<PAGE>
As filed with the Securities and Exchange Commission on July 6, 1999
Registration No. 333-77995
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
Under
The Securities Act of 1933
________________
FOCAL COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
________________
<TABLE>
<S> <C> <C>
Delaware 4813 36-4167094
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</TABLE>
200 North LaSalle Street, Suite 1100, Chicago, Illinois 60601
(312) 895-8400
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
----------------
JOSEPH A. BEATTY
Executive Vice President and Chief Financial Officer
Focal Communications Corporation
200 North LaSalle Street, Suite 1100
Chicago, Illinois 60601
(312) 895-8400
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
Copies to:
Elizabeth C. Kitslaar, Esq. Leigh P. Ryan, Esq.
Jones, Day, Reavis & Pogue Paul, Hastings, Janofsky & Walker LLP
77 West Wacker Drive 399 Park Avenue
Suite 3500 31st Floor
Chicago, Illinois 60601-1692 New York, New York 10022-4697
(312) 782-3939 (212) 318-6000
----------------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to made pursuant to Rule 434,
check the following box. [_]
CALCULATION OF REGISTRATION FEE
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- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Proposed maximum
Title of each class of aggregate Amount of
securities to be registered offering price (1) registration fee (2)
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Common Stock (par value $0.01 per share)... $115,000,000 $31,970
- -------------------------------------------------------------------------------------------
</TABLE>
- -------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457.
(2) The registration fee was paid on May 6, 1999.
----------------
The registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this
registration statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until the registration statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This prospectus is not an +
+offer to sell these securities and it is not soliciting an offer to buy these +
+securities where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JULY 6, 1999
PROSPECTUS
9,000,000 Shares
[Focal Logo]
Focal Communications Corporation
Common Stock
$ per share
--------
Focal Communications Corporation is selling 9,000,000 shares of common stock.
The underwriters named in this prospectus may purchase up to 1,350,000
additional shares of our common stock from us under certain circumstances.
This is an initial public offering of common stock. We currently expect the
initial public offering price to be between $10.00 and $12.00 per share, and
have applied to have the common stock included for quotation on the Nasdaq
National Market under the symbol "FCOM."
--------
Investing in our common stock involves risks. See "Risk Factors" beginning on
page 6.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
--------
<TABLE>
<CAPTION>
Per Share Total
------------ ------------
<S> <C> <C>
Public Offering Price $ $
Underwriting Discount $ $
Proceeds to Focal (before expenses) $ $
</TABLE>
The underwriters are offering the shares subject to various conditions. The
underwriters expect to deliver the shares to purchasers on or about July ,
1999.
--------
Salomon Smith Barney
Donaldson, Lufkin & Jenrette
Morgan Stanley Dean Witter
Credit Suisse First Boston
DLJdirect Inc.
, 1999
<PAGE>
[MAP OF UNITED STATES SHOWING OPERATIONAL MARKETS AND MARKETS UNDER
DEVELOPMENT; MAP OF NEW YORK METROPOLITAN AREA ILLUSTRATINGLOCAL NETWORK
CONFIGURATION; INSET OF MANHATTAN DETAILINGLOCAL FIBER LAYOUT AND SWITCH AND
COLOCATION CENTERS]
<PAGE>
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with different information. We are
not making an offer of these securities in any state where the offer is not
permitted. You should not assume that the information provided by this
prospectus is accurate as of any date other than the date on the front of the
prospectus.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 6
Use of Proceeds........................................................... 15
Capitalization............................................................ 16
Dilution.................................................................. 17
Selected Consolidated Financial and Operating Data........................ 18
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 20
Business.................................................................. 28
Management................................................................ 45
Security Ownership of Certain Beneficial Owners and Management............ 58
Certain Transactions...................................................... 60
Description of Capital Stock.............................................. 62
Dividend Policy........................................................... 64
Description of Notes...................................................... 65
Shares Eligible for Future Sale........................................... 67
United States Federal Tax Considerations for Non-U.S. Holders of Common
Stock.................................................................... 68
Underwriting.............................................................. 72
Legal Matters............................................................. 74
Experts................................................................... 74
Where You Can Find More Information....................................... 74
Glossary.................................................................. 75
Index to Consolidated Financial Statements................................ F-1
</TABLE>
We have applied to register the following trademarks which may appear in
this prospectus: Focal(TM), Focal and Design(TM), Focal Communications
Corporation(TM) and FocaLINC(TM).
<PAGE>
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
We make statements in this prospectus that are not historical facts. These
"forward-looking statements" can be identified by the use of terminology such
as "believes," "expects," "may," "will," "should" or "anticipates" or
comparable terminology. These forward-looking statements include, among others,
statements concerning:
. Our business strategy and competitive advantages
. Our anticipation of potential revenues from designated markets
. Statements regarding the growth of the telecommunications industry and
our business
. The markets for our services and products
. Forecasts of when we will enter particular markets or begin offering
particular services
. Our anticipated capital expenditures and funding requirements
. Anticipated regulatory developments
These statements are only predictions. You should be aware that these
forward-looking statements are subject to risks and uncertainties, including
financial and regulatory developments and industry growth and trend
projections, 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 us from achieving our stated goals include, but are not
limited to, our failure to:
. Prevail in legal and regulatory proceedings regarding reciprocal
compensation for Internet-related calls or changes to laws and
regulations that govern reciprocal compensation
. Successfully expand our operations into new geographic markets on a
timely and cost-effective basis
. Successfully introduce and expand our data and voice service offerings
on a timely and cost-effective basis
. Respond to competitors in our existing and planned markets
. Execute and renew interconnection agreements with incumbent carriers on
terms satisfactory to us
. Maintain our agreements for transport facilities
. Maintain acceptance of our services by new and existing customers
. Attract and retain talented employees
. Obtain and maintain any required governmental authorizations, franchises
and permits, all in a timely manner, at reasonable costs and on
satisfactory terms and conditions
. Respond effectively to regulatory, legislative and judicial developments
. Manage administrative, technical and operational issues presented by our
expansion plans
. Address Year 2000 remediation issues
For a discussion of some of these factors, see "Risk Factors" beginning on
page 6.
<PAGE>
PROSPECTUS SUMMARY
This summary highlights information that we believe is especially important
concerning our business and the offering. As a summary, it is necessarily
incomplete and does not contain all of the information that you should consider
before investing in our common stock. You should read the entire prospectus
carefully. Except as otherwise required by the context, references in this
prospectus to "Focal," "we," "us," or "our" refer to the combined businesses of
Focal Communications Corporation and all of its subsidiaries. For a description
of some of the industry terminology used in this prospectus, you should refer
to the "Glossary." You should also read and consider the information in the
"Risk Factors" section of this prospectus before making an investment in shares
of our common stock.
Unless otherwise indicated, the information in this prospectus gives effect
to a recapitalization pursuant to which our Class A common stock, Class B
common stock and Class C common stock will be converted into a single class of
common stock and a 500-for-1 stock split. Both the recapitalization and the
stock split will be completed immediately before the offering is completed.
BUSINESS
Focal is a rapidly growing competitive local exchange carrier, or CLEC. We
provide data, voice and colocation services to large, communications-intensive
users in major cities. Our target customers include large corporations,
Internet service providers and value-added resellers. We offer our customers an
attractive alternative to incumbent local exchange carriers, or ILECs. Since
other CLECs have chosen to compete in smaller cities or target smaller
customers, we believe we have a unique strategy.
We began operations in 1996, initiated service first in Chicago in May 1997
and currently offer service in 13 large, metropolitan markets nationwide. As of
June 30, 1999, we had sold approximately 130,000 access lines, of which
approximately 106,000 were installed and in service. We estimate that at least
70% of these lines are utilized by our customers to carry data traffic.
A majority of our revenue is currently derived from the provision of
switched data services for our targeted customers. Due to customer demand, we
are deploying additional services such as digital subscriber line, or DSL,
nationwide networking using asynchronous transfer mode, or ATM, technology.
Once these services are deployed, we believe we will have an advantage over
other data and voice CLECs offering these services due to our established
relationships with some of the largest corporate and Internet service provider
customers in the nation, our highly reliable network, and our ability to
package switched and high-speed data connections. Leveraging these
relationships, we recently entered into a five-year joint marketing and service
agreement whereby we have become the preferred provider of DSL services to
Splitrock Services, Inc., one of our largest ISP customers. Under this
agreement, Splitrock has agreed to purchase from us a minimum of 10,000 DSL
lines as may be needed to serve their customers.
We believe we were the first CLEC to employ the "smart-build" approach to
designing networks. As such, we own and operate our switches, and initially
lease, rather than own, transport capacity. Currently, we use leased facilities
for 100% of our transport requirements. However, based on the increase in
volume of customer traffic in some of our markets, we now believe it is
economically attractive for us to own a portion of our transport capacity. We
have signed agreements with Level 3 Communications and Metromedia Fiber Network
Services to acquire a combined minimum of 10,800 fiber miles of our own local
fiber transport capacity in at least 16 markets. By combining leased fiber
transport facilities with owned fiber capacity, we expect to be better able to
control these assets and generate stronger operating results.
To further develop our long distance service offerings, we have signed
agreements with a number of carriers under which we plan to lease approximately
10,000 DS-3 miles of fiber transport capacity connecting each of our existing
and planned markets. Using these facilities, we are developing a nationwide ATM
network
1
<PAGE>
to carry data and voice traffic. For example, we expect to be able to price
long distance voice calls that remain on the Focal network as if they were
local calls--a service we call FocaLINC(TM). In addition, we expect to offer
our corporate customers nationwide toll-free access to their local area
networks--a service we call Virtual Office.
We also offer colocation services. Many of our Internet service provider
customers house their equipment in colocation space we operate within our
switching centers. We provide equipment management services to some of these
customers. We currently have over 64,000 square feet of secure and
environmentally conditioned colocation space available to our customers or
under development. We believe the proximity of existing and future colocation
customers to our network as well as the concentration of Internet traffic
within our space will provide us with an advantage in marketing additional
services in the future.
In order to increase our coverage of major U.S. cities, we plan to provide
our services in three additional markets in 1999 and another four markets in
2000. When we complete our planned expansion, we will provide service in 20
markets, which encompass a total of 50 metropolitan statistical areas. We
estimate there will be approximately 20 million business access lines in these
markets by the end of 1999, which will represent about 36% of the total
business access lines in the nation. We estimate that in 1999 these lines will
generate approximately $18 billion in annual local switched service revenue. In
addition to our local switched service opportunity, Frost & Sullivan projects
that the total U.S. market for high-speed and switched data services will grow
from $18 billion in 1997 to approximately $40 billion by 2002. We estimate that
the addressable market for high-speed and switched data services in our
targeted markets will be approximately $9 billion by the end of 1999.
We believe that our management and operations team has been critical to our
initial success and will continue to differentiate Focal from its competitors.
We have built a skilled and experienced management team with extensive prior
work experience at major telecommunications companies, such as MFS
Communications, Sprint, MCI WorldCom, AT&T and Ameritech.
STRATEGY
Our objective is to become the provider of choice for data and voice
communications services to large, communications-intensive customers in our
target markets. The key elements of our strategy are as follows:
. Leverage Current Customer Relationships--Our customer base includes a
substantial number of large companies and Internet service providers,
some of which are:
<TABLE>
<S> <C> <C> <C>
IBM Sony Citigroup United Airlines
E*Trade Merrill Lynch Mindspring PSINet
CompuServe Nortel Networks Sears Motorola
</TABLE>
We believe that this customer base of communications-intensive users
gives us an advantage in successfully marketing additional services.
Consequently, we plan to leverage the relationships we have built with
our customers and increase our share of their total communications
expenditures by expanding our service offerings and market coverage.
. Expand Data Service Offerings--The majority of our access lines are
utilized for switched data services. We believe a significant
opportunity exists with our existing and targeted customers to
successfully offer a wider array of data services. As a result, we are
currently developing high-speed local area network and Internet access
using DSL technology as well as private line data services.
. Connect our Local Networks Nationally--We believe that the number and
types of services we can provide to communications-intensive customers
in major markets will be greatly enhanced if our networks in these
markets are interconnected. Therefore, we are developing a seamless,
nationwide network based on ATM technology that will interconnect our
switching and colocation centers
2
<PAGE>
in the U.S. We expect this will give us the necessary network platform
to offer additional services such as virtual private network and private
line data and voice services.
. Design and Install a Highly Capital-Efficient Network--We believe we
have optimized our return on invested capital by initially leasing fiber
capacity and by making most of our capital expenditures in switching
facilities and information systems. Going forward, we believe that our
hybrid network, which will combine leased and owned transport capacity,
is the best way to balance capital efficiency and control of network
assets.
. Maximize Network Utilization through Value Added Resellers--We provide
service to value added resellers, or VARs, such as managers of large
multi-dwelling units and companies that market bundled
telecommunications services to small- and medium-sized businesses. This
VAR distribution channel allows us to increase the number of access
lines served by our networks, which further maximizes network
utilization.
Our principal executive offices are located at 200 North LaSalle Street,
Suite 1100, Chicago, Illinois 60601. Our phone number is (312) 895-8400.
THE OFFERING
The following information assumes that the underwriters will not exercise
their over-allotment option. See "Underwriting." The number of shares of common
stock outstanding after the offering excludes a total of 8,258,750 shares of
common stock reserved for issuance under our equity incentive plans as of July
1, 1999, of which 6,463,225 shares are reserved for issuance upon exercise of
outstanding options at a weighted average exercise price of $2.98 per share.
<TABLE>
<C> <S>
Common stock offered.................... 9,000,000 shares
Common stock outstanding after the
offering............................... 58,108,430 shares
Proposed Nasdaq National Market symbol.. FCOM
Use of proceeds......................... We intend to use the net proceeds
from the offering to fund capital
expenditures and operating losses,
for working capital and potential
acquisitions, and for general
corporate purposes.
Risk factors............................ Investing in shares of our common
stock involves risks. See "Risk
Factors" for a discussion of matters
you should consider before investing
in shares of our common stock.
</TABLE>
3
<PAGE>
Summary Consolidated Financial and Operating Data
The summary consolidated financial data presented below for the seven month
period ended December 31, 1996, for the years ended December 31, 1997 and 1998
and for the three months ended March 31, 1998 and 1999, have been derived from
Focal's Consolidated Financial Statements and the notes related thereto, which
begin on page F-3. The summary financial data for the three month periods ended
March 31, 1998 and March 31, 1999 have been derived from our unaudited
consolidated financial statements which, in the opinion of management, include
all adjustments, consisting of normal recurring adjustments, necessary for a
fair presentation of our financial condition and results of operations for
these periods. The results of operations for these interim periods are not
necessarily indicative of full year results. You should not assume that the
results of operations below are indicative of the financial results we can
achieve in the future.
<TABLE>
<CAPTION>
Period From
Commencement of Years Ended Three Months Ended March
Operations December 31, 31,
(May 31, 1996) to -------------------------- --------------------------
December 31, 1996 1997 1998 1998 1999
----------------- ------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ -- $ 4,023,690 $ 43,531,846 $ 5,102,448 $ 26,003,897
Expenses:
Customer service and
network operations.... -- 2,154,980 15,284,641 1,826,893 10,369,319
Selling, general and
administrative........ 421,777 2,887,372 12,209,821 1,307,625 5,665,896
Depreciation and
amortization.......... 1,150 615,817 6,670,986 890,871 4,026,750
Non-cash compensation
expense............... 108,333 1,300,000 3,069,553 325,000 1,559,576
---------- ------------ ------------ ------------ ------------
Operating income (loss). (531,260) (2,934,479) 6,296,845 752,059 4,382,356
Interest income
(expense), net......... 17,626 67,626 (9,605,832) (1,093,250) (4,097,502)
Provision for income
taxes.................. -- -- (4,660,000) -- --
Accretion to redemption
value of Class A common
stock.................. -- (103,565) -- -- --
---------- ------------ ------------ ------------ ------------
Net income (loss)
applicable to common
stockholders........... $ (513,634) $ (2,970,418) $ (7,968,987) $ (341,191) $ 284,854
========== ============ ============ ============ ============
Basic net income (loss)
per share.............. $ (0.06) $ (0.07) $ (0.18) $ (0.01) $ 0.01
========== ============ ============ ============ ============
Diluted net income
(loss) per share....... $ (0.06) $ (0.07) $ (0.18) $ (0.01) $ 0.01
========== ============ ============ ============ ============
Basic weighted average
common stock
outstanding............ 8,498,000 42,186,500 43,763,000 44,153,500 43,961,000
========== ============ ============ ============ ============
Diluted weighted average
common stock
outstanding............ 8,498,000 42,186,500 43,763,000 44,153,500 51,803,000
========== ============ ============ ============ ============
Other Financial Data:
EBITDA.................. $ (421,777) $ (1,018,662) $ 16,037,384 $ 1,967,930 $ 9,968,682
Capital expenditures.... 82,303 11,655,524 64,229,247 7,593,061 24,476,209
Summary Cash Flow Data:
Net cash provided by
(used in) operating
activities............. $ (152,576) $ (1,634,017) $ 22,596,957 $ 3,745,255 $ (1,304,626)
Net cash used in
investing activities... (82,303) (11,655,524) (72,189,187) (7,593,061) (23,977,119)
Net cash provided by
financing activities... 4,025,000 11,755,972 173,376,679 154,350,198 5,839,625
Operating Data:
Access lines in service. -- 7,394 52,011 14,528 70,572
Minutes of use
(millions)............. -- 282 3,568 402 2,033
</TABLE>
<TABLE>
<CAPTION>
As of March 31, 1999
-------------------------
As Adjusted
for the
Actual Offering
------------ ------------
(Unaudited)
<S> <C> <C>
Balance Sheet Data:
Total cash, cash equivalents and short-term
investments......................................... $114,059,731 $205,059,731
Total assets......................................... 226,571,111 317,571,111
Long-term debt, including current portion............ 195,545,892 195,545,892
Total stockholders' equity........................... 21,714,695 112,714,695
</TABLE>
4
<PAGE>
You should keep the following matters in mind when you read the information
in the tables above:
. Non-cash compensation expense consists of:
--charges totaling $0.1 million for 1996, $1.3 million for each of 1997
and 1998, and $0.3 million for each three-month period ended March 31,
1998 and 1999, which resulted from the vesting over time of shares of
common stock issued to some of our executive officers in November 1996
--charges of $1.8 million for 1998 and $0.1 million for the three months
ended March 31, 1999, which resulted from the vesting and cancellation
of shares of common stock in connection with the September 30, 1998
amendment of vesting agreements with some of our executive officers
--charges of $1.2 million for the three months ended March 31, 1999,
which resulted from our first quarter 1999 stock option grants to
employees and directors, and common stock issued to a director
. EBITDA represents earnings before interest, income taxes, depreciation
and amortization and other non-cash charges, including non-cash
compensation expense. EBITDA is not a measurement of financial
performance under generally accepted accounting principles. EBITDA is
not intended to represent cash flow from operations and should not be
considered as an alternative to net loss applicable to common
stockholders as an indicator of our operating performance or to cash
flows as a measure of liquidity. We believe that EBITDA is widely used
by analysts, investors and other interested parties in the
telecommunications industry. EBITDA is not necessarily comparable to
similarly titled measures for other companies. See "Consolidated
Financial Statements--Consolidated Statements of Cash Flows" on page F-
6.
. Before giving effect to the recapitalization and the 500-for-1 stock
split to be completed immediately prior to completion of the offering,
basic and diluted net income (loss) per share and basic and diluted
weighted average common stock outstanding were:
<TABLE>
<CAPTION>
Period From
Commencement of Years Ended Three Months
Operations December 31, Ended March 31,
(May 31, 1996) to ----------------- ----------------
December 31, 1996 1997 1998 1998 1999
----------------- -------- -------- -------- -------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Basic net income
(loss) per share..... $(30.22) $(35.21) $(91.05) $ (3.86) $ 3.24
======== ======== ======== ======== =======
Diluted net income
(loss) per share..... $(30.22) $(35.21) $(91.05) $ (3.86) $ 2.75
======== ======== ======== ======== =======
Basic weighted average
common stock
outstanding.......... 16,996 84,373 87,526 88,307 87,922
======== ======== ======== ======== =======
Diluted weighted
average common stock
outstanding.......... 16,996 84,373 87,526 88,307 103,606
======== ======== ======== ======== =======
</TABLE>
. We count access lines as of the end of the period indicated and on a
one-for-one basis using DS-0 equivalents.
. The "As Adjusted" column in the balance sheet data table assumes that we
will sell 9,000,000 shares of our common stock at $11.00 per share and
receive net proceeds of $91 million.
5
<PAGE>
RISK FACTORS
In addition to the other information in this prospectus, you should consider
carefully the following risk factors in evaluating our company and its business
before you invest in our common stock.
Limited Operating History--We have a limited history of operations and you
therefore have limited information on which to base your investment decision.
We were incorporated in April 1996 and began providing service in our first
market, Chicago, in May 1997. Therefore, you have limited historical financial
and operating information with which to evaluate our performance.
Probable Future Losses--We expect negative operating cash flows and substantial
operating losses for the foreseeable future.
The development of our business requires significant capital and operational
expenditures to expand our networks, services and customer base. Many of these
expenditures must be completed before any revenue can be realized in a
particular market. These expenditures are expected to increase as we grow our
customer base in existing markets, expand into new markets and diversify our
service offerings.
Reciprocal compensation has historically represented a substantial portion
of our revenues. Reciprocal compensation payments are amounts we receive when
we complete local calls from another local exchange carrier's network. These
payments represented approximately 75% of our 1998 revenues and 73% of our
revenues for the first quarter of 1999. We expect current rates for reciprocal
compensation to decrease substantially beginning in the fourth quarter of 1999.
As a result, revenues attributable to reciprocal compensation will decrease
substantially.
We expect negative operating cash flow and substantial operating losses
until these trends stabilize, our newer markets and service offerings are
established and mature, and we establish an adequate revenue base. Although we
had operating income in fiscal 1998 and for the three months ended March 31,
1999 of $6.3 million and $4.4 million, respectively, we expect substantial
operating losses for fiscal 1999 and 2000. We may continue to sustain negative
operating cash flow and operating losses as a result of low prices, including
reduced rates attributable to reciprocal compensation, and/or higher costs,
including cash interest costs.
Significant Capital Requirements--Our future growth will require significant
capital.
Our business plan requires us to expand our existing networks and services,
acquire and develop new networks and services in additional markets, deploy our
own fiber capacity in a majority of our markets and fund our initial operating
losses. These activities will require significant capital for the foreseeable
future. Capital required from April 1, 1999 through the third quarter of 2000
for our current business plan is estimated to be approximately $230 million. We
currently plan to fund these requirements with the net proceeds of this
offering, together with:
. Our existing cash balances, cash equivalents and short-term investments
. Borrowing capacity under our $50 million equipment term loan facility
. Future cash flows from ongoing operations
Our expectations of our future capital requirements and cash flows from
operations are based on current estimates. Our actual capital expenditures and
cash flows could differ significantly from these estimates. If we require
additional capital to complete our budgeted expansion or if customer demand
significantly differs from our current expectations, our funding needs may
increase. In addition, we may be unable to produce sufficient cash flows from
ongoing operations to fund our business plan and future growth. This would
require us to alter our business plan, including delaying or abandoning our
expansion or spending plans, which could have a
6
<PAGE>
material adverse effect on our business. In addition, we may elect to pursue
other attractive business opportunities that could require additional capital
investments in our networks. If any of these events were to happen, we could be
required to borrow more money, issue additional debt or equity securities or
enter into joint ventures.
Substantial Debt--We have a substantial amount of debt that could impact our
future prospects and we may not have sufficient cash flow to service our debt.
We currently have a substantial amount of debt in relation to our
stockholders' equity. At March 31, 1999 we had total debt outstanding of $195.5
million and total stockholders' equity of $21.7 million. Interest on our
original issue discount Notes will increase this indebtedness by an additional
$98.9 million by February 15, 2003. The indenture related to our Notes also
permits us to incur additional indebtedness, which we plan to do.
Our high level of debt could adversely affect our future prospects by:
. Impairing our ability to borrow additional money
. Requiring us to use a substantial portion of our cash flows from
operations to pay interest or repay debt which will reduce the funds
available to us for our operations, acquisition opportunities and
capital expenditures
. Placing us at a competitive disadvantage with companies that are less
restricted by their debt agreements
. Making us more vulnerable in the event of a downturn in general economic
conditions
We cannot assure you that we will be able to meet our debt obligations. If
we are unable to generate sufficient cash to meet our obligations or if we fail
to satisfy the requirements of our debt agreements, we will be in default. A
default would permit the debtholders to require payment before the scheduled
due date of the debt, resulting in further financial strain on us and causing
additional defaults under our other indebtedness.
In order to repay our debt and fund our capital expenditures, we must
successfully implement our business strategy. If we are unable to do so, we may
have to reduce or delay our planned capital expenditures, sell assets, sell
additional equity or debt securities or refinance or restructure our debt. Any
delay in our planned capital expenditures could materially and adversely affect
our future revenue prospects. Any sale of assets to raise money to meet our
financial obligations could also occur on unfavorable terms.
Focal Communications Corporation is a holding company which receives all its
revenues from its subsidiaries. Its ability to obtain payments from its
subsidiaries may be restricted by the profitability and cash flows of its
subsidiaries and laws regulating the payment of dividends by a subsidiary to
its parent company. If its subsidiaries are unable to pay dividends, the
holding company may be unable to service its debt. In this situation, creditors
of its subsidiaries and future holders of preferred stock, if any, of its
subsidiaries, would have prior claims on the assets of the subsidiaries over
the claims of the holding company and its stockholders.
Network Expansion--Difficulties in expanding our networks could increase our
estimated costs and delay scheduled completion.
The expansion of our existing networks and the construction of networks in
new markets is a significant undertaking. This will require that we install and
operate additional facilities, switches and related equipment and develop,
introduce and market new products and services, including data services. In
addition, the deployment of additional data services, such as high-speed LAN
and Internet access, will require modifications to our network architecture.
The development and expansion of some of our data services offerings will also
require us to obtain and install our equipment in the ILECs' central office
colocation space. Administrative, technical, operational, regulatory and other
problems that could arise may be more difficult to address and solve due to the
scope and complexity of our planned expansion. We are also dependent on timely
performance by
7
<PAGE>
third-party suppliers and contractors, including suppliers of network
equipment. Many of these factors and problems are beyond our control. As a
result, our network build-out may not be completed as planned or for the costs
and in the time frame that we currently estimate. We may be materially
adversely affected as a result of any significant increase in the estimated
cost of the network build-out or any significant delay in its anticipated
completion.
Management of Growth--An inability to effectively manage our planned rapid
growth could adversely affect our operations.
Our business plan contemplates rapid expansion of our business for the
foreseeable future. This growth will increase our operating complexity and
require that we, among other things:
. Accurately assess our markets
. Expand our employee base with highly-skilled personnel
. Develop additional financial and management controls and systems
. Control expenses related to our business plan
. Integrate any acquired operations and joint ventures
. Obtain and maintain necessary regulatory approvals
A failure to satisfy any of these requirements or manage our growth effectively
could have a material adverse effect on us.
Internet-Related Reciprocal Compensation--Our entitlement to reciprocal
compensation for Internet traffic is subject to uncertainties that could
adversely affect us.
Several of the ILECs continue to challenge, through legal proceedings, the
CLECs' entitlement to reciprocal compensation payments under existing
interconnection agreements for calls made to ISPs on the grounds that these
calls should be considered interstate in nature, and that interstate calls are
not subject to reciprocal compensation. Several of these legal challenges seek
a refund of reciprocal compensation previously paid by the ILECs. Some ILECs
have refused to pay or have indicated they will escrow reciprocal compensation
for inbound Internet service provider, or ISP, traffic.
We have recorded all revenues from reciprocal compensation and related
accounts receivable and have not established any reserve for disputed amounts.
There is a risk that courts and regulatory authorities that previously ordered
payment for reciprocal compensation will revisit this issue and revise their
prior decisions, including possibly permitting the ILECs to recoup reciprocal
compensation payments. A judicial or regulatory determination that we are not
entitled to the reciprocal compensation we have historically recognized, or an
order that we refund reciprocal compensation paid to date, could have a
material adverse effect on us and our results of operations.
Information Support Systems--Any failure to develop and enhance effective
information support systems could have a material adverse effect on us.
Our business plan depends on our ability to develop and enhance
sophisticated information support systems. This is a complicated undertaking
requiring significant resources and expertise, and support from third-party
vendors. Since our business plan provides for growth in the volume and types of
services we offer, we need to develop and enhance these information support
systems on a schedule sufficient to meet our
8
<PAGE>
proposed service roll-out dates. In addition, we will require these information
support systems to expand and adapt with our rapid growth. The failure to
develop and timely enhance effective information support systems could have a
material adverse effect on us and our ability to implement our growth strategy.
Regulation--We are subject to significant regulation that could change in a
manner adverse to us.
Communications services are subject to significant regulation at the
federal, state and local levels. The following factors may have a material
adverse effect on us:
. Delays in receiving required regulatory approvals or onerous conditions
imposed on these approvals
. Difficulties completing interconnection agreements with ILECs
. The enactment of new and adverse legislation or regulatory requirements
or changes in the interpretation of existing legislation and/or changes
in regulatory requirements
Recent federal legislation governing the U.S. telecommunications industry
remains subject to judicial review and additional FCC rule-making. As a result,
we cannot predict the legislation's effect on our future operations or results.
Many regulatory actions regarding important items that impact us are underway
or are being contemplated by federal and state authorities. Changes in current
or future regulations adopted by federal, state or local regulators, or other
legislative or judicial initiatives relating to the telecommunications
industry, could have a material adverse effect on us.
Unlike some of our competitors, particularly the ILECs, we are not currently
subject to some of the burdensome regulations imposed by federal legislation.
Our ability to compete in the local exchange market will depend upon a
continued favorable, pro-competitive regulatory environment, and could be
adversely affected by new regulations or legislation affording greater
flexibility and regulatory relief to our competitors.
In August 1998, the FCC requested comments on new rules that would allow
ILECs to provide their own DSL services free from ILEC regulation through a
separate affiliate. The provision of DSL services by an affiliate of an ILEC
not subject to ILEC regulation could have a material adverse effect on us.
We are currently required to publicly file with governmental authorities our
tariffs describing the prices we charge our customers and the terms and
conditions for some intrastate, interstate and international services.
Challenges to these tariffs by regulators or third parties could cause us to
incur substantial legal and administrative expenses.
Federal and state regulatory agencies also have the right to impose
sanctions and forfeitures, mandate refunds or impose other penalties for
regulatory non-compliance.
Reliance on Leased Transport Facilities--Our reliance on leased transport
facilities could materially and adversely affect our business.
Our network design strategy contemplates us owning and operating our own
switches but initially leasing a substantial portion of our transport
facilities, or network lines, from third parties. Currently, we use leased
facilities for 100% of our transport requirements. Although we have begun to
selectively acquire our own fiber transport capacity in some of our markets, we
expect, for the foreseeable future, to continue to lease a substantial portion
of our transport capacity from other carriers, some of which are competitors in
our service territories.
We are also dependent on third-party suppliers for substantial amounts of
fiber, conduit, computers, software, switches, routers and related components
that we use to expand and upgrade our network. If any of
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<PAGE>
these relationships is terminated or a supplier fails to provide reliable
services or equipment, and we are unable to reach suitable alternative
arrangements quickly or on favorable terms, we may experience significant
delays and additional costs. If that happens, it could have a material adverse
effect on us.
We currently lease a majority of our transport facilities from one carrier.
Although we believe that adequate alternative sources of transport facilities
exist, if this carrier's facilities become unavailable, our business could be
disrupted. In addition, although we believe we have protection against
unexpected increases in the costs of our leased transport facilities, an
unexpected material increase in these costs could have a material adverse
effect on our results.
Relationship with ILECs--Our reliance on ILEC interconnections and changes to
our agreements with the ILECs could have a material adverse effect on us.
In addition to agreements with transport providers, we are dependent upon
our agreements with the ILECs operating in our existing and targeted markets.
These agreements, called interconnection agreements, specify how we connect our
networks with the network of the ILEC in each of our markets. Federal
legislation regulating the telecommunications industry has enhanced competition
in the local service market by requiring the ILECs to provide access to their
networks through interconnection agreements and to offer unbundled elements of
their network and retail services at prescribed rates to other
telecommunications carriers. A failure to negotiate required interconnection
agreements or renew existing interconnection agreements on favorable terms
could have a material adverse effect on our business.
Our interconnection agreements also require the ILECs to provide sufficient
transmission capacity to keep blocked calls between our networks within
industry limits. Accordingly, we are partially dependent on the ILECs in our
efforts to provide our customers with superior service and avoid blocked calls.
The failure by the ILECs to comply with their obligations under our
interconnection agreements could result in customer dissatisfaction and the
loss of existing and potential customers. In addition, the rates charged to us
under the interconnection agreements may be too high to permit us to offer
usage rates that are low enough to attract a sufficient number of customers and
permit us to operate profitably.
The pace at which we are able to add new customers and services could be
adversely affected if the ILECs do not provide us with necessary network
elements, colocation space, intercompany network connections and the means to
share information about customer accounts, service orders and repairs on a
timely basis. In addition, our ability to provide high-speed data services will
be dependent on our obtaining space from the various ILECs for physical
colocation of our equipment in the ILECs' central offices and elsewhere. In
many instances the ILECs do not timely or fully comply with these requirements.
Also, the rules governing which elements the ILECs must provide and the cost
methodology for providing these elements are currently under FCC and judicial
review.
Interconnection agreements are subject to review and approval by various
federal and state regulators. In addition, parties to the agreements may seek
to have the agreements modified based upon the outcome of regulatory or
judicial rulings occurring after the dates of the agreements. The outcome of
these rulings, or any modified agreements, could have a material adverse effect
on us. In addition, certain aspects of interconnection agreements, including
the price and economic terms of these agreements, have been subject to
litigation and regulatory action. See "Business--Regulation" for a more
complete description of these developments.
Competition--We compete in the telecommunications industry with participants
that have greater resources, a more established network and a broader customer
base than we do.
Portions of the telecommunications industry are highly competitive. Many of
our existing and potential competitors, including the ILECs and some CLECs,
have financial, personnel, marketing and other resources significantly greater
than ours. Many of these competitors have the added competitive advantage of an
established network and an existing customer base.
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<PAGE>
Our principal competitor in each of our markets is the ILEC. Although recent
federal legislation and rule-making have afforded us increased opportunities,
they also provide the ILECs with some advantages which could adversely affect
our business. In addition, current competitive advantages afforded to CLECs may
also be adversely affected by changes in existing regulation of
telecommunications services. These changes include permitting ILECs to:
. Reduce their prices because of fewer regulatory restrictions
. Offer selective discount pricing to their customers
. Provide advanced data networks through less-regulated separate
subsidiaries that may be used for voice traffic
. Eliminate the resale of advanced services
. Provide out-of-region long distance service
. Limit the network elements required to be provided on an unbundled basis
In addition, significant new competitors in the local exchange market could
arise as a result of:
. Consolidation and strategic alliances in the industry
. Foreign carriers being allowed to compete in the U.S. market
. Further technological advances
. Further deregulation and other regulatory initiatives
Other competitors and potential market entrants include long distance
companies, cable television companies, electric utilities, microwave carriers,
wireless telephone system operators, data service companies and operators of
private networks.
Quarterly Operating Results--Our quarterly operating results may vary
significantly.
We anticipate that our operating results could vary greatly from quarter to
quarter due to:
. The significant expenses associated with the expansion and development
of our networks and services
. The variability of the level of revenues generated through sales of our
services
This type of variability could have a material adverse effect on us.
Reliance on Key Personnel--We may be unable to hire and retain sufficient
qualified personnel; the loss of any of our key executive officers could
materially adversely affect us.
We believe that our future success will depend in large part on our ability
to attract and retain highly skilled, knowledgeable, sophisticated and
qualified managerial, professional and technical personnel. To implement our
business plan and manage our planned growth successfully, we will need to add a
substantial number of additional employees. We have experienced significant
competition in attracting and retaining personnel who possess the skills that
we are seeking. As a result of this competition, we may experience a shortage
of qualified personnel.
Our business is managed by a relatively small number of senior management
and operating personnel. Losing some members of the senior management team or
key operating personnel could have a material adverse effect on us. We may be
unable to retain our senior management or other key employees, or retain other
skilled personnel in the future.
Limited Number of Stockholders--A limited number of stockholders controls us
and their interests may be different from the interests of public stockholders.
Madison Dearborn Capital Partners, L.P., Frontenac VI, L.P. and Battery
Ventures III, L.P., our three principal institutional investors, will control
approximately 63.2% of our total voting power after the offering.
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<PAGE>
As a result, these institutional investors and our management will have the
ability to control our future operations and strategy. Conflicts of interest
between these institutional investors and our public stockholders may arise
with respect to sales of shares of common stock owned by these institutional
investors or other matters. For example, sales of shares by these institutional
investors could result in a "Change of Control" under our Notes indenture,
which would require us to offer to repurchase our Notes. In addition, the
interests of our institutional investors and other existing stockholders
regarding any proposed merger or sale of Focal may differ from the interests of
our new public stockholders, especially if the consideration to be paid for the
common stock is less than the price paid by public stockholders.
Potential Conflicts of Interest--Our institutional investors invest in other
telecommunications companies and conflicts of interest may arise from these
investments.
Madison Dearborn, Frontenac and Battery Ventures or their affiliates
currently have significant investments in telecommunications services companies
other than Focal. These institutional investors may in the future invest in
other entities that compete with us. In addition, four of our directors, each
of whom is a principal of one of these institutional investors, serve as
directors of other public telecommunications services companies. As a result,
these four directors may be subject to conflicts of interest during their
tenure as directors of Focal. Because of these potential conflicts, these four
directors may be required to periodically disclose financial or business
opportunities to us and to the other companies to which they owe fiduciary
duties. Following completion of the offering, the Audit Committee of our Board
of Directors will resolve all conflict of interest issues. A majority of the
members of the Audit Committee will be independent directors.
Franchises and Rights-of-Way--Our ability to develop networks will be adversely
affected if we cannot obtain necessary permits and rights-of-way.
We plan to selectively develop our own fiber transport facilities where it
makes economic sense to do so. To do this, we may need to obtain local rights
to utilize underground conduit and pole space, franchises, permits and other
rights-of-way from various public and private entities. The process of
obtaining these franchises, permits and rights-of-way is time consuming and
burdensome. The failure to enter into and maintain these arrangements for a
particular network on acceptable terms and on a timely basis may adversely
affect our ability to develop that network. In addition, the cancellation or
non-renewal of the rights, franchises or permits we do obtain could have a
material adverse affect on us.
Acquisitions--A failure to manage risks associated with acquisitions could have
a material adverse effect on our business and results of operations.
A portion of our future growth may come from acquisitions of other
businesses. The acquisition of businesses will expose us to additional risks.
In order to make successful acquisitions, we must be able to:
. Identify suitable acquisition candidates, negotiate acceptable terms for
their acquisition and arrange suitable financing
. Integrate the operations, including networks and services, of an
acquired company into our operations
. Avoid the potential disruption of our existing business if our
management focuses on any acquisition or its integration at the expense
of our existing business
. Successfully capitalize on any opportunities presented by the
acquisition
We cannot be certain that we will make any acquisitions in the future. Any
acquisitions we do make may not be done in a timely manner or on terms
favorable to us. In addition, we cannot be certain that any acquisition we may
make would be successfully integrated with our existing business.
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<PAGE>
Technological Changes--Our business could be adversely affected if we do not
keep pace with rapid technological changes.
The telecommunications industry is subject to rapid and significant changes
in technology. We believe that for the foreseeable future we will be able to
acquire necessary technologies. We cannot, however, predict the effect of
technological changes on our business. In addition, the introduction of new
products or technologies may reduce the cost or increase the supply of services
similar to those that we plan to provide. As a result, our most significant
competitors in the future may be new entrants to the communications services
industry. These new entrants may not be burdened by an installed base of
outdated equipment. Technological changes and the resulting competition could
have a material adverse effect on us.
Dividends--We do not intend to pay dividends and our indenture restricts our
ability to do so.
We have never declared or paid any cash dividends on our common stock. For
the foreseeable future, we intend to retain any earnings to finance the
development and expansion of our business, and we do not anticipate paying any
cash dividends on our common stock. Payment of any future dividends on our
common stock will depend upon our earnings and capital requirements, the terms
of our debt facilities and other factors our Board of Directors considers
appropriate. Our ability to declare and pay dividends on our common stock is
also currently restricted by covenants in our Notes indenture.
No Trading Market and Volatility--There is no trading market for our common
stock; our stock price may be volatile.
This is the initial public offering of our common stock, and no public
market for our common stock currently exists. We cannot assure you that an
active trading market will develop or be sustained after the offering is
completed. The initial public offering price will be determined through
negotiations between us and the underwriters based on several factors and may
not be indicative of the market price of the common stock after the offering.
The market price of our shares may be significantly affected by factors
including:
. An actual or anticipated fluctuation in our operating results
. New products or services or new contracts by us or our competitors
. Legislative and regulatory developments
. Conditions and trends in the telecommunications industry, general market
conditions and other factors beyond our control
In addition, the stock market has periodically experienced significant price
and volume fluctuations that have particularly affected the market prices of
common stock of telecommunications companies. These changes have often been
unrelated to the operating performance of particular companies. These broad
market fluctuations may also adversely affect the market price of our shares.
Future Stock Sales--Sales of large amounts of our common stock or the
perception that sales could occur may depress our stock price.
After this offering, our existing stockholders will own 84.5% of the
outstanding shares of our common stock. In addition, as of July 1, 1999, there
were 6,463,225 shares of our common stock reserved for issuance upon exercise
of outstanding options granted under our equity incentive plans. Almost all of
the shares of our common stock outstanding prior to this offering are subject
to a registration rights agreement that grants holders of these shares the
right to have their shares registered either on demand or together with shares
we intend to sell. We also intend to register under the Securities Act of 1933
up to approximately 8,258,750 shares of our common stock reserved for issuance
under our equity incentive plans. Focal, each of our significant institutional
investors, our directors, officers and some of our employees will, with
specified exceptions, be prohibited from selling or, with respect to shares
subject to the registration rights agreement, requesting registration of shares
of our common stock for 180 days after the date of this prospectus.
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<PAGE>
The market price of our common stock could drop as a result of sales of a
large number of our shares in the public market after the offering. The
perception that sales may occur could also have the same result.
Anti-takeover Provisions--Provisions of our charter, applicable law and our
Notes indenture may delay or prevent a change in control.
Our certificate of incorporation and bylaws, the Delaware corporations
statute and our Notes indenture may make it difficult or even prevent a third
party from acquiring us without the approval of our incumbent Board of
Directors. These provisions, among other things:
. Divide our Board of Directors into three classes, with members of each
class to be elected in staggered three-year terms
. Limit the right of stockholders to remove directors
. Prohibit stockholder action by written consent in place of a meeting
. Limit the right of stockholders to call special meetings of stockholders
. Regulate how stockholders may present proposals or nominate directors
for election at annual meetings of stockholders
. Authorize our Board of Directors to issue preferred stock in one or more
series without any action on the part of stockholders
These provisions could limit the price that investors might be willing to
pay in the future for shares of our common stock, may discourage third party
bidders from bidding for us and could significantly impede the ability of the
holders of our common stock to change our management.
Our business is subject to regulation by the FCC and state regulatory
commissions or similar state regulatory agencies in the states in which we
operate. The FCC and some states have statutes or regulations that would
require an investor who acquires a specified percentage of our securities or
the securities of one of our subsidiaries to obtain approval to own such
securities from the FCC or the state commission.
Dilution--You will experience immediate and substantial dilution in your
investment.
The initial public offering price is substantially higher than the net
tangible book value per share of our common stock. As a result, you will
experience immediate and substantial dilution in net tangible book value when
you buy shares of our common stock in the offering. This means that you are
paying a higher price per share than the amount of our total assets, minus our
total liabilities, divided by the number of outstanding shares. To the extent
that outstanding options to purchase our common stock are exercised or we issue
additional shares of our common stock at prices lower than the then-current net
tangible book value, there will be further dilution to the holders of our
common stock.
Year 2000 Compliance--The Year 2000 issue may cause system failure or
disruption of our services.
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of our computer
programs or systems, or those of our suppliers, that have date-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculation causing
disruption of our operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities or interruptions of customer service. If we fail to achieve
Year 2000 readiness with respect to our systems and hardware, we may be
adversely affected.
We have performed an internal assessment of our own material information
systems, including our DMS-500 SuperNode central office switches, and hardware
to determine whether our systems and hardware are Year 2000 compliant. However,
we have not, nor do we plan to, identify, validate as compliant or remediate
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<PAGE>
integrated circuits in any other systems or hardware. We have received
assurances from all of our major software and hardware vendors that the
products we are currently using are Year 2000 compliant in all material
respects and will function adequately after December 31, 1999.
Our services are also dependent on network systems and transport facilities
maintained by other carriers, including the ILECs and inter-exchange carriers,
or IXCs. The risks associated with the failure of these carriers' systems or
transport facilities include potential interruption of service, blocked calls
and delayed call completion. Interruptions of this type, if prolonged, could
have a material adverse effect on us.
Investment Company Act--We may be required to register as an investment
company, which would adversely affect us.
We now have and after the offering will continue to have substantial cash
balances and short-term investments. As a result, we may be considered an
"investment company" under the Investment Company Act of 1940. The Investment
Company Act requires companies that are engaged primarily in the business of
investing, reinvesting, owning, holding or trading in securities, or that fail
numerical tests regarding composition of assets and sources of income and that
are not primarily engaged in a business other than investing, reinvesting,
owning, holding or trading in securities, to register as "investment
companies." Various substantive restrictions are imposed on these "investment
companies" by the Investment Company Act.
Because we are primarily engaged in a business other than investing,
reinvesting, owning, holding or trading securities, we do not believe that we
are an investment company within the meaning of the Investment Company Act. If
we are required to register as an investment company under the Investment
Company Act, we would become subject to substantial regulation with respect to
our capital structure, management, operations, transactions with "affiliated
persons," as defined in the Investment Company Act, and other matters. To avoid
having to register as an investment company, we may have to hold a portion of
our liquid assets as cash or government securities instead of as investment
securities. Having to register as an investment company or holding a material
portion of our liquid assets as cash or government securities to avoid
registration could have a material adverse effect on us.
USE OF PROCEEDS
After deducting estimated underwriter discounts and offering expenses, we
expect to receive net proceeds from the offering of approximately $91 million,
or approximately $105 million if the underwriters exercise their over-allotment
option in full. This estimate is based on an assumed initial public offering
price of $11.00 per share. We intend to use the net proceeds, together with
amounts available from our existing cash balances, our equipment term loan and
future cash flow from ongoing operations, to fund capital expenditures and
operating losses, for working capital and potential acquisitions, and for
general corporate purposes. We will have broad discretion in determining the
uses and exact amounts for each use of the net proceeds. Pending these uses, we
will invest the net proceeds in short-term money market and other market-rate,
investment-grade instruments. See "Risk Factors--Investment Company Act" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources."
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CAPITALIZATION
The following table sets forth our total cash, cash equivalents and short-
term investments and capitalization as of March 31, 1999 on an actual basis and
on an as adjusted basis to give effect to:
. the 500-for-1 stock split and recapitalization of our common stock into
a single class that will occur immediately before this offering is
completed
. the offering and our receipt of net proceeds from the sale of common
stock in this offering, based on an assumed initial public offering
price of $11.00 per share
You should read the information in this table in conjunction with our
Consolidated Financial Statements and the notes related thereto included
elsewhere in this prospectus. See also "Use of Proceeds" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources."
<TABLE>
<CAPTION>
As of March 31, 1999
----------------------------------------------
As Adjusted for the As Adjusted
Stock Split and for the
Actual Recapitalization Offering
------------ ------------------- ------------
<S> <C> <C> <C>
Total cash, cash equivalents
and short-term investments.... $114,059,731 $114,059,731 $205,059,731
============ ============ ============
Long-term debt, including
current portion............... $195,545,892 $195,545,892 $195,545,892
Stockholders' equity:
Common stock, Class A, $.01
par value; 100,000 shares
authorized actual and no
shares authorized as
adjusted for the stock split
and recapitalization and as
adjusted for the offering;
75,746, 0 and 0 shares
issued and outstanding
actual, as adjusted for the
stock split and
recapitalization and as
adjusted for the offering,
respectively................ 757 -- --
Common stock, Class B, $.01
par value; 35,000 shares
authorized actual and no
shares authorized as
adjusted for the stock split
and recapitalization and as
adjusted for the offering;
22,000, 0 and 0 shares
issued and outstanding
actual, as adjusted for the
stock split and
recapitalization and as
adjusted for the offering,
respectively................ 220 -- --
Common stock, Class C, $.01
par value; 15,000 shares
authorized actual and no
shares authorized as
adjusted for the stock split
and recapitalization and as
adjusted for the offering;
no shares issued and
outstanding actual, as
adjusted for the stock split
and recapitalization and as
adjusted for the offering... -- -- --
Preferred stock, $.01 par
value; no shares authorized
actual and 2,000,000 shares
authorized as adjusted for
the stock split and
recapitalization and as
adjusted for the offering;
no shares issued and
outstanding actual, as
adjusted for the stock split
and recapitalization and as
adjusted for the offering... -- -- --
Common stock, $.01 par value;
no shares authorized actual
and 100,000,000 shares
authorized as adjusted for
the stock split and
recapitalization and as
adjusted for the offering;
0, 48,873,000 and 57,873,000
shares issued and
outstanding actual, as
adjusted for the stock split
and recapitalization and as
adjusted for the offering,
respectively................ -- 977 90,977
Additional paid-in capital..... 37,117,360 37,117,360 128,027,360
Deferred compensation.......... (4,339,022) (4,339,022) (3,039,022)
Accumulated deficit............ (11,064,620) (11,064,620) (12,364,620)
------------ ------------ ------------
Total stockholders' equity... 21,714,695 21,714,695 112,714,695
------------ ------------ ------------
Total capitalization....... $217,260,587 $217,260,587 $308,260,587
============ ============ ============
</TABLE>
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DILUTION
The net tangible book value of our common stock as of March 31, 1999 was
$21.7 million or approximately $0.44 per share. Net tangible book value per
share represents the amount of our stockholders' equity, less intangible
assets, divided by the number of shares of common stock outstanding.
Net tangible book value dilution per share represents the difference between
the following:
(1) the amount paid per share by purchasers of common stock in the
offering
(2) the adjusted net tangible book value per share of purchasers of common
stock in the offering immediately after completion of the offering
After giving effect to our sale of 9,000,000 shares of common stock in the
offering, our adjusted net tangible book value as of March 31, 1999, based on
an assumed initial public offering price of $11.00 per share would have been
$112,714,695 or $1.94 per share of common stock. This represents an immediate
increase in net tangible book value of $1.50 per share to existing stockholders
and an immediate dilution of net tangible book value of $9.06 per share to you.
The following table illustrates this dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share of common
stock......................................................... $11.00
Net tangible book value per share of common stock as of March
31, 1999...................................................... $0.44
Net increase in net tangible book value per share of common
stock attributable to this offering........................... 1.50
-----
Pro forma net tangible book value per share as of March 31,
1999 after giving effect to the offering...................... 1.94
------
Immediate dilution per share to new investors.................. $ 9.06
======
</TABLE>
The table below summarizes on a pro forma basis as of March 31, 1999, after
giving effect to the stock split and recapitalization and based on an assumed
initial public offering price of $11.00 per share, the difference between our
existing stockholders and the new investors in the offering with respect to the
number of shares purchased from us, the total consideration paid and the
average price per share paid.
<TABLE>
<CAPTION>
Average
Shares Purchased Total Consideration Price
------------------ -------------------- Per
Number Percent Amount Percent Share
---------- ------- ------------ ------- -------
<S> <C> <C> <C> <C> <C>
Existing shareholders........ 49,108,430 85% $ 26,845,241 21% $ 0.55
New investors................ 9,000,000 15 99,000,000 79 11.00
---------- ----- ------------ ----- ------
Total...................... 58,108,430 100.0% $125,845,241 100.0% $ 2.17
========== ===== ============ ===== ======
</TABLE>
The tables above assume no exercise of outstanding options. As of July 1,
1999, there were 6,463,225 shares of common stock reserved for issuance upon
exercise of outstanding options at a weighted average exercise price of $2.98
per share. The tables above also assume no exercise of the underwriters' over-
allotment option. To the extent that any shares are issued in connection with
outstanding options or the underwriters' over-allotment option, you will
experience further dilution. See "Management" and "Underwriting."
17
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected consolidated financial data presented below for the seven month
period ended December 31, 1996, and as of and for the years ended December 31,
1997 and 1998, have been derived from our Consolidated Financial Statements and
the notes related thereto, which begin on page F-3 of this prospectus. Our
Consolidated Financial Statements for the seven-month period ended December 31,
1996 and as of and for the years ended December 31, 1997 and 1998 have been
audited by Arthur Andersen LLP, our independent public accountants. The balance
sheet data as of December 31, 1996 has been derived from our audited
consolidated financial statements not included in this prospectus. The selected
financial data as of and for the three-month periods ended March 31, 1998 and
1999 have been derived from our unaudited consolidated financial statements
which, in the opinion of management, include all adjustments, consisting of
normal recurring adjustments, necessary for a fair presentation of our
financial condition and results of operations for these periods. The results of
operations for interim periods are not necessarily indicative of full year
results. You should read the information in this table in conjunction with
"Capitalization," "Management's Discussion and Analysis of Financial Condition
and Results of Operation," "Business" and our Consolidated Financial Statements
and the notes related thereto, and the other financial data appearing elsewhere
in this prospectus.
<TABLE>
<CAPTION>
Period from
Commencement Three Months Ended
of Operations Years Ended December 31, March 31,
(May 31, 1996) to -------------------------- --------------------------
December 31, 1996 1997 1998 1998 1999
----------------- ------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ -- $ 4,023,690 $ 43,531,846 $ 5,102,448 $ 26,003,897
Expenses:
Customer service and
network operations... -- 2,154,980 15,284,641 1,826,893 10,369,319
Selling, general and
administrative....... 421,777 2,887,372 12,209,821 1,307,625 5,665,896
Depreciation and
amortization......... 1,150 615,817 6,670,986 890,871 4,026,750
Non-cash compensation
expense.............. 108,333 1,300,000 3,069,553 325,000 1,559,576
---------- ------------ ------------ ------------ ------------
Operating income (loss). (531,260) (2,934,479) 6,296,845 752,059 4,382,356
Interest income
(expense), net......... 17,626 67,626 (9,605,832) (1,093,250) (4,097,502)
Provision for income
taxes.................. -- -- (4,660,000) -- --
Accretion to redemption
value of Class A common
stock.................. -- (103,565) -- -- --
---------- ------------ ------------ ------------ ------------
Net income (loss)
applicable to common
stockholders........... $ (513,634) $ (2,970,418) $ (7,968,987) $ (341,191) $ 284,854
========== ============ ============ ============ ============
Basic net income (loss)
per share.............. $ (0.06) $ (0.07) $ (0.18) $ (0.01) $ 0.01
========== ============ ============ ============ ============
Diluted net income
(loss) per share....... $ (0.06) $ (0.07) $ (0.18) $ (0.01) $ 0.01
========== ============ ============ ============ ============
Basic weighted average
common stock
outstanding............ 8,498,000 42,186,500 43,763,000 44,153,500 43,961,000
========== ============ ============ ============ ============
Diluted weighted average
common stock
outstanding............ 8,498,000 42,186,500 43,763,000 44,153,500 51,803,000
========== ============ ============ ============ ============
Other Financial Data:
EBITDA.................. $ (421,777) $ (1,018,662) $ 16,037,384 $ 1,967,930 $ 9,968,682
Capital expenditures.... 82,303 11,655,524 64,229,247 7,593,061 24,476,209
Summary Cash Flow Data:
Net cash provided by
(used in) operating
activities............. $ (152,576) $ (1,634,017) $ 22,596,957 $ 3,745,255 $ (1,304,626)
Net cash used in
investing activities... (82,303) (11,655,524) (72,189,187) (7,593,061) (23,977,119)
Net cash provided by
financing activities... 4,025,000 11,755,972 173,376,679 154,350,198 5,839,625
Operating Data:
Access lines in service. -- 7,394 52,011 14,528 70,572
Minutes of use
(millions)............. -- 282 3,568 402 2,033
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
As of December 31, As of March 31,
------------------------------------- -------------------------
1996 1997 1998 1998 1999
---------- ----------- ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents
and short-term
investments............ $3,790,121 $ 2,256,552 $134,000,941 $152,758,944 $114,059,731
Current assets.......... 3,807,004 4,737,808 144,637,266 158,404,803 131,184,638
Fixed assets, net....... 81,153 11,176,774 69,973,120 18,125,851 90,723,762
Total assets............ 3,888,157 15,914,582 219,574,280 182,228,022 226,571,111
Long-term debt,
including current
portion................ -- 3,536,886 185,295,793 152,093,513 195,545,892
Total stockholders'
equity (deficit)....... (404,954) (2,075,372) 19,328,412 24,111,655 21,714,695
</TABLE>
You should not assume that the results of operations above are indicative of
the financial results we can achieve in the future. You should also keep the
following matters in mind when you read this information:
. Non-cash compensation expense consists of:
--charges totaling $0.1 million for 1996, $1.3 million for each of 1997
and 1998 and $0.3 million for each three-month period ended March 31,
1998 and 1999, which resulted from the vesting over time of shares of
common stock issued to some of our executive officers in November 1996
--charges of $1.8 million for 1998 and $0.1 million for the three
months ended March 31, 1999, which resulted from the vesting and
cancellation of shares of common stock in connection with the
September 30, 1998 amendment of vesting agreements with some of our
executive officers
--charges of $1.2 million for the three months ended March 31, 1999,
which resulted from our first quarter 1999 stock option grants to
employees and directors, and common stock issued to a director
. EBITDA represents earnings before interest, income taxes, depreciation
and amortization and other non-cash charges, including non-cash
compensation expense. EBITDA is not a measurement of financial
performance under generally accepted accounting principles, is not
intended to represent cash flow from operations, and should not be
considered as an alternative to net loss applicable to common
stockholders as an indicator of our operating performance or to cash
flows as a measure of liquidity. We believe that EBITDA is widely used
by analysts, investors and other interested parties in the
telecommunications industry. EBITDA is not necessarily comparable to
similarly titled measures for other companies. See "Consolidated
Financial Statements--Consolidated Statements of Cash Flows," on page F-
6.
. Before giving effect to the recapitalization and the 500-for-1 stock
split to be completed immediately prior to completion of the offering,
basic and diluted net income (loss) per share and basic and diluted
weighted average common stock outstanding were:
<TABLE>
<CAPTION>
Period From
Commencement of Years Ended Three Months
Operations December 31, Ended March 31,
(May 31, 1996) to ----------------- ----------------
December 31, 1996 1997 1998 1998 1999
----------------- -------- -------- -------- -------
(Unaudited)
<S> <C> <C> <C> <C> <C>
Basic net income (loss)
per share.............. $(30.22) $(35.21) $(91.05) $ (3.86) $ 3.24
======== ======== ======== ======== =======
Diluted net income
(loss) per share....... $(30.22) $(35.21) $(91.05) $ (3.86) $ 2.75
======== ======== ======== ======== =======
Basic weighted average
common stock
outstanding............ 16,996 84,373 87,526 88,307 87,922
======== ======== ======== ======== =======
Diluted weighted average
common stock
outstanding............ 16,996 84,373 87,526 88,307 103,606
======== ======== ======== ======== =======
</TABLE>
. We count access lines as of the end of the period indicated and on a
one-for-one basis using DS-0 equivalents.
19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
General. We provide data, voice and colocation services to large,
communications-intensive users in major cities. We began operations in 1996 and
initiated service first in Chicago in May 1997. We currently serve a total of
13 markets, which encompass a total of 34 metropolitan statistical areas, or
MSAs, and plan to serve 16 markets, or 42 MSAs, by the end of 1999 and 20
markets, or 50 MSAs, by the end of 2000. We believe our market expansion will
allow us to reach a critical mass of geographic coverage and service capability
for our target customer base of communications-intensive users. As of June 30,
1999, we had sold approximately 130,000 access lines, of which approximately
106,000 were installed and in service.
Our operating results are expected to change over the next 15 months as a
result of several trends in our business and in the regulatory environment.
First, we anticipate that the mix of lines we sell will shift from being
dominated by ISP customer lines to being more evenly balanced among ISP,
corporate and VAR customer lines due to expanded marketing efforts. Second, we
expect our revenue from and margin on ISP lines to decline as our
interconnection agreements in each state in which we operate come up for
renewal. In connection with these trends, we intend to emphasize the sale of
new products that leverage our network to maximize revenues per line and
operating margins. These products include high-speed access to the Internet and
LANs connected via DSL technology. Third, our continued expansion may result in
negative operating cash flows and operating losses for a period of time. If
this occurs, we expect to again produce positive operating cash flows once
these trends stabilize and operating activities in our newer markets are
established and mature. If, however, these trends do not stabilize or our
operating activities are not established or do not mature as expected, we may
continue to sustain negative operating cash flows and net losses.
Revenue. Our revenue is comprised of monthly recurring charges, usage
charges and initial, non-recurring charges. Monthly recurring charges include
the fees paid by our customers for lines in service, additional features on
those lines, and colocation space. Monthly recurring charges are derived only
from end user customers. Usage charges consist of fees paid by end users for
each call made, fees paid by the ILEC and other CLECs as reciprocal
compensation, and access charges paid by the IXCs for long distance traffic
that we originate and terminate. Non-recurring revenues are typically derived
from fees charged to install new customer lines.
We earn reciprocal compensation revenue for calls made by customers of
another local exchange carrier to our customers. Conversely, we incur
reciprocal compensation expense to other local exchange carriers for calls by
our customers to their customers. Reciprocal compensation has historically been
a significant component of our total revenue due to the preponderance of
inbound applications utilized by our customers. Reciprocal compensation
represented approximately 81% of total revenues in 1997, approximately 75% of
total revenues in 1998 and approximately 73% of total revenues in the first
quarter of 1999.
We expect the proportion of revenues represented by reciprocal compensation
to substantially decrease in the future as a result of the expiration and
subsequent renegotiation of our existing interconnection agreements with the
ILECs and as a result of our focus on increasing the percentage of our lines
that are sold to non-ISP customers. We expect the most significant impact of
the reduction in reciprocal compensation to occur when our existing
interconnection agreement with Ameritech Illinois, which expires during the
fourth quarter of 1999, is renegotiated. Although we expect to renew our
existing interconnection agreements on satisfactory terms, we expect that the
new agreements will result in lower negotiated interconnection rates for future
reciprocal compensation. Revenues from reciprocal compensation could also
decline as a result of adverse judicial or regulatory determinations. See
"Business--Regulation."
20
<PAGE>
We believe we can produce a positive return on capital despite a substantial
reduction in reciprocal compensation revenue resulting from lower rates for
reciprocal compensation. The table below represents 1998 fourth quarter
historical selected financial data for the Chicago market reflecting:
. actual results
. pro forma results with the reciprocal compensation rate adjusted
downward to $0.003 per minute from the current rate of $0.009 per minute
We cannot predict new rates at which reciprocal compensation payments will
be made or the types of traffic eligible for reciprocal compensation. These
rates may be more or less than the rates described in the table below. You
should not assume that the following results are indicative of results we can
achieve in the future.
<TABLE>
<CAPTION>
Pro Forma Results for the
Actual Results Fourth Quarter of 1998 with
For the Fourth the Reciprocal
Quarter of Compensation Rate of
Chicago 1998 $0.003 per Minute of Use
- ------- -------------- ---------------------------
(dollars in millions)
<S> <C> <C> <C>
Revenues......................... $12.9 $ 7.3
EBITDA(1)........................ $ 9.2 $ 3.6
EBITDA Margin.................... 71.4% 49.8%
</TABLE>
- --------
(1) EBITDA represents earnings before interest, income taxes, depreciation and
amortization and other non-cash charges, including non-cash compensation
expense. EBITDA is not a measurement of financial performance under
generally accepted accounting principles, is not intended to represent cash
flow from operations, and should not be considered as an alternative to net
loss applicable to common stockholders as an indicator of our operating
performance or to cash flows as a measure of our liquidity. We believe that
EBITDA is widely used by analysts, investors and other interested parties
in the telecommunications industry. EBITDA is not necessarily comparable to
similarly titled measures for other companies. See "Consolidated Financial
Statements--Consolidated Statements of Cash Flows."
Operating Expenses. Our operating expenses are categorized as customer
service and network operations, selling, general and administrative,
depreciation and amortization, and non-cash compensation expense. Settlement
costs are a significant portion of customer service and network operations
expense and are comprised of leased transport charges and reciprocal
compensation payments. Leased transport charges are the lease payments we make
for the use of fiber transport facilities connecting our customers to our
switches and for our connection to the ILECs' and other CLECs' networks. Our
strategy of initially leasing rather than building our own fiber transport
facilities has resulted in our cost of service being a significant component of
total costs. To date, we have been successful in negotiating lease agreements
that match the duration of our customer contracts, thereby allowing us to avoid
the risk of incurring expenses associated with transport facilities that are
not being used by revenue generating customers.
Historically, leasing rather than building our transport network has
resulted in capital expenditures which we believe are lower than those of CLECs
of similar size that own their fiber networks. Our capital expenditures have
been driven by customer service demands and projected near-term revenue streams
from our established markets. In addition, we believe that the percentage of
these "success-based" capital expenditures is higher than those of fiber-based
CLECs. In contrast, we incur operating expenses for leased facilities that are
proportionately higher than those incurred by fiber-based CLECs. The margin
impact of these higher, anticipated operating expenses is expected to be
mitigated, in part, by a higher revenue per line, which we anticipate as a
result of our focus on communications-intensive users.
As contemplated by our business plan, in April and May 1999 we entered into
a number of agreements to use fiber transport facilities for combined minimum
commitments of $98.6 million over five years and $42.8 million over the next
fifteen years. These commitments will result in increased operating expenses
for future
21
<PAGE>
periods, which we believe should be more than offset by future revenues
associated with new services made possible, in part, by these agreements.
Other customer service and network operations expense consists of the costs
of operating our network and the costs of providing customer care activities.
Major components include wages, rent, power, equipment maintenance, supplies
and contract employees.
Selling, general and administrative expense consists of sales force
compensation and promotional expenses as well as the cost of corporate
activities related to regulatory, finance, human resources, legal, executive,
and other administrative activities. We expect our selling, general and
administrative expense to be lower as a percentage of revenue than that of our
competitors because we have relatively high sales productivity associated with
our strategy of serving communications-intensive customers. These customers
generally utilize a large number of switched access lines relative to the
average business customer, resulting in more revenue per sale. Further, fewer
sales representatives are required to service the relatively smaller number of
communications-intensive customers in a given region.
We record monthly non-cash compensation expense related to shares issued to
some of our executive officers in November 1996, in connection with the
September 30, 1998 amendments to vesting agreements with some of our executive
officers and in connection with stock options granted to employees and
directors and shares issued to a director prior to this offering. We will
continue to record non-cash compensation expense in future periods relating to
these events through the third quarter of 2003. See Notes 6 and 11 to our
Consolidated Financial Statements.
Quarterly Results
The following table sets forth unaudited financial, operating and
statistical data for each of the specified quarters of 1998 and 1999. The
unaudited quarterly financial information has been prepared on the same basis
as our Consolidated Financial Statements and, in our opinion, contains all
normal recurring adjustments necessary to fairly state this information. The
operating results for any quarter are not necessarily indicative of results for
any future period.
<TABLE>
<CAPTION>
1998 1999
------------------------------------------------ -----------
First Second Third Fourth First
Quarter Quarter Quarter Quarter Quarter
---------- ---------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenues................ $5,102,448 $8,078,043 $12,755,293 $17,596,062 $26,003,897
EBITDA.................. $1,967,930 $3,326,828 $4,348,713 $ 6,393,913 $ 9,968,682
Lines sold to date...... 21,082 30,385 41,316 68,184 85,329
Lines in service to
date(1)................ 14,528 24,357 33,188 52,011 70,572
Estimated data lines (%
of installed lines).... 83% 81% 69% 71% 71%
Lines on switch (%)..... 100% 100% 100% 100% 100%
Customer lines colocated
(%).................... N/A N/A N/A N/A 48%
ILEC central offices
interconnected......... N/A 249 297 340 443
ILEC central office
colocations in service
or under development... 0 0 0 0 23
Average monthly revenue
per line............... $155 $139 $148 $138 $141
Quarterly minutes of use
switched (in millions). 402 683 1,039 1,444 2,033
Markets in operation.... 2 2 6 10 12
MSAs served............. 6 6 13 29 31
Switches operational.... 2 2 4 6 7
Focal customer
colocation space in
service (square feet).. N/A 2,938 9,882 23,302 29,282
Capital expenditures (in
millions).............. $8 $13 $24 $21 $24
Employees............... 82 131 186 233 312
</TABLE>
- --------
(1) Does not include approximately 12,000 access lines in Boston that are being
managed by us on behalf of Level 3 Communications as a result of our
purchase of Level 3's switch in January of 1999. These lines are expected
to eventually migrate to Level 3's network.
22
<PAGE>
Although we have generated positive EBITDA in the most recent six quarters,
we anticipate that as a result of the recent operating and regulatory trends
described above, we may experience negative EBITDA for a period of time until
these trends stabilize and operating activities in our newer markets mature.
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31,
1998
Total revenues for the three months ended March 31, 1999 were $26.0 million
compared to $5.1 million for the three months ended March 31, 1998. This $20.9
million increase is primarily due to our rapid growth in our Chicago and New
York markets. Customer service and network operations expenses totaled $10.4
million for the first quarter of 1999 compared to $1.8 million for the first
quarter of 1998. This increase resulted from our rapid expansion and related
costs for leased facilities, usage settlements, customer care and operational
personnel, equipment maintenance and other operating expenses. Selling, general
and administrative expense also increased due to our expansion from $1.3
million during the three months ended March 31, 1998 to $5.7 million during the
most recent three month period. Similarly, depreciation and amortization
increased from $0.9 million to $4.0 million in the comparative periods as a
result of a significant increase in the level of fixed assets we put into
service between April 1, 1998 and March 31, 1999. Non-cash compensation expense
was $1.6 million for the first quarter of 1999 compared to $0.3 million for the
first quarter of 1998. The increase in non-cash compensation expense is the
result of the September 30, 1998 amendments of vesting agreements with some of
our executive officers and stock options granted to employees and directors and
shares issued to a director during the first quarter of 1999.
Interest income increased from $1.0 million in the three months ended March
31, 1998, to $1.3 million in the three months ended March 31, 1999 due to our
receiving interest income from the Notes proceeds for only half of the first
quarter of 1998. Interest expense increased from $2.1 million in the first
quarter of 1998 to $5.4 million in the first quarter of 1999. This increase is
due to an additional $2.9 million of amortization of our Notes and $0.4 million
of interest expense on our secured equipment term loan that was entered into
during December 1998. Interest on the Notes is not payable in cash until August
2003.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Total revenues for 1998 were $43.5 million compared to $4.0 million for
1997. The significant increase is due to the rapid growth in our Chicago and
New York markets during 1998 and the fact that service was first initiated in
Chicago in May 1997. Customer service and network operations expense was $15.3
million in 1998 compared to $2.2 million during 1997. The increase resulted
from our rapid expansion and the related costs of leased facilities, usage
settlements, customer care and operations personnel, equipment maintenance and
other operating expenses. Selling, general and administrative expense also
increased from $2.9 million for 1997 to $12.2 million for 1998 due to our
expansion. Similarly, depreciation and amortization increased from $0.6 million
in 1997 to $6.7 million in 1998 as a result of a significant increase in the
level of fixed assets put into service. Non-cash compensation expense
associated with the vesting over time of shares of common stock issued to some
of our executive officers in November 1996, and the vesting and cancellation of
shares of common stock in connection with the September 30, 1998 amendments to
vesting agreements with some of our executive officers, was $3.1 million for
1998 compared to $1.3 million for 1997. The increase of $1.8 million is due to
the September 30, 1998 amendment to these vesting agreements.
Interest income increased from $0.2 million in 1997 to $6.5 million for 1998
due primarily to the investment of the proceeds received in February 1998 from
the sale of the Notes. Interest expense for 1998 was $16.1 million compared to
$0.1 million for 1997. The increase is primarily due to the amortization of the
discount on the Notes.
Year Ended December 31, 1997 Compared to Seven-Month Period Ended December 31,
1996
We had total revenues of $4.0 million in 1997. We had no revenues in 1996.
The increase is due to the recording of our first revenue during May 1997.
Prior to May 1997, we incurred start-up and operating
23
<PAGE>
expenses in advance of revenue as we prepared to launch our network services in
the Chicago market. Customer service and network operations expense increased
from zero in 1996 to $2.2 million in 1997. There were no customer service or
network activities during 1996. Such activities began as we initiated
construction of our first network in January 1997 and as we began to provide
service in May 1997. Selling, general and administrative expense increased from
$0.4 million in 1996 to $2.9 million in 1997, largely due to a rapid increase
in sales and administrative personnel in 1997. Depreciation and amortization
increased from near zero in 1996 to $0.6 million in 1997 due to the increase in
assets put into service during 1997. Non-cash compensation expense associated
with certain shares issued to some of our executive officers in November 1996
increased from $0.1 million in 1996 to $1.3 million in 1997 based on a full
year's impact of this expense during 1997 as compared to one month of non-cash
compensation expense during 1996.
Interest income increased from $0.02 million in 1996 to $0.2 million in 1997
as a result of significantly greater cash balances we maintained after
receiving additional equity contributions during 1997. Interest expense was
$0.1 million in 1997 due to debt financing incurred by one of our subsidiaries.
We did not have any interest expense during 1996.
Liquidity and Capital Resources
We intend to continue to increase our coverage of major U.S. cities by
expanding our services to three additional markets in 1999 and another four
markets in 2000. This business plan will require that we expand our existing
networks and services, deploy our own fiber capacity in a majority of our
markets and fund our initial operating losses. We will require significant
capital to fund the purchase and installation of telecommunications switches,
equipment, infrastructure and fiber facilities and/or long-term rights to use
fiber transport capacity. The implementation of this plan requires significant
capital expenditures, a substantial portion of which will be incurred before
significant related revenues from our new markets are expected to be realized.
These expenditures, together with associated early operating expenses, may
result in our having substantial negative operating cash flow and substantial
net operating losses for the foreseeable future, including in 1999 and 2000.
Although we believe that our cost estimates and the scope and timing of our
build-out are reasonable, we cannot assure you that actual costs or the timing
of the expenditures, or that the scope and timing of our build-out, will be
consistent with current estimates.
Our capital expenditures were approximately $11.7 million in 1997, $64.2
million in 1998 and $24.5 million for the first quarter of 1999, primarily
reflecting capital spending for the build-out of 13 of 20 of our markets,
including the $7.7 million acquisition of network assets and associated
infrastructure from Level 3 Communications for our Boston market. We estimate
that our capital expenditures in connection with our business plan will be
approximately $125 million for the remainder of 1999. The 1999 expenditures are
expected to be made primarily for the build-out of additional markets, the
expansion of our existing markets and services, including high-speed data
services, and the purchase of local fiber transport capacity in a majority of
our markets.
We estimate that the implementation of our business plan, as currently
contemplated, including the remaining 1999 capital expenditures previously
described, operating losses in newer markets and working capital needs, will
require approximately $230 million from April 1, 1999 through the third quarter
of 2000. Upon completion of this offering, we will have pre-funded these
capital requirements with cash, cash equivalents and short-term investments
currently on hand, borrowing capacity under our $50 million equipment term loan
facility (described below), anticipated cash flows from future operations and
the net proceeds from this offering.
Our expectations of our future capital requirements and cash flows from
operations are based on current estimates. If our plans or assumptions change
or prove to be inaccurate, we may be required to seek additional sources of
capital or seek additional capital sooner than currently anticipated. We may
also choose to raise additional capital to take advantage of favorable
conditions in the capital markets. See "Risk Factors--Significant Capital
Requirements" and "--Substantial Debt."
24
<PAGE>
Net cash used in operating activities was $0.2 million for the seven months
ended December 31, 1996 and $1.6 million for 1997. Net cash provided by
operations was $22.6 million in 1998, an increase of $24.2 million from 1997.
The increase is primarily due to an increase in non-cash reconciling items for
depreciation and amortization, non-cash compensation expense, amortization of
discount on the Notes and an increase in accounts payable and accrued
liabilities. Net cash used in operating activities for the three months ended
March 31, 1999 was $1.3 million, a decrease of $5.0 million from the same
period in 1998. This decrease is primarily the result of the $3.7 million in
income taxes we paid during the first quarter of 1999 and the increase in the
change in accounts receivable between comparable periods totaling $3.3 million,
which was offset by increased depreciation and amortization of $3.1 million
during the first quarter of 1999. Net cash used in investing activities was
$0.1 million for the seven months ended December 31, 1996, $11.7 million for
1997 and $72.2 million for 1998. The increase of $60.5 million from 1997
represents a $52.6 million increase in capital expenditures due to our 1998
expansion into new markets and the purchase of short-term investments of $8.0
million. Short-term investments primarily consist of debt securities, which
typically mature between three months and one year. Net cash used in investing
activities for the first quarter of 1999 was $24.0 million compared to $7.6
million in the first quarter of 1998. This increase of $16.4 million from the
first quarter of 1998 is primarily due to our build-out of additional markets
and includes the $7.7 million acquisition of network assets and associated
infrastructure from Level 3 Communications for our Boston market. Net cash
provided by financing activities consisted of $4.0 million for the seven months
ended December 31, 1996, $11.8 million in 1997 and $173.4 million in 1998. The
increase of $161.6 million from 1997 to 1998 is mainly the result of net
proceeds from the Notes offering of $143.9 million after $6.1 million in
issuance costs and $19.2 million in borrowings under a secured equipment term
loan facility (the "Credit Agreement") during 1998. Net cash provided by
financing activities for the first quarter of 1999 was $5.8 million, a decrease
of $148.5 million from the first quarter of 1998. This decrease is primarily
the result of our receipt of $144.1 million in net proceeds from the issuance
of Notes during the first quarter of 1998.
The Credit Agreement provides that NTFC Capital Corporation will make term
loans to us in an aggregate principal amount of up to $50 million. These loans
are to be used solely for the purchase of telecommunications equipment and
related software licenses. To secure the loans, we have granted NTFC a security
interest in the assets acquired with the loans. Loans must be repaid over a
five-year period from the date of the borrowing, which must be on or prior to
December 31, 1999. Principal and interest payments are due monthly, and
interest accrues based on the five-year swap rate, plus additional basis
points. Interest will accrue at a lower rate if we meet specified financial
tests. As of March 31, 1999, we had $24.5 million outstanding under this term
loan facility.
We have historically incurred net losses and have an accumulated deficit of
$11.3 million as of December 31, 1998 and $11.1 million as of March 31, 1999.
Most recently, we funded a large portion of our future operating losses and
capital expenditures through the 1998 offering of the Notes and by other
financings. On February 18, 1998, we received $150 million in gross proceeds
from the sale of the Notes. The Notes will accrete to an aggregate stated
principal amount of $270 million by February 15, 2003. As of March 31, 1999,
the principal amount of the Notes had accreted to approximately $171.1 million.
No interest is payable on the Notes prior to August 15, 2003. Thereafter, cash
interest will be payable semiannually on August 15 and February 15 of each
year.
Prior to the issuance of the Notes in February 1998, a substantial portion
of our funding needs was met through the private sale of equity securities. In
November 1996, we entered into a stock purchase agreement that provided for the
contribution over time of approximately $26.1 million of equity funding by a
group of investors. As of February 13, 1998, we had received the entire $26.1
million. In addition, in 1997, our Illinois subsidiary borrowed approximately
$3.5 million under a bank credit facility. We used a portion of the net
proceeds from the issuance of the Notes to repay this indebtedness and cancel
this facility.
Impact of the Year 2000 Issue
The year 2000 issue results from computer programs being written using two
digits rather than four to define the year. Any of our computer programs or
systems, or those of our suppliers, that have date-sensitive
25
<PAGE>
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculation causing
disruption of operations, including, among other things:
. A temporary inability to process transactions
. A temporary inability to send invoices
. A temporary inability to engage in normal business activities
. Interruptions of customer service
Our Year 2000 compliance program can be divided into several phases. These
phases include:
. Assessing our material information systems and hardware for Year 2000
readiness
. Assessing the Year 2000 readiness of third parties with whom we have
significant business relationships and on whose systems and hardware we
rely
. Contingency planning
As part of our internal assessment phase, we examined our material
information systems, including our DMS-500 SuperNode central office switches,
and hardware to determine whether these systems and hardware are Year 2000
compliant. However, we have not nor do we plan to identify, validate as
compliant or remediate integrated circuits in any other systems or hardware. We
have received assurances from all of our major software and hardware vendors
that the products we use are Year 2000 compliant in all material respects and
will function adequately after December 31, 1999.
Our services are also dependent on network systems and transport facilities
maintained by other carriers, including ILECs and IXCs. We are in the process
of assessing the Year 2000 compliance status of other carriers with whom we
have material relationships. Our assessment relies, without any independent
verification, on the statements and assumptions underlying the statements these
carriers have made in their periodic reports filed with the Securities and
Exchange Commission. The risks associated with the failure of these carriers'
systems or transport facilities include potential interruption of service,
including blocked calls and delayed call completion. Interruptions of this type
would heavily impact our customers and, if prolonged, could have a material
adverse effect on our business, financial condition or results of operations.
Because we currently lease 100% of our transport facilities, we are
dependent on the availability of fiber transport facilities owned by other
carriers. There are few, if any, contingency measures we can take if Year 2000
problems cause these carriers' facilities to fail. We lease transport
facilities from multiple carriers in each market in which we operate in an
attempt to provide redundancy and diversity in service. However, we cannot
assure you that there will not be multiple network failures in a particular
market. If our transport vendors experience facilities failures, our business
may be disrupted and we may suffer a material adverse effect.
To date, we have spent approximately $0.2 million on our Year 2000
compliance program. We expect future Year 2000 remediation expenditures to
total approximately $0.3 million. All of these costs will be expensed as they
are incurred.
We intend to continue our Year 2000 compliance assessment of our software.
If it comes to our attention that any of our software is not Year 2000
compliant, we intend to develop an action plan and further assess the risks of
non-compliance and the resources that would be required to resolve the problem.
We also intend to develop contingency plans to the extent we believe those
plans would be useful.
Based on our current schedule for completion of our Year 2000 compliance
program, we believe that our planning is adequate to secure Year 2000 readiness
of our critical systems. Nevertheless, Year 2000 readiness is subject to a
number of risks and uncertainties, some of which, like the readiness of other
carriers upon whom we rely, are out of our control. We are not able to predict
all the factors that could cause actual results to differ materially from our
current expectations about Year 2000 readiness. The cost of our Year 2000
compliance
26
<PAGE>
program is based upon our management's best estimate. At this time, we believe
that the major risks associated with an inability of our systems or software to
process Year 2000 data correctly are a system failure or miscalculation causing
a disruption of business activities or interruptions in customer service. If
we, or third parties with whom we have significant business relationships, fail
to achieve Year 2000 readiness with respect to critical systems, there could be
a material adverse effect on our business, financial condition or results of
operations. See "Risk Factors--Reliance on Leased Transport Facilities," "--
Relationship with ILECs" and
"--Year 2000 Compliance."
The discussions under "Management's Discussion and Analysis of Financial
Condition and Results of Operations" contain forward-looking statements. Our
future performance is subject to a number of risks and uncertainties that could
cause actual results to differ substantially from our projections. Factors that
could impact the variability of future results include those described under
"Risk Factors."
Quantitative and Qualitative Disclosures about Market Risk
We are exposed to minimal market risks. We manage sensitivity of our results
of operations to these risks by maintaining a conservative investment
portfolio, which primarily consists of debt securities, typically maturing
within one year, and entering into long-term debt obligations with appropriate
pricing and terms. We do not hold or issue derivative, derivative commodity or
other financial instruments for trading purposes. Financial instruments held
for other than trading purposes do not impose a material market risk on us.
We are exposed to interest rate risk, as additional debt financing is
periodically needed due to the large operating losses and capital expenditures
associated with establishing and expanding our network coverage. The interest
rate that we will be able to obtain on debt financing will depend on market
conditions at that time, and may differ from the rates we have secured on our
current debt.
While all of Focal's long-term debt bears fixed interest rates, the fair
market value of our fixed rate long-term debt is sensitive to changes in
interest rates. We have no cash flow or earnings exposure due to market
interest rate changes for our fixed long-term debt obligations. The table below
provides additional information about our Notes. For additional information
about our long-term debt obligations, see Note 4 to our Consolidated Financial
Statements.
<TABLE>
<CAPTION>
As of December 31, 1998
--------------------------------------
Average
Expected Fixed Interest
Maturity Debt Rate
---------------- ------------ --------
<S> <C> <C>
1999 $ -- --
2000 -- --
2001 -- --
2002 -- --
2003 -- --
Thereafter 270,000,000 12.125%
------------ ------
$270,000,000 12.125%
============ ======
Fair Market
Value $146,000,000
============
</TABLE>
27
<PAGE>
BUSINESS
Introduction
We are a rapidly growing CLEC that provides data, voice and colocation
services to large corporations, ISPs and VARs in large metropolitan markets. We
began operations in 1996, initiated service first in Chicago in May 1997 and
currently offer service in the following 13 markets:
Chicago New York Philadelphia
San Francisco San Jose Oakland
Orange County, California Los Angeles Northern Virginia
Washington, D.C. Boston Northern New Jersey
Detroit
As part of our expansion, we plan to offer services in the following seven
additional markets:
<TABLE>
<CAPTION>
By
December
31, 1999: By December 31, 2000:
--------- ---------------------
<S> <C>
Dallas Atlanta
Fort Worth Houston
Seattle Minneapolis
Cleveland
</TABLE>
When we complete our planned expansion, we will provide service in 20
markets, which encompass a total of 50 metropolitan statistical areas. As of
June 30, 1999, we had sold approximately 130,000 access lines, of which
approximately 106,000 were installed and in service. This compares to 68,184
lines sold and 52,011 lines installed and in service as of December 31, 1998
and 13,411 lines sold and 7,394 lines installed and in service as of December
31, 1997. Our primary objective is to become the provider of choice of data and
voice services to communications-intensive customers in our markets.
A majority of our revenue is currently derived from the provision of
switched data services for our targeted customers. Due to customer demand, we
are deploying additional services such as high-speed data access using DSL
technology and nationwide networking using ATM technology. Once these services
are deployed, we believe we will have an advantage over other data and voice
CLECs offering these services due to our established relationships with some of
the largest corporate and ISP customers in the nation, our highly reliable
network, and our ability to package switched and high-speed data connections.
We also believe that by providing these data services, we will appeal to a
broader customer base.
We believe we were the first CLEC to employ the "smart-build" approach to
designing networks. As such, we own and operate our switches, and initially
lease, rather than own, transport capacity. Currently, we use leased facilities
for 100% of our transport requirements. However, based on the increase in
volume of customer traffic in some of our markets, we now believe it is
economically attractive for us to own a portion of our transport capacity. We
have signed agreements with Level 3 Communications and Metromedia Fiber Network
Services to acquire a combined minimum of 10,800 fiber miles of our own local
fiber transport capacity in 16 markets. By combining leased fiber transport
facilities with owned fiber capacity, we expect to be better able to control
these assets and generate stronger operating results.
To further develop our long distance service offerings, we have signed
agreements with a number of carriers under which we plan to lease approximately
10,000 DS-3 miles of fiber transport capacity connecting each of our existing
and planned markets. Using these facilities, we are developing a nationwide ATM
network to carry data and voice traffic. This will allow us to provide virtual
private network services for both data and voice. We also expect to price long
distance voice calls that remain on the Focal network as if they were local
calls using our FocaLINC service.
28
<PAGE>
We also offer colocation services. Many of our ISP and some of our VAR
customers house their equipment in colocation space we operate within our
switching centers, and we provide equipment management services to some of
these customers. We currently have over 64,000 square feet of secure and
environmentally conditioned colocation space available to our customers or
under development. We believe the proximity of existing and future colocation
customers to our network as well as the concentration of Internet traffic
within our space will provide us with an advantage in marketing additional
services in the future.
We believe that our management and operations team has been critical to our
initial success and will continue to differentiate Focal from its competitors.
We have built a skilled and experienced management team with extensive prior
work experience at major telecommunications companies, such as MFS
Communications, Sprint, MCI WorldCom, AT&T and Ameritech.
We were re-incorporated in Delaware in June 1997 in connection with a Plan
of Reorganization and Agreement dated June 12, 1997, whereby we became the
holding company of Focal Communications Corporation of Illinois and each of its
subsidiaries.
Market Potential
We believe communications-intensive users in large metropolitan markets are
inadequately supplied with highly reliable, local data and voice services. We
also believe that these types of users will increasingly demand diversity in
local communications providers as they do in long distance and private-line
communications services.
As a result, we have chosen to initially do business only in large
metropolitan markets with a high concentration of communications-intensive
customers. We select our target geographical markets using several criteria:
. Sufficient market size
. Favorable state regulatory environment
. The existence of multiple fiber transport providers with extensive
networks
. The existence of, or ability to obtain, attractive interconnection
agreements with the ILEC
The market potential for CLECs is large and growing for both local switched
services and data communications. According to data published by the FCC, local
communications services in the United States in 1997 generated total revenues
of approximately $102 billion. While this represents total local service from
both residential and business customers, we estimate that approximately $44
billion, or 43%, of this revenue represented local switched service by
businesses. We also estimate that business usage will grow to $50 billion in
1999. A market study done by our management estimates that the total local
switched service from the business segment in the 20 large, metropolitan
markets in which we intend to offer service represents approximately 36% of
total business access lines in the nation and will generate approximately $18
billion in 1999.
Data communications is one of the fastest growing areas of the
telecommunications industry. According to Frost & Sullivan, the total U.S.
market for high-speed and switched data services will grow at an annual rate of
approximately 17% from $18 billion in 1997 to approximately $40 billion by
2002. The DSL portion of this market alone is expected to grow at an annual
rate of approximately 44% over the same time period. Much of the growth is
expected to result from increased demand for e-mail, web hosting services, e-
commerce, collaborative workflow and real-time video services and applications.
We estimate that the addressable market for high-speed and switched data
services in our targeted markets will be approximately $9 billion by the end of
1999.
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<PAGE>
The table below summarizes estimates from our market study regarding our
current and planned markets. You should be aware that, with the exception of
the "Operational Markets," the launch period shown in the second column is our
current estimate of when we will begin providing services in our planned
markets. These estimates are subject to change based upon numerous factors,
including timely performance by third party suppliers, receipt of required
regulatory approvals and financing, including completion of this offering. See
"Risk Factors--Management of Growth," "--Regulation," "--Reliance on Leased
Transport Facilities" and "--Relationship with ILECs."
<TABLE>
<CAPTION>
Estimated Addressable 1999 Market
Data(1)
--------------------------------------
Number of
Business Switched Revenue from
Launch Period Access Lines Local Business Calls
------------------- ----------------- --------------------
(dollars in
(in thousands) millions)
<S> <C> <C> <C>
Operational Markets:
Chicago, IL............. May 1997 1,899 $ 1,709
New York, NY............ January 1998 2,420 2,178
Philadelphia, PA........ September 1998 1,324 1,191
San Francisco, CA....... September 1998 589 530
San Jose, CA............ September 1998 361 325
Oakland, CA............. September 1998 521 469
Washington, D.C. ....... December 1998 1,481(2) 1,333(2)
Northern Virginia, VA... December 1998 -- (2) -- (2)
Los Angeles, CA......... December 1998 1,778 1,600
Orange County, CA....... December 1998 1,002 902
Northern New Jersey..... January 1999 1,275 1,147
Boston, MA.............. January 1999 1,306 1,176
Detroit, MI............. June 1999 1,059 953
Planned Markets:
Seattle, WA............. Third Quarter 1999 699 629
Dallas, TX.............. Fourth Quarter 1999 774 697
Fort Worth, TX.......... Fourth Quarter 1999 299 269
Atlanta, GA............. First Quarter 2000 886 798
Houston, TX............. First Quarter 2000 935 841
Cleveland, OH........... Second Quarter 2000 786 707
Minneapolis, MN......... Third Quarter 2000 674 607
------ -------
Total:................ 20,068 $18,061
====== =======
</TABLE>
- --------
(1) This addressable market data does not include information for non-switched
data and voice services.
(2) Data for Northern Virginia is included in the data for Washington, D.C.
Strategy
Our objective is to become the provider of choice for data and voice
communications services to large, communications-intensive customers in our
target markets. The key elements of our strategy to achieve this objective are
discussed below.
. Leverage Current Customer Relationships--We orient the profile of our
sales teams and customer care processes to meet the very stringent
requirements of our target customer base of communications-intensive
users. As a result, we have built a customer base that includes a
substantial number of large, sophisticated companies and ISPs, some of
which are:
<TABLE>
<S> <C> <C> <C>
IBM Sony Citigroup United Airlines
E*Trade Merrill Lynch Mindspring PSINet
CompuServe Nortel Networks Sears Motorola
</TABLE>
We believe that this customer base of communications-intensive users
gives us an advantage in successfully marketing additional services.
Consequently, we plan to leverage the relationships we have built with
our customers and increase our share of their total communications
expenditures by expanding our service offerings and market coverage.
30
<PAGE>
. Expand Data Service Offerings--The majority of our access lines are
utilized for switched data services. These typically involve dial-up
data calls utilizing modems for access to a corporate customer's LAN or
an ISP customer's remote access server. We believe we have developed an
excellent reputation among our customers as a provider of reliable
switched data services. Moreover, we believe a significant opportunity
exists with our targeted customers to successfully offer a wider array
of data services. We expect that home workers and Internet users will
increasingly seek higher speed access to their corporate LANs and the
Internet. As a result, we are currently developing high-speed LAN and
Internet access using DSL technology as well as private line data
services.
. Connect our Local Networks Nationally--We believe that the number and
types of services we can provide to communications-intensive customers
in major markets will be greatly enhanced if our networks in these
markets are interconnected. For example, we expect to sell long distance
calling between our markets for the price of a local phone call to those
customers who utilize our network in each market. In order to facilitate
this connectivity, we are developing a seamless, nationwide backbone
network based on ATM technology that will interconnect our switching and
colocation centers in the U.S. We expect this will give us the necessary
network platform to offer additional services such as virtual private
network and private line data and voice services.
. Design and Install a Highly Capital-Efficient Network. We believe we
have optimized our return on invested capital by initially leasing fiber
capacity and by making most of our capital expenditures in switching
facilities and information systems. Currently, we lease fiber from
multiple vendors in each of our markets. We believe that this strategy
has resulted in a lower, less risky capital investment than that of
other CLECs that build their own fiber facilities right away. Compared
to these other CLECs, a greater proportion of our ultimate capital
requirement is "success-based." As our market penetration and customer
base increases, we intend to purchase fiber transport capacity where it
is economically attractive, as illustrated by our recent agreements with
Level 3 Communications and Metromedia Fiber Network Services described
below. Going forward, we believe that our hybrid network, which will
combine leased and owned transport capacity, is the best way to balance
capital efficiency and control of network assets.
. Maximize Network Utilization through VARs. We provide service to VARs
such as managers of large multi-dwelling units and companies that market
bundled telecommunications services to small- and medium-sized
businesses. This VAR distribution channel enables us to increase the
number of access lines served by our networks, which further maximizes
network utilization.
Networks
We have installed Nortel DMS-500 SuperNode digital central office switches
in each of our existing markets, and currently plan to deploy similar switches
in our additional markets. As we add customers in a market, it has generally
been cost-effective for us to use leased fiber transport capacity to connect
our customers to our network. We have initially leased local network trunking
facilities from the ILECs in each of our markets in order to connect our
switches to major ILEC central offices serving our central business district
and outlying areas of business concentrations. We have chosen to design our
networks using this "smart-build" approach, which involves purchasing and
maintaining our own switches while leasing our fiber transport facilities on an
as-needed basis. This provides us with added negotiating leverage in obtaining
favorable terms from transport providers and allows us to offer our customers
both redundancy and diversity. In addition, we have designed our networks to
maximize call completion and significantly reduce the likelihood of blocked
calls, which helps us satisfy the needs of our high-volume customers. This
smart-build approach is possible because there are multiple vendors of local
fiber transport facilities in each of our large metropolitan markets, both
current and planned. Our switch-based, leased transport network architecture
has allowed us to:
. Reduce the time and money required to launch a new market
. Minimize financial risk associated with under-utilized networks
. Generate revenue and cash flow more quickly
We have the flexibility to add or subtract leased local transport capacity
on an incremental basis with the addition or loss of customers. We believe that
the quantity of existing and planned fiber transport facilities
31
<PAGE>
available from numerous carriers will be sufficient to satisfy our need for
local leased transport facilities and permit us to obtain these facilities at
competitive prices for the foreseeable future. The fiber transport providers in
our current and planned markets compete with each other for our business in
order to maximize the return on their fixed-asset networks, which enables us to
obtain competitive pricing. In addition, because each of our fiber transport
capacity providers is a common carrier, they are required to make their
transport services available to us on terms no less favorable than those
provided to similar customers.
Although we currently lease 100% of our transport facilities, we believe
that it is now economically attractive for us to own a portion of our local
transport capacity because of increased volumes of customer traffic between our
switches and specific ILEC central offices in some of our markets. We recently
signed agreements with Level 3 Communications and Metromedia Fiber Network
Services for the acquisition of local fiber transport capacity covering a
combined minimum of 10,800 fiber miles in at least 16 markets.
Our agreement with Level 3 Communications provides us with an indefeasible
right of use, or IRU, for a specified number of fibers being constructed or
acquired by Level 3. The IRU in each covered market has a 20-year term and
covers a total of approximately 8,300 fiber miles in our Chicago, New York,
Philadelphia, San Francisco, Los Angeles, Seattle and Detroit markets. Under
this agreement, we are required to pay fees totaling approximately $18 million,
payable in installments based upon the achievement of construction and
installation milestones. The Level 3 agreement also requires us to pay nominal
quarterly operations and maintenance fees based upon the number of fiber route
miles covered. Focal's 20-year agreement with Metromedia Fiber Network Services
provides for the long-term lease of a minimum of 2,500 fiber miles of fiber
optic capacity for approximately $53 million over the 20-year term. This
agreement also gives us the option to lease additional fiber in Metromedia
Fiber Network Services' markets for lease payments that decrease according to a
sliding scale based on volume.
We have also employed a "smart-build" approach in developing our inter-city
strategy. Initially, we resold long distance transmission service by buying
minutes on a wholesale basis. Going forward, we have decided to lease fiber
optic transport capacity connecting our switches between each of our existing
and planned markets. We will therefore transport our calls from market to
market over our own network and terminate the calls either directly at our
customer's location or at the ILEC switch. For international calls, we have
negotiated agreements with various international carriers for termination of
our international calls throughout the world.
To implement our inter-city network, we have signed agreements with a number of
carriers under which we plan to lease approximately 10,000 DS-3 miles of fiber
transport capacity connecting each of our existing and planned markets. This
inter-city, DS-3 backbone network will initially be based on time division
multiplexing technology. Early in 2000, we plan to convert the inter-city
backbone to ATM technology. We believe the use of ATM switches will provide
greater flexibility in creating and managing both data and voice services over
the same physical network. Once these network elements are in place, we expect
to be able to price inter-city calls that remain on our network as if they were
local calls--a service we call FocaLINC. In addition, we expect to offer our
corporate customers nationwide, toll-free access to their LAN--a service we
call Virtual Office.
We recently executed a five-year private line service agreement with MCI
WorldCom providing for the lease of fiber transport capacity that will be used
to connect our existing and planned markets. Under this agreement, we have
agreed to pay total usage charges for private line services of at least $70
million in the aggregate over the five-year term, including existing private
lines used within our markets to provide local service. The usage charges are
payable as minimum annual volume commitments of $10 million in the first year,
$13.2 million in the second year and $15.6 million in each of the final three
years. If we terminate the agreement prior to the end of the five-year term, we
are required, with limited exceptions, to pay the difference between the
commitment for the relevant year and our actual usage charge, as well as 50% of
the commitment for each subsequent year of the five-year term.
In order to support high-speed access to corporate LANs and the Internet, we
are beginning in 1999 to deploy DSL technology in our key markets. We will seek
to obtain colocation space from the ILECs and install DSL access multiplexers,
or DSLAMs, in colocation cages in ILEC central offices located in densely
populated regions. Once installed, the DSLAMs will terminate into an ATM
switch. Using either leased transport or
32
<PAGE>
Focal's owned transport capacity, the ATM switches will be connected together
to form a wide-area ATM network, which will transport high-speed data from end
users to Focal's corporate and ISP customers. These customers will then manage
the flow of this traffic onto their corporate LANs or the Internet, as
appropriate.
We are a party to a products purchase agreement with Nortel Networks that
expires December 31, 2002. This agreement establishes favorable terms and
conditions for our purchase of Nortel Networks products, including switches,
related software and services. This contract requires us to place orders for
the delivery and installation of Nortel Networks products, including DMS-500
SuperNode central office switches, in a minimum aggregate amount over the term
of the agreement of $75 million, at pre-established prices. If we fail to meet
our minimum requirements on an annual basis, we are required to pay a specified
penalty based on the difference between our requirements and the amount
actually purchased.
We have also entered into a software license agreement with IBM under which
we were granted a non-exclusive and non-transferable license to use select IBM
billing software. We paid an initial license fee and are required to pay
specified incremental use fees based on the number of access lines for which we
use the software. Unless terminated by us or IBM as permitted by the agreement,
the license is perpetual.
Products and Services
Data Services
Focal Virtual Office is designed to allow a corporate customer's employees
to dial-in to the corporate customer's local area network using a telephone
number in the employee's local calling area. This allows the employee to access
the local area network for the price of a local call and enables our corporate
customer to avoid the higher cost of maintaining region-wide 800 service for
local area network access. In addition, our Virtual Office customers are able
to use the Focal(TM) Finder service, an interactive tool placed on the
customer's web site that automatically provides a telecommuting employee with
the local calling number to be used for server access.
Focal Multi-Exchange Service, a variant of the Focal Virtual Office service
marketed to ISPs, allows an ISP's customers to cost-effectively access the
ISP's remote access servers. The combination of the multi-exchange service
capacity and our high level of customer care has resulted in strong demand for
our Multi-Exchange Service from ISPs.
We also offer our customers the ability to colocate equipment in our
switching and operations centers. Equipment colocation benefits the customer by
allowing it to inexpensively house its data equipment without having to
maintain secure, environmentally controlled space. In addition, customers that
colocate are eligible for special discounts on our monthly line rates. We also
offer them equipment maintenance services. These services are particularly
well-suited to our ISP customers, who frequently operate remote access servers
and routers in conjunction with our switched services. Currently, we have over
64,000 square feet of customer colocation space available or under development.
We are currently in the test phase of offering DSL access service to provide
high-speed, dedicated access to corporate LANs and the Internet. This service
will be marketed to each of our targeted customer segments-- large
corporations, ISPs and VARs. DSL service is or will be available in a variety
of speeds ranging from 144 kilobits per second to up to 52 megabits per second.
We believe DSL access service is a natural extension of the switched data
services that we have provided since inception.
On July 2, 1999, Focal entered into a five-year Joint Marketing and Service
Agreement with Splitrock Services, Inc., a provider of advanced data
communications services to ISPs, telecommunications carriers and other
businesses. Under this agreement, Splitrock has agreed to purchase a minimum of
10,000 DSL lines as may be needed by Splitrock to provide service to
Splitrock's wholesale customers or retail end-users in Focal's markets, subject
to service availability on a timely basis. Focal also has been granted a right
of first refusal to
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provide DSL service to Splitrock within Focal's service territory to the extent
Splitrock is not providing DSL services over its own network. In turn,
Splitrock has been granted a right of first refusal to offer specified data
communications and network services if Focal itself does not offer these
services within the relevant geographic market. The parties have also agreed to
cooperate in selected network planning functions.
With the purchase of our own fiber capacity, we believe we can offer both
intra-city and inter-city private line data services at attractive prices.
Consequently, we plan to more aggressively market private lines for data
applications to new and existing customers.
Voice Services
Inbound Services. Our basic, inbound service allows for the completion of
calls to a new phone number we supply to our customer. Alternatively, local
number portability, or LNP, allows us to provide inbound services using a
customer's existing phone number. While LNP is occasionally unavailable and
cumbersome to implement, it permits us to serve customers without altering
their existing phone numbers. Consequently, we expect LNP to become
increasingly useful to us in taking existing business from our primary
competitors, the ILECs.
Direct inward dial service allows inbound calls to reach a particular
station on a customer's phone system without operator intervention. We market
direct inward dial service to our corporate customers as both a primary and
backup service. As a primary service, the customer uses Focal numbers where a
new line and number are needed, as when a customer hires a new employee. As a
backup service, we can implement an alternative numbering plan for the customer
in case the customer's primary service from the ILEC or another CLEC is
interrupted.
Outbound Services. Our basic outbound services allow local and toll calls to
be completed within a metropolitan region and long distance calls to be
completed worldwide. This direct outward dial service is utilized by end users
in several ways. As a primary service, a customer uses Focal as a replacement
for the ILEC in placing calls to destinations within the region. In our least
cost routing application, a customer can utilize our service in conjunction
with its existing ILEC service to route calls using whichever carrier is least
expensive for that particular type of call or time of day.
Other outbound applications include outbound 800 calling and long distance
overflow service. In order to encourage customers to use our service, we offer
customers an incentive for letting us provide their outbound 800 calls. In the
case of long distance overflow service, we act as a backup to the customer's
existing long distance carrier in order to optimize the number of direct,
special access lines installed from the customer's premises to the long
distance carrier's network.
Our FocaLINC service is designed to price inter-city calls that remain on
our network as if they were local calls. This product will provide a cost-
effective way for our customers in one market to make calls to their offices in
other Focal markets. We believe that FocaLINC will redefine local calling. This
service is still under development, and will not be commercially viable until
we have linked our various city networks with long-haul fiber capacity. We
have, however, signed agreements under which we plan to lease approximately
10,000 DS-3 miles of fiber transport capacity connecting each of our current
and planned markets.
All of the services described above are commonly provisioned over a high-
speed digital communications circuit called a T-1 facility and interface
directly with our customers' private branch exchange or other customer-owned
equipment. Direct interfacing averts our need to provide multiplexing
equipment, which combines a number of communications paths onto one path, at
the customer's location. This is possible due to the high call volume generated
by the large communications-intensive customers we target. Our ability to
directly interface with existing customer equipment further minimizes our
capital investment and maximizes our overall return on capital. We also believe
our installation of DSL technology will allow us to more cost-effectively
provision T-1 facilities needed for voice customers. In addition DSL technology
will allow us to reach more customers in areas not currently served by fiber.
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Advanced Services
CDR Express provides our VAR customers with automated delivery of daily call
detail records, or CDRs, via the Internet. This system enables these customers
to accurately bill their customers in a secure environment. CDR Express, as
well as some other Focal products, are located in Your Domain--a section of our
web site specifically dedicated to each customer. Your Domain enables our
customers to access their most recent invoices, call detail records and the
customer order entry forms. Your Domain is protected by a customer's user name
and password. Your Domain can also inform customers of new product offerings
being developed by us. Our Form View product, located in Your Domain, allows
our customers to download order forms and other important documents through the
Internet at their convenience.
Focal FLOW is an outbound service marketed to VARs that need to be able to
switch outbound traffic among multiple long distance or international carriers.
We partition our central office switch so VARs can utilize the core switching
capability of our equipment at reasonable per minute or per port cost.
Sales and Marketing
Our primary objective is to satisfy the need for highly reliable
communications services for communications-intensive users in the large
metropolitan markets in which we operate by providing diverse, reliable and
sophisticated services. We believe that we have a competitive advantage in
satisfying this need since we are focused on delivering a specific set of
innovative services to our target customers.
Diversity. Focal provides diversity to communications-intensive users by
delivering highly reliable, local communications services as an alternative to
the ILEC. This type of diversity already exists in other areas of
communications services, such as long distance. Communications-intensive
customers clearly embrace the benefits of diversity, particularly because
redundancy minimizes the effects of facilities failures and maximizes
competitive pricing. As a result, most of our target customers typically have
multiple long distance providers, multiple equipment vendors and multiple local
private-line providers. Because of our focused strategy, we believe that we are
uniquely positioned to become the provider of choice for data and voice
communications services for large, communications-intensive corporate users,
VARs and ISPs. Our focused strategy is based on our ability to deliver the
superior level of diverse, reliable and sophisticated services that our
customers require.
Reliability. We provide reliable service to communications-intensive users,
who are highly sensitive to the potential effects of facilities failures, by
designing our networks around the same theme of diversity that we advocate for
our customers. Although local services are perceived as simple, basic services,
the delivery of highly reliable, local services requires sophisticated systems.
We have engineered our switching and transport networks to meet the demanding
traffic and reliability requirements of our target customers. Our network
strategy is based on developing and operating a robust, reliable, high-
throughput local network relative to the ILECs and other CLECs. Because we are
a relatively new entrant to the markets we serve, we must meet or exceed the
performance quality of the existing local networks in order to attract
communications-intensive users to our networks. Unlike smaller users that tend
to pre-qualify vendors based on price, we believe that communications-intensive
users choose vendors based on the performance of their networks, and
specifically, their reliability. As a result, the design and operation of our
network are key success factors in our business development process.
In choosing our equipment, we conducted extensive research to identify the
best hardware for the high-volume users that we serve. As a result of this
research, we selected Nortel DMS-500 SuperNode central office switches, which
we have engineered to reduce significantly the likelihood of blocked calls and
to maximize call completion. As such, our customers are unlikely to find
themselves unable to complete or receive calls due to limitations inherent in
our switches. We typically connect to a large number of switches in the ILEC's
network. As of June 30, 1999, we had connected to a total of 771 ILEC switches.
We believe this is a competitive advantage because it increases call completion
even if a portion of the ILEC's trunking network becomes blocked. We optimize
the configuration of our network by implementing overflow routing between the
ILEC's
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network and ours, where available. Because the customer base of the ILECs and
other CLECs is not typically as communications-intensive as ours, we
specifically engineered our network to accommodate traffic volumes per customer
far in excess of that which the ILECs or other CLECs typically experience. We
believe that our design is unique among ILECs and CLECs and is attractive to
our target customer base of communications-intensive users. In addition, we
enhance our reliability by delivering service from our switches to customers
over multiple fiber transport systems.
We have also implemented safeguards in our network design to maximize
reliability. The DMS-500 SuperNode switch allows us to distribute customer
traffic across multiple bays of equipment, thus minimizing the effects of any
customer outage. In addition, these switches were engineered by Nortel Networks
with fully redundant processors and memory in the event of a temporary failure.
Our disaster prevention strategy includes service from multiple power sources
where available, on-site battery backup and diesel generator power at each
switching facility to protect against failures of our electrical service.
Sophistication. Our target customers are knowledgeable, sophisticated buyers
of communications services that demand a high level of professionalism
throughout a vendor's organization. We believe that the technical
sophistication of our management and operations team has been a critical factor
in our initial success and will continue to differentiate us from our
competitors. Execution of our strategy of penetrating communications-intensive
accounts requires a well-experienced team of sales professionals. As a result,
attracting and retaining experienced sales professionals is important to our
overall success. Our sales professionals' compensation is structured to retain
these valuable employees through the grant of stock options and cash
compensation incentives based on our revenue and operating cash flow
objectives.
We divide our direct sales force into three groups:
. The data services group
. The corporate services group
. The telecom services group
The data services group is responsible for selling to information services
providers, DSL providers and other data carriers, including ISPs. We are able
to offer several innovative services to ISPs, such as environmentally
conditioned colocation space, virtually non-blocking switching and transport
facilities and firm installation times. Servicing ISPs also maximizes our
network utilization by bringing traffic onto our network during periods, such
as evenings or weekends, when the network would otherwise be under-utilized.
The corporate services group is responsible for selling to large corporate
users. Our sales strategy for these corporate customers is to complement the
customer's service from the ILEC. Our initial sale to a corporate customer
typically involves installing incremental lines for specialized inbound
services, such as Virtual Office, or replacing only a limited number of
outbound lines. After we build the service relationship, we anticipate
increasing our overall penetration of the customer's local service. Over a
period of time, we hope to dominate a corporate customer's local switched
traffic. We emphasize the diversity, reliability and sophistication of our
services in order to earn our place as the local provider of choice for our
corporate customers.
The telecom services group markets directly to VARs and other carriers by
positioning us as a highly-reliable, responsive and cost-effective source of
wholesale local communications services. We believe a wide array of
communications service providers, including long distance companies, will seek
to provide bundled communications services in the large metropolitan markets we
target. We are well-positioned to be the provider of choice for re-bundled
local service. Because we do not intend to directly distribute our services to
residential or small- and medium-sized business customers, we believe that VARs
and other carriers looking to purchase the local service portion of their
bundled service offerings are more likely to purchase service from us rather
than from other ILECs or CLECs that compete with them.
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Superior customer service is critical to achieving our goal of capturing
market share. We are continually enhancing our service approach, which utilizes
a trained team of customer sales and service representatives to coordinate
customer installation, billing and service. Comprehensive support systems are
also a critical component of our service delivery. We have installed systems
designed to address all aspects of our business, including service order,
network provisioning, end-user and carrier billing, and trouble reporting. The
efficiency of our operating processes contributes to our ability to rapidly
initiate service to new accounts. Our installation desk follows a customer's
order, ensuring the installation date is met. Additionally, our customer sales
representatives respond to all other customer service inquiries, including
billing questions and repair calls.
We believe automation of internal processes contributes to the overall
success of a service provider and that billing is a critical element of any
telephone company's operation. We deliver billing information in a number of
media besides paper, including electronic files and Internet inquiry. Our
Invoice Domain service allows customers to securely access and view their
monthly invoices over the Internet. In addition, this service allows customers
to download call detail records. Similarly, our VAR customers can download call
records on a daily basis through our secure web site. This allows them to
efficiently process invoices for their end-user customers.
Significant Relationships
Ameritech Illinois accounted for approximately 81% of our consolidated
revenues in 1997. Ameritech Illinois and Bell Atlantic New York accounted for
approximately 59% and 16%, and 51% and 22%, of our consolidated revenues in
1998 and for the three months ended March 31, 1999, respectively. The revenues
from these carriers in 1997, 1998 and the three months ended March 31, 1999 are
the result of interconnection agreements we have entered into with them that
provide for reciprocal compensation relating to the transport and termination
of communications traffic. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" for further discussion regarding
reciprocal compensation. No other entities accounted for more than 10% of 1997
or 1998 revenues.
Competition
Portions of our industry are highly competitive. We face a variety of
existing and potential competitors, including:
. The ILECs in our current and target markets
. Other voice and data CLECs
. Long distance carriers
. Potential market entrants, including cable television companies,
electric utilities, microwave carriers, wireless telephone system
operators and private networks built by large end-users
Our primary competitor in each of our existing and planned markets is the
ILEC. Examples include BellSouth, Bell Atlantic, Ameritech, U S WEST, SBC and
GTE. These ILECs are generally required to file their prices with the state
regulatory agencies in their service areas. Any price changes must be reflected
in these filings. The ILECs have also generally been given the flexibility to
respond to competition with lower pricing. In most cases, proposals for lower
pricing must also be filed with the state utility commissions and the pricing
must be made available to similarly situated customers. We believe this
provides a disincentive for the ILECs to significantly vary or discount prices
even in competitive situations. However, as a CLEC, similar obligations apply
to us. See "--Regulation--State Regulation."
Some of the ILECs recently requested, among other things, that the FCC relax
regulation of their provision of advanced data networks, which may also be used
for voice traffic. While the FCC has denied those requests, it has initiated a
rule-making that is intended to establish the procedures and safeguards
necessary before these ILECs could, through separate subsidiary companies,
provide these services on a largely
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deregulated basis. If adopted, these rules may provide additional opportunities
for competition from these ILECs. The FCC recently released an order
addressing, among other things, colocation rights of carriers offering advanced
data services, but deferred action on the separate subsidiary issue.
The ILECs offer a wider variety of services in a broader geographic area
than ours and have much greater resources than we do. This may encourage an
ILEC to subsidize the pricing for services with which we compete with the
profits of other services in which the ILEC remains the dominant provider. We
believe competition has limited the number of services dominated by ILECs. In
addition, state regulators have exercised their enforcement powers in a way
that makes it unlikely the ILECs would be able to successfully pursue this type
of protective pricing strategy for an extended period.
In addition to competition from ILECs, we also face competition from a
growing number of other CLECs. Although CLECs overall have only captured
approximately 5% of total revenue of the U.S. local telecommunications market,
we nevertheless compete to some extent with other CLECs in our customer
segments. There are typically several other CLECs competing in each
metropolitan market we serve or plan to enter. Examples of data and voice CLECs
in our markets include Allegiance Telecom, Covad Communications Group, MCI
WorldCom, NEXTLINK Communications, NorthPoint Communications Group, Rhythms
NetConnections and Teleport Communications Group, now a part of AT&T. In some
instances, these CLECs have resources greater than ours and offer a wider range
of services. Many of the CLECs in our markets target small- and medium-sized
business customers, which differs from our target customer base of large,
communications-intensive users.
In addition to ILECs and other CLECs, we are increasingly competing with
long distance carriers. A number of long distance carriers have introduced
local telecommunications services to compete with us and the ILECs. These
services include toll calling and other local calling services, which are often
packaged with the carrier's long distance service. While we do not believe the
packaging aspect of the service is particularly attractive to the
communications-intensive customers we target, large long distance carriers
enjoy certain competitive advantages due to their vast financial resources and
brand name recognition. In addition, we believe there is a risk the long
distance carriers may subsidize the pricing of their local services with
profits from long distance services. We anticipate that the entry of some of
the ILECs into the long distance market will reduce the risk of this type of
activity by reducing the profitability of the long distance carrier's long
distance minutes. Further, to the extent the long distance carrier purchases
our service on a wholesale basis and rebundles it at a subsidized rate, we may
benefit as the subsidized, wholesale service could result in higher market
penetration than we would otherwise have achieved. In addition, we have
displaced long distance carriers where the customer was dissatisfied with the
quality of the long distance carrier's local service. We expect our reputation
for exceptional service quality and customer care will continue to result in us
displacing the long distance carrier as the primary alternative to the ILEC in
competitive situations. In addition, we expect that some of our recent and
proposed service offerings, which enable long distance calls to be priced like
local calls, will increase our competitiveness.
For a description of how we compete, see "--Sales and Marketing."
Regulation
The following summary of regulatory developments and legislation is not
complete. It does not describe all present and proposed federal, state and
local regulation and legislation affecting the telecommunications industry.
Existing federal and state regulations are currently subject to judicial
proceedings, legislative hearings and administrative proposals that could
change, in varying degrees, the manner in which our industry operates. We
cannot predict the outcome of these proceedings or their impact on the
telecommunications industry or us.
Overview. Our services are subject to varying degrees of federal, state and
local regulation. The FCC exercises jurisdiction over all the facilities of,
and services offered by, telecommunications common carriers
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like us to the extent we use our facilities to provide, originate or terminate
interstate or international communications. State regulatory commissions retain
jurisdiction over most of the same facilities and services to the extent they
are used to provide, originate or terminate intrastate communications. The
decisions of these regulatory bodies are often subject to judicial review,
which makes it difficult for us to predict outcomes in this area.
Federal Regulation. We must comply with the requirements of common carriage
under the Communications Act of 1934. Comprehensive amendments to the
Communications Act of 1934 were made by the Telecommunications Act of 1996,
referred to as the Telecom Act, which substantially altered both federal and
state regulation of the telecommunications industry. The purpose of this
legislation was to deregulate the telecommunications industry to a significant
degree, thereby fostering increased competition among carriers. Because
implementation of the Telecom Act is subject to numerous federal and state
policy rule-making and judicial review, we cannot predict with certainty what
its ultimate effect on us will be.
Under the Telecom Act, any entity may enter a telecommunications market,
subject to reasonable state safety, quality and consumer protection
regulations. The Telecom Act makes local markets accessible by requiring the
ILEC to permit interconnection to its network and establishing ILEC obligations
with respect to:
. Colocation of equipment. This allows companies like us to install and
maintain our own network equipment, including DSLAMs, ATM switches, and
fiber optic equipment, in ILEC central offices.
. Reciprocal compensation. This requires the ILECs and CLECs to compensate
each other for telecommunications traffic that originates on the network
of one carrier and is sent to the network of the other.
. Resale of service offerings. This requires the ILEC to establish
wholesale rates for services it provides to end-users at retail rates to
promote resale by CLECs.
. Interconnection. This requires the ILECs to permit their competitors to
interconnect with ILEC facilities at any technically feasible point in
the ILECs' networks.
. Access to unbundled network elements. This requires the ILECs to
unbundle and provide access to some components of their local service
network to other local service providers. Unbundled network elements are
portions of an ILEC's network, such as copper lines or "loops", that
CLECs can lease in order to build their own facilities networks.
. Number portability. This requires the ILECs and CLECs to allow a
customer to retain an existing phone number within the same local area
even if the customer changes telecommunications services providers. All
telecommunications carriers will be required to contribute to the shared
industry costs of number portability, with the first payments being due
in the fourth quarter of 1999.
. Dialing parity. This requires the ILECs and CLECs to establish dialing
parity so that customers do not perceive a quality difference between
networks when dialing.
. Access to rights-of-way. This requires the ILECs and CLECs to establish
non-discriminatory access to telephone poles, ducts, conduits and
rights-of-way.
ILECs are required to negotiate in good faith with other carriers that
request any or all of the arrangements discussed above. If a requesting carrier
is unable to reach agreement with the ILEC within a prescribed time, either
carrier may request arbitration by the applicable state commission. If an
agreement still cannot be reached, carriers are forced to abide by the
obligations established by the FCC and the applicable state commission.
We have entered into a number of interconnection agreements with the ILECs
in our markets and will enter into additional agreements as our build-out
progresses. We have existing interconnection agreements in each of our existing
markets and in several of our planned markets. Nine of the interconnection
agreements covering our existing markets, including the agreement covering
Chicago, expire in 1999. Eight of the
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interconnection agreements covering our existing markets, including the
agreement covering New York, expire in 2000. The expiration of these agreements
will require that we negotiate new interconnection terms with the ILECs.
Pending conclusion of these negotiations, the existing interconnection
agreements should continue to govern the payment of reciprocal compensation and
other interconnection terms. See "Risk Factors--Internet-Related Reciprocal
Compensation" and "--Relationship with ILECs."
The FCC is charged with establishing guidelines to implement the Telecom
Act. In August 1996, the FCC released a decision, known as the Interconnection
Decision, that established rules for the interconnection requirements outlined
above and provided guidelines for interconnection agreements by state
commissions. The U.S. Court of Appeals for the Eighth Circuit vacated portions
of the Interconnection Decision. On January 25, 1999, the U.S. Supreme Court
reversed the Eighth Circuit and upheld the FCC's authority to issue regulations
governing pricing of unbundled network elements provided by the ILECs in
interconnection agreements, including regulations governing reciprocal
compensation, which are discussed in more detail below. In addition, the
Supreme Court affirmed an FCC rule that allows requesting carriers to "pick and
choose" the most attractive portions of existing interconnection agreements
with other carriers. The Supreme Court did not, however, address other
challenges raised about the FCC's rules at the Eighth Circuit because those
challenges were not decided by the Eighth Circuit. These challenges will have
to be addressed by the Eighth Circuit in light of the Supreme Court's decision.
In addition, the Supreme Court disagreed with the standard applied by the FCC
for determining whether an ILEC should be required to provide a competitor with
particular unbundled network elements. This issue will be addressed by the FCC
in a new rule-making proceeding that the FCC recently initiated.
The decisions of the Eighth Circuit and Supreme Court have not resolved the
uncertainty about the rules governing the pricing terms and conditions of
interconnection agreements. The Supreme Court's actions in particular may
affect the renegotiation of existing agreements. The ILECs may, as a result of
the Supreme Court reversal, seek to stop providing some unbundled elements.
Although state commissions continue to implement and enforce interconnection
agreements, the Supreme Court ruling and future FCC and court rulings may
affect these commissions' authority to implement or enforce interconnection
agreements or lead to additional rule-making by the FCC. The resulting
uncertainty makes it difficult to predict whether we will be able to continue
to rely on our existing interconnection agreements or have the ability to
negotiate acceptable interconnection agreements in the future.
In addition to requiring the ILECs to open their networks to competitors and
reducing the level of regulation applicable to CLECs, the Telecom Act also
reduces the level of regulation that applies to the ILECs, thereby increasing
their ability to respond quickly in a competitive market. For example, the FCC
has applied "streamlined" tariff regulation of the ILECs, which shortens the
requisite waiting period before which tariff changes may take effect. These
developments enable the ILECs to change rates more quickly in response to
competitive pressures. The FCC has also proposed heightened price flexibility
for the ILECs, subject to specified caps. If implemented, this flexibility may
decrease our ability to effectively compete with the ILECs in our markets.
In March 1999, the FCC issued an order requiring ILECs to provide unbundled
loops and colocation on more favorable terms than had previously been
available. The order permits colocation of equipment that could be used to more
efficiently provide advanced data services such as high-speed DSL service, and
requires less expensive "cageless" colocation. In the March order, the FCC
deferred action on its previous proposal to permit ILECs to offer advanced data
services through separate affiliates, free from some of the obligations of the
Telecom Act. Permitting ILECs to provision data services through separate
affiliates with fewer regulatory requirements could have a material adverse
impact on our ability to compete in the data services sector. These areas of
regulation are subject to change through additional proceedings at the FCC or
judicial challenge.
The Telecom Act also gives the FCC authority to determine not to regulate
carriers if it believes regulation would not serve the public interest. The FCC
is charged with reviewing its regulations for continued relevance on a regular
basis. As a result of this mandate, a number of regulations that apply to CLECs
have been and
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may in the future continue to be eliminated. We cannot, however, guarantee that
any regulations that are now or will in the future be applicable to us will be
eliminated.
Reciprocal Compensation. We expect that reciprocal compensation payments
will make up a significant portion of our initial revenues in each of our
markets. Reciprocal compensation is the compensation paid by one carrier to
complete particular calls on another local exchange carrier's network. Because
a significant portion of our customers typically receive more calls than they
make, we expect to receive more reciprocal compensation than we pay for calls
that originate on our networks. As a result of the current regulatory
environment and several trends in our business, which are discussed below, we
expect our revenues from reciprocal compensation to decline significantly.
Some ILECs have refused to pay reciprocal compensation charges that they
estimate are the result of inbound ISP traffic because they believe that this
type of traffic is outside the scope of existing interconnection agreements.
For example, Ameritech disputed a portion of the reciprocal compensation
charges billed to it by us, which it believes are related to Internet access
charges. In March of 1998, the Illinois Commerce Commission ruled in favor of
Focal and other CLECs regarding this dispute. In October 1998, Ameritech
complied with the ruling and we received payment for past reciprocal
compensation charges that represent substantially all of the disputed amounts.
Reciprocal compensation payments from Ameritech comprised approximately 81% of
our revenues for the year ended December 31, 1997 and payments from Ameritech
and another ILEC comprised approximately 75% and 73% of our revenues for the
year ended December 31, 1998 and the three months ended March 31, 1999,
respectively. On June 18, 1999, the Seventh Circuit affirmed the Illinois
Commerce Commission's order requiring the payment of reciprocal compensation
for ISP-bound traffic.
Some states in which our current and planned markets are located have
ordered the ILECs to pay reciprocal compensation for Internet-related calls.
The majority of states that have addressed the question have ruled that
compensation is owed for this traffic. However, these states and other states
that have not considered the issue to date may yet determine that no
compensation is owed. A finding that reciprocal compensation is not payable for
ISP traffic in Illinois, New York or Pennsylvania would have a material adverse
effect on us.
In addition, on February 26, 1999, the FCC issued a declaratory ruling and
Notice of Proposed Rulemaking concerning inbound ISP traffic. The FCC concluded
in its ruling that ISP traffic is jurisdictionally mixed and largely interstate
in nature, and thus within the FCC's jurisdiction. The FCC has requested
comment as to what reciprocal compensation rules should govern this traffic
upon expiration of existing interconnection agreements. The FCC also determined
that no federal rule existed that governed reciprocal compensation for ISP
traffic at the time existing interconnection agreements were negotiated and
concluded that it should permit states to determine whether reciprocal
compensation should be paid for calls to ISPs under existing interconnection
agreements. The FCC order has been appealed by several parties. Briefing is
scheduled to be completed by September 2, 1999, but no date for oral argument
has been set.
In light of the FCC's order, state commissions, which previously addressed
this issue and required reciprocal compensation to be paid for ISP traffic, may
reconsider and may modify their prior rulings. Several ILECs, including
Ameritech, are seeking to overturn prior orders that they claim are
inconsistent with the FCC's February 26, 1999 order. Relief sought could
include repayment of reciprocal compensation amounts previously paid by the
ILECs. Of the 13 state commissions that have considered the issue since the
FCC's February 26, 1999 order, 11 of these states have upheld the requirement
to pay reciprocal compensation for ISP-bound traffic. Only Massachusetts and
Missouri are not requiring reciprocal compensation for this traffic, at least
pending negotiations and a further FCC decision. At least one ILEC has already
filed suit in United States District Court seeking a refund from another
carrier of reciprocal compensation the ILEC paid to that carrier. That suit was
dismissed for lack of subject matter jurisdiction. Bell Atlantic sought
permission to escrow future reciprocal compensation payments to CLECs in New
York, but its request has been denied by the New York Public Service
Commission, which has opened an inquiry into this issue that is expected to be
completed in
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August of 1999. Bell Atlantic has also informed us that it intends to
unilaterally escrow these payments in two smaller markets, New Jersey and
Delaware. In addition, Bell Atlantic has notified us that it will retroactively
reduce its reciprocal compensation payments in New York based on a reduction to
the Bell Atlantic tariff ordered by the New York Public Service Commission in a
proceeding unrelated to the ISP reciprocal compensation issue. We are
vigorously challenging this reduction before the New York Public Service
Commission.
Upon expiration of our existing interconnection agreements, we must
negotiate new rates for reciprocal compensation with each carrier. Pending
conclusion of these negotiations, the existing interconnection agreements are
expected to continue to govern the payment of reciprocal compensation. We
expect rates for reciprocal compensation will be lower under new
interconnection agreements than under our existing agreements. A reduction in
rates payable for reciprocal compensation could have a material adverse effect
on us, as could any requirement to refund reciprocal compensation paid to date.
Tariff and Filing Requirements. Non-dominant carriers, including Focal, must
file tariffs with the FCC listing the rates, terms and conditions of interstate
and international services provided by the carrier. On October 29, 1996, the
FCC adopted an order in which it eliminated the requirement that non-dominant
interstate carriers maintain tariffs on file with the FCC for domestic
interstate services. The FCC's order was issued pursuant to authority granted
in the Telecom Act to forebear from regulating any telecommunications services
provider if specified statutory analyses are satisfied. The FCC's order,
however, has been stayed by a federal court. Accordingly, non-dominant
interstate carriers, including Focal, currently must continue to file
interstate tariffs with the FCC until final determination of the issue. Any
challenges to these tariffs by regulators or third parties could cause us to
incur substantial legal and administrative expenses.
In addition, periodic reports concerning carriers' interstate circuits and
deployment of network facilities also are required to be filed with the FCC.
The FCC generally does not exercise direct oversight over cost justification
and the level of charges for services of non-dominant carriers, although it has
the power to do so. The FCC may also impose prior approval requirements on
transfers of control and assignments of operating authorizations. Fines or
other penalties also may be imposed for violations of FCC rules or regulations.
The FCC also requires that certified carriers like Focal notify the FCC of
foreign carrier affiliations and secure a determination that such affiliations,
if in excess of a specified amount, are in the public interest.
State Regulation. Most states regulate entry into the markets for local
exchange and other intrastate services, and states' regulation of CLECs vary in
their regulatory intensity. The majority of states require that companies
seeking to provide local exchange and other intrastate services to apply for
and obtain the requisite authorization from a state regulatory body, such as a
state commission. This authorization process generally requires the carrier to
demonstrate that it has sufficient financial, technical and managerial
capabilities and that granting the authorization will serve the public
interest. As of July 1, 1999, we had obtained local exchange certification or
were otherwise authorized to provide local exchange service in:
California Illinois Michigan Texas
Delaware Indiana New Jersey Virginia
District of Columbia Maryland New York Washington
Florida Massachusetts Pennsylvania
We also had applications pending for local exchange certification or other
authorization in Georgia and Missouri. To the extent that an area within a
state in which we provide service is served by a small or rural exchange
carrier not currently subject to competition, we may not currently have
authority to provide service in those areas at this time.
As a CLEC, we are and will continue to be subject to the regulatory
directives of each state in which we are and will be certified. Most states
require that CLECs charge just and reasonable rates and not discriminate among
similarly situated customers. Some other state requirements include:
42
<PAGE>
. The filing of periodic reports
. The payment of various regulatory fees and surcharges
. Compliance with service standards and consumer protection rules
States also often require prior approvals or notifications for certain
transfers of assets, customers, or ownership of a CLEC and for issuances by
certified carriers of equity securities, notes or indebtedness, although the
terms of this offering do not require any prior approval. States generally
retain the right to sanction a carrier or to revoke certifications if a carrier
violates relevant laws and/or regulations. Delays in receiving required
regulatory approvals could also have a material adverse effect on us. We cannot
assure you that regulators or third parties will not raise material issues with
regard to our compliance or non-compliance with applicable laws or regulations.
In most states, certificated carriers like us are required to file tariffs
setting forth the terms, conditions, and prices for services which are
classified as intrastate. In some states, the required tariff may list a range
of prices for particular services, and in others, such prices can be set on an
individual customer basis. We may, however, be required to file tariff addenda
of the contract terms.
Under the Telecom Act, implementation of our plans to compete in local
markets is and will continue to be, to a certain extent, controlled by the
individual states. The states in which we operate or intend to operate have
taken regulatory and legislative action to open local communications markets to
various degrees of local exchange competition.
Local Regulation. We are also subject to numerous local regulations, such as
building code requirements. These regulations may vary greatly from state to
state and from city to city.
Employees
As of June 30, 1999, we employed 418 full-time employees, none of whom were
covered by a collective bargaining agreement. We believe that our future
success will depend on our continued ability to attract and retain highly
skilled and qualified employees. We believe that our relations with our
employees are good.
Properties
We lease office space in a number of locations, primarily for network
equipment installations and sales and administrative offices. As of June 30,
1999, our material leased switching and network properties were as listed
below:
<TABLE>
<CAPTION>
Square
Location Feet Lease Term
- -------- ------ ----------
<S> <C> <C>
Chicago, Illinois 57,511 June 2004
Chicago, Illinois 10,236 January 2006, with two five-year renewal options
New York, New York 15,196 May 2012, with one five-year renewal option
San Francisco,
California 20,151 July 2008, with two five-year renewal options
Philadelphia,
Pennsylvania 17,608 June 2008, with one thirty-month renewal option
Washington, D.C. 19,414 October 2013
Los Angeles,
California 19,199 January 2009
Southfield, Michigan 22,600 August 2008, with two five-year renewal options
Seattle, Washington 20,000 November 2008, with one five-year renewal option
Cambridge,
Massachusetts 13,274 December 2008, with two five-year renewal options
Houston, Texas 21,704 September 2009, with two five-year renewal options
Dallas, Texas 19,249 June 2009, with two five-year renewal options
Atlanta, Georgia 23,609 May 2009, with two five-year renewal options
Jersey City, New
Jersey 18,500 February 2009, with two five-year renewal options
</TABLE>
43
<PAGE>
A number of these locations also house sales and administrative offices. Our
corporate headquarters are located in one of our Chicago, Illinois facilities.
In addition, we have sales offices in New York, San Jose and Orange County. We
also own approximately 13 acres of real property in Elk Grove Township,
Illinois. This property, which includes a 52,000 square foot building, houses
our second Chicago switching center, national data center and national network
operations center.
Legal and Administrative Proceedings
With the exception of the matters discussed below, we are not aware of any
litigation against us. In the ordinary course of our business, we are involved
in a number of regulatory proceedings before various state commissions and the
FCC.
On September 16, 1997, we filed a complaint and request for temporary
injunction against Ameritech Illinois with the Illinois Commerce Commission.
The complaint claimed breach of the terms of the interconnection agreement
between us and Ameritech Illinois because Ameritech Illinois refused to pay
reciprocal compensation for our transport and termination of calls to our end-
users that Ameritech Illinois believed were ISPs. In the interests of obtaining
a more timely judgment, we withdrew our complaint without prejudice on October
17, 1997 and filed to intervene in a consolidated suit that included similar
complaints against Ameritech Illinois by several other CLECs. On March 11,
1998, the Illinois Commerce Commission issued an order that required Ameritech
Illinois to pay reciprocal compensation for calls made to ISPs. On March 15,
1998, Ameritech Illinois filed a motion with the Illinois Commerce Commission
to stay the order pending an appeal, which was denied on March 23, 1998. On
March 27, 1998, Ameritech Illinois filed suit in the United States District
Court for the Northern District of Illinois seeking reversal of the Illinois
Commerce Commission order. Ameritech Illinois also sought a stay of this order
from the District Court, which was granted while the case was decided. On July
21, 1998, the District Court upheld the Illinois Commerce Commission's order,
finding that calls to ISPs are local calls and therefore subject to the
reciprocal compensation rules contained in the Telecom Act. The District Court
stayed the decision to permit any party to appeal. Ameritech Illinois then
appealed the decision to the U.S. Court of Appeals for the Seventh Circuit on
August 25, 1998, and was denied a stay while the appeal is pending. In October
1998, Ameritech Illinois complied with the order and we received payment for
past reciprocal compensation charges that represent substantially all of the
disputed amounts. On June 18, 1999, the Seventh Circuit affirmed the Illinois
Commerce Commission's order requiring the payment of reciprocal compensation
for ISP-bound traffic. See
"--Regulation" for a description of federal rule-making and other developments
affecting reciprocal compensation.
We were named as a defendant, along with other parties, in a case filed in
March 1998 in the Supreme Court of the State of New York, County of New York
involving the wrongful death of an electrician who died while working at our
leased premises in New York. The plaintiffs, the decedent's wife and his
estate, are seeking damages from the defendants of $20 million. The decedent
was not under contract with us, nor was he working at our request. We tendered
the defense of this claim to, and it has been accepted by, our insurance
carrier. The aggregate amount of our insurance coverage is $7 million. We do
not believe that we were the cause of the injuries and subsequent death that
gave rise to this lawsuit.
44
<PAGE>
MANAGEMENT
Executive Officers, Selected Key Employees and Directors
The table below contains information about the ages and positions of Focal's
executive officers, selected key employees, and directors, as of June 30, 1999.
<TABLE>
<CAPTION>
Name Age Position(s)
- ---- --- -----------
<S> <C> <C>
Robert C. Taylor, Jr.... 39 Director, President and Chief Executive Officer
John R. Barnicle........ 34 Director, Executive Vice President and Chief Operating Officer
Joseph A. Beatty........ 35 Executive Vice President and Chief Financial Officer
Brian F. Addy........... 34 Executive Vice President
Renee M. Martin......... 44 Senior Vice President, General Counsel and Secretary
Robert M. Junkroski..... 35 Vice President and Treasurer
Gregory J. Swanson...... 32 Controller
Leonard A. Dedo......... 47 Senior Vice President of Marketing and Alternate Channels
Richard J. Metzger...... 50 Vice President of Regulatory Affairs and Public Policy
James E. Crawford, III.. 53 Director
John A. Edwardson....... 49 Director
Paul J. Finnegan........ 46 Director
Richard D. Frisbie...... 49 Director
James N. Perry, Jr...... 38 Director
Paul G. Yovovich........ 45 Director
</TABLE>
Robert C. Taylor, Jr. Mr. Taylor has been our President and Chief Executive
Officer and a director since August 1996 and is a co-founder of Focal. From
1994 to 1996, Mr. Taylor was the Vice President of Global Accounts for MFS
Communications Corporation, a telecommunications company. At MFS
Communications, he was responsible for the operations and management of the
Global Services Group, which included MFS Communications' fifty largest
customers. He focused on developing all activities in Mexico and Canada. From
1993 to 1994, Mr. Taylor was one of the original senior executives at McLeod
Telecommunications Group, a Cedar Rapids, Iowa based CLEC. Mr. Taylor has also
held management positions with MCI Communications Corporation (1990-1993) and
Ameritech (1985-1990). Mr. Taylor also serves as the Vice Chairman of the
Association for Local Telecommunications Services, the national trade
association for facilities-based providers of competitive local
telecommunications services. Mr. Taylor received his M.B.A. from the University
of Chicago Graduate School of Business and holds a Bachelor of Science degree
in Mechanical Engineering.
John R. Barnicle. Mr. Barnicle has been Executive Vice President and Chief
Operating Officer and a director since June 1996. Mr. Barnicle is a co-founder
of Focal and is responsible for day-to-day operations, engineering, marketing
and long-term planning. In 1996, Mr. Barnicle was Vice President of Marketing
for MFS Telecom Companies, a subsidiary of MFS Communications. From 1994 to
1996, Mr. Barnicle was a Vice President of Duff & Phelps Credit Rating Company
and before that held various marketing, operations and engineering positions
with MFS Telecom (1992-1994) and Centel Corporation, a local exchange carrier
(1986-1992). Mr. Barnicle received his M.B.A. with Distinction from DePaul
University and holds a Bachelor of Science degree in Electrical Engineering.
Joseph A. Beatty. Mr. Beatty has been Executive Vice President and Chief
Financial Officer since November 1996 and was also Treasurer from November 1996
through January 1999 and Secretary from November 1996 through April 1998. He
was also a director from May 1996 to November 1996. Mr. Beatty is a co-founder
of Focal and is responsible for all financial operations and information
systems. From 1994 to 1996, Mr. Beatty was a Vice President with NationsBanc
Capital Markets, where he was responsible for investment research coverage of
the telecommunications industry. From 1992 to 1994, Mr. Beatty was a Vice
President of
45
<PAGE>
Duff & Phelps Credit Rating Company with responsibility for credit ratings in
the telecommunications and electric utility sectors. From 1985 to 1992, Mr.
Beatty held various technical management positions with Centel Corporation's
local exchange carrier division. Mr. Beatty received his M.B.A. with a
concentration in Finance from the University of Chicago Graduate School of
Business and is a Chartered Financial Analyst. In addition, Mr. Beatty holds a
Bachelor of Science degree in Electrical Engineering.
Brian F. Addy. Mr. Addy has been Executive Vice President since May 1996.
Mr. Addy is a co-founder of Focal and is responsible for our new market
evaluation and development opportunities. From 1996 to 1998, he led our sales
efforts. He was also a director from May 1996 to November 1996. From 1993 to
1996, Mr. Addy was a Vice President of ProLogis, formerly Security Capital
Industrial Trust, a real estate investment trust, where he was responsible for
acquisitions, development and national marketing. From 1986 to 1993, Mr. Addy
held various management positions with Centel Corporation's cellular, paging,
telephone and telephone systems operating units. Mr. Addy holds a Bachelor of
Science degree in Electrical Engineering.
Renee M. Martin. Ms. Martin has been Senior Vice President, General Counsel
and Secretary since March 1998. Ms. Martin is responsible for our legal,
regulatory, real estate and human resources functions. From 1984 to 1998, Ms.
Martin held various executive positions at Ameritech, most recently as Vice
President and General Counsel Small Business Services, where she directed
corporate legal resources to address contract negotiations, employment issues,
regulatory affairs and litigation, and managed outside legal counsel. From 1982
to 1984, Ms. Martin was an attorney at the law firm of Cook and Franke, S.C.
where she concentrated on general business and corporate law. Ms. Martin
received her J.D. from the University of Wisconsin and holds a Bachelor of Arts
degree in Journalism.
Robert M. Junkroski. Mr. Junkroski has been Vice President and Treasurer
since January 1999 and was Controller from January 1997 to January 1999. He is
responsible for all our accounting, revenue assurance, audit, cash and risk
management and customer credit functions. From 1995 to 1997, Mr. Junkroski was
Controller for Brambles Equipment Services, Inc., an equipment leasing company,
where he was responsible for establishing and maintaining the divisional
accounting, financial reporting and budgeting functions. From 1987 to 1995, Mr.
Junkroski was Controller for Focus Leasing Corporation, an equipment leasing
company, where he was responsible for the development and implementation of the
accounting and financial reporting functions of several emerging companies. Mr.
Junkroski is a Certified Public Accountant, received his M.B.A. with honors
from Roosevelt University concentrating in Finance and Accounting and holds a
Bachelor of Business Administration degree.
Gregory J. Swanson. Mr. Swanson has been Controller since January 1999 and
is our principal accounting officer. He is responsible for all internal and
external accounting and reporting functions. From June 1998 to December 1998,
Mr. Swanson was Director of External Reporting for Allegiance Corporation, a
health care manufacturing and distribution company. Before that he spent
approximately nine years at Arthur Andersen LLP, a public accounting firm,
where he was responsible for audit and business advisory services to technology
and manufacturing companies. Mr. Swanson is a Certified Public Accountant and
holds a Bachelor of Science degree in Accounting.
Leonard A. Dedo. Mr. Dedo has been Senior Vice President of Marketing and
Alternate Channels since November of 1998. Mr. Dedo is responsible for
marketing, product development, business analysis and public relations
activities. From January 1998 through October 1998, Mr. Dedo was Vice President
of Marketing for Billing Concepts Corporation, a billing solution provider for
the telecommunications industry. In 1997, Mr. Dedo was director of carrier
sales for MCI Communications Corporation. From 1985 to 1997, Mr. Dedo held
various executive management positions in sales, marketing and strategic
planning with MCI. Mr. Dedo received his Masters in Management from
Northwestern University. He also holds a Bachelor of Arts degree in Economics.
Richard J. Metzger. Mr. Metzger has been Vice President of Regulatory
Affairs and Public Policy since September 1998. From 1994 to 1998, he served as
General Counsel of the Association for Local
46
<PAGE>
Telecommunications Services. From 1984 to 1993, he held various legal positions
with Ameritech including serving as Vice President and General Counsel of
Wisconsin Bell and Michigan Bell. From 1976 to 1984, he was an attorney at the
law firm of Sidley & Austin. Mr. Metzger received his J.D. from the University
of Chicago and holds a Bachelor of Arts degree in Philosophy of Science.
James E. Crawford, III. Mr. Crawford has served as a director of Focal since
November 1996. Since August 1992, he has been a general partner of Frontenac
Company, a venture capital firm. From February 1984 to August 1992, Mr.
Crawford was a general partner of William Blair Venture Management Co., the
general partner of William Blair Venture Partners III, a venture capital fund.
He was also a general partner of William Blair & Company, an investment bank
and brokerage firm affiliated with William Blair Venture Management Co., from
January 1987 to August 1992. Mr. Crawford serves as a director of Optika, Inc.,
Input Software, Inc., Allegiance Telecom and several private companies.
John A. Edwardson. Mr. Edwardson has served as a director of Focal since
February 1999. He has been President and Chief Executive Officer of Borg-Warner
Security Corp., a security services company, since March 1999. From 1994 to
1998, Mr. Edwardson was President of UAL Corporation, the holding company for
United Airlines and also served as UAL's Chief Operating Officer from April
1995 through September 1998. He previously was Executive Vice President and
Chief Financial Officer of Ameritech and held executive positions with
Northwest Airlines. Mr. Edwardson also serves as a director of Borg-Warner
Security Corp. and Household International, Inc.
Paul J. Finnegan. Mr. Finnegan has served as a director of Focal since
November 1996. Since January 1993, Mr. Finnegan has been Managing Director of
Madison Dearborn Partners, Inc., the general partner of Madison Dearborn.
Previously, he served in various positions at First Capital Corporation of
Chicago and its affiliates. Mr. Finnegan currently serves on the Board of
Trustees of The Skyline Fund and the Board of Directors or Managers, as
applicable, of CompleTel, LLC and Allegiance Telecom.
Richard D. Frisbie. Mr. Frisbie has served as a director of Focal since
November 1996. Mr. Frisbie is a founder and has been Managing Partner of
Battery Ventures since 1983. He is responsible for management of the Battery
Funds and focuses principally on communications opportunities. Mr. Frisbie
serves as a director of Allegiance Telecom.
James N. Perry, Jr. Mr. Perry has been a director of Focal since November
1996. From January 1993 to January 1999, he served as Vice President of Madison
Dearborn Partners, Inc., and since January of 1999 has served as Managing
Director of Madison Dearborn Partners, Inc. Previously, Mr. Perry served in
various positions at First Capital Corporation of Chicago and its affiliates.
Mr. Perry currently serves as a director or manager, as applicable, of Clearnet
Communications, Inc., Omnipoint Corporation, CompleTel, LLC and Allegiance
Telecom.
Paul G. Yovovich. Mr. Yovovich has served as a director of Focal since March
1997. Mr. Yovovich served as President of Advance Ross Corporation, an
international transaction services and manufacturing company, from 1993 to
1996. He is a private investor. He served in several executive positions with
Centel Corporation from 1982 to 1992, where his last position was that of
President of its Central Telephone Company unit. Before joining Centel, he was
a Vice President in the investment banking unit of Dean Witter. Mr. Yovovich
also serves as a director of 3Com Corporation, APAC TeleServices, Inc., Van
Kampen Open End Funds, an investment company, Comarco, Inc. and several private
companies.
How Our Directors Are Elected
The Board of Directors presently consists of eight members. At present all
directors are elected annually and serve until the next annual meeting of
stockholders or until the election and qualification of their successors.
Effective upon completion of the offering, the Board of Directors will be
divided into three classes, as nearly equal in number as possible. Each
director will serve a three-year term and one class will be elected
47
<PAGE>
at each year's annual meeting of stockholders. Mr. Finnegan and Mr. Frisbie
will be in the class of directors whose term will expire at our 2000 annual
meeting of stockholders. Mr. Barnicle, Mr. Crawford and Mr. Yovovich will be in
the class of directors whose term will expire at our 2001 annual meeting of
stockholders. Mr. Edwardson, Mr. Perry and Mr. Taylor will be in the class of
directors whose term will expire at our 2002 annual meeting of stockholders. At
each annual meeting of stockholders, successors to the class of directors whose
terms expire at the meeting will be elected to serve for three-year terms and
until their successors are elected and qualified.
Our existing stockholders are parties to a Stockholders Agreement dated as
of November 27, 1996. Each stockholder has agreed to vote all of its shares so
that our Board of Directors will consist of:
. Two representatives of Madison Dearborn
. One representative of Frontenac
. One representative of Battery Ventures
. Two of Mr. Addy, Mr. Barnicle, Mr. Beatty or Mr. Taylor
. Two non-employee directors
Currently, Mr. Finnegan and Mr. Perry serve as the Madison Dearborn
representatives, Mr. Crawford serves as the Frontenac representative, Mr.
Frisbie serves as the Battery Ventures representative, Mr. Barnicle and Mr.
Taylor serve as the executive representatives and Mr. Edwardson and Mr.
Yovovich serve as the non-employee directors. The terms of the Stockholders
Agreement relating to election of directors will terminate upon completion of
the offering. Thereafter, each director will be elected by a plurality vote of
our stockholders.
Our Board Committees
The Board has established three committees. They are the:
. Compensation Committee
. Audit Committee
. Nominating Committee
The Compensation Committee establishes salaries, incentives and other forms
of compensation for our directors, executive officers and key employees and
administers our equity incentive plans and other incentive and benefit plans.
Upon completion of the offering, the members of the Compensation Committee will
be Mr. Crawford, Mr. Edwardson, Mr. Perry and Mr. Yovovich.
The Audit Committee oversees the work of our independent auditors, reviews
internal audit controls and evaluates conflict of interest issues. Upon
completion of the offering, the members of the Audit Committee will be Mr.
Edwardson, Mr. Finnegan and Mr. Yovovich.
The Nominating Committee identifies nominees to stand for election to our
Board of Directors. Upon completion of the offering, the members of the
Nominating Committee will be Mr. Taylor, Mr. Perry, Mr. Crawford and Mr.
Yovovich.
Compensation of Our Directors
Except for Mr. Edwardson and Mr. Yovovich, our directors do not currently
receive directors fees or other compensation for serving as directors or for
attending meetings of the Board of Directors or its committees. In April 1997,
Mr. Yovovich was granted an option to purchase 130,000 shares of our common
stock under our 1997 Plan. Ten percent of the shares covered by the option
vested immediately and an additional 15% of the shares vest every six months
thereafter. In January 1999, Mr. Yovovich was granted an additional option to
48
<PAGE>
purchase 20,000 shares of common stock under the 1997 Plan, which has the same
vesting terms as his earlier grant. In February 1999, Mr. Edwardson was granted
an option under our 1997 Plan to purchase 130,000 shares of our common stock on
the same vesting terms as the options previously granted to Mr. Yovovich. We
reimburse directors for out-of-pocket expenses incurred in connection with
attendance at meetings of the Board of Directors or committees of the Board of
Directors.
Following the offering, we presently intend to pay our non-employee
directors, other than designees of our institutional investors, in lieu of a
cash retainer, annual director compensation in the form of an annual grant of
stock options. The number of shares subject to each stock option to be granted
to each of these directors on an annual basis will be equal to $60,000 divided
by the option exercise price, which will be the fair market value per share on
the date of grant. All directors will continue to be reimbursed for expenses
incurred to attend Board of Directors or committee meetings. In addition, each
non-employee director may receive stock options or other equity compensation
under the Director Plan. See "--Director Plan."
Potential Conflicts of Interest of Some of Our Directors
In addition to serving as members of our Board of Directors, Mr. Crawford,
Mr. Finnegan, Mr. Frisbie and Mr. Perry each serve as directors of other
telecommunications services companies and other private companies. As a result,
these four directors may be subject to conflicts of interest during their
tenure on our Board of Directors. Accordingly, they may be periodically
required to inform us and the other companies to which they owe fiduciary
duties of financial or business opportunities. We do not currently have any
standard procedures for resolving potential conflicts of interest relating to
corporate opportunities or otherwise. Following completion of the offering,
conflict of interest issues will be resolved by our Audit Committee. Mr.
Finnegan will serve on the Audit Committee.
49
<PAGE>
Compensation of Our Executive Officers
The table below presents information about compensation earned by our Chief
Executive Officer and each of our four other most highly compensated executive
officers whose combined salary and bonus for 1998 exceeded $100,000 for
services rendered in all capacities for our last three fiscal years. The
officers listed in the following table are referred to as the Named Executive
Officers:
Summary Compensation Table
<TABLE>
<CAPTION>
Long-term Compensation
----------------------
Awards(1)
---------
Annual Compensation
Name and Principal -------------------- Securities Underlying All Other
Position Year Salary ($) Bonus ($) Options (#) Compensation (2)($)
- ------------------ ---- ---------- --------- --------------------- -------------------
<S> <C> <C> <C> <C> <C>
Robert C. Taylor, Jr.
Chief Executive Officer 1996 $ 20,000 $ -- -- $ --
1997 120,000 50,000 -- --
1998 150,000 100,000 -- --
John R. Barnicle
Chief Operating Officer 1996 $ 20,000 $ -- -- $ --
1997 120,000 47,000 -- --
1998 140,000 75,000 -- --
Joseph A. Beatty
Chief Financial Officer 1996 $ 20,000 $ -- -- $ --
1997 120,000 45,000 -- 25,000(2)
1998 140,000 75,000 --
Brian F. Addy
Executive Vice President
of
Market Development 1996 $ 20,000 $ -- -- $ --
1997 120,000 38,000 -- --
1998 125,000 50,000 -- --
Renee M. Martin
Senior Vice President
and General Counsel 1996 $ -- $ -- -- $ --
1997 -- -- -- --
1998 127,000 45,000 127,000 --
</TABLE>
- --------
(1) Does not include 2,500,000 shares of common stock issued to each of Mr.
Taylor, Mr. Barnicle, Mr. Beatty and Mr. Addy in 1996 that are subject to
time-vesting requirements set forth in their Employment Agreements, of
which 500,000 shares vested in each of 1996, 1997 and 1998. The remaining
1,000,000 shares will vest in 1999, assuming completion of the offering. At
an assumed initial public offering price of $11.00 per share, these
1,000,000 shares would have an aggregate value of $11,000,000. See "--
Employment Agreements." Also does not include 1,838,943 shares of common
stock issued to each of Mr. Taylor, Mr. Barnicle, Mr. Beatty and Mr. Addy
in 1996 that were subject to performance-vesting requirements set forth in
their Vesting Agreements with some of our institutional investors. Of these
shares, 1,588,943 were canceled in connection with the September 30, 1998
amendments to the Vesting Agreements. The remaining 250,000 shares are
subject to time-vesting requirements set forth in Restricted Stock
Agreements signed at the time of the September 30, 1998 amendments to these
Vesting Agreements. Of these shares, 200,000 remain subject to future
vesting requirements. At an assumed initial public offering price of $11.00
per share, these 200,000 shares would have an aggregate value of
$2,200,000. See "--Vesting Agreements." We do not anticipate paying any
dividends on any of these shares.
(2) Represents reimbursement of moving expenses.
50
<PAGE>
Stock Option Grants
The table below provides information regarding stock options granted to the
Named Executive Officers during the year ended December 31, 1998. None of the
Named Executive Officers received stock appreciation rights, or SARs.
<TABLE>
<CAPTION>
Potential Realizable Value
at Assumed Annual Rates
of Stock Price Appreciation
Individual Grants(1) for Option Term(2)
-------------------------------------------------------- ----------------------------
% of Total
Number of Options
Securities Granted to Exercise or
Underlying Employees in Base Price
Name Options Granted Fiscal Year (per share) Expiration Date 5% 10%
- ---- --------------- ------------ ----------- --------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Robert C. Taylor, Jr.... -- -- -- -- -- --
John R. Barnicle........ -- -- -- -- -- --
Joseph A. Beatty........ -- -- -- -- -- --
Brian F. Addy........... -- -- -- -- -- --
Renee M. Martin......... 67,000 2.2% $2.10 March 31, 2008 $ 88,485 $ 224,239
60,000 2.2% $3.00 August 20, 2008 $ 113,200 $ 286,874
</TABLE>
- --------
(1) The options granted to Ms. Martin were granted under the 1997 Plan (as
defined below). See "--1997 Plan." No stock option grants were made to any
of the Named Executive Officers in years prior to the year ended December
31, 1998. The 67,000 options were granted on April 1, 1998 and vest 25% on
the first anniversary of the date of grant and 12.5% every six months
thereafter. The 60,000 options were granted on August 21, 1998. Of these
options, 20% vested immediately and 10%, 15%, 20% and 35%, respectively,
will vest on the subsequent four anniversaries of the date of grant.
(2) Based on a ten-year option term and annual compounding, the 5% and 10%
calculations are set forth in compliance with the rules of the Securities
and Exchange Commission. The appreciation calculations do not take into
account any appreciation in the price of the common stock to date and are
not necessarily indicative of future values of stock options or the common
stock.
Exercise of Stock Options and Year-End Values
The following table sets forth information regarding the number and value of
unexercised stock options held by each of the Named Executive Officers as of
December 31, 1998. None of the Named Executive Officers exercised stock options
in 1998. None of the Named Executive Officers holds SARs.
<TABLE>
<CAPTION>
Value of
Unexercised In-
Number of the-Money
Unexercised Options ($) at
Options at Fiscal Year
Fiscal Year End End(2)
---------------- ----------------
Exercisable/ Exercisable/
Name Unexercisable(1) Unexercisable
- ---- ---------------- ----------------
<S> <C> <C>
Robert C. Taylor, Jr.......................... -- $ --
John R. Barnicle.............................. -- --
Joseph A. Beatty.............................. -- --
Brian F. Addy................................. -- --
Renee M. Martin............................... 12,000/115,000 $36,000/$345,000
</TABLE>
- --------
(1) These shares represent shares issuable pursuant to stock options granted
under our 1997 Plan. See "--1997 Plan."
(2) At December 31, 1998, an estimated market value of $3.00 per share of
common stock was used to determine the value of the in-the-money options.
At an assumed initial public offering price of $11.00 per share, the
unexercisable options would have an aggregate value equal to $1,265,000.
51
<PAGE>
1997 Plan
Our 1997 Non-Qualified Stock Option Plan (the "1997 Plan") permits our Board
of Directors broad discretion to grant non-qualified stock options to
directors, officers and other key employees. The total number of shares of
common stock that may be issued or transferred under the 1997 Plan may not
exceed 8,530,000 shares of common stock. The maximum share number can be
adjusted if Focal undertakes a stock split, stock dividend or other similar
transactions. The Board of Directors determines who will receive options and
what the terms of the options will be. The terms that the Board of Directors
has discretion to determine include:
. The exercise price of the option
. Any vesting provisions, including whether accelerated vesting will occur
in connection with a Change in Control of Focal
. The term of the option, which cannot exceed 10 years
The option agreements between us and each existing optionee provide that,
upon the occurrence of a Change in Control, the portion of the option that
would have vested in the 12 month period following the Change in Control (if
the optionee remained employed by us during that period) will automatically
become vested as of the date of the Change in Control. In addition, if we
terminate the optionee's employment, actually or constructively, in connection
with or in anticipation of a Change in Control, or within two years after a
Change in Control, all of the optionee's remaining options will automatically
become vested and exercisable as of the date of termination.
"Change in Control" is defined under the 1997 Plan to mean any of the
following:
. a sale of all or substantially all of our assets or a merger or other
similar transaction involving us which results in less than a majority
of the voting power of the surviving corporation being held by the
holders of our common stock immediately prior to the transaction
. during any two year period, a majority of the Board of Directors
consists of persons who are not members of or have not been approved by
the incumbent Board of Directors
or
. the ownership or acquisition of 50% or more of our voting power (other
than by us, any employee benefit plan sponsored by us or Madison
Dearborn) by any person or group
As of July 1, 1999, there were options covering 6,463,225 shares of Focal's
common stock outstanding under the 1997 Plan with a weighted average exercise
price of $2.98 per share.
1998 Plan
We also have the 1998 Equity Performance and Incentive Plan (the "1998
Plan") that permits the Board of Directors to grant a variety of awards to
officers and other key employees. The Board of Directors can grant:
. Incentive and non-qualified stock options
. SARs, which are rights to receive an amount equal to a specified portion
of the increase in market value of a common stock over a specified
exercise price between the date of grant and the date of exercise
. Restricted shares, which involve the immediate transfer of shares of
common stock for the performance of services. Restricted shares must be
subject to a "substantial risk of forfeiture" within the meaning of
Section 83 of the Internal Revenue Code
. Deferred shares, which involve an agreement to deliver shares of common
stock in the future in consideration for the performance of services
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<PAGE>
. Performance shares, each of which is a bookkeeping unit equivalent to
one share of common stock
. Performance units, each of which is a bookkeeping unit equivalent to
$1.00
The total number of shares of common stock that may be issued or transferred
under the 1998 Plan may not exceed 5,750,000, and is dependent upon, among
other things, the number of shares issued, or reserved for issuance, under the
1997 Plan prior to completion of this offering. The maximum share number is
subject to adjustment in the event of a stock split, stock dividend or other
similar transactions.
The Board of Directors has broad discretion in granting and establishing the
terms of awards under the 1998 Plan. However, the 1998 Plan does contain the
following limitations:
. The total number of shares of common stock actually issued or
transferred upon the exercise of incentive stock options may not exceed
2,500,000 shares of common stock
. No individual can be granted in any calendar year options and stock
appreciation rights for more than 500,000 total shares of common stock
. The number of shares of common stock issued as restricted shares may not
exceed 1,250,000 shares
. No individual can be granted in any one calendar year performance shares
or performance units having a total maximum value in excess of
$5,000,000, as judged on the grant date
. The per share exercise price of options must be at least equal to the
per share market value on the date of grant
. The term of options may not be more than 10 years
. The amount to be paid to the holder of a stock appreciation right upon
exercise of that right may not exceed 100% of the difference between the
base price for the stock appreciation right and the market value per
share on the date of exercise
. Performance shares and performance units must specify performance
criteria which, if achieved, will result in payment. These awards must
also specify a minimum level of achievement and the method for
determining the amount of payment if the minimum level, but not the
maximum level, of achievement occurs
The broad discretion given to the Board of Directors includes the discretion
to:
. Provide for the payment of dividend equivalents to an optionee or holder
of deferred shares, performance shares or performance units or the
crediting of dividend equivalents against an option exercise price
. Determine any vesting terms of an award, including whether vesting will
accelerate in connection with a Change in Control
. Determine whether an optionee will automatically be granted an
additional option upon exercise of a first option and the terms of the
additional option
. Determine the terms upon which the forfeiture of restricted shares will
lapse
Under the 1998 Plan, the Board of Directors must establish performance
criteria for purposes of performance shares and performance units. The Board of
Directors may also specify performance criteria for stock options, stock
appreciation rights, restricted shares and dividend credits. Performance
criteria may be described in terms of either company-wide objectives or
objectives that are related to the performance of the individual participant or
a division, department, region or function within Focal. Performance criteria
applicable to any award to a participant who is, or is determined by the Board
of Directors likely to become, a "covered employee" within the meaning of
Section 162(m) of the Internal Revenue Code must be limited to specified levels
of, or growth in, one or more of the following criteria:
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<PAGE>
. Market value of our stock
. Book value of our stock
. Market share of our business
. Operating profit
. Net income
. Cash flow
. Earnings, including earnings before interest, taxes, depreciation and
other non-cash items
. Debt/capital ratio
. Return on capital
. Return on equity
. Costs or expenses
. Net assets
. Return on assets
. Margins
. Earnings per share growth
. Revenue growth
. Product volume growth, including growth in lines in service or minutes
of use
. Total return to stockholders
Except where a modification would result in an award to a "covered employee" no
longer qualifying as performance-based compensation within the meaning of
Section 162(m) of the Internal Revenue Code, the Board of Directors may modify
a part or all of these performance criteria as it deems appropriate and
equitable in light of events and circumstances, such as changes in our
business, operations, corporate structure or capital structure.
The 1998 Plan will become effective on the date immediately prior to
completion of the offering. The Board of Directors may not grant awards under
the 1998 Plan after August 21, 2008.
No awards have been made under the 1998 Plan, and immediately following
completion of the offering, there will be no awards outstanding under the 1998
Plan.
Director Plan
We also have a 1998 Equity Plan for Non-Employee Directors that permits our
non-employee directors ("Non-Employee Directors") who are not employees,
representatives or affiliates of any of Madison Dearborn, Frontenac or Battery
Ventures (collectively, the "Institutional Investors") to elect to receive all
or a portion of their compensation as directors in the form of shares of common
stock. The Director Plan also permits us to issue to Non-Employee Directors
options to purchase shares of common stock.
Available Shares. The number of shares of common stock that may be issued or
transferred under the Director Plan, plus the number of shares of common stock
covered by outstanding awards, may not in the aggregate exceed 150,000 shares.
The maximum number of shares may be adjusted if Focal undertakes a stock split,
stock dividend or other similar transactions.
Voluntary Shares. Each Non-Employee Director may elect to have up to 100% of
his annual director compensation paid in the form of shares of common stock
("Voluntary Shares") instead of cash. An election is irrevocable until the end
of that year. An election continues in effect for subsequent calendar years,
unless modified or revoked by another election.
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<PAGE>
Voluntary Shares will be issued on a quarterly basis in arrears and will
have a value based on the market value per share of the common stock on the
last trading day of the applicable quarter. The total number of Voluntary
Shares to be issued will equal the amount of fees that would otherwise have
been payable to the Non-Employee Director in cash.
Discretionary Options. The Director Plan also permits the Board of Directors
to grant stock options to Non-Employee Directors. The Board of Directors will
determine the terms and conditions of options in accordance with the following
provisions:
. the per share exercise price of an option must be equal to or greater
than the market value per share on the date of grant
. each award must specify the type of consideration to be paid in
satisfaction of the exercise price and the manner of payment of such
consideration, which may be any combination of the following:
--in cash or by check acceptable to us
--by the tender to us of shares of common stock owned by the optionee
and having a total fair market value at the time of exercise equal to
the exercise price
--by delivery of irrevocable instructions to a financial institution or
broker to deliver promptly to us sale or loan proceeds with respect to
the shares sufficient to pay the total option exercise price
--through the written election of the optionee to have shares of common
stock withheld by us from the shares otherwise to be received, with
such withheld shares having an aggregate fair market value on the date
of exercise equal to the aggregate option exercise price of the shares
being purchased
Each discretionary option must provide conditions to be satisfied before the
option becomes exercisable in whole or in part. These conditions could include
a specified period of continuous service as a Non-Employee Director or
achievements of performance objectives.
No discretionary option right may have a term of more than ten years from
the date of grant.
Effective Date and Termination. The Director Plan will become effective on
the date immediately prior to completion of the offering. The Board of
Directors may not make awards under the Director Plan after August 21, 2008.
Effect of Termination of Directorships. If a Non-Employee Director who has
been granted options under the Director Plan is terminated due to death,
disability, hardship or other special circumstances, and his options are not
immediately and fully exercisable, the Board of Directors may, in its sole
discretion, take any action that it deems equitable under the circumstances or
in our best interests. These actions may include waiving or modifying any
limitation or requirement with respect to any award under the Director Plan.
No awards have been made under the Director Plan and immediately following
completion of the offering, there will be no awards outstanding under the
Director Plan.
Employment Agreements
Focal is a party to identical Executive Stock Agreement and Employment
Agreements ( "Employment Agreements") with each of Mr. Taylor, Mr. Barnicle,
Mr. Beatty and Mr. Addy (the "Executive Investors"). The Employment Agreements
provide that each Executive Investor will receive a minimum base salary of
$120,000 (or any greater amount approved by a majority of the Board of
Directors, including the Madison Dearborn designee and one of the Frontenac or
Battery Ventures designees) and bonuses determined by the Board of Directors
and based upon our achievement of performance goals set in advance of each year
in the sole discretion of the Board of Directors. Unless he is terminated for
cause, each Executive Investor is entitled for a period of between six and 12
months following termination of his employment with us (depending on the
55
<PAGE>
basis for termination) to continue to receive his salary and medical benefits,
less any amounts the Executive Investor receives as compensation for other
employment.
We entered into an employment agreement with Ms. Martin on March 20, 1998,
on substantially the same employment terms as the Executive Investors. Each
Employment Agreement and Ms. Martin's agreement also require the Executive
Investor or Ms. Martin, as applicable, to assign to us all inventions developed
in the course of employment, maintain the confidentiality of our proprietary
information and refrain from competing with and soliciting employees from Focal
during his or her employment and for a period of up to eighteen months after
his or her termination. During this period, after any applicable severance pay
period has expired, the Executive Investor or Ms. Martin, as applicable, is
entitled to receive noncompetition compensation equal to his or her salary and
medical benefits (net of any amounts he or she receives as compensation for
other employment), unless he or she breaches his or her non-disclosure, non-
compete or non-solicitation obligations.
Pursuant to the Employment Agreements and in exchange for shares of common
stock held by the Executive Investors prior to November 27, 1996:
. 2,500,000 shares of common stock subject to time-vesting requirements
set forth in the Employment Agreements were issued to each of the
Executive Investors on November 27, 1996
and
. 1,838,943 shares of common stock subject to performance-vesting
requirements set forth in the Vesting Agreements (as defined below) were
issued to each of the Executive Investors on November 27, 1996. Of these
shares, 1,588,943 were canceled in connection with the September 30,
1998 amendments to the Vesting Agreements. The remaining 250,000 shares
are subject to time-vesting requirements set forth in Restricted Stock
Agreements signed on September 30, 1998. See "--Vesting Agreements"
Of the 2,500,000 shares issued on November 27, 1996 that are subject to
time-vesting requirements under the Employment Agreements, 500,000 shares
vested immediately and the remaining shares vest in equal installments over a
four year period that commenced November 27, 1997 so long as the Executive
Investor remains employed by Focal. Pursuant to this schedule, 500,000 shares
vested on each of November 27, 1997 and 1998. Upon completion of the offering,
500,000 shares of the 1,000,000 shares that remain subject to vesting under the
Employment Agreements will immediately vest and the remaining 500,000 shares
will vest on November 27, 1999, if the Executive Investor remains in our
employ. The Employment Agreements also contain provisions that provide for
partial acceleration of vesting upon specific business combinations and total
acceleration of vesting upon other business combinations or the Executive
Investor's death or disability.
Each Employment Agreement further provides Focal and other existing
stockholders with rights (which will terminate with respect to vested shares of
common stock upon the completion of the offering) if the Executive Investor
ceases to be employed by Focal for any reason.
Vesting Agreements
Pursuant to the original terms of three separate Vesting Agreements (the
"Vesting Agreements"), each dated November 27, 1996, among Focal, the Executive
Investors and each of our Institutional Investors, each of the Executive
Investors was entitled to earn 1,838,943 shares of common stock if specified
financial performance criteria were satisfied. If any of these shares of common
stock vested, an equal number of shares of common stock held by the
Institutional Investors would be forfeited by the Institutional Investors.
Pursuant to amendments to the Vesting Agreements, on September 30, 1998, the
Vesting Agreements terminated and:
. The Institutional Investors collectively forfeited 2,500,000 shares of
common stock
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<PAGE>
. The Executive Investors each forfeited 1,588,943 shares of common stock
held by them (or a total of 6,355,770 shares for all Executive
Investors)
. 250,000 shares of common stock held by each Executive Investor were
vested and became subject to new time-vesting requirements based on
periods of continuous service with us (the "Restricted Shares"). Twenty
percent of the Restricted Shares immediately vested and the remaining
Restricted Shares will vest 10% on September 30, 1999, 15% on September
30, 2000, 20% on September 30, 2001 and 35% on September 30, 2002. The
Executive Investors are entitled to voting, dividend and other ownership
rights with respect to the Restricted Shares, but the Restricted Shares
are subject to restrictions on transfer until they vest. Vesting of the
Restricted Shares is accelerated under specified circumstances,
including upon a Change in Control or the Executive Investor's death or
disability. Change in Control has the same definition as in the 1997
Plan
Compensation Committee Interlocks and Insider Participation
The Compensation Committee of the Board of Directors currently consists of
five directors, including Mr. Taylor, our President and Chief Executive
Officer. Upon the completion of the offering, the Compensation Committee of the
Board will consist of four directors, none of whom will be an executive
officer. All matters concerning executive compensation in 1998 were addressed
by the full Board of Directors, including Messrs. Taylor and Barnicle, who were
executive officers of Focal during 1998. None of our executive officers served
as a member of the compensation committee or as a director of any other entity.
57
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The table below sets forth information regarding beneficial ownership of our
common stock as of July 1, 1999 for:
. Each of the Named Executive Officers
. Each of our directors
. All of our executive officers and directors as a group
. Each other person who we know beneficially owns 5% or more of our common
stock
All share amounts in the table have been adjusted to reflect the
recapitalization, but not the stock split. Unless otherwise noted, the address
of each Named Executive Officer and director of Focal is 200 North LaSalle
Street, Suite 1100, Chicago, Illinois 60601.
<TABLE>
<CAPTION>
Number of Shares Percent of Percent of
Name Beneficially Owned (1) Shares Before the Offering Shares After the Offering (2)
- ---- ---------------------- -------------------------- -----------------------------
<S> <C> <C> <C>
Named Executive Officers
Robert C. Taylor, Jr.
(3).................... 2,865,385 5.8% 4.9%
John R. Barnicle (4).... 2,795,885 5.7% 4.8%
Joseph A. Beatty (5).... 2,865,385 5.8% 4.9%
Brian F. Addy (6)....... 2,865,385 5.8% 4.9%
Renee M. Martin (7)..... 34,750 * *
Directors
James N. Perry, Jr. (8). 21,606,425 44.0% 37.2%
Paul T. Finnegan (9).... 21,606,425 44.0% 37.2%
James E. Crawford III
(10)................... 10,082,980 20.5% 17.4%
Richard D. Frisbie (11). 5,041,365 10.3% 8.7%
Paul G. Yovovich (12)... 244,719 * *
John A. Edwardson (13).. 182,500 * *
All Executive Officers
and Directors as a
Group (13 persons)
(14)................... 48,584,859 98.7% 83.3%
Other 5% Owners
Madison Dearborn Capital
Partnership, L.P. (15). 21,606,425 44.0% 37.2%
Frontenac VI, L.P. (16). 10,082,980 20.5% 17.4%
Battery Ventures III,
L.P. (17).............. 5,041,365 10.3% 8.7%
</TABLE>
- --------
* Less than 1% of the issued and outstanding shares of our common stock.
(1) In accordance with the rules of the Securities and Exchange Commission,
each beneficial owner's holding have been calculated assuming full
exercise of outstanding warrants and options exercisable by the holder
within 60 days after July 1, 1999, but no exercise of outstanding warrants
and options held by any other person. The table above assumes that the
over-allotment option is not exercised by the underwriters. Unless
otherwise indicated below, the persons and entities named in the table
have sole voting and sole investment power with respect to all shares
beneficially owned by them, subject to applicable community property laws.
(2) Assumes no exercise of the underwriters' over-allotment option.
(3) Includes 1,000,000 and 200,000 shares of common stock subject to vesting
provisions contained in the executive's Employment Agreement and the
Restricted Stock Agreements, respectively. See "Management--Employment
Agreements" and "--Vesting Agreements." Also includes 1,115,385
58
<PAGE>
shares of common stock held by Mistral Partners, L.P., a family limited
partnership. Mr. Taylor exercises sole voting and investment power over
shares held by this partnership.
(4) Includes 1,000,000 and 200,000 shares of common stock subject to vesting
provisions contained in the executive's Employment Agreement and the
Restricted Stock Agreements, respectively. See "Management--Employment
Agreements" and "--Vesting Agreements." Also includes 350,000 shares of
common stock held by JRB Partners, L.P., a family limited partnership.
Mr. Barnicle exercises sole voting and investment power over shares held
by this partnership.
(5) Includes 1,000,000 and 200,000 shares of common stock subject to vesting
provisions contained in the executive's Employment Agreement and the
Restricted Stock Agreements, respectively. See "Management--Employment
Agreements" and "--Vesting Agreements." Also includes 865,000 shares of
common stock held by Coventry Court Partners, L.P., a family limited
partnership. Mr. Beatty exercises sole voting and investment power over
shares held by this partnership.
(6) Includes 1,000,000 and 200,000 shares of common stock subject to vesting
provisions contained in the executive's Employment Agreement and the
Restricted Stock Agreements, respectively. See "Management--Employment
Agreements" and "--Vesting Agreements." Also includes 1,115,385 shares of
common stock held by Ad-Venture Capital Partners, L.P., a family limited
partnership. Mr. Addy exercises sole voting and investment power over
shares held by this partnership.
(7) Consists of shares of common stock subject to options which are
exercisable within 60 days of July 1, 1999.
(8) Mr. Perry, a director, owns no shares in his own name. Consists of shares
of common stock owned by Madison Dearborn. See footnote 15 below. Mr.
Perry's address is c/o Madison Dearborn Partners, Inc., Three First
National Plaza, Suite 3800, Chicago, IL 60602.
(9) Mr. Finnegan, a director, owns no shares in his own name. Consists of
shares of common stock owned by Madison Dearborn. See footnote 15 below.
Mr. Finnegan's address is c/o Madison Dearborn Partners, Inc., Three
First National Plaza, Suite 3800, Chicago, IL 60602.
(10) Mr. Crawford, a director, owns no shares in his own name. Consists of
shares of common stock owned by Frontenac. See footnote 16 below. Mr.
Crawford's address is c/o Frontenac Company, 135 S. LaSalle Street, Suite
3800, Chicago, IL 60603.
(11) Mr. Frisbie, a director, owns no shares in his own name. Consists of
shares of common stock owned by Battery. See footnote 17 below. Mr.
Frisbie's address is c/o Battery Ventures, 20 William Street, Wellesley,
MA 02481.
(12) Includes 148,719 shares of common stock and an additional 96,000 shares
of common stock subject to options which are exercisable within 60 days
of July 1, 1999.
(13) Includes 150,000 shares of common stock and an additional 32,500 shares
of common stock subject to options which are exercisable within 60 days
of July 1, 1999.
(14) Includes 48,381,609 shares of common stock and an additional 203,250
shares of common stock subject to options which are exercisable within 60
days of July 1, 1999.
(15) Consists of shares of common stock owned by Madison Dearborn. Messrs.
Perry and Finnegan, directors of Focal, are principals of Madison
Dearborn Capital Partners, Inc., the general partner of Madison Dearborn.
Because of these positions, Messrs. Perry and Finnegan share voting and
investment power with respect to the shares owned by Madison Dearborn.
The address of Madison Dearborn is Three First National Plaza, Suite
3800, Chicago, IL 60602. See "Management--Potential Conflicts of Interest
of Some of Our Directors."
(16) Consists of shares of common stock owned by Frontenac. Mr. Crawford, a
director, is a general partner of Frontenac Company, the general partner
of Frontenac. Because of this position, Mr. Crawford shares voting and
investment power with respect to the shares owned by Frontenac. The
address of Frontenac is 135 S. LaSalle Street, Suite 3800, Chicago, IL
60603. See "Management--Potential Conflicts of Interest of Some of Our
Directors."
59
<PAGE>
(17) Consists of shares of common stock owned by Battery Ventures. Mr. Frisbie,
a director, is a managing general partner of Battery Ventures. Because of
this position, Mr. Frisbie shares voting and investment power with respect
to the shares owned by Battery Ventures. The address of Battery Ventures
is 20 William Street, Wellesley, MA 02481. See "Management--Potential
Conflicts of Interest of Some of Our Directors."
CERTAIN TRANSACTIONS
The Stock Purchase Agreement and Stockholders' Agreement
We have entered into a Stock Purchase Agreement with some of our
stockholders, dated as of November 27, 1996 and amended after that date.
Pursuant to the Stock Purchase Agreement and additional related agreements, our
existing stockholders were granted put rights, voting rights, and registration
rights described below and elsewhere in this prospectus.
The Stock Purchase Agreement contains standard representations and
warranties by Focal and affirmative and restrictive covenants and permits the
Institutional Investors to force us to liquidate after February 2003. Most of
the affirmative and restrictive covenants in the Stock Purchase Agreement and
the right to force liquidation will terminate upon the completion of the
offering. However, after completion of the offering, we will continue to be
required to:
. Deliver financial information to the Institutional Investors and certain
of their transferees in a private sale of shares of common stock
. Provide access by the Institutional Investors, and certain of their
transferees in a private sale of shares of common stock, to our physical
properties, books and records
. Comply with the periodic reporting requirements under the Securities
Exchange Act of 1934 to enable holders of "restricted shares" of common
stock to sell those shares of common stock pursuant to Rule 144 under
the Securities Act of 1933 or a short-form registration statement under
the Securities Act of 1933. See "Shares Eligible For Future Sale"
The Stockholders' Agreement contains provisions relating to:
. Election of our directors (see "Management--How Our Directors Are
Elected")
. Business combinations involving Focal
. Transfer restrictions and rights of first refusal and participation
related to sales of shares of common stock by existing stockholders
All of these provisions and restrictions, other than transfer restrictions
on unvested shares of common stock held by the Executive Investors, will
terminate upon completion of the offering.
See "Description of Our Capital Stock" for a more detailed discussion of the
various rights and restrictions affecting our common stock and our
stockholders. See "Management--Employment Agreements" and "--Vesting
Agreements" for a more detailed discussion of the various provisions of the
Employment Agreements and Vesting Agreements.
Registration Rights
Focal has granted registration rights to some holders of its common stock.
These holders of common stock have the benefit of the following demand
registration:
. Subject to minimum dollar amounts, Madison Dearborn may demand two
registrations on Form S-1
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<PAGE>
. Frontenac and Battery may each demand one registration on Form S-1
. The holders of 8% of all shares of common stock subject to the
registration agreement, approximately 3,906,974 shares of common stock,
may demand an unlimited number of registrations on Form S-2 or Form S-3
In addition, stockholders that have been granted registration rights have
unlimited "piggyback" registration rights under which they have the right to
request that we register their shares of common stock whenever we register any
of our securities under the Securities Act of 1933 and the registration form to
be used may be used for the registration of their shares of common stock. These
piggyback registration rights will not, however, be available:
. If the piggyback registration is in connection with an underwritten
registration and the managing underwriter concludes that including
shares of common stock owned by holders of "piggyback" registration
rights would have an adverse impact on the marketing of the securities
to be sold in the underwritten offering
. For registrations undertaken because of a demand registration
Stock Purchases by Our Directors
In May 1997, Mr. Yovovich purchased 115,385 shares of common stock for a
purchase price of $75,000. In November 1998, he purchased an additional 33,334
shares of common stock for himself and members of his family for a purchase
price of $100,000. In March 1999, Mr. Edwardson purchased 150,000 shares of
common stock for a purchase price of $472,500.
Some of Our Directors are also Directors of our Competitors
Some of our directors, who serve as representatives of the Institutional
Investors, also serve on the boards of directors of companies with which we may
compete or enter into agreements. Specifically, Mr. Crawford, Mr. Finnegan, Mr.
Frisbie and Mr. Perry are directors of Allegiance Telecom, a Dallas-based CLEC.
Allegiance Telecom is one of our competitors. See "Management--Potential
Conflicts of Interest of Some of Our Directors."
61
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon completion of the offering, Focal's authorized capital stock will
consist of 100,000,000 shares of common stock, $.01 par value per share, and
2,000,000 shares of preferred stock, $.01 par value per share. Giving effect to
the stock split and recapitalization to be completed immediately prior to
completion of the offering, 49,108,430 shares of common stock will be issued
and outstanding, and no shares of preferred stock will be issued or
outstanding. The discussion set forth below describes our capital stock and our
certificate of incorporation and our by-laws that will be in effect upon
completion of the offering.
Common Stock
Holders of common stock are entitled to one vote per share on all matters to
be voted upon by the stockholders generally, including the election of
directors. Holders of common stock will be entitled to receive dividends, if
any, declared from time to time by the Board of Directors out of funds legally
available for dividends. If Focal is liquidated, dissolved or wound-up, holders
of common stock will share proportionately in all assets available for
distribution. However, dividend and distribution rights of holders of common
stock will be subject to the rights of any holders of any series of preferred
stock as described below. The holders of common stock have no preemptive or
conversion rights. The common stock does not have cumulative voting rights. As
a result, the holder or holders of more than half of the shares of common stock
voting for the election of directors can elect all directors being elected at
that time. All shares of common stock outstanding immediately following the
offering will be fully paid and will not be subject to further calls or
assessments. There are no redemption or sinking fund provisions applicable to
the common stock.
Preferred Stock
The certificate of incorporation gives our Board of Directors the authority,
without further stockholder action, to issue shares of preferred stock in one
or more series and to fix the relative powers, preferences, rights,
qualifications, limitations or restrictions of the preferred stock, including:
. Dividend rates
. Conversion rights
. Voting powers
. Terms of redemption
. Redemption prices
. Amounts payable upon liquidation
. The number of shares constituting any series or the designation of such
series
The issuance of preferred stock may have the effect of delaying, deferring
or preventing a change in control of Focal and may adversely affect the voting
and other rights of the holders of the common stock. These effects may include
the loss of voting control to others. We currently have no plans to issue any
shares of preferred stock.
Delaware Law and Anti-Takeover Provisions
Section 203 of the Delaware General Corporation Law. Upon completion of the
offering, we will be subject to the provisions of Section 203 of the Delaware
General Corporation Law. Section 203 provides that a Delaware corporation may
not engage in any of a broad range of business combinations with a person or
affiliate or associate of the person who is an interested stockholder for a
period of three years from the date that the person became an interested
stockholder, unless any of the following occurs:
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. the transaction resulting in a person's becoming an interested
stockholder, or the business combination, is approved by the Board of
Directors of the corporation before the person becomes an interested
stockholder
. the interested stockholder acquires 85% or more of the outstanding
voting stock of the corporation in the same transaction that makes the
person an interested stockholder, excluding shares owned by persons who
are both officers and directors of the corporation and shares held by
employee stock ownership plans
. on or after the date the person became an interested stockholder, the
business combination is approved by the corporation's board of
directions and by the holders of at least 66 2/3% of the corporation's
outstanding voting stock at a stockholder meeting, excluding shares by
the interested stockholder
An "interested stockholder" is defined as any person that is:
. The owner of 15% or more of the outstanding voting stock of the
corporation
. An affiliate or associate of the corporation and was the owner of 15% or
more of the outstanding voting stock of the corporation at any time
within the three-year period immediately prior to the date on which it
is sought to be determined whether the person is an interested
stockholder
Section 203 may have the effect of delaying, deferring or preventing a
change in control of Focal.
Classified Board of Directors. Following completion of the offering, our
Board of Directors will be divided into three classes of directors. Each class
will serve a staggered three-year term. As a result, approximately one-third of
the Board of Directors will be elected each year. Generally a director will
stand for election only once every three years. The Board of Directors believes
that a classified board will help to assure the continuity and stability of the
board and our business strategies and policies. The classified board provision
could have the effect, however, of discouraging a third party from making a
tender offer or otherwise attempting to obtain control of Focal, even though
the attempt might be beneficial to us and our stockholders. In addition, the
classified board provision could delay stockholders who do not agree with the
policies of the board from removing a majority of the board for two years.
Other Provisions. Following completion of the offering, the certificate of
incorporation and bylaws will provide, in general, that:
. the directors in office will fill any vacancy or newly created
directorship on the Board of Directors, with any new director to serve
for the remaining term of the class of directors to which he or she is
elected
. directors may be removed by our stockholders only for cause and by a
vote of the holders of at least 66 2/3% of our stock entitled to vote
generally in the election of directors ("voting stock")
. special meetings of stockholders may be called only by the Board of
Directors or a committee of the Board of Directors expressly authorized
to call a special meeting, and the business permitted to be conducted at
a special meeting is limited to business brought before the meeting by
the Board of Directors
. election of directors and votes regarding amendments to the certificate
of incorporation or bylaws must be by written ballot
. stockholders may not act by written consent and must act on all
proposals at an annual or special meeting
The bylaws also require that stockholders wishing to bring any business,
including director nominations, before an annual meeting of stockholders
deliver written notice to us not later than 60 days or more than 90
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days prior to the date on which we first mailed our proxy materials for the
prior year's annual meeting of stockholders. If, however, our annual meeting is
set for a date that is not within 30 calendar days of the anniversary of the
prior year's meeting, notice by the stockholder must be delivered to us not
later than the close of business on the tenth day following the day on which we
publicly announce the date of our annual meeting. The bylaws further require
that the notice by the stockholder set forth, among other things:
. A description of the business to be brought before the meeting,
including information with respect to a nominated director
. The reasons for conducting the business at the meeting
. Specific information concerning the stockholder proposing the business
and the beneficial owner, if any, on whose behalf the proposal is made
The certificate of incorporation and bylaws provide that the provisions
summarized above and the provisions relating to the classification of the Board
of Directors may not be amended by our stockholders, nor may any provision
inconsistent therewith be adopted by our stockholders, without the affirmative
vote of the holders of at least 66 2/3% of Focal's voting stock, voting
together as a single class.
The foregoing provisions of the certificate of incorporation and bylaws
relating to removal of directors, special meetings of stockholders and advance
notice of stockholder proposals may discourage or make more difficult the
acquisition of control of Focal by means of a tender offer, open market
purchase, proxy contest or otherwise. These provisions may have the effect of
discouraging specific types of coercive takeover practices and inadequate
takeover bids and may encourage persons seeking to acquire control of Focal
first to negotiate with the Board of Directors. We believe that these measures
will benefit us and our stockholders by enhancing our ability to negotiate with
the proponent of any unfriendly or unsolicited proposal to acquire or
restructure Focal. We also believe that the benefits outweigh the disadvantages
of discouraging these proposals because, among other things, negotiation of
these proposals could result in better terms.
Registration Rights
Focal has granted registration rights to some holders of its common stock.
See "Certain Transactions--Registration Rights" for a description of these
registration rights.
Listing
We have applied to have the common stock included for quotation on the
Nasdaq National Market under the symbol "FCOM."
Transfer Agent and Registrar
We have appointed Harris Trust and Savings Bank as the transfer agent and
registrar for our common stock.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock. We
have no plans to pay dividends on our common stock in the future and presently
intend to retain any earnings to fund the growth of our business. The payment
of any future dividends will be determined by the Board of Directors in light
of conditions then existing, including the results of our operations, financial
condition, cash requirements, restrictions in financing agreements, business
conditions and other factors. Our ability to pay dividends is currently
restricted by covenants contained in the Notes indenture.
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DESCRIPTION OF NOTES
The following description is a summary of the material provisions of the
Notes and the Notes indenture. It does not restate those agreements in their
entirety. We urge you to read the Notes indenture and a sample Note, which we
have previously filed with the Securities and Exchange Commission.
The Notes have the following characteristics:
. They mature on February 15, 2008 and are limited to an aggregate stated
principal amount at maturity of $270,000,000
. They were issued at an issue price of $555.6578 per $1,000 stated
principal amount at maturity (the "Issue Price"), which represents
55.56578% of the stated principal amount at maturity
. They generated gross proceeds to Focal of $150,027,606
. They are senior, unsecured obligations of Focal
. They bear interest on the Issue Price at a rate of 12.125% per annum
computed on a semiannual Note equivalent basis from the Issue Date
. In the period prior to February 15, 2003, interest at a rate of 12.125%
per annum will accrue on the Issue Price of the Notes but will not be
payable in cash ("Deferred Interest")
. From and after February 15, 2003, interest at a rate of 12.125% per
annum ("Current Interest") on the stated principal amount at maturity of
the Notes will be payable in cash semiannually on August 15 and February
15 of each year, beginning on August 15, 2003
. The stated principal amount at maturity is $1,000 per Note and
represents the Issue Price, plus Deferred Interest accrued but unpaid up
to February 15, 2003. Focal will pay interest on overdue principal and
premium, if any, of the Notes and, to the extent lawful, interest on
overdue installments of interest on the Notes at a rate per annum equal
to the interest rate payable on the Notes
We may elect to redeem all or part of the Notes at any time or from time to
time, on or after February 15, 2003 at the redemption prices set forth below,
which are expressed as percentages of stated principal amount at maturity, plus
accrued and unpaid Current Interest, if any, on the stated principal amount at
maturity so redeemed to the redemption date if redeemed during the 12-month
period commencing February 15 of the years set forth below:
<TABLE>
<CAPTION>
Redemption
Year Price
---- ----------
<S> <C>
2003........................................................... 106.063%
2004........................................................... 104.042%
2005........................................................... 102.021%
2006 and thereafter............................................ 100.000%
</TABLE>
In addition, at any time and from time to time prior to February 15, 2001,
we may redeem in the aggregate up to 35% of the original aggregate stated
principal amount at maturity of the Notes with the proceeds from one or more
registered underwritten primary public offerings of common stock. Redemption
will be at a price (expressed as a percentage of the accreted value of the
Notes on the redemption date) of 112.125% so long as at least 65% of the
original aggregate stated principal amount at maturity of the Notes remains
outstanding after each redemption. We do not intend to redeem any Notes with
the net proceeds of the offering.
If a Change of Control (as defined below) occurs, each holder of a Note will
have the right to require us to repurchase all or any part of the holder's
Notes at a purchase price equal to 101% of the accreted value thereof, plus
accrued and unpaid Current Interest, if any, up to but excluding the Change of
Control payment date. If after giving effect to the Change of Control
repurchase offer, at least 95% of the original aggregate stated principal
amount at maturity of the Notes has been redeemed or repurchased, we have the
right to redeem the
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balance of the Notes at a purchase price equal to 101% of the accreted value
thereof, plus accrued and unpaid Current Interest, if any, up to but excluding
the determined redemption date.
A "Change of Control" will occur under the Notes indenture if:
. the sale, conveyance, transfer or lease of all or substantially all of
the assets of Focal to any "person" or "group" (as such term is used in
Sections 13(d)(3) and 14(d)(2) of the Exchange Act, including any group
acting for the purpose of acquiring, holding, voting or disposing of
securities within the meaning of Rule 13d-5(b)(i) under the Exchange
Act), other than Madison Dearborn, Frontenac, Battery Ventures or any of
their affiliates, or subsidiaries of Focal, occurs
. any "person" or "group" (as the term is used in Sections 13(d)(3) and
14(d)(2) of the Exchange Act, including any group acting for the purpose
of acquiring, holding, voting or disposing of securities within the
meaning of Rule 13d-5(b)(i) under the Exchange Act), other than Madison
Dearborn, Frontenac, Battery or any of their affiliates, becomes the
"beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) of
more than 50% of the total voting power of all classes of the capital
stock the holders of which are entitled to vote for the election of
directors ("voting stock") of Focal (including any warrants, options or
rights to acquire such voting stock), calculated on a fully diluted
basis
. during any period of two consecutive years, individuals who at the
beginning of such period constituted the Board (together with any
directors whose election or appointment by the Board or whose nomination
for election by the stockholders of Focal was approved by a vote of a
majority of the directors then still in office who were either directors
at the beginning of such period or whose election or nomination for
election was previously so approved) cease for any reason to constitute
a majority of the Board then in office
or
. the merger, amalgamation or consolidation of Focal with or into another
person or the merger of another person with or into Focal shall have
occurred, and the securities of Focal that are outstanding immediately
prior to such transaction and which represent 100% of the aggregate
voting power of the voting stock of Focal are changed into or exchanged
for cash, securities or property, unless pursuant to such transaction
such securities are changed into or exchanged for, in addition to any
other consideration, securities of the surviving corporation that
represent immediately after giving effect to such transaction, at least
a majority of the aggregate voting power of the voting stock of the
surviving corporation
We are also required to offer to repurchase the Notes if all or some of the
net proceeds of an asset sale are not used to purchase telecommunications
equipment or repay other senior indebtedness.
The Notes indenture contains restrictive covenants which, among other
things, restrict our ability to:
. Incur additional indebtedness and, in the case of our subsidiaries,
issue preferred stock
. Pay dividends
. Prepay subordinated indebtedness
. Repurchase capital stock
. Enter into sale and leaseback transactions
. Make investments
. Engage in transactions with affiliates
. Create liens on our assets
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. Cause encumbrances or restrictions to exist on the ability of our
subsidiaries to pay dividends
. Sell assets
. Engage in mergers and consolidations
An event of default will occur under the Notes indenture if, among other
things:
. any principal payment in excess of $1,000,000 with respect to
indebtedness of Focal is not paid when due within any applicable grace
period
. our indebtedness is accelerated by its holders and the principal amount
of the accelerated indebtedness exceeds $5,000,000
. a court enters a final judgment against us in an uninsured or
unindemnified aggregate amount in excess of $10,000,000, which is not
discharged, waived, appealed, stayed, bonded or satisfied for a period
of 60 consecutive days
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the offering, there has been no public market for the common stock.
Future sales of substantial amounts of common stock in the public market, or
the perception that substantial sales could occur, could adversely affect the
prevailing market price of the common stock. Upon completion of the offering,
there will be 58,108,430 shares of common stock outstanding. Of these shares,
the 9,000,000 shares to be sold in the offering will be freely transferable
without restriction or further registration under the Securities Act of 1933,
except for shares purchased by our "affiliates," as that term is defined in
Rule 144 under the Securities Act of 1933. The remaining 49,108,430 shares of
common stock outstanding will be "restricted securities" under Rule 144, and
may in the future be sold without registration under the Securities Act of 1933
to the extent permitted by Rule 144 or any other applicable exemption under the
Securities Act of 1933. Some holders of outstanding shares of common stock
immediately prior to the offering may, under certain circumstances, include
their shares in a registration statement filed by Focal for a public offering
of common stock. Some existing stockholders also have the right to demand that
we register their shares of common stock for resale. See "Description of
Capital Stock--Registration Rights."
In connection with the offering, we, our executive officers and directors
and some of our employees and other stockholders have agreed that, subject to
specified exceptions, we and they will not offer, sell, contract to sell,
pledge, assign or otherwise dispose of or hedge any shares of common stock or
any securities convertible into or exchangeable for common stock without the
prior written consent of Salomon Smith Barney Inc. for a period of 180 days
after the date of this prospectus. Salomon Smith Barney Inc. has sole
discretion to release any of the shares subject to these lock-up agreements at
any time without notice.
In general, under Rule 144, a person, or persons whose shares are
aggregated, including an affiliate, who has beneficially owned "restricted
securities" for at least one year would be entitled to sell within any three-
month period a number of shares that does not exceed the greater of (i) 1% of
the number of shares of common stock then outstanding, which will equal
approximately 581,084 shares immediately after the offering or (ii) the average
weekly trading volume of the common stock on the Nasdaq National Market during
the four calendar weeks preceding the filing with the Securities and Exchange
Commission of a notice on Form 144 with respect to the sale. Sales under Rule
144 are also subject to other requirements regarding the manner of sale, notice
and availability of current public information about Focal. Under Rule 144(k),
a person who is not deemed to have been an affiliate of Focal at any time
during the 90 days preceding a sale, and who has beneficially owned the shares
proposed to be sold for at least two years, including the holding period of any
prior owner except an affiliate, is entitled to sell those shares without
complying with the manner of sale, public information, volume limitation or
notice provisions of Rule 144. Of the 49,108,430 shares of common stock to be
outstanding immediately prior to the offering, 415,651 shares will be eligible
for sale under Rule 144(k)
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immediately after the offering. None of these shares will be subject to lock-up
agreements. An additional 48,692,779 shares will be eligible for sale under
Rule 144, subject to the limitations described above, immediately after the
offering. All of these shares will be subject to lock-up agreements.
As of the date of this prospectus, we have granted options to purchase an
aggregate of 6,463,225 shares of common stock to some of our officers,
directors and employees under the 1997 Plan. Approximately 811,176 of the
shares subject to these options are immediately exercisable and 5,652,049 of
these shares will become exercisable at various times following completion of
the offering, subject to conditions contained in the 1997 Plan and in the
agreements covering the options. Upon completion of the offering, we intend to
register the sale of shares of common stock issued or to be issued under our
1997 Plan, 1998 Plan and Director Plan. See "Management." Thereafter, these
shares may be freely traded unless they are subject to vesting restrictions,
limitations on resale by "affiliates" under Rule 144 or the 180-day lock-up
agreement described above.
UNITED STATES FEDERAL TAX CONSIDERATIONS
FOR NON-U.S. HOLDERS OF COMMON STOCK
The following is a summary of the material United States federal income and
estate tax consequences of the ownership and disposition of Focal common stock
applicable to non-U.S. holders, as defined below, of such common stock. You are
a "non-U.S. holder" for United States federal income tax purposes if you are a
beneficial owner of Focal common stock and are any of the following:
. A nonresident alien individual as to the United States
. A corporation (or other entity treated as a corporation under the United
States Internal Revenue Code of 1986 and the Treasury Regulations
thereunder) that is not created or organized under the laws of the
United States or of any State
. A partnership (or other entity treated as a partnership under the United
States Internal Revenue Code of 1986 and the Treasury Regulations
thereunder) that is not created or organized under the laws of the
United States or of any State
. An estate that is not subject to United States federal income tax on a
net income basis in respect of income or gain on the common stock
. A trust if either its administration is not subject to the primary
supervision of a United States court or with respect to which no United
States persons (as defined in the United States Internal Revenue Code of
1986) have authority to control all substantial decisions of the trust
If you are an individual who is not a United States citizen, you should be
aware that the rules for determining whether you are a nonresident alien
individual as to the United States (and thus subject to United States federal
income and estate taxation as described below) or a resident alien individual
(and thus subject to United States federal income and estate taxation in the
same manner as a United States citizen) are highly complex. You may be a
resident alien individual as to the United States for United States federal
income tax purposes for any year if any of the following apply:
. You are a lawful permanent resident of the United States at any time
during the year
. You have elected to be treated as a resident alien individual under the
provisions of the United States Internal Revenue Code of 1986
. You are physically present in the United States for at least 31 days
during the year and a number of other conditions are satisfied
You should consult your own tax advisors regarding your status as a non-U.S.
holder of Focal common stock.
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This discussion does not deal with all aspects of United States federal
income and estate taxation and does not consider the specific facts and
circumstances that may be relevant to a particular holder in light of such
holder's personal investment or tax position. In addition, it does not address
the treatment of holders of Focal common stock under the laws of any state,
local or non-United States taxing jurisdiction.
This discussion is based on the federal tax laws of the United States,
including the Internal Revenue Code of 1986, the Treasury Regulations
promulgated thereunder, rulings and pronouncements of the United States
Internal Revenue Service and judicial decisions now in effect, all of which are
subject to change at any time. Any of these changes may be applied
retroactively in a manner that could cause the tax consequences to vary
substantially from the consequences described below, possibly having an adverse
effect on a beneficial owner of Focal common stock.
You are urged to consult with your own tax advisors with regard to the
application of the federal income and estate tax laws to your particular
situation, as well as the applicability and effect of any state, local or non-
United States tax laws to which you may be subject.
Dividends
If you are a non-U.S. holder of Focal common stock, dividends paid to you
are subject to withholding of United States federal income tax at a 30% rate or
at a lower rate if so specified in an applicable income tax treaty. If,
however, the dividends you receive are effectively connected with the conduct
of a trade or business in the United States by you or by a partnership that
holds the common stock and of which you are a partner (and the dividends are
attributable to a permanent establishment that is maintained by you or the
partnership in the United States, if this further requirement must be met under
the terms of an applicable income tax treaty as a condition for subjecting you
to United States federal income taxation on a net income basis on such
dividends), then such "effectively connected" dividends generally are not
subject to withholding tax, provided that you satisfy a number of certification
requirements. Instead, such effectively connected dividends are taxed on a net
income basis at the same graduated rates applicable to United States citizens
and resident alien individuals and United States corporations. In general, you
will not be considered to be engaged in a trade or business in the United
States solely as a result of your ownership of Focal common stock.
Effectively connected dividends received by a non-U.S. holder that is a
corporation may, in some circumstances, be subject to an additional "branch
profits tax" at a 30% rate or at a lower rate if so specified in an applicable
income tax treaty.
Under currently effective United States Treasury Regulations, dividends paid
to an address in a foreign country are presumed to be paid to a resident of
that country, unless the payor has actual knowledge to the contrary, for
purposes of the 30% withholding tax discussed above. Under current
interpretations of these United States Treasury Regulations, this presumption
that dividends paid to an address in a foreign country are paid to a resident
of that country, unless the payor has actual knowledge to the contrary, also
applies for purposes of determining whether a lower rate of withholding tax
applies under an applicable income tax treaty.
Under newly issued United States Treasury Regulations, which will generally
apply to dividends paid after December 31, 2000 (the "final withholding
regulations"), if you claim the benefit of a lower rate of withholding tax
under an applicable income tax treaty, you must satisfy a number of
certification requirements. In addition, in the case of Focal common stock held
by a foreign partnership, the certification requirements generally will apply
to the partners of the partnership, and the partnership itself will have to
provide some information, including a United States taxpayer identification
number. The final withholding regulations also provide look-through rules for
tiered partnerships.
If you are eligible for a reduced rate of United States withholding tax
under an applicable income tax treaty, you may obtain a refund of any excess
amounts withheld by filing a refund claim with the Internal Revenue Service.
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Gain on Disposition of Common Stock
If you are a non-U.S. holder, you generally will not be subject to United
States federal income tax on any gain recognized on a sale or other disposition
of Focal common stock unless:
. The gain is effectively connected with the conduct of a trade or
business in the United States by you or by a partnership that holds the
common stock and of which you are a partner (and the gain is
attributable to a permanent establishment maintained by you or the
partnership in the United States, if this further requirement must be
met under the terms of an applicable income tax treaty as a condition
for subjecting you to United States federal income taxation on a net
income basis on gain from the sale or other disposition of the common
stock)
. You are an individual, you or a partnership of which you are a partner
holds the common stock as a capital asset, and you are present in the
United States for 183 or more days during the year of the sale or other
disposition and several other conditions are satisfied
. You are an individual who is a former citizen or long-term resident
alien of the United States and are subject to tax pursuant to the
provisions of the United States federal income tax laws applicable to
United States expatriates
or
. Focal is or has been a "United States real property holding corporation"
for United States federal income tax purposes and you held, directly or
indirectly, at any time during the five-year period ending on the date
of the sale or other disposition, more than 5% of the total outstanding
common stock of Focal (and you are not eligible for any exemption under
an applicable income tax treaty)
Focal has not been, is not and does not anticipate becoming a "United States
real property holding corporation" for United States federal income tax
purposes.
Effectively connected gains are taxed on a net income basis at the same
graduated rates applicable to United States citizens and resident alien
individuals and United States corporations. Effectively connected gains
recognized by a non-U.S. holder that is a corporation may, in some
circumstances, be subject to an additional "branch profits tax" at a 30% rate
or at a lower rate if so specified in an applicable income tax treaty.
Federal Estate Taxes
Focal common stock owned by an individual non-U.S. holder at the time of
death will be included in the holder's gross estate for United States federal
estate tax purposes and thus may be subject to United States federal estate
tax, at graduated rates of up to 55%, unless an applicable estate tax treaty
provides otherwise.
Information Reporting and Backup Withholding Tax
In general, United States information reporting requirements and backup
withholding tax will not apply to dividends paid to you if you are either:
. Subject to the 30% withholding tax discussed above
or
. Not subject to the 30% withholding tax because an applicable income tax
treaty reduces or eliminates the withholding tax
although dividend payments to you will be reported to the Internal Revenue
Service for purposes of the withholding tax. See "--Dividends." If you do not
meet either of these requirements for exemption and you fail to provide
necessary information (including your United States taxpayer identification
number) or
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otherwise establish your status as an "exempt recipient," you may be subject to
backup withholding of United States federal income tax at a rate of 31% on
dividends paid to you with respect to your Focal common stock.
Under current law, Focal may generally treat dividends paid to a payee with
an address outside the United States as exempt from backup withholding tax and
information reporting requirements unless Focal has actual knowledge that the
payee is a United States person. However, under the final withholding
regulations, dividends paid after December 31, 2000 will generally be subject
to backup withholding and information reporting unless a number of
certification requirements are met. See "--Dividends" for the rules applicable
to foreign partnerships under the final withholding regulations.
United States information reporting requirements and backup withholding tax
generally will not apply to a payment of the proceeds of a sale or other
disposition of Focal common stock made outside the United States through an
office outside the United States of a non-U.S. broker. However, United States
information reporting requirements, but not backup withholding tax, will apply
to a payment of the proceeds of a sale or other disposition of common stock
made outside the United States through an office outside the United States of a
broker that:
. Is a United States person
. Is a non-United States person who derives 50% or more of its gross
income for a specified period preceding the year of the sale or other
disposition from the conduct of a trade or business in the United States
. Is a "controlled foreign corporation" as to the United States for United
States federal income tax purposes
or
. With respect to payments made after December 31, 2000, is a foreign
partnership, if at any time during its tax year:
. one or more of its partners are United States persons, as defined in
applicable Treasury Regulations, who in the aggregate hold more than
50% of the income or capital interests in the partnership
or
. the foreign partnership is engaged in the conduct of a trade or
business in the United States
unless that broker has documentary evidence in its records that the holder or
beneficial owner of the common stock disposed of is a non-U.S. holder (and the
broker has no actual knowledge to the contrary), or the payee otherwise
establishes its entitlement to an exemption.
Payment of the proceeds of a sale or other disposition of Focal common stock
through a United States office of a broker is subject to both United States
information reporting requirements and backup withholding tax at the rate of
31% unless the non-U.S. holder certifies as to its non-U.S. status under
penalties of perjury or otherwise establishes its entitlement to an exemption.
Backup withholding is not an additional tax. A non-U.S. holder generally may
obtain a refund of any excess amounts withheld under the backup withholding
rules by filing a refund claim with the Internal Revenue Service.
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UNDERWRITING
Subject to the terms and conditions stated in the underwriting agreement
dated the date of this prospectus, each underwriter named below has severally
agreed to purchase, and we have agreed to sell to the underwriter, the number
of shares set forth below opposite the name of the underwriter.
<TABLE>
<CAPTION>
Number of
Name Shares
---- ---------
<S> <C>
Salomon Smith Barney Inc.
Donaldson, Lufkin & Jenrette Securities Corporation
Morgan Stanley Dean Witter
Credit Suisse First Boston Corporation
DLJdirect Inc.
---------
Total 9,000,000
---------
</TABLE>
The underwriting agreement provides that the obligations of the several
underwriters to purchase the shares included in this offering are subject to
approval of specific legal matters by counsel and to some other conditions. The
underwriters are obligated to purchase all of the shares, other than those
covered by the over-allotment option described below, if they purchase any of
the shares.
The underwriters, for whom Salomon Smith Barney Inc., Donaldson, Lufkin &
Jenrette Securities Corporation, Morgan Stanley Dean Witter, Credit Suisse
First Boston Corporation and DLJdirect Inc. are acting as representatives,
propose to offer some of the shares directly to the public at the public
offering price set forth on the cover page of this prospectus and some of the
shares to selected dealers at the public offering price less a concession not
in excess of $ per share. The underwriters may allow, and these dealers may
reallow, a concession not in excess of $ per share on sales to other
dealers. If all of the shares are not sold at the initial offering price, the
representatives may change the public offering price and other selling terms.
We have granted to the underwriters an option, exercisable for 30 days from
the date of this prospectus, to purchase up to 1,350,000 additional shares of
common stock at the public offering price less the underwriting discount. The
underwriters may exercise this option solely for the purpose of covering any
over-allotments, if any, in connection with this offering. To the extent the
option is exercised, each underwriter will be obligated, subject to specified
conditions, to purchase a number of additional shares approximately
proportionate to that underwriter's initial purchase commitment.
We, our executive officers and directors, some of our employees and other
stockholders have agreed that, subject to specified exceptions, for a period of
180 days after the date of this prospectus, we and they will not, without the
prior written consent of Salomon Smith Barney Inc., offer, sell, contract to
sell, pledge, assign or otherwise dispose of or hedge any shares of our common
stock or any securities convertible into or exchangeable for common stock.
Salomon Smith Barney Inc. in its sole discretion may release any of the
securities subject to these lock-up agreements at any time without notice.
At our request, some of the underwriters have reserved up to 5% of the
shares being offered (the "Directed Shares") for sale at the initial public
offering price to persons who are directors, officers or employees of Focal, or
who are otherwise associated with Focal and its affiliates or employees, and
who have advised Focal of their desire to purchase these shares. The number of
shares of common stock available for sale
72
<PAGE>
to the general public will be reduced to the extent of sales of Directed Shares
to any of the persons for whom they have been reserved. Any shares not so
purchased will be offered by the underwriters on the same basis as all other
shares of common stock offered hereby. Focal has agreed to indemnify the
underwriters against specified liabilities and expenses, including liabilities
under the Securities Act of 1933, in connection with the sales of the Directed
Shares.
Prior to this offering, there has been no public market for our common
stock. Consequently, the initial public offering for the shares was determined
by negotiations between the representatives and us. Among the factors
considered in determining the initial public offering price were our record of
operations, our current financial condition, our future prospects, our markets,
the economic conditions in and future prospects for the industry in which we
compete, our management, and currently prevailing general conditions in the
equity securities markets, including current market valuations of publicly
traded companies considered comparable to us. There can be no assurance,
however, that the prices at which the shares will sell in the public market
after this offering will not be lower than the price at which they are sold by
the underwriters or that an active trading market in the common stock will
develop and continue after this offering.
We have applied to have the common stock included for quotation on the
Nasdaq National Market under the symbol "FCOM."
The table below shows the underwriting discounts and commissions to be paid
to the underwriters by us in connection with this offering. These amounts are
shown assuming both no exercise and the full exercise of the underwriters'
option to purchase additional shares of common stock.
<TABLE>
<CAPTION>
Paid by Focal
-------------------------
No Exercise Full Exercise
----------- -------------
<S> <C> <C>
Per share....................................... $ $
Total........................................... $ $
</TABLE>
In connection with the offering, Salomon Smith Barney Inc., on behalf of the
underwriters, may purchase and sell shares of common stock in the open market.
These transactions may include over-allotment, syndicate covering transactions
and stabilizing transactions. Over-allotment involves syndicate sales of common
stock in excess of the number of shares to be purchased by the underwriters in
the offering, which creates a syndicate short position. Syndicate covering
transactions involve purchases of the common stock in the open market after the
distribution has been completed in order to cover syndicate short positions.
Stabilizing transactions consist of specific bids or purchases of common stock
made for the purpose of preventing or retarding a decline in the market price
of the common stock while the offering is in progress.
The underwriters also may impose a penalty bid. Penalty bids permit the
underwriters to reclaim a selling concession from a syndicate member when
Salomon Smith Barney Inc., in covering syndicate short positions or making
stabilizing purchases, repurchases shares originally sold by that syndicate
member.
Any of these activities may cause the price of the common stock to be higher
than the price that otherwise would exist in the open market in the absence of
these transactions. These transactions may be effected on the Nasdaq National
Market or in the over-the-counter market, or otherwise and, if commenced, may
be discontinued at any time.
We estimate that the total expenses of this offering will be $1,000,000.
We have agreed to indemnify the underwriters against specified liabilities,
including liabilities under the Securities Act of 1933, or to contribute to
payments the underwriters may be required to make in respect of any of those
liabilities.
73
<PAGE>
LEGAL MATTERS
Jones, Day, Reavis & Pogue in Chicago, Illinois will pass upon for Focal the
validity of the shares of common stock offered under this prospectus. Swidler
Berlin Shereff Friedman, LLP in Washington, D.C. will pass upon for Focal
specific regulatory legal matters. Paul, Hastings, Janofsky & Walker LLP in New
York, New York will pass upon specific legal matters for the underwriters.
EXPERTS
The financial statements and schedules included in this prospectus and
elsewhere in the registration statement have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in giving said reports.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549, a Registration Statement on Form S-1 under the
Securities Act of 1933 with respect to the offering. As permitted by the rules
and regulations of the Securities and Exchange Commission, this prospectus does
not contain all the information contained in the Registration Statement. For
further information about us and the offering, you can read the registration
statement and the exhibits and financial schedules filed with the registration
statement. The statements contained in this prospectus about the contents of
any contract or other document are not necessarily complete. You can read a
copy of each contract or other document filed as an exhibit to the registration
statement.
We are currently subject to the informational reporting requirements of the
Securities Exchange Act of 1934 and we file periodic reports and other
information with the Securities and Exchange Commission. After the offering we
will also file proxy statements with the Securities and Exchange Commission.
You can inspect the registration statement and the exhibits and schedules to
the registration statement, as well as the periodic reports, proxy statements
and other information we file with the Securities and Exchange Commission,
without charge at the Public Reference Section of the Securities and Exchange
Commission located at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549. You may obtain information on the operation of the
Public Reference Section of the Securities and Exchange Commission by calling
the Securities and Exchange Commission at 1-800-SEC-0330. You can also inspect
and copy these filings at the regional offices of the Securities and Exchange
Commission located at Seven World Trade Center, 13th Floor, New York, New York
10048 and the Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661. You can obtain copies of all or any portion of these filings
from the Public Reference Section of the Securities and Exchange Commission
upon payment of prescribed fees. Electronic filings made through the Electronic
Data Gathering, Analysis, and Retrieval system are also publicly available
through the Securities and Exchange Commission's Web site (http://www.sec.gov).
We intend to furnish our stockholders with annual reports containing
financial statements audited by independent auditors.
74
<PAGE>
GLOSSARY
Access charges--The charges paid by an IXC to a local exchange carrier for
the origination or termination of the IXC's customer's long distance calls.
Access line--A telephone line that connects a customer to the telephone
company's central office switching equipment.
ATM (Asynchronous Transfer Mode)--High bandwidth, low-delay, connection-
oriented, packet-like switching and multiplexing technique requiring 53-byte,
fixed-sized cells.
Backbone--An element of the network infrastructure that provides high-
speed, high-capacity connections among the network's physical points of
presence, i.e., connection points and service centers. The backbone is used to
transport end user traffic across the metropolitan area and across the United
States.
Bandwidth--Refers to the maximum amount of data that can be transferred
through a computer's backbone or communication channel in a given time. It is
usually measured in Hertz, cycles per second, for analog communications and
bits per second for digital communications.
Carrier--A telephone service provider.
Central office--A carrier's facility where subscriber lines are joined to a
switching office.
Circuit--An electronic, radio or optical connection over which
communications may occur.
CLEC (competitive local exchange carrier)--A category of telephone service
provider that offers services similar to the former monopoly local telephone
company, as recently allowed by changes in telecommunications law and
regulation. A CLEC may also provide other types of telecommunications services
(long distance, Internet access, etc.)
CLEC certification--Granted by a state public service commission or public
utility commission, this allows a telecommunications service provider the
legal standing to offer local exchange telephone services in direct
competition with the ILEC and other CLECs. Such certifications are granted on
a state-by-state basis.
Colocation--A location where a carrier's or customer's equipment
interconnects with the network of a carrier inside the carrier's facility.
Communications Act of 1934--Federal legislation that established rules for
broadcast and nonbroadcast communications, both wireless and wired telephony.
Copper line or loop--A pair of traditional copper telephone lines using
electric current to carry signals.
Data communications--Digital transmissions through wired or wireless
networks, usually linking computers.
Digital--Describes a method of storing, processing and transmitting
information through the use of distinct electronic or optical pulses that
represent the binary digits 0 and 1. Digital transmission and switching
technologies employ a sequence of these pulses to convey information, as
opposed to the continuously variable analog signal. The precise digital
numbers minimize distortion, such as graininess or "snow," in the case of
video transmission, or static or other background distortion in the case of
audio transmission.
DMS-500--A digital central office switch manufactured by Northern Telecom,
that provides both local exchange switching (also known as a "class 5" switch)
and long distance switching (also known as a "class 4" switch) in a single
device.
75
<PAGE>
DSL (Digital Subscriber Line)--A transmission technology enabling high-speed
access in the local copper loop, often for the last mile between the network
service provider--i.e., an incumbent carrier, competitive carrier or an
Internet service provider--and end user.
DSLAM (Digital Subscriber Line Access Multiplexer)--A multiplexer which
houses individual circuit cards used to provide DSL service.
DS-0, DS-1, DS-3--Standard telecommunications industry digital signal
formats, which are distinguishable by bit rate (the number of binary digits (0
and 1) transmitted per second). DS-0 service has a bit rate of up to 64
kilobits per second. DS-1 service has a bit rate of 1.544 megabits per second
and DS-3 service has a bit rate of 45 megabits per second. DS-0 is also
equivalent to one standard telephone line.
FCC (Federal Communications Commission)--The United States government
federal regulatory agency with the authority to regulate all interstate and
international communications media (i.e., radio, television, wire, etc.)
originating or terminating in the United States.
Fiber transport--A physical facility carrying optical signals over fiber
cable.
ILEC (incumbent local exchange carrier)--A company historically providing
local telephone service. Often refers to one of the RBOCs or GTE.
Interconnection agreement--A contract between an ILEC and a CLEC for the
interconnection of the ILEC's and CLEC's networks, for the purpose of mutual
passing of traffic between the networks, allowing customers of one of the
networks to call users served by the other network. These agreements set out
the financial and operational aspects of such interconnection.
ISP (Internet Service Provider)--A company that provides its customers with
access to the Internet.
IXC (Interexchange Carrier)--A provider of telecommunications services
between exchanges, or cities; also called long distance carrier. A long
distance carrier may offer services over its own or another carrier's
facilities.
Local exchange--An area inside of which telephone calls are generally
completed without any toll or long distance charges. Local exchange areas are
defined by the state regulator of telephone services.
LNP (Local number portability)--A technique that allows local exchange
service customers of an ILEC to keep their existing telephone number, while
moving their service to a CLEC.
Minutes of use--A measure of time during which a telecommunications circuit
is maintained.
Modem--An abbreviation of Modulator-Demodulator. An electronic signal-
conversion device used to convert digital signals from a computer to analog
form for transmission over the telephone network. At the transmitting end, a
modem working as a modulator converts the computer's digital signals into
analog signals that can be transmitted over a telephone line. At the receiving
end, another modem working as a demodulator converts analog signals back into
digital signals and sends them to the receiving computer.
MSA (metropolitan statistical area)--A contiguous, geographic area, which
has a population of at least 50,000, defined by the United States government as
having a substantial economic community of interest.
Multiplexing--An electronic or optical process that combines several lower
speed transmission signals into one higher speed signal.
Network--An integrated system composed of switching equipment and
transmission facilities designed to provide for the direction, transport and
recording of telecommunications traffic.
76
<PAGE>
Reciprocal Compensation--The compensation paid by one carrier to send
traffic to another carrier's network.
RBOC (Regional Bell Operating Company)--The five remaining local telephone
companies (formerly part of AT&T) established as a result of the AT&T
divestiture decree. These include BellSouth, Bell Atlantic, Ameritech, U S WEST
and SBC.
Router--A device that accepts the Internet Protocol from a local area
network or another wide area network device and switches/routes Internet
Protocol packets across a network backbone. Some routers also provide protocol
conversion services to transfer Internet Protocol packets over frame relay,
Asynchronous Transfer Mode, and other backbone network services.
Switch--A device that opens or closes circuits or selects the paths or
circuits to be used for transmission of information. Switching is a process of
interconnecting circuits to form a transmission path between users. The DMS-500
by Northern Telecom is an example of a switch.
Switched services--Transmission of switched calls through the local switched
network.
T-1--A digital communications circuit operating at a speed of 1.5 Mbps, also
known as a DS-1 (digital signaling level one) and equivalent to 24 DS-0s.
Time Division Multiplexing--An electronic process that combines multiple
communications channels onto a single, higher-speed channel by interleaving
portions of each in a consistent manner over time.
Trunk or trunking--A circuit between two switches.
VARs (value-added resellers)--Organizations that purchase telecommunications
services on a wholesale basis, generally combine it with other products and
services, and sell the resulting package of services to an end user.
77
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-2
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets as of December 31, 1997, 1998 and March 31,
1999................................................................... F-3
Consolidated Statements of Operations for the Period from May 31, 1996
(Commencement of Operations), to December 31, 1996, for the Years Ended
December 31, 1997, 1998 and for the Three Months Ended March 31, 1998
and 1999............................................................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the Period
from May 31, 1996 (Commencement of Operations), to December 31, 1996,
for the Years Ended December 31, 1997, 1998 and for the Three Months
Ended March 31, 1999................................................... F-5
Consolidated Statements of Cash Flows for the Period from May 31, 1996
(Commencement of Operations), to December 31, 1996, for the Years Ended
December 31, 1997, 1998 and for the Three Months Ended March 31, 1998
and 1999............................................................... F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................................ F-7
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-23
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS............................. F-24
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Focal Communications Corporation:
We have audited the accompanying consolidated balance sheets of FOCAL
COMMUNICATIONS CORPORATION AND SUBSIDIARIES (a Delaware corporation) as of
December 31, 1997 and 1998, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for the period from
May 31, 1996 (commencement of operations), to December 31, 1996, and for the
years ended December 31, 1997 and 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Focal
Communications Corporation and Subsidiaries as of December 31, 1997 and 1998,
and the results of their operations and their cash flows for the period from
May 31, 1996 (commencement of operations), to December 31, 1996, and for the
years ended December 31, 1997 and 1998, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 22, 1999 (except with respect to the matters discussed in Note 16 and
Note 6, to which the date is May 24, 1999 and July 2, 1999, respectively)
F-2
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December December 31, March 31,
ASSETS 31, 1997 1998 1999
------ ----------- ------------ ------------
(Unaudited)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents........... $ 2,256,552 $126,041,001 $106,598,881
Short-term investments.............. -- 7,959,940 7,460,850
Accounts receivable, net of
allowance for doubtful accounts of
$469,000, $1,189,000, and
$1,960,000 at December 31, 1997,
1998 and March 31, 1999,
respectively....................... 2,355,814 9,792,532 15,975,803
Related-party receivables........... 34,883 -- --
Other current assets................ 90,559 843,793 1,149,104
----------- ------------ ------------
Total current assets.............. 4,737,808 144,637,266 131,184,638
----------- ------------ ------------
Fixed assets, at cost:
Buildings and improvements.......... -- 2,350,000 2,350,000
Communications network.............. 7,906,336 44,774,965 57,015,325
Construction in progress............ 1,938,236 15,103,564 23,496,685
Computer equipment.................. 941,237 3,503,512 4,550,282
Leasehold improvements.............. 652,173 8,577,724 11,089,518
Furniture and fixtures.............. 355,759 1,790,596 2,041,502
Motor vehicles...................... -- 19,289 52,548
----------- ------------ ------------
11,793,741 76,119,650 100,595,860
Less--Accumulated depreciation and
amortization....................... 616,967 6,146,530 9,872,098
----------- ------------ ------------
Fixed assets, net................. 11,176,774 69,973,120 90,723,762
----------- ------------ ------------
Other noncurrent assets............... -- 4,963,894 4,662,711
----------- ------------ ------------
$15,914,582 $219,574,280 $226,571,111
=========== ============ ============
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
(DEFICIT)
------------------------------------
<S> <C> <C> <C>
Current liabilities:
Accounts payable.................... $ 1,502,479 $ 8,365,470 $ 5,152,815
Accrued liabilities................. 367,890 1,941,377 2,513,581
Income taxes payable................ -- 4,055,000 --
Current maturities of long-term
debt............................... 943,621 2,887,036 4,108,935
----------- ------------ ------------
Total current liabilities......... 2,813,990 17,248,883 11,775,331
----------- ------------ ------------
Long-term debt, net of current
maturities........................... 2,593,265 182,408,757 191,436,957
----------- ------------ ------------
Other noncurrent liabilities.......... 179,481 588,228 1,644,128
----------- ------------ ------------
Redeemable common stock:
Class A, $.01 par value; 100,000
shares authorized; 80,307, 0 and 0
shares issued and outstanding at
December 31, 1997, 1998, and March
31, 1999, respectively............. 12,403,218 -- --
----------- ------------ ------------
Commitments and contingencies
Stockholders' equity (deficit):
Common Stock, Class A, $.01 par
value; 100,000 shares authorized;
0, 75,374, and 75,746 shares issued
and outstanding at December 31,
1997, 1998, and March 31, 1999,
respectively....................... -- 753 757
Common Stock, Class B, $.01 par
value; 35,000 shares authorized;
20,000, 22,000 and 22,000 shares
issued at December 31, 1997, 1998,
and March 31, 1999, respectively... 200 220 220
Common Stock, Class C, $.01 par
value; 15,000 shares authorized;
14,711, issued at December 31, 1997
and no shares issued at December
31, 1998 and March 31, 1999,
respectively....................... 147 -- --
Additional paid-in capital.......... 5,096,435 35,413,345 37,117,360
Deferred compensation............... (3,791,667) (4,736,432) (4,339,022)
Accumulated deficit................. (3,380,487) (11,349,474) (11,064,620)
----------- ------------ ------------
Total stockholders' equity
(deficit)........................ (2,075,372) 19,328,412 21,714,695
----------- ------------ ------------
$15,914,582 $219,574,280 $226,571,111
=========== ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from
May 31, 1996
(Commencement
of For the
Operations), year ending For the year For the
to December December ending three months ending
31, 31, December 31, March 31,
------------- ----------- ------------ -----------------------
1996 1997 1998 1998 1999
------------- ----------- ------------ ---------- -----------
(Unaudited)
<S> <C> <C> <C> <C> <C>
REVENUES................ $ -- $ 4,023,690 $ 43,531,846 $5,102,448 $26,003,897
--------- ----------- ------------ ---------- -----------
EXPENSES:
Customer service and
network operations... -- 2,154,980 15,284,641 1,826,893 10,369,319
Selling, general and
administrative....... 421,777 2,887,372 12,209,821 1,307,625 5,665,896
Depreciation and
amortization......... 1,150 615,817 6,670,986 890,871 4,026,750
Non-cash compensation
expense.............. 108,333 1,300,000 3,069,553 325,000 1,559,576
--------- ----------- ------------ ---------- -----------
Total expenses...... 531,260 6,958,169 37,235,001 4,350,389 21,621,541
--------- ----------- ------------ ---------- -----------
OPERATING INCOME (LOSS). (531,260) (2,934,479) 6,296,845 752,059 4,382,356
--------- ----------- ------------ ---------- -----------
OTHER INCOME (EXPENSE):
Interest income....... 17,626 195,696 6,528,541 1,015,902 1,306,082
Interest expense...... -- (128,070) (16,134,373) (2,109,152) (5,403,584)
--------- ----------- ------------ ---------- -----------
Total other income
(expense).......... 17,626 67,626 (9,605,832) (1,093,250) (4,097,502)
--------- ----------- ------------ ---------- -----------
INCOME (LOSS) BEFORE
INCOME TAXES........... (513,634) (2,866,853) (3,308,987) (341,191) 284,854
PROVISION FOR INCOME
TAXES.................. -- -- (4,660,000) -- --
--------- ----------- ------------ ---------- -----------
Net income (loss)....... (513,634) (2,866,853) (7,968,987) (341,191) 284,854
ACCRETION TO REDEMPTION
VALUE OF CLASS A COMMON
STOCK.................. -- (103,565) -- -- --
--------- ----------- ------------ ---------- -----------
Net income (loss)
applicable to common
stockholders........... $(513,634) $(2,970,418) $ (7,968,987) $ (341,191) $ 284,854
========= =========== ============ ========== ===========
BASIC NET INCOME (LOSS)
PER SHARE OF COMMON
STOCK.................. $ (30.22) $ (35.21) $ (91.05) $ (3.86) $ 3.24
========= =========== ============ ========== ===========
DILUTED NET INCOME
(LOSS) PER SHARE OF
COMMON STOCK........... $ (30.22) $ (35.21) $ (91.05) $ (3.86) $ 2.75
========= =========== ============ ========== ===========
BASIC WEIGHTED AVERAGE
NUMBER OF SHARES OF
COMMON STOCK
OUTSTANDING............ 16,996 84,373 87,526 88,307 87,922
========= =========== ============ ========== ===========
DILUTED WEIGHTED AVERAGE
NUMBER OF SHARES OF
COMMON STOCK
OUTSTANDING............ 16,996 84,373 87,526 88,307 103,606
========= =========== ============ ========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
For the Period from May 31, 1996 (Commencement of Operations), to
December 31, 1996, for the Years Ended December 31, 1997, 1998, and for the
Three Months Ended March 31, 1999
<TABLE>
<CAPTION>
Common Stock, $.01 Par Value
----------------------------------------------
Common Stock Class A Class B Class C Additional
-------------- -------------- ------------- ---------------- Paid-in Deferred Accumulated
Shares Amount Shares Amount Shares Amount Shares Amount Capital Compensation Deficit
------ ------ ------ ------ ------ ------ -------- ------ ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
May 31, 1996
(commencement of
operations) -- $-- -- $ -- -- $-- -- $ -- $ -- $ -- $ --
Issuance of
Common Stock.... 1,500 -- -- -- -- -- -- -- -- -- --
Conversion of
Common Stock to
Class B Common.. (1,125) -- -- -- 20,000 200 -- -- -- -- --
Conversion of
Common Stock to
Class C Common.. (375) -- -- -- -- -- 14,711 147 -- -- --
Deferred
compensation.... -- -- -- -- -- -- -- -- 5,200,000 (5,200,000) --
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- -- 108,333 --
Net loss........ -- -- -- -- -- -- -- -- -- -- (513,634)
------ ---- ------ ----- ------ ---- -------- ----- ----------- ----------- ------------
BALANCE,
December 31,
1996 -- -- -- -- 20,000 200 14,711 147 5,200,000 (5,091,667) (513,634)
Accretion of
redeemable
Common Stock.... -- -- -- -- -- -- -- -- (103,565) -- --
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- -- 1,300,000 --
Net loss........ -- -- -- -- -- -- -- -- -- -- (2,866,853)
------ ---- ------ ----- ------ ---- -------- ----- ----------- ----------- ------------
BALANCE,
December 31,
1997 -- -- -- -- 20,000 200 14,711 147 5,096,435 (3,791,667) (3,380,487)
Reclassification
resulting from
amendment to
stock purchase
agreement....... -- -- 80,307 803 -- -- -- -- 12,402,415 -- --
Class A Common
capital
contributions... -- -- -- -- -- -- -- -- 13,800,000 -- --
Issuance of
Class A Common
Stock........... -- -- 67 -- -- -- -- -- 100,000 -- --
Cancellation and
conversion of
Common Stock.... -- -- (5,000) (50) 2,000 20 (14,711) (147) 4,014,495 (4,014,318) --
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- -- 3,069,553 --
Net loss........ -- -- -- -- -- -- -- -- -- -- (7,968,987)
------ ---- ------ ----- ------ ---- -------- ----- ----------- ----------- ------------
BALANCE,
December 31,
1998 -- -- 75,374 753 22,000 220 -- -- 35,413,345 (4,736,432) (11,349,474)
Issuance of
Class A Common
Stock........... -- -- 372 4 -- -- -- -- 541,849 -- --
Non-cash
compensation.... -- -- -- -- -- -- -- -- 1,162,166 -- --
Amortization of
deferred
compensation.... -- -- -- -- -- -- -- -- -- 397,410 --
Net income...... -- -- -- -- -- -- -- -- -- -- 284,854
------ ---- ------ ----- ------ ---- -------- ----- ----------- ----------- ------------
BALANCE, March
31, 1999
(Unaudited)..... -- $-- 75,746 $ 757 22,000 $220 -- $ -- $37,117,360 $(4,339,022) $(11,064,620)
====== ==== ====== ===== ====== ==== ======== ===== =========== =========== ============
<CAPTION>
Total
------------
<S> <C>
May 31, 1996
(commencement of
operations) $ --
Issuance of
Common Stock.... --
Conversion of
Common Stock to
Class B Common.. 200
Conversion of
Common Stock to
Class C Common.. 147
Deferred
compensation.... --
Amortization of
deferred
compensation.... 108,333
Net loss........ (513,634)
------------
BALANCE,
December 31,
1996 (404,954)
Accretion of
redeemable
Common Stock.... (103,565)
Amortization of
deferred
compensation.... 1,300,000
Net loss........ (2,866,853)
------------
BALANCE,
December 31,
1997 (2,075,372)
Reclassification
resulting from
amendment to
stock purchase
agreement....... 12,403,218
Class A Common
capital
contributions... 13,800,000
Issuance of
Class A Common
Stock........... 100,000
Cancellation and
conversion of
Common Stock.... --
Amortization of
deferred
compensation.... 3,069,553
Net loss........ (7,968,987)
------------
BALANCE,
December 31,
1998 19,328,412
Issuance of
Class A Common
Stock........... 541,853
Non-cash
compensation.... 1,162,166
Amortization of
deferred
compensation.... 397,410
Net income...... 284,854
------------
BALANCE, March
31, 1999
(Unaudited)..... $21,714,695
============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from
May 31, 1996
(Commencement
of
Operations), For the year For the year
to December ended ended For the three months
31, December 31, December 31, ended March 31,
------------- ------------ ------------ --------------------------
1996 1997 1998 1998 1999
------------- ------------ ------------ ------------ ------------
(Unaudited)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net income (loss)..... $ (513,634) $ (2,866,853) $ (7,968,987) $ (341,191) $ 284,854
Adjustments to
reconcile net income
(loss) to net cash
provided by (used in)
operating
activities--
Depreciation and
amortization....... 1,150 615,817 6,670,986 890,871 4,026,750
Deferred lease
costs.............. -- 179,481 408,747 89,741 389,234
Non-cash
compensation
expense............ 108,333 1,300,000 3,069,553 325,000 1,559,576
Amortization of
discount on senior
discount notes..... -- -- 16,080,249 2,062,174 4,952,327
Provision for losses
on accounts
receivable......... -- 469,000 720,000 577,000 1,145,000
Changes in operating
assets and
liabilities--
Accounts
receivable....... -- (2,824,814) (8,156,718) (3,418,065) (7,328,271)
Related-party
receivables...... (16,883) (18,000) 34,883 (85,466) --
Other current
assets........... -- (90,559) (753,234) (238,072) (305,311)
Accounts payable
and accrued
liabilities...... 268,458 1,601,911 8,436,478 3,883,263 (2,640,451)
Income taxes
payable.......... -- -- 4,055,000 -- (4,055,000)
Other non-current
liabilities...... -- -- -- -- 666,666
---------- ------------ ------------ ------------ ------------
Net cash provided
by (used in)
operating
activities...... (152,576) (1,634,017) 22,596,957 3,745,255 (1,304,626)
---------- ------------ ------------ ------------ ------------
CASH FLOWS FROM
INVESTING ACTIVITIES:
Capital expenditures.. (82,303) (11,655,524) (64,229,247) (7,593,061) (24,476,209)
Change in short-term
investments.......... -- -- (7,959,940) -- 499,090
---------- ------------ ------------ ------------ ------------
Net cash used in
investing
activities...... (82,303) (11,655,524) (72,189,187) (7,593,061) (23,977,119)
---------- ------------ ------------ ------------ ------------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Loan origination fees. -- -- (90,000) -- --
Proceeds from issuance
of long-term debt.... -- 3,697,500 163,103,565 144,083,351 5,807,191
Payments on long-term
debt................. -- (216,528) (3,536,886) (3,533,153) (509,419)
Proceeds from the
issuance of Class A
Common Stock......... 4,025,000 8,275,000 13,900,000 13,800,000 541,853
---------- ------------ ------------ ------------ ------------
Net cash provided
by financing
activities...... 4,025,000 11,755,972 173,376,679 154,350,198 5,839,625
---------- ------------ ------------ ------------ ------------
NET INCREASE (DECREASE)
IN CASH AND CASH
EQUIVALENTS........... 3,790,121 (1,533,569) 123,784,449 150,502,392 (19,442,120)
CASH AND CASH
EQUIVALENTS
beginning of period... -- 3,790,121 2,256,552 2,256,552 126,041,001
---------- ------------ ------------ ------------ ------------
CASH AND CASH
EQUIVALENTS
end of period......... $3,790,121 $ 2,256,552 $126,041,001 $152,758,944 $106,598,881
========== ============ ============ ============ ============
</TABLE>
F-6
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997 and 1998, and March 31, 1999--(Unaudited)
1. ORGANIZATION AND OPERATIONS
Focal Communications Corporation began operations on May 31, 1996. Focal
Communications Corporation and Subsidiaries (the "Company") is a competitive
local exchange carrier ("CLEC") in the United States and offers a range of
telecommunications services. The Company competes with incumbent local exchange
carriers ("ILECs") by providing high-quality, local telecommunications services
to meet the data, voice and colocation transmission needs of its customers. The
Company's customers include large corporations, Internet service providers and
value-added resellers.
The Company incurred an accumulated deficit of $11,349,474, from May 31,
1996 (commencement of operations), through December 31, 1998. The Company had
an accumulated deficit of $11,064,620 as of March 31, 1999. The Company must
generate significant sales and obtain additional capital to adequately grow its
operations. Future profitability of the Company is dependent upon continued
market acceptance and the Company continuing to adequately provide and maintain
its services. Management believes that current financial forecasts, marketing
strategies and capital raising plans are adequate to address these issues.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The 1997, 1998, and March 31, 1999 consolidated balance sheets include the
accounts of the Company and all wholly owned subsidiaries. All material
intercompany transactions and balances have been eliminated in consolidation.
Basis of Accounting
The accompanying consolidated financial statements have been prepared on the
accrual basis of accounting.
Unaudited Interim Financial Information
The unaudited consolidated balance sheet as of March 31, 1999, the unaudited
consolidated statement of stockholders' equity for the three months ended March
31, 1999 and the unaudited statements of operations and cash flows for the
three months ended March 31, 1998 and 1999 include, in the opinion of
management, all adjustments (consisting of normal and recurring adjustments)
necessary to present fairly the Company's financial position, results of
operations and cash flows. Operating results for the three months ended March
31, 1999 are not necessarily indicative of the results which may be expected
for the year ended December 31, 1999. All information included in these notes
to consolidated financial statements related to the three months ended March
31, 1999 is unaudited.
Use of Estimates and Assumptions
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-7
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Risks and Uncertainties
Reciprocal compensation payments are amounts paid by one carrier to send
particular traffic to another carrier's network. Reciprocal compensation is
currently a significant component of the Company's total revenues representing
approximately 81%, 75% and 73% of the Company's total revenues for 1997, 1998
and for the first quarter of 1999, respectively.
Ameritech is disputing its obligation to pay the reciprocal compensation
owed to the Company. This dispute was ruled on in favor of the Company by the
Illinois Commerce Commission in March 1998 and by federal court in July 1998,
and most recently by the Seventh Circuit Court of Appeals. Substantially all of
the disputed amounts have since been collected. There is a risk that prior
decisions and any future appeal regarding the settlement of this dispute in
favor of the Company could be revisited, which could allow the carrier to
obtain a refund of prior reciprocal compensation payments.
As a result of several trends in our business and the current regulatory
environment, the Company expects revenues from reciprocal compensation to
decline significantly. A reduction in or elimination of revenues attributable
to reciprocal compensation which is not offset by increases in other revenues
generated by the Company may have a material adverse effect on the Company.
Concentration of Suppliers
The Company currently leases its transport capacity from a limited amount of
suppliers and is dependent upon the availability of fiber transmission
facilities owned by the suppliers. The Company is currently vulnerable to the
risk of renewing favorable supplier contracts, timeliness of the supplier in
processing the Company's orders for customers and is at risk to regulatory
agreements that govern the rates to be charged to the Company.
Financial Instruments
The Company considers all liquid interest-earning investments with a
maturity of three months or less at the date of purchase to be cash
equivalents. Short-term investments primarily consist of debt securities, which
typically mature between three months and one year from the purchase date and
are held to maturity and valued at amortized cost, which approximates fair
value. The carrying value for current assets and current liabilities as of
December 31, 1997, 1998 and March 31, 1999 reasonably approximates fair value
due to the nature of the financial instrument and the short maturity of these
items. Fair value for the Company's long-term debt is based on market quotes,
where available or by discounting expected cash flows at the rates currently
offered to the Company for debt of the same remaining maturities. The fair
value of the Company's long-term debt is approximately $3,500,000, $165,000,000
and $171,641,000 as of December 31, 1997, 1998 and March 31, 1999,
respectively.
Revenue Recognition
Revenue is recognized over the period in which the services are provided.
Monthly recurring charges include fees paid by customers for lines in service,
additional features on those lines and colocation space. These charges are
billed monthly, in advance, and are fully earned during the month. Usage
charges, initial, nonrecurring charges and reciprocal compensation charges are
billed in arrears and are fully earned when billed.
F-8
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Depreciation and Amortization
Depreciation is provided on a straight-line basis over the estimated useful
lives of the assets as follows:
<TABLE>
<CAPTION>
Asset Description Useful Life
----------------- --------------------------------------
<S> <C>
Buildings and improvements......... 20 years
Communications network............. 3-8 years
Computer equipment................. 3 years
Leasehold improvements............. Shorter of asset life or life of lease
Furniture and fixtures............. 2-5 years
Motor vehicles..................... 2-3 years
</TABLE>
When depreciable assets are replaced or retired, the amounts at which such
assets were carried are removed from the respective accounts and charged to
accumulated depreciation and any gains or losses on disposition is recorded
currently in the consolidated statements of operations.
Maintenance and repairs are charged to expense as incurred, while major
replacements and improvements are capitalized.
Impairment of Long-Lived Assets
The Company periodically assesses the recoverability of the carrying cost
of its long-lived assets based on a review of its projected undiscounted cash
flows related to the asset held for use. If assets are determined to be
impaired, then the asset is written down to its fair value based on the
present value of the discounted cash flows of the related asset or other
relevant measures (quoted market prices, third-party offers, etc.). Based on
its review, management does not believe that an impairment of the long-lived
assets has occurred.
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes," pursuant to which deferred income tax assets and liabilities are
determined based on the difference between the financial statement and tax
bases of assets and liabilities, using enacted tax rates currently in effect.
State and local taxes may be based on factors other than income.
Segment Information
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," replacing the
"industry approach" with the "management approach." The management approach
designates the internal reporting that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. We operate in a single industry segment, "Communication
Services." Operations are managed and financial performance is evaluated based
on the delivery of multiple communications services to customers over fiber
networks. The adoption of SFAS No. 131 did not affect the Company's results of
operations or financial position but did affect the disclosure of segment
information (Note 14).
Stock-based Compensation
The Company has chosen to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25,
the exercise price of the employee stock options equals the fair value of the
underlying stock on the date of grant and no compensation expense is recorded.
The Company has adopted the disclosure only provisions of the SFAS No. 123,
"Accounting for Stock-Based Compensation."
F-9
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Accretion to Redemption Value of Class A Common Stock
Accretion to redemption value of redeemable Class A Common Stock represents
the change in the redemption value of all outstanding Class A Common Stock
allocable to each period. The redemption values for all Class A Common shares
are based on fair market value and accretion is calculated using the effective
interest method (Note 12).
Comprehensive Income
In June, 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 established reporting and
disclosure requirements for comprehensive income and its components within the
financial statements. Other than net loss applicable to Common stockholders,
the Company had no comprehensive income components for the period from May 31,
1996, to December 31, 1996, for the years ended December 31, 1997, 1998 and for
the three months ended March 31, 1999.
Accounting for Derivative Instruments and Hedging Activities
In June, 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
requires that all derivatives be recognized at fair value as either assets or
liabilities. SFAS No. 133 also requires an entity that elects to apply hedge
accounting to establish the method to be used in assessing the effectiveness of
the hedging derivatives and the measurement approach for determining the
ineffectiveness of the hedge at the inception of the hedge. The methods chosen
must be consistent with the entity's approach to managing risk. The standard is
effective for the Company's 2000 fiscal year. The Company will adopt SFAS No.
133 during 1999. Adoption of SFAS No. 133 is not expected to have a material
effect on the Company based on the Company not currently using derivatives or
participating in hedging activities.
Reclassifications
Certain prior-year amounts have been reclassified to conform to the fiscal
1998 and March 31, 1999 presentation. These changes had no impact on the
Company's previously reported financial position or results of operations.
3. RELATED-PARTY RECEIVABLES
As part of the stock purchase agreement (Note 11), executive shareholders,
as defined, purchased their Class A Common shares with 90-day promissory notes.
The promissory notes are with recourse to each executive and have a prepayment
provision without penalty. The notes are secured by a pledge of all Company
Common Stock and other assets held by the executives. Interest accrues on a
daily basis at a rate equal to the applicable federal rate for obligations of
similar duration. These notes were paid in January 1998.
4. LONG-TERM DEBT
During September 1997, the Company entered into a credit facility with a
bank which provides for, among other things, a committed equipment line of up
to a maximum principal amount of $6,000,000. In February 1998, all amounts
outstanding on this credit facility were repaid and the credit facility was
terminated.
In February 1998, the Company completed its offering of $270 million stated
principal amount at maturity of its 12.125% senior discount notes due 2008 (the
"Notes"), which resulted in gross proceeds of $150,027,606. The Notes bear
interest at the rate of 12.125% per annum (computed on a semiannual Note
equivalent basis). In the period prior to February 15, 2003, interest will
accrue but will not be payable in cash.
F-10
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
From February 15, 2003, interest on the stated principal amount at maturity of
the Notes will be payable in cash semiannually on August 15 and February 15 of
each year, beginning on August 15, 2003.
The Notes are senior unsecured obligations of the Company ranking pari passu
in right of payment with all other existing and future senior indebtedness of
the Company, if any, and will rank senior in right of
payment to all existing and future subordinated indebtedness of the Company, if
any. Holders of secured indebtedness of the Company, however, will have claims
that are prior to the claims of the holders of the Notes with respect to the
assets securing such other indebtedness. The Notes will be effectively
subordinated to all existing and future indebtedness and other liabilities of
the Company's subsidiaries (including accounts payable).
The Notes are redeemable, at the Company's option, in whole or in part, at
any time or from time to time, on or after February 15, 2003, at 106.063% of
their stated principal amount at maturity, plus accrued and unpaid current
interest, declining ratably to 100% of their stated principal amount at
maturity, plus accrued and unpaid current interest, on or after February 15,
2006. In addition, at any time and from time to time, prior to February 15,
2001, the Company may redeem in the aggregate up to 35% of the original
aggregate stated principal amount at maturity of the Notes with the proceeds
from one or more public equity offerings following which there is a public
market, at a redemption price (expressed as a percentage of accreted value on
the redemption date) of 112.125%, plus additional interest, if any; provided
that at least 65% of the original aggregate stated principal amount at maturity
of the Notes remains outstanding after each such redemption.
The Notes indenture contains certain covenants which, among other things,
restrict the ability of the Company and certain of its subsidiaries to incur
additional indebtedness (and, in the case of certain subsidiaries, issue
preferred stock), pay dividends or make distributions in respect of the
Company's or such subsidiaries' capital stock, make other restricted payments,
enter into sale and leaseback transactions, incur liens, cause encumbrances or
restrictions to exist on the ability of certain subsidiaries to pay dividends
or make distributions in respect of their capital stock, issue and sell capital
stock of certain subsidiaries, enter into transactions with affiliates, sell
assets, or amalgamate, consolidate, merge or sell or otherwise dispose of all
or substantially all of their property and assets. These covenants are subject
to exceptions and qualifications. The Company is in compliance with these
covenants as of December 31, 1998 and as of March 31, 1999.
In December 1998, the Company obtained a secured equipment term loan (the
"Facility") from a third party with a maximum borrowing level of $25,000,000.
The Facility provides for, among other things, equipment drawdowns through
December 30, 1999, and requires repayment based on 60 equal monthly
installments of principal and interest for each drawdown. All drawdowns under
the Facility bear interest at the five-year swap rate percent plus additional
basis points, as defined in the Facility. Total drawdowns of $19,192,809 and
$24,490,581 were outstanding under the Facility as of December 31, 1998 and
March 31, 1999, respectively. The Facility provides for certain restrictive
financial and nonfinancial covenants. Among other things, these covenants
require the maintenance of minimum cash flow and revenue levels. The Company
was in compliance with these covenants as of December 31, 1998 and March 31,
1999.
In April 1999, the Company amended the Facility to provide a maximum
borrowing level of $50 million (Note 16).
F-11
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Long-term debt at December 31, 1997, 1998 and March 31, 1999, consists of
the following:
<TABLE>
<CAPTION>
December 31, March 31,
----------------------- ------------
1997 1998 1999
---------- ------------ ------------
<S> <C> <C> <C>
Credit facility with a bank, maximum
borrowing level at $6,000,000........... $3,480,972 $ -- $ --
12.125% senior discount notes due 2008,
net of unamortized discount of
$103,897,016 and $98,944,689 at December
31, 1998 and March 31, 1999,
respectively............................ -- 166,102,984 171,055,311
Secured equipment term loan, maximum
borrowing level at $25,000,000.......... -- 19,192,809 24,490,581
Capital leases on equipment with interest
at 14.66%, $2,327 due monthly through
April, 2000............................. 55,914 -- --
---------- ------------ ------------
3,536,886 185,295,793 195,545,892
Less--Current maturities................. 943,621 2,887,036 4,108,935
---------- ------------ ------------
$2,593,265 $182,408,757 $191,436,957
========== ============ ============
</TABLE>
Aggregate maturities of long-term debt outstanding as of December 31, 1998,
is as follows:
<TABLE>
<S> <C>
1999......................................................... $ 2,887,036
2000......................................................... 3,442,991
2001......................................................... 3,777,502
2002......................................................... 4,143,053
2003......................................................... 4,544,309
Thereafter................................................... 166,500,902
------------
Total.................................................... $185,295,793
============
</TABLE>
5. STOCK OPTIONS
The Company established the Focal Communications Corporation 1997 Non
Qualified Stock Option Plan (the "1997 Plan") effective February 27, 1997. The
1997 Plan is administered by the compensation committee of the Company's Board
of Directors (the "Board"). The Board has sole and complete authority to select
participants and grant options for the Company's Class A Common shares which
shall not exceed 5,260 shares, as defined in the plan. On August 21, 1998, the
1997 Plan was amended and the Board increased the number of shares available
for issuance under the 1997 Plan to up to 17,060.
The Company adopted the Focal Communications Corporation 1998 Equity and
Performance Incentive Plan (the "1998 Plan") on August 21, 1998. The Board has
sole and complete authority to select participants and grant options, and other
equity-based instruments for the Company's Class A Common shares. The total
number of shares authorized for issuance pursuant to the 1998 Plan shall not
exceed 11,500 shares, and is dependent upon, among other things, the number of
shares issued, or reserved for issuance, under the 1997 Plan prior to the
consummation of an initial public offering of Common Stock by the Company.
On August 21, 1998, the Company also adopted the 1998 Equity Plan for Non-
Employee Directors of Focal Communications Corporation (the "1998 Non-Employee
Plan"). The Board has sole and complete authority to select participants and
grant options for the Company's Class A Common shares which shall not exceed
300 shares, as defined in the 1998 Non-Employee Plan.
The total number of shares available under the amended 1997 Plan, the 1998
Plan and the 1998 Non-Employee Plan shall not exceed 17,060 shares.
F-12
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Under the Company's stock option plans, the Board has complete discretion in
determining vesting periods and terms of each participant's options granted.
The options granted to participants under the Company's stock option plans
typically vest at 25% on the first-year anniversary from grant date and vesting
at 12.5% every six months for the remainder of vesting years. The term of each
option has a life of 10 years. In addition, the plans provide for accelerated
vesting upon certain events, as defined.
The following summarizes option activity:
<TABLE>
<CAPTION>
Weighted
Average
Exercise Exercise
Shares Prices Prices
------ ----------- --------
<S> <C> <C> <C>
Outstanding at December 31, 1996................... -- $ -- $ --
Granted during 1997................................ 1,222 290-320 297
----- ----------- ------
Outstanding at December 31, 1997................... 1,222 290-320 297
Granted during 1998................................ 6,110 335-1,500 1,229
Canceled during 1998............................... (142) 315-1,500 134
----- ----------- ------
Outstanding at December 31, 1998................... 7,190 $290-$1,500 $1,090
===== =========== ======
Granted during the three months ended March 31,
1999.............................................. 1,034 $ 1,575 $1,575
Exercised during the three months ended March 31,
1999.............................................. (72) 290-1,500 962
Canceled during the three months ended March 31,
1999.............................................. (30) 1,500-1,575 1,530
----- ----------- ------
Outstanding at March 31, 1999...................... 8,122 $290-$1,575 $1,165
===== =========== ======
</TABLE>
The following table summarizes information about fixed stock options
outstanding at December 31, 1998 and March 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Exercise Options Contractual Exercise Options Exercise
Prices Outstanding Life Price Exercisable Price
----------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$290-$335 1,799 8.6 $ 311 569 $ 301
$1,050-$1,500 5,391 9.6 1,350 504 1,500
----- --- ------ ----- ------
At December 31, 1998 7,190 9.3 $1,090 1,073 $ 864
===== === ====== ===== ======
$290-$335 1,767 8.3 $ 311 596 $ 307
$1,050-$1,575 6,355 9.4 1,384 494 1,504
----- --- ------ ----- ------
At March 31, 1999 8,122 9.4 $1,165 1,090 $ 850
===== === ====== ===== ======
</TABLE>
The Company utilized the Black-Scholes option pricing model to estimate the
fair value of options at the date of grant during 1997, 1998 and for the three
months ended March 31, 1999. Had the Company adopted SFAS No. 123, pro forma
net income (loss) applicable to Common stockholders and pro forma basic and
diluted net loss per share of Common Stock would have been approximately
$(3,010,434) and $(35.68), $(8,602,554) and $(98.29), for the years ended
December 31, 1997 and 1998. Pro forma net loss applicable to Common
stockholders and pro forma basic and diluted net loss per share of Common Stock
would have been approximately $226,000 and $2.57 and $2.18 for the three months
ended March 31,1999, respectively. The pro forma disclosure is not likely to be
indicative of pro forma results which may be expected in future years because
of the fact that options vest over several years, compensation expense is
recognized over the vesting period and additional awards may also be granted.
F-13
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Black-Scholes option model estimated the weighted average fair value at
the date of grant of options granted in 1997, 1998, and for the three months
ended March 31, 1999 to be approximately $167, $1,114 and
$1,113 per option, respectively. The remaining contractual life of all options
was approximately nine years. Principal assumptions used in applying the Black-
Scholes model were as follows:
<TABLE>
<CAPTION>
For the
Three Months
Ended
March 31,
1997 1998 1999
--------- --------- ------------
<S> <C> <C> <C>
Risk-free interest rates................. 5.6%-6.7% 4.4%-5.6% 4.57%
Expected life............................ 5 years 5 years 5 years
Expected volatility...................... 41.67% 142.03% 87.29%
Expected dividend yield.................. -- -- --
========= ========= =======
</TABLE>
6. EQUITY TRANSACTIONS
During the first quarter of 1999, the Company granted 1,034 stock options to
employees and directors in which, giving effect to the Company's proposed
initial public offering, the estimated fair market value of the Company's
common stock exceeded the exercise price of the options granted. The Company
also sold 300 shares of Class A Common Stock to a director at a price below the
proposed initial public offering price. Total non-cash compensation related to
these transactions of approximately $3,821,000 will be recognized, of which
$985,000 will be recorded during the first quarter of 1999, and $2,836,000 will
be ratably charged to operations over the four year vesting period of the
options. Non-cash compensation expense totaling approximately $1,162,000 has
been recorded for the three months ended March 31, 1999.
On April 1, 1999 and July 1, 1999, employees were granted 1,267 and 1,641
stock options, respectively. Giving effect to the Company's proposed initial
public offering, the estimated fair market value of the Company's common stock
exceeded the exercise price of the options granted. Total non-cash compensation
related to these grants of approximately $3,789,000 and $5,314,000,
respectively, will be ratably charged to operations over the four-year vesting
period of the options. In addition, during the second quarter of 1999, the
Company granted 2,443 stock options to employees which grant would be effective
only upon the closing of the Company's initial public offering (IPO). The
estimated fair market value of the Company's common stock on the date of the
IPO is expected to exceed the exercise price of these options. Based upon
estimates received from the Company's underwriters, total non-cash compensation
of approximately $8,631,000 may be incurred upon the IPO date. This amount
would be ratably charged to operations over the four year vesting period of the
options.
7. INCOME TAXES
There is no current or deferred tax expense for the period from May 31, 1996
(commencement of operations), to December 31, 1996, for the year ended December
31, 1997 and for the three months ended March 31, 1998 and 1999. Valuation
allowances were provided which offset the tax benefits recorded as deferred tax
assets relating primarily to operating loss carryforwards. The state and local
taxes, net of the federal tax benefit, and the change in valuation allowances
are the only differences between the U.S. federal statutory tax rate and the
Company's effective tax rate for these periods.
For the year ended December 31, 1998, the Company recorded an income tax
provision of $4,660,000. Even though the Company is reporting a loss before
income taxes, the Company has a positive taxable income and is paying income
taxes. This is primarily the result of the nondeductibility, for tax purposes,
of the interest accrued on the Company's 12.125% discount Notes. This interest
expense is subject to the high yield discount obligation ("HYDO") rules which
limits the amount of original issue discount ("OID") which can be deducted in
the current taxable period. This interest will become deductible for tax
purposes in the period in
F-14
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
which the Notes are redeemed or when the interest is paid. The deferred tax
consequences related to the interest accrued and other temporary differences in
reporting items for financial statement and income tax purposes are recognized,
if appropriate. Realization of future tax benefits related to the deferred tax
assets is dependent on many factors, including the Company's ability to
generate taxable income. Management has considered these factors and has
concluded that a full valuation allowance for financial reporting purposes is
required for the deferred tax assets.
The income tax provision for the year ended December 31, 1998, consists of
the following:
<TABLE>
<S> <C>
Current taxes--
U.S. federal................................................. $4,100,000
State and local.............................................. 560,000
----------
4,660,000
----------
Deferred taxes--
U.S. federal................................................. --
State and local.............................................. --
----------
--
----------
Income tax provision....................................... $4,660,000
==========
</TABLE>
U.S. income tax benefit at the statutory tax rate is reconciled below to the
Company's overall provision for income taxes for the year ended December 31,
1998:
<TABLE>
<S> <C>
Tax at U.S. federal income tax rate......................... $(1,125,000)
State and local taxes, net of U.S. federal tax benefit...... 560,000
Non-cash compensation expense............................... 1,044,000
Change in valuation allowance............................... 4,005,000
Other....................................................... 176,000
-----------
Provision for income taxes.............................. $ 4,660,000
===========
</TABLE>
The income tax effect of temporary differences comprising the net deferred
tax assets and tax liabilities as of December 31, 1997, 1998 and March 31, 1999
consists of the following:
<TABLE>
<CAPTION>
December
December 31, 31, March 31,
------------ ----------- -----------
1997 1998 1999
------------ ----------- -----------
<S> <C> <C> <C>
Deferred income tax liabilities--
Depreciation........................... $(227,000) $(2,331,000) $(2,998,000)
Deferred income tax assets--
Net operating loss carryforwards....... 724,000 -- --
Interest on 12.125% discount notes..... -- 6,432,000 8,413,000
Allowance for doubtful accounts........ 17,500 476,000 784,000
Employment related accruals............ 187,500 130,000 218,000
--------- ----------- -----------
929,000 7,038,000 9,415,000
Less--Valuation allowance................ (702,000) (4,707,000) (6,417,000)
--------- ----------- -----------
Net deferred tax assets.............. $ -- $ -- $ --
========= =========== ===========
</TABLE>
The Company has an alternative minimum tax ("AMT") credit carryforward as of
December 31, 1998 and March 31, 1999, of approximately $320,000 for tax
purposes to offset the Company's future regular federal
F-15
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
income tax liability. The AMT benefit has not been recorded as an asset due to
the uncertainty of its realization. The AMT credit does not expire.
8. INCOME (LOSS) PER SHARE
SFAS No. 128, "Earnings Per Share," requires the Company to calculate its
earnings per share based on basic and diluted earnings per share, as defined.
Basic and diluted income (loss) per share for the period from May 31, 1996
(commencement of operations), to December 31, 1996, for the years ended
December 31, 1997, 1998 and for the three months ended March 31, 1998 and 1999,
was computed by dividing net income (loss) applicable to Common stockholders by
the weighted average number of shares of Common Stock (Class A Common Stock and
the vested Class B Common Stock).
Diluted earnings per common share are adjusted for the assumed exercise of
dilutive options and unvested Class B Common shares. Since the adjustments
required for the calculation of diluted weighted average common shares
outstanding are anti-dilutive, this calculation has been excluded from the
diluted loss per share calculation for the period from May 31, 1996
(commencement of operations), to December 31, 1996, for the years ended
December 31, 1997, 1998 and for the first quarter of 1998. Under the
requirements of SFAS No. 128 the Company's basic and diluted weighted average
number of shares outstanding at December 31, 1996, 1997, 1998 and at March 31,
1998 and 1999 is as follows:
<TABLE>
<CAPTION>
December 31, December 31, December 31, March 31, March 31,
1996 1997 1998 1998 1999
------------ ------------ ------------ --------- ---------
<S> <C> <C> <C> <C> <C>
Basic Weighted Average
Number of Common Shares
Outstanding............ 16,996 84,373 87,526 88,307 87,922
Dilutive Stock Options
and Unvested Class B
Common Stock........... 1,447 12,048 11,043 13,304 15,684
------ ------ ------ ------- -------
Dilutive Weighted
Average Number of
Common Shares
Outstanding............ 18,443 96,421 98,569 101,611 103,606
====== ====== ====== ======= =======
</TABLE>
9. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) Plan (the "Plan") covering substantially all
eligible employees. Under the Plan, participants may make pretax contributions
from 1% to 15% of eligible earnings, as defined. The
Company may elect to contribute to the Plan at its discretion. There have been
no Company contributions to the Plan for the period from May 31, 1996, to
December 31, 1996, and for the year ended December 31, 1997. In February, 1998,
the Company elected to match 30% of the first 10% that an employee contributes
to the Plan. The Company's matching contributions totaled approximately
$145,000 and $84,000 for the year ended December 31, 1998 and for the three
months ended March 31, 1999, respectively.
F-16
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. COMMITMENTS AND CONTINGENCIES
Under the terms of various short- and long-term contracts, the Company is
obligated to pay office rents and rent for leasing fiber transmission
facilities. The Company is obligated to pay office rents with its operations
through 2012. The office rent contracts provide for certain scheduled increases
and for possible escalation of basic rentals based on a change in the cost of
living or on other factors. The Company expects to enter into other contracts
for additional office space, other facilities, equipment and maintenance
services in the future. A summary of such fixed commitments at December 31,
1998, is as follows:
<TABLE>
<CAPTION>
Year Amount
---- -----------
<S> <C>
1999.......................................................... $ 3,388,548
2000.......................................................... 3,667,922
2001.......................................................... 3,614,522
2002.......................................................... 3,721,598
2003.......................................................... 3,787,627
Thereafter.................................................... 20,438,214
-----------
Total..................................................... $38,618,431
===========
</TABLE>
Rent expense under operating leases for office rent and rent for leasing
fiber transmission facilities was approximately $6,488, $651,159, $1,522,499
and $1,125,044, respectively, for the period from May 31, 1996, to December 31,
1996, for the years ended December 31, 1997, 1998 and for the three months
ended March 31, 1999.
In April and May of 1999, the Company entered into three agreements for the
rights to use fiber transport capacity with a combined total minimum commitment
of $141.4 million (Note 16).
11. STOCK PURCHASE AGREEMENT
On November 27, 1996, the Company entered into a Stock Purchase Agreement
(the "Agreement") with Institutional Investors and Executives ("Investors"), as
defined. The Agreement resulted in 79,384 shares of Class A Common Stock, par
value $.01 per share being issued for an aggregate purchase price of $4
million, and subsequent transactions in which Investors were required to make
pro rata contributions to the capital of the Company (with no additional shares
being issued) of up to an additional $21.8 million (total investment of up to
$25.8 million). Total capital contributions to the Company for the issuance of
Class A Common were $4,025,000, $8,275,000 and $13,900,000, respectively, for
the period from May 31, 1996, to December 31, 1996, and for the years ended
December 31, 1997 and 1998, respectively.
Subsequent to the closing of the Agreement, the Company sold 77 shares and
846 shares of Class A Common shares to Designees (as defined in the Agreement)
of the Institutional Investors, for a total purchase price of $25,000 and
$275,000 for the period from May 31, 1996 to December 31, 1996 and for the year
ended December 31, 1997, respectively.
As part of the Agreement, the existing Common Stock held by the Executives
was converted into newly issued Class B Common and Class C Common shares (the
"Exchange"). The closing of the Exchange and issuance of Class B Common and
Class C Common shares took place simultaneously with the initial closing of the
issuance of Class A Common shares under the Agreement. In connection with this
transaction, compensation expense totaling approximately $5.2 million will be
charged to income over the vesting period of the Class B Common shares issued
that did not vest immediately. Total non-cash compensation expense of $108,333
was recorded for the period from May 31, 1996, to December 31, 1996; $1,300,000
for 1997 and 1998; and $325,000 for each of the three month periods ended March
31, 1998 and 1999.
F-17
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company amended certain vesting agreements of the Executives and
Institutional Investors on September 30, 1998, which effected the cancellation
of 12,711 shares of the Company's Class C Common Stock then outstanding,
cancellation of 5,000 shares of the Company's Class A Common Stock held by
certain institutional shareholders and the conversion of 2,000 shares of the
Company's Class C Common Stock into Class B Common Stock. The new converted
Class B Common Stock is subject to certain restrictions, and was issued to the
Company's executives (founding shareholders) in satisfaction of the obligations
of the Company and such shareholders set forth in certain vesting agreements as
defined in the Agreement. In connection with such transactions, non-cash
compensation expense totaling approximately $4 million will be charged to
income over the vesting period of the restricted Class B Common shares issued.
Total non-cash compensation expense relating to this matter of $1,769,553 and
$72,410 was recorded during 1998 and for the first quarter of 1999,
respectively. A summary of the Company's Class A, B and C Common Stock is as
follows:
Class A Common--A total of 100,000 shares are authorized, of which 80,307,
75,374 and 75,746 were issued and outstanding as of December 31, 1997, 1998 and
March 31, 1999, respectively. Institutional Investors, as defined, who hold
Class A Common shares had the right to put the shares to the Company at fair
market value but the Agreement was amended and the put right was replaced by a
provision which would require the Company to voluntarily liquidate (Note 11).
The Class A Common Stock held by Institutional Investors have demand
registration rights; all Class A Common stockholders have voting rights,
piggyback registration rights, participate in earnings and dividends and other
preference features, as defined.
Class B Common--A total of 35,000 shares have been authorized and 20,000,
22,000 and 22,000 shares are issued and outstanding as of December 31, 1997,
1998 and March 31, 1999, respectively. Class B Common stockholders have demand
registration rights, voting rights, piggyback registration rights, participate
in earnings and dividends and other preference features, as defined. The Class
B Common issued upon the Exchange will vest 20% on the closing of the Agreement
and 20% on each of the four anniversaries of the closing date of the Agreement.
Accelerated vesting will occur on the dates of certain (as defined) events: (a)
qualified sale of the Company; (b) qualified reorganization; and (c) public
offering of the Company's stock. For the Class B Common converted from Class C
Common, the Restricted Stock Agreement ("RSA") provides, among other things,
vesting of 20% at the closing of the RSA (September 30, 1998), 10%, 15%, 20%
and 35% on each of the consecutive anniversaries of the closing of the RSA,
respectively, with immediate vesting upon a Change in Control, as defined in
the RSA.
Class C Common--A total of 15,000 shares have been authorized and 14,711 and
0 shares are issued and outstanding as of December 31, 1997 and 1998,
respectively. The Company amended certain vesting agreements of the Executives
and Institutional Investors on September 30, 1998, which effected the
cancellation of 12,711 shares of the Company's Class C Common Stock then
outstanding and the conversion of 2,000 shares of the Company's Class C Common
Stock into Class B Common Stock.
12. REDEEMABLE COMMON STOCK
As defined in the Agreement (Note 11), Institutional Investors which hold an
aggregate of 78,461 shares of Class A Common shares had the right to put the
shares to the Company on or after November 27, 2003, at
the greater of the initial purchase price per share of Class A Common owned by
the Institutional Investors or fair market value, as defined in the Agreement.
On January 23, 1998, the Agreement was amended and the aforementioned put right
was replaced by a provision which would allow the Class A Common Institutional
Investors, Executive Investors and Designees of Institutional Investors, as
defined, to require the Company to voluntarily liquidate. The Institutional
Investors at any time and from time to time on or after November 27, 2003, but
not after the consummation of a public offering, shall have the right to
require the Company to voluntarily liquidate the assets of the Company. Upon
receipt of notice of the required liquidation, the Company may elect to
purchase all but not less than all of the Institutional Investors' Class A
Common shares.
F-18
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Although management had not obtained an appraisal of the fair market value
of the Company during 1997, certain public equity transactions have occurred
within the industry upon which management has based its estimate on the
potential redemption value of the aforementioned shares to be $333 per share as
of December 31, 1997. The Company recorded accretion totaling $0 and $103,565
for the period from May 31, 1996, to December 31, 1996, and for the year ended
December 31, 1997.
13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest and non-cash investing and financing activities for
the period from May 31, 1996 (commencement of operations), to December 31,
1996, for the years ended December 31, 1997, 1998 and for the three months
ended March 31, 1999, was as follows:
<TABLE>
<CAPTION>
Three Months
ended
March 31,
1996 1997 1998 1999
----- --------- -------- ------------
<S> <C> <C> <C> <C>
Cash paid during the year for interest. $ -- $ 94,533 $ 69,079 $ 452,069
Fixed assets acquired under capital
leases................................ $ -- $ 68,589 $ -- $ --
Payments made under capital leases..... $ -- $ 12,675 $ 51,908 $ --
Accretion to redemption value of Class
A
Common Stock........................... $-- $103,565 $ -- $ --
Cash paid for income taxes............. $ -- $ -- $605,000 $3,725,000
</TABLE>
14. SEGMENT INFORMATION
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The Company is organized primarily on the
basis of strategic geographic operating segments that provide communications
services in each respective geographic region. All of the Company's geographic
operating segments as of December 31, 1998 and March 31, 1999 have been
aggregated into one reportable segment, "Communications Services," for the year
and as of December 31, 1998 and as of and for the three months ended March 31,
1999. The Company has two strategic geographic operating segments as of
December 31, 1997, and they have been aggregated into one reportable segment,
"Communications Services," for the year and as of December 31, 1997. For the
period from May 31, 1996, to December 31, 1996, the Company did not separately
track its only geographic operating segment from its corporate operations, and
it is not practicable to restate its results by operating segment for that
period.
The accounting policies of the segments are the same as those described in
the "Summary of Significant Accounting Policies." The Company's chief operating
decision maker views earnings before interest, taxes, depreciation and
amortization ("EBITDA") as the primary measure of profit and loss. The
following represents information about revenues and EBITDA which excludes non-
cash compensation, total assets and
capital expenditures for the Communications Services reportable segment as of
and for the years ended December 31, 1997, 1998 and for the three months ended
March 31, 1999:
<TABLE>
<CAPTION>
March 31,
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Revenues............................. $ 4,023,690 $43,531,846 $26,003,897
EBITDA............................... (986,815) 15,161,031 10,000,062
Total assets......................... 13,006,600 73,436,768 94,287,205
Capital expenditures................. 11,655,524 64,229,247 24,476,209
=========== =========== ===========
</TABLE>
F-19
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The following reconciles total segment EBITDA to consolidated net income
(loss) before income taxes for the years ended December 31, 1997, 1998 and for
the three months ended March 31, 1999:
<TABLE>
<CAPTION>
Three months
ended
1997 1998 March 31, 1999
----------- ------------ --------------
<S> <C> <C> <C>
Total EBITDA for reportable
segment....................... $ (986,815) $ 15,161,031 $10,000,062
Corporate EBITDA............... (31,847) 876,353 (31,380)
Depreciation and amortization.. (615,817) (6,670,986) (4,026,750)
Interest expense............... (128,070) (16,134,373) (5,403,584)
Interest income................ 195,696 6,528,541 1,306,082
Non-cash compensation.......... (1,300,000) (3,069,553) (1,559,576)
----------- ------------ -----------
Net income (loss) before
income taxes.............. $(2,866,853) $ (3,308,987) $ 284,854
=========== ============ ===========
</TABLE>
The following reconciles segment total assets to consolidated total assets
as of December 31, 1997, 1998 and March 31, 1999:
<TABLE>
<CAPTION>
December December 31, March 31,
31, 1997 1998 1999
----------- ------------ ------------
<S> <C> <C> <C>
Total assets for reportable
segment........................... $13,006,600 $ 73,436,768 $ 94,287,205
Cash, cash equivalents and short-
term investments.................. 2,037,861 133,307,515 114,059,731
Other current assets............... 41,864 1,125,124 199,235
Fixed assets, net.................. 828,257 6,740,979 13,362,229
Other noncurrent assets............ -- 4,963,894 4,662,711
----------- ------------ ------------
Total consolidated assets...... $15,914,582 $219,574,280 $226,571,111
=========== ============ ============
</TABLE>
The Company currently only operates in the United States. Revenues by major
customer for the years ended December 31, 1997, 1998 and for the three months
ended March 31, 1999, are as follows:
<TABLE>
<CAPTION>
Three months
ended
1997 1998 March 31, 1999
---------- ----------- --------------
<S> <C> <C> <C>
Revenues from major customer A..... $3,266,853 $25,747,481 $13,265,330
Revenues from major customer B..... $ -- $ 6,735,663 $ 5,761,531
========== =========== ===========
</TABLE>
F-20
<PAGE>
FOCAL COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. SELECTED QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
1997--
Revenues................. $ -- $ 86,908 $ 1,226,076 $ 2,710,706
Loss from operations..... (757,521) (1,145,689) (786,384) (244,885)
Net loss applicable to
Common stockholders..... (740,492) (1,119,257) (791,445) (319,224)
=========== =========== =========== ===========
Basic and diluted net
loss per share.......... $ (8.87) $ (13.34) $ (9.39) $ (3.72)
=========== =========== =========== ===========
1998--
Revenues................. $ 5,102,448 $ 8,078,043 $12,755,293 $17,596,062
Income from operations... 752,059 1,886,430 418,968 3,239,388
Net loss applicable to
Common stockholders..... (341,191) (583,399) (4,653,717) (2,390,680)
=========== =========== =========== ===========
Basic and diluted net
loss per share.......... $ (3.86) $ (6.61) $ (52.73) $ (28.04)
=========== =========== =========== ===========
1999--
Revenues................. $26,003,897
Income from operations... 4,382,356
Net income applicable to
Common stockholders..... 284,854
===========
Basic net income per
share................... $ 3.24
===========
Diluted net income per
share................... $ 2.75
===========
</TABLE>
The Company's net loss applicable to Common stockholders and basic and
diluted net loss per share increased significantly in the third quarter of 1998
from the second quarter of 1998 due primarily to the immediate recognition of
approximately $1,697,000 of non-cash compensation resulting from the amendment
to the stock purchase agreement. Additionally, the Company determined that it
would become liable for income taxes in the third quarter, and a tax provision
of approximately $2,197,000 was recorded.
16. SUBSEQUENT EVENTS
On March 25, 1999, the Company amended its product purchase agreement with a
vendor, which provides for, among other things, a minimum commitment to
purchase $25 million in communications network equipment every 12 months, or an
aggregate over the term of the agreement of $75 million, at pre-established
prices.
On April 15, 1999, the Company amended the Facility to increase the maximum
borrowing level from $25 million to $50 million.
On April 28, 1999, the Company signed an agreement for the acquisition of
indefeasible rights of use for fiber transport capacity for a minimum of 8,300
fiber miles. The term of the agreement is 20 years and the total minimum
commitment is approximately $17.9 million. The agreement requires an initial
payment of approximately $3.6 million in the second quarter of 1999.
On May 4, 1999, the Company signed an agreement with another carrier for the
lease of fiber transport capacity for a five year term and a minimum commitment
of $70 million. The Company has committed to $10 million in year one; $13.2
million in year two; and $15.6 million for each of the remaining three years of
the agreement.
F-21
<PAGE>
On May 24, 1999, the Company entered into an agreement for the lease of the
rights to use fiber transport capacity for a minimum of 2,500 fiber miles. The
term of the agreement is 20 years with a renewal option, as defined. The total
minimum commitment is approximately $53.3 million over the lease term.
F-22
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Focal Communications Corporation:
We have audited, in accordance with generally accepted auditing standards,
the consolidated financial statements of Focal Communications Corporation and
its Subsidiaries included in this annual report and issued our report thereon
dated January 22, 1999. Our audits were made for the purpose of forming an
opinion on the basic financial statements taken as a whole. The schedule of
Valuation and Qualifying Accounts, is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not a part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Arthur Andersen LLP
Chicago, Illinois
January 22, 1999
F-23
<PAGE>
Schedule II
FOCAL COMMUNICATIONS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance
at the
Beginning Charged to Charged Balance at
of the Cost and to other the End of
Accounts Period Expense Accounts Deductions the Period
- -------- --------- ---------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
1996:
Allowance for Doubtful
Accounts................ $ -- $ -- $-- $ -- $ --
1997:
Allowance for Doubtful
Accounts................ $ -- $ 469,000 $-- $ -- $ 469,000
1998:
Allowance for Doubtful
Accounts................ $469,000 $1,348,000 $-- $628,000 $1,189,000
</TABLE>
F-24
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
9,000,000 Shares
Focal Communications Corporation
Common Stock
[FOCAL LOGO]
--------
PROSPECTUS
, 1999
--------
Salomon Smith Barney
Donaldson, Lufkin & Jenrette
Morgan Stanley Dean Witter
Credit Suisse First Boston
DLJdirect Inc.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the estimated expenses to be borne by Focal
in connection with the issuance and distribution of the securities being
registered hereby, other than underwriting discounts and commissions.
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee........... $ 31,970
NASD Filing Fee............................................... 12,000
NASDAQ Listing Fee............................................ 95,000
Printing...................................................... 250,000
Legal Fees and Expenses....................................... 350,000
Accounting Fees and Expenses.................................. 75,000
Transfer Agent Fees and Expenses.............................. 10,000
Miscellaneous................................................. 176,030
----------
Total..................................................... $1,000,000
==========
</TABLE>
Item 14. Indemnification of Directors and Officers
Delaware General Corporation Law. We have statutory authority to indemnify
our officers and directors. The applicable provisions of the DGCL state that,
to the extent an officer or director is successful on the merits or otherwise,
a corporation may indemnify any person who was or is a party or who is
threatened to be made a party to any threatened, pending or completed action,
suit or proceeding, whether civil, criminal, administrative or investigative
(other than an action by or in the right of the corporation), by reason of the
fact that he is or was a director, officer, employee or agent of the
corporation or is or was serving at the request of the corporation as a
director, officer, employee or agent of another corporation, partnership, joint
venture, trust or other enterprise (each, a "Person"), against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement,
actually and reasonably incurred by such Person, if he acted in good faith and
in a manner he reasonably believed to be in, or not opposed to, the best
interests of the corporation and with respect to any criminal action or
proceeding, had no reasonable cause to believe his conduct was unlawful. In any
threatened, pending or completed action by or in the right of the corporation,
a corporation also may indemnify any such Person for costs actually and
reasonably incurred by him in connection with that action's defense or
settlement, if he acted in good faith and in a manner he reasonably believed to
be in, or not opposed to, the best interests of the corporation; however, no
indemnification shall be made with respect to any claim, issue or matter as to
which such Person shall have been adjudged to be liable to the corporation,
unless and only to the extent that a court shall determine that such indemnity
is proper.
Under the applicable provisions of the DGCL, any indemnification shall be
made by the corporation only as authorized in the specific case upon a
determination that the indemnification of the director, officer, employee or
agent is proper in the circumstances because he has met the applicable standard
of conduct. Such determination shall be made:
(1) By the Board of Directors by a majority vote the directors who are
not parties to such action, suit or proceeding, even if less than a quorum;
(2) By a committee of such directors designated by a majority vote of
the directors who are not parties to such action, suit or proceeding, even
if less than a quorum;
(3) If there are no such directors, or if such directors so direct, by
independent legal counsel in a written opinion; or
II-1
<PAGE>
(4) By the stockholders.
Focal's certificate of incorporation and bylaws provide for indemnification
to the full extent permitted by the laws of the State of Delaware against and
with respect to threatened, pending or completed actions, suits or proceedings
arising from or alleged to arise from, a party's actions or omissions as a
director, officer, employee or agent of Focal or of any subsidiary of Focal or
of any other corporation, partnership, joint venture, trust or other entity
which he has served in such capacity at the request of Focal if such acts or
omissions occurred or were or are alleged to have occurred, while said party
was a director, officer employee or agent of Focal.
Item 15. Recent Sales of Unregistered Securities
Since its inception, Focal has issued the following securities without
registration under the Securities Act (the disclosure, including the number of
shares, set forth below gives effect to the recapitalization and stock split
referred to in the prospectus). As used below, the term "Focal," for all times
prior to June 12, 1997 (the date of the Plan of Reorganization and Agreement
whereby Focal became the holding company of Focal Communications of Illinois
and its subsidiaries), refers to Focal Communications Corporation of Illinois.
On May 18, 1996, in connection with Focal's formation, Focal issued 500
shares of common stock to Robert C. Taylor, Jr. for consideration of $1.00.
On October 19, 1996, Focal issued an aggregate of 749,500 shares of common
stock to the Executive Investors for consideration of $1,499.
On November 27, 1996, Focal issued an aggregate of 39,730,771 shares of
common stock to the Institutional Investors, the Executive Investors and an
institution for an aggregate initial purchase price of $4,025,000.
On November 27, 1996, Focal issued an aggregate of 17,355,770 shares of
common stock to the Executive Investors upon conversion of the 750,000 shares
of common stock previously held by them pursuant to the terms of Focal's
Amended and Restated Certificate of Incorporation. The issuance of these
securities was exempt from registration under the Securities Act pursuant to
Section 3(a)(9) of the Securities Act, as exempt securities.
On May 20, 1997, Focal issued an aggregate of 423,075 shares of common stock
to a director, two other individuals and a partnership for an aggregate
purchase price of $275,000.
On June 30, 1997, Focal issued an aggregate of 57,509,555 shares of common
stock to the Institutional Investors, the Executive Investors, a director, two
other individuals, a partnership and an institution in exchange for an equal
number of shares of such classes of common stock of Focal Communications
Corporation of Illinois, pursuant to a Plan of Reorganization and Agreement
between Focal and Focal Communications Corporation of Illinois whereby Focal
became the holding company of Focal Communications Corporation of Illinois and
its subsidiaries. The issuance of these securities was exempt from registration
under the Securities Act pursuant to Section 3(a)(9) of the Securities Act, as
exempt securities.
No underwriters were engaged in connection with the foregoing sales of
securities. Except as specifically otherwise provided above, the above-
described transactions were exempt from registration under the Securities Act
pursuant to Section 4(2) of the Securities Act, as transactions not involving
any public offering.
On February 12, 1998, Focal issued $270,000,000 stated amount at maturity of
12.125% Senior Discount Notes due February 15, 2008 (the "Notes"). Focal
received approximately $150.0 million in gross proceeds and $144.0 million in
net proceeds (after discounts and commissions of approximately $6.0 million and
other
II-2
<PAGE>
transaction costs) from the issuance of the Notes. The Notes were issued to (1)
"qualified institutional buyers" (as defined in Rule 144A under the Securities
Act), and (2) outside the United States in compliance with Regulation S under
the Securities Act, and therefore, the issuance of the Notes was exempt from
registration under the Securities Act. Salomon Brothers Inc, Morgan Stanley &
Co. Incorporated and NationsBanc Montgomery Securities LLC were the initial
purchasers of the Notes.
On November 23, 1998, Focal issued 33,334 shares of common stock to a
director and to a director and his wife as custodian for their children for an
aggregate purchase price of $100,000.
On March 24, 1999, Focal issued 150,000 shares of common stock to a director
for a purchase price of $472,500.
On March 27, 1999, an employee of Focal was issued 36,125 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $69,352.50.
On May 7, 1999, an employee of Focal was issued 9,000 shares of common stock
upon exercise of stock options granted under Focal's 1997 Plan for an aggregate
purchase price of $27,000.
On May 10, 1999, an employee of Focal was issued 17,875 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $29,367.50.
On May 24, 1999, two employees of Focal were issued an aggregate of 7,375
shares of common stock upon exercise of stock options granted under Focal's
1997 Plan for an aggregate purchase price of $4,912.00.
On June 3, 1999, an employee of Focal was issued 2,000 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $4,200.00.
On June 9, 1999, an employee of Focal was issued 3,125 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $6,562.50.
On June 10, 1999, three employees of Focal were issued an aggregate of
26,875 shares of common stock upon exercise of stock options granted under
Focal's 1997 Plan for an aggregate purchase price of $59,182.50.
On June 14, 1999, an employee of Focal was issued 12,500 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $8,325.00.
On June 16, 1999, an employee of Focal was issued 38,500 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $72,450.00.
On June 18, 1999, two employees of Focal were issued an aggregate of 23,125
shares of common stock upon exercise of stock options granted under Focal's
1997 Plan for an aggregate purchase price of $38,497.50.
On June 25, 1999, two employees of Focal were issued an aggregate of 23,000
shares of common stock upon exercise of stock options granted under Focal's
1997 Plan for an aggregate purchase price of $66,300.00.
On June 29, 1999, an employee of Focal was issued 33,000 shares of common
stock upon exercise of stock options granted under Focal's 1997 Plan for an
aggregate purchase price of $51,700.00.
On June 30, 1999, four employees of Focal were issued an aggregate of 38,750
shares of common stock upon exercise of stock options granted under Focal's
1997 Plan for an aggregate purchase price of $35,547.00.
No underwriters were engaged in connection with the sales of securities set
forth in the seven preceding paragraphs, and these transactions were exempt
from registration under the Securities Act pursuant to Section 4(2) of the
Securities Act, as transactions not involving any public offering, or pursuant
to Rule 701 under the Securities Act as sales of securities pursuant to certain
compensatory benefit plans.
II-3
<PAGE>
Item 16. Exhibits And Financial Statement Schedules
(A) Exhibits
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S>
1.1 Form of Underwriting Agreement.
2.1 Plan of Reorganization and Agreement by and among Focal
Communications Corporation and its Subsidiaries, dated June 12,
1997. (Incorporated by reference to Exhibit No. 2.1 to the
Registrant's Registration Statement on Form S-4 originally filed
with the Securities and Exchange Commission on August 13, 1998
(Registration No. 333-49397) (the "S-4"))
3.1 Certificate of Incorporation. (Incorporated by reference to
Exhibit No. 3.1 of the S-4)
3.2 Amendment to Certificate of Incorporation. (Incorporated by
reference to Exhibit No. 3.2 to Focal's Annual Report on Form
10-K for year ended December 31, 1998 originally filed with the
Securities and Exchange Commission on March 31, 1998 (the "1998
10-K"))
3.3 Form of Amended and Restated Certificate of Incorporation.
3.4 By-Laws. (Incorporated by reference to Exhibit No. 3.2 of the S-
4)
3.5 Form of Amended and Restated By-Laws.
4.1 Indenture with Harris Trust and Savings Bank, dated February 18,
1998. (Incorporated by reference to Exhibit No. 4.1 of the S-4)
4.2 Initial Global 12.125% Senior Discount Note Due February 15,
2008, dated February 18, 1998. (Incorporated by reference to
Exhibit No. 4.2 of the S-4)
4.3 Stock Purchase Agreement with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty, and Robert C. Taylor Jr.,
dated November 27, 1996. (Incorporated by reference to Exhibit
No. 4.5 of the S-4)
4.4 Amendment No. 1 to Stock Purchase Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P., Battery
Ventures III, L.P., Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor Jr., dated January 23, 1998.
(Incorporated by reference to Exhibit No. 4.6 of the S-4)
4.5 Amendment No. 2 to Stock Purchase Agreement with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P., Battery
Ventures III, L.P., Brian F. Addy, John R. Barnicle, Joseph
Beatty and Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.8 to the
Registrant's Quarterly Report on Form 10-Q for the period ending
September 30, 1998, originally filed with the Securities and
Exchange Commission on November 16, 1998 (the "3rd Quarter 1998
10-Q"))
4.6 Vesting Agreement with Madison Dearborn Capital Partners, L.P.,
Brian F. Addy, John R. Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of November 27, 1996. (Incorporated by
reference to Exhibit No. 4.1 of the 3rd Quarter 1998 10-Q)
4.7 Vesting Agreement with Frontenac VI, L.P., Brian F. Addy, John
R. Barnicle, Joseph Beatty and Robert C. Taylor, Jr., dated as
of November 27, 1996. (Incorporated by reference to Exhibit No.
4.2 of the 3rd Quarter 1998 10-Q)
4.8 Vesting Agreement with Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty and Robert C. Taylor, Jr.,
dated as of November 27, 1996. (Incorporated by reference to
Exhibit No. 4.3 of the 3rd Quarter 1998 10-Q)
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S>
4.9 Amendment No. 1 to Vesting Agreement and Consent as of August
21, 1998, between Focal Communications Corporation with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P., Battery
Ventures III, L.P., Brian F. Addy, John R. Barnicle, Joseph
Beatty and Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.4 of the 3rd Quarter
1998 10-Q)
4.10 Amendment No. 1 to Vesting Agreement and Consent as of August
21, 1998, between Focal Communications Corporation with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P., Battery
Ventures III, L.P., Brian F. Addy, John R. Barnicle, Joseph
Beatty and Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.5 of the 3rd Quarter
1998 10-Q)
4.11 Amendment No. 1 to Vesting Agreement and Consent as of August
21, 1998, between Focal Communications Corporation with Madison
Dearborn Capital Partners, L.P., Frontenac VI, L.P., Battery
Ventures III, L.P., Brian F. Addy, John R. Barnicle, Joseph
Beatty and Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.6 of the 3rd Quarter
1998 10-Q)
4.12 Form of Restricted Stock Agreement, dated September 30, 1998
between Focal Communications Corporation and each of Brian F.
Addy, John R. Barnicle, Joseph Beatty, and Robert C. Taylor, Jr.
(Incorporated by reference to Exhibit No. 4.7 of the 3rd Quarter
1998 10-Q)
4.13 Stockholders Agreement with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty, and Robert C. Taylor,
Jr., dated November 27, 1996. (Incorporated by reference to
Exhibit No. 4.11 of the S-4)
4.14 Amendment No. 1 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty and
Robert C. Taylor, Jr., dated as of July 7, 1998. (Incorporated
by reference to Exhibit No. 4.9 of the 3rd Quarter 1998 10-Q)
4.15 Amendment No. 2 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty and
Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.10 of the 3rd
Quarter 1998 10-Q)
4.16 Amendment No. 3 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty, and
Robert C. Taylor, Jr., dated February 16, 1999. (Incorporated by
reference to Exhibit No. 4.16 to the 1998 10-K)
4.17 Executive Stock Agreement and Employment Agreement with Brian F.
Addy, dated November 27, 1996. (Incorporated by reference to
Exhibit No. 4.12 of the S-4)#
4.18 Executive Stock Agreement and Employment Agreement with John R.
Barnicle, dated November 27, 1996. (Incorporated by reference to
Exhibit No. 4.13 of the S-4)#
4.19 Executive Stock Agreement and Employment Agreement with Joseph
A. Beatty, dated November 27, 1996. (Incorporated by reference
to Exhibit No. 4.14 of the S-4)#
4.20 Executive Stock Agreement and Employment Agreement with Robert
C. Taylor, Jr., dated November 27, 1996. (Incorporated by
reference to Exhibit No. 4.15 of the S-4)#
4.21 Amendment No. 1 to Executive Employment Agreement and Consent
with Brian F. Addy, dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.11 of the 3rd Quarter 1998 10-Q)#
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S>
4.22 Amendment No. 1 to Executive Employment Agreement and Consent
with John R. Barnicle, dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.12 of the 3rd
Quarter 1998 10-Q)#
4.23 Amendment No. 1 to Executive Employment Agreement and Consent
with Joseph Beatty, dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.13 of the 3rd Quarter 1998 10-Q)#
4.24 Amendment No. 1 to Executive Employment Agreement and Consent
with Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.14 of the 3rd
Quarter 1998 10-Q)#
4.25 Registration Agreement with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures III, L.P., Brian F.
Addy, John R. Barnicle, Joseph Beatty, and Robert C. Taylor,
Jr., dated November 27, 1996. (Incorporated by reference to
Exhibit No. 4.16 of the S-4)
4.26 Amendment No. 1 to Registration Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty and
Robert C. Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No. 4.15 of the 3rd
Quarter 1998 10-Q)
4.27 Amendment No. 4 to Stockholders Agreement with Madison Dearborn
Capital Partners, L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R. Barnicle, Joseph Beatty and
Robert C. Taylor, Jr., dated as of May 21, 1999.
5.1 Opinion of Jones, Day, Reavis & Pogue regarding validity of
shares.
10.1 Interconnection Agreement with Ameritech Information Industry
Services, dated October 28, 1996. (Incorporated by reference to
Exhibit No. 10.1 of the S-4)
10.2 Interconnection Agreement with Ameritech Information Industry
Services, dated October 31, 1997. (Incorporated by reference to
Exhibit No. 10.2 of the S-4)
10.3 Interconnection Agreement with New York Telephone Company, dated
November 10, 1997. (Incorporated by reference to Exhibit No.
10.3 of the S-4)
10.4 Amended and Restated Interconnection Agreement with Ameritech
Information Industry Services, dated March 16, 1998.
(Incorporated by reference to Exhibit No. 10.4 of the 1998 S-4)
10.5 Interconnection Agreement with Bell Atlantic-Pennsylvania, dated
April 27, 1998. (Incorporated by reference to Exhibit No. 10.26
of the S-4)
10.6 Interconnection Agreement with Bell Atlantic-Delaware, dated
April 27, 1998. (Incorporated by reference to Exhibit No. 10.25
of the S-4)
10.7 Interconnection Agreement with Bell Atlantic-New Jersey, dated
April 27, 1998. (Incorporated by reference to Exhibit No. 10.24
of the S-4)
10.8 Interconnection Agreement with GTE--California, dated June 12,
1998. (Incorporated by reference to Exhibit No. 10.23 of the S-
4)
10.9 Interconnection Agreement with Pacific Bell, dated June 15,
1998. (Incorporated by reference to Exhibit No. 10.22 of the S-
4)
10.10 Interconnection Agreement with Bell-Atlantic-District of
Columbia dated October 1, 1998. (Incorporated by reference to
Exhibit No. 10.1 to Focal's Quarterly Report on Form 10-Q for
the Period Ended March 31, 1999 (the "1st Quarter 1999 10-Q"))
</TABLE>
II-6
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S>
10.11 Interconnection Agreement with Bell-Atlantic-Maryland dated
October 2, 1998. (Incorporated by reference to Exhibit No. 10.2
to the 1st Quarter 1999 10-Q)
10.12 Interconnection Agreement with Bell Atlantic-Virginia dated
October 2, 1998. (Incorporated by reference to Exhibit No. 10.3
to the 1st Quarter 1999 10-Q)
10.13 Interconnection Agreement with U.S. West-Washington State dated
January 15, 1999. (Incorporated by reference to Exhibit No. 10.4
to the 1st Quarter 1999 10-Q)
10.14 Interconnection Agreement with Ameritech Information Industry
Services, on behalf of and as agent for Ameritech Michigan dated
February 10, 1999. (Incorporated by reference to Exhibit No.
10.5 to the 1st Quarter 1999 10-Q)
10.15 Interconnection Agreement with Bell Atlantic-Massachusetts dated
February 15, 1999. (Incorporated by reference to Exhibit No.
10.6 to the 1st Quarter 1999 10-Q)
10.16 First Amendment to the Interconnection Agreement with Ameritech
Information Industry Services, dated September 8, 1998.
(Incorporated by reference to Exhibit No. 10.1 of the 3rd
Quarter 1998 10-Q)
10.17 Network Products Purchase Agreement with Northern Telecom Inc.,
dated January 21, 1997. (Incorporated by reference to Exhibit
No. 10.5 of the S-4)*
10.18 Amendments No. 1 and No. 2 to Network Products Purchase
Agreement with Northern Telecom Inc., both dated March 6, 1998.
(Incorporated by reference to Exhibit No. 10.6 of the S-4)*
10.19 Amendment No. 3 to Network Products Purchase Agreement with
Northern Telecom Inc., dated March 25, 1999. (Incorporated by
reference to Exhibit No. 10.7 to the 1st Quarter 1999 10-Q)*
10.20 Software License with DPI/TFS, Inc., dated April 10, 1997.
(Incorporated by reference to Exhibit No. 10.17 of the S-4)*
10.21 Second Amendment to Lease Agreement for property located at 200
North LaSalle, Chicago, IL, dated November 15, 1997.
(Incorporated by reference to Exhibit No. 10.9 of the S-4)
10.22 Lease Agreement for property located at 200 North LaSalle,
Chicago, IL, dated December 31, 1996. (Incorporated by reference
to Exhibit No. 10.7 of the S-4)
10.23 First Amendment to Lease Agreement for property located at 200
North LaSalle, Chicago, IL, dated May 14, 1997. (Incorporated by
reference to Exhibit No. 10.8 of the S-4)
10.24 Loan and Security Agreement with NTFC Capital Corporation dated
December 30, 1998. (Incorporated by reference to Exhibit No.
10.17 of the 1998 10-K)*
10.25 Amendment No. 1 to Loan and Security Agreement with NTFC Capital
Corporation dated as of April 15, 1999.+
10.26 Purchase Agreement with XCOM Technologies, Inc., dated January
6, 1999. (Incorporated by reference to Exhibit No. 10.8 to the
1st Quarter 1999 10-Q)*
10.27 Third Amendment to Lease Agreement for property located at 200
North LaSalle, Chicago, IL, dated March 2, 1998. (Incorporated
by reference to Exhibit No. 10.10 of the S-4)
</TABLE>
II-7
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S>
10.28 Fourth Amendment to Lease Agreement for property located at 200
North LaSalle, Chicago, IL, dated April 4, 1998. (Incorporated
by reference to Exhibit No. 10.18 of the S-4)
10.29 Fifth Amendment to Lease Agreement for property located at 200
North LaSalle, Chicago, IL, dated October 14, 1998.
(Incorporated by reference to Exhibit No. 10.9 to the 1st
Quarter 1999 10-Q)
10.30 Sixth Amendment to Lease Agreement for property located at 200
North LaSalle, Chicago, IL, dated February 18, 1999.
(Incorporated by reference to Exhibit No. 10.10 to the 1st
Quarter 1999 10-Q)
10.31 Lease Agreement for property located at 32 Old Slip, New York,
NY, dated May 20, 1997. (Incorporated by reference to Exhibit
No. 10.11 of the S-4)
10.32 Lease Agreement for property located at 650 Townsend Street, San
Francisco, CA, dated January 26, 1998. (Incorporated by
reference to Exhibit No. 10.12 of the S-4)
10.33 First Amendment to Lease Agreement for property located at 650
Townsend Street, San Francisco, CA, dated March 3, 1998.
(Incorporated by reference to Exhibit No. 10.11 to the 1st
Quarter 1999 10-Q)
10.34 Second Amendment to Lease Agreement for property located at 650
Townsend Street, San Francisco, CA, dated June 16, 1998.
(Incorporated by reference to Exhibit No. 10.12 to the 1st
Quarter 1999 10-Q)
10.35 Third Amendment to Lease Agreement for property located at 650
Townsend Street, San Francisco, CA, dated February 16, 1999.
(Incorporated by reference to Exhibit No. 10.13 to the 1st
Quarter 1999 10-Q)
10.36 Lease Agreement for property located at 701 Market Street,
Philadelphia, Pennsylvania, dated March 10, 1998. (Incorporated
by reference to Exhibit No. 10.13 of the S-4)
10.37 Lease Agreement for property located at 1120 Vermont Avenue, NW,
Washington, D.C., dated as of May 4, 1998. (Incorporated by
reference to Exhibit No. 10.19 of the S-4)
10.38 First Amendment to Lease Agreement for property located at 1120
Vermont, NW, Washington, D.C., dated July 23, 1998.
(Incorporated by reference to Exhibit No. 10.6 of the 3rd
Quarter 1998 10-Q)
10.39 Lease Agreement for property located at 1200 West Seventh
Street, Los Angeles, California, dated as of May 19, 1998.
(Incorporated by reference to Exhibit No. 10.20 of the 1998 S-4)
10.40 First Amendment to Lease Agreement for property located at 1200
West 7th Street, Los Angeles, CA, dated July 8, 1998.
(Incorporated by reference to Exhibit No. 10.5 of the 3rd
Quarter 1998 10-Q)
10.41 Lease Agreement for property located at 1511 6th Avenue,
Seattle, WA, dated August 7, 1998. (Incorporated by reference to
Exhibit No. 10.2 of the 3rd Quarter 1998 10-Q)
10.42 Lease Agreement for property located at 23800 West Ten Mile
Road, Southfield, MI, dated August 31, 1998. (Incorporated by
reference to Exhibit No. 10.3 of the 3rd Quarter 1998 10-Q)
10.43 Lease Agreement for property located at One Penn Plaza, New
York, NY, dated September 25, 1998. (Incorporated by reference
to Exhibit No. 10.4 of the 3rd Quarter 1998 10-Q)
</TABLE>
II-8
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description
------- -------------------
<C> <S>
10.44 Lease Agreement for property located at 1950 Stemmons Freeway,
Dallas, TX, dated December 15, 1998. (Incorporated by reference
to Exhibit No. 10.14 to the 1st Quarter 1999 10-Q)
10.45 Lease Agreement for property located at One Main Street,
Cambridge, MA, dated January 6, 1999. (Incorporated by reference
to Exhibit No. 10.15 to the 1st Quarter 1999 10-Q)
10.46 Lease Agreement for property located at 250 Williams Street,
Atlanta, GA, dated February 5, 1999. (Incorporated by reference
to Exhibit No. 10.16 to the 1st Quarter 1999 10-Q)
10.47 Lease Agreement for property located at Christopher Columbus
Drive & Washington Street, Jersey City, NJ, dated February 19,
1999. (Incorporated by reference to Exhibit No. 10.17 to the 1st
Quarter 1999 10-Q)
10.48 Employment Agreement with Renee M. Martin, dated March 20, 1998.
(Incorporated by reference to Exhibit No. 10.16 of the S-4)#
10.49 Amendment No. 1 to Executive Employment Agreement with Renee M.
Martin, dated as of August 21, 1998. (Incorporated by reference
to Exhibit No. 10.10 of the 3rd Quarter 1998 10-Q)#
10.50 1997 Nonqualified Stock Option Plan, amended and restated as of
August 21, 1998. (Incorporated by reference to Exhibit No. 10.7
of the 3rd Quarter 1998 10-Q)#
10.51 Form of Amended and Restated Stock Option Agreement.
(Incorporated by reference to Exhibit No. 10.33 of the 1998
10-K)#
10.52 1998 Equity and Performance Incentive Plan. (Incorporated by
reference to Exhibit No. 10.8 of the 3rd Quarter 1998 10-Q)#
10.53 1998 Equity Plan for Non-Employee Directors. (Incorporated by
reference to Exhibit No. 10.9 of the 3rd Quarter 1998 10-Q)#
10.54 Agreement for Sale of Real Property between Focal Communications
Corporation and United Air Lines, Inc. dated August 13, 1998.
(Incorporated by reference to Exhibit No. 10.36 of the 1998
10-K)
10.55 IRU Agreement dated April 28, 1999, by and between Focal
Financial Services, Inc. and Level 3 Communications, LLC.*+
10.56 Private Line Service Agreement, dated May 4, 1999, by and
between Focal Communications Corporation and WorldCom
Technologies, Inc.*+
10.57 Fiber Optic Network leased Fiber Agreement between Metromedia
Fiber Network Services, Inc. and Focal Financial Services, Inc.,
dated as of May 24, 1999.*++
10.58 Amendment to 1997 Nonqualified Stock Option Plan (amended and
restated as of August 21, 1998), dated as of May 21, 1999.#
21.1 Subsidiaries of the Registrant.
23.1 Consent of Arthur Andersen LLP.
23.2 Consent of Jones, Day, Reavis & Pogue. (included as part of its
opinion filed as Exhibit 5.1)
24.1 Powers of Attorney.+
</TABLE>
- --------
*Portions of this exhibit have been omitted pursuant to a request for
confidential treatment, and the omitted portions have been filed separately
with the Securities and Exchange Commission.
II-9
<PAGE>
+Filed with the Registration Statement on May 7, 1999.
++Filed with Amendment No. 1 to the Registration Statement on June 7, 1999.
#Management Contract or Compensatory Plan
(B) Financial Statement Schedules.
Schedule II Valuation of Qualifying Accounts
Item 17. Undertakings
The Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(l) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person in the successful defense
of any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
II-10
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Amendment No. 2 to the Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Chicago, State of Illinois, on July 6, 1999.
Focal Communications Corporation
/s/ Robert C. Taylor, Jr.
By: _________________________________
Robert C. Taylor, Jr.
President and Chief Executive
Officer
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 2 to the Registration Statement has been signed by the following persons in
the capacities indicated on July 6, 1999.
<TABLE>
<CAPTION>
Signature Title(s)
--------- --------
<S> <C>
/s/ Robert C. Taylor, Jr. President, Chief Executive Officer and
___________________________________________ Director (Principal Executive Officer)
Robert C. Taylor, Jr.
/s/ John R. Barnicle Executive Vice President, Chief Operating
___________________________________________ Officer and Director
John R. Barnicle
/s/ Joseph A. Beatty Executive Vice President and Chief
___________________________________________ Financial Officer (Principal Financial
Joseph A. Beatty Officer)
/s/ Gregory J. Swanson Controller (Principal Accounting Officer)
___________________________________________
Gregory J. Swanson
/s/ James E. Crawford, III* Director
___________________________________________
James E. Crawford, III
/s/ John A. Edwardson* Director
___________________________________________
John A. Edwardson
/s/ Paul J. Finnegan* Director
___________________________________________
Paul T. Finnegan
/s/ Richard D. Frisbie* Director
___________________________________________
Richard D. Frisbie
/s/ James N. Perry, Jr.* Director
___________________________________________
James N. Perry, Jr.
/s/ Paul G. Yovovich* Director
___________________________________________
Paul G. Yovovich
</TABLE>
- --------
* Signed by Joseph A. Beatty pursuant to a power of attorney filed as an
exhibit to this registration statement.
II-11
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
1.1 Form of Underwriting Agreement. Filed herewith
2.1 Plan of Reorganization and Agreement by Incorporated by reference
and among Focal Communications Corporation
and its Subsidiaries, dated June 12, 1997.
(Incorporated by reference to Exhibit No.
2.1 to the Registrant's Registration
Statement on Form S-4 originally filed
with the Securities and Exchange
Commission on August 13, 1998
(Registration No. 333-49397) (the "S-4"))
3.1 Certificate of Incorporation. Incorporated by reference
(Incorporated by reference to Exhibit
No. 3.1 of the S-4)
3.2 Amendment to Certificate of Incorporation. Incorporated by reference
(Incorporated by reference to Exhibit No.
3.2 to Focal's Annual Report on Form 10-K
for year ended December 31, 1998
originally filed with the Securities and
Exchange Commission on March 31, 1998 (the
"1998 10-K"))
3.3 Form of Amended and Restated Certificate Filed herewith
of Incorporation.
3.4 By-Laws. (Incorporated by reference to Incorporated by reference
Exhibit No. 3.2 of the S-4)
3.5 Form of Amended and Restated By-Laws. Filed herewith
4.1 Indenture with Harris Trust and Savings Incorporated by reference
Bank, dated February 18, 1998.
(Incorporated by reference to Exhibit No.
4.1 of the S-4)
4.2 Initial Global 12.125% Senior Discount Incorporated by reference
Note Due February 15, 2008, dated February
18, 1998. (Incorporated by reference to
Exhibit No. 4.2 of the S-4)
4.3 Stock Purchase Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P.,
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor Jr., dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.5 of the S-4)
4.4 Amendment No. 1 to Stock Purchase Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty, and
Robert C. Taylor Jr., dated January 23,
1998. (Incorporated by reference to
Exhibit No. 4.6 of the S-4)
4.5 Amendment No. 2 to Stock Purchase Incorporated by reference
Agreement with Madison Dearborn Capital
Partners, L.P., Frontenac VI, L.P.,
Battery Ventures III, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty and Robert
C. Taylor, Jr., dated as of August 21,
1998. (Incorporated by reference to
Exhibit No. 4.8 to the Registrant's
Quarterly Report on Form 10-Q for the
period ending September 30, 1998,
originally filed with the Securities and
Exchange Commission on November 16, 1998
(the "3rd Quarter 1998 10-Q"))
4.6 Vesting Agreement with Madison Dearborn Incorporated by reference
Capital Partners, L.P., Brian F. Addy,
John R. Barnicle, Joseph Beatty and Robert
C. Taylor, Jr., dated as of November 27,
1996. (Incorporated by reference to
Exhibit No. 4.1 of the 3rd Quarter 1998
10-Q)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
4.7 Vesting Agreement with Frontenac VI, L.P., Incorporated by reference
Brian F. Addy, John R. Barnicle, Joseph
Beatty and Robert C. Taylor, Jr., dated as
of November 27, 1996. (Incorporated by
reference to Exhibit No. 4.2 of the 3rd
Quarter 1998 10-Q)
4.8 Vesting Agreement with Battery Ventures Incorporated by reference
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of November 27,
1996. (Incorporated by reference to
Exhibit No. 4.3 of the 3rd Quarter 1998
10-Q)
4.9 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent as of August 21, 1998, between
Focal Communications Corporation with
Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle,
Joseph Beatty and Robert C. Taylor, Jr.,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.4 of the 3rd
Quarter 1998 10-Q)
4.10 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent as of August 21, 1998, between
Focal Communications Corporation with
Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle,
Joseph Beatty and Robert C. Taylor, Jr.,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.5 of the 3rd
Quarter 1998 10-Q)
4.11 Amendment No. 1 to Vesting Agreement and Incorporated by reference
Consent as of August 21, 1998, between
Focal Communications Corporation with
Madison Dearborn Capital Partners, L.P.,
Frontenac VI, L.P., Battery Ventures III,
L.P., Brian F. Addy, John R. Barnicle,
Joseph Beatty and Robert C. Taylor, Jr.,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.6 of the 3rd
Quarter 1998 10-Q)
4.12 Form of Restricted Stock Agreement, dated Incorporated by reference
September 30, 1998 between Focal
Communications Corporation and each of
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor, Jr.
(Incorporated by reference to Exhibit No.
4.7 of the 3rd Quarter 1998 10-Q)
4.13 Stockholders Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P.,
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor Jr., dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.11 of the S-4)
4.14 Amendment No. 1 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of July 7, 1998.
(Incorporated by reference to Exhibit No.
4.9 of the 3rd Quarter 1998 10-Q)
4.15 Amendment No. 2 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.10 of the 3rd Quarter 1998 10-Q)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
4.16 Amendment No. 3 to Stockholders Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty, and Robert C.
Taylor, Jr., dated February 16, 1999.
(Incorporated by reference to Exhibit No.
4.16 to the 1998 10-K)
4.17 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Brian F. Addy, dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.12 of the S-4)#
4.18 Executive Stock Agreement and Employment Incorporated by reference
Agreement with John R. Barnicle, dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.13 of the S-4)#
4.19 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Joseph A. Beatty, dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.14 of the S-4)#
4.20 Executive Stock Agreement and Employment Incorporated by reference
Agreement with Robert C. Taylor, Jr.,
dated November 27, 1996. (Incorporated by
reference to Exhibit No. 4.15 of the S-4)#
4.21 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Brian F. Addy,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.11 of the
3rd Quarter 1998 10-Q)
4.22 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with John R.
Barnicle, dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.12 of the 3rd Quarter 1998 10-Q)#
4.23 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Joseph Beatty,
dated as of August 21, 1998. (Incorporated
by reference to Exhibit No. 4.13 of the
3rd Quarter 1998 10-Q)#
4.24 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement and Consent with Robert C.
Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.14 of the 3rd Quarter 1998 10-Q)#
4.25 Registration Agreement with Madison Incorporated by reference
Dearborn Capital Partners, L.P., Frontenac
VI, L.P., Battery Ventures III, L.P.,
Brian F. Addy, John R. Barnicle, Joseph
Beatty, and Robert C. Taylor Jr., dated
November 27, 1996. (Incorporated by
reference to Exhibit No. 4.16 of the S-4)
4.26 Amendment No. 1 to Registration Agreement Incorporated by reference
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of August 21, 1998.
(Incorporated by reference to Exhibit No.
4.15 of the 3rd Quarter 1998 10-Q)
4.27 Amendment No. 4 to Stockholders Agreement Filed herewith
with Madison Dearborn Capital Partners,
L.P., Frontenac VI, L.P., Battery Ventures
III, L.P., Brian F. Addy, John R.
Barnicle, Joseph Beatty and Robert C.
Taylor, Jr., dated as of May 21, 1999.
5.1 Opinion of Jones, Day, Reavis & Pogue Filed herewith
regarding validity of shares.
10.1 Interconnection Agreement with Ameritech Incorporated by reference
Information Industry Services, dated
October 28, 1996. (Incorporated by
reference to Exhibit No. 10.1 of the S-4)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
10.2 Interconnection Agreement with Ameritech Incorporated by reference
Information Industry Services, dated
October 31, 1997. (Incorporated by
reference to Exhibit No. 10.2 of the S-4)
10.3 Interconnection Agreement with New York Incorporated by reference
Telephone Company, dated November 10,
1997. (Incorporated by reference to
Exhibit No. 10.3 of the S-4)
10.4 Amended and Restated Interconnection Incorporated by reference
Agreement with Ameritech Information
Industry Services, dated March 16, 1998.
(Incorporated by reference to Exhibit No.
10.4 of the 1998 S-4)
10.5 Interconnection Agreement with Bell Incorporated by reference
Atlantic--Pennsylvania, dated April 27,
1998. (Incorporated by reference to
Exhibit No. 10.26 of the
S-4)
10.6 Interconnection Agreement with Bell Incorporated by reference
Atlantic--Delaware, dated April 27, 1998.
(Incorporated by reference to Exhibit No.
10.25 of the S-4)
10.7 Interconnection Agreement with Bell Incorporated by reference
Atlantic--New Jersey, dated April 27,
1998. (Incorporated by reference to
Exhibit No. 10.24 of the S-4)
10.8 Interconnection Agreement with GTE-- Incorporated by reference
California, dated June 12, 1998.
(Incorporated by reference to Exhibit No.
10.23 of the S-4)
10.9 Interconnection Agreement with Pacific Incorporated by reference
Bell, dated June 15, 1998. (Incorporated
by reference to Exhibit No. 10.22 of the
S-4)
10.10 Interconnection Agreement with Bell- Incorporated by reference
Atlantic--District of Columbia dated
October 1, 1998. (Incorporated by
reference to Exhibit No. 10.1 to Focal's
Quarterly Report on Form 10-Q for the
Period Ended March 31, 1999 (the "1st
Quarter 1999 10-Q"))
10.11 Interconnection Agreement with Bell- Incorporated by reference
Atlantic--Maryland dated October 2, 1998.
(Incorporated by reference to Exhibit No.
10.2 to the 1st Quarter 1999 10-Q)
10.12 Interconnection Agreement with Bell Incorporated by reference
Atlantic--Virginia dated October 2, 1998.
(Incorporated by reference to Exhibit No.
10.3 to the 1st Quarter 1999 10-Q)
10.13 Interconnection Agreement with U.S. West-- Incorporated by reference
Washington State dated January 15, 1999.
(Incorporated by reference to Exhibit No.
10.4 to the 1st Quarter 1999 10-Q)
10.14 Interconnection Agreement with Ameritech Incorporated by reference
Information Industry Services, on behalf
of and as agent for Ameritech Michigan
dated February 10, 1999. (Incorporated by
reference to Exhibit No. 10.5 to the 1st
Quarter 1999 10-Q)
10.15 Interconnection Agreement with Bell Incorporated by reference
Atlantic--Massachusetts dated February 15,
1999. (Incorporated by reference to
Exhibit No. 10.6 to the 1st Quarter 1999
10-Q)
10.16 First Amendment to the Interconnection Incorporated by reference
Agreement with Ameritech Information
Industry Services, dated September 8,
1998. (Incorporated by reference to
Exhibit No. 10.1 of the 3rd Quarter 1998
10-Q)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
10.17 Network Products Purchase Agreement with Incorporated by reference
Northern Telecom Inc., dated January 21,
1997. (Incorporated by reference to
Exhibit No. 10.5 of the S-4)*
10.18 Amendments No. 1 and No. 2 to Network Incorporated by reference
Products Purchase Agreement with Northern
Telecom Inc., both dated March 6, 1998.
(Incorporated by reference to Exhibit No.
10.6 of the S-4)*
10.19 Amendment No. 3 to Network Products Incorporated by reference
Purchase Agreement with Northern Telecom
Inc., dated March 25, 1999. (Incorporated
by reference to Exhibit No. 10.7 to the
1st Quarter 1999 10-Q)*
10.20 Software License with DPI/TFS, Inc., dated Incorporated by reference
April 10, 1997. (Incorporated by reference
to Exhibit No. 10.17 of the S-4)*
10.21 Second Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated November 15, 1997.
(Incorporated by reference to Exhibit No.
10.9 of the S-4)
10.22 Lease Agreement for property located at Incorporated by reference
200 North LaSalle, Chicago, IL, dated
December 31, 1996. (Incorporated by
reference to Exhibit No. 10.7 of the S-4)
10.23 First Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated May 14, 1997.
(Incorporated by reference to Exhibit No.
10.8 of the S-4)
10.24 Loan and Security Agreement with NTFC Incorporated by reference
Capital Corporation dated December 30,
1998. (Incorporated by reference to
Exhibit No. 10.17 of the 1998 10-K)*
10.25 Amendment No. 1 to Loan and Security Previously filed
Agreement with NTFC Capital Corporation
dated as of April 15, 1999.
10.26 Purchase Agreement with XCOM Technologies, Incorporated by reference
Inc., dated January 6, 1999. (Incorporated
by reference to Exhibit No. 10.8 to the
1st Quarter 1999 10-Q)*
10.27 Third Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated March 2, 1998.
(Incorporated by reference to Exhibit No.
10.10 of the S-4)
10.28 Fourth Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated April 4, 1998.
(Incorporated by reference to Exhibit No.
10.18 of the S-4)
10.29 Fifth Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated October 14, 1998.
(Incorporated by reference to Exhibit No.
10.9 to the 1st Quarter 1999 10-Q)
10.30 Sixth Amendment to Lease Agreement for Incorporated by reference
property located at 200 North LaSalle,
Chicago, IL, dated February 18, 1999.
(Incorporated by reference to Exhibit No.
10.10 to the 1st Quarter 1999 10-Q)
10.31 Lease Agreement for property located at 32 Incorporated by reference
Old Slip, New York, NY, dated May 20,
1997. (Incorporated by reference to
Exhibit No. 10.11 of the S-4)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
10.32 Lease Agreement for property located at Incorporated by reference
650 Townsend Street, San Francisco, CA,
dated January 26, 1998. (Incorporated by
reference to Exhibit No. 10.12 of the S-4)
10.33 First Amendment to Lease Agreement for Incorporated by reference
property located at 650 Townsend Street,
San Francisco, CA, dated March 3, 1998.
(Incorporated by reference to Exhibit No.
10.11 to the 1st Quarter 1999 10-Q)
10.34 Second Amendment to Lease Agreement for Incorporated by reference
property located at 650 Townsend Street,
San Francisco, CA, dated June 16, 1998.
(Incorporated by reference to Exhibit No.
10.12 to the 1st Quarter 1999 10-Q)
10.35 Third Amendment to Lease Agreement for Incorporated by reference
property located at 650 Townsend Street,
San Francisco, CA, dated February 16,
1999. (Incorporated by reference to
Exhibit No. 10.13 to the 1st Quarter 1999
10-Q)
10.36 Lease Agreement for property located at Incorporated by reference
701 Market Street, Philadelphia,
Pennsylvania, dated March 10, 1998.
(Incorporated by reference to Exhibit No.
10.13 of the S-4)
10.37 Lease Agreement for property located at Incorporated by reference
1120 Vermont Avenue, NW., Washington,
D.C., dated as of May 4, 1998.
(Incorporated by reference to Exhibit No.
10.19 of the S-4)
10.38 First Amendment to Lease Agreement for Incorporated by reference
property located at 1120 Vermont, NW,
Washington, D.C., dated July 23, 1998.
(Incorporated by reference to Exhibit No.
10.6 of the 3rd Quarter 1998 10-Q)
10.39 Lease Agreement for property located at Incorporated by reference
1200 West Seventh Street, Los Angeles,
California, dated as of May 19, 1998.
(Incorporated by reference to Exhibit No.
10.20 of the 1998 S-4)
10.40 First Amendment to Lease Agreement for Incorporated by reference
property located at 1200 West 7th Street,
Los Angeles, CA, dated July 8, 1998.
(Incorporated by reference to Exhibit No.
10.5 of the 3rd Quarter 1998 10-Q)
10.41 Lease Agreement for property located at Incorporated by reference
1511 6th Avenue, Seattle, WA, dated August
7, 1998. (Incorporated by reference to
Exhibit No. 10.2 of the 3rd Quarter 1998
10-Q)
10.42 Lease Agreement for property located at Incorporated by reference
23800 West Ten Mile Road, Southfield, MI,
dated August 31, 1998. (Incorporated by
reference to Exhibit No. 10.3 of the 3rd
Quarter 1998 10-Q)
10.43 Lease Agreement for property located at Incorporated by reference
One Penn Plaza, New York, NY, dated
September 25, 1998. (Incorporated by
reference to Exhibit No. 10.4 of the 3rd
Quarter 1998 10-Q)
10.44 Lease Agreement for property located at Incorporated by reference
1950 Stemmons Freeway, Dallas, TX, dated
December 15, 1998. (Incorporated by
reference to Exhibit No. 10.14 to the 1st
Quarter 1999 10-Q)
10.45 Lease Agreement for property located at Incorporated by reference
One Main Street, Cambridge, MA, dated
January 6, 1999. (Incorporated by
reference to Exhibit No. 10.15 to the 1st
Quarter 1999 10-Q)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- ------------------------------------------ -------------------------
<C> <S> <C>
10.46 Lease Agreement for property located at Incorporated by reference
250 Williams Street, Atlanta, GA, dated
February 5, 1999. (Incorporated by
reference to Exhibit No. 10.16 to the 1st
Quarter 1999 10-Q)
10.47 Lease Agreement for property located at Incorporated by reference
Christopher Columbus Drive & Washington
Street, Jersey City, NJ, dated February
19, 1999. (Incorporated by reference to
Exhibit No. 10.17 to the 1st Quarter 1999
10-Q)
10.48 Employment Agreement with Renee M. Martin, Incorporated by reference
dated March 20, 1998. (Incorporated by
reference to Exhibit No. 10.16 of the
S-4)#
10.49 Amendment No. 1 to Executive Employment Incorporated by reference
Agreement with Renee M. Martin, dated as
of August 21, 1998. (Incorporated by
reference to Exhibit No. 10.10 of the 3rd
Quarter 1998 10-Q)#
10.50 1997 Nonqualified Stock Option Plan, Incorporated by reference
amended and restated as of August 21,
1998. (Incorporated by reference to
Exhibit No. 10.7 of the 3rd Quarter 1998
10-Q)#
10.51 Form of Amended and Restated Stock Option Incorporated by reference
Agreement. (Incorporated by reference to
Exhibit No. 10.33 of the 1998 10-K)#
10.52 1998 Equity and Performance Incentive Incorporated by reference
Plan. (Incorporated by reference to
Exhibit No. 10.8 of the 3rd Quarter 1998
10-Q)#
10.53 1998 Equity Plan for Non-Employee Incorporated by reference
Directors. (Incorporated by reference to
Exhibit No. 10.9 of the 3rd Quarter 1998
10-Q)#
10.54 Agreement for Sale of Real Property Incorporated by reference
between Focal Communications Corporation
and United Air Lines, Inc. dated August
13, 1998. (Incorporated by reference to
Exhibit No. 10.36 of the 1998 10-K)
10.55 IRU Agreement dated April 28, 1999, by and Previously filed
between Focal Financial Services, Inc. and
Level 3 Communications, LLC.*
10.56 Private Line Service Agreement, dated May Previously filed
4, 1999, between Focal Communications
Corporation and WorldCom Technologies,
Inc.*
10.57 Fiber Optic Network leased Fiber Agreement Previously filed
between Metromedia Fiber Network Services,
Inc. and Focal Financial Services, Inc.
dated as of May 24, 1999.*
10.58 Amendment to 1997 Nonqualified Stock Filed herewith
Option Plan (amended and restated as of
August 21, 1998), dated as of May 21,
1999.#
21.1 Subsidiaries of the Registrant. Filed herewith
23.1 Consent of Arthur Andersen LLP. Filed herewith
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Exhibit Description Location
------- --------------------------------------------------- ----------------
<C> <S> <C>
23.2 Consent of Jones, Day, Reavis & Pogue. (included as Filed herewith
part of its opinion filed as Exhibit 5.1)
24.1 Powers of Attorney. Previously filed
</TABLE>
- --------
* Portions of this exhibit have been omitted pursuant to a request for
confidential treatment, and the omitted portions have been filed separately
with the Securities and Exchange Commission
# Management Contract or Compensatory Plan
<PAGE>
FOCAL COMMUNICATIONS CORPORATION
9,000,000 Shares
Common Stock
($0.01 par value)
Underwriting Agreement
New York, New York
July , 1999
Salomon Smith Barney Inc.
Donaldson, Lufkin & Jenrette Securities Corporation
Morgan Stanley Dean Witter
Credit Suisse First Boston Corporation
DLJdirect Inc.
As Representatives of the several Underwriters,
c/o Salomon Smith Barney Inc.
388 Greenwich Street
New York, New York 10013
Ladies and Gentlemen:
Focal Communications Corporation, a corporation organized under the laws of
Delaware (the "Company"), proposes to sell to the several underwriters named in
Schedule I hereto (the "Underwriters"), for whom you (the "Representatives") are
acting as representatives, 9,000,000 shares of Common Stock, $0.01 par value
("Common Stock") of the Company (said shares to be issued and sold by the
Company being hereinafter called the "Underwritten Securities"). The Company
also proposes to grant to the Underwriters an option to purchase up to 1,350,000
additional shares of Common Stock to cover over-allotments (the "Option
Securities"; the Option Securities, together with the Underwritten Securities,
being hereinafter called the "Securities"). To the extent there are no
additional Underwriters listed on Schedule I other than you, the term
Representatives as used herein shall mean you, as Underwriters, and the terms
Representatives and Underwriters shall mean either the singular or plural as the
context requires. Certain terms used herein are defined in Section 17 hereof.
As part of the offering contemplated by this Agreement, Salomon Smith
Barney Inc. ("Salomon Smith Barney") has agreed to reserve out of the Securities
set forth opposite its name on Schedule II to this Agreement, up to shares
for sale to the Company's employees, officers, and directors and other parties
associated with the Company and its affiliates or employees
<PAGE>
(collectively, "Participants"), as set forth in the Prospectus under the heading
"Underwriting" (the "Directed Share Program"). The Securities to be sold by
Salomon Smith Barney pursuant to the Directed Share Program (the "Directed
Shares") will be sold by Salomon Smith Barney pursuant to this Agreement at the
public offering price. Any Directed Shares not orally confirmed for purchase by
any Participants by the end of the business day on which this Agreement is
executed will be offered to the public by Salomon Smith Barney as set forth in
the Prospectus.
1. Representations and Warranties. The Company represents and warrants
-------------------------------
to, and agrees with, each Underwriter as set forth below in this Section 1 .
(a) The Company has prepared and filed with the Commission a
registration statement (Reg. No. 333-77995) on Form S-1, including a
related Preliminary Prospectus, for registration under the Act of the
offering and sale of the Securities. The Company may have filed one or more
amendments thereto, including a related Preliminary Prospectus, each of
which has previously been furnished to you. The Company will next file with
the Commission either (1) prior to the Effective Date of such registration
statement, a further amendment to such registration statement (including
the form of final prospectus) or (2) after the Effective Date of such
registration statement, a final prospectus in accordance with Rules 430A
and 424(b). In the case of clause (2), the Company has included in such
registration statement, as amended at the Effective Date, all information
(other than Rule 430A Information) required by the Act and the rules
thereunder to be included in such registration statement and the
Prospectus. As filed, such amendment and form of final prospectus, or such
final prospectus, shall contain all Rule 430A Information, together with
all other such required information, and, except to the extent the
Representatives shall agree in writing to a modification, shall be in all
substantive respects in the form furnished to you prior to the Execution
Time or, to the extent not completed at the Execution Time, shall contain
only such specific additional information and other changes (beyond that
contained in the latest Preliminary Prospectus) as the Company has advised
you, prior to the Execution Time, will be included or made therein.
(b) On the Effective Date, the Registration Statement did or will, and
when the Prospectus is first filed (if required) in accordance with Rule
424(b) and on the Closing Date (as defined herein) and on any date on which
Option Securities are purchased, if such date is not the Closing Date (a
"settlement date"), the Prospectus (and any supplements thereto) will,
comply in all material respects with the applicable requirements of the Act
and the rules thereunder; on the Effective Date and at the Execution Time,
the Registration Statement did not or will not contain any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary in order to make the statements therein not
misleading; and, on the Effective Date, the Prospectus, if not filed
pursuant to Rule 424(b), will not, and on the date of any filing pursuant
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to Rule 424(b) and on the Closing Date and any settlement date, the
Prospectus (together with any supplement thereto) will not, include any
untrue statement of a material fact or omit to state a material fact
necessary in order to make the statements therein, in the light of the
circumstances under which they were made, not misleading; provided,
---------
however, that the Company makes no representations or warranties as to the
--------
information contained in or omitted from the Registration Statement or the
Prospectus (or any supplement thereto) in reliance upon and in conformity
with information furnished in writing to the Company by or on behalf of any
Underwriter through the Representatives specifically for inclusion in the
Registration Statement or the Prospectus (or any supplement thereto), it
being understood and agreed that the only such information is that
described as such in Section 8(b) hereof.
(c) Each of the Company and its subsidiaries (as hereinafter defined)
has been duly incorporated and is validly existing as a corporation in good
standing under the laws of the jurisdiction in which it is chartered or
organized with full corporate power and authority to own or lease, as the
case may be, and to operate its properties and conduct its business as
described in the Prospectus, and is duly qualified to do business as a
foreign corporation and is in good standing under the laws of each
jurisdiction which requires such qualification.
(d) All the outstanding shares of capital stock of each Subsidiary
have been duly and validly authorized and issued and are fully paid and
nonassessable, and, except as otherwise set forth in the Prospectus, all
outstanding shares of capital stock of the Subsidiaries are owned by the
Company either directly or through wholly owned subsidiaries free and clear
of any perfected security interest or any other security interests, claims,
liens or encumbrances.
(e) The Company's authorized equity capitalization is as set forth in
the Prospectus; the capital stock of the Company conforms in all material
respects to the description thereof contained in the Prospectus; the
outstanding shares of Common Stock have been duly and validly authorized
and issued and are fully paid and nonassessable; the Securities have been
duly and validly authorized, and, when issued and delivered to and paid for
by the Underwriters pursuant to this Agreement, will be fully paid and
nonassessable; the Securities are duly listed, and admitted and authorized
for trading, subject to official notice of issuance, on the Nasdaq National
Market; the certificates for the Securities are in valid and sufficient
form; the holders of outstanding shares of capital stock of the Company are
not entitled to preemptive or other rights to subscribe for the Securities;
and, except as set forth in the Prospectus, no options, warrants or other
rights to purchase, agreements or other obligations to issue, or rights to
convert any obligations into or exchange any securities for, shares of
capital stock of or ownership interests in the Company are outstanding.
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(f) There is no franchise, contract or other document of a character
required to be described in the Registration Statement or Prospectus, or to
be filed as an exhibit thereto, which is not described or filed as
required.
(g) The statements in the Prospectus under the headings "Risk
Factors--Reciprocal Compensation--Reciprocal compensation represents a
substantial portion of our revenues; a greater than expected decrease in
reciprocal compensation revenues could have a material adverse effect on
us", "Risk Factors--Regulation--We are subject to significant regulation
that could change in a manners adverse to us", "Risk Factors--Relationship
with ILECs--Our reliance on ILEC interconnection and changes to our
agreements with the ILECs could have a material adverse effect on us",
"United States Federal Tax Considerations for Non-U.S. Holders of Common
Stock", "Business--Regulation" and "Business--Legal and Administrative
Proceedings" fairly and accurately summarize the matters therein described.
(h) This Agreement has been duly authorized, executed and delivered by
the Company.
(i) The Company is not and, after giving effect to the offering and
sale of the Securities and the application of the proceeds thereof as
described in the Prospectus, will not be an "investment company" as defined
in the Investment Company Act of 1940, as amended.
(j) No consent, approval, authorization, filing with, registration,
qualification, license, permit or order of any court or governmental agency
or body is required in connection with the execution, delivery and
performance by the Company of this Agreement, the issuance and sale of the
Securities or the consummation of the other transactions contemplated
herein, except such as have been obtained under the Act, or pursuant to
other applicable requirements, and such as may be required under the blue
sky laws of any jurisdiction in connection with the purchase and
distribution of the Securities by the Underwriters in the manner
contemplated herein and in the Prospectus.
(k) Neither the execution, delivery or performance of this Agreement,
the issue and sale of the Securities, the consummation of any other of the
transactions herein contemplated nor the fulfillment of the terms hereof
will conflict with, result in a breach or violation or imposition of any
lien, charge or encumbrance upon any property or assets of the Company or
any of its subsidiaries pursuant to, (i) the charter or by-laws of the
Company or any of its subsidiaries, (ii) the terms of any indenture,
contract, lease, mortgage, deed of trust, note agreement, loan agreement or
other agreement, obligation, condition, covenant or instrument to which the
Company or any of its subsidiaries is a party or bound or to which its or
their property is subject, or (iii) any statute, law, rule,
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regulation, ordinance, judgment, requirement, order or decree applicable to
the Company or any of its subsidiaries, including, without limitation, the
Communications Act of 1934, as amended, including the Telecommunications
Act of 1996, as amended (collectively referred to as the
"Telecommunications Act"), and the rules and regulations of the Federal
Communications Commission (the "FCC"), of any court, regulatory body,
administrative agency, governmental body, arbitrator or other authority
having jurisdiction over the Company or any of its subsidiaries or any of
its or their assets or properties.
(l) No holders of securities of the Company have rights to the
registration of such securities under the Registration Statement.
(m) The consolidated historical financial statements and schedules of
the Company and its consolidated subsidiaries included in the Prospectus
and the Registration Statement present fairly in all material respects the
financial condition, results of operations and cash flows of the Company as
of the dates and for the periods indicated, comply as to form with the
applicable accounting requirements of the Act and have been prepared in
conformity with generally accepted accounting principles applied on a
consistent basis throughout the periods involved (except as otherwise noted
therein). The selected financial data set forth under the caption "Selected
Consolidated Financial and Operating Data" in the Prospectus and
Registration Statement fairly present, on the basis stated in the
Prospectus and the Registration Statement, the information included
therein.
(n) There is (i) no action, suit, investigation or proceeding by or
before any court or governmental agency, authority or body or any
arbitrator involving the Company or any of its subsidiaries or its or their
property pending or, to the best knowledge of the Company, threatened or
(ii) no local, state, or federal law, statute, ordinance, regulation,
requirement, judgment or court decree (including without limitation, the
Telecommunications Act and the rules and regulations of the FCC) or order
that has been adopted, enacted or issued by any governmental agency or to
the best of the Company's knowledge, that has been proposed by any
governmental body, that (a) could reasonably be expected to have a material
adverse effect on the performance of this Agreement or the consummation of
any of the transactions contemplated hereby or (b) could reasonably be
expected to have a material adverse effect on the condition (financial or
otherwise), prospects, earnings, business or properties of the Company and
its subsidiaries, taken as a whole, whether or not arising from
transactions in the ordinary course of business, except as set forth in or
contemplated in the Prospectus (exclusive of any supplement thereto).
(o) Each of the Company and its subsidiaries (i) owns or leases all
such properties as are necessary to the conduct of its operations as
presently conducted, (ii) has good and marketable title to all of the
properties and assets
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described in the Prospectus as owned by it, free and clear of all liens,
charges, encumbrances and restrictions, except such as are described in the
Prospectus or as would not have a material adverse effect on the condition
(financial or otherwise), prospects, earnings, business or properties of
the Company and its subsidiaries, taken as a whole, whether or not arising
from transactions in the ordinary course of business, and (iii) has
peaceful and undisturbed possession under all leases to which it is a party
as lessee.
(p) Neither the Company nor any of its subsidiaries is in violation of
or default under (i) any provision of its charter or bylaws, (ii) the terms
of any indenture, contract, lease, mortgage, deed of trust, note agreement,
loan agreement or other agreement, obligation, condition, covenant or
instrument to which it is a party or bound or to which its property is
subject, or (iii) any statute, law, rule, regulation, judgment, order or
decree of any court, regulatory body, administrative agency, governmental
body, arbitrator or other authority having jurisdiction over the Company or
such subsidiary or any of its properties, as applicable.
(q) Arthur Andersen LLP, who have certified certain financial
statements of the Company and its consolidated subsidiaries and delivered
their report with respect to the audited consolidated financial statements
and schedules included in the Prospectus, are independent public
accountants with respect to the Company within the meaning of the Act and
the applicable published rules and regulations thereunder.
(r) There are no transfer taxes or other similar fees or charges under
federal law or the laws of any state, or any political subdivision thereof,
required to be paid in connection with the execution and delivery of this
Agreement or the issuance by the Company or sale by the Company of the
Securities.
(s) The Company has filed in a timely manner all foreign, federal,
state and local tax returns that are required to be filed or has requested
extensions thereof (except in any case in which the failure so to file
would not have a material adverse effect on the condition (financial or
otherwise), prospects, earnings, business or properties of the Company and
its subsidiaries, taken as a whole, whether or not arising from
transactions in the ordinary course of business, except as set forth in or
contemplated in the Prospectus (exclusive of any supplement thereto)) and
has paid all taxes required to be paid by it and any other assessment, fine
or penalty levied against it, to the extent that any of the foregoing is
due and payable, except for any such assessment, fine or penalty that is
currently being contested in good faith or as would not have a material
adverse effect on the condition (financial or otherwise), prospects,
earnings, business or properties of the Company and its subsidiaries, taken
as a whole, whether or not arising from transactions in the ordinary course
of business, except as set forth in or contemplated in the Prospectus
(exclusive of any supplement thereto).
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<PAGE>
(t) No labor problem or dispute with the employees of the Company or
any of its subsidiaries exists or is threatened or imminent (including,
without limitation, any unfair labor practice complaint against the Company
or any of its subsidiaries before the National Labor Relations Board, any
state or local labor relations board or any foreign labor relations board),
and the Company is not aware of any existing or imminent labor disturbance
by the employees of any of its or its subsidiaries' principal suppliers,
contractors or customers, that could have a material adverse effect on the
condition (financial or otherwise), prospects, earnings, business or
properties of the Company and its subsidiaries, taken as a whole, whether
or not arising from transactions in the ordinary course of business, except
as set forth in or contemplated in the Prospectus (exclusive of any
supplement thereto).
(u) The Company and each of its subsidiaries are insured by insurers
of recognized financial responsibility against such losses and risks and in
such amounts as are prudent and customary in the businesses in which they
are engaged; all policies of insurance insuring the Company or any of its
subsidiaries or their respective businesses, assets, employees, officers
and directors are in full force and effect; the Company and its
subsidiaries are in compliance with the terms of such policies and
instruments in all material respects; and there are no claims by the
Company or any of its subsidiaries under any such policy or instrument as
to which any insurance company is denying liability or defending under a
reservation of rights clause; neither the Company nor any such subsidiary
has been refused any insurance coverage sought or applied for; and neither
the Company nor any such subsidiary has any reason to believe that it will
not be able to renew its existing insurance coverage as and when such
coverage expires or to obtain similar coverage from similar insurers as may
be necessary to continue its business at a cost that would not have a
material adverse effect on the condition (financial or otherwise),
prospects, earnings, business or properties of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions in
the ordinary course of business, except as set forth in or contemplated in
the Prospectus (exclusive of any supplement thereto).
(v) No subsidiary of the Company is currently prohibited, directly or
indirectly, from paying any dividends to the Company, from making any other
distribution on such subsidiary's capital stock, from repaying to the
Company any loans or advances to such subsidiary from the Company or from
transferring any of such subsidiary's property or assets to the Company or
any other subsidiary of the Company, except as described in or contemplated
by the Prospectus.
(w) The Company and its subsidiaries possess all licenses,
certificates, permits, authorizations approvals, franchises and other
rights from, and has made all declarations and filings (including but not
limited to tariffs and annual filing with the appropriate federal, state,
local or foreign regulatory authorities
7
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("Authorizations") (including, without limitation, the FCC) necessary to
conduct their respective businesses as presently conducted by them, and
neither the Company nor any such subsidiary has any reason to believe that
any regulatory authority is considering limiting, modifying, suspending or
revoking any such certificate, authorization or permit which, except to the
extent that, if the subject of an unfavorable decision, ruling or finding,
such action or actions, single or in the aggregate, would not have a
material adverse effect on the condition (financial or otherwise),
prospects, earnings, business or properties of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions in
the ordinary course of business, except as set forth in or contemplated in
the Prospectus (exclusive of any supplement thereto). All such licenses,
certificates, permits, authorizations, if approvals, franchises and other
rights are valid and in full force and effect, and each of the Company and
its subsidiaries is in compliance with the terms and conditions thereof and
with the rules and regulations of regulatory bodies having jurisdiction
with respect thereto.
(x) The Company and each of its subsidiaries maintain a system of
internal accounting controls sufficient to provide reasonable assurance
that (i) transactions are executed in accordance with management's general
or specific authorizations; (ii) transactions are recorded as necessary to
permit preparation of financial statements in conformity with generally
accepted accounting principles and to maintain asset accountability; (iii)
access to assets is permitted only in accordance with management's general
or specific authorization; and (iv) the recorded accountability for assets
is compared with the existing assets at reasonable intervals and
appropriate action is taken with respect to any differences.
(y) The Company has not taken, directly or indirectly, any action
designed to or which has constituted or which might reasonably be expected
to cause or result, under the Exchange Act or otherwise, in stabilization
or manipulation of the price of any security of the Company to facilitate
the sale or resale of the Securities. The Company has not taken nor will it
take, directly or indirectly, any action prohibited by Regulation M under
the Exchange Act, in connection with the offering of the Securities.
(z) The Company and its subsidiaries are (i) in compliance with any
and all applicable foreign, federal, state and local laws and regulations
relating to the protection of human health and safety, the environment or
hazardous or toxic substances or wastes, pollutants or contaminants
("Environmental Laws"), (ii) have received and are in compliance with all
permits, licenses or other approvals required of them under applicable
Environmental Laws to conduct their respective businesses and (iii) have
not received notice of any actual or potential liability for the
investigation or remediation of any disposal or release of hazardous or
toxic substances or wastes, pollutants or contaminants, except where such
non-
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compliance with Environmental Laws, failure to receive required permits,
licenses or other approvals, or liability would not, individually or in the
aggregate, have a material adverse change in the condition (financial or
otherwise), prospects, earnings, business or properties of the Company and
its subsidiaries, taken as a whole, whether or not arising from
transactions in the ordinary course of business, except as set forth in or
contemplated in the Prospectus (exclusive of any supplement thereto).
Except as set forth in the Prospectus, neither the Company nor any of the
subsidiaries has been named as a "potentially responsible party" under the
Comprehensive Environmental Response, Compensation, and Liability Act of
1980, as amended.
(aa) In the ordinary course of its business, the Company periodically
reviews the effect of Environmental Laws on the business, operations and
properties of the Company and its subsidiaries, in the course of which it
identifies and evaluates associated costs and liabilities (including,
without limitation, any capital or operating expenditures required for
clean-up, closure of properties or compliance with Environmental Laws, or
any permit, license or approval, any related constraints on operating
activities and any potential liabilities to third parties). On the basis of
such review, the Company has reasonably concluded that such associated
costs and liabilities would not, singly or in the aggregate, have a
material adverse effect on the condition (financial or otherwise),
prospects, earnings, business or properties of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions in
the ordinary course of business, except as set forth in or contemplated in
the Prospectus (exclusive of any supplement thereto).
(bb) Each of the Company and its subsidiaries has fulfilled its
obligations, if any, under the minimum funding standards of Section 302 of
the United States Employee Retirement Income Security Act of 1974 ("ERISA")
and the regulations and published interpretations thereunder with respect
to each "plan" (as defined in Section 3(3) of ERISA and such regulations
and published interpretations) in which employees of the Company and its
subsidiaries are eligible to participate and each such plan is in
compliance in all material respects with the presently applicable
provisions of ERISA and such regulations and published interpretations. The
Company and its subsidiaries have not incurred any unpaid liability to the
Pension Benefit Guaranty Corporation (other than for the payment of
premiums in the ordinary course) or to any such plan under Title IV of
ERISA.
(cc) The subsidiaries listed on Annex A attached hereto (the
"Subsidiaries") are the only significant subsidiaries of the Company as
defined by Rule 1-02 of Regulation S-X.
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(dd) The Company and its subsidiaries own, possess, license or have
other rights to use, on reasonable terms, all patents, patent applications,
trade and service marks, trade and service mark registrations, trade names,
copyrights, licenses, inventions, trade secrets, technology, know-how and
other intellectual property (collectively, the "Intellectual Property")
necessary for the conduct of the Company's business as now conducted or as
proposed in the Prospectus to be conducted. Except as set forth in the
Prospectus, (a) to the Company's best knowledge, there are no rights of
third parties to any such Intellectual Property; (b) to the Company's best
knowledge, there is no material infringement by third parties of any such
Intellectual Property; (c) there is no pending or, to the Company's best
knowledge, threatened action, suit, proceeding or claim by others
challenging the Company's rights in or to any such Intellectual Property,
and the Company is unaware of any facts which would form a reasonable basis
for any such claim; (d) to the Company's best knowledge, there is no
pending or threatened action, suit, proceeding or claim by others
challenging the validity or scope of any such Intellectual Property, and
the Company is unaware of any facts which would form a reasonable basis for
any such claim; (e) there is no pending or, to the Company's best
knowledge, threatened action, suit, proceeding or claim by others that the
Company infringes or otherwise violates any patent, trademark, copyright,
trade secret or other proprietary rights of others, and the Company is
unaware of any other fact which would form a reasonable basis for any such
claim; (f) to the Company's best knowledge, there is no U.S. patent or
published U.S. patent application which contains claims that dominate or
may dominate any Intellectual Property described in the Prospectus as being
owned by or licensed to the Company or that interferes with the issued or
pending claims of any such Intellectual Property; and (g) there is no prior
art of which the Company is aware that may render any U.S. patent held by
the Company invalid or any U.S. patent application held by the Company
unpatentable which has not been disclosed to the U.S. Patent and Trademark
Office.
(ee) Except as disclosed in the Registration Statement and the
Prospectus, the Company (i) does not have any material lending or other
relationship with any bank or lending affiliate of any of the Initial
Purchasers and (ii) does not intend to use any of the proceeds from the
sale of the Securities hereunder to repay any outstanding debt owed to any
affiliate of any of the Underwriters.
(ff) The Company and its subsidiaries have operated in compliance
with, and are not in violation of, any and all statutes (including, but not
limited to, telecommunications laws), ordinances, rules, regulations,
judgments, orders, decisions or decrees of any court, regulatory body,
administrative body, administrative agency, governmental body, arbitrator
or other authority having jurisdiction over the Company or its subsidiaries
or any of their assets or properties, as applicable, including, but not
limited to, the FCC and any state
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authority having jurisdiction over the Company or its subsidiaries or over
their respective assets or properties except for such noncompliance or
violations which would not have a material adverse effect on the condition
(financial or otherwise), prospects, earnings, business or properties of
the Company and its subsidiaries, taken as a whole, whether or not arising
from transactions in the ordinary course of business.
(gg) The Company and its subsidiaries have filed with all
administrative bodies, administrative agencies, governmental bodies,
arbitrators or other authorities having jurisdiction over the Company or
its subsidiaries or its or their assets or properties all applications,
statements, reports, tariffs, information, forms, or any documents or
materials required under any statute, law, ordinances, rule, regulation,
judgment, order, decision or decree, except where the failure to file would
not have a material adverse effect on the Company's or any of its
subsidiaries' ability to provide its services as described in the
Prospectus. To the Company's best knowledge, such filings or submissions
were in compliance with applicable laws and regulations when filed or
submitted and no deficiencies have been asserted by any administrative
bodies, administrative agencies, governmental bodies, arbitrators or other
authorities with respect to such filings or submissions, except where the
deficiency is of such a nature that failure to cure any such deficiency
would not have a material adverse effect on the Company's ability to
provide its services as described in the Prospectus. To the Company's best
knowledge, the information contained in such filings or submissions was and
continues to be in all material respects, accurate, complete and up-to-date
at the time the filings or submissions were made.
(hh) The Company and its subsidiaries are implementing a
comprehensive, detailed program to analyze and address the risk that the
computer hardware and software used by them may be unable to recognize and
properly execute date-sensitive functions involving certain dates prior to
and any dates after December 31, 1999 (the "Year 2000 Problem"), and
reasonably believes that such risk will be remedied on a timely basis
without material expense and will not have a material adverse effect upon
the financial condition and results of operations of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions in
the ordinary course of business; and the Company believes, after due
inquiry, that each supplier, vendor, customer or financial service
organization used or serviced by the Company and its subsidiaries has
remedied or will remedy on a timely basis the Year 2000 Problem, except to
the extent that a failure to remedy by any such supplier, vendor, customer
or financial service organization would not have a material adverse effect
on the Company and its subsidiaries, taken as a whole. The Company is in
compliance with the Commission's staff legal bulletin No. 5 dated January
12, 1998 related to Year 2000 compliance, as amended to date.
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(ii) The Company has filed in a timely manner each document or report
required to be filed by it pursuant to the Exchange Act and the rules and
regulations thereunder, each such document or report at the time it was
filed conformed to the requirements of the Exchange Act and the rules and
regulations thereunder; and none or such documents or reports contained an
untrue statement of any material fact or omitted to state any material fact
required to be stated therein or necessary to make the statements therein
not misleading.
(jj) Since the date of the most recent financial statements included
in the Prospectus, there has been no material adverse effect on the
condition (financial or otherwise), prospects, earnings, business or
properties of the Company and its subsidiaries, taken as a whole, whether
or not arising from transactions in the ordinary course of business, except
as set forth in or contemplated in the Prospectus.
(kk) [The Company has not offered, or caused the Underwriters to
offer, Shares to any person pursuant to the Directed Share Program with the
specific intent to unlawfully influence (i) a customer or supplier of the
Company to alter the customer's or supplier's level or type of business
with the Company, or (ii) a trade journalist or publication to write or
publish favorable information about the Company or its products.]
(ll) The Registration Statement, the Prospectus and any Preliminary
Prospectus comply, and any further amendments or supplements thereto will
comply, with any applicable laws or regulations of foreign jurisdictions in
which the Prospectus or any Preliminary Prospectus, as amended or
supplemented, if applicable, are distributed in connection with the
Directed Share Program, and no authorization, approval, consent, license,
order, registration or qualification of or with any government,
governmental instrumentality or court, other than such as have been
obtained, is necessary under the securities laws and regulations of foreign
jurisdictions in which the Directed Shares are offered outside the United
States.
Any certificate signed by any officer of the Company and delivered to the
Representatives or counsel for the Underwriters in connection with the offering
of the Securities shall be deemed a representation and warranty by the Company,
as to matters covered thereby, to each Underwriter.
2. Purchase and Sale. (a) Subject to the terms and conditions and in
------------------
reliance upon the representations and warranties herein set forth, the Company
agrees to sell to each Underwriter, and each Underwriter agrees, severally and
not jointly, to purchase from the Company, at a purchase price of $ per
share, the amount of the Underwritten Securities set forth opposite such
Underwriter's name in Schedule I hereto.
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(b) Subject to the terms and conditions and in reliance upon the
representations and warranties herein set forth, the Company hereby grants an
option to the several Underwriters to purchase, severally and not jointly, up to
Option Securities at the same purchase price per share as the Underwriters shall
pay for the Underwritten Securities. Said option may be exercised only to cover
over-allotments in the sale of the Underwritten Securities by the Underwriters.
Said option may be exercised in whole or in part at any time on or before the
30th day after the date of the Prospectus upon written or telegraphic notice by
the Representatives to the Company setting forth the number of shares of the
Option Securities as to which the several Underwriters are exercising the option
and the settlement date. The number of Option Securities to be purchased by each
Underwriter shall be the same percentage of the total number of shares of the
Option Securities to be purchased by the several Underwriters as such
Underwriter is purchasing of the Underwritten Securities, subject to such
adjustments as you in your absolute discretion shall make to eliminate any
fractional shares.
3. Delivery and Payment. Delivery of and payment for the Underwritten
---------------------
Securities and the Option Securities (if the option provided for in Section 2(b)
hereof shall have been exercised on or before the third Business Day prior to
the Closing Date) shall be made at 10:00 a.m., New York City time, on July,
1999, or at such time on such later date not more than three Business Days after
the foregoing date as the Representatives shall designate, which date and time
may be postponed by agreement between the Representatives and the Company or as
provided in Section 9 hereof (such date and time of delivery and payment for the
Securities being herein called the "Closing Date"). Delivery of the Securities
shall be made to the Representatives for the respective accounts of the several
Underwriters against payment by the several Underwriters through the
Representatives of the purchase price thereof to or upon the order of the
Company by wire transfer payable in same-day funds to an account specified by
the Company. Delivery of the Underwritten Securities and the Option Securities
shall be made through the facilities of The Depository Trust Company unless the
Representatives shall otherwise instruct.
If the option provided for in Section 2(b) hereof is exercised after the
third Business Day prior to the Closing Date, the Company will deliver the
Option Securities (at the expense of the Company) to the Representatives, at 388
Greenwich Street, New York, New York, on the date specified by the
Representatives (which shall be within three Business Days after exercise of
said option) for the respective accounts of the several Underwriters, against
payment by the several Underwriters through the Representatives of the purchase
price thereof to or upon the order of the Company by wire transfer payable in
same-day funds to an account specified by the Company. If settlement for the
Option Securities occurs after the Closing Date, the Company will deliver to the
Representatives on the settlement date for the Option Securities, and the
obligation of the Underwriters to purchase the Option Securities shall be
conditioned upon receipt of, supplemental opinions, certificates and letters
confirming as of such date
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the opinions, certificates and letters delivered on the Closing Date pursuant to
Section 6 hereof.
4. Offering by Underwriters. It is understood that the several
-------------------------
Underwriters propose to offer the Securities for sale to the public as set forth
in the Prospectus.
5. Agreements. The Company agrees with the several Underwriters that:
-----------
(a) The Company will use its best efforts to cause the Registration
Statement, if not effective at the Execution Time, and any amendment
thereof, to become effective. Prior to the termination of the offering of
the Securities, the Company will not file any amendment of the Registration
Statement or supplement to the Prospectus or any Rule 462(b) Registration
Statement unless the Company has furnished you a copy for your review prior
to filing and will not file any such proposed amendment or supplement to
which you reasonably object. Subject to the foregoing sentence, if the
Registration Statement has become or becomes effective pursuant to Rule
430A, or filing of the Prospectus is otherwise required under Rule 424(b),
the Company will cause the Prospectus, properly completed, and any
supplement thereto to be filed with the Commission pursuant to the
applicable paragraph of Rule 424(b) within the time period prescribed and
will provide evidence satisfactory to the Representatives of such timely
filing. The Company will promptly advise the Representatives (1) when the
Registration Statement, if not effective at the Execution Time, shall have
become effective, (2) when the Prospectus, and any supplement thereto,
shall have been filed (if required) with the Commission pursuant to Rule
424(b) or when any Rule 462(b) Registration Statement shall have been filed
with the Commission, (3) when, prior to termination of the offering of the
Securities, any amendment to the Registration Statement shall have been
filed or become effective, (4) of any request by the Commission or its
staff for any amendment of the Registration Statement, or any Rule 462(b)
Registration Statement, or for any supplement to the Prospectus or for any
additional information, (5) of the issuance by the Commission of any stop
order suspending the effectiveness of the Registration Statement or the
institution or threatening of any proceeding for that purpose and (6) of
the receipt by the Company of any notification with respect to the
suspension of the qualification of the Securities for sale in any
jurisdiction or the institution or threatening of any proceeding for such
purpose. The Company will use its best efforts to prevent the issuance of
any such stop order or the suspension of any such qualification and, if
issued, to obtain as soon as possible the withdrawal thereof.
(b) If, at any time when a prospectus relating to the Securities is
required to be delivered under the Act, any event occurs as a result of
which the Prospectus as then supplemented would include any untrue
statement of a material fact or omit to state any material fact necessary
to make the statements therein in the light of the circumstances under
which they were made not misleading, or if it
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<PAGE>
shall be necessary to amend the Registration Statement or supplement the
Prospectus to comply with the Act or the rules thereunder, the Company
promptly will (1) notify the Representatives of any such event, (2) prepare
and file with the Commission, subject to the second sentence of paragraph
(a) of this Section 5, an amendment or supplement which will correct such
statement or omission or effect such compliance; and (3) supply any
supplemented Prospectus to you in such quantities as you may reasonably
request.
(c) As soon as practicable, the Company will make generally available
to its security holders and to the Representatives an earnings statement or
statements of the Company and its subsidiaries which will satisfy the
provisions of Section 11(a) of the Act and Rule 158 under the Act.
(d) The Company will furnish to the Representatives and counsel for
the Underwriters signed copies of the Registration Statement (including
exhibits thereto) and to each other Underwriter a copy of the Registration
Statement (without exhibits thereto) and, so long as delivery of a
prospectus by an Underwriter or dealer may be required by the Act, as many
copies of each Preliminary Prospectus and the Prospectus and any supplement
thereto as the Representatives may reasonably request.
(e) The Company will arrange, if necessary, for the qualification of
the Securities for sale under the laws of such jurisdictions as the
Representatives may designate and will maintain such qualifications in
effect so long as required for the distribution of the Securities; provided
that in no event shall the Company be obligated to qualify to do business
in any jurisdiction where it is not now so qualified or to take any action
that would subject it to service of process in suits, other than those
arising out of the offering or sale of the Securities, in any jurisdiction
where it is not now so subject.
(f) The Company will not, without the prior written consent of
Salomon Smith Barney Inc., offer, sell, contract to sell, pledge, assign or
otherwise dispose of, (or enter into any transaction which is designed to,
or might reasonably be expected to, result in the disposition (whether by
actual disposition or effective economic disposition due to cash settlement
or otherwise) by the Company or any affiliate of the Company or any person
in privity with the Company or any affiliate of the Company) directly or
indirectly, including the filing (or participation in the filing) of a
registration statement with the Commission in respect of, or establish or
increase a put equivalent position or liquidate or decrease a call
equivalent position within the meaning of Section 16 of the Exchange Act,
any other shares of Common Stock or any securities convertible into, or
exercisable, or exchangeable for, shares of Common Stock; or publicly
announce an intention to effect any such transaction, for a period of 180
days after the date of the Underwriting Agreement, provided, however, that
-------- -------
the
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<PAGE>
Company may issue and sell Common Stock pursuant to any employee stock
option plan, stock ownership plan or dividend reinvestment plan of the
Company in effect at the Execution Time and the Company may issue Common
Stock issuable upon the conversion of securities or the exercise of
warrants outstanding at the Execution Time.
(g) The Company will not take, directly or indirectly, any action
designed to or which has constituted or which might reasonably be expected
to cause or result, under the Exchange Act or otherwise, in stabilization
or manipulation of the price of any security of the Company to facilitate
the sale or resale of the Securities.
(h) The Company will use its best efforts to effect and maintain the
quotation of the Securities on the Nasdaq National Market and will file
with the Nasdaq National Market all documents and notices required by the
Nasdaq National Market of companies that have securities that are traded in
the over-the-counter market and quotations for which are reported by the
Nasdaq National Market.
(i) The Company will use the net proceeds received by it from the
sale of the Securities in the manner specified in the Prospectus under "Use
of Proceeds."
(j) In connection with the Directed Share Program, the Company will
ensure that the Directed Shares will be restricted to the extent required
by the National Association of Securities Dealers, Inc. (the "NASD") or the
NASD rules from sale, transfer, assignment, pledge or hypothecation for a
period of three months following the date of the effectiveness of the
Registration Statement. Salomon Smith Barney will notify the Company as to
which Participants will need to be so restricted. The Company will direct
the transfer restrictions upon such period of time.
(k) The Company agrees to pay all fees and disbursements of counsel
incurred by the Underwriters in connection with the Directed Share Program
and stamp duties, similar taxes or duties or other taxes, if any, incurred
by the Underwriters in connection with the Directed Share Program.
(l) The Company covenants with Salomon Smith Barney that the Company
will comply with all applicable securities and other applicable laws, rules
and regulations in each foreign jurisdiction in which the Directed Shares
are offered in connection with the Directed Share Program.
(m) The Company agrees to pay the costs and expenses relating to the
following matters: (i) the preparation, printing or reproduction and filing
with the Commission of the Registration Statement (including financial
statements and
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<PAGE>
exhibits thereto), each Preliminary Prospectus, the Prospectus, and each
amendment or supplement to any of them; (ii) the printing (or reproduction)
and delivery (including postage, air freight charges and charges for
counting and packaging) of such copies of the Registration Statement, each
Preliminary Prospectus, the Prospectus, and all amendments or supplements
to any of them, as may, in each case, be reasonably requested for use in
connection with the offering and sale of the Securities; (iii) the
preparation, printing, authentication, issuance and delivery of
certificates for the Securities, including any stamp or transfer taxes in
connection with the original issuance and sale of the Securities; (iv) the
printing (or reproduction) and delivery of this Agreement, any blue sky
memorandum and all other agreements or documents printed (or reproduced)
and delivered in connection with the offering of the Securities; (v) the
registration of the Securities under the Exchange Act and the listing of
the Securities on the Nasdaq National Market; (vi) any registration or
qualification of the Securities for offer and sale under the securities or
blue sky laws of the several states (including filing fees and the
reasonable fees and expenses of counsel for the Underwriters relating to
such registration and qualification); (vii) any filings required to be made
with the NASD (including filing fees and the reasonable fees and expenses
of counsel for the Underwriters relating to such filings); (viii) the
transportation and other expenses incurred by or on behalf of Company
representatives in connection with presentations to prospective purchasers
of the Securities; (ix) the fees and expenses of the Company's accountants
and the fees and expenses of counsel (including local and special counsel)
for the Company; and (x) all other costs and expenses incident to the
performance by the Company of its obligations hereunder.
6. Conditions to the Obligations of the Underwriters. The obligations of
--------------------------------------------------
the Underwriters to purchase the Underwritten Securities and the Option
Securities, as the case may be, shall be subject to the accuracy of the
representations and warranties on the part of the Company contained herein as of
the Execution Time, the Closing Date and any settlement date pursuant to Section
3 hereof, to the accuracy of the statements of the Company made in any
certificates pursuant to the provisions hereof, to the performance by the
Company of its obligations hereunder and to the following additional conditions:
(a) If the Registration Statement has not become effective prior to
the Execution Time, unless the Representatives agree in writing to a later
time, the Registration Statement will become effective not later than (i)
6:00 p.m. New York City time on the date of determination of the public
offering price, if such determination occurred at or prior to 3:00 p.m. New
York City time on such date or (ii) 9:30 a.m. on the Business Day following
the day on which the public offering price was determined, if such
determination occurred after 3:00 p.m. New York City time on such date; if
filing of the Prospectus, or any supplement thereto, is required pursuant
to Rule 424(b), the Prospectus, and any such supplement, will be filed in
the manner and within the time period required by
17
<PAGE>
Rule 424(b); and no stop order suspending the effectiveness of the
Registration Statement shall have been issued and no proceedings for that
purpose shall have been instituted or threatened.
(b) All consents, approvals, authorizations, certificates or permits
required for the consummation of the transactions contemplated in this
Agreement and the Prospectus shall have been received.
(c) The Company shall have requested and caused Jones, Day, Reavis &
Pogue, counsel for the Company, to have furnished to the Representatives
their opinion, dated the Closing Date and addressed to the Representatives,
to the effect that:
(i) each of the Company and the Subsidiaries has been duly
incorporated and is validly existing as a corporation in good standing
under the laws of the jurisdiction in which it is chartered or
organized, with full corporate power and authority to own or lease, as
the case may be, and to operate its properties and conduct its
business as described in the Prospectus, and is duly qualified to do
business as a foreign corporation and is in good standing under the
laws of each jurisdiction which requires such qualification;
(ii) all the outstanding shares of capital stock of each
Subsidiary have been duly and validly authorized and issued and are
fully paid and nonassessable, and, except as otherwise set forth in
the Prospectus, all outstanding shares of capital stock of the
Subsidiaries are owned by the Company either directly or through
wholly owned subsidiaries free and clear of any perfected security
interest and, to the knowledge of such counsel, after due inquiry, any
other security interest, claim, lien or encumbrance;
(iii) the Company's authorized equity capitalization is as set
forth in the Prospectus; the capital stock of the Company conforms in
all material respects to the description thereof contained in the
Prospectus; the outstanding shares of Common Stock have been duly and
validly authorized and issued and are fully paid and nonassessable; the
Securities have been duly and validly authorized, and, when issued and
delivered to and paid for by the Underwriters pursuant to this
Agreement, will be fully paid and nonassessable; the Securities are
duly listed, and admitted and authorized for trading, subject to
official notice of issuance, on the Nasdaq National Market; the
certificates for the Securities are in valid and sufficient form; the
holders of outstanding shares of capital stock of the Company are not
entitled to preemptive or other rights to subscribe for the Securities;
and, except as set forth in the Prospectus, no options, warrants
18
<PAGE>
or other rights to purchase, agreements or other obligations to issue, or
rights to convert any obligations into or exchange any securities for,
shares of capital stock of or ownership interests in the Company are
outstanding;
(iv) to the knowledge of such counsel, there is no pending or
threatened action, suit or proceeding by or before any court or
governmental agency, authority or body or any arbitrator involving the
Company or any of its subsidiaries or its or their property of a character
required to be disclosed in the Registration Statement which is not
adequately disclosed in the Prospectus, and there is no franchise, contract
or other document of a character required to be described in the
Registration Statement or Prospectus, or to be filed as an exhibit thereto,
which is not described or filed as required;
(v) the statements included in the Prospectus under the headings
"United States Federal Tax Considerations for Non-U.S. Holders of Common
Stock" and "Business--Legal and Administrative Proceedings" fairly and
accurately summarize the matters therein described;
(vi) the Registration Statement has become effective under the Act;
any required filing of the Prospectus, and any supplements thereto,
pursuant to Rule 424(b) has been made in the manner and within the time
period required by Rule 424(b); to the knowledge of such counsel, no stop
order suspending the effectiveness of the Registration Statement has been
issued, no proceedings for that purpose have been instituted or threatened
and the Registration Statement and the Prospectus (other than the financial
statements and other financial information contained therein, as to which
such counsel need express no opinion) comply as to form in all material
respects with the applicable requirements of the Act and the rules
thereunder; and such counsel has no reason to believe that on the Effective
Date or at the Execution Time the Registration Statement contained any
untrue statement of a material fact or omitted to state any material fact
required to be stated therein or necessary to make the statements therein
not misleading or that the Prospectus as of its date and on the Closing
Date included or includes any untrue statement of a material fact or
omitted or omits to state a material fact necessary to make the statements
therein, in the light of the circumstances under which they were made, not
misleading (in each case, other than the financial statements and other
financial information contained therein, as to which such counsel need
express no opinion);
(vii) this Agreement has been duly authorized, executed and delivered
by the Company;
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<PAGE>
(viii) the Company is not and, after giving effect to the offering and
sale of the Securities and the application of the proceeds thereof as
described in the Prospectus, will not be, an "investment company" as
defined in the Investment Company Act of 1940, as amended;
(ix) no consent, approval, authorization, filing with or order of any
court or governmental agency or body is required in connection with the
transactions contemplated herein, except such as have been obtained under
the Act and such as may be required under the blue sky laws of any
jurisdiction in connection with the purchase and distribution of the
Securities by the Underwriters in the manner contemplated in this Agreement
and in the Prospectus and such other approvals (specified in such opinion)
as have been obtained;
(x) neither the issue and sale of the Securities, nor the consummation
of any other of the transactions herein contemplated nor the fulfillment of
the terms hereof will conflict with, result in a breach or violation of;
default under or imposition of any lien, charge or encumbrance upon any
property or assets of the Company or its subsidiaries pursuant to, (i) the
charter or by-laws of the Company or its subsidiaries, (ii) the terms of
any indenture, contract, lease, mortgage, deed of trust, note agreement,
loan agreement or other agreement, obligation, condition, covenant or
instrument to which the Company or its subsidiaries is a party or bound or
to which its or their property is subject, or (iii) any statute, law, rule,
regulation, judgment, order or decree applicable to the Company or its
subsidiaries of any court, regulatory body, administrative agency,
governmental body, arbitrator or other authority having jurisdiction over
the Company or its subsidiaries or any of its or their properties; and
(xi) no holders of securities of the Company have rights to the
registration of such securities under the Registration Statement.
In rendering such opinion, such counsel may rely (A) as to matters
involving the application of laws of any jurisdiction other than the State of
Illinois or the federal laws of the United States, to the extent they deem
proper and specified in such opinion, upon the opinion of other counsel of good
standing whom they believe to be reliable and who are satisfactory to counsel
for the Underwriters and (B) as to matters of fact, to the extent they deem
proper, on certificates of responsible officers of the Company and public
officials. References to the Prospectus in this paragraph (b) include any
supplements thereto at the Closing Date.
20
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(d) The Company shall have requested and caused Swidler Berlin Shereff
Friedman, LLP, regulatory counsel for the Company, to have furnished to the
Representatives their opinion, dated the Closing Date and addressed to the
Representatives on behalf of the Underwriters, to the effect that:
(i) The licenses, certificates, permits, registrations and
authorizations (the "Authorizations") set forth in the schedule to such
opinion constitute all of the licenses, certificates, permits and
authorizations required by the FCC and the State Regulatory Agencies (as
defined below) for the provision of telecommunications services by the
Company and the Subsidiaries as such counsel understands those services
currently to be provided based on the declaration of an executive officer
of the Company attached to such opinion, where the failure to obtain or
hold such Authorizations would materially adversely affect the ability of
the Company or the Subsidiaries to provide such services, and none of the
Company or any Subsidiary has received any notice of proceedings relating
to the revocation or modification of any such Authorizations which, singly
or in the aggregate, if the subject of an unfavorable decision, ruling or
finding, would have a material adverse effect on the Company or such
Subsidiary, in connection with the provision of such services;
(ii) The Company and/or its Subsidiaries holds the Authorizations set
forth in the schedule to such opinion, and those Authorizations are valid
and in full force and effect;
(iii) To the best knowledge of such counsel, after due inquiry,
neither the Company nor any of the Subsidiaries is subject to any pending
or threatened proceeding, complaint or investigation before the FCC or any
State Regulatory Agency based on any alleged violation by the Company or
its Subsidiaries in connection with the provision of or failure to provide
telecommunications services, of a character that would be required to be
disclosed or incorporated by reference in the Registration Statement and
the Prospectus, which is not adequately disclosed in the Registration
Statement and the Prospectus;
(iv) The statements included in the Prospectus under the headings
"Risk Factors--Reciprocal Compensation; "Risk Factors--Regulation," "Risk
Factors--Relationship with ILECs" and "Business--Regulation" fairly and
accurately summarize the matters therein described;
(v) No consent, approval, authorization, license, certificate, permit
or order of the FCC or any State Regulatory Agency is required for the
consummation of the transactions contemplated by this Agreement or
21
<PAGE>
to the extent such consent, approval, authorization, license, certificate
or permit is required it shall have been secured;
(vi) Neither the execution and delivery of this Agreement nor the
issuance and sale of the Securities contemplated hereby will conflict with
or result in a breach or violation of the Communications Act of 1934, as
amended, the Telecommunications Act of 1996, as amended, any order, rule or
regulation of the FCC or any state regulatory agency applicable to the
Company or any of its Subsidiaries or cause the suspension, revocation,
impairment, forfeiture, nonrenewal or termination of any FCC license or
other authorization of the FCC;
(vii) Although such counsel has not independently checked or verified
and is neither passing upon nor assuming any responsibility for the factual
accuracy, completeness or fairness of the statements contained in the
Registration Statement and the Prospectus or any amendment thereof or
supplement thereto, nothing has come to its attention which would cause it
to believe that the statements included in the Prospectus under the
headings "Risk Factors--Reciprocal Compensation," "Risk Factors--
Relationship with ILECs," "Business--Regulation", on the date thereof or on
the Closing Date contain an untrue statement of material fact or omit to
state a material fact necessary to make the statements therein, in the
light of the circumstances under which they were made, not misleading;
(viii) The Company and its Subsidiaries have operated in compliance
with all, and are not in violation of any, statutes (including, but not
limited to, the Communications Act of 1934, as amended, or the
Telecommunications Act of 1996) laws, rules, regulations, judgments,
orders, decisions or decrees of any court, regulatory body, administrative
body, administrative agency, governmental body, arbitrator or other
authority having jurisdiction over the Company or its Subsidiaries or any
of their assets or properties, as applicable, including, but not limited
to, the FCC and any state authority having jurisdiction over the Company or
its Subsidiaries or over their respective assets or properties except for
such noncompliance or violations as would not have a Material Adverse
Effect.
(ix) The Company and its subsidiaries have filed with all
administrative bodies, administrative agencies, governmental bodies,
arbitrators or other authorities having jurisdiction over the Company or
its subsidiaries or any of its or their assets or properties, as
applicable, all applications, statements, reports, tariffs, information,
forms, or any other documents or materials required under all statutes,
laws, rules, regulations, judgments, orders, decisions or decrees, except
where the
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failure to file would not have a Material Adverse Effect on the Company's
or any of its subsidiaries' ability to provide its services as described in
the Registration Statement. To such counsel's knowledge after due inquiry,
such filings or submissions were in compliance with applicable laws or
regulations when filed or submitted and no deficiencies have been asserted
by any administrative bodies, administrative agencies, governmental bodies,
arbitrators or other authorities with respect to such filings or
submissions, except where the deficiency is of such a nature that failure
to cure any such deficiency would not have a Material Adverse Effect on the
Company's ability to provide its services as described in the Registration
Statement. To such counsel's knowledge, after due inquiry, the information
contained in such filings or submissions was and continues to be in all
material respects, accurate, complete and up-to-date at the time the
filings or submissions were made.
(x) To such counsel's knowledge, after due inquiry, there is no
outstanding adverse judgment, injunction, decision, decree or order that
has been issued by any court, regulatory body, administrative agency,
governmental body, arbitrator or other foreign, federal, state or local
authority having jurisdiction over any of the Company or its subsidiaries
or any of its or their properties or assets, as applicable, which, either
singly or in the aggregate, would have a Material Adverse Effect.
Such counsel's opinions may be based solely on the Communications Act of
1934, as amended, the Telecommunications Act, decisions of the FCC and FCC
rules, regulations and orders comparable state statutes governing
telecommunications, and the rules, regulations and orders of comparable state
regulatory agencies with direct regulatory jurisdiction over telecommunications
matters in the states in which the Company and its subsidiaries provide
intrastate services ("State Regulatory Agencies"). Such counsel's opinion may be
limited solely to matters arising under these authorities regarding federal
common carrier telecommunications regulatory requirements and comparable state
regulatory requirements in states in which the Company and its subsidiaries
provide intrastate services.
(e) The Representatives shall have received from Paul, Hastings, Janofsky &
Walker LLP, counsel for the Underwriters, such opinion or opinions, dated the
Closing Date and addressed to the Representatives, with respect to the issuance
and sale of the Securities, the Registration Statement, the Prospectus (together
with any supplement thereto) and other related matters as the Representatives
may reasonably require, and the Company shall have furnished to such counsel
such documents as they request for the purpose of enabling them to pass upon
such matters.
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(f) The Company shall have furnished to the Representatives a certificate
of the Company, signed by the Chairman of the Board or the President and the
principal financial or accounting officer of the Company, dated the Closing
Date, to the effect that the signers of such certificate have carefully examined
the Registration Statement, the Prospectus, any supplements to the Prospectus
and this Agreement and that:
(i) the representations and warranties of the Company in this
Agreement are true and correct in all material respects on and as of the
Closing Date with the same effect as if made on the Closing Date and the
Company has complied with all the agreements and satisfied all the
conditions on its part to be performed or satisfied at or prior to the
Closing Date;
(ii) no stop order suspending the effectiveness of the Registration
Statement has been issued and no proceedings for that purpose have been
instituted or, to the Company's best knowledge, threatened; and
(iii) since the date of the most recent financial statements included
in the Prospectus (exclusive of any supplement thereto), there has been no
material adverse effect on the condition (financial or otherwise),
prospects, earnings, business or properties of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions in
the ordinary course of business, except as set forth in or contemplated in
the Prospectus (exclusive of any supplement thereto).
(g) The Company shall have requested and caused Arthur Andersen LLP to have
furnished to the Representatives, at the Execution Time and at the Closing Date,
letters, dated respectively as of the Execution Time and as of the Closing Date,
in form and substance satisfactory to the Representatives, confirming that they
are independent accountants within the meaning of the Act and Exchange Act and
the respective applicable rules and regulations adopted by the Commission
thereunder and Rule 101 of the Code of Professional Conduct of American
Certified Public Accountants and stating in effect that:
(i) in their opinion the audited financial statements and financial
statement schedules included in the Registration Statement and the
Prospectus and reported on by them comply as to form in all material
respects with the applicable accounting requirements of the Act and the
related rules and regulations adopted by the Commission;
(ii) on the basis of a reading of the latest unaudited financial
statements made available by the Company and its subsidiaries; their
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<PAGE>
limited review, in accordance with standards established under Statement on
Auditing Standards No. 71, of the unaudited interim financial information
for the three-month period ended March 31, 1999, and as at March 31, 1999;
carrying out certain specified procedures (but not an examination in
accordance with generally accepted auditing standards) which would not
necessarily reveal matters of significance with respect to the comments set
forth in such letter; a reading of the minutes of the meetings of the
stockholders, directors and the compensation, audit and nominating
committees of the Company and its subsidiaries; and inquiries of certain
officials of the Company who have responsibility for financial and
accounting matters of the Company and its subsidiaries as to transactions
and events subsequent to December 31, 1998, nothing came to their attention
which caused them to believe that:
1. with respect to the period subsequent to December 31, 1999,
there were any changes, at a specified date not more than five days
prior to the date of the letter, in the long-term debt, net of current
maturities of the Company and its subsidiaries or capital stock of the
Company or decreases in the stockholders' equity of the Company or
current assets of the Company and its subsidiaries as compared with
the amounts shown on the December 31, 1998 consolidated balance sheet
included in the Registration Statement and the Prospectus, or for the
period from January 1, 1999 to such specified date there were any
decreases, as compared with the corresponding period in the preceding
year in revenues, operating income or interest income or any
increases, as compared with the corresponding period in the preceding
year in loss before income taxes or in total or per share amounts of
net loss of the Company and its subsidiaries, except in all instances
for such changes, decreases or increases, as applicable, set forth in
such letter, in which case the letter shall be accompanied by an
explanation by the Company as to the significance thereof unless said
explanation is not deemed necessary by the Representatives; and
2. the information included in the Registration Statement and
Prospectus in response to Regulation S-K, Item 301 (Selected Financial
Data), Item 302 (Supplementary Financial Information), Item 402
(Executive Compensation) and Item 503(d) (Ratio of Earnings to Fixed
Charges) is not in conformity with the applicable disclosure
requirements of Regulation S-K;
(iii) they have performed certain other specified procedures as a
result of which they determined that certain information of an accounting,
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financial or statistical nature (which is limited to accounting, financial
or statistical information derived from the general accounting records of
the Company and its subsidiaries) set forth in the Registration Statement
and the Prospectus, including the information set forth under the captions
"Selected Consolidated Financial and Operating Data" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
in the Prospectus, agrees with the accounting records of the Company and
its subsidiaries, excluding any questions of legal interpretation;
(iv) The Company shall have received from Arthur Andersen LLP (and
furnished to the Representatives) a report with respect to a review of
unaudited interim financial information of the Company for the six quarters
ending December 31, 1998 in accordance with Statement on Auditing Standards
No. 71;
(v) The Company shall have received from Arthur Andersen LLP (and
furnished to the Representatives) an examination report with respect to
Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company for the two fiscal years ending December 31,
1998, and the corresponding period for the prior fiscal year, each in
accordance with Statement on Standards for Attestation Engagements No. 8
issued by the Auditing Standards Board of the American Institute of
Certified Public Accountants, and such examination report shall be included
in the Registration Statement.
(h) Subsequent to the Execution Time or, if earlier, the dates as of which
information is given in the Registration Statement (exclusive of any amendment
thereof) and the Prospectus (exclusive of any supplement thereto), there shall
not have been (i) any change or decrease specified in the letter or letters
referred to in paragraph (e) of this Section 6 or (ii) any change, or any
development involving a prospective change, in or affecting the condition
(financial or otherwise), earnings, business or properties of the Company and
its subsidiaries taken as a whole, whether or not arising from transactions in
the ordinary course of business, except as set forth in or contemplated in the
Prospectus (exclusive of any supplement thereto) the effect of which, in any
case referred to in clause (i) or (ii) above, is, in the sole judgment of the
Representatives, so material and adverse as to make it impractical or
inadvisable to proceed with the offering or delivery of the Securities as
contemplated by the Registration Statement (exclusive of any amendment thereof)
and the Prospectus (exclusive of any supplement thereto).
26
<PAGE>
(i) Prior to the Closing Date, the Company shall have furnished to
the Representatives such further information, certificates and documents as
the Representatives may reasonably request.
(j) Subsequent to the Execution Time, there shall not have been any
decrease in the rating of any of the Company's debt securities by any
"nationally recognized statistical rating organization" (as defined for
purposes of Rule 436(g) under the Act) or any notice given of any intended
or potential decrease in any such rating or of a possible change in any
such rating that does not indicate the direction of the possible change.
(k) The Securities shall have been listed and admitted and authorized
for trading, subject to official notice of issuance, on the Nasdaq National
Market, and satisfactory evidence of such actions shall have been provided
to the Representatives.
(l) At the Execution Time, the Company shall have furnished to the
Representatives a letter substantially in the form of Exhibit A hereto from
each executive officer and director of the Company and certain stockholders
specified in a separate letter from the Representatives addressed to the
Representatives.
(m) The Company shall have consummated the recapitalization and the
_____ for one stock split (as described in the Prospectus).
If any of the conditions specified in this Section 6 shall not have been
fulfilled in all material respects when and as provided in this Agreement, or if
any of the opinions and certificates mentioned above or elsewhere in this
Agreement shall not be in all material respects reasonably satisfactory in form
and substance to the Representatives and counsel for the Underwriters, this
Agreement and all obligations of the Underwriters hereunder may be canceled at,
or at any time prior to, the Closing Date by the Representatives. Notice of
such cancellation shall be given to the Company in writing or by telephone or
facsimile confirmed in writing.
The documents required to be delivered by this Section 6 shall be delivered
at the office of Paul, Hastings, Janofsky & Walker LLP, counsel for the
Underwriters, at 399 Park Avenue, New York, New York 10022, on the Closing Date.
7. Reimbursement of Underwriters' Expenses. If the sale of the Securities
----------------------------------------
provided for herein is not consummated because any condition to the obligations
of the Underwriters set forth in Section 6 hereof is not satisfied, because of
any termination pursuant to Section 10 hereof or because of any refusal,
inability or failure on the part of the Company to perform any agreement herein
or comply with any provision hereof other than by reason of a default by any of
the Underwriters, the Company will reimburse the Underwriters severally through
Salomon Smith Barney on demand for all out-of-pocket
27
<PAGE>
expenses (including reasonable fees and disbursements of counsel) that shall
have been incurred by them in connection with the proposed purchase and sale of
the Securities.
8. Indemnification and Contribution. (a) The Company agrees to indemnify
---------------------------------
and hold harmless each Underwriter, the directors, officers, employees and
agents of each Underwriter and each person who controls any Underwriter within
the meaning of either the Act or the Exchange Act against any and all losses,
claims, damages or liabilities, joint or several, to which they or any of them
may become subject under the Act, the Exchange Act or other federal or state
statutory law or regulation, at common law or otherwise, insofar as such losses,
claims, damages or liabilities (or actions in respect thereof) arise out of or
are based upon any untrue statement or alleged untrue statement of a material
fact contained in the registration statement for the registration of the
Securities as originally filed or in any amendment thereof, or in any
Preliminary Prospectus or the Prospectus, or in any amendment thereof or
supplement thereto, or arise out of or are based upon the omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein not misleading, and agrees to reimburse
each such indemnified party, as incurred, for any legal or other expenses
reasonably incurred by them in connection with investigating or defending any
such loss, claim, damage, liability or action; provided, however, that the
-------- -------
Company will not be liable in any such case to the extent that any such loss,
claim, damage or liability arises out of or is based upon any such untrue
statement or alleged untrue statement or omission or alleged omission made
therein in reliance upon and in conformity with written information furnished to
the Company by or on behalf of any Underwriter through the Representatives
specifically for inclusion in the Registration Statement or the Prospectus (or
any amendment or supplement thereto), it being understood and agreed that the
only such information is that described as such in Section 8(b) hereof. This
indemnity agreement will be in addition to any liability which the Company may
otherwise have.
(b) Each Underwriter severally and not jointly agrees to indemnify and hold
harmless the Company, each of its directors, each of its officers who signs the
Registration Statement, and each person who controls the Company within the
meaning of either the Act or the Exchange Act, to the same extent as the
foregoing indemnity from the Company to each Underwriter, but only with
reference to written information relating to such Underwriter furnished to the
Company by or on behalf of such Underwriter through the Representatives
specifically for inclusion in the documents referred to in the foregoing
indemnity. This indemnity agreement will be in addition to any liability which
any Underwriter may otherwise have. The Company acknowledges that (i) the list
of Underwriters and their respective participation in the sale of the
Securities, (ii) the sentences related to concessions and reallowances and (iii)
the paragraph related to stabilization, syndicate covering transactions and
penalty bids under the heading "Underwriting" in any Preliminary Prospectus and
the Prospectus constitute the only information furnished in writing by or on
behalf of the several Underwriters for inclusion in any Preliminary Prospectus
or the Prospectus.
28
<PAGE>
(c) The Company agrees to indemnify and hold harmless Salomon Smith Barney
and each person, if any, who controls Salomon Smith Barney within the meaning of
either Section 15 of the Securities Act or Section 20 of the Exchange Act
("Salomon Smith Barney Entities"), from and against any and all losses, claims,
damages and liabilities (including, without limitation, any legal or other
expenses reasonably incurred in connection with defending or investigating any
such action or claim) (i) caused by any untrue statement or alleged untrue
statement of a material fact contained in the prospectus wrapper material
prepared by or with the consent of the Company for distribution in foreign
jurisdictions in connection with the Directed Share Program attached to the
Prospectus or any Preliminary Prospectus, caused by any omission or alleged
omission to state therein a material fact required to be stated therein or
necessary to make the statements therein, when considered in conjunction with
the Prospectus or any applicable Preliminary Prospectus, not misleading; (ii)
caused by the failure of any Participant to pay for and accept delivery of the
shares which immediately following the effective of the Registration Statement,
were subject to a properly confirmed agreement to purchase; or (iii) related to,
arising out of, or in connection with the Directed Share Program, provided,
however, that the Company shall not be responsible under this clause (iii) for
any losses, claim, damages or liabilities (or expenses relating thereto) that
are finally judicially determined to have resulted from the bad faith or gross
negligence of Salomon Smith Barney Entities.
(d) Promptly after receipt by an indemnified party under this Section 8 of
notice of the commencement of any action, such indemnified party will, if a
claim in respect thereof is to be made against the indemnifying party under this
Section 8, notify the indemnifying party in writing of the commencement thereof;
but the failure so to notify the indemnifying party (i) will not relieve it from
liability under paragraph (a), (b) or (c) above unless and to the extent it did
not otherwise learn of such action and such failure results in the forfeiture by
the indemnifying party of substantial rights and defenses and (ii) will not, in
any event, relieve the indemnifying party from any obligations to any
indemnified party other than the indemnification obligation provided in
paragraph (a), (b) or (c) above. The indemnifying party shall be entitled to
appoint counsel of the indemnifying party's choice at the indemnifying party's
expense to represent the indemnified party in any action for which
indemnification is sought (in which case the indemnifying party shall not
thereafter be responsible for the fees and expenses of any separate counsel
retained by the indemnified party or parties except as set forth below);
provided, however, that such counsel shall be satisfactory to the indemnified
- -------- -------
party. Notwithstanding the indemnifying party's election to appoint counsel to
represent the indemnified party in an action, the indemnified party shall have
the right to employ separate counsel (including local counsel), and the
indemnifying party shall bear the reasonable fees, costs and expenses of such
separate counsel if (i) the use of counsel chosen by the indemnifying party to
represent the indemnified party would present such counsel with a conflict of
interest, (ii) the actual or potential defendants in, or targets of, any such
action include both the indemnified party and the indemnifying party and the
indemnified party shall have reasonably concluded that there may be legal
29
<PAGE>
defenses available to it and/or other indemnified parties which are different
from or additional to those available to the indemnifying party, (iii) the
indemnifying party shall not have employed counsel satisfactory to the
indemnified party to represent the indemnified party within a reasonable time
after notice of the institution of such action or (iv) the indemnifying party
shall authorize the indemnified party to employ separate counsel at the expense
of the indemnifying party. An indemnifying party will not, without the prior
written consent of the indemnified parties, settle or compromise or consent to
the entry of any judgment with respect to any pending or threatened claim,
action, suit or proceeding in respect of which indemnification or contribution
may be sought hereunder (whether or not the indemnified parties are actual or
potential parties to such claim or action) unless such settlement, compromise or
consent includes an unconditional release of each indemnified party from all
liability arising out of such claim, action, suit or proceeding.
(e) In the event that the indemnity provided in paragraph (a), (b) or (c)
of this Section 8 is unavailable to or insufficient to hold harmless an
indemnified party for any reason, the Company and the Underwriters severally
agree to contribute to the aggregate losses, claims, damages and liabilities
(including legal or other expenses reasonably incurred in connection with
investigating or defending same) (collectively "Losses") to which the Company
and one or more of the Underwriters may be subject in such proportion as is
appropriate to reflect the relative benefits received by the Company on the one
hand and by the Underwriters on the other from the offering of the Securities;
provided, however, that in no case shall any Underwriter (except as may be
- -------- -------
provided in any agreement among underwriters relating to the offering of the
Securities) be responsible for any amount in excess of the underwriting discount
or commission applicable to the Securities purchased by such Underwriter
hereunder. If the allocation provided by the immediately preceding sentence is
unavailable for any reason, the Company and the Underwriters severally shall
contribute in such proportion as is appropriate to reflect not only such
relative benefits but also the relative fault of the Company on the one hand and
of the Underwriters on the other in connection with the statements or omissions
which resulted in such Losses as well as any other relevant equitable
considerations. Benefits received by the Company shall be deemed to be equal to
the total net proceeds from the offering (before deducting expenses) received by
it, and benefits received by the Underwriters shall be deemed to be equal to the
total underwriting discounts and commissions, in each case as set forth on the
cover page of the Prospectus. Relative fault shall be determined by reference
to, among other things, whether any untrue or any alleged untrue statement of a
material fact or the omission or alleged omission to state a material fact
relates to information provided by the Company on the one hand or the
Underwriters on the other, the intent of the parties and their relative
knowledge, access to information and opportunity to correct or prevent such
untrue statement or omission. The Company and the Underwriters agree that it
would not be just and equitable if contribution were determined by pro rata
allocation or any other method of allocation which does not take account of the
equitable considerations referred to above. Notwithstanding the provisions of
this paragraph (e), no person guilty of
30
<PAGE>
fraudulent misrepresentation (within the meaning of Section 11(f) of the Act)
shall be entitled to contribution from any person who was not guilty of such
fraudulent misrepresentation. For purposes of this Section 8, each person who
controls an Underwriter within the meaning of either the Act or the Exchange Act
and each director, officer, employee and agent of an Underwriter shall have the
same rights to contribution as such Underwriter, and each person who controls
the Company within the meaning of either the Act or the Exchange Act, each
officer of the Company who shall have signed the Registration Statement and each
director of the Company shall have the same rights to contribution as the
Company, subject in each case to the applicable terms and conditions of this
paragraph (e).
(f) Notwithstanding anything contained herein to the contrary, if
indemnity may be sought pursuant to Section 8(b) hereof in respect of such
action or proceeding, then in addition to such separate firm for the indemnified
parties, the indemnifying party shall be liable for the reasonable fees and
expenses of not more than one separate firm (in addition to any local counsel)
for Salomon Smith Barney for the defense of any losses, claims, damages and
liabilities arising out of the Directed Share Program, and all persons, if any,
who control Salomon Smith Barney within the meaning of either Section 15 of the
Act or Section 20 of the Exchange Act.
9. Default by an Underwriter. If any one or more Underwriters shall fail
--------------------------
to purchase and pay for any of the Securities agreed to be purchased by such
Underwriter or Underwriters hereunder and such failure to purchase shall
constitute a default in the performance of its or their obligations under this
Agreement, the remaining Underwriters shall be obligated severally to take up
and pay for (in the respective proportions which the amount of Securities set
forth opposite their names in Schedule I hereto bears to the aggregate amount of
Securities set forth opposite the names of all the remaining Underwriters) the
Securities which the defaulting Underwriter or Underwriters agreed but failed to
purchase; provided, however, that in the event that the aggregate amount of
-------- -------
Securities which the defaulting Underwriter or Underwriters agreed but failed to
purchase shall exceed 10% of the aggregate amount of Securities set forth in
Schedule I hereto, the remaining Underwriters shall have the right to purchase
all, but shall not be under any obligation to purchase any, of the Securities,
and if such nondefaulting Underwriters do not purchase all the Securities, this
Agreement will terminate without liability to any nondefaulting Underwriter or
the Company. In the event of a default by any Underwriter as set forth in this
Section 9, the Closing Date shall be postponed for such period, not exceeding
five Business Days, as the Representatives shall determine in order that the
required changes in the Registration Statement and the Prospectus or in any
other documents or arrangements may be effected. Nothing contained in this
Agreement shall relieve any defaulting Underwriter of its liability, if any, to
the Company and any nondefaulting Underwriter for damages occasioned by its
default hereunder.
10. Termination. This Agreement shall be subject to termination in the
------------
absolute discretion of the Representatives, by notice given to the Company prior
to
31
<PAGE>
delivery of and payment for the Securities, if at any time prior to such time
(i) trading in the Company's Common Stock shall have been suspended by the
Commission or the Nasdaq National Market or trading in securities generally on
the New York Stock Exchange or the Nasdaq National Market shall have been
suspended or limited or minimum prices shall have been established on such
Exchange or the Nasdaq National Market, (ii) a banking moratorium shall have
been declared either by federal or New York State authorities or (iii) there
shall have occurred any outbreak or escalation of hostilities, declaration by
the United States of a national emergency or war, or other calamity or crisis
the effect of which on financial markets is such as to make it, in the sole
judgment of the Representatives, impractical or inadvisable to proceed with the
offering or delivery of the Securities as contemplated by the Prospectus
(exclusive of any supplement thereto).
11. Representations and Indemnities to Survive. The respective agreements,
-------------------------------------------
representations, warranties, indemnities and other statements of the Company or
its officers and of the Underwriters set forth in or made pursuant to this
Agreement will remain in full force and effect, regardless of any investigation
made by or on behalf of any Underwriter or the Company or any of the officers,
directors, employees, agents or controlling persons referred to in Section 8
hereof, and will survive delivery of and payment for the Securities. The
provisions of Sections 7 and 8 hereof shall survive the termination or
cancelation of this Agreement.
12. Notices. All communications hereunder will be in writing and effective
--------
only on receipt, and, if sent to the Representatives, will be mailed, delivered
or telefaxed to the Salomon Smith Barney Inc. General Counsel (fax no.: (212)
816-7912) and confirmed to the General Counsel, Salomon Smith Barney Inc., at
388 Greenwich Street, New York, New York, 10013, Attention: General Counsel; or,
if sent to the Company, will be mailed, delivered or telefaxed to and
confirmed to it at , attention of the Legal Department.
13. Successors. This Agreement will inure to the benefit of and be
-----------
binding upon the parties hereto and their respective successors and the
officers, directors, employees, agents and controlling persons referred to in
Section 8 hereof, and no other person will have any right or obligation
hereunder.
14. Applicable Law. This Agreement will be governed by and construed in
---------------
accordance with the laws of the State of New York applicable to contracts made
and to be performed within the State of New York.
15. Counterparts. This Agreement may be signed in one or more
-------------
counterparts, each of which shall constitute an original and all of which
together shall constitute one and the same agreement.
32
<PAGE>
16. Headings. The section headings used herein are for convenience only
---------
and shall not affect the construction hereof.
17. Definitions. The terms which follow, when used in this Agreement,
------------
shall have the meanings indicated.
"Act" shall mean the Securities Act of 1933, as amended, and the rules
and regulations of the Commission promulgated thereunder.
"Business Day" shall mean any day other than a Saturday, a Sunday or a
legal holiday or a day on which banking institutions or trust companies are
authorized or obligated by law to close in New York City [or Chicago,
Illinois].
"Commission" shall mean the Securities and Exchange Commission.
"Effective Date" shall mean each date and time that the Registration
Statement, any post-effective amendment or amendments thereto and any Rule
462(b) Registration Statement became or become effective.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended, and the rules and regulations of the Commission promulgated
thereunder.
"Execution Time" shall mean the date and time that this Agreement is
executed and delivered by the parties hereto.
"Preliminary Prospectus" shall mean any preliminary prospectus
referred to in Section 1(a) and any preliminary prospectus included in the
Registration Statement at the Effective Date that omits Rule 430A
Information.
"Prospectus" shall mean the prospectus relating to the Securities that
is first filed pursuant to Rule 424(b) after the Execution Time or, if no
filing pursuant to Rule 424(b) is required, shall mean the form of final
prospectus relating to the Securities included in the Registration
Statement at the Effective Date.
"Registration Statement" shall mean the registration statement
referred to in Section 1(a), including exhibits and financial statements,
as amended at the Execution Time (or, if not effective at the Execution
Time, in the form in which it shall become effective) and, in the event any
post-effective amendment thereto or any Rule 462(b) Registration Statement
becomes effective prior to the Closing Date, shall also mean such
registration statement as so amended or such Rule 462(b) Registration
Statement, as the case may be. Such term shall include any Rule 430A
Information deemed to be included therein at the Effective Date as provided
by Rule 430A.
33
<PAGE>
"Rule 424", "Rule 430A" and "Rule 462" refer to such rules under the
Act.
"Rule 430A Information" shall mean information with respect to the
Securities and the offering thereof permitted to be omitted from the
Registration Statement when it becomes effective pursuant to Rule 430A.
"Rule 462(b) Registration Statement" shall mean a registration
statement and any amendments thereto filed pursuant to Rule 462(b) relating
to the offering covered by the registration statement referred to in
Section 1(a) hereof.
[Intentionally left blank]
34
<PAGE>
If the foregoing is in accordance with your understanding of our agreement,
please sign and return to us the enclosed duplicate hereof, whereupon this
letter and your acceptance shall represent a binding agreement among the Company
and the several Underwriters.
Very truly yours,
FOCAL COMMUNICATIONS CORPORATION
By:
-----------------------------------
Name
Title:
The foregoing Agreement is hereby
confirmed and accepted as of the
date first above written.
SALOMON SMITH BARNEY INC.
DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION
MORGAN STANLEY DEAN WITTER
CREDIT SUISSE FIRST BOSTON CORPORATION
DLJdirect Inc.
By: SALOMON SMITH BARNEY INC.
By:
-----------------------------------
Name:
Title:
For themselves and the other
several Underwriters named in
Schedule I to the foregoing
Agreement.
35
<PAGE>
[PHJ&W Draft 4/02/99]
SCHEDULE I
----------
<TABLE>
<CAPTION>
Number of Underwritten
Securities to be
Underwriters Purchased
- ------------ ----------------------
<S> <C>
Salomon Smith Barney Inc. . . . . . . . . . . .
Donaldson, Lufkin & Jenrette Securities
Corporation. . . . . . . . . . . . . . . . . .
Morgan Stanley Dean Witter. . . . . . . . . . .
Credit Suisse First Boston Corporation. . . . .
DLJdirect Inc. . . . . . . . . . . . . . . . .
------------
Total . . . . . . . . . . . . . . . .
============
</TABLE>
<PAGE>
ANNEX A
SUBSIDIARIES
Focal Communications Corporation of New York
Focal Communications Corporation of the Mid-Atlantic
Focal Communications Corporation of New Jersey
Focal Communications Corporation of Virginia
Focal Communications Corporation of Massachusetts
Focal Communications Corporation of Florida
Focal Communications Corporation of Illinois
Focal Communications Corporation of Pennsylvania
Focal Communications Corporation of Michigan
Focal Communications Corporation of California
Focal Communications Corporation of Washington
Focal Telecommunications Corporation
Focal Communications Corporation of Texas
Focal Communications Corporation of Missouri
Focal Communications Corporation of Georgia
Focal Communications Corporation of Colorado
Focal Communications Corporation of Wisconsin
Focal Financial Services, Inc.
Focal International Corp.
<PAGE>
EXHIBIT A
[Letterhead of officer, director or major shareholder of
Corporation]
Focal Communications Corporation
--------------------------------
Public Offering of Common Stock
-------------------------------
July , 1999
Salomon Smith Barney Inc.
Donaldson, Lufkin & Jenrette Securities Corporation
Morgan Stanley Dean Witter
Credit Suisse First Boston Corporation
DLJdirect Inc.
As Representatives of the several Underwriters,
c/o Salomon Smith Barney Inc.
388 Greenwich Street
New York, New York 10013
Ladies and Gentlemen:
This letter is being delivered to you in connection with the proposed
Underwriting Agreement (the "Underwriting Agreement"), between Focal
Communications Corporation, a Delaware corporation (the "Company"), and each of
you as representatives of a group of Underwriters named therein, relating to an
underwritten public offering of Common Stock, $0.01 par value (the "Common
Stock"), of the Company.
In order to induce you and the other Underwriters to enter into the
Underwriting Agreement, the undersigned will not, without the prior written
consent of Salomon Smith Barney Inc., offer, sell, contract to sell, pledge,
assign or otherwise dispose of, (or enter into any transaction which is designed
to, or might reasonably be expected to, result in the disposition (whether by
actual disposition or effective economic disposition due to cash settlement or
otherwise) by the Company or any affiliate of the Company or any person in
privity with the Company or any affiliate of the Company) directly or
indirectly, including the filing (or participation in the filing of) a
registration statement with the Securities and Exchange Commission in respect
of, or establish or increase a put equivalent position or liquidate or decrease
a call equivalent position within the meaning of Section 16 of the Securities
Exchange Act of 1934, as amended, and the rules and regulations of the
Securities and Exchange Commission promulgated thereunder with respect to, any
shares of capital stock of the Company or any securities convertible into, or
exercisable or exchangeable for such capital stock, or publicly announce an
intention to effect any such transaction, for a period of 180 days after the
date of the Underwriting Agreement, other than shares of Common Stock disposed
of as bona fide gifts approved by Salomon Smith Barney Inc.
In addition, the undersigned agrees that, without the prior written
consent of Salomon Smith Barney Inc., it will not, for a period of 180 days
after the date of the Underwriting Agreement, make any demand for or exercise
any right with respect to, the registration of any shares of Common Stock or any
security convertible into or exercisable or exchangeable for Common Stock that
would result in a registration statement relating to such Common Stock or
security being filed prior to the date that is 180 days after the date of the
Underwriting Agreement.
<PAGE>
If for any reason the Underwriting Agreement shall be terminated prior
to the Closing Date (as defined in the Underwriting Agreement), the agreement
set forth above shall likewise be terminated.
Yours very truly,
By:
------------------------------------
Name:
Title:
<PAGE>
EXHIBIT 3.3
AMENDED AND RESTATED
CERTIFICATE OF INCORPORATION
OF
FOCAL COMMUNICATIONS CORPORATION
FIRST. The name of the corporation is Focal Communications Corporation
-----
(the "Company").
SECOND. The address of the Company's registered office in the State of
------
Delaware is 1313 N. Market Street, Wilmington, Delaware 19801-1151, County of
New Castle. The name of the Company's registered agent at such address is The
Company Corporation.
THIRD. The purpose of the Company is to engage in any lawful act or
-----
activity for which corporations may be organized under the General Corporation
Law of the State of Delaware, as amended (the "DGCL").
FOURTH. Section 1. Authorized Capital Stock. The Company is authorized
------ ------------------------
to issue two classes of capital stock, designated Common Stock and Preferred
Stock. The total number of shares of capital stock that the Company is
authorized to issue is 102,000,000 shares, consisting of 100,000,000 shares of
Common Stock, par value $.01 per share ("Common Stock"), and 2,000,000 shares of
Preferred Stock, par value $.01 per share ("Preferred Stock").
Immediately upon the effectiveness of this Amended and Restated Certificate
of Incorporation, each outstanding share of the Company's Class A common stock,
par value $.01 per share, Class B common stock, par value $.01 per share, and
Class C common stock, par value $.01 per share, shall without further action by
the Company or the holder thereof automatically be reclassified, changed and
converted into 500 shares of Common Stock.
Section 2. Preferred Stock. The Preferred Stock may be issued in one or
---------------
more series. The Board of Directors of the Company (the "Board") is hereby
authorized to issue the shares of Preferred Stock in such series and to fix from
time to time before issuance the number of shares to be included in any such
series and the designation, powers, preferences, rights and qualifications,
limitations or restrictions of such series. The authority of the Board with
respect to each such series will include, without limiting the generality of the
foregoing, the determination of any or all of the following:
(a) the number of shares of any series and the designation to
distinguish the shares of such series from the shares of all other series;
(b) the voting powers, if any, and whether such voting powers are full
or limited in such series;
<PAGE>
(c) the redemption provisions, if any, applicable to such series,
including the redemption price or prices to be paid;
(d) whether dividends, if any, will be cumulative or noncumulative,
the dividend rate of such series and the dates and preferences of dividends
on such series;
(e) the rights of such series upon the voluntary or involuntary
dissolution of, or upon any distribution of the assets of, the Company;
(f) the provisions, if any, pursuant to which the shares of such
series are convertible into, or exchangeable for, shares of any other class
or classes or of any other series of the same or any other class or classes
of stock, or any other security, of the Company or any other corporation or
other entity and the rates or other determinants of conversion or exchange
applicable thereto;
(g) the right, if any, to subscribe for or to purchase any securities
of the Company or any other corporation or other entity;
(h) the provisions, if any, of a sinking fund for such series; and
(i) any other relative, participating, optional or other special
powers, preferences or rights and qualifications, limitations or
restrictions thereof;
all as may be determined from time to time by the Board and stated or expressed
in the resolution or resolutions providing for the issuance of such Preferred
Stock (collectively, a "Preferred Stock Designation").
Section 3. Common Stock. Subject to the rights of the holders of any
------------
series of Preferred Stock, the holders of Common Stock will be entitled to one
vote on each matter submitted to a vote at a meeting of stockholders for each
share of Common Stock held of record by such holder as of the record date for
such meeting.
FIFTH. The Board may make, amend and repeal the By-Laws of the Company.
-----
Any By-Law made by the Board under the powers conferred hereby may be amended or
repealed by the Board (except as specified in any such By-Law so made or
amended) or by the stockholders in the manner provided in the By-Laws of the
Company. Notwithstanding the foregoing and anything contained in this Amended
and Restated Certificate of Incorporation to the contrary, By-Laws 1, 3, 8, 10,
11, 12, 13 and 45 may not be amended or repealed by the stockholders and no
provision inconsistent therewith may be adopted by the stockholders, without the
affirmative vote of the holders of at least 66 2/3 of the voting power of the
outstanding Voting Stock (as defined below), voting together as a single class.
The Company may in its By-Laws confer powers upon the Board in addition to the
foregoing and in addition to the powers and authorities expressly conferred upon
the Board by applicable law. For the purposes of this Amended and Restated
Certificate of Incorporation, "Voting Stock" means stock of the Company of any
class or series entitled to vote generally in the election of the directors of
the Board (the "Directors"). Notwithstanding anything contained in this Amended
and Restated Certificate of Incorporation to the contrary, the affirmative vote
of the holders of at least 66 2/3 of the voting power of the
-2-
<PAGE>
outstanding Voting Stock, voting together as a single class, is required to
amend or repeal, or to adopt any provisions inconsistent with, this Article
Fifth.
SIXTH. Subject to the rights of the holders of any series of Preferred
-----
Stock:
(a) any action required or permitted to be taken by the stockholders
of the Company must be effected at a duly called annual or special meeting
of stockholders of the Company and may not be effected otherwise by any
consent in writing of such stockholders; and
(b) special meetings of stockholders of the Company may be called only
by (i) the Chairman of the Board (the "Chairman") or (ii) the Secretary of
the Company (the "Secretary") within 10 calendar days after receipt of the
written request of a majority of the total number of Directors that the
Company would have if there were no vacancies (the "Whole Board").
At any annual meeting or special meeting of stockholders of the Company, only
such business will be conducted or considered as has been brought before such
meeting in the manner provided in the By-Laws of the Company. Notwithstanding
anything contained in this Amended and Restated Certificate of Incorporation to
the contrary, the affirmative vote of the holders of at least 66 2/3 of the
voting power of the outstanding Voting Stock, voting together as a single class,
will be required to amend or repeal, or adopt any provision inconsistent with,
this Article Sixth.
SEVENTH. Section 1. Number, Election and Terms of Directors. Subject to
------- ---------------------------------------
the rights, if any, of the holders of any series of Preferred Stock to elect
additional Directors under circumstances specified in a Preferred Stock
Designation, the number of the Directors of the Company will be fixed from time
to time in the manner provided in the By-Laws of the Company. The Directors,
other than those who may be elected by the holders of any series of Preferred
Stock, will be classified with respect to the time for which they severally hold
office into three classes, as nearly equal in number as possible, designated
Class I, Class II and Class III. The Directors first appointed to Class I will
hold office for a term expiring at the annual meeting of stockholders to be held
in 2000, the Directors first appointed to Class II will hold office for a term
expiring at the annual meeting of stockholders to be held in 2001, and the
Directors first appointed to Class III will hold office for a term expiring at
the annual meeting of stockholders to be held in 2002, with the members of each
class to hold office until their successors are elected and qualified. At each
annual meeting of the stockholders of the Company, the successors to the class
of Directors whose term expires at that meeting will be elected by plurality
vote of all votes cast at such meeting to hold office for a term expiring at the
annual meeting of stockholders held in the third year following the year of
their election. Subject to the rights, if any, of the holders of any series of
Preferred Stock to elect additional Directors under circumstances specified in a
Preferred Stock Designation, Directors may be elected by the stockholders only
at an annual meeting of stockholders. Election of Directors of the Company must
be by written ballot.
Section 2. Nomination of Director Candidates. Advance notice of
---------------------------------
stockholder nominations for the election of Directors must be given in the
manner provided in the By-Laws of the Company.
-3-
<PAGE>
Section 3. Newly Created Directorships and Vacancies. Subject to the
-----------------------------------------
rights, if any, of the holders of any series of Preferred Stock to elect
additional Directors under circumstances specified in a Preferred Stock
Designation, newly created directorships resulting from any increase in the
number of Directors and any vacancies on the Board resulting from death,
resignation, disqualification, removal or other cause will be filled solely by
the affirmative vote of a majority of the remaining Directors then in office,
even though less than a quorum of the Board, or by a sole remaining Director.
Any Director elected in accordance with the preceding sentence will hold office
for the remainder of the full term of the class of Directors in which the new
directorship was created or the vacancy occurred and until such Director's
successor has been elected and qualified. No decrease in the number of
Directors constituting the Board may shorten the term of any incumbent Director.
Section 4. Removal. Subject to the rights, if any, of the holders of any
-------
series of Preferred Stock to elect additional Directors under circumstances
specified in a Preferred Stock Designation, any Director may be removed from
office by the stockholders only for cause and only in the manner provided in
this Section 4. At any annual meeting or special meeting of the stockholders,
the notice of which states that the removal of a Director or Directors is among
the purposes of the meeting, the affirmative vote of the holders of at least 66
2/3 of the voting power of the outstanding Voting Stock, voting together as a
single class, may remove such Director or Directors for cause.
Section 5. Amendment, Repeal, Etc. Notwithstanding anything contained in
----------------------
this Amended and Restated Certificate of Incorporation to the contrary, the
affirmative vote of the holders of at least 66 2/3 of the voting power of the
outstanding Voting Stock, voting together as a single class, is required to
amend or repeal, or adopt any provision inconsistent with, this Article Seventh.
The amendment or repeal of, or the adoption of any provision inconsistent with,
this Article Seventh must be by written ballot.
EIGHTH. A Director shall not be personally liable to the Company or its
------
stockholders for monetary damages for breach of fiduciary duty as a Director,
except for liability (i) for any breach of the Director's duty of loyalty to the
Company or its stockholders, (ii) for acts or omissions not in good faith or
which involve intentional misconduct or a knowing violation of law, (iii) under
Section 174 of the DGCL or (iv) for any transaction from which the Director
derived any improper personal benefit. If the DGCL is amended after the filing
of this Amended and Restated Certificate of Incorporation to authorize corporate
action further eliminating or limiting the personal liability of directors, then
the liability of a Director shall be eliminated or limited to the fullest extent
permitted by the DGCL, as so amended. No modification or repeal of the
provisions of this Article Eighth shall adversely affect any right or protection
of any Director existing at the date of such modification or repeal or create
any liability or adversely affect any such right or protection for any acts or
omissions of such director occurring prior to such modification or repeal.
-4-
<PAGE>
EXHIBIT 3.5
================================================================================
FOCAL COMMUNICATIONS CORPORATION
AMENDED AND RESTATED
BY-LAWS
As Adopted and in
Effect on July __, 1999
================================================================================
<PAGE>
FOCAL COMMUNICATIONS CORPORATION
AMENDED AND RESTATED
BY-LAWS
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
STOCKHOLDERS' MEETINGS...................................................... 1
1. Time and Place of Meetings........................................ 1
2. Annual Meeting.................................................... 1
3. Special Meetings.................................................. 1
4. Notice of Meetings................................................ 1
5. Inspectors........................................................ 1
6. Quorum............................................................ 1
7. Voting; Proxies................................................... 2
8. Order of Business................................................. 2
DIRECTORS................................................................... 4
9. Function.......................................................... 4
10. Number, Election and Terms........................................ 4
11. Vacancies and Newly Created Directorships......................... 4
12. Removal........................................................... 4
13. Nominations of Directors; Election................................ 4
14. Resignation....................................................... 6
15. Regular Meetings.................................................. 6
16. Special Meetings.................................................. 6
17. Quorum............................................................ 6
18. Participation in Meetings by Telephone Conference................. 6
19. Committees........................................................ 6
20. Compensation...................................................... 7
21. Rules............................................................. 7
NOTICES.................................................................... 7
22. Generally......................................................... 7
23. Waivers........................................................... 7
OFFICERS.................................................................... 7
24. Generally......................................................... 7
25. Compensation...................................................... 8
26. Succession........................................................ 8
27. Chairman of the Board............................................. 8
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
28. Chief Executive Officer.......................................... 8
29. The President.................................................... 8
30. Vice Presidents.................................................. 8
31. The Chief Financial Officer...................................... 9
32. The Secretary and Assistant Secretaries.......................... 9
33. The Treasurer and Assistant Treasurers........................... 9
34. Controller....................................................... 9
STOCK...................................................................... 10
35. Certificates..................................................... 10
36. Classes of Stock................................................. 10
37. Lost, Stolen or Destroyed Certificates........................... 10
38. Record Dates..................................................... 10
INDEMNIFICATION............................................................ 11
39. Damages and Expenses............................................. 11
40. Insurance, Contracts and Funding................................. 11
GENERAL.................................................................... 12
41. Fiscal Year...................................................... 12
42. Seal............................................................. 12
43. Reliance Upon Books, Reports and Records......................... 12
44. Time Periods..................................................... 12
45. Amendments....................................................... 12
46. Certain Defined Terms............................................ 12
</TABLE>
(ii)
<PAGE>
STOCKHOLDERS' MEETINGS
----------------------
1. Time and Place of Meetings. All meetings of the stockholders for the
--------------------------
election of the members of the Board of Directors of the Company (the
"Directors") or for any other purpose will be held at such time and place,
within or without the State of Delaware, as may be designated by the Board of
Directors of the Company (the "Board") or, in the absence of a designation by
the Board, the Chairman of the Board (the "Chairman"), the Chief Executive
Officer, the President or the Secretary, and stated in the notice of meeting.
The Board may postpone and reschedule any previously scheduled annual or special
meeting of the stockholders.
2. Annual Meeting. An annual meeting of the stockholders will be held at
--------------
such date and time as may be designated from time to time by the Board, at which
meeting the stockholders will elect by a plurality vote the Directors to succeed
those Directors whose terms expire at such meeting and will transact such other
business as may properly be brought before the meeting in accordance with By-Law
8.
3. Special Meetings. Special meetings of the stockholders may be called
----------------
only (i) by the Chairman or (ii) by the Secretary within 10 calendar days after
receipt of the written request of a majority of the total number of Directors
that the Company would have if there were no vacancies (the "Whole Board"). Any
such request by a majority of the Whole Board must be sent to the Chairman and
the Secretary and must state the purpose or purposes of the proposed meeting.
Special meetings of holders of the outstanding Preferred Stock, $.01 par value,
of the Company (the "Preferred Stock"), if any, may be called in the manner and
for the purposes provided in the applicable Preferred Stock Designation (as
defined in the Amended and Restated Certificate of Incorporation (the
"Certificate of Incorporation")).
4. Notice of Meetings. Written notice of every meeting of the
------------------
stockholders, stating the place, date and hour of the meeting and, in the case
of a special meeting, the purpose or purposes for which the meeting is called,
will be given not less than 10 nor more than 60 calendar days before the date of
the meeting to each stockholder of record entitled to vote at such meeting,
except as otherwise provided herein or by law. When a meeting is adjourned to
another place, date or time, written notice need not be given of the adjourned
meeting if the place, date and time thereof are announced at the meeting at
which the adjournment is taken; provided, however, that if the adjournment is
-------- -------
for more than 30 calendar days, or if after the adjournment a new record date is
fixed for the adjourned meeting, written notice of the place, date and time of
the adjourned meeting must be given in conformity herewith. At any adjourned
meeting, any business may be transacted which properly could have been
transacted at the original meeting.
5. Inspectors. The Board may appoint one or more inspectors of election
----------
to act as judges of the voting and to determine those entitled to vote at any
meeting of the stockholders, or any adjournment thereof, in advance of such
meeting. The Board may designate one or more persons as alternate inspectors to
replace any inspector who fails to act. If no inspector or alternate is able to
act at a meeting of stockholders, the presiding officer of the meeting may
appoint one or more substitute inspectors.
6. Quorum. Except as otherwise provided by law or in a Preferred Stock
------
Designation, the holders of a majority of the stock issued and outstanding and
entitled to vote
<PAGE>
thereat, present in person or represented by proxy, will constitute a quorum at
all meetings of the stockholders for the transaction of business thereat. If,
however, such quorum is not present or represented at any meeting of the
stockholders, the stockholders entitled to vote thereat, present in person or
represented by proxy, will have the power to adjourn the meeting from time to
time, without notice other than announcement at the meeting, until a quorum is
present or represented.
7. Voting; Proxies. Except as otherwise provided by law, by the
---------------
Certificate of Incorporation or in a Preferred Stock Designation, each
stockholder will be entitled at every meeting of the stockholders to one vote
for each share of stock having voting power standing in the name of such
stockholder on the books of the Company on the record date for the meeting and
such votes may be cast either in person or by proxy. A stockholder may
authorize another person or persons to act for him as proxy by (i) executing a
writing authorizing another person or persons to act for him as proxy (such
execution may be accomplished by the stockholder or his authorized officer,
director, employee or agent signing such writing or causing his or her signature
to be affixed to such writing by any reasonable means including, but not limited
to, by facsimile signature), or (ii) transmitting or authorizing the
transmission of a telegram, cablegram, or other means of electronic transmission
(including by telephone) to the person who will be the holder of the proxy or to
a proxy solicitation firm, proxy support service organization or like agent duly
authorized by the person who will be the holder of the proxy to receive such
transmission, provided that any such telegram, cablegram or other means of
electronic transmission must either set forth or be submitted with information
from which it can be determined that the telegram, cablegram or other electronic
transmission was authorized by the stockholder. No proxy shall be voted or
acted upon after three years from its date, unless the proxy provides for a
longer period. If no date is stated in a proxy, such proxy shall be presumed to
have been executed on the date of the meeting at which it is to be voted. Each
proxy shall be revocable unless expressly provided therein to be irrevocable and
coupled with an interest sufficient in law to support an irrevocable power or
unless otherwise made irrevocable by law. The vote upon any question brought
before a meeting of the stockholders may be by voice vote, unless otherwise
required by the Certificate of Incorporation or these By-Laws or unless the
Chairman or the holders of a majority of the outstanding shares of all classes
of stock entitled to vote thereon present in person or by proxy at such meeting
otherwise determine. Every vote taken by written ballot will be counted by the
inspectors of election. When a quorum is present at any meeting, the
affirmative vote of the holders of a majority of the stock present in person or
represented by proxy at the meeting and entitled to vote on the subject matter
and which has actually been voted will be the act of the stockholders, except in
the election of Directors or as otherwise provided in these By-Laws, the
Certificate of Incorporation, a Preferred Stock Designation or by law.
8. Order of Business. (a) The Chairman, or such other officer of the
-----------------
Company designated by a majority of the Whole Board, will call meetings of the
stockholders to order and will act as presiding officer thereof. Unless
otherwise determined by the Board prior to the meeting, the presiding officer at
the meeting of the stockholders will also determine the order of business and
have the authority in his or her sole discretion to regulate the conduct of any
such meeting, including without limitation by (i) imposing restrictions on the
persons (other than stockholders of the Company or their duly appointed proxies)
who may attend any such stockholders' meeting, (ii) ascertaining whether any
stockholder or his proxy may be excluded from any meeting of the stockholders
based upon any determination by the presiding officer, in his sole discretion,
that any such person has unduly disrupted or is likely to disrupt the
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<PAGE>
proceedings thereat, and (iii) determining the circumstances in which any person
may make a statement or ask questions at any meeting of the stockholders.
(b) No business may be transacted at an annual meeting of stockholders,
other than business that is either (i) specified in the notice of meeting (or
any supplement thereto) given by or at the direction of the Board (or any duly
authorized committee thereof), (ii) otherwise properly brought before the annual
meeting by or at the direction of the Board (or any duly authorized committee
thereof), or (iii) otherwise properly brought before the annual meeting by any
stockholder of the Company (A) who is a stockholder of record on the date of the
giving of the notice provided for in this By-Law and on the record date for the
determination of stockholders entitled to vote at such annual meeting and (B)
who complies with the notice procedures set forth in this By-Law 8.
(c) In addition to any other applicable requirements, for business to be
properly brought before an annual meeting by a stockholder, such stockholder
must have given timely notice thereof in proper written form to the Secretary of
the Company. To be timely, a stockholder's notice to the Secretary must be
delivered to or mailed and received at the principal executive offices of the
Company not less than 60 nor more than 90 calendar days prior to the date on
which the Company first mailed its proxy materials for the prior year's annual
meeting of stockholders; provided, however, that in the event that the annual
-------- -------
meeting is called for a date that is not within 30 calendar days before or after
the anniversary of the prior year's annual meeting, notice by the stockholder in
order to be timely must be so received not later than the close of business on
the tenth calendar day following the day on which public disclosure of the date
of the annual meeting was made. In no event will the public disclosure of an
adjournment of an annual meeting commence a new time period for the giving of a
stockholder's notice as described above. For purposes of the foregoing, the date
on which the Company first mailed its proxy materials to stockholders will be
the date so described in such proxy materials.
(d) To be in proper written form, a stockholder's notice to the Secretary
must set forth as to each matter such stockholder proposes to bring before the
annual meeting (i) a brief description of the business desired to be brought
before the annual meeting and the reasons for conducting such business at the
annual meeting, (ii) the name and record address of such stockholder, (iii) the
class or series and number of shares of capital stock of the Company which are
owned beneficially or of record by such stockholder, (iv) a description of all
arrangements or understandings between such stockholder and any other person or
persons (including their names) in connection with the proposal of such business
by such stockholder and any material interest of such stockholder in such
business, and (v) a representation that such stockholder intends to appear in
person or by proxy at the annual meeting to bring such business before the
meeting.
(e) At a special meeting of stockholders, only such business may be
conducted or considered as is properly brought before the meeting. To be
properly brought before a special meeting, business must be (i) specified in the
notice of the meeting (or any supplement thereto) given by or at the direction
of the Chairman or a majority of the Whole Board in accordance with By-Law 4 or
(ii) otherwise properly brought before the meeting by the presiding officer or
by or at the direction of a majority of the Whole Board.
-3-
<PAGE>
(f) The determination of whether any business sought to be brought before
any annual or special meeting of the stockholders is properly brought before
such meeting in accordance with this By-Law 8 will be made by the presiding
officer of such meeting. If the presiding officer determines that any business
is not properly brought before such meeting, he or she will so declare to the
meeting and any such business will not be conducted or considered.
DIRECTORS
---------
9. Function. The business and affairs of the Company will be managed
--------
under the direction of its Board.
10. Number, Election and Terms. Subject to the rights, if any, of any
--------------------------
series of Preferred Stock to elect additional Directors under circumstances
specified in a Preferred Stock Designation, the authorized number of Directors
may be determined from time to time only by a vote of a majority of the Whole
Board. The Directors, other than those who may be elected by the holders of any
series of the Preferred Stock, will be classified with respect to the time for
which they severally hold office in accordance with the Certificate of
Incorporation.
11. Vacancies and Newly Created Directorships. Subject to the rights, if
-----------------------------------------
any, of the holders of any series of Preferred Stock to elect additional
Directors under circumstances specified in a Preferred Stock Designation, newly
created directorships resulting from any increase in the number of Directors and
any vacancies on the Board resulting from death, resignation, disqualification,
removal or other cause will be filled solely by the affirmative vote of a
majority of the remaining Directors then in office, even though less than a
quorum of the Board, or by a sole remaining Director. Any Director elected in
accordance with the preceding sentence will hold office for the remainder of the
full term of the class of Directors in which the new directorship was created or
the vacancy occurred and until such Director's successor is elected and
qualified. No decrease in the number of Directors constituting the Board will
shorten the term of an incumbent Director.
12. Removal. Subject to the rights, if any, of the holders of any series
-------
of Preferred Stock to elect additional Directors under circumstances specified
in a Preferred Stock Designation, any Director may be removed from office by the
stockholders only for cause and only in the manner provided in the Certificate
of Incorporation and, if applicable, any amendment to this By-Law 12.
13. Nominations of Directors; Election. (a) Subject to the rights, if
----------------------------------
any, of the holders of any series of Preferred Stock to elect additional
Directors under circumstances specified in a Preferred Stock Designation, only
persons who are nominated in accordance with the following procedures will be
eligible for election as Directors of the Company. Nominations of persons for
election to the Board may be made at any annual meeting of stockholders (i) by
or at the direction of the Board (or any duly authorized Committee thereof) or
(ii) by any stockholder of the Company (A) who is a stockholder of record on the
date of the giving of the notice provided for in this By-Law 13 and on the
record date for the determination of stockholders entitled to vote at such
annual meeting and (B) who complies with the notice procedures set forth in this
By-Law 13. In addition to any other applicable requirements, for a nomination
to be made by a stockholder, such stockholder must have given timely notice
thereof in proper written form to the
-4-
<PAGE>
Secretary of the Company. To be timely, a stockholder's notice to the Secretary
must be delivered to or mailed and received at the principal executive offices
of the Company not less than 60 nor more than 90 calendar days prior to the date
on which the Company first mailed its proxy materials for the prior year's
annual meeting of stockholders; provided, however, that in the event that the
-------- -------
annual meeting is called for a date that is not within 30 calendar days before
or after the anniversary of the prior year's annual meeting, notice by the
stockholder in order to be timely must be so received not later than the close
of business on the tenth calendar day following the day on which public
disclosure of the date of the annual meeting was made. In no event will the
public disclosure of an adjournment of an annual meeting commence a new time
period for the giving of a stockholder's notice as described above. For purposes
of the foregoing, the date on which the Company first mailed its proxy materials
to stockholders will be the date so described in such proxy materials.
(b) To be in proper written form, a stockholder's notice to the Secretary
must set forth (i) as to each person whom the stockholder proposes to nominate
for election as a director (A) the name, age, business address and residence
address of the person, (B) the principal occupation or employment of the person,
(C) the class or series and number of shares of capital stock of the Company
which are owned beneficially or of record by the person, and (D) any other
information relating to the person that would be required to be disclosed in a
proxy statement or other filings required to be made in connection with
solicitations of proxies for election of directors pursuant to Section 14 of the
Securities Exchange Act of 1934, as amended, and the rules and regulations
thereunder (the "Exchange Act"), and the rules and regulations promulgated
thereunder, and (ii) as to the stockholder giving the notice (A) the name and
record address of such stockholder, (B) the class or series and number of shares
of capital stock of the Company which are owned beneficially or of record by
such stockholder, (C) a description of all arrangements or understandings
between or among such stockholder and each proposed nominee and any other person
or persons (including their names) pursuant to which the nomination(s) are to be
made by such stockholder, (D) a representation that such stockholder intends to
appear in person or by proxy at the meeting to nominate the persons named in its
notice, and (E) any other information relating to such stockholder that would be
required to be disclosed in a proxy statement or other filings required to be
made in connection with solicitations of proxies for election of directors
pursuant to the Exchange Act. Such notice must be accompanied by a written
consent of each proposed nominee to being named as a nominee and to serve as a
director if elected.
(c) If the presiding officer of the meeting determines that a nomination
was not made in accordance with the foregoing procedures, the presiding officer
will declare to the meeting that the nomination was defective and such defective
nomination will be disregarded.
(d) Notwithstanding anything in this By-Law 13 to the contrary, in the
event that the number of Directors to be elected to the Board is increased and
there is no public disclosure by the Company naming all of the nominees for
Director or specifying the size of the increased Board at least 70 calendar days
prior to the date on which the Company first mailed its proxy materials for the
preceding year's annual meeting of stockholders, a stockholder's notice required
by this By-Law will also be considered timely, but only with respect to nominees
for any new positions created by such increase, if it is delivered to the
Secretary at the principal executive offices of the Company not later than the
close of business on the tenth day following the day on which such public
disclosure is first made by the Company.
-5-
<PAGE>
14. Resignation. Any Director may resign at any time by giving written
-----------
notice of his or her resignation to the Chairman or the Secretary. Any
resignation will be effective upon actual receipt by any such person or, if
later, as of the date and time specified in such written notice.
15. Regular Meetings. Regular meetings of the Board may be held
----------------
immediately after the annual meeting of the stockholders and at such other time
and place either within or without the State of Delaware as may from time to
time be determined by the Board. Notice of regular meetings of the Board need
not be given.
16. Special Meetings. Special meetings of the Board may be called by the
----------------
Chairman or the President on one day's notice to each Director by whom such
notice is not waived, given either personally or by mail, telephone, telegram,
telex, facsimile or similar medium of communication, and will be called by the
Chairman or the President, in like manner and on like notice, on the written
request of a majority of the Whole Board. Special meetings of the Board may be
held at such time and place either within or without the State of Delaware as is
determined by the Board or specified in the notice of any such meeting.
17. Quorum. At all meetings of the Board, a majority of the total number
------
of Directors then in office will constitute a quorum for the transaction of
business. Except for actions required by these By-Laws or the Certificate of
Incorporation to be taken by a majority of the Whole Board, the act of a
majority of the Directors present at any meeting at which there is a quorum will
be the act of the Board. If a quorum is not present at any meeting of the
Board, the Directors present thereat may adjourn the meeting from time to time
to another place, time or date, without notice other than announcement at the
meeting, until a quorum is present.
18. Participation in Meetings by Telephone Conference. Members of the
-------------------------------------------------
Board or any committee designated by the Board may participate in a meeting of
the Board or any such committee, as the case may be, by means of telephone
conference or similar means by which all persons participating in the meeting
can hear each other, and such participation in a meeting will constitute
presence in person at the meeting.
19. Committees. (a) The Board may designate one or more committees. Each
----------
such committee will consist of one or more Directors and will have such lawfully
delegable powers and duties as the Board may confer ; provided, however, that no
-------- -------
committee shall exercise any power or duty expressly required by the Delaware
General Corporation Law, as it may be amended from time to time, to be acted
upon by the Board. Any such committee designated by the Board will have such
name as may be determined from time to time by resolution adopted by the Board.
(b) The members of each committee of the Board will serve in such capacity
at the pleasure of the Board or as may be specified in any resolution from time
to time adopted by the Board. The Board may designate one or more Directors as
alternate members of any such committee, who may replace any absent or
disqualified member at any meeting of such committee. In lieu of such
designation by the Board, in the absence or disqualification of any member of a
committee of the Board, the members thereof present at any such meeting of such
committee and not disqualified from voting, whether or not they constitute a
quorum, may
-6-
<PAGE>
unanimously appoint another member of the Board to act at the meeting in the
place of any such absent or disqualified member.
(c) Unless otherwise prescribed by the Board, a majority of the members of
any committee of the Board will constitute a quorum for the transaction of
business, and the act of a majority of the members present at a meeting at which
there is a quorum will be the act of such committee. Each committee of the
Board may prescribe its own rules for calling and holding meetings and its
method of procedure, subject to any rules prescribed by the Board, and will keep
a written record of all actions taken by it.
20. Compensation. The Board may establish the compensation for, and
------------
reimbursement of the expenses of, Directors for membership on the Board and on
committees of the Board, attendance at meetings of the Board or committees of
the Board, and for other services by Directors to the Company or any of its
majority-owned subsidiaries.
21. Rules. The Board may adopt rules and regulations for the conduct of
-----
meetings and the oversight of the management of the affairs of the Company.
NOTICES
-------
22. Generally. Except as otherwise provided by law, these By-Laws or the
---------
Certificate of Incorporation, whenever by law or under the provisions of the
Certificate of Incorporation or these By-Laws notice is required to be given to
any Director or stockholder, it will not be construed to require personal
notice, but such notice may be given in writing, by mail, addressed to such
Director or stockholder, at the address of such Director or stockholder as it
appears on the records of the Company, with postage thereon prepaid, and such
notice will be deemed to be given at the time when the same is deposited in the
United States mail. Notice to Directors may also be given by telephone,
telegram, telex, facsimile, electronic mail or similar medium of communication
or as otherwise may be permitted by these By-Laws.
23. Waivers. Whenever any notice is required to be given by law or under
-------
the provisions of the Certificate of Incorporation or these By-Laws, a waiver
thereof in writing, signed by the person or persons entitled to such notice,
whether before or after the time of the event for which notice is to be given,
will be deemed equivalent to such notice. Attendance of a person at a meeting
will constitute a waiver of notice of such meeting, except when the person
attends a meeting for the express purpose of objecting, at the beginning of the
meeting, to the transaction of any business because the meeting is not lawfully
called or convened.
OFFICERS
--------
24. Generally. The officers of the Company will be elected by the Board
---------
and will consist of a Chief Executive Officer (who, unless the Board specifies
otherwise, will also be the Chairman), a President, a Chief Financial Officer, a
Secretary, a Treasurer and a Controller. The Board of Directors may also choose
any or all of the following: one or more Vice Chairmen, one or more Assistants
to the Chairman, one or more Vice Presidents (who may be given particular
designations with respect to authority, function or seniority), one or more
Assistant Secretaries,
-7-
<PAGE>
one or more Assistant Treasurers and such other officers as the Board may from
time to time determine. Notwithstanding the foregoing, by specific action the
Board may authorize the Chairman to appoint any person to any office other than
Chairman, Chief Executive Officer, President, Chief Financial Officer,
Secretary, Treasurer or Controller. Any number of offices may be held by the
same person. Any of the offices may be left vacant from time to time as the
Board may determine. In the case of the absence or disability of any officer of
the Company or for any other reason deemed sufficient by a majority of the
Board, the Board may delegate the absent or disabled officer's powers or duties
to any other officer or to any Director.
25. Compensation. The compensation of all officers and agents of the
------------
Company who are also Directors of the Company will be fixed by the Board or by a
committee of the Board. The Board may fix, or delegate the power to fix, the
compensation of other officers and agents of the Company to an officer of the
Company.
26. Succession. The officers of the Company will hold office until their
----------
successors are elected and qualified. Any officer may be removed at any time by
the affirmative vote of a majority of the Whole Board. Any vacancy occurring in
any office of the Company may be filled by the Board or by the Chairman as
provided in By-Law 24.
27. Chairman of the Board. The Chairman shall preside at all meetings of
---------------------
the stockholders and of the Board and shall have such other powers and perform
such other duties as may be prescribed to him or her by the Board or provided in
these By-laws.
28. Chief Executive Officer. The Chief Executive Officer shall have the
-----------------------
powers and perform the duties incident to that position. Subject to the powers
of the Board, the Chief Executive Officer shall be in the general and active
charge of the entire business and affairs of the Company, and shall be its chief
policy making officer. The Chief Executive Officer shall have such other powers
and perform such other duties as may be prescribed by the Board or provided in
these By-laws. The Chief Executive Officer is authorized to execute bonds,
mortgages and other contracts requiring a seal, under the seal of the Company,
except where required or permitted by law to be otherwise signed and executed
and except where the signing and execution thereof shall be expressly delegated
by the Board to some other officer or agent of the Company.
29. The President. The President of the Company shall, subject to the
-------------
powers of the Board, and if the President is not also the Chief Executive
Officer, the Chairman and the Chief Executive Officer, have general charge of
the business, affairs and property of the Company, and control over its
officers, agents and employees. The President shall see that all orders and
resolutions of the Board are carried into effect. The President is authorized to
execute bonds, mortgages and other contracts requiring a seal, under the seal of
the Company, except where required or permitted by law to be otherwise signed
and executed and except where the signing and execution thereof shall be
expressly delegated by the Board to some other officer or agent of the Company.
The President shall have such other powers and perform such other duties as may
be prescribed by the Board, and if the President is not also the Chief Executive
Officer, the Chairman and Chief Executive Officer, or as may be provided in
these By-laws.
30. Vice Presidents. The Vice President, or if there shall be more than
---------------
one, the Vice Presidents in the order determined by the Board or the Chairman,
shall, in the absence or
-8-
<PAGE>
disability of the President, act with all of the powers and be subject to all
the restrictions of the President. The Vice Presidents shall also perform such
other duties and have such other powers as the Board, the Chairman, the Chief
Executive Officer, the President or these By-laws may, from time to time,
prescribe. The Vice Presidents may also be designated as Executive Vice
Presidents, Senior Vice Presidents or Regional Vice Presidents, as the Board may
from time to time prescribe.
31. The Chief Financial Officer. The Chief Financial Officer shall have
---------------------------
the custody of the corporate funds and securities; shall keep full and accurate
all books and accounts of the Company as shall be necessary or desirable in
accordance with applicable law or generally accepted accounting principles;
shall deposit all monies and other valuable effects in the name and to the
credit of the Company as may be ordered by the Chairman or the Board; shall
cause the funds of the Company to be disbursed when such disbursements have been
duly authorized, taking proper vouchers for such disbursements; and shall render
to the Board, at its regular meeting or when the Board so requires, an account
of the Company; shall have such powers and perform such duties as the Board, the
Chairman, the Chief Executive Officer, the President or these By-laws may, from
time to time, prescribe.
32. The Secretary and Assistant Secretaries. The Secretary shall attend
---------------------------------------
all meetings of the Board, all meetings of the committees thereof and all
meetings of the stockholders and record all the proceedings of the meetings in a
book or books to be kept for that purpose or shall ensure that his or her
designee attends each such meeting to act in such capacity. Under the Chairman's
supervision, the Secretary shall give, or cause to be given, all notices
required to be given by these By-laws or by law; shall have such powers and
perform such duties as the Board, the Chairman, the Chief Executive Officer, the
President or these By-laws may, from time to time, prescribe; and shall have
custody of the corporate seal of the Company. The Secretary, or an assistant
secretary, shall have authority to affix the corporate seal to any instrument
requiring it and when so affixed, it may be attested by his or her signature or
by the signature of such assistant secretary. The Board may give general
authority to any other officer to affix the seal of the Company and to attest
the affixing by his or her signature. The Assistant Secretary, or if there be
more than one, any of the Assistant Secretaries, shall in the absence or
disability of the Secretary, perform the duties and exercise the powers of the
Secretary and shall perform such other duties and have such other powers as the
Board, the Chairman, the Chief Executive Officer, the President, or Secretary
may, from time to time, prescribe.
33. The Treasurer and Assistant Treasurers. The Treasurer shall perform
--------------------------------------
such duties and exercise such powers as may be assigned by the Chief Financial
Officer. In the absence or disability of the Chief Financial Officer, the
Treasurer shall perform the duties and exercise the powers of the Chief
Financial Officer until such time as the Chief Financial Officer is no longer
absent or disabled or a new Chief Financial Officer is appointed. The Assistant
Treasurer, or if there be more than one, any of the Assistant Treasurers, shall
in the absence or disability of the Treasurer, perform the duties and exercise
the powers of the Treasurer and shall perform such other duties and have such
other powers as the Board, the Chairman, the Chief Executive Officer, the
President, or Treasurer may, from time to time, prescribe.
34. Controller. The Controller shall be the chief accounting officer of
----------
the Company, shall have charge of its accounting department and shall keep or
cause to be kept full and accurate records of the assets, liabilities, business
and transactions of the Company. The
-9-
<PAGE>
Controller shall perform such other duties and have such other powers as the
Board, the Chairman, the Chief Executive Officer or the President may, from time
to time, prescribe.
STOCK
-----
35. Certificates. Certificates representing shares of stock of the
------------
Company will be in such form as is determined by the Board, subject to
applicable legal requirements. Each such certificate will be numbered and its
issuance recorded in the books of the Company, and such certificate will exhibit
the holder's name and the number of shares and will be signed by, or in the name
of, the Company by the Chairman or the President and the Secretary or an
Assistant Secretary, or the Treasurer or an Assistant Treasurer, and will also
be signed by, or bear the facsimile signature of, a duly authorized officer or
agent of any properly designated transfer agent of the Company. Any or all of
the signatures and the seal of the Company, if any, upon such certificates may
be facsimiles, engraved or printed. Such certificates may be issued and
delivered notwithstanding that the person whose facsimile signature appears
thereon may have ceased to be such officer at the time the certificates are
issued and delivered.
36. Classes of Stock. The designations, powers, preferences and rights of
----------------
the various classes of stock or series thereof, and the qualifications,
limitations or restrictions thereof, will be set forth in full or summarized on
the face or back of the certificates which the Company issues to represent its
stock or, in lieu thereof, such certificates will set forth the office of the
Company from which the holders of certificates may obtain a copy of such
information.
37. Lost, Stolen or Destroyed Certificates. The Secretary may direct a
--------------------------------------
new certificate or certificates to be issued in place of any certificate or
certificates theretofore issued by the Company alleged to have been lost, stolen
or destroyed, upon the making of an affidavit of that fact, satisfactory to the
Secretary, by the person claiming the certificate of stock to be lost, stolen or
destroyed. As a condition precedent to the issuance of a new certificate or
certificates, the Secretary may require the owners of such lost, stolen or
destroyed certificate or certificates to give the Company a bond in such sum and
with such surety or sureties as the Secretary may direct as indemnity against
any claims that may be made against the Company with respect to the certificate
alleged to have been lost, stolen or destroyed or the issuance of the new
certificate.
38. Record Dates. (a) In order that the Company may determine the
------------
stockholders entitled to notice of or to vote at any meeting of stockholders or
any adjournment thereof, the Board may fix a record date, which will not be more
than 60 nor less than 10 calendar days before the date of such meeting. If no
record date is fixed by the Board, the record date for determining stockholders
entitled to notice of or to vote at a meeting of stockholders will be at the
close of business on the calendar day next preceding the day on which notice is
given, or, if notice is waived, at the close of business on the calendar day
next preceding the day on which the meeting is held. A determination of
stockholders of record entitled to notice of or to vote at a meeting of the
stockholders will apply to any adjournment of the meeting; provided, however,
that the Board may fix a new record date for the adjourned meeting.
(b) In order that the Company may determine the stockholders entitled to
receive payment of any dividend or other distribution or allotment of any rights
or the stockholders
-10-
<PAGE>
entitled to exercise any rights in respect of any change, conversion or exchange
of stock, or for the purpose of any other lawful action, the Board may fix a
record date, which record date will not be more than 60 calendar days prior to
such action. If no record date is fixed, the record date for determining
stockholders for any such purpose will be at the close of business on the
calendar day on which the Board adopts the resolution relating thereto.
(c) The Company will be entitled to treat the person in whose name any
share of its stock is registered as the owner thereof for all purposes and will
not be bound to recognize any equitable or other claim to, or interest in, such
share on the part of any other person, whether or not the Company has notice
thereof, except as expressly provided by applicable law.
INDEMNIFICATION
---------------
39. Damages and Expenses. (a) The Company will to the fullest extent
--------------------
permitted by applicable law as then in effect indemnify any person (an
"Indemnitee") who is or was involved in any manner (including without limitation
as a party or a witness) or is threatened to be made so involved in any
threatened, pending or completed investigation, claim, action, suit or
proceeding, whether civil, criminal, administrative or investigative (including
without limitation any action, suit or proceeding by or in the right of the
Company to procure a judgment in its favor) (a "Proceeding") by reason of the
fact that such person is or was or had agreed to become a Director or officer of
the Company, or is or was serving at the request of the Board or an officer of
the Company as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other entity, whether for profit or not for
profit, or anything done or not done by such person in any such capacity,
against all expenses (including attorneys' fees), judgments, fines and amounts
paid in settlement actually and reasonably incurred by such person in connection
with such Proceeding. Such indemnification will (i) be a contract right, (ii)
include the right to receive payment in advance of any expenses incurred by an
Indemnitee in connection with a Proceeding, consistent with the provisions of
applicable law as then in effect, and (iii) inure to the benefit of the estate,
heirs, executors and administrators of any Indemnitee who is or shall become
deceased.
(b) The right of indemnification provided in this By-Law 39 will not be
exclusive of any other rights to which any person seeking indemnification may
otherwise be entitled and will be applicable to Proceedings commenced or
continuing after the adoption of this By-Law 39, whether arising from acts or
omissions occurring before or after such adoption.
40. Insurance, Contracts and Funding. The Company may purchase and
--------------------------------
maintain insurance to protect itself and any Indemnitee against any expenses,
judgments, fines and amounts paid in settlement or incurred by any Indemnitee in
connection with any Proceeding referred to in By-Law 39 or otherwise, to the
fullest extent permitted by applicable law as then in effect. The Company may
enter into contracts with any person entitled to indemnification under By-Law 39
or otherwise and may create a trust fund, grant a security interest or use other
means (including without limitation a letter of credit) to ensure the payment of
such amounts as may be necessary to effect indemnification as provided in By-Law
39.
-11-
<PAGE>
GENERAL
-------
41. Fiscal Year. The fiscal year of the Company will end on December 31st
-----------
of each year or such other date as may be fixed from time to time by the Board.
42. Seal. The Board may adopt a corporate seal and use the same by
----
causing it or a facsimile thereof to be impressed or affixed or reproduced or
otherwise.
43. Reliance Upon Books, Reports and Records. Each Director, each member
----------------------------------------
of a committee designated by the Board and each officer of the Company will, in
the performance of his or her duties, be fully protected in relying in good
faith upon the records of the Company and upon such information, opinions,
reports or statements presented to the Company by any of the Company's officers
or employees or committees of the Board, or by any other person or entity as to
matters the Director, committee member or officer believes are within such other
person's professional or expert competence and who has been selected with
reasonable care by or on behalf of the Company.
44. Time Periods. In applying any provision of these By-Laws that
------------
requires that an act be performed or not be performed a specified number of days
before or after the occurrence of an event or that an act be performed or not be
performed during a period of a specified number of days before or after the
occurrence of an event, calendar days will be used unless otherwise specified,
the day of the performance of the act will be excluded and the day of the
occurrence of the event will be included.
45. Amendments. Except as otherwise provided by law or by the Certificate
----------
of Incorporation or these By-Laws, these By-Laws or any of them may be amended
in any respect or repealed at any time, either (i) at any meeting of
stockholders, provided that any amendment or supplement proposed to be acted
upon at any such meeting has been described or referred to in the notice of such
meeting, or (ii) at any meeting of the Board, provided that no amendment adopted
by the Board may vary or conflict with any amendment adopted by the
stockholders.
46. Certain Defined Terms. Terms used herein with initial capital letters
---------------------
that are not otherwise defined are used herein as defined in the Certificate of
Incorporation. In addition, for purposes of By-Laws 8 and 13, "public
disclosure" means disclosure in a press release reported by the Dow Jones News
Service, Associated Press or comparable national news service or in a document
filed by the Company with the Securities and Exchange Commission pursuant to the
Exchange Act. Notwithstanding the foregoing provisions of By-Laws 8 and 13, a
stockholder must comply with all applicable requirements of the Exchange Act
with respect to the matters set forth in those By-Laws. Nothing in By-Laws 8 and
13 will be deemed to affect any rights of stockholders to request inclusion of
proposals in the Company's proxy materials in accordance with Rule 14a-8 under
the Exchange Act.
-12-
<PAGE>
EXHIBIT 4.27
AMENDMENT NO. 4 TO
STOCKHOLDERS AGREEMENT AND CONSENT
----------------------------------
This Amendment No. 4 to Stockholders Agreement and Consent (this
"Amendment") is entered into as of this 21st day of May, 1999, among Focal
Communications Corporation, a Delaware corporation (the "Company") and the
stockholders listed on the signature page hereof (the "Stockholders").
Capitalized terms not otherwise defined in this Agreement are used herein with
the meanings assigned to such terms in the Stock Purchase Agreement, dated
November 27, 1996, by and among the parties hereto (the "Stock Purchase
Agreement").
WHEREAS, the Company and the Stockholders wish to amend the provisions of
the Stockholders Agreement, dated November 27, 1996, by and among the parties
hereto and certain other stockholders of the Company, as amended (the
"Stockholders Agreement") as provided in paragraph 1 of this Amendment;
WHEREAS, the Stockholders collectively own all of the Institutional
Investor Stock and the Executive Stock; and
WHEREAS, the Stockholders wish to consent to the amendment (as provided in
paragraph 1 of this Amendment) for purposes of the Stock Purchase Agreement;
NOW, THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties to this Amendment
hereby agree as follows:
1. Amendment to Stockholders Agreement. Pursuant to Section 9 of the
-----------------------------------
Stockholders Agreement, the first sentence of Section 3(b) of the Stockholders
Agreement is hereby amended and restated to read in its entirety as follows:
"Permitted Transfer" means (i) any Transfer of Common Stock (A)
pursuant to applicable laws of descent and distribution, (B) among such
Stockholder's Family Group (as defined below), or (C) in the case of a
Stockholder that is not a natural person, to such Stockholder's Affiliates
or (ii) any pledge of Common Stock that constitutes Vested Shares (as
defined in the Executive Stock Agreements) to a bank or other lending
institution for purposes of securing loans, mortgages or other financing
(A) with respect to which there is no default in the obligation secured by
the pledge, or (B) with respect to which a default giving the pledgee a
right to the security in the obligation secured by the pledge has occurred;
provided that, (X) except with respect to a transfer pursuant to clause
--------
(ii)(A) of this paragraph 3(b), the restrictions and conditions described
in this Agreement, the Stock Purchase Agreement, or any Executive Stock
Agreement to which the transferor is a party shall continue to be
applicable to such Common Stock after any such Permitted Transfer, and the
transferee(s) of such stock (the "Permitted Transferee(s)") shall have
agreed in writing to be bound by the provisions of such agreements; and (Y)
provided further that if any such stock is transferred pursuant to clause
(i)(C) of this paragraph
<PAGE>
3(b), any transfer of control of such Affiliate thereafter will be deemed
to be a transfer of such stock for purposes of this Agreement and will not
be considered a Permitted Transfer unless such deemed Transfer itself
satisfies the requirements of this paragraph 3(b)."
2. Consent. For all purposes of the Stock Purchase Agreement (including,
-------
without limitation, Sections 4.1(c)(xii) and 4.1E thereof), each of the
Stockholders consents to the amendment set forth in paragraph 1 of this
Amendment.
3. Counterparts. This Amendment may be executed in multiple
------------
counterparts, each of which shall be an original and all of which taken together
shall constitute one and the same agreement.
4. Descriptive Headings. The descriptive headings of this Amendment are
--------------------
inserted for convenience only and do not constitute a part of this Amendment.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment as of
the date first above written.
<TABLE>
<S> <C>
/s/ Brian F. Addy MADISON DEARBORN CAPITAL
- ------------------------------
Brian F. Addy PARTNERS, L.P.
By: Madison Dearborn Partners, its General Partner
By: Madison Dearborn Partners, Inc., its General
Partner
/s/ John R. Barnicle By: /s/ James N. Perry
- ------------------------------ -----------------------------------------------
John R. Barnicle Its: MD
--------------------------------------
/s/ Joseph Beatty FRONTENAC VI, L.P.
- ------------------------------
Joseph Beatty By: Frontenac Company, its General Partner
By: /s/ James E. Crawford, III
------------------------------------------------
Its: _______________________________________
/s/ Robert C. Taylor, Jr. BATTERY VENTURES III, L.P.
- ------------------------------
Robert C. Taylor, Jr. By: Battery Partners III, L.P., its
General Partner
By: /s/ Richard D. Frisbie
------------------------------------------------
Its:________________________________________
FOCAL COMMUNICATIONS CORPORATION
By: /s/ Robert C. Taylor, Jr.
------------------------------------------------
Its: Chief Executive Officer and President
---------------------------------------
</TABLE>
2
<PAGE>
EXHIBIT 5.1
July 6, 1999
Focal Communications Corporation
200 North LaSalle Street
Suite 1100
Chicago, Illinois 60601
Re: 10,350,000 Shares of Common Stock, Par Value $0.01
---------------------------------------------------
Ladies and Gentlemen:
We have acted as counsel for Focal Communications Corporation (the
"Company") in connection with the issuance and sale by the Company of 9,000,000
shares of common stock, par value $0.01 per share, of the Company (the "Common
Stock") in accordance with the Underwriting Agreement (the "Underwriting
Agreement") among the Company and the Underwriters listed in Schedule I thereto
(the "Underwriters") and up to an 1,350,000 additional shares of Common Stock
that may be issued and sold by the Company pursuant to an over-allotment option
granted to the Underwriters (the 9,000,000 and 1,350,000 shares, collectively
referred to herein as the "Shares").
We have examined such documents, records and matters of law as we have
deemed necessary for the purposes of this opinion. In rendering this opinion,
we have assumed that the signatures on all documents examined by us are genuine
and that the person who affixed such signature to such documents had authority
to do so, including corporate and fiduciary authority and, in the case of
consents of holders of shares of Common Stock, authority for such accounts and
trusts in which such shares have been held.
Based on the foregoing and the following assumptions, it is our
opinion that, when issued and sold to the Underwriters pursuant to the
Underwriting Agreement against payment of consideration therefor as provided
therein, the Shares will be duly authorized, validly issued, fully paid and
nonassessable.
In rendering the foregoing opinion, we have assumed that, prior to the
issuance and sale of the Shares to the Underwriters pursuant to the Underwriting
Agreement, (i) an Amended and Restated Certificate of Incorporation in the form
previously provided to us by the Company, duly approved and adopted by the
Company's Board of Directors and stockholders and authorizing the Company to
issue a total of 100,000,000 shares of Common Stock, will have been duly filed
with the Secretary of State of the State of Delaware and will be in full force
and effect at all times at which the Shares are offered or sold by the Company,
(ii) Amended and Restated By-laws, in the form previously provided to us by the
Company, will have been duly approved and adopted by the Company's Board of
Directors and stockholders and will be in full force and effect at all times at
which the Shares are offered or sold by the Company and (iii) resolutions
authorizing the Company to issue, offer and sell the
<PAGE>
Focal Communications Corporation
July 6, 1999
Page 2
Shares will have been duly adopted by the Company's Board of Directors and will
be in full force and effect at all times at which the Shares are offered or sold
by the Company.
We hereby consent to the filing of this opinion as Exhibit 5.1 to the
Registration Statement on Form S-1 (Reg. No. 333-77995) as amended through
Amendment No. 2 dated the date hereof filed by the Company to effect
registration of the Shares under the Securities Act of 1933, as amended, and to
the reference to us under the caption "Legal Matters" in the Prospectus
constituting a part of such Registration Statement.
Very truly yours,
/s/ JONES, DAY, REAVIS & POGUE
<PAGE>
Amendment to 1997 Nonqualified Stock Option Plan
May 21, 1999
ARTICLE I of the Plan is amended to restate the defined term
"Participant" in its entirety as follows:
"Participant" shall mean a person who is selected by the Board
to receive benefits under this Plan and who is at the time a
consultant, an officer or other key employee of the Company or any one
or more of its Subsidiaries or who has agreed to commence serving in
any of such capacities."
<PAGE>
EXHIBIT 21.1
FOCAL COMMUNICATIONS CORPORATION
List of Subsidiaries
. FOCAL COMMUNICATIONS CORPORATION OF CALIFORNIA
. FOCAL COMMUNICATIONS CORPORATION OF COLORADO
. FOCAL COMMUNICATIONS CORPORATION OF FLORIDA
. FOCAL COMMUNICATIONS CORPORATION OF GEORGIA
. FOCAL COMMUNICATIONS CORPORATION OF ILLINOIS
. FOCAL COMMUNICATIONS CORPORATION OF MASSACHUSETTS
. FOCAL COMMUNICATIONS CORPORATION OF MICHIGAN
. FOCAL COMMUNICATIONS CORPORATION OF MID-ATLANTIC
. FOCAL COMMUNICATIONS CORPORATION OF MINNESOTA
. FOCAL COMMUNICATIONS CORPORATION OF MISSOURI
. FOCAL COMMUNICATIONS CORPORATION OF NEW JERSEY
. FOCAL COMMUNICATIONS CORPORATION OF NEW YORK
. FOCAL COMMUNICATIONS CORPORATION OF OHIO
. FOCAL COMMUNICATIONS CORPORATION OF PENNSYLVANIA
. FOCAL COMMUNICATIONS CORPORATION OF TEXAS
. FOCAL COMMUNICATIONS CORPORATION OF VIRGINIA
. FOCAL COMMUNICATIONS CORPORATION OF WASHINGTON
. FOCAL COMMUNICATIONS CORPORATION OF WISCONSIN
. FOCAL TELECOMMUNICATIONS CORPORATION
. FOCAL FINANCIAL SERVICES, INC.
. FOCAL INTERNATIONAL CORP.
<PAGE>
Exhibit 23.1
Consent of Independent Public Accountants
As independent public accountants, we hereby consent to the use of our reports
(and to all references to our Firm) included in or made a part of this
Registration Statement File No. 333-77995.
ARTHUR ANDERSEN LLP
Chicago, Illinois
July 2, 1999
