to be received per the customer contracts
referred to above.
During fiscal 1998, the Company's three largest customers accounted for 44%,
11% and 10% of telecommunications services revenue. During fiscal year 1997, the
Company's three largest customers accounted for 18%, 18% and 16% of
telecommunications services revenue. During fiscal year 1996, the Company's
three largest customers accounted for 47%, 21% and 10% of telecommunications
services revenue. The Company's contracts provide for reduced payments and
varying penalties for late delivery of route segments, and allow the customers,
after expiration of grace periods, to delete such non-delivered segment from the
system route to be delivered. A significant reduction in the level of services
the Company provides for any of these customers could have a material adverse
F-15
<PAGE>
effect on the Company's results of operations or financial condition. In
addition, the Company's business plan assumes increased revenue from its
carrier's carrier services operations to partially fund the expansion of the DTI
network. Many of the Company's customer arrangements are subject to termination
and do not provide the Company with guarantees that service quantities will be
maintained at current levels. The Company is aware that certain interexchange
carriers are constructing or considering new networks. Accordingly, there can be
no assurance that any of the Company's carrier's carrier services customers will
increase their use of the Company's services, or will not reduce or cease their
use of the Company's services, either of which could have a material adverse
effect on the Company's ability to fund the expansion of the DTI network.
8. Investment in Joint Venture
Effective July 1996, the Company entered into an agreement with KLT to form
KCDT LLC ("KCDT") as a limited liability company for the purpose of financing,
establishing, constructing and maintaining a fiber-optic network communications
system ("System") within the Kansas City, Missouri metropolitan area. The
Company received a 50% interest in KCDT for its contribution of an indefeasible
right to use the signal transmission capacity of certain optic fiber strands
within the System. KLT received a 50% interest in KCDT for its contribution of
access rights of utility right-of-ways in Kansas City and a capital contribution
not to exceed $5,000,000 in cash, as needed, for the construction of the System
or operations of KCDT.
As part of the Stock Purchase Agreement, which closed March 12, 1997 (Note
5), KLT contributed to the Company its ownership interest in KCDT which amounted
to $4,000,000. Assets and liabilities of the joint venture at the date of
contribution consisted of $2,253,045 in cash, $1,816,043 in network and
equipment and $69,088 in other liabilities, all of which assets and liabilities
were determined to approximate fair market value. This transaction was accounted
for as a purchase by the Company. Additionally, as of March 12, 1997, KCDT had
no operations in service. The only income earned by KCDT consisted of interest
income earned on bank deposits.
Prior to receipt of KLT's interest in KCDT, the Company accounted for its
investment in KCDT using the equity method. Equity in earnings of joint venture
represents the Company's 50% interest in the operations of KCDT under the equity
method. Upon receipt of KLT's interest in KCDT, operations of KCDT have been
consolidated with the Company's operations.
On September 23, 1997, DTI's Board of Directors and stockholders approved
the merger of KCDT with and into the Company, which merger became effective on
October 17, 1997.
9. Income Taxes
The actual income tax benefit for the years ended June 30, 1996, 1997 and
1998 differs from the "expected" income tax expense, computed by applying the
U.S. Federal corporate tax rate of 35% to loss before income taxes as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ----------- ---------
<S> <C> <C> <C>
Tax benefit at federal statutory rates.............. $ 275,231 $ 648,117 $4,004,879
State income tax benefit net of federal effect...... 29,728 52,684 572,126
Change in valuation allowance....................... (321,596) 424,964 (2,232,780)
Permanent and other differences..................... 16,637 88,566 (324,225)
-------- -------- --------
Benefit for income taxes....................... $ -- $ 1,214,331 $2,020,000
========== =========== ==========
</TABLE>
F-16
<PAGE>
Significant components of the benefits for income taxes are as follows at
June 30:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ------- -------
<S> <C> <C> <C>
Deferred:
Federal.............................. $ -- $ 1,062,540 $1,767,500
State................................ -- 151,791 252,500
----- ------- -------
Benefit for income taxes.......... $ -- $ 1,214,331 $2,020,000
========= =========== ==========
</TABLE>
Temporary differences, which give rise to long-term deferred taxes as
reported on the balance sheet, are as follows at June 30:
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Deferred revenues.................................. $ 571,711 $ 603,723
Net operating loss carryforward.................... 1,175,712 1,546,244
Accretion on senior discount notes................. -- 4,195,779
Accrued expenses................................... -- 315,651
--------- -------
Total deferred tax assets....................... 1,747,423 6,661,397
Deferred tax liabilities-- accelerated depreciation.. (533,092) (1,194,353)
Valuation allowance.................................. (2,232,713)
----------- -----------
Net deferred tax assets......................... $ 1,214,331 $ 3,234,331
=========== ===========
</TABLE>
A valuation allowance of $2,232,713 was established for the year ended June 30,
1998 to offset a portion of the Company's deferred tax asset, primarily related
to the accretion on the Senior Discount Notes, that may not be realizable. The
Company believes that it is more likely than not that it will generate taxable
income sufficient to realize the tax benefit associated with future deductible
temporary differences and net operating loss carryforwards prior to their
expiration related to the remaining net deferred tax asset. This belief is based
primarily upon changes in operations over the last two years which included the
equity investment by KLT (see Note 5) and the senior discount note offering (see
Note 4), which allowed the Company to significantly expand its fiber optic
network, deferred revenues of the Company which have been collected under
certain IRUs and end-user service agreements, future payments due under existing
contracts, and available tax planning strategies. Tax net operating losses of
approximately $3.9 million expire in years 2010-2013 if not utilized in future
income tax returns. The availability of the loss carryforwards may be limited in
the event of a significant change in the ownership of the Company or its
subsidiary.
10. Operating Leases
The Company is a lessee under operating leases for equipment and for office
space. The Company's headquarters and network control center was leased from the
Company's President and Chief Executive Officer at a rate of $75,000 per year
through December 31, 1998. Rent expense related to the prior headquarters for
fiscal years 1996, 1997 and 1998 was $15,405, $49,897, and $75,000,
respectively. In June 1998, the Company entered into a three-year lease
agreement for new headquarters and network control center space, which was
occupied beginning in August 1998. Additionally, equipment space is leased in
various buildings throughout the Company's service areas. Minimum rental
commitments under these leases, some of which contain renewal options and
escalation clauses, and all other leases are as follows:
Year ending June 30:
1999................................ $488,736
2000................................ 435,211
2001................................ 407,856
Total..........................$1,331,803
11. Commitments
Highway and Utility Rights-of-Way -- In July 1994, the Company entered into
an agreement with MHTC to install and maintain a buried fiber optic network
within the cable corridor along the federal interstate highway system in
Missouri. Under the terms of this agreement, MHTC will receive certain dedicated
F-17
<PAGE>
dark and lighted fiber optic strands in the statewide system and the necessary
connections thereto and the Company, in turn, receives exclusive easements
within certain of MHTC's airspace for a forty-year period. Pursuant to this
contract DTI is obligated to complete by December 31, 1998 construction of 1,200
miles of fiber cable along the Missouri interstate and state highway systems.
DTI anticipates meeting this obligation and completing substantially all of its
currently planned network in Missouri by such date. The Company must complete
construction of an additional 800 miles by the end of 1999 to maintain its
exclusive rights to such routes. Additionally, the Company was required to post
a $250,000 performance and payment bond under the terms of this Agreement. The
Company's May 1997 agreement with the Department of Transportation of the State
of Arkansas grants to DTI, in exchange for certain dedicated dark fiber optic
strands located in the State of Arkansas, the right, without obligation, to
install its network along 250 miles of the interstate and state highway systems
in Arkansas, as well as the right to expand its network onto additional routes
in the future. On July 12, 1998, the Company entered into an agreement with the
Department of Transportation of the State of Kansas providing for rights-of-way
throughout the highway system in metropolitan Kansas City, Kansas, in exchange
for fiber and other telecommunications services. DTI also has a license from
KCPL granting it the right to use conduits, poles, ducts, manholes and
rights-of-way owned by KCPL to construct the DTI network in the Kansas City
metropolitan area. The Company will seek to obtain the rights-of-way that it
needs for the expansion of its network in areas where it will construct network
rather than purchase or swap fiber optic strands by entering into agreements
with other state highway departments and other governmental authorities,
utilities or pipeline companies and it may enter into joint ventures or other
"in-kind" transfers in order to obtain such rights. In addition, DTI may use
available public rights-of-way.
Licensing Agreements -- The Company has entered into various licensing
agreements with municipalities in Arkansas, Kansas and Missouri. Under the terms
of these agreements, the Company maintains certain performance bonds, totaling
$350,000 in the aggregate, and minimum insurance levels. Such agreements
generally have terms from 10 to 15 years and grant to the Company a
non-exclusive license to construct, operate, maintain and replace communications
transmission lines for its fiber optic cable system and other necessary
appurtenances on public roads, rights-of-way and easements within the
municipality. In exchange for such licenses, the Company generally provides to
the municipality in-kind rights and services (such as the right to use certain
dedicated strands of optic fiber in the DTI network within the municipality,
interconnection services to the DTI network within the municipality, and
maintenance of the municipality's fibers), or, less frequently, a nominal
percentage of the gross revenues of the Company for services provided within the
municipality. In one instance, the Company is obligated to make nominal annual
cash payments for such rights based on linear footage.
Nonrecourse Note to Customer -- The Company's performance under one IRU
agreement is secured by a nonrecourse note in the amount of $250,000.
Employment Agreements -- DTI has employment agreements entered into during
fiscal year 1997 and 1998 with certain senior management personnel. These
agreements are effective for various periods through December 31, 1999, unless
terminated earlier by the executive or DTI, and provide for annual salaries,
additional compensation in the form of bonuses based on performance of the
executive, and participation in the various benefit plans of DTI. The agreements
contain certain benefits to the executive if DTI terminates the executive's
employment without cause or if the executive terminates his employment as a
result of change in ownership of DTI.
Supplier Agreements -- DTI's supplier agreements are with its major network
construction contractors and its equipment suppliers.
Purchase Commitments -- DTI's remaining aggregate purchase commitment for
construction and switching equipment at June 30, 1998 is approximately $23
million. The switching equipment commitment totaling $15 million is cancelable
upon the payment of a $42,000 cancellation fee for each of the remaining eight
unpurchased switches. Additionally, in June, July and September 1998 the Company
entered into preliminary and definitive agreements to purchase for cash IRUs for
F-18
<PAGE>
fiber optic strands (fiber usage rights) and short-term fiber lease agreements.
The IRU and short-term lease agreements have 20-year and 2 1/2-year terms,
respectively, and require cash payments totaling approximately $133 million,
with each agreement providing for an initial payment and subsequent payments
over a period of less than one year from the date of execution of a definitive
agreement. The fiber usage rights related to the IRUs will be recorded at cost
as a separate component of property, plant and equipment.
Other Commitments -- In September 1998 the Company also entered into a
long-term IRU and fiber swap agreement, in which it will obtain access to dark
fiber and receive approximately $5 million in cash in exchange for providing
dark fiber along the Company's network.
12. Contingencies
On June 20, 1995, the Company and its President were named as defendants in
a suit in which the plaintiff alleges that (i) the plaintiff entered into an
oral contract with the defendants pursuant to which the plaintiff was to receive
a percentage of the Company's common stock, (ii) the plaintiff provided services
to the Company for which the plaintiff was not and should be compensated, and
(iii) the defendants misrepresented certain facts to the plaintiff in order to
induce him to loan money and provide services to the defendants. Based on these
allegations, the plaintiff is suing for breach of contract and fraud and is
seeking actual monetary damages, punitive damages and a percentage of the common
stock of the Company. Management believes the plaintiff's claims are without
merit and intends to vigorously defend the claims. It is not possible to
determine what impact, if any, the outcome of this litigation might have on the
financial condition, results of operations or cash flows of the Company at this
time. The President has agreed personally to indemnify the Company against any
and all losses and damages resulting from any judgments and awards rendered
against the Company in this litigation. However, no guarantee can be made as to
the ability to satisfy all such amounts. The President has also agreed to
indemnify the holder of the convertible preferred stock from such losses and
damages, and has pledged his stock ownership in the Company to secure such
obligation.
The Company has received notice from a customer that it intends to set off
against amounts payable to the Company $15,000 per month, which as of June 30,
1998 totaled approximately $90,000 (in addition to $400,000 previously set off
against other payments) as damages and penalties under the Company's contract
with that customer due to the failure by the Company to meet certain
construction deadlines, and such customer reserved its rights to seek other
remedies under the contract. The Company believes that if such $90,000 setoff
were to be made, it would not be material to the Company's business, financial
position or results of operations. The Company is behind schedule with respect
to such contract as a result of such customer's not obtaining on behalf of the
Company certain rights-of-way required for completion of certain network
facilities, and the Company's limitations on its financial and human resources,
particularly prior to the Senior Discount Notes Offering. The Company has
obtained alternative rights-of-way and hired additional construction supervisory
personnel to accelerate the completion of such construction. Upon completion and
turn-up of services, such customer is contractually required to pay the Company
a lump sum of approximately $4.2 million for the Company's telecommunications
services over its network
From time to time the Company is named as a defendant in routine lawsuits
incidental to its business. The Company believes that none of such current
proceedings, individually or in the aggregate, will have a material adverse
effect on the Company's financial position, results of operations or cash flows.
13. Valuation and Qualifying Accounts
Activity in the Company's allowance for doubtful accounts was as follows:
F-19
<PAGE>
<TABLE>
<CAPTION>
Additions Charged
Balance at to Costs and Balance at
For the year ended Beginning of Expenses Deductions End of Year
------------------ ------------- -------- ---------- -------
Year
<S> <C> <C> <C> <C>
June 30, 1996......... $ -- $ -- $ -- $ --
========= ========== ========= ========
June 30, 1997......... $ $ 48,000 $ -- $ 48,000
========= ========== ========= ========
June 30, 1998......... $ 48,000 $ 139,768 $ 187,768 --
========= ========== ========= ========
</TABLE>
14. Quarterly Results (Unaudited)
The Company's unaudited quarterly results are as follows:
<TABLE>
<CAPTION>
For the 1997 Quarter Ended
---------------------------
September 30 December 31 March 31 June 30
------------ ----------- -------- -------
<S> <C> <C> <C> <C>
Total revenues........ $ 232,385 $ 270,879 $ 366,581 $ 1,164,145
================ ================= ================= =================
Income (loss) from
operations............ $ (266,266) $ (306,299) $ (488,114) $ 7,002
================ ================= ================= =================
Net income (loss)..... $ (292,948) $ (189,029) $ (378,300) $ 222,844
================ ================= ================= =================
For the 1998 Quarter Ended
--------------------------
September 30 December 31 March 31 June 30
------------ ----------- -------- -------
Total revenues........ $ 452,082 $ 566,449 $ 1,104,043 $ 1,510,197
================ ================= ================= =================
Loss from operations.. $ (747,554) $ (1,072,123) $ (905,902) $ (1,725,162)
================ ================ ================= =================
Net loss.............. $ (417,277) $ (602,254) $ (1,824,755) $ (6,578,226)
================ ================= ================= =================
</TABLE>
* * * * * *
F-20
<PAGE>
Exhibit Index
Number Description
2.1 Stock Purchase Agreement by and between KLT Telecom Inc. and Digital
Teleport, Inc., dated December 31, 1996 (incorporated herein by
reference to Exhibit 2.1 to the Company's Registration Statement on
Form S-4 (File No. 333-50049) (the "S-4")).
2.2 Amendment No. 1 to Stock Purchase Agreement between KLT Telecom Inc.
and Digital Teleport, Inc. dated February 12, 1998 (incorporated
herein by reference to Exhibit 2.2 to the S-4).
3.1 Restated Articles of Incorporation of the Registrant (incorporated
herein by reference to Exhibit 3.1 to the S-4).
3.2 Restated Bylaws of the Registrant (incorporated herein by reference to
Exhibit 3.2 to the S-4).
4.1 Indenture by and between the Registrant and The Bank of New York, as
Trustee, for the Registrant's 12 1/2% Senior Discount Notes due 2008,
dated February 23, 1998 (the "Indenture") (including form of the
Company's 12 1/2% Senior Discount Note due 2008 and 12 1/2% Series B
Senior Discount Note due 2008) (incorporated herein by reference to
Exhibit 4.1 to the S-4).
4.2 Note Registration Rights Agreement by and among the Registrant and the
Initial Purchasers named therein, dated as of February 23, 1998
(incorporated herein by reference to Exhibit 4.2 to the S-4).
4.3 Warrant Agreement by and between the Registrant and The Bank of New
York, as Warrant Agent, dated February 23, 1998 (incorporated herein
by reference to Exhibit 4.3 to the S-4).
4.4 Warrant Registration Rights Agreement by and among the Registrant and
the Initial Purchasers named therein, dated February 23, 1998
(incorporated herein by reference to Exhibit 4.4 to the S-4).
4.5 Digital Teleport, Inc. Shareholders' Agreement between Richard D.
Weinstein and KLT Telecom Inc., dated March 12, 1997 (incorporated
herein by reference to Exhibit 4.5 to the S-4).
4.6 Amendment No. 1 to the Digital Teleport, Inc. Shareholders' Agreement,
dated November 7, 1997 (incorporated herein by reference to Exhibit
4.6 to the S-4).
4.7 Amendment No. 2 to the Digital Teleport, Inc. Shareholders' Agreement,
dated December 18, 1997 (incorporated herein by reference to Exhibit
4.7 to the S-4).
4.8 Amendment No. 3 to the Digital Teleport, Inc. Shareholders' Agreement,
dated February 12, 1998 (incorporated herein by reference to Exhibit
4.8 to the S-4).
4.9 Stock Pledge Agreement between Richard D. Weinstein and KLT Telecom
Inc., dated March 12, 1997, securing the performance of Digital
Teleport, Inc.'s obligations under that certain Stock Purchase
Agreement dated as of December 31, 1996, as amended, (incorporated
herein by reference to Exhibit 4.9 to the S-4).
4.10 Amendment No. 1 to Stock Pledge Agreement between Richard D. Weinstein
and KLT Telecom Inc., dated December 18, 1997 (incorporated herein by
reference to Exhibit 4.10 to the S-4).
4.11 Amendment No. 2 to Stock Pledge Agreement between Richard D. Weinstein
and KLT Telecom Inc., dated February 12, 1998 (incorporated herein by
reference to Exhibit 4.11 to the S-4).
<PAGE>
4.12 Subordination Agreement, by and among the Registrant, Digital
Teleport, Inc., KLT Telecom Inc. and Richard D. Weinstein, dated
February 12, 1998 (incorporated herein by reference to Exhibit 4.12 to
the S-4).
10.1 Employment Agreement between Digital Teleport, Inc. and Richard D.
Weinstein, dated December 31, 1996 (incorporated herein by reference
to Exhibit 10.1 to the S-4).
10.2 Director Indemnification Agreement between the Registrant and Richard
D. Weinstein, dated December 23, 1997 (incorporated herein by
reference to Exhibit 10.2 to the S-4).
10.3 Director Indemnification Agreement between the Registrant and Jerome
W. Sheehy, dated December 23, 1997 (incorporated herein by reference
to Exhibit 10.3 to the S-4).
10.4 Director Indemnification Agreement between the Registrant and Bernard
J. Beaudoin, dated December 23, 1997 (incorporated herein by reference
to Exhibit 10.4 to the S-4).
10.5 Director Indemnification Agreement between the Registrant and Ronald
G. Wasson, dated December 23, 1997 (incorporated herein by reference
to Exhibit 10.5 to the S-4).
10.6 Director Indemnification Agreement between the Registrant and James V.
O'Donnell, dated December 23, 1997 (incorporated herein by reference
to Exhibit 10.6 to the S-4).
10.7 Director Indemnification Agreement between the Registrant and Kenneth
V. Hager, dated December 23, 1997 (incorporated herein by reference to
Exhibit 10.7 to the S-4).
10.8 1997 Long-Term Incentive Award Plan of the Registrant (incorporated
herein by reference to Exhibit 2.2 to the S-4).
10.9 Employment Agreement between Digital Teleport, Inc. and Robert F.
McCormick, dated September 9, 1997 (incorporated herein by reference
to Exhibit 10.9 to the S-4).
10.10Amendment No. 1 to the Employment Agreement between Digital Teleport,
Inc. and Robert F. McCormick, dated January 28, 1998 (incorporated
herein by reference to Exhibit 10.10 to the S-4).
10.11Amendment No. 2 to the Employment Agreement between Digital Teleport,
Inc. and Robert F. McCormick, dated January 28, 1998 (incorporated
herein by reference to Exhibit 10.11 to the S-4).
10.12Product Attachment -- Carrier Networks Products Agreement between
Digital Teleport, Inc. and Northern Telecom, Inc., effective October
23, 1997 (incorporated herein by reference to Exhibit 10.12 to the
S-4).
10.13Agreement re: Fiber Optic Cable on Freeways in Missouri, between the
Missouri Highway and Transportation Commission and Digital Teleport,
Inc., effective July 29, 1994 (incorporated herein by reference to
Exhibit 10.13 to the S-4).
10.14First Amendment to Agreement re: Fiber Optic Cable on Freeways in
Missouri, between the Missouri Highway and Transportation Commission
and Digital Teleport, Inc., effective September 22, 1994 (incorporated
herein by reference to Exhibit 10.14 to the S-4).
10.15Second Amendment to Agreement re: Fiber Optic Cable on Freeways in
Missouri, between the Missouri Highway and Transportation Commission
and Digital Teleport, Inc., effective November 7, 1994 (incorporated
herein by reference to Exhibit 10.15 to the S-4).
10.16Third Amendment to Agreement re: Fiber Optic Cable on Freeways in
Missouri, between the Missouri Highway and Transportation Commission
and Digital Teleport, Inc., effective October 9, 1996 (incorporated
herein by reference to Exhibit 10.16 to the S-4).
<PAGE>
10.17Contract Extension to Agreement re: Fiber Optic Cable on Freeways in
Missouri, between the Missouri Department of Transportation (as
successor to the Missouri Highway and Transportation Commission) and
Digital Teleport, Inc., dated February 7, 1997, (incorporated herein
by reference to Exhibit 10.17 to the S-4).
10.18Fiber Optic Cable Agreement, between the Arkansas State Highway and
Transportation Department and Digital Teleport, Inc., dated May 29,
1997 (incorporated herein by reference to Exhibit 10.18 to the S-4).
10.19Missouri Interconnection Agreement between Southwestern Bell
Telephone Company and Digital Teleport, Inc., executed July 1, 1997
(incorporated herein by reference to Exhibit 10.19 to the S-4).
10.20Arkansas Interconnection Agreement between Southwestern Bell
Telephone Company and Digital Teleport, Inc., executed August 21, 1997
(incorporated herein by reference to Exhibit 10.20 to the S-4).
10.21Kansas Interconnection Agreement between Southwestern Bell Telephone
Company and Digital Teleport, Inc., executed August 21, 1997
(incorporated herein by reference to Exhibit 10.21 to the S-4).
10.22Oklahoma Interconnection Agreement between Southwestern Bell
Telephone Company and Digital Teleport, Inc., executed August 21, 1997
(incorporated herein by reference to Exhibit 10.22 to the S-4).
10.23Missouri Interconnection, Resale and Unbundling Agreement between GTE
Midwest Incorporated, GTE Arkansas Incorporated and Digital Teleport,
Inc. executed November 7, 1997 (incorporated herein by reference to
Exhibit 10.23 to the S-4).
10.24 Arkansas Interconnection, Resale and Unbundling Agreement between GTE
Southwest Incorporated, GTE Midwest Incorporated, GTE Arkansas
Incorporated and Digital Teleport, Inc., executed November 7, 1997
(incorporated herein by reference to Exhibit 10.24 to the S-4).
10.25Oklahoma Interconnection, Resale and Unbundling Agreement between GTE
Southwest Incorporated, GTE Arkansas Incorporated, GTE Midwest and
Digital Teleport, Inc., executed November 7, 1997 (incorporated herein
by reference to Exhibit 10.25 to the S-4).
10.26Texas Interconnection, Resale and Unbundling Agreement between GTE
Southwest Incorporated and Digital Teleport, Inc., executed November
18, 1997 (incorporated herein by reference to Exhibit 10.26 to the
S-4).
10.27Kansas Master Resale Agreement between United Telephone Company of
Kansas (Sprint) and Digital Teleport, Inc., dated September 30, 1997
(incorporated herein by reference to Exhibit 10.27 to the S-4).
10.28Commercial Lease between Richard D. Weinstein and Digital Teleport,
Inc., dated December 31, 1996 (incorporated herein by reference to
Exhibit 10.28 to the S-4).
10.29Commercial Lease Extension Agreement between Richard D. Weinstein and
Digital Teleport, Inc., dated December 31, 1997 (incorporated herein
by reference to Exhibit 10.29 to the S-4).
10.30Purchase Agreement by and between the Registrant and the Initial
Purchasers named therein, dated as of February 13, 1998 (incorporated
herein by reference to Exhibit 10.30 to the S-4).
10.31IRU and Maintenance Agreement between Digital Teleport, Inc. and IXC
Communications Services, Inc., executed July 30, 1998 (Greenwood,
Indiana to New York City, New York), (incorporated herein by reference
to Exhibit 10.31 to the S-4).
10.32IRU and Maintenance Agreement between Digital Teleport, Inc. and IXC
Communications Services, Inc., executed July 30, 1998 (Chicago,
Illinois to Hudson, Ohio) (incorporated herein by reference to Exhibit
10.32 to the S-4).
10.33Consulting Agreement between Digital Teleport, Inc. and H.P. Scott,
dated May 4, 1998, (incorporated herein by reference to Exhibit 10.33
to the S-4).
<PAGE>
10.34Employment Agreement between Digital Teleport, Inc. and Gary W.
Douglass, dated July 20, 1998 (incorporated herein by reference to
Exhibit 10.34 to the S-4).
10.35Agreement for Purchase and Sale of Equipment between Digital
Teleport, Inc. and Pirelli Cables and Systems LLC, dated as of June
26, 1998 (incorporated herein by reference to Exhibit 10.35 to the
S-4).
+10.36 Agreement for the Purchase and Sale of Optical Amplifier and Dense
Wavelength Division Multiplexing Equipment between Digital Teleport,
Inc. and Pirelli Cables and Systems LLC dated as of September 1, 1998.
12 Statement re Computation of Ratios
21 Subsidiaries of the Registrant (incorporated herein by reference to
Exhibit 21.1 to the S-4).
27 Financial Data Schedule
99 Risk Factors
- -------------------------
+ To be filed by amendment.
DTI Holdings, Inc.
Computation of Ratio of Earnings to Fixed Charges
<TABLE>
Fiscal Year Ended June 30,
<S> <C> <C> <C>
1996 1997 1998
---- ---- ----
SELECTED HISTORICAL DATA E
arnings were calculated as follows:
Loss before income taxes (786,375.00) (1,851,764.00) (11,442,512.00)
Add: Fixed charges 1,672,114.00 1,454,130.00 13,122,332.67
Deduct: Capitalized Interest (1,227,149.00) (562,750.00) (848,000.00)
==============================================================
Earnings................................. (341,410) (960,384) 1,679,821
==============================================================
Fixed charges were calculated as follows:
Interest expense 384,859.00 51,023.00 11,545,559.00
Amortization of deferred financing costs - - 509,869.00
Portion of rentals attributable to interest 60,106.00 55,857.00 218,904.67
(one-third of lease payments)
Loan commitment fees - 784,500.00 -
Capitalized interest 1,227,149.00 562,750.00 848,000.00
=============================================================
Fixed charges............................ 1,672,114.00 1,454,130.00 13,122,332.67
=============================================================
Ratio fixed earnings to fixed charges n/a n/a n/a
Deficiency 2,013,524.00 2,414,514.00 11,442,512.00
</TABLE>
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED
JUNE 30, 1997 AND 1998
</LEGEND>
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Jun-30-1998
<PERIOD-START> Jul-01-1997
<PERIOD-END> Jun-30-1998
<CASH> 251,057,274
<SECURITIES> 0
<RECEIVABLES> 501,612
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 251,628,521
<PP&E> 81,036,957
<DEPRECIATION> 3,265,430
<TOTAL-ASSETS> 342,865,160
<CURRENT-LIABILITIES> 6,636,691
<BONDS> 0
0
300
<COMMON> 300,000
<OTHER-SE> 41,657,822
<TOTAL-LIABILITY-AND-EQUITY> 342,865,160
<SALES> 0
<TOTAL-REVENUES> 3,542,771
<CGS> 0
<TOTAL-COSTS> 7,993,510
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12,055,428
[INTEREST-INCOME] 5,063,655
<INCOME-PRETAX> (11,442,512)
<INCOME-TAX> 2,020,000
<INCOME-CONTINUING> (9,422,512)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,422,512)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
EXHIBIT 99
to Registrant's Annual Report on Form 10-K
for the year-ended June 30, 1998
RISK FACTORS
This Annual Report on Form 10-K, to which this Exhibit is appended,
contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 that include, among others, statements by the
Company with respect to (i) projected capital expenditures and costs and the
timing thereof, (ii) projected dates of construction or acquisition of routes,
commencement of service and completion of the DTI network, (iii) assumptions
about the pricing of telecommunications services and (iv) assumptions about the
cost and availability of the Company's telecommunications equipment. These
forward-looking statements are subject to risks and uncertainties that could
cause actual events or results to differ materially from those expressed or
implied by the statements. The most important factors that could prevent the
Company from achieving its stated goals include, but are not limited to, (a)
failure to obtain substantial amounts of additional financing at reasonable
costs and on acceptable terms, (b) failure to effectively and efficiently manage
the expansion and construction of the Company's network, (c) failure to enter
into additional indefeasible rights to use ("IRUs") and/or wholesale network
capacity agreements, (d) failure to obtain and maintain sufficient
rights-of-way, (e) intense competition and pricing decreases, (f) potential for
rapid and significant changes in telecommunications technology and their effect
on the Company's business, and (g) adverse changes in the regulatory
environment. These cautionary statements should be considered in connection with
any subsequent written or oral forward-looking statements that may be issued by
the Company or on its behalf.
Limited History of Operations; Operating Losses and Negative Cash Flow
Digital Teleport was formed in June 1989 and began offering
telecommunications services in February 1994. Prospective investors, therefore,
have limited historical financial information about the Company upon which to
base an evaluation of the Company's performance. The Company must increase its
revenue substantially in order to make payments on the Company's 12-1/2% Series
B Senior Discount Notes due 2008 (the "Senior Discount Notes"). As a result of
development and operating expenses, the Company has incurred significant
operating and net losses to date. Operating losses for fiscal 1996, 1997, and
1998 were approximately $595,000, $1.1 million and $4.5 million, respectively.
DTI's operations have resulted in negative EBITDA of $169,000, $259,000 and $2.4
million for fiscal 1996, 1997 and 1998, respectively. In addition, the Company's
accumulated deficit was approximately $12.8 million at June 30, 1998. The
Company may incur significant and possibly increasing operating losses and
expects to generate negative net cash flows after capital expenditures during at
least the next two years of the Company's expansion of the DTI network. The
Company also expects to invest substantial funds to complete the DTI network
during the next several years while the Company continues to develop and expand
its telecommunications services and customer base. There can be no assurance
that the Company will achieve or sustain profitability or generate sufficient
positive cash flow to meet its debt service obligations and working capital
requirements. If the Company cannot achieve operating profitability or positive
cash flows from operating activities, it may not be able to service the Senior
Discount Notes or to meet its other debt service or working capital
requirements, which would have a material adverse effect on the Company.
99-1
<PAGE>
High Leverage; Ability to Service Indebtedness; Restrictive Covenants
The Company is and will continue to be highly leveraged. As of June 30,
1998, the Company had approximately $277.5 million of indebtedness outstanding,
all of which was evidenced by the Company's Senior Discount Notes. Because the
Company is a holding company that conducts its business through Digital
Teleport, all existing and future indebtedness and other liabilities and
commitments of the Company's subsidiary, including trade payables, are
effectively senior to the Senior Discount Notes, and the Company's subsidiary
will not be a guarantor of the Senior Discount Notes. As of June 30, 1998,
Digital Teleport had aggregate liabilities of $300.9 million, including $16.8
million of deferred revenues. The indenture under which the Senior Discount
Notes were issued ("Indenture") limits but does not prohibit the incurrence of
additional indebtedness by the Company, and the Company expects to incur
additional indebtedness in the future, some of which may be incurred by Digital
Teleport and any future subsidiaries. The Company's leverage could result in
certain adverse consequences which may include, among other things: (i) a
substantial portion of the Company's cash flow will be dedicated to the payment
of the Company's interest expense and may be insufficient to meet its payment
obligations on the Senior Discount Notes, in addition to paying other
indebtedness and obligations of the Company as they become due; (ii) the
Company's ability to obtain any necessary financing in the future for completion
of the DTI network or other purposes may be impaired; (iii) certain of the
future borrowings by the Company may be at variable rates of interest that could
cause the Company to be vulnerable to increases in interest rates; (iv) the
Company may be more leveraged than certain of its competitors, which may place
the Company at a competitive disadvantage; and (v) the Company's vulnerability
to the effects of general economic downturns or to delays in or increases in the
cost of completing the DTI network may be increased. The Company's ability to
pay the principal of and interest on its indebtedness will depend upon the
Company's future performance, which is subject to a variety of factors,
uncertainties and contingencies, many of which are beyond the Company's control.
There can be no assurance that the Company will generate sufficient cash flow in
the future to enable it to meet its anticipated debt service requirements,
including those with respect to the Senior Discount Notes.
The Indenture imposes and will impose significant operating and financial
restrictions on the Company, Digital Teleport and any future subsidiaries. These
restrictions affect, and in certain cases significantly limit or prohibit, among
other things, the ability of the Company and its subsidiary to incur certain
indebtedness, pay dividends and make certain other restricted payments, create
liens, permit other restrictions on dividends and other payments by Restricted
Subsidiaries (as defined in the Indenture), issue and sell capital stock of
Restricted Subsidiaries, guarantee certain indebtedness, sell assets, enter into
transactions with affiliates or related persons, or consolidate, merge or
transfer all or substantially all of their assets. There can be no assurance
that such covenants will not adversely affect the Company's ability to finance
its future operations or capital needs or to engage in other business
activities. Further, there can be no assurance that the Company will have
available, or will be able to acquire from alternative sources of financing,
funds sufficient to repurchase the Senior Discount Notes in the event of a
Change of Control (as defined in the Indenture).
In addition, any future indebtedness incurred by the Company is likely to
impose restrictions on the Company. Failure by the Company or its subsidiaries
to comply with these restrictions could lead to a default under the terms of
such indebtedness and the Senior Discount Notes, notwithstanding the ability of
the Company to meet its debt service obligations. In the event of such a
default, the holders of such indebtedness could elect to declare all such
indebtedness to be due and payable, together with accrued and unpaid interest.
In such event, a significant portion of the Company's indebtedness (including
the Senior Discount Notes) may become immediately due and payable, and there can
be no assurance that the Company would be able to make such payments or borrow
sufficient funds from alternative sources to make any such payment. Even if
additional financing could be obtained, there can be no assurance that it would
be on terms that are acceptable to the Company.
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Substantial Capital Requirements
The development of the Company's business and the installation and expansion
of the DTI network have required and will continue to require substantial
capital. In the past, the Company has funded its capital expenditures through a
combination of advance payments for future telecommunications services received
from certain major customers, private debt and equity financings and external
borrowings. The Company is funding its future capital expenditure requirements
through the net proceeds of the sale of the Senior Discount Notes ("Senior
Discount Notes Offering"), advance payments under existing and additional IRUs
and wholesale network capacity agreements, and available cash flow from
operations, if any. In addition, the Company may seek borrowings under bank
credit facilities and additional debt or equity financings. The Company
estimates that total capital expenditures necessary to complete the DTI network
will be approximately $780 million, of which the Company had expended $81
million as of June 30, 1998. During the balance of calendar 1998 and all of
calendar 1999, the Company anticipates its capital expenditure priorities will
be focused principally on expanding from its existing Missouri/Arkansas base by
building additional regional rings that adjoin existing rings and those that
initiate new rings in areas in which strong carrier interest has been expressed.
The Company anticipates that its existing financial resources will be adequate
to fund the above-mentioned priorities and its existing capital commitments,
principally payments required under existing preliminary and definitive IRU and
short-term lease agreements, totaling $133 million which are payable in varying
installments over the period through December 31, 1999. In addition, the Company
has a commitment at June 30, 1998 for eight pieces of switching equipment
totaling $15 million which is cancelable upon the payment of a cancellation fee
of $42,000 for each of the remaining unpurchased switches. The Company also may
require additional capital in the future to fund operating deficits and net
losses and for potential strategic alliances, joint ventures and acquisitions.
These activities could require significant additional capital not included in
the foregoing estimated capital requirements.
The Company is in various stages of discussions with potential customers for
additional IRUs and wholesale network capacity agreements. There can be no
assurance, however, that the Company will continue to obtain advance payments
from customers prior to commencing construction of, or obtaining IRUs for,
planned routes, that it will be able to obtain financing under any credit
facility or that other sources of capital will be available on a timely basis
and on terms that are acceptable to the Company and within the restrictions
under the Company's existing financing arrangements, or at all. If the Company
fails to obtain the capital required to complete the DTI network, the Company
could modify, defer or abandon plans to build or acquire certain portions of the
DTI network. The failure of the Company, however, to raise the substantial
capital required to complete the DTI network could have a material adverse
effect on the Company and its ability to make payments on the Senior Discount
Notes.
The Company's expectation of required future capital is based on the
Company's current estimates and network expansion schedule. The actual amount
and timing of DTI's future capital requirements may differ materially from its
current estimates depending on demand for the Company's services, the Company's
ability to implement its current business strategy and regulatory, technological
and competitive developments in the telecommunications industry. There can be no
assurance that actual expenditures will not differ significantly from such
estimates. The Company may seek to raise additional capital from public or
private equity or debt sources. There can be no assurance that the Company will
be able to raise such capital on satisfactory terms or at all. If the Company
decides to raise additional capital through the incurrence of debt, the Company
may become subject to additional or more restrictive financial covenants. In the
event that the Company is unable to obtain such additional capital on acceptable
terms or at all, the Company may be required to reduce the scope or pace of
deployment of the DTI network, which could materially adversely affect the
Company's business, results of operations and financial condition and its
ability to compete and to make payments on the Senior Discount Notes.
Risks Related to Completing the DTI Network and Increasing Traffic Volume;
Non-Compliance with Construction Schedules
The Company's ability to achieve its strategic objectives will depend in
large part upon the successful, timely and cost-effective completion of the DTI
network, as well as on achieving substantial traffic volumes on the DTI network.
The completion of the DTI network may be affected by a variety of factors,
uncertainties and contingencies, many of which are beyond the Company's control.
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The successful and timely completion of the DTI network will depend upon,
among other things, the Company's ability to (i) obtain substantial amounts of
additional capital and financing, at reasonable costs and on satisfactory terms
and conditions, (ii) effectively and efficiently manage the construction and
acquisition of the planned DTI network route segments, (iii) obtain IRUs from
other carriers on satisfactory terms and conditions and at reasonable prices,
(iv) access markets and enter into additional customer contracts to sell or
lease high volume capacity on the DTI network and (v) obtain additional
franchises, permits and rights-of-way to permit it to complete its planned
strategic routing. Successful completion of the DTI network also will depend
upon the Company's ability to procure commitments from suppliers and third-party
contractors with respect to the supply of certain equipment and construction of
network facilities and timely performance by such suppliers and third-party
contractors of their obligations. There can be no assurance that the Company
will obtain sufficient capital and financing to fund its currently planned
capital expenditures, successfully manage construction, sell fiber and capacity
to additional customers, meet contractual timetables for future services, or
maintain existing and acquire necessary additional franchises, permits and
rights-of-way. Any failure by DTI to accomplish these objectives may
significantly delay or prevent, or substantially increase the cost of,
completion of the DTI network, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
Certain of the Company's customer contracts provide for reduced payments and
varying penalties for late delivery of route segments and allow the customers,
after expiration of grace periods, to delete such non-delivered segment from the
system route to be delivered. The Company is currently not in compliance with
construction schedules under contracts with two of its customers. The Company
has received notice from a customer that it intends to set off against amounts
payable to the Company $15,000 per month, which as of June 30, 1998 totaled
approximately $90,000 (in addition to $400,000 previously set off against other
payments) as damages and penalties under the Company's contract with that
customer due to the failure by the Company to meet certain construction
deadlines, and such customer reserved its rights to seek other remedies under
the contract. The Company believes that if such $90,000 setoff were to be made,
it would not be material to the Company's business, financial position or
results of operations. The Company is behind schedule with respect to such
contract as a result of such customer's not obtaining on behalf of the Company
certain rights-of-way required for completion of certain network facilities, and
the Company's limitations on its financial and human resources, particularly
prior to the Senior Discount Notes Offering. The Company has obtained
alternative rights-of-way and hired additional construction supervisory
personnel to accelerate the completion of such construction. Upon completion and
turn-up of services, such customer is contractually required to pay the Company
a lump sum of approximately $4.2 million for the Company's telecommunications
services over its network. The Company is also behind schedule in the
construction of fiber optic facilities for another customer, which facilities
were to have been completed in December 1997, primarily as a result of a delay
in obtaining rights-of-way required for completion of certain network
facilities, and the Company's limitations on its financial and human resources,
particularly prior to the Senior Discount Notes Offering. The Company has
obtained the needed right-of-way, and will utilize other publicly available
rights-of-way, and, as indicated above, has hired additional construction
supervisory personnel. Upon completion, such customer will begin paying the
Company $133,000 per month for the use of such completed facilities. There can
be no assurance that such customers or other customers will not in the future
find the Company to have materially breached its contracts, that such customers
will not terminate such contracts or that such customers will not seek other
remedies.
Under its agreement with the Missouri Highway and Transportation Commission
("MHTC"), the Company has the exclusive right to build a long-haul, fiber optic
network along the interstate highway system in Missouri in exchange for
providing to MHTC long-haul telecommunications services along such network. The
MHTC Agreement requires the Company to build a total of approximately 1,200
route miles by the end of 1998, certain portions of which must be built prior to
such time. The Company also must complete construction of an additional 800
miles by the end of 1999 to maintain its rights to such additional routes. Over
1,700 route miles of the entire 2,000-mile network have been completed; however,
the Company did not meet an intermediate construction deadline for the
construction of approximately 30 route miles but has received from MHTC a waiver
of such construction delay and an extension of the 30-mile completion date to
October 1, 1998. The Company expects to complete such construction prior to such
date except where delayed by unattained permits The Company may lose its
exclusive rights under the MHTC Agreement only in the event of its breach and
failure to timely exercise its right to cure within sixty days of notice if any
such breach, which would allow MHTC to terminate the MHTC Agreement. As of
99-4
<PAGE>
September 30, 1998, the Company has not received any notice of breach that has
not been waived or cured. The failure by the Company to meet the remaining
deadline and the loss of its exclusive rights to routes constructed in
accordance with the MHTC Agreement could have a material adverse effect on the
Company's business, financial condition and results of operations and its
ability to make payments on the Senior Discount Notes.
Competition
The telecommunications industry is highly competitive. The Company competes
and, as it expands its network, expects to continue to compete with numerous
established facilities-based IXCs, ILECs and CLECs. Many of these competitors
have substantially greater financial and technical resources, long-standing
relationships with their customers and the potential to subsidize competitive
services from less competitive service revenues. DTI is aware that other
facilities-based providers of local and long distance telecommunications
services are planning and constructing additional networks that, if and when
completed, could employ advanced fiber optic technology similar to, or more
advanced than, the DTI network. Such competing networks may also have operating
capability similar to, or more advanced than, that of the DTI network and be
positioned geographically to compete directly with the DTI network for many of
the same customers along a significant portion of the same routes.
The Company competes primarily on the basis of price, transmission quality,
reliability and customer service and support. Prices have been declining and are
expected to continue to do so. The Company's competitors in carrier's carrier
services include many large and small IXCs, including AT&T, Sprint, MCI
WorldCom, IXC Communications, Qwest Communications International Inc. ("Qwest")
and McLeod USA Incorporated, Inc. ("McLeod"). The Company competes with both
LECs and IXCs in its end-user business. In the end-user private line services
market, the Company's principal competitors are SBC Communications, Inc.
("SBC"), GTE and Sprint/United Telephone. In the local exchange market, the
Company expects to face competition from ILECs and other competitive providers,
including non-facilities based providers, and, as the local access markets
become opened to IXCs under the Telecommunications Act of 1996 (the "Telecom
Act"), from long distance providers.
MCI WorldCom, together with its wholly owned subsidiaries MFS Communications
Company, Inc. ("MFS") and Brooks Fiber Properties, Inc. ("Brooks Fiber"),
currently provide both local exchange and long distance telecommunications
services throughout the United States. AT&T has announced its agreement to
acquire Teleport Communications Group, Inc. ("TCG"), a facilities-based CLEC
with networks in operation in 57 markets in the United States, SBC has announced
agreements to acquire Ameritech Corp. ("Ameritech"), one of the original seven
Regional Bell Operating Companies ("RBOCs"), and Southern New England
Telecommunications Corp. ("SNET") and Bell Atlantic Corp. ("Bell Atlantic") has
recently announced its intention to acquire GTE. Further, Qwest, a
communications provider building a 18,449-mile fiber optic network in the United
States, announced its agreement to acquire LCI International Inc., a retail long
distance provider, which acquisition would create the nation's fifth largest
long distance company. The Company also believes that high initial network cost
and low marginal costs of carrying long distance traffic have led to a trend
among non-facilities-based carriers to consolidate in order to achieve economies
of scale. Such consolidation among significant telecommunications carriers could
result in larger, better capitalized competitors that can offer a "one-stop
shopping" combination of long distance and local switched services in many of
DTI's target markets.
Certain companies, such as Level 3 Communications Inc. ("Level 3") have
recently announced efforts to use Internet technologies to supply
telecommunications services, potentially leading to a lower cost of supplying
these services and therefore increased pressure on IXCs and other
telecommunications companies to reduce their prices. There can be no assurance
that the Company's IXC and other carrier customers will not experience
substantial decreases in call volume or pricing due to competition from
Internet-based telecommunications, which could lead to a decreased need for the
Company's services, or a reduction in the amount these companies are willing or
able to pay for the Company's services. There can also be no assurance that the
Company will be able to offer its telecommunications services to end users at a
price that is competitive with the Internet-based telecommunications services
offered by these new companies. The Company does not currently market to
Internet service providers ("ISPs") and therefore may not realize any revenues
from the Internet-based telecommunications market. If the Company does commence
marketing to ISPs, there can be no assurance that it will be able to do so
successfully, which would have a material adverse effect on the Company's
business, financial condition and results of operations.
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<PAGE>
In addition to IXCs and LECs, entities potentially capable of offering
services in competition with the DTI network include cable television companies,
such as Tele-Communications, Inc. ("TCI"), the second-largest cable television
company in the United States, which AT&T has agreed to acquire, electric
utilities, microwave carriers, wireless telephone system operators and large
subscribers who build private networks. Previous impediments to certain utility
companies entering telecommunications markets under the Public Utility Holding
Company Act of 1935 were also removed by the Telecom Act, at the same time
creating both a new competitive threat and a source of strategic business and
customer relationships for DTI.
In the future, the Company may be subject to more intense competition due to
the development of new technologies, an increased supply of transmission
capacity, the consolidation in the industry among local and long distance
service providers and the effects of deregulation resulting from the Telecom
Act. The telecommunications industry is experiencing a period of rapid
technological evolution, marked by the introduction of new product and service
offerings and increasing satellite transmission capacity for services similar to
those provided by the Company. For instance, recent technological advances
permit substantial increases in transmission capacity of both new and existing
fiber, and certain companies have begun to deploy and use ATM network backbones
for both data and packetized voice transmission and have announced plans to
transport interstate long distance calls via such voice-over-data technology.
The introduction of such new products or emergence of such new technologies may
reduce the cost or increase the supply of certain services similar to those
provided by the Company. The Company cannot predict which of many possible
future product and service offerings will be crucial to maintain its competitive
position or what expenditures will be required to develop profitably and provide
such products and services.
The Company believes its existing and planned rights-of-way along
interstate highway systems and public utility infrastructures have played and
could continue to play a significant role in achieving its business objectives.
However, there can be no assurance that competitors will not obtain rights to
use the same or similar rights-of-way for expansion of their communications
networks.
Many of the Company's competitors and potential competitors have financial,
personnel, marketing and other resources significantly greater than those of the
Company, as well as other competitive advantages. A continuing trend toward
business combinations and alliances in the telecommunications industry may
increase the resources available to DTI's competitors, create significant new
competitors and potentially decrease the Company's carrier customer base. The
ability of DTI to compete effectively will depend upon, among other things, its
ability to deploy the DTI network and to maintain high quality services at
prices equal to or below those charged by its competitors. There can be no
assurance that the Company will be able to compete successfully with existing
competitors or new entrants in the markets for carrier's carrier services and
end-user services. Failure of the Company to do so would have a material adverse
effect on the Company.
Need to Obtain and Maintain Franchises, Permits and Rights-of-Way
In order to develop its networks, the Company must obtain local franchises
and other permits, as well as rights to utilize underground conduit, pole space
and other rights-of-way from entities such as utilities, state highway
authorities, local governments, ILECs and IXCs. The Telecom Act requires that
local governmental authorities treat telecommunications carriers in a
competitively neutral, non-discriminatory manner, and that most utilities,
including electric companies and most ILECs, afford CLECs access to their
conduits, poles and rights-of-way at reasonable rates and on non-discriminatory
terms and conditions. However, owners of rights-of-way, particularly the ILECs,
may seek to delay the Company's access. The Company has entered into long-term
agreements with highway authorities in Missouri, Arkansas and Kansas and with
electric utilities operating in Missouri and southern Illinois, pursuant to
which the Company generally has access to various rights-of-ways in given
localities. However, these agreements cover only a small portion of the planned
DTI network. There can be no assurance that the Company will be able to maintain
its existing franchises, permits and rights-of-way or to obtain and maintain the
other franchises, permits and rights-of-way needed to complete the DTI network
on acceptable terms. Although the Company does not believe that any of its
existing franchises, permits or rights-of-way will be terminated or not renewed
as needed, termination or non-renewal of certain of franchises, permits or
rights-of-way relating to a significant portion of the existing DTI network
could materially adversely affect the Company.
Dependence on Limited Number of Large Customers
The Company has business relationships with a small number of large
customers. During fiscal years 1996, 1997 and 1998 the Company's three largest
customers accounted for 52%, 53% and 66%, respectively, of the Company's
telecommunications services revenues. In addition, the Company's business plan
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<PAGE>
assumes that a large proportion of its future revenues will come from its
carrier's carrier services, which by their nature are marketed to a limited
number of telecommunications carriers. Carrier customers will frequently change
suppliers based on very small changes in prices. To the extent the Company sells
to its carrier customers on a short-term basis, it will be particularly
vulnerable to price competition. Therefore, dissatisfaction with the Company's
services by a relatively small number of customers could have a material adverse
effect on the Company's business, financial condition and results of operations.
The Company is aware that certain IXCs are constructing or considering
construction of new networks, or buying companies with local networks, which
could reduce their need for the Company's services. In addition, it is possible
that as IXCs expand their product offerings and networks, and the Company
expands its product offerings and the geographic scope of the DTI network, the
Company may become a competitor of one or more of its large customers for
certain end-user customers. Accordingly, there can be no assurance that any of
the Company's carrier's carrier customers will continue to use or increase their
use of the Company's services, which would have a material adverse effect on the
Company's business, financial condition and results of operations.
Expansion and Managing Anticipated Rapid Growth
The Company must grow rapidly in order to implement its business plan and be
able to make payments on the Senior Discount Notes. The Company had 29 full time
employees as of September 30, 1998. Rapid growth will place a significant strain
on the Company's administrative, operational, management and financial
resources. The expansion of the DTI network and the Company's services will
depend on, among other things, its ability to enter new markets, design fiber
optic network routes, construct, acquire and install facilities and obtain
rights-of-way, building access and any required government authorizations and/or
permits, all in a timely manner, at reasonable costs and on satisfactory terms
and conditions. The expansion of the DTI network and services also will require
substantial growth in the Company's management base, systems and other
operations. Implementation of the Company's current and future expansion plans
will also depend on factors such as: (i) the availability of financing and
regulatory approvals; (ii) the existence of strategic alliances or
relationships; (iii) technological, regulatory or other developments in the
Company's business; (iv) changes in the competitive climate in which the Company
operates; and (v) the emergence of future opportunities. There can be no
assurance that the Company will be able to expand its existing network or
services in a cost effective manner.
A key part of the Company's business strategy is to achieve rapid growth by
expanding the DTI network from its existing Missouri/Arkansas base and building
additional rings adjacent to existing rings where one side already exists. In
addition, the Company intends to light those portions of routes that close
regional rings that adjoin existing rings and those that initiate new rings in
areas in which strong carrier interest has been expressed. The Company's ability
to manage its expansion effectively will depend upon, among other things: (i)
expansion, training and management of its employee base, including attracting
and retaining highly skilled personnel; (ii) expansion and improvement of the
Company's customer service, billing and support systems and improvement or
cost-effective outsourcing of the Company's operational and financial systems;
(iii) development, introduction and marketing of new products and services; and
(iv) control of the Company's expenses. The failure of the Company to satisfy
these requirements and to otherwise manage its growth effectively would have a
material adverse effect on the Company.
Dependence on Key Personnel
The Company's future performance depends to a significant degree upon the
continued contributions of a small number of key executives, particularly
Richard D. Weinstein, the Company's founder, Chief Executive Officer and
President. The Company has entered into employment agreements with certain of
these executives. Nonetheless, the loss of these individuals and the inability
of the Company to attract and retain suitable replacements could have a material
adverse effect on the Company's business, financial condition, results of
operations and business prospects. In the past, the Company has lost the
services of certain of its senior executives. The Company's future success and
ability to manage growth will be dependent also upon its ability to hire and
retain additional highly skilled employees for a variety of management,
engineering, technical, and sales and marketing positions. The competition for
such personnel is intense. There can be no assurance that the Company will be
able to attract and retain sufficient qualified personnel. The failure to do so
could have a material adverse effect on the Company.
Dependence on Single or Limited Source Suppliers
The Company is dependent upon single or limited source suppliers for its
fiber optic cable and electronic equipment used in the DTI network, some of
which components employ advanced technologies built to specifications provided
99-7
<PAGE>
by the Company to such suppliers. In particular, the Company is dependent
primarily on Pirelli Cables and Systems LLC ("Pirelli"), with whom the Company
has entered into a two-year agreement to purchase all of its fiber optic cable.
The Company has also entered into a three-year agreement with Pirelli pursuant
to which the Company agreed to purchase from such affiliate at least 80% of its
needs for DWDM equipment. Therefore, the Company is dependent on Pirelli and to
a lesser extent, Ciena Corporation, for DWDM equipment. To date, the Company's
arrangements have provided it with a supply of fiber optic cable at a stable,
attractive price. DTI's network design strategy also is dependent on obtaining
transmission equipment from Fujitsu Network Transmission Systems, Inc.
("Fujitsu") which supplies such equipment to other substantially larger
customers. There can be no assurance that the Company's suppliers will be able
to meet the Company's future requirements on a timely basis. The Company
believes that there are alternative suppliers or alternative components for all
of the components contained in the planned DTI network. However, any extended
interruption in the supply of any of the key components currently obtained from
a single or limited source, disturbance in the pricing arrangements with Pirelli
or Fujitsu, or delay in transitioning a replacement supplier's product into the
DTI network, could disrupt the Company's operations and have a material adverse
effect on the Company's operating results and its ability to make payments on
the Senior Discount Notes. In addition, the substitution of different DWDM
equipment might prove technically difficult, leading to delays and added
expense. There can be no assurance that such interruption, disturbance, delay or
expense will not occur or that the Company will be successful in obtaining
alternative suppliers. Significant delays in the expansion of the DTI network
resulting from interruptions in the supply of any key network components or
other problems with suppliers could have a material adverse effect on the
Company.
Some of the technologically advanced equipment, including the DWDM
equipment, which the Company plans to deploy in the DTI network has not been
extensively field tested. The Company believes that such equipment will meet or
exceed the required specifications and will perform satisfactorily once
installed. However, any extended failure of such equipment to perform as
expected could have a material adverse effect on the Company.
Performance Guarantees Under Customer IRU Agreements
The Company has a continuing obligation to guarantee the performance of the
fibers that are subject to IRUs leased by the Company to its carrier customers.
These costs are potentially significant, and the Company cannot reasonably
estimate such costs over the terms of the IRU agreements due principally to the
limited history of operations of the Company to date, the long-term nature of
the agreements and the various possible causes of service disruption that the
Company must remedy pursuant to the agreements, many of which causes are beyond
the control of the Company. There can be no assurance that such costs will not
be material or will not have a material adverse effect on the Company.
Pricing Pressures and Risk of Industry Over-Capacity
Although the Company believes that, in the last several years, increasing
demand has corrected the telecommunications capacity supply imbalance and slowed
the decline in prices, the Company anticipates that prices for carrier's carrier
services and end-user services will continue to decline over the next several
years due primarily to (i) installation of additional fiber that provides
substantially more transmission capacity than will be needed over the short or
medium term, (ii) technological advances that permit substantial increases in
the transmission capacity of both new and existing fiber, and (iii) strategic
alliances or similar transactions, such as long distance capacity purchasing
alliances among certain RBOCs, that increase customer purchasing power.
Such price decreases could have a material adverse effect on the Company.
Since the cost of fiber and related equipment is a small portion of building
new transmission lines, persons building such lines are likely to install
substantially more fiber than they expect to use over the short or medium term.
This can lead to substantial over-capacity and price declines. In addition, if
the Company sells any carrier more capacity on its routes than such carrier
ultimately needs, then such carrier may resell such capacity, causing further
price competition. Likewise, if the Company acquires fiber on other carriers'
networks, those carriers will be well positioned to engage in price competition
with the Company. Furthermore, the marginal cost of carrying calls over fiber
optic cable is extremely low. As a result, certain industry observers have
predicted that, within a few years, there may be dramatic and substantial price
declines and that long distance calls will not be significantly more expensive
than local calls. Any of the foregoing could have a material adverse effect on
the Company.
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Rapid Technological Changes
The telecommunications industry is subject to rapid and significant changes
in technology. For instance, recent technological advances including DWDM
equipment permit substantial increases in transmission capacity of both new and
existing fiber, and the introduction of new products or the emergence of new
technologies may reduce the cost or increase the supply of certain services
similar to those provided by the Company. While the Company believes that, for
the foreseeable future, technological changes will neither materially affect the
continued use of fiber optic cable nor materially hinder the Company's ability
to acquire necessary technologies, the actual effect of technological changes on
the Company's operations cannot be predicted and could have a material adverse
effect on the Company.
Development of Accounting, Processing and Information Systems; Year 2000
Compliance
Sophisticated information and processing systems are vital to the Company's
operations and growth and its ability to monitor costs, process customer orders,
provide customer service, render monthly invoices for services and achieve
operating efficiencies. The Company has developed processes and procedures in
the implementation and servicing of customer orders for telecommunications
services, the provisioning, installation and delivery of those services and
monthly billing for those services. However, the Company must improve its
internal processes and procedures and install additional accounting, processing
and information systems to accommodate its anticipated growth. The Company
intends to obtain and install the accounting, processing and information systems
necessary to provide its services efficiently. However, there can be no
assurance that the Company will be able to successfully obtain, install or
operate such systems. The failure to develop effective internal processes and
systems for these service elements could have a material adverse effect upon the
Company's ability to achieve its growth strategy. As the Company begins to
provide local switched services, the need for sophisticated billing and
information systems will also increase significantly and the Company will have
significant additional requirements for data interface with ILECs. Additionally,
any acquisitions would place additional burdens on the Company's accounting,
information and other systems.
While the Company believes that its existing systems and software
applications are, and that any new systems to be installed will be, Year 2000
compliant, there can be no assurance until the year 2000 that all of the
Company's systems then in place will function adequately. The failure of the
Company's systems or software applications to accommodate the year 2000 could
have a material adverse effect on its business, financial condition and results
of operations. Further, if the systems or software applications of
telecommunications equipment suppliers, ILECs, IXCs or others on whose services
or products the Company depends are not Year 2000 compliant, any loss of such
services or products could have a material adverse effect on the Company's
business, financial condition and results of operations. The Company intends to
continue to monitor the performance of its accounting, information and
processing systems and software applications and those of its suppliers and
customers to identify and resolve any Year 2000 issues. To the extent necessary,
the Company may need to replace, upgrade or reprogram certain systems to ensure
that all interfacing applications will be Year 2000 compliant when operating
jointly. Based on current information, the Company does not expect that the
costs of such replacements, upgrades and reprogramming will be material to its
business, financial condition or results of operations. Most major domestic
carriers have announced that they expect to achieve Year 2000 compliance for
their networks and support systems by mid-1999; however, other domestic and
international carriers may not be Year 2000 compliant, and failures on their
networks and systems could adversely affect the operation of the Company's
networks and support systems and have a material adverse effect on the Company's
business, financial condition and results of operations. The Company has not
developed a contingency plan with respect to the failure of its systems or the
systems of its suppliers or other carriers to achieve year 2000 compliance.
Unanticipated problems in any of the above areas, or the Company's inability
to implement solutions in a timely manner or to establish or upgrade systems as
necessary, could have a material adverse impact on the ability of the Company to
reach its objectives and on its business, financial condition and results of
operations.
Regulation Risks
The Company is required to obtain certain authorizations from state
public utility commissions ("PUC") to offer certain of its telecommunication
services, as well as to file tariffs with the FCC and the PUCs for many of its
services. The Company has received state certification from the states of
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Missouri and Illinois, has filed for certification in the states of Arkansas,
Georgia, Iowa, Kansas, Oklahoma, and Texas, and is in the process of preparing
and filing the necessary tariffs and additional applications for certification
to provide services throughout the planned DTI network. The receipt by the
Company of necessary state certifications is dependent upon the specific
procedural requirements of the applicable PUC and the workload of its staff.
Additionally, receipt of state certifications may be subject to delay as a
result of a challenge to the applications and/or tariffs by third parties,
including the ILECS, which could cause the Company to delay the Company's
provision of services over affected portions of the planned DTI network and to
incur substantial legal and administrative expenses. To date, the Company has
not experienced significant difficulties in receiving certifications,
maintaining tariffs, or otherwise complying with its regulatory obligations.
There can be no assurances, however, that the Company will not experience delay
or be subject to third-party challenges in obtaining necessary regulatory
authorizations. The failure to obtain such authorizations on a timely basis
would have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's ability to provide local switched services is heavily
dependent upon implementation of the provisions of the Telecom Act. The Telecom
Act preempted state and local laws to the extent that they prohibited local
telephone competition, and imposed a variety of new duties on incumbent local
exchange carriers intended to advance such competition, including the duty to
negotiate in good faith with competitors requesting interconnection to the
ILEC's network. Negotiation with ILECS, however, has sometimes involved
considerable delays and the resulting agreements may not necessarily be obtained
on terms and conditions that are acceptable to the Company. In such instances,
the Company may petition the proper state regulatory agency to arbitrate
disputed issues. There can be no assurance that the Company will be able to
negotiate acceptable new interconnection agreements with ILECs or that if the
state regulatory agency impose terms and conditions on the parties in
arbitration, such terms will be acceptable to the Company.
On August 1, 1996, the FCC adopted an order in which it attempted to
adopt a framework of minimum, national rules to enable the states and the FCC to
implement the local competition provisions of the Telecom Act. This order
included pricing rules that apply to state commissions when they are called on
to arbitrate rate disputes between ILECS and entities entering the local
telephone market. The order also included rules addressing the three paths of
entry into the local telephone market. Several parties filed appeals of the
order, which were consolidated in the U.S. Court of Appeals for the Eighth
Circuit ("Eighth Circuit"). On October 15, 1996, the Eighth Circuit issued a
stay of the implementation of certain of the FCC's rules and on July 18, 1997,
the Court issued its first decision finding that the FCC lacked statutory
authority under the Telecom Act for certain of its rules, particularly the
pricing standards governing unbundled local network elements or wholesale local
services of the ILECS. The Court also struck down other FCC rules, including the
one which would have enable new entrants to "pick and choose" from provisions of
established interconnection agreements between the ILECs and other carriers. The
Court rejected certain other objections to the FCC rules brought by the ILECs or
the states, including challenges to the FCC's definition of unbundled elements,
and to the FCC's rules allowing new competitors to create their own networks by
combining ILEC network elements together without adding additional facilities of
their own.
On October 14, 1997, the Court issued its second decision in the case
and ruled in favor of the ILECS petitioners and substantially modified it July
18, 1997 decision. The Eighth Circuit ruled that ILECs cannot be compelled to
"combine" two or more unbundled elements into "platforms" or combinations,
finding that IXC must either combine the elements themselves, or purchase entire
retail services at the applicable wholesale discount if they wish to offer local
services to their customers. The latter omission was the subject of petitions
for reconsideration filed with the Eight Circuit by ILECs.
On August 10, 1998, in its third decision, the Eighth Circuit upheld
the FCC's determination that ILECs have the duty to provide unbundled access to
"shared transport" as a network element. On September 24, 11998, GTE
Corporation, SBC Communications, Inc. ("SBC"), Ameritech Corporation
("Ameritech"), Bell Atlantic Corporation, and U S West, among others, asked the
Eighth Circuit to reconsider its August 10, 1998 ruling.
The overall impact of the Eighth Circuit's decisions is to materially
reduce the role of the FCC in fostering local competition, including it ability
to take enforcement action if the Telecom Act is violated, and increase the role
of state utility commission. The Supreme Court recently announced that it would
review the Eighth Circuit's first decision. Most state commissions have
initiated or implemented procedures to promote local telephone competition using
the authority they have under the ruling, lessening the significance of the
reduced FCC role. At this time the impact of the Eighth Circuit's decisions
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cannot be evaluated, but there can be no assurances that the Eighth Circuit's
decisions and related developments will not have a material adverse affect on
the Company.
The Telecom Act also creates the foundation for increased competition
in the long distance market form ILECs, which could affect the successful
implementation of the Company's business plans. For example, certain provisions
eliminate previous prohibitions on the provision of inter-LATA long distance
services (both carrier's carrier and end-user services) by the RBOCs, subject to
compliance by such companies with requirements set forth in the Telecom Act and
implemented by the FCC. The FCC currently has not found any application by a
RBOC to provide inter-LATA long distance services within regions in which it
provides local exchange services ("In-region Inter-LATA Long Distance Services")
to meet the requirements set forth in the Telecom Act or comply with the rules
and regulations implemented by the FCC.
SBC Communications, Inc. ("SBC") challenged the constitutionality of
the provisions of the Telecom Act applicable to the RBOC's provision of
In-region Inter-LATA Long Distance Services in the U.S. District Court, Northern
District of Texas (Wichita Falls) (the "SBC Court") (the "SBC Communications
Case"). On December 31, 1997, the SBC Court overturned, as unconstitutional, the
provisions of the Telecom Act which prevented SBC from providing In-region
Inter-LATA Long Distance Services without demonstrating that the local exchange
market was opened to local competition. AT&T, MCI, and other intervenors, and
the FCC filed petitions for stay of the decision in the SBC Court. On February
11, 1998, the SBC Court stayed its decision in the SBC Communications Case,
which placed the provisions of the Telecom Act found to be unconstitutional back
into effect. On September 4, 1998, the U.S. Court of Appeals for the Fifth
Circuit ("Fifth Circuit") found that the provisions of the Telecom Act relating
to the RBOC's provision of In-region Inter-LATA Long Distance services was
constitutional, and reversed the SBC Court's ruling. SBC has not determined
whether it will appeal the Fifth Circuit's ruling to the Supreme Court.
SBC also challenged the FCC's rejection of its application to provide
In-region Inter-LATA Long Distance services in Oklahoma in the U.S. Court of
Appeals for the District of Columbia ("D.C. Circuit Court"). On March 20, 1998,
the D.C. Circuit Court upheld the FCC's ruling. BellSouth also petitioned the
D.C. Circuit Court to review the FCC's rejection of BellSouth's application to
provide In-region Inter-LATA Long Distance Services in South Carolina and to
determine the constitutionality of the applicable provisions of the Telecom Act.
On September 24, 1998, a three-judge panel heard oral arguments by the parties
in the case. U S West has intervened in the SBC and BellSouth challenges, and
the decisions in each case would apply to U S West.
The FCC also has rejected the application of Ameritech to provide
In-region Inter-LATA Long Distance Services in Michigan and a BellSouth
application for such service in Louisiana. In July 1998, BellSouth re-filed its
application to provide In-region Inter-LATA Long Distance Services in Louisiana,
which application remains pending before the FCC.
On January 22, 1998, the Eighth Circuit ordered the FCC to abide by the
Eighth Circuit's mandate and to refrain from subsequent attempts to apply either
directly or indirectly the FCC's vacated pricing policies and to confine its
consideration of whether a RBOC has complied with the pricing methodology and
rules adopted by the state commission in effect in the respective states in
which such RBOC seeks to provide In-Region Inter-LATA Long Distance Services.
On September 28, 1998, the FCC barred U S West and Ameritech from
marketing long distance service on behalf of Qwest Communications, Inc.
("Qwest"). The FCC found that the arrangements which permitted the RBOCs to
collect fees for referring customers to Qwest violated the Telecom Act. U S West
stated that it will appeal the FCC's ruling. Ameritech has not determined its
course of action.
The Company would be adversely affected if the RBOCS were allowed to
provide wireline long distance services within their own regions before local
competition is established. There are no assurances that further appeals of the
FCC's rulings and the provisions of the Telecom Act applicable to the RBOCs'
provision of In-region Inter-LATA Long Distance Services will not be adverse to
the Company.
In a related development, on May 8, 1997, the FCC released an order
intended to reform its system of interstate access charges to make that regime
compatible with the pro-competition deregulatory framework of the Telecom Act.
The order adopted various changes to it rules and policies governing interstate
access service pricing designed to move access charges, over time, to more
economically efficient levels and rate structures. On August 19, 1998, the
Eighth Circuit upheld the FCC's decision in regard to interstate access charges.
Though the Company believes that access reform through lowering and/or
eliminating excessive access service charges will have a positive effect on its
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services offerings and operations, it cannot predict how or when such benefits
may present themselves, or the outcome of additional judicial appeals or pending
petitions for FCC reconsideration.
The Company also will be affected by how the states regulate the retail
prices of the ILECs with which it competes. As the degree of intrastate
competition increases, the states may offer the ILECs increasing pricing
flexibility. This flexibility may present the ILECS with an opportunity to
subsidize services that compete with the Company's services with revenues
generated by non-competitive services, thereby allowing ILECs to offer
competitive services at lower prices than they may otherwise could. Any pricing
flexibility or other significant deregulation of the ILECs by the states could
have a material adverse effect on the Company.
In addition to the rules effecting local and long distance competition,
the FCC or the states have adopted, or may adopt, rules and regulations which
impose fees or surcharges based on revenues derived from provision of
telecommunications services by the Company or require changes to the Company's
network configuration to provide certain services. Compliance by the Company
with these existing and future regulations may have a material adverse effect on
the Company's results of operations.
Variability of Operating Results
As the Company expands the DTI network, it will incur significant costs
relating principally to fiber, switching and other equipment and construction
costs. The installation and expansion of the DTI network has required and will
continue to require considerable expenses in advance of anticipated revenues
associated with newly constructed or acquired network routes and may cause
substantial fluctuations in the Company's operating results. The losses created
by this lag in revenues are expected to increase until the revenues from the
completed DTI network overtake the costs associated with its deployment. The
Company may incur significant and possibly increasing operating losses and
expects to generate negative net cash flow after capital expenditures during at
least the next two years of the Company's expansion of the DTI network.
