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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 333-53553
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TIME WARNER TELECOM LLC
(Exact name of registrant as specified in its charter)
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Delaware 84-1465464
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5700 S. Quebec Street
Greenwood Village, CO 80111
(Address of Principal Executive Offices)
(303) 566-1000
(Registrant's telephone Number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
None
Documents Incorporated by Reference:
None
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO
--- ----
Indicate by check mark if disclosure of delinquent filer pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
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This document contains certain "forward-looking statements," within the
meaning of the Private Securities Litigation Reform Act of 1995, including
statements regarding, among other items, the Company's business and operating
strategy, operations, economic performance and financial condition. These
forward-looking statements are based on management's current expectations and
are naturally subject to risks, uncertainties and changes in circumstances,
certain of which are beyond the Company's control. Actual results may differ
materially from those expressed or implied by such forward-looking statements.
Factors that could cause such differences include, but are not limited to, those
discussed under "Factors That Could Affect Future Performance." The Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the forward-looking
events and circumstances discussed in this report might not occur.
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In this report:
The term "Company" refers to Time Warner Telecom LLC ("TWT LLC"), its
consolidated and unconsolidated subsidiaries including Time Warner Telecom
Inc., a wholly owned subsidiary of TWT LLC formed solely to serve as co-
obligor of the 9 3/4% Senior Notes due 2009 offered by the Company to the
public on July 21, 1998 ("Notes") ("TWT Inc."), and all operations of the
Company that were historically conducted by the Members (as defined).
The term "Members" refers to
(a) Time Warner Inc. and certain of its subsidiaries (collectively,
"TW"),
(b) MediaOne of Colorado, Inc. and certain of its subsidiaries
(collectively, "MediaOne"), and
(c) Advance/Newhouse Partnership ("Newhouse").
TW and MediaOne, through certain subsidiaries, are partners in Time
Warner Entertainment Company, L.P. ("TWE"). TWE and Newhouse are partners
in Time Warner Entertainment-Advance/Newhouse Partnership ("TWE-A/N").
On March 22, 1999, MediaOne and Comcast Corporation ("Comcast")
entered into an agreement pursuant to which MediaOne will be merged into
Comcast, with Comcast as the surviving corporation.
The term "TW Cable" refers collectively to the cable systems owned by
subsidiaries and divisions of TWE, TWE-A/N and TW.
The term "Reconstitution" refers to the provision of the Amended and
Restated Limited Liability Agreement of the Company that, if the Members
unanimously agree to do so, the Company will be reconstituted as a Delaware
Corporation (either by merger, exchange, contribution of assets or similar
transaction) so that an initial public offering of the Class A Common Stock
of such corporation may be effected.
See "Glossary" on Page 58 for definitions of certain other terms used in
this report.
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PART I
Item 1. Business
Overview
The Company is a leading fiber facilities-based competitive local exchange
carrier ("CLEC") in selected metropolitan areas across the United States,
offering a wide range of business telephony services, primarily to medium- and
large-sized business customers and other carriers. The Company's customers are
principally telecommunications-intensive business end-users, long distance
carriers ("IXCs"), internet service providers ("ISPs") wireless communications
companies and governmental entities. Such customers are offered a wide range of
integrated telecommunications services, including dedicated transmission, local
switched, long distance, data and video transmission services and certain
internet services. The Company has deployed switches in 16 of its 19 service
areas as of December 31, 1998, and management expects that a growing portion of
the Company's revenues will be derived from providing switched services. In
addition, the Company benefits from its strategic relationship with TW Cable
both through network facilities access and cost-sharing. As a result, the
Company's networks have been constructed primarily through licensing the use of
fiber capacity from TW Cable. As of December 31, 1998, the Company operated
networks in 19 metropolitan areas that spanned 6,968 route miles, contained
272,390 fiber glass miles and offered service to 4,321 buildings. Combined
revenues for the Company, which have historically been primarily derived from
private line services, grew by 120.0% for the year ended December 31, 1998 as
compared to the same period in 1997.
The business of the Company was commenced in 1993 by TW Cable, originally
to provide certain telephony services together with cable television. In January
1997, the Company put in place a new management team that is implementing a
business strategy focused exclusively on serving business customers, rapidly
providing switched services in all the Company's service areas and expanding the
range of business telephony services offered by the Company.
The Company believes that the Telecommunications Act of 1996 (the "1996
Act" and certain state regulatory initiatives provide increased opportunities in
the telecommunications marketplace by opening all local service areas to
competition and requiring incumbent local exchange carriers ("ILECs") to provide
increased direct interconnection. According to the Federal Communications
Commission ( "FCC"), in 1997 the total revenues for the telecommunications
industry amounted to approximately $230.0 billion, of which approximately $130.0
billion was local service and approximately $100.0 billion was long distance. To
capitalize on these significant opportunities, the Company has accelerated its
deployment of high capacity digital switches in its service areas and is
aggressively marketing switched services to medium- and large-sized businesses.
Business Strategy
The Company's primary objective is to be a leading CLEC in its existing and
future service areas offering medium- and large-sized businesses superior
telecommunications services through advanced networks. The key elements of the
Company's business strategy include the following:
Leverage Existing Fiber Optic Networks. The Company has designed and built
its networks to serve geographic locations where management believes there are
large numbers of potential customers. As of December 31, 1998, the Company
operated networks that spanned over 6,968 route miles and contained over 272,390
fiber glass miles. The Company's highly concentrated networks have yet to be
fully exploited and provide the capacity to serve a substantially larger base of
customers. Management believes that the Company's extensive fiber network
capacity allows it to: (i) increase orders substantially from new and existing
customers while incurring significantly lower capital expenditures and operating
expenses than non-fiber facilities based carriers; (ii) emphasize its fiber
facilities-based services rather than resales of network capacity of other
providers; and (iii) provide better customer service because the Company can
exert greater control over its services than its competitors that depend on off-
net facilities.
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Expand Switched Services. The Company provided a broad range of switched
services in 16 of its 19 service areas as of December 31, 1998, and plans to
provide switched services in all of its current service areas by 2000. For the
year ended September 30, 1998, combined revenues from switched services grew by
248.1% as compared to the same period in 1997. Because the demand for switched
services is greater than for dedicated transport services and the Company has
been rapidly installing switches in its markets, management expects the Company
to derive a growing portion of its revenues from switched services. The Company
utilizes high capacity digital 5-ESS switches manufactured by Lucent.
Expand Data Services Capacity. Data services are becoming increasingly
important to the Company's target customers. In particular, the Company believes
that the demand for high speed, high-quality Local Area Network ("LAN") and Wide
Area Network ("WAN") connectivity, virtual private networks, website hosting, e-
commerce, intranet and internet access and transport services is growing
rapidly. During the second quarter of 1999, the Company plans to deploy a fully
managed, fiber-based nationwide infrastructure to ensure that its long-haul data
products provide the capacity and high quality level of service increasingly
demanded by its customers.
Target Medium- and Large-Sized Business Customers. The Company operates
networks in metropolitan areas that have high concentrations of medium- and
large-sized businesses. Such businesses tend to be telecommunications-intensive
and are more likely to seek the greater reliability provided by an advanced
network such as the Company's. Thus, management believes that significant
economies of scale may be achieved by focusing and intensifying its sales and
marketing efforts on such businesses as they are potentially high volume users
of the Company's services. To drive revenue growth in these markets, the Company
is aggressively expanding its direct sales force to focus on such business
customers.
Interconnect Service Areas. The Company groups the 19 service areas in
which the Company currently operates into six geographic clusters across the
United States. See "Telecommunications Networks and Facilities --
Telecommunications Networks." The Company plans to interconnect each service
area within a cluster with its own broadband, fiber optic facilities or with
facilities licensed from TW Cable and/or third parties. This is expected to
increase its revenue potential by addressing customers' regional long distance
voice, data and video requirements. The Company began interconnecting its
service areas in 1998.
Utilize Strategic Relationships with TW Cable. The Company has benefited
from and continues to leverage its relationships with TW Cable, the largest
multiple system cable operator in the U.S., by licensing and sharing the cost of
digital fiber optic facilities. This licensing arrangement allows the Company to
benefit from TW Cable's access to rights-of-way, easements, poles, ducts and
conduits. See "Certain Relationships and Related Transactions -- Certain
Operating Agreements." By leveraging its existing relationship with TW Cable,
the Company believes that it can increase revenues, benefit from existing
regulatory approvals and licenses, derive economies of scale in network costs
and extend its existing networks in a rapid, efficient and cost-effective
manner. Furthermore, management believes that the strong awareness and positive
recognition of the "Time Warner" brand name significantly contributes to its
marketing programs and sales efforts by distinguishing it from its competitors.
Enter New Geographic Areas. The Company's strategy is to target
metropolitan areas possessing demographic, economic and telecommunications
demand profiles that it believes provide it with the potential to generate an
attractive economic return. Currently, the Company operates networks in a total
of 19 metropolitan areas and has announced plans to enter Dallas, Texas and
Jersey City, New Jersey by the third quarter of 1999, which brings the total to
21. Management plans to have networks in operation or under construction in 1
additional service area by the end of 1999.
Continue Disciplined Expenditure Program. The Company increases operational
efficiencies by pursuing a disciplined approach to capital expenditures. This
capital expenditure program requires that prior to making any expenditure on a
project, the project must be expected to meet stringent financial criteria such
as minimum recurring revenue, cash flow margins and rate of return. In addition,
to control capital expenditures and share the risks of developing costly new
networks, management is considering establishing strategic alliances with other
telecommunications providers in the form of joint ventures and possible co-
branding marketing programs.
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Market Opportunity
The Company believes that the 1996 Act and certain state regulatory
initiatives provide increased opportunities in the telecommunications
marketplace by opening all local markets to competition and requiring ILECs to
provide increased direct interconnection. According to the FCC, in 1997 the
total revenues for the telecommunications industry amounted to approximately
$230.0 billion, of which approximately $130.0 billion was local service and
approximately $100.0 billion was long distance. To capitalize on these
significant opportunities, the Company accelerated its deployment of high
capacity digital switches in its markets and is aggressively marketing switched
services to its customers.
A number of important trends are reshaping the U.S. communications
industry, creating substantial opportunities for CLECs beyond capturing market
share from ILECs in local exchange services. These trends include:
. increasing customer demand for high speed, broadband services, such as
internet access and transport and personal computer -- and internet
protocol-based applications,
. the emergence of e-commerce as a new paradigm for business transactions,
and
. continued consolidation among service providers to broaden their service
offerings and technical capabilities.
By leveraging customer relationships and bundling service offerings, CLECs
have begun to exploit a variety of opportunities, including high speed internet
access and transport, xDSL, LAN and WAN connectivity, managed network services,
virtual private networks, remote access, and e-commerce services. The Company
believes that new entrants have an excellent opportunity to establish themselves
as leading providers of such value-added services.
High-speed connectivity has become important to business due to the
dramatic increase in internet usage and the proliferation of PC- and IP-based
applications. According to International Data Corporation, an independent
telecommunications and technology research company, the number of internet users
worldwide reached approximately 69 million in 1997 and is forecasted to grow to
approximately 320 million by 2002. The popularity of the internet with
consumers has also driven the rapid growth in exploiting the internet as a
commercial medium, as businesses establish Web sites, corporate intranets and
extranets and implement e-commerce applications to expand their customer reach
and improve their communications efficiency. International Data Corporation
estimates that the value of goods and services sold worldwide through the
internet will increase from $12 billion in 1997 to over $400 billion in 2002.
The Company believes that these applications are becoming increasingly important
to businesses of all sizes, making the availability of broadband capacity,
network quality, a value-added services portfolio and technical capability an
important competitive distinction among service providers.
Services
The Company provides its customers with a wide range of telecommunications
services, including dedicated transmission, local switched, long distance, data
and video transmission services and high-speed dedicated internet access
services. The Company's dedicated services, which include private line and
special access services, use high-capacity digital circuits to carry voice, data
and video transmissions from point-to-point in multiple configurations. Switched
voice services offered by the Company use high-capacity digital switches to
route voice transmissions anywhere on the public switched telephone network. In
offering its dedicated transmission and switched services, the Company also
provides private network management and systems integration services for
businesses that require combinations of various dedicated and switched
telecommunications services. Data services provided by the Company allow
customers to create their own internal computer networks and access external
computer networks and the internet. The Company can provide its customers,
including companies in the media industry, with advanced video transport
services such as point-to-point, broadcast-quality video to major television
networks as well as to advertising agencies and other customers. Internet
services provided by the Company include dedicated internet access, website
hosting, transport and electronic commerce services for business customers and
local ISPs.
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Dedicated Transport Services
The Company currently provides a complete range of dedicated transport
services with transmission speeds from 2.4 Kbps to 2.488 Gbps to its IXC and
end-user customers. All products and services can be used for voice, data, image
and video transmission.
The Company offers the following dedicated transport links:
. POP-to-POP Special Access. Telecommunications lines linking the Points of
Presence ("POPs") of one IXC or the POPs of different IXCs in a market,
allowing the POPs to exchange transmissions for transport to their final
destinations.
. End-User/IXC Special Access. Telecommunications lines between an end-
user, such as a large business, and the local POP of its selected IXC.
. Private Line. Telecommunications lines connecting various locations of a
customer's operations, suitable for transmitting voice and data traffic
internally.
. Transport Arrangement Service. Provides dedicated transport between local
exchange carrier ("LEC") central offices and customer designated POPs of
an IXC for transport of LEC provided switched access or LEC provided
special access. This point-to-point service is available at DS1 or DS3
interfaces at both ends. DS1 and DS3 interfaces are standard North
American telecommunications industry digital signal formats that are
distinguishable by the number of binary digits transmitted per second, or
bit rate. DS1 has a bit rate of 1.544 megabits per second and DS3 has a
bit rate of 44.736 megabits per second.
The Company provides the following services that use high-capacity digital
circuits to carry voice, data and video transmissions from point to point in
flexible configurations involving different standardized transmission speeds and
circuit capacities:
. broadcast video TV-1, which is the dedicated transport of broadcast
quality video signals;
. STS-1, which is the full duplex, synchronous optical transmission of
digital data on synchronous optical network, or SONET, standards, which
eliminates the need to maintain and pay for multiple dedicated lines; and
. private network transport service, which is a private, dedicated premium
quality service over fully redundant, diverse routed, SONET rings with
bandwidth that is dedicated and always available.
The transmission speeds and circuit capacities used for these services
include DSO, DS1, DS3 and SONET OC-N. DSO is a standard North American
telecommunications industry digital signal format that has a bit rate of 64
kilobits per second.
Switched Services
The Company's switched services provide business customers with local
calling capabilities and connections to their IXCs. The Company owns, houses,
manages and maintains the switch used to provide the services. The Company's
switched services include the following:
. Business Access Line Service. This service provides voice and data
customers quality analog voice grade telephone lines for use at any time.
Business Access Line Service provides customers with flexibility in
network configurations because lines can be added, deleted and moved as
needed.
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. TW Access Trunks. TW Access Trunks provide communication lines between
two switching systems. These trunks are utilized by private branch
exchange, or PBX, customers which are customers that own and operate a
switch on their own premises. PBX customers use these trunks to provide
access to the local, regional and long distance telephone networks. PBX
customers may use either the Company's telephone numbers or their ILEC-
assigned telephone numbers. Customer access to the Company's local
exchange services is accomplished by a DS1 digital connection or DS0
analog trunks between the customer's PBX port and the Company's switching
centers.
. TW Local Toll Service. This service provides customers with a competitive
alternative to ILEC service for intraLATA toll calls. It is a customized,
high-quality local calling plan available to Business Access Line and TW
Access Trunk customers. The Company works with customers to devise cost-
saving programs based on actual usage and calling patterns.
. Local Telephone Service. Local telephone service is basic local exchange
service which can be tailored to a customer's particular calling
requirements. Local telephone service includes operator and directory
assistance services, as well as an optional intraLATA toll plan.
. Switched Access Service. The connection between a long distance carrier's
POP and an end user's premises that is provided through the switching
facilities of a local exchange carrier are referred to as switched access
services. These services provide IXCs with a switched connection to their
customers for the origination and termination of long distance telephone
calls.
. Other services offered by the Company include telephone numbers,
listings, customized calling features, voice messaging, hunting, blocking
services and two-way, simultaneous voice and data transmission in digital
formats over the same transmission line, which is an international
standard referred to as integrated services digital network or ISDN.
Data Transmission Services
The Company offers its customers a broad array of data transmission
services that enable customers to create their own internal computer networks
and access external computer networks and the internet. In 1996, the Company
introduced its native speed LAN inter-networking data service which is used to
connect workstations and personal computer users on one or more LANs. Native
speed services avoid the bottleneck problems that are frequently encountered
with customary DS-1 connections by providing the customer with a circuit that
matches the transmission speeds of its LAN. The Company's LAN service provides
dedicated circuits, guaranteed transmission capacity and guaranteed bandwidth
for virtually all LAN applications. Users can share files and databases as if
they were all working on the same computer, or within the same LAN.
As companies and communications become more sophisticated, there is an
increased need for customer access to superior traffic management of sensitive
data, video and voice transmission within a single metropolitan area, or between
various company operations. The Company's switched data services offer
sophisticated switching technology and provide high standards in reliability and
flexibility while enabling users to reduce the costs associated with
interconnecting architecturally diverse information systems. The Company's data
service offerings support evolving high-speed applications, such as multimedia,
desktop video conferencing and medical imaging. The Company offers native speed
connections to both end-users as well as interexchange data carriers. The
Company's services allow users to interconnect both high speed and low speed LAN
environments and to benefit from flexible billing, as well as detailed usage
reports.
Video Transmission Services
The Company provides broadcast quality digital and analog video link
services to its video services customers, including media industry customers,
such as television networks, and advertising agencies. The Company's video
services include offering broadcast quality, digital channel transmissions that
can be provided on a point-to-point or point-to-multipoint basis.
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Internet Services
Late in 1998, the Company contracted with a local internet service provider
to deploy a national fiber-based internet protocol backbone connecting the
Company's hub cities. By the end of the second quarter of 1999, the network is
expected to be operational in the 19 markets that the Company currently serves.
Through this relationship, the Company will manage its 19 asynchronous transfer
mode data switches through which it provides dedicated internet connectivity at
speeds of up to DS3.
Long Distance Services
The Company began to offer basic long distance services in 1998 and intends
to offer additional services, such as toll free, calling card and international
gateways to Europe and the Pacific, targeting medium- and small-size business
customers. Generally, large businesses tend to obtain their long distance needs
directly from the major IXCs. The Company believes medium- and small-size
businesses are more likely to obtain their long distance services from CLECs
rather than the major IXCs. As a result, management believes that such medium-
and small-sized end-users represent a potential customer base for developing a
market for the Company's long distance services. The Company purchases long
distance capacity under agreements with major IXCs that provide the Company
capacity at competitive rates for resale and all support and billing services.
The Company has negotiated a non-exclusive resale agreement with a long distance
carrier and may negotiate additional resale agreements with other long distance
carriers. Management believes that the offering of long distance services will
contribute to revenue growth with profitable margins and will also add strategic
sales and marketing value as a bundled product.
Telecommunications Networks and Facilities
Overview. The Company uses the latest technologies and network
architectures to develop a highly reliable infrastructure for delivering high-
speed, quality digital transmissions of voice, data and video
telecommunications. The Company's basic transmission platform consists primarily
of optical fiber equipped with high capacity SONET equipment deployed in fully
redundant, self-healing rings. These SONET rings give the Company the capability
of routing customer traffic in both directions around the ring, thereby
eliminating loss of service in the event of a cable cut. The Company's networks
are designed for remote automated provisioning, which allows the Company to meet
customers' real time service needs. The Company extends SONET rings or point to
point links from rings to each customer's premises over its own fiber optic
cable and unbundled facilities obtained from ILECs. The Company also installs
diverse building entry points where a customer's security needs require such
redundancy. The Company then places necessary customer-dedicated or shared
electronic equipment at a location near or in the customer's premises to
terminate the link.
The Company serves its customers from one or more central offices or hubs
strategically positioned throughout its networks. The central offices house the
transmission and switching equipment needed to interconnect customers with each
other, the IXCs and other local exchange networks. Redundant electronics, with
automatic switching to the backup equipment in the event of failure, protects
against signal deterioration or outages. The Company continuously monitors
system components from its NOC and proactively focuses on avoiding problems
rather than merely reacting upon failure.
The Company adds switched, dedicated and data services to its basic fiber
optic transmission platform by installing sophisticated digital electronics at
its central offices and nodes and at customer locations. The Company's advanced
Lucent 5-ESS digital telephone switches are connected to multiple ILEC and long
distance carrier switches to provide the Company's customers access to
telephones in the local market as well as the public switched telephone network.
Similarly, in certain markets, the Company provides ATM switched and LAN
multiplexers at its customers' premises and in its central offices to provide
high speed LAN interconnection services.
The Company's strategy for adding customers is designed to maximize the
speed and impact of its marketing efforts while maintaining attractive rates of
return on capital invested to connect customers directly to its networks. To
initially serve a new customer, the Company may use various transitional links,
such as reselling a portion of an
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ILEC's network. Once the new customer's communications volume and product needs
are identified, the Company may build its own fiber optic connection between the
customer's premises and the Company's network to accommodate: (i) the customer's
needs; and (ii) the Company's efforts to maximize return on network investment.
Telecommunications Networks. The following chart sets forth information
regarding each of the Company's telecommunications networks as of December 31,
1998:
<TABLE>
<CAPTION>
Network Switch Commercial
Commercially Commercially Fiber Route Buildings MSA Business
Metropolitan Area Available Available(1) Miles(2) On-Net Lines(3)
- ------------------------- ------------ --------------- -------------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
New York Region
Albany, New York......... Jul. 95 Sep. 99 (6) 42 16 302,130
Binghamton, New York..... Jan. 95 TBD 81 27 78,868
Manhattan, New York...... Feb. 96 Feb. 96 157 53 2,473,048
Rochester, New York...... Dec. 94 Feb. 95 366 91 368,522
Jersey City, New Jersey.. July 99 (6) July 99 (6) na na 203,312
Southwest Region
Austin, Texas............ Sep. 94 Apr. 97 284 89 374,200
Dallas, Texas............ Sept. 99 (6) Sept. 99 (6) na na 1,095,916
Houston, Texas........... Jan. 96 Sep. 97 471 153 1,262,601
San Antonio, Texas....... May 93 (4) Nov. 97 524 151 431,989
Southeast Region
Charlotte, N. Carolina... Sep. 94 Dec. 97 634 192 494,477
Greensboro, N. Carolina.. Jan. 96 Sep. 99 (6) 142 20 317,637
Memphis, Tennessee....... May 95 May 97 503 112 267,339
Raleigh, N. Carolina..... Oct. 94 Sep. 97 523 131 277,378
Midwest Region
Cincinnati, Ohio......... Jul. 95 Nov. 97 299 86 524,937
Columbus, Ohio(5)........ Mar. 91 (4) Jul. 97 371 105 433,323
Indianapolis, Indiana.... Sep. 87 (4) Dec. 97 281 137 452,874
Milwaukee, Wisconsin..... Feb. 96 Sep. 97 422 96 524,155
Southern Region
Tampa, Florida........... Dec. 97 Jan. 98 423 10 978,203
Orlando, Florida......... Jul. 95 Jul. 97 912 152 833,765
Western Region
Honolulu, Hawaii......... Jun. 94 Jan. 98 296 195 223,224
San Diego, California.... Jun. 95 Jul. 97 237 103 1,125,674
------- ---------- ------------
Total.................... 6,968 1,919 13,043,572
======= ========== ============
</TABLE>
1. Date of switch commercially available is the first date on which switched
services were provided to a customer of the Company.
2. Licensed and owned fiber optic route miles.
3. Metropolitan Statistical Areas ("MSA") business lines data are from
Statistics of Communications Common Carrier 1997 Business Data.
4. The networks in Columbus, Ohio, San Antonio, Texas and Indianapolis, Indiana
were built by certain predecessor companies prior to the commencement of the
Company's business.
5. The Columbus market is operated under a partnership, MetroComm AxS, L.P.,
which is a 50% owned entity of the Company. However, the switch is owned by
the Company.
6. Estimated.
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Information Systems Infrastructure. The Company uses advanced technology in
its information systems infrastructure. The Company also uses an integrated,
nationwide client server platform and coherent relational databases to increase
employee productivity, link itself electronically to some of its customers and
develop real time data and information. The architecture also enables the
Company to rapidly re-engineer its processes and procedures to lower its costs
and to respond rapidly to changing industry conditions. The Company's
information systems deliver data at the network, regional or corporate level,
and also by customer and vendor. The Company's information systems assist in the
delivery of superior customer service and real time support of network
operations. The systems, which were partially developed by an outside vendor but
are operated internally, utilize open system standards and architecture. As a
result, the Company is positioned to either purchase from third parties or
develop in-house supplementary information support systems as its needs arise.
The Company has contracted with an outside vendor to install certain new back
office systems to enhance the Company's capabilities and accommodate the planned
scale of its business. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000."
Network Monitoring and Management. The Company provides a single point of
contact for all of its customers and consolidates all of its systems support,
expertise and technical training at its network operations center in Greenwood
Village, Colorado. With over 400 technicians, customer service representatives
and administrative support staff dedicated to providing superior customer
service, the Company is able to quickly correct, and often anticipate, any
problems that may arise in its networks. The Company provides 24 hour-a-day, 7
days-a-week surveillance and monitoring of networks to achieve the Company's
99.98% network reliability and performance. Network analysts monitor real-time
alarm, status and performance information for network circuits, which allows
them to react swiftly to repair network failures.
Network Development and Application Laboratory. The Company's Network
Development and Application Laboratory is a comprehensive telecommunications
technology, applications and services development laboratory, equipped with
advanced systems and equipment, including those used by the Company in the
operation of its local digital networks. The center is designed to provide a
self-contained testing and integration environment, fully compatible with the
Company's digital networks, for the purposes of: (i) verifying the technical and
operational integrity of new equipment prior to installation in the networks;
(ii) developing new services and applications; (iii) providing a realistic
training environment for technicians, engineers and others; and (iv) providing a
network simulation environment to assist in fault isolation and recovery.
Technologies currently under evaluation in the lab include Dense Wave Division
Multiplexing ("DWDM"), optical bandwidth management and internet protocol
telephony, and related data applications.
Billing Systems. The Company contracts with outside vendors for customer
billing. The Company has licensed a system for switched services billing that it
operates on its own equipment and has a service bureau arrangement with another
vendor for dedicated transport service and interconnection billing. See "Factors
that Could Affect Future Performance -- Dependence on Information and Billing
Systems" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Year 2000."
Agreements with TW Cable. The Company has entered into several agreements
with TW Cable for the license of fiber optic networks and certain facilities,
administrative and operating services and residential telephony support
services. See "Factors That Could Affect Future Performance -- Relationship with
TW Cable" and "Certain Relationships and Related Transactions -- Certain
Operating Agreements."
Network Design and Construction
In order to leverage its relationship with TW Cable, the Company has
constructed its existing networks in selected metropolitan areas served by TW
Cable's fiber optic infrastructure. This has allowed the Company to develop, in
a cost-efficient way, an extensive network in each of its service areas. As of
December 31, 1998, the Company's networks spanned 6,968 route miles, contained
272,390 fiberglass miles and offered service to 4,321 buildings with 2,953,454
voice grade equivalent circuits and 78,036 access lines in service.
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The Company anticipates that it will construct new networks in certain
cities, using its relationship with TW Cable or other fiber providers, or by
developing the networks in house, whichever is most effective and economical.
Before deciding to construct or acquire a network in a particular city, the
Company's corporate development staff reviews the demographic, economic,
competitive and telecommunications demand characteristics of the city, including
its location, the concentration of potential business, government and
institutional end-user customers, the economic prospects for the area, available
data regarding IXC and end-user special access and switched access transport
demand and actual and potential competitive access provider ("CAP")/CLEC
competitors. Market demand is estimated on the basis of market research
performed by Company personnel and others, utilizing a variety of data including
estimates of the number of interstate access and intrastate private lines in the
city based primarily on FCC reports and commercial databases. This process has
enabled the Company to reduce its start-up costs and expedite lead times.
If a particular city targeted for development is found to have sufficiently
attractive demographic, economic, competitive and telecommunications demand
characteristics, the Company's network planning and design personnel design a
network targeted to provide access to the major IXC, POPs and the ILEC's
principal central office(s) in the city. Consistent with the Company's
disciplined capital expenditure program, distribution rings are designed to
cover strategic or highly concentrated business parks and downtown metropolitan
areas, and build-out to 100% of the identified end-users is generally not
considered to be cost-effective since a portion of the end-users are located in
low density areas.
Based on the data obtained through the foregoing process, in connection
with either the construction or an acquisition of a network, the Company
develops detailed financial estimates based on the anticipated demand for the
Company's current services. If the financial estimates meet or exceed the
Company's minimum rate of return thresholds using a discounted cash flow
analysis, the Company's corporate planning personnel prepare a detailed business
and financial plan for the proposed network.
Prior to commencing construction, the Company's local staff, working
together with TW Cable, where applicable, obtains any needed city franchises,
permits, or other municipal requirements to initiate construction and operate
the network. In some cities, a construction permit is all that is required. In
other cities, a right-of-way agreement or franchise may also be required. Such
agreements and franchises are generally for a term of limited duration. In
addition, the 1996 Act requires that local governmental authorities treat all
telecommunications carriers in a competitively neutral, non-discriminatory
manner. The Company's current right-of-way agreements and franchises expire in
years ranging from 1999 to 2015. City franchises often require payment of
franchise fees which in some cases can be directly passed through on customers'
invoices. The Company's local staff also finalizes arrangements for other needed
rights-of-way. Rights-of-way are typically licensed from TW Cable under multi-
year agreements with renewal options and are generally non-exclusive. See
"Certain Relationships and Related Transactions -- Certain Operating
Agreements." The Company leases underground conduit and pole space and other
rights-of-way from entities such as LECs and other utilities, railroads, long
distance providers, state highway authorities, local governments and transit
authorities. The 1996 Act requires most utilities, including most LECs and
electric companies, to afford CAPs/CLECs access to their poles, conduits and
rights-of-way at reasonable rates on non-discriminatory terms and conditions.
The Company's networks are constructed to cost-effectively access areas of
significant commercial end-user telecommunications traffic, as well as the POPs
of most IXCs and cellular companies and the principal LEC central offices in a
city. The Company establishes general requirements for network design, and
internally engineers the contemplated network and the required deployment.
Construction and installation services are provided by independent contractors,
including TW Cable, selected through a competitive bidding process. Company
personnel provide project management services, including contract negotiation
and supervision of the construction, testing and certification of all
facilities. The construction period for a new network varies depending upon the
number of route miles to be installed, the initial number of buildings targeted
for connection to the network, the general deployment of the network and other
field conditions. Networks that the Company has installed to date generally have
become operational within six to nine months after the beginning of
construction.
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Equipment Supply
The Company acquires Lucent 5-ESS digital switches pursuant to an exclusive
vendor agreement (the "Lucent Agreement"), which provides for discounted
pricing. The Lucent Agreement expires in June of 2002 and is renewable for up to
four additional years upon the parties' mutual agreement. The Lucent Agreement
provides that if the Company purchases digital switches from a vendor other than
Lucent during the term of such agreement, Lucent, among other things, may
discontinue the agreed upon discounted pricing on all future orders, renegotiate
higher prices for digital switches and may not be liable for failures to meet
certain delivery and installation schedules on future orders.
Customers and Sales and Marketing
The Company's customers are principally telecommunications-intensive
medium-and large-sized businesses, IXCs, ISPs, wireless communications companies
and various governmental entities. Historically, the Company's customers were
primarily long distance carriers. See "Factors That Could Affect Future
Performance -- Dependence on Significant Customers." While the Company's long
distance carrier business has grown by approximately 67% in 1998 over 1997, it
has declined as a proportion of total revenues by 24.0%, to approximately 26.0%
of the Company's total revenues. Of this long distance carrier revenue,
approximately 60% is influenced by the end-user customer rather than the long
distance carrier since an end user may switch long distance carriers while
retaining the Company as its local exchange carrier. Although the Company's top
2 customers for 1998, which are long distance carriers, accounted for 23.7% of
total revenues, a significant portion of the revenue stream from those two long
distance carriers is not controlled by them. Accordingly, the Company does not
believe that the loss of the revenue controlled by one of those two long
distance carriers would have a material adverse effect on its business. No other
customer, including customers who direct their business through long distance
carriers, accounted for 10% or more of revenues. For the year ended December 31,
1998, the Company's top 10 customers accounted for 37.8% of the Company's total
revenues.
The Company provides incentives to its sales force to negotiate service
contracts that have a minimum term of 1 year, and provides enhanced commissions
to its sales force for executing agreements with terms of 3 years or greater.
Currently, more than 50% of service agreements have a duration of greater than 3
years.
The Company's marketing emphasizes its: (i) reliable, facilities-based
networks, (ii) flexibly priced, bundled products and services; (iii) responsive
customer service orientation; and (iv) integrated operations, customer support
and network monitoring and management systems. The Company's centrally managed
customer support operations are designed to facilitate the processing of orders
for changes and upgrades in customer services. To reduce the inherent risk in
bringing new and untested telecommunications products and services to a
dynamically changing market, the Company introduces its products and services
once market demand develops and offers them in diversified, competitively-priced
bundles, thereby increasing usage among its existing customers and attracting
new customers. The services offered by the Company are typically priced at a
discount to the prices of the ILECs.
With a direct sales force in each of its service areas along with regional
and national sales support, the Company targets medium- and large-sized
telecommunications-intensive businesses in the areas served by its networks.
Compensation for the Company's sales representatives is based primarily on
commissions that are tied to sales generated. The Company's customers include
financial services firms, health care, media, telecommunications services and
high tech companies and various governmental institutions. In addition, the
Company markets its services through sales agents, landlords, advertisements,
trade journals, media relations, direct mail and participation in trade
conferences.
The Company also targets IXCs, ISPs, large, strategic business accounts and
wireless telephone companies through its national sales organization. The
Company has master services agreements (which generally set forth technical
standards, ordering processes, pricing methodologies and service grade
requirements, but do not guarantee any specified level of business for the
Company) with a significant number of the IXCs, including AT&T, MCI-Worldcom,
Sprint Corporation, and Qwest-LCI, Inc. By providing IXCs with a local
connection to their customers, the Company enables them to avoid complete
dependence on the ILECs for access to customers and to obtain a high quality and
reliable local connection. The Company provides a variety of transport services
and arrangements that allow IXCs to connect their own switches in both local
areas (intra-city) and in wide areas (inter-city). Additionally, IXCs may
purchase the Company's transport services that allow them to connect their
switch to an ILEC switch and
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to end-user locations directly. The Company's advanced networks allow it to
offer high volume business customers and IXCs uniformity of services, pricing,
quality standards and customer service.
Customer Service
With over 400 expert technicians, customer service representatives and
administrative support staff, the Company provides its customers with continuous
support and superior service. To serve its customers, account representatives
are assigned to the Company's customers to act as effective liaisons with the
Company. Technicians and other support personnel are available in each of the
Company's service areas to react to any network failures or problems. In
addition, the NOC provides 24 hour-a-day, 7 days-a-week surveillance and
monitoring of networks to maintain the Company's network reliability and
performance. See " -- Telecommunications Networks and Facilities -- Network
Monitoring and Management."
Competition
The Company believes that the principal competitive factors affecting its
business are, and will continue to be:
(a) pricing,
(b) the availability of proven support systems for the Company's back
office systems, including provisioning and billing,
(c) competition for skilled, experienced personnel, and
(d) regulatory decisions and policies that promote competition.
The Company believes that it competes favorably with other companies in the
industry or is impacted favorably with respect to each of these factors. The
technologies and systems which provide back office support for the CLEC industry
are nascent and may not keep pace with the growth of order volume, integration
with other systems, and production of required information for systems managers.
The best personnel in all areas of the Company's operations are in demand by the
numerous participants in the highly specialized CLEC industry. While the
Company's employee base is very stable, it is anticipated that others in the
industry will continue to demand high quality personnel and will thus drive
pressure to maintain extremely competitive compensation and benefits packages in
addition to an attractive work environment. Regulatory environments at both the
state and Federal level differ widely and have considerable influence on the
Company's market and economic opportunities and resulting investment decisions.
The Company believes it must continue monitoring regulatory developments and
remain active in its participation in regulatory issues.
Services substantially similar to those offered by the Company are also
offered by the ILECs, which include Ameritech Corporation, Bell Atlantic
Corporation, BellSouth Corporation, SBC Communications, Inc. ("SBC") and GTE
Corporation. The Company believes that many ILECs may have competitive
advantages over the Company. ILECs generally benefit from their long-standing
relationships with customers and greater technical and financial resources. The
ILECs have the potential to subsidize services of the type offered by the
Company from service revenues in unrelated businesses and currently benefit from
recent regulations that relax price restrictions and decrease regulatory
oversight of ILECs. In addition, in most of the metropolitan areas in which the
Company currently operates, at least one, and sometimes several, other CAPs or
CLECs offer substantially similar services at substantially similar prices to
those of the Company. The Company also faces competition from new entrants in
the local services business who may also be better established and have greater
financial resources. Other CLECs, CAPs, cable television companies, electric
utilities, long distance carriers, microwave carriers, wireless telephone system
operators and private networks built by large end users currently do, and may in
the future, offer services similar to those offered by the Company.
In addition, the current trend of business combinations and alliances in
the telecommunications industry, including mergers between subsidiaries of BOCs,
between BOCs and other ILECs, and between major IXCs and CLECs, may create
significant new competitors for the Company. For example, Bell Atlantic has
acquired the LECs owned by NYNEX and SBC, corporate parent of Southwestern Bell
Telephone Company, has acquired Southern New England Telephone and Pacific
Telesis. In addition, SBC and Ameritech have agreed to merge, as have Bell
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Atlantic and GTE Corporation. On July 23, 1998, AT&T announced that it had
completed its acquisition of Teleport Communications Group ("TCG"), a competitor
of the Company. The latter two mergers have not yet been consummated pending
regulatory approval. In March, 1999, AT&T acquired Tele-Communications, Inc.
("TCI"), a major cable operator. TW and AT&T have also announced their intention
to form a joint venture to offer any distance telephone services to residential
and small business customers in TW Cable's service areas over TW Cable's cable
facilities.
The Company believes that the 1996 Act will provide increased business
opportunities by opening all local markets to competition. The 1996 Act:
. requires all local exchange providers to offer their services for resale;
. requires incumbent local exchange carriers to provide increased direct
interconnection;
. requires incumbent local exchange carriers to offer network elements on
an unbundled basis; and
. requires incumbent local exchange carriers to offer the services they
provide to end-users to other carriers at wholesale rates.
However, under the 1996 Act, the FCC and some state regulatory authorities
may provide ILECs with increased flexibility to reprice their services as
competition develops and as ILECs allow competitors to interconnect to their
networks. In addition, some new entrants in the local market may price certain
services to particular customers or for particular routes below the prices
charged by the Company for services to those customers or for those routes, just
as the Company may itself underprice those new entrants for other services,
customers or routes. If the ILECs and other competitors lower their rates and
can sustain significantly lower prices over time, this may adversely affect
revenues of the Company if it is required by market pressure to price at or
below the ILECs' prices. If regulatory decisions permit the ILECs to charge
CAPs/CLECs substantial fees for interconnection to the ILECs' networks or afford
ILECs other regulatory relief, such decisions could also have a material adverse
effect on the Company. However, the Company believes that the negative effects
of the 1996 Act may be more than offset by (i) the increased revenues available
as a result of being able to address the entire local exchange market, (ii)
mutual reciprocal compensation with the ILEC that results in the Company
terminating its local exchange traffic on the ILEC's network at little or no net
cost to the Company, (iii) obtaining access to off- network customers through
more reasonably priced expanded interconnection with ILEC networks and (iv) a
shift by IXCs to purchase access services from CAPs/CLECs instead of ILECs.
There can be no assurance, however, that these anticipated results will offset
completely the effects of increased competition as a result of the 1996 Act.
Historically, the Company has been able to build new networks and expand
existing networks in a timely and economical manner through strategic
arrangements such as leasing fiber optic cable from TW Cable, which already
possesses rights-of-way and has facilities in place. The Company intends to use
its experience and presence in the telecommunications industry to fully exploit
its available capacity, further develop and expand its existing
telecommunications infrastructure and offer a diversified range of products and
services in competitively priced bundles.
Government Regulation
Historically, interstate and foreign communication services were subject to
the regulatory jurisdiction of the FCC, and intrastate and local
telecommunications services were subject to regulation by state public service
commissions. With the enactment of the 1996 Act, competition in all
telecommunications market segments, including interstate and intrastate, local
and long distance, became matters of national policy. As described below, the
respective roles of Federal and state regulators to establish rules and pricing
requirements to implement that policy remain the subject of litigation.
Nonetheless, the Company believes that the national policy fostered by the 1996
Act should contribute to an increase in the market opportunities for the
Company. Because these developments require numerous actions to be implemented
by individual Federal and state regulatory commissions, and are subject to
particular legal, political and economic conditions, it is not possible to
predict the pace at which regulatory liberalization will occur.
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Telecommunications Act of 1996. In early 1996, President Clinton signed the
1996 Act, the most comprehensive reform of the nation's telecommunications laws
since the Communications Act. The 1996 Act prohibits state and local governments
from enforcing any law, rule or legal requirement that prohibits or has the
effect of prohibiting any entity from providing any interstate or intrastate
telecommunications service. This provision of the 1996 Act should enable the
Company to provide a full range of local telecommunications services in any
state. States retain jurisdiction under the 1996 Act to adopt competitively
neutral regulations necessary to preserve universal service, protect public
safety and welfare, ensure the continued quality of telecommunications services
and safeguard the rights of consumers. States are also responsible for mediating
and arbitrating CLEC-ILEC interconnection arrangements if voluntary agreements
are not reached. Therefore, the degree of state regulation of local
telecommunications services may be substantial.
The 1996 Act imposes a number of access and interconnection requirements on
all LECs, including CLECs, with additional requirements imposed on ILECs. The
1996 Act requires CLECs and ILECs to attempt to resolve interconnection issues
through negotiations for at least 135 days. During these negotiations, the
parties may submit disputes to state regulators for mediation and, after the
negotiation period has expired, the parties may submit outstanding disputes to
state regulators for arbitration. As of December 1, 1998, the Company has
executed 36 definitive interconnection agreements with ILECs, covering 18 of its
markets. The Company has executed interconnection agreements with the ILECs in
each of its markets in which it offers switched services and has negotiated, or
is negotiating, secondary interconnection arrangements with carriers whose
territories are adjacent to the Company's for intrastate intraLATA toll traffic
and extended area services.
Under the 1996 Act, the FCC was required to establish rules and regulations
to implement the local competition provisions of the 1996 Act within six months
of enactment. In August 1996, the FCC issued two reports and orders. In the
First Report and Order, the FCC promulgated rules to govern interconnection,
resale, unbundled network elements, and the pricing of those facilities and
services, as well as the negotiation and arbitration procedures to be utilized
by states to implement those requirements. In the Second Report and Order, the
FCC adopted rules to govern the dialing parity requirements of the 1996 Act.
In July 1997, the Eighth Circuit Court of Appeals issued a decision in
which it affirmed certain portions of the FCC's rules and vacated others. It
vacated the FCC rules governing the pricing of interconnection, resale, and
unbundled network elements on the basis that the FCC lacks jurisdiction to
establish pricing rules for intrastate service. It also vacated rules allowing
requesting carriers to select from among various provisions of individual
interconnection agreements between ILECs and other carriers, and rules
permitting the combining of network elements. In a subsequent decision, the
court vacated the FCC's dialing parity rules with respect to intraLATA service.
In October 1997, the Eighth Circuit Court of Appeals issued an order on
rehearing in which it vacated one additional FCC rule. The vacated rule
prohibited ILECs from separating network elements that they currently combine,
except upon request. Although the FCC's rules governing the pricing of
interconnection, unbundled network elements and resale have been vacated by the
Eighth Circuit Court of Appeals, interconnection and arbitration proceedings at
the state level have continued with the states implementing their own pricing
standards.
Several entities, including the United States government, submitted
petitions for certiorari asking the U.S. Supreme Court to review the orders of
the Eighth Circuit Court of Appeals. Those petitions asked the Supreme Court to
review the Court of Appeals' ruling that the FCC lacks jurisdiction to establish
pricing rules for intrastate services and facilities as well as to establish
dialing parity requirements for intrastate (including most intraLATA) service.
In addition, the petitions asked the Supreme Court to review the Court of
Appeals' decision to vacate the so-called "pick and choose" rule established by
the FCC. That rule required LECs to make available to requesting carriers
(including the Company) any provision from any interconnection, unbundled
network element or resale agreement between an ILEC and any requesting carrier
approved by a state commission. Finally, several of the petitions (including
that of the U.S. government) also asked the Supreme Court to review the October
1996 rehearing order vacating the FCC rule which required ILECs to make
available combined packages of network elements. In January 1998, the Supreme
Court granted those petitions for certiorari and agreed to review the Eighth
Circuit decisions.
On January 25, 1999, the Supreme Court issued its decision with respect to
its review of orders of the Eighth Circuit Court of Appeals. The Court upheld
most of the FCC's rules with respect to interconnection and
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resale, including the "pick and choose rule," and the dialing parity rule. The
Supreme Court also held that the FCC has authority under the Communications Act
to promulgate national pricing rules for interconnection, unbundled network
elements, and resale to implement the local competition provisions of the
Communications Act. However, the Supreme Court did not address the lawfulness of
the pricing rules established by the FCC. The Court vacated a rule which
required ILECs to make available to requesting carriers any of the network
elements within the FCC's definition of that term, because the FCC failed to
consider (1) whether network elements are necessary and (2) whether the failure
to make elements available would impair the ability of requesting carriers to
provide the services they seek to offer. It is not clear whether the FCC will
require ILECs to make available the same list of unbundled network elements when
it reconsiders the issue as a result of the decision. The Court also reinstated
the FCC's rule that requires the ILECs to offer combined platforms of network
elements. Whether the reinstatement of this rule will in effect allow entrants
access to an entire pre-assembled network depends upon the outcome of the FCC's
reconsideration of which elements must be made available. The Company believes
that the availability of combined platforms of network elements at prices based
on the FCC's cost methodology (Total Element Long Run Incremental Costs) could
create economic incentives for new competitors to enter local markets through
acquisition of ILEC network element platforms rather than by investing in their
own network facilities as the Company does.
The 1996 Act provides a detailed list of items that are subject to these
interconnection negotiations, as well as a detailed set of duties for all
affected carriers. All LECs, including CLECs like the Company, have a duty to
(i) not unreasonably limit the resale of their services, (ii) provide number
portability if technically feasible, (iii) provide dialing parity to competing
providers, (iv) provide access to poles, ducts and conduits and (v) establish
reciprocal compensation arrangements for the transport and termination of
telecommunications.
Under the 1996 Act and rules established by the FCC in 1996 (and modified
on reconsideration in 1997), LECs, including the Company, are required to make
available number portability. Number portability refers to the ability of users
of telecommunications services to retain, at the same location, existing
telecommunications numbers without impairment of quality, reliability, or
convenience when switching from one telecommunications carrier to another. Under
the schedule for number portability implementation established by the FCC, LECs
are required to implement number portability in the 100 largest MSAs over a 5-
phase period which began on October 1, 1997 and concluded on December 31, 1998.
Thereafter, in areas outside the 100 largest MSAs, LECs are required to make
available number portability within 6 months of receipt of a specific request
from another telecommunications carrier.
The 1996 Act and the FCC's rules also require LECs to implement dialing
parity. Dialing parity refers to the ability of a person that is not an
affiliate of a LEC to be able to provide telecommunications services in such a
manner that customers have the ability to route automatically without the use of
any access code, their telecommunications to the telecommunications service
provider of the customer's designation from among 2 or more telecommunications
service providers (including such LEC). Under rules promulgated by the FCC in
1996, all LECs, including the Company, are required to provide intraLATA and
interLATA dialing parity not later than February 8, 1999. However, if a LEC also
provides interLATA service as the Company does, that LEC was required to provide
dialing parity by August 8, 1997. LECs unable to comply with that August 8, 1997
deadline were required to have notified the FCC by May 8, 1997.
The Company does not restrict the resale of its services, engages in
reciprocal compensation arrangements, provides dialing parity, and provides full
number portability, satisfying four of the five requirements. The Company
generally licenses poles, ducts and conduits, and therefore owns few such
rights-of-way subject to the requirement to make them available to other
carriers.
In addition to those general duties of all LECs, ILECs have additional
duties to (i) interconnect at any technically feasible point and provide service
equal in quality to that provided to their customers or the ILEC itself, (ii)
provide unbundled access to network elements at any technically feasible point,
(iii) offer retail services at wholesale prices for the use of competitors, (iv)
provide reasonable public notice of changes in the network or the information
necessary to use the network and (v) provide for physical collocation. The 1996
Act further imposes various pricing guidelines for the provision of certain of
these services. Both the ILECs and the requesting carriers have a statutory duty
to negotiate in good faith regarding these arrangements, and the RBOCs, in
particular, must successfully achieve agreements, leading to the development of
facilities-based competition for business and
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residential users, in order to enter the long distance markets within their
regions. The Company has successfully concluded agreements governing
interconnection arrangements in all of the states in which it holds CLEC
authority. Several of these agreements are expiring in 1999 and the Company
anticipates that the ILECs will want to renegotiate the terms and conditions,
including reciprocal compensation. The Company cannot predict the outcome of the
negotiations, especially in light of the Supreme Court's recent decision
regarding the interconnection rules.
The 1996 Act establishes procedures under which BOCs may apply to the FCC
for authority to provide interLATA service from states within their operating
regions. A BOC seeking in-region interLATA authority must demonstrate that it is
subject to competition from a competitor in the state with whom it has entered
into an interconnection agreement and which is providing service to business and
residential customers within the state exclusively or predominantly over its own
facilities. Alternatively, the BOC may seek in-region interLATA authority if no
provider has requested access and interconnection, and the BOC has in place a
state commission-approved statement of generally available terms and conditions
for access and interconnection which is available to competitors. Further,
access and interconnection agreements must comply with each point of a 14 point
competitive checklist. To date, five applications have been filed by BOCs with
the FCC for authority pursuant to Section 271 of the Communications Act to
provide interLATA long distance service in states within their operating
territories. All five of those applications have been denied by the FCC. An
application by SBC for FCC authority to provide long distance service in
Oklahoma was denied in June 1997. SBC's appeal of that decision was denied by
the U.S. Court of Appeals for the District of Columbia Circuit in March 1998. In
August 1997, the FCC also denied an application by Ameritech to provide long
distance service in Michigan. BellSouth applications for FCC approval to provide
long distance service in South Carolina and Louisiana also were denied by the
FCC in December 1997 and February 1998, respectively. In July 1998, BellSouth
again applied to the FCC to provide long distance service in Louisiana. That
application was denied by the FCC in October 1998. In addition to those FCC
applications, SBC Corporation brought a lawsuit in the U.S. District Court for
the Northern District of Texas in which it challenged on constitutional grounds
the BOC long distance entry provisions of the Communications Act. In December
1997, the District Court ruled in favor of SBC finding those provisions to be
unconstitutional. Shortly thereafter, the District Court stayed its decision
pending review by the U.S. Court of Appeals for the Fifth Circuit. On September
4, 1998, the U.S. Court of Appeals for the Fifth Circuit reversed that decision
of the District Court concluding that the provisions of Section 271 governing
the BOCs interLATA service entry is not an unconstitutional bill of attainder.
Several parties, including SBC, have filed petitions for certiorari with the
U.S. Supreme Court asking that it review the decision of the Fifth Circuit. On
January 19, 1999, the Supreme Court declined to review that decision. The
Company anticipates that eventually the BOCs will be found to comply with the
requirements of the Communications Act governing in-region long distance entry
and their applications for authority to provide interLATA service will be
approved and they will be permitted to offer interLATA services within their
operating territories.
The Company, like other competitive local exchange carriers, receives
reciprocal compensation from incumbent local exchange carriers for local calls
which it terminates at the premises of internet service providers. Incumbent
local exchange carriers have attempted to persuade state commissions and the FCC
that such traffic is interstate traffic rather than local traffic and that such
traffic should not be subject to reciprocal compensation. To date, every state
commission which has considered the issue has concluded that local traffic
terminated at internet service provider locations is local traffic and is
subject to reciprocal compensation under state-approved interconnection
agreements. However, on February 26, 1999, the FCC released a declaratory ruling
in which it concluded that local traffic that terminates at internet service
providers is largely interstate traffic. The FCC did not determine whether or
not such traffic may be subject to reciprocal compensation on a prospective
basis, but commenced a rulemaking on that subject. Pending completion of that
rulemaking, determinations of whether reciprocal compensation should be paid on
traffic terminated at internet service provider locations will be made by state
commissions and under the terms of approved agreements. It is expected that
ILECs will attempt to persuade the FCC and state commissions that local traffic
delivered to internet service providers should not be subject to reciprocal
compensation. Exclusion of such traffic from reciprocal compensation
requirements could reduce the revenues received by the Company for terminating
traffic originated by incumbent local exchange carriers.
If the BOCs become authorized to provide in-region interLATA service, they
will be able to offer customers a full range of local and long distance
services. BOC entry into the interLATA services markets may reduce the market
shares held by major IXCs, which are among the Company's largest customers.
However, the Company
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believes that the entry of BOCs into the interLATA market will encourage IXCs to
increase their use of exchange access services offered by the Company and by
other CLECs rather than the exchange access services of the BOCs. When BOCs
provide long distance services outside their local telephone service areas, they
will be potential customers of the Company's services as well as services of
other CLECs and CAPs.
Federal Regulation. The 1996 Act obligates the FCC to establish mechanisms
for ensuring that consumers, including low income consumers and those located in
rural, insular and high cost areas, have access to telecommunications and
information services at rates reasonably comparable to those charged for similar
services in urban areas. The 1996 Act also requires the FCC to establish funding
mechanisms to make available access to telecommunications services, including
advanced services, to schools, libraries and rural health care centers. These
requirements are generally referred to as the "universal service requirements"
of the 1996 Act. In May 1997, the FCC adopted rules to implement the universal
service requirements. Under those rules, all telecommunications carriers,
including the Company, are required to contribute to support universal service.
If the Company offers to provide local exchange service to all customers within
certain geographic areas, it may be deemed to be an "Eligible Carrier" and
therefore entitled to subsidy funds under the program established by the FCC.
Certain aspects of universal service, including the formulas to be used to
quantify local service costs remain under study by the FCC. In addition, several
parties appealed the FCC's May 1997 universal service order. Those appeals were
consolidated in the U.S. Court of Appeals for the Fifth Circuit and are pending.
On December 23, 1998, the FCC established rules to govern the manner in
which telecommunications carriers effectuate and verify selection by consumers
of preferred providers of local exchange and interexchange services. The Company
will be subject to those rules and will be required to comply with the specific
verification requirements established by the FCC. Violation of those rules could
subject the Company to sanctions imposed by the FCC.
Following a June 1997 decision of the FCC, the Company has been permitted
to provide its interstate access services without having tariffs on file with
the FCC. Following that decision, the Company withdrew its interstate access
services tariff and now provides such services pursuant to contracts entered
into with customers. This will improve the Company's ability to rapidly change
its access service pricing in response to competition and will reduce the
Company's regulatory compliance costs. The Company is still required to file
with the FCC tariffs for its other interstate telecommunications services,
including long distance service.
The FCC's action does not, however, impact the Company's state public
utility commission tariff requirements. Whether or not the Company is subject to
a tariff filing requirement, the Company must offer its interstate services on a
nondiscriminatory basis, at just and reasonable rates, and it is subject to the
complaint provisions of the Communications Act. For its current offering of
interstate services as a non-dominant carrier, the Company is not subject to
rate of return or price cap regulation by the FCC and may install and operate
digital facilities for the transmission of interstate communications without
prior FCC authorization. Pursuant to the 1996 Act, the Company is subject to
additional Federal regulatory obligations when it provides local exchange
service in a market, such as the access and interconnection requirements that
are imposed on all LECs. See "--Telecommunications Act of 1996."
The Communications Assistance for Law Enforcement Act, enacted in 1994,
requires telecommunications carriers, including the Company, to make their
equipment and facilities capable of assisting authorized law enforcement
agencies to conduct electronic surveillance. By September 8, 1998, subject
carriers were required to notify the Attorney General of systems which do not
have the capacity to meet surveillance requirements specified by the Attorney
General. By October 25, 1998, telecommunications carriers, including the
Company, were required to meet the surveillance standards set by the Attorney
General. The FCC has extended the date for compliance with these requirements
until June 30, 2000.
State Regulation. The Company has acquired all state government authority
needed to conduct its business as currently contemplated. Most state public
service commissions require carriers that wish to provide local and other
jurisdictionally intrastate common carrier services to be authorized to provide
such services. The Company's operating subsidiaries and affiliates are
authorized as common carriers in ten states. These certifications cover the
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provision of switched services including local basic exchange service, point to
point private line, competitive access services, and in five states long
distance services.
Local Government Authorizations. The Company may be required to obtain from
municipal authorities street opening and construction permits and other rights
and other rights-of-way to install and expand its networks in certain cities. In
some cities, the Company's affiliates or subcontractors may already possess the
requisite authorizations to construct or expand the Company's networks. Any
increase in the difficulty or cost of obtaining these authorizations and permits
could adversely affect the Company, particularly where it must compete with
companies that already have the necessary permits.
In some of the metropolitan areas where the Company provides network
services, the Company pays license or franchise fees based on a percent of gross
revenues. There can be no assurance that municipalities that do not currently
impose fees will not seek to impose fees in the future, nor is there any
assurance that, following the expiration of existing franchises, fees will
remain at their current levels. Under the 1996 Act, municipalities are required
to impose such fees on a competitively neutral and nondiscriminatory basis.
However, municipalities that currently favor the ILECs may or may not conform
their practices in a timely manner or without legal challenges by the Company or
another CAP or CLEC. Moreover, there can be no assurance that ILECS with whom
the Company competes will not be excluded from such local franchise fee
requirements by previously-enacted legislation allowing them to utilize rights-
of-way throughout their states without being required to pay franchise fees to
local governments.
If any of the Company's existing franchise or license agreements for a
particular metropolitan area were terminated prior to its expiration date and
the Company were forced to remove its fiber optic cables from the streets or
abandon its network in place, even with compensation, such termination could
have a material adverse effect on the Company's operation in that metropolitan
area and could have a material adverse effect on the Company.
The Company is party to various regulatory and administrative proceedings,
however, subject to the discussion above, the Company does not believe that any
such proceedings will have a material adverse effect on its business.
Company Name
The use of the "Time Warner" name by the Company is subject to a License
Agreement with TW. See "Factors That Could Affect Future Performance --
Discontinuance of Use of "Time Warner Name" and "Certain Relationships and
Related Transactions -- Certain Operating Agreements."
Employees
As of December 31, 1998, the Company employed approximately 898 full-time
employees. The Company believes that its relations with its employees are good.
By succession, the New York City operating entity is a party to a collective
bargaining agreement. In connection with the construction and maintenance of its
networks and the conduct of its other business operations, the Company uses
third party contractors, some of whose employees may be represented by unions or
collective bargaining agreements. The Company believes that its success will
depend in part on its ability to attract and retain highly qualified employees
and maintain good working relations with its current employees.
FACTORS THAT COULD AFFECT FUTURE PERFORMANCE
Limited History of Operations; Negative Cash Flow and Operating Losses
The Company was formed in 1998 to continue the business telephony services
commenced by TW Cable in 1993. Accordingly, there is limited historical
financial information upon which to base an evaluation of the Company's
performance. The Company's prospects must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in their early
stage of development and growth.
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The Company has incurred operating losses and negative cash flow since
inception, and expects to continue to incur operating losses and negative cash
flow while it installs, develops and expands its existing and future
telecommunications networks and builds its customer base. For the years ended
December 31, 1996, 1997 and 1998, on a combined basis, the predecessor entities
of the Company and the predecessor entities operating the commercial
telecommunications operations of the Parent Companies sustained combined
operating losses of $84.5 million, $78.1 million and $73.4 million,
respectively, and negative EBITDA of $62.2 million, $39.6 million and $22.7
million, respectively. "EBITDA" is defined as operating income (loss) before
depreciation and amortization expense. It does not include charges for interest
expense or provision for income taxes. Accordingly, EBITDA is not intended to
replace operating income, net income, cash flow and other measures of financial
performance and liquidity reported in accordance with generally accepted
accounting principles. Rather, EBITDA is a measure of operating performance and
liquidity that may be considered in addition to those measures. The Company
believes that EBITDA is a standard measure of operating performance and
liquidity that is commonly reported and widely used by analysts, investors and
other interested parties in the telecommunications industry because it
eliminates many differences in financial, capitalization, and tax structures, as
well as non-operating and one-time charges to earnings. EBITDA is used
internally by the company's management to assess on-going operations and is a
component of a covenant of the Senior Notes limiting certain additional future
indebtedness. However, EBITDA as used herein may not be comparable to similarly
titles measures reported by other companies due to differences in accounting
policies
The capital expenditures of the Company associated with the installation,
development and expansion of its existing networks and possible acquisitions of
future networks are substantial, and a significant portion of these expenditures
generally are incurred before any related revenues are realized. These
expenditures, together with associated initial operating expenses, will
generally result in negative cash flow and operating losses from a network until
an adequate customer base and revenue stream for the network have been
established. Accordingly, the Company expects that each network will generally
produce negative cash flow for at least two and a half years after operations
commence in such network. The Company expects to incur net losses for the
foreseeable future as it continues to acquire, install, develop and expand its
existing and new telecommunications networks and build its customer base. There
can be no assurance that an adequate revenue base will be established from each
of the Company's networks or that the Company will achieve or sustain
profitability or generate sufficient positive cash flow, if any, to meet its
working capital requirements and to service its indebtedness.
Significant Capital Requirements
The development and expansion of the Company's existing and future networks
and services will require significant capital to fund capital expenditures,
working capital and debt service. The Company's principal capital expenditure
requirements over the next two years are expected to consist of approximately
(i) $300.0 million to purchase and install switches, electronics, fiber and
other additional technologies in existing networks and in additional networks to
be constructed in new service areas and (ii) $50 million for capital
expenditures with respect to the Company's management information system
infrastructure. The Company will continue to evaluate additional revenue
opportunities in each of its service areas and, as opportunities develop, the
Company plans to make the additional capital investments in its networks that
are required to pursue such opportunities.
The Company, from time to time, evaluates potential acquisitions of, and
joint ventures relating to, networks currently owned and operated by other
companies, including affiliates of the Members, and expects to continue to do
so. In the event the Company enters into a definitive agreement with respect to
any acquisition or joint venture, it may require additional financing or it may
elect to use a portion of the proceeds from the sale of the Notes not
theretofore expended for other purposes.
While the Company intends to continue to leverage its relationship with TW
Cable in pursuing expansion opportunities, to the extent the Company seeks to
expand into service areas where TW Cable does not conduct cable operations, the
Company may incur significant additional costs in excess of those historically
incurred by the Company when expanding into existing TW Cable service areas. In
addition, TW Cable is not obligated to construct or provide additional fiber
optic capacity in excess of what is already licensed to the Company under the
Capacity License (as defined). Accordingly, if the Company is unable to lease
such additional capacity at the same rates as are
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currently provided for under the Capacity License, the Company may be required
to obtain additional capacity on more expensive terms. See "Certain
Relationships and Related Transactions --Certain Operating Agreements."
The Company sustained significant working capital deficits in each year
since inception. The Company has historically been funded by capital
contributions and advances from the Members. As of December 31, 1998, the
Company had outstanding approximately $174.9 million of subordinated
indebtedness to the Members. The Members do not have any obligation to make
additional equity investments in or loans to the Company.
The Company expects that the net proceeds received from the sale of the
Notes and internally generated funds, will provide sufficient funds for the
Company to expand its business as currently planned, pay interest on the Notes
and to fund its currently expected losses through the middle of 2000.
Thereafter, the Company expects to require additional financing. However, in the
event that the Company's plans or assumptions change or prove to be inaccurate,
or the foregoing sources of funds prove to be insufficient to fund the Company's
growth and operations, or if the Company consummates acquisitions or joint
ventures, the Company may be required to seek additional capital sooner than
currently anticipated. The Company's revenues and costs are dependent upon many
factors that are not within the Company's control, such as regulatory changes,
changes in technology and increased competition. Due to the uncertainty of these
and other factors, actual revenues and costs may vary from expected amounts,
possibly to a material degree, and such variations are likely to affect the
level of the Company's future capital expenditures and expansion plans. Sources
of financing may include public or private debt or equity financing by the
Company or its subsidiaries, vendor financing or other financing arrangements.
At a future date, the Company may negotiate a bank credit facility to provide it
with working capital and enhance its financial flexibility. There can be no
assurance that such financing will be available on terms acceptable to the
Company or at all.
There can be no assurance that the Company will be successful in generating
sufficient cash flow or raising additional financing in sufficient amounts on
terms acceptable to it or within the limitations contained in its financing
arrangements, or that the terms of any such additional financing will not impair
the Company's ability to develop its business. The failure to generate
sufficient cash flow or to raise sufficient funds may require the Company to
modify, delay or abandon some or all of its development and expansion plans,
which could have a material adverse effect on the Company's growth, its ability
to compete in the telecommunications services business and its ability to
service its debt. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Substantial Leverage
The Company is highly leveraged. As of December 31, 1998,the Company had
approximately $574.9 million of consolidated total debt, $174.9 million of
which is subordinated loans payable to the Parent Companies. The degree to which
the Company is leveraged could have a material adverse effect upon the Company,
including: (i) the Company's ability to obtain additional financing in the
future for capital expenditures, acquisitions, joint ventures, working capital
or general corporate or other purposes may be limited; (ii) a substantial
portion of the Company's cash flow from operations will be dedicated to the
payment of the principal of, and interest on, its debt; and (iii) the Company's
substantial leverage may make it more vulnerable to economic downturns, limit
its ability to withstand competitive pressures and reduce its flexibility in
responding to changing business and economic conditions. A failure by the
Company to comply with the covenants and other provisions of financing documents
to which the Company is a party, including the Indenture governing the Notes
(the "Indenture"), or other debt instruments to which the Company may become
party in the future, could permit acceleration of the debt under such
instruments and, in some cases, acceleration of debt under other instruments
that contain cross-default or cross-acceleration provisions. The Indenture
contains certain restrictive covenants. Such restrictions affect, and in many
respects significantly limit or prohibit, among other things, the ability of the
Company to incur indebtedness, make prepayments of certain indebtedness, pay
dividends, make investments, engage in transactions with shareholders and
affiliates, issue capital stock of subsidiaries, create liens, sell assets and
engage in mergers and consolidations.
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Risks Of Expansion; And Possible Inability To Manage Growth
The Company's ability to expand its business and manage its transition to
switched services depends on a variety of factors. These factors include the
Company's ability to assess markets, design fiber optic network backbone routes,
acquire and install facilities, obtain and utilize rights-of-way and building
access, obtain any required governmental authorizations and permits and
implement interconnection with LECs. There can be no assurance that the Company
will be able to achieve this expansion in a timely manner, at a reasonable cost,
or on terms and conditions acceptable to the Company.
Although the Company commenced operations in 1993, to date its business has
consisted primarily of offering dedicated point-to-point services. With the
adoption of the 1996 Act, the Company accelerated the implementation of switched
services in its markets. The Company expects that switched services will in the
future become the predominant source of its revenues. Switched services support
both analog and digital equipment compatible with the Time Division Multiple
Access ("TDMA"), Frequency Division Multiple Access ("FDMA") and Code Division
Multiple Access ("CDMA") forms of digital telephone technology. In addition to
this transition to switched services, the Company intends to enter into new
geographic markets, expand its operations in existing markets, interconnect its
existing markets and offer additional telecommunications services, when and if
it becomes economically desirable to do so.
The successful implementation of the Company's expansion strategy will be
subject to a variety of risks, including operating and technical problems,
regulatory uncertainties, competition and the availability of capital. There can
be no assurance that any existing networks will be successfully expanded or any
new networks will be developed. In addition, there can be no assurance that any
networks that are developed will be completed on schedule, at commercially
reasonable costs or within the Company's specifications. There also can be no
assurance that any new or expanded networks will become profitable or generate
positive cash flow at any time in the future. A substantial portion of the
Company's network build-out plans within existing markets are dependent upon its
continuing relationship with TW Cable. See " -- Relationship with TW Cable." The
Company's inability to expand its existing networks and operations or install
new networks or manage effectively such expansion and installation could have a
material adverse effect upon the Company's business operations, financial
condition and results of operations. In addition, the expansion of the Company's
business may involve acquisitions or joint ventures which, if made or entered
into, could divert the resources and management time of the Company and could
require integration with the Company's operations. See " -- Acquisition Related
Risks."
The Company's future performance will depend, in part, upon its ability to
manage its growth effectively. The Company's rapid growth has placed, and in the
future may continue to place, a significant strain on its administrative,
operational and financial resources. The Company's ability to continue to manage
its growth successfully will require the Company to further enhance its
operations, management, financial and information systems and controls and to
expand, train and manage its employee base. In addition, as the Company
increases its service offerings and expands its targeted markets, there will be
additional demands on the Company's customer support, sales, marketing, and
administrative resources and network infrastructure. There can be no assurance
that the Company's administrative, operating and financial resources, systems
and controls will be adequate to manage the Company's growth effectively. The
Company's inability to manage its expansion effectively, including the emergence
of unexpected expansion difficulties, could have a material adverse effect on
the Company's business, results of operations and financial condition.
Relationship With TW Cable
The Company is largely dependent upon TW Cable's governmental licenses,
permits and rights-of-way to operate the Company's current business. TW Cable is
generally managed by a management committee that includes representatives of
MediaOne and TW. The Company presently licenses pursuant to the Capacity
License, and may enter into future licenses for the capacity of significant
numbers of optical fibers from TW Cable; however, TW Cable is not obligated to
construct or provide additional fiber optic capacity in excess of what is
already licensed to the Company under the Capacity License. See "Certain
Relationships and Related Transactions -- Certain Operating Agreements."
Historically, the Company has relied on TW Cable's fiber optics in constructing
its own networks. In
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addition, most of the new service areas in which management is considering
operating or constructing networks are located in areas where TW Cable has
already made substantial infrastructure investments. The inability of the
Company to license additional fiber optic capacity from TW Cable could
materially affect the Company's expansion plans, future business and operations.
Any adverse changes in the ability of TW Cable to obtain and maintain all
necessary permits, licenses, conduit agreements or pole attachment agreements
from governmental authorities or private rights-of-way providers necessary to
effectuate such license transactions may have a material adverse effect on the
Company's business and financial condition.
The Capacity License expires in 2028. Although TW Cable has agreed to
negotiate renewal or alternative provisions in good faith at that time, there
can be no assurance that the parties will agree on the terms of any renewal or
that the terms of any renewal or alternative provisions which may be agreed upon
by the parties will be favorable to the Company. If the Capacity License is not
renewed in 2028, the Company will have no residual interest in the capacity
under the Capacity License and may need to build, lease or otherwise obtain
transmission capacity in order to service its customers in the service areas
covered by the Capacity License. The terms of such arrangements could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Capacity License also provides that the license of fiber optic capacity
by the Company may be terminated by TW Cable upon:
. a material impairment or termination of TW Cable's ability to provide
such license under relevant law,
. the Company's material breach of the terms and conditions of the Capacity
License, or
. the institution of any proceedings to impose any public utility or common
carrier status or obligations on TW Cable or any other proceedings
challenging TW Cable's operating authority as a result of the services
provided to the Company under the Capacity License.
In addition, under the terms of the Capacity License, the Company is
restricted from utilizing such capacity for Residential Services (as defined)
and Content Services (as defined) during the term of such license. Although
management does not believe that the restrictions contained in the Capacity
License will materially affect its business and operations in the immediate
future, the effect of such restrictions in the rapidly changing
telecommunications industry cannot be predicted. See "Certain Relationships and
Related Transactions -- Certain Operating Agreements." The termination of the
Capacity License would terminate the Company's ability to serve its customers in
the applicable market and would have a material adverse effect on the Company's
business, financial condition and results of operations.
TW and AT&T have announced their intention to form a joint venture to offer
any distance telephone services to residential and small business customers in
TW Cable's service areas, over TW Cable's cable facilities. Although the Company
primarily targets large and medium size business customers in the same services
areas, the proposed joint venture could compete directly with the Company with
respect to small business customers.
Risks Relating to Long Distance
Currently, the Company offers primarily local telecommunications services.
However, the Company continues to examine opportunities to expand into other
related telecommunications services. If the Company were to expand into new
categories of telecommunications services, it could incur certain additional
demands and risks in connection with such expansion, including demands on its
ability to manage growth, technological compatibility risks, legal and
regulatory risks and possible adverse reaction by some of its current customers.
The Company has begun to offer long distance service and expects to realize
increased revenues therefrom by the second quarter of 1999. The long distance
business is extremely competitive and prices have declined substantially in
recent years and are expected to continue to decline. In addition, the long
distance industry has historically had a high average churn rate, as customers
frequently change long distance providers in response to the offering of lower
rates or promotional incentives by competitors. The Company markets its long
distance services to
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smaller businesses, a market segment that has not been a principal focus of the
Company's business in the past and thus one to which the Company has limited
experience marketing. The Company relies on other carriers to provide
transmission and termination services for a majority of its long distance
traffic. The Company has negotiated a non-exclusive resale agreement with a long
distance carrier and may negotiate additional resale agreements with other long
distance carriers to provide it with additional transmission services. Such
agreements typically provide for the resale of long distance services on a per
minute basis and may contain minimum volume commitments. Negotiation of these
agreements involves estimates of future supply and demand for transmission
capacity as well as estimates of the calling pattern and traffic levels of the
Company's future long distance customers. If the Company were to fail to meet
any minimum volume commitments, it could be obligated to pay underutilization
charges and in the event it underestimates its need for transmission capacity,
the Company may be required to obtain capacity through more expensive means.
Dependence Upon Interconnection With ILECS; Competition
The Company operates in an increasingly competitive environment. Services
substantially similar to those offered by the Company are also offered by ILECs
serving the markets currently served or intended to be served by the Company.
ILECs have long-standing relationships with their customers, have financial and
technical resources substantially greater than those of the Company, have the
potential to subsidize services of the type offered by the Company from service
revenues not subject to effective competition and currently benefit from certain
existing regulations that favor the ILECs over CLECs such as the Company in
certain respects. While recent regulatory initiatives, which allow CLECs such as
the Company to interconnect with ILEC facilities, provide increased business
opportunities for the Company, such interconnection opportunities have been
accompanied by increased pricing flexibility for and relaxation of regulatory
oversight of the ILECs.
To the extent the Company interconnects with and uses ILEC networks to
service its customers, the Company will be dependent upon the technology and
capabilities of the ILECs to meet certain telecommunications needs of the
Company's customers and to maintain its service standards. The Company will
become increasingly dependent on interconnection with ILECs as switched services
become a greater percentage of the Company's business. The 1996 Act imposes
interconnection obligations on ILECs; however, such interconnection requires the
negotiation of interconnection and collocation agreements with the ILECs, which
can take considerable time, effort and expense and are subject to Federal and
state regulation. There can be no assurance that the Company will be able to
obtain the interconnection it requires at rates, and on terms and conditions,
that permit the Company to offer switched services at rates that are both
competitive and profitable. In the event that the Company experiences
difficulties in obtaining high quality, reliable and reasonably priced service
from the ILECs, the attractiveness of the Company's services to its customers
could be impaired.
In addition, the 1996 Act allows the RBOCs and others such as electric
utilities to enter the long distance market. Certain of the RBOCs have begun
providing out-of-region long distance services across Local Access and Transport
Areas ("interLATA"). When an RBOC obtains authority to provide in-region
interLATA services, it will be able to offer customers both local and long
distance telephone services. Given the market power the RBOCs currently possess
in the local exchange market, the ability to provide both local and long
distance services is expected to make the RBOCs very strong competitors. Certain
RBOCs are actively working to satisfy prerequisites for entry into the in-region
long distance business. Formal applications by the RBOCs to provide long
distance service have been denied by the FCC.
In addition, a U.S. District Court in Texas held that the provisions of
Section 271 of the 1996 Act limiting the RBOCs' entry into the long distance
business violate the U.S. Constitution. On September 4, 1998, the U.S. Court of
Appeals for the Fifth Circuit reversed that District Court decision, concluding
that the provisions of Section 271 governing the RBOCs interLATA service entry
do not constitute an unconstitutional bill of attainder. Several parties,
including SBC, have filed petitions for certiorari with the U.S. Supreme Court
asking that it review the decision of the Fifth Circuit. On January 19, 1999,
the Supreme Court declined to review that decision. In addition, two RBOCs,
Ameritech and U S WEST Communications, Inc. ("U S WEST"), had entered into
agreements with a long distance carrier, Qwest Communications Corp. ("Qwest"),
under which they plan to jointly market Qwest long distance service to local
telephone service consumers in their operating territories. Those agreements
were challenged
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by several IXCs and CLECs before U.S. District Courts and before
the FCC. On September 28, 1998, the FCC released a Memorandum Opinion and Order
determining that the offering by Ameritech and U S WEST of Qwest's long distance
service as part of combined packages of service violates Section 271 of the 1996
Act. However, that decision has been appealed. Further, a continuing trend
toward consolidation, mergers, acquisitions and strategic alliances in the
telecommunications industry could also give rise to significant new competitors
to the Company or to the Company's customers. See "Business -- Government
Regulation."
In most of the areas in which the Company operates, at least one (and in
many markets several) other CAP or CLEC offers many local telecommunications
services similar to those provided by the Company, generally at similar prices.
Potential and actual new market entrants in the local telecommunications
services business include other CAPs and CLECs, ILECs entering new geographic
markets, cable television companies, electric utilities, long distance and
international carriers, microwave carriers, wireless telephone system operators
and private networks built by large end users. Many of these potential
competitors have financial, personnel and other resources substantially greater
than those of the Company.
In addition, the current trend of business combinations and alliances in
the telecommunications industry, including mergers between BOCs, between BOCs
and other ILECs, and between major interexchange carriers and CLECs, may create
significant new competitors for the Company. For example, Bell Atlantic has
acquired the LECs owned by NYNEX and SBC, has acquired Southern New England
Telephone and Pacific Telesis. In addition, SBC and Ameritech have agreed to
merge, as have Bell Atlantic and GTE Corporation. On July 23, 1998, AT&T
announced that it had completed its acquisition of TCG, a competitor of the
Company. AT&T also acquired TCI, a major cable operator, in March, 1999.
The 1996 Act has increased and will continue to increase competition in the
local telecommunications business. The 1996 Act requires all local exchange
providers, including new entrants, to offer their services for resale and
requires ILECs to offer their network facilities on an unbundled basis. Further,
pursuant to the 1996 Act, ILEC services provided to end-users are required to be
made available to other telecommunications carriers for resale at wholesale
rates. There can be no assurance that any unbundled rates or facilities offered
by ILECs to the Company will be available in a timely manner or will be
economically attractive or technically viable. See "Business -- Government
Regulation -- Telecommunications Act of 1996." These requirements facilitate
entry by new competitors with reduced capital risk or investment. See "Business
- -- Competition."
The recent World Trade Organization ("WTO") agreement on basic
telecommunications services could increase the Company's competition for
telecommunications services both domestically and internationally. Under this
agreement, which became effective in 1998, the United States and other members
of the WTO committed themselves to opening their telecommunications markets to
competition and foreign ownership and to adopting regulatory measures to protect
competitors against anticompetitive behavior by dominant telephone companies. As
part of the U.S. government's implementation of the WTO Agreement, the FCC has
established new rules making it easier for foreign carriers to enter the U.S.
telecommunications market. See "Business -- Competition" and " -- Government
Regulation."
Dependence on Information and Billing Systems
Sophisticated information and processing systems are vital to the Company's
growth and its ability to monitor costs, bill customers, provision customer
orders and achieve operating efficiencies. As the Company continues to grow, the
need for more sophisticated information systems will increase significantly. The
Company has entered into agreements with certain vendors providing for the
development and/or operation of back office systems including ordering,
provisioning and billing systems. The failure of such vendors to perform their
services in a timely and effective manner at acceptable costs could have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operation -- Year 2000."
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Dependence on Significant Customers
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. For the year ended
December 31, 1998, the Company's top 10 customers accounted for 37.8% of the
Company's combined revenues. Although the Company's top 2 customers, which are
IXCs, accounted for 23.7% of the Company's combined revenues, a significant
portion of the revenue stream from those two long distance carriers is not
controlled by them. Accordingly, the Company does not believe that the loss of
the revenue controlled by one of those two long distance carriers would have a
material adverse effect on its business. No other customer, including customers
who direct their business through long distance carriers, accounted for 10% or
more of revenues. Some of the Company's customer arrangements are subject to
termination on short notice and do not provide the Company with guarantees that
service quantities will be maintained at current levels, and there can be no
assurance that such customers will continue to purchase the same service
quantity levels. The Company believes that certain IXCs are pursuing
alternatives to their current practices with regard to obtaining local
telecommunications services, including acquisition or construction of their own
facilities. For example, on July 23, 1998, AT&T, a customer of the Company,
announced that it had completed its acquisition of TCG, which is a CLEC that
operates in several of the Company's service areas. This type of activity has
accelerated as a result of the 1996 Act, which limits the authority of states to
impose legal restrictions that have the effect of prohibiting a company,
including an IXC, from providing any telecommunications service. In addition,
the 1996 Act requires ILECs to unbundle their network facilities and to offer
their services for resale by other companies at wholesale discounts.
Accordingly, long distance carriers soon will be able to provide local service
by reselling the facilities or services of an ILEC, which may be more cost-
effective for an IXC than using the services of the Company or another CAP or
CLEC. See "Business -- Customers and Sales and Marketing."
Federal and State Regulation
The Company is subject to Federal and state regulation. Existing Federal
and state regulations, or new regulations that may be adopted by the FCC or
state regulatory authorities may have a material adverse effect on the Company.
In most states, the Company is subject to certification and tariff filing
requirements with respect to intrastate services. Although many restrictions on
the services that may be provided by the Company were eliminated as a result of
the 1996 Act, which prohibits states from imposing legal restrictions that
effectively prohibit the provision of any telecommunications service, states
retain authority under the 1996 Act to impose on the Company and other
telecommunications carriers competitively neutral requirements to preserve
universal service, protect public safety, ensure quality of service and protect
consumers. States are also responsible under the 1996 Act for mediating and
arbitrating interconnection arrangements between CLECs and ILECs if the carriers
fail to agree on such arrangements.
In the past, the Company had been required to offer its interstate services
pursuant to rates, terms, and conditions set forth in tariffs filed with the
FCC. However, on June 19, 1997, the FCC issued a memorandum opinion and order
granting the Company's request that the FCC forbear from imposing on the Company
the tariff filing requirements of the Communications Act of 1934 (the
"Communications Act"), with respect to interstate access services offered by the
Company. Following that favorable ruling on the Company's request, the Company
has withdrawn its interstate access tariff and will now offer its interstate
access services pursuant to contracts with each of its customers. The Company is
still required to offer any interstate services other than interstate access
services, including, for example, interstate and international long distance
telephone service, pursuant to tariffs filed with the FCC.
As a result of rules and policies implemented by the FCC, ILECs have been
required to reduce the access charges paid by IXCs. Access charges are the fees
which IXCs pay to LECs for the use of local exchange telecommunications
facilities to originate and terminate interexchange (long distance) telephone
calls. These mandatory reductions in the access charges of ILECs, including the
RBOCs, may place downward pressure on the prices charged by the Company for
access services which it provides to IXCs.
Under the 1996 Act, the Company is subject to certain Federal regulatory
obligations when it provides local exchange service in a market. All LECs,
including CLECs, must interconnect with other carriers, make their services
available for resale by other carriers, provide nondiscriminatory access to
rights-of-way, offer reciprocal
27
<PAGE>
compensation for termination of traffic and provide dialing parity and telephone
number portability. The Company is subject to requirements that the rates,
terms, classifications and practices with respect to its interstate access
service be just and reasonable and may not be unreasonably discriminatory.
However, as a non-dominant carrier, the Company's rates, terms, classifications
and practices are presumed to be lawful. The Company's intrastate services,
including local service and intrastate access, are subject to similar
requirements under state laws. In addition, as a telecommunications carrier, the
Company will be required to contribute to a fund to preserve universal service
and to enable schools, libraries and rural health care centers to have access to
telecommunications services and advanced information services at discounted
prices.
Pursuant to the requirements of the 1996 Act and the FCC's rules
promulgated to implement the 1996 Act, the Company is required to compensate
other LECs for termination of local exchange traffic originated by the Company.
Conversely, the Company is entitled to receipt of compensation from other LECs
when it terminates local exchange traffic originated by other LECs. This
requirement is commonly referred to as reciprocal compensation. Several BOCs and
other ILECs have taken the position that traffic terminated at the premises of
internet service providers ("ISPs") should be considered to be interstate
traffic rather than local traffic and that such traffic should not be subject to
the reciprocal compensation obligation described above. Those LECs have asked
state commissions and the FCC to reach the same conclusion. To date, every state
commission which has considered the issue has concluded that traffic transported
within a local exchange which is terminated at the premises of ISPs is local
traffic and is subject to the reciprocal compensation requirement. In a
declaratory ruling adopted February 25, 1999, the FCC concluded that dial-up ISP
traffic is largely interstate in nature, but that this conclusion did not
determine whether reciprocal compensation is applicable. While the FCC
acknowledged that it had not adopted a specific ruling governing compensation
for such traffic, the historical policy of treating ISP traffic as local for
purposes of interstate access charges would, in the question of reciprocal
compensation for dial-up ISP traffic, suggest that such compensation is due for
that traffic. The FCC also commenced a rulemaking with respect to the
determination of mutual compensation for ISP traffic on a prospective basis. The
declaratory ruling emphasized that carriers are bound by their existing
interconnection agreements, as interpreted by state commissions, and are subject
to reciprocal compensation as determined by those state commissions. Since
ILECs will likely challenge the previous state commission decisions regarding
ISP traffic, the impact of those proceedings on the mutual compensation received
by the Company for local traffic cannot be predicted. See "Business--Government
Regulation." A determination by the FCC or by state utility commissions that
such traffic should not be subject to reciprocal compensation could be adverse
to the Company.
Governmental and Other Authorizations
The development, expansion and maintenance of the Company's networks will
depend on, among other things, its ability to obtain rights-of-way and any other
required governmental authorizations and permits, all in a timely manner, at
reasonable costs and on satisfactory terms and conditions. In certain of the
cities or municipalities where the Company provides network services, it pays
license or franchise fees, usually based on a percentage of gross revenues or a
rate per circuit. The 1996 Act permits municipalities to charge such fees only
if they are competitively neutral and nondiscriminatory, but there can be no
assurance that municipalities that presently favor a particular carrier,
typically the ILEC, will conform their practices to the requirements of the 1996
Act in a timely manner or without legal challenge. Furthermore, there can be no
assurance that certain cities or municipalities that do not now impose such fees
will not seek to impose fees, nor can there be any assurance that, following the
expiration of existing franchises, fees will remain at their current levels or
that the franchises will be renewed. Some of the Company's franchise agreements
also provide for increases or renegotiation of fees at intervals prior to the
expiration thereof.
In addition, the Company currently licenses capacity of, and plans in the
future to enter into similar arrangements for, significant numbers of optical
fibers from TW Cable. See "Certain Relationships and Related Transactions --
Certain Operating Agreements." There can be no assurance that municipalities
which regulate TW Cable will not seek to impose additional franchise fees or
otherwise charge TW Cable (subject to reimbursement by the Company) in
connection with such licenses. There can also be no assurance that TW Cable or
the Company will be able to obtain all necessary permits, licenses, conduit
agreements or pole attachment agreements from governmental authorities or
private rights-of-way providers necessary to effectuate future license
transactions. As a
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<PAGE>
result, there can be no assurance that the Company will be able to expand its
existing networks or develop new networks successfully, which would have a
material adverse effect on the Company's growth and financial condition.
There can be no assurance that the Company will be able to utilize TW
Cable's existing licenses, permits and rights-of-way or that it will be able to
obtain the governmental licenses and permits and rights-of-way required to enter
new markets on acceptable terms. The cancellation or non-renewal of existing
permits, licenses or rights-of-ways, or the inability to obtain the permits,
licenses or rights-of-ways to expand in accordance with its plans, could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Acquisition Related Risks
The Company may, as part of its business strategy, acquire other businesses
that will complement its existing business. Management is unable to predict
whether or when any prospective acquisitions will occur or the likelihood of any
material transactions being completed on favorable terms and conditions. The
Company's ability to finance acquisitions may be constrained by, among other
things, its high degree of leverage. The Indenture significantly limits the
Company's ability to make acquisitions and to incur indebtedness in connection
with acquisitions. Such transactions commonly involve certain risks, including,
among others:
. the difficulty of assimilating the acquired operations and personnel;
. the potential disruption of the Company's ongoing business and diversion
of resources and management time;
. the possible inability of management to maintain uniform standards,
controls, procedures and policies;
. the risks of entering markets in which the Company has little or no prior
experience; and
. the potential impairment of relationships with employees or customers as
a result of changes in management or business.
There can be no assurance that any acquisition will be made, that the
Company will be able to obtain additional financing needed to finance any
acquisition and, if any acquisitions are made, that the acquired business will
be successfully integrated into the Company's operations so that the acquired
business will perform as expected. The Company has no definitive agreement with
respect to any acquisition, although from time to time it has discussions with
other companies, including affiliates of the Existing Stockholders, and assesses
opportunities on an ongoing basis.
The Company may also enter into joint venture transactions. These
transactions present many of the same risks involved in acquisitions and may
also involve the risk that other joint venture partners may have economic,
business or legal interests or objectives that are inconsistent with those of
the Company. Joint venture partners may also be unable to meet their economic or
other obligations, thereby forcing the Company to fulfill these obligations.
Variability of Quarterly Operating Results
As a result of the limited revenues and significant expenses associated
with the expansion and development of its networks and services, the Company
anticipates that its operating results could vary from period to period. In
addition, the Company's revenues are, and may continue to be, dependent upon
certain significant customers and contracts and as a result, may vary from
quarter to quarter. See " -- Dependence on Significant Customers."
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<PAGE>
Control by Members; Conflicts of Interest; Possible Competition
The Members hold all the limited liability company interests in the Company
and have the collective ability to control all matters requiring member
approval, including the appointment of representatives (the "Representatives")
to the Management Committee of the Company (the "Management Committee").
All of the Members are in the cable television business and may, now or in
the future, provide services which are the same or similar to those provided by
the Company. There is no restriction on the Members' ability to compete with the
Company and no assurance can be given that the Members will not compete with the
Company in its service areas or in the provision of certain telecommunications
services. The Company is subject to certain restrictions on offering Residential
Services and Content Services. See " -- Limitations on Business Activity."
Representatives of the Company who are also directors, officers or employees of
the Members are in positions that may create conflicts of interest with respect
to certain business opportunities available to, and certain transactions
involving, the Company. The Members have not adopted any special voting
procedures to deal with such conflicts of interest, and there can be no
assurance that any such conflict will be resolved in favor of the Company.
Limitations on Business Activity
The Company is currently restricted from offering telecommunications
services to residences and from providing content services to its customers. The
LLC Agreement provides that the Company may not, directly or indirectly (through
a subsidiary or affiliate of the Company), without the affirmative vote of all
the holders of the Class B limited liability company interests:
. engage in the business of providing, offering, packaging, marketing,
promoting or branding (alone or jointly with or as an agent for other
parties) any wireline telecommunications services or other services
(including data services) to residences (collectively, "Residential
Services"), or
. engage in the business of producing, packaging, distributing, marketing,
hosting, offering, promoting, branding or otherwise providing
entertainment, information or any other content services, whether fixed
or interactive, or any services incidental thereto (but excluding acting
solely as a carrier of video, audio or data of unaffiliated third parties
by providing transport services, so long as the Company has no other
direct or indirect pecuniary interest in the transmitted information or
content) (collectively, "Content Services"),
in each case, without the affirmative vote of the Members. If the
Reconstitution occurs, the Certificate of Incorporation of the Company will
continue the foregoing restrictions for a maximum period of five years from the
date of the Reconstitution. Similar restrictions against using fiber capacity
licensed from TW Cable under the Capacity License for Residential Services and
Content Services extend for the 30 year term of such license. Accordingly, the
Capacity License restrictions will apply after the restrictions in the
Certificate of Incorporation have terminated. See "Certain Relationships and
Related Transactions -- Certain Operating Agreements." Violations of the
limitations on business activities of the Company contained in the LLC
Agreement, the Certificate of Incorporation or the Capacity License may, subject
to the cure period provided in the Capacity License, result in a termination of
the Capacity License. Although Management does not believe that the
restrictions contained in the LLC Agreement, the Certificate of Incorporation or
the Capacity License will materially affect its business and operations in the
immediate future, the effect of such restrictions in the rapidly changing
telecommunications industry cannot be predicted.
Similar restrictions against using fiber capacity licensed from TW Cable
under the Capacity License for Residential Services and Content Services extend
for the 30-year term of such license. Accordingly, the Capacity License
restrictions will apply after the restrictions in the Restated Certificate of
Incorporation have terminated. See "Certain Relationships and Related
Transactions -- Certain Operating Agreements." Violations of the limitations on
business activities of the Company contained in the Restated Certificate of
Incorporation or the Capacity License may, subject to the cure period provided
in the Capacity License, result in a termination of the Capacity License.
Although management does not believe that the restrictions contained in the
Restated Certificate of Incorporation or
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the Capacity License will materially affect its business and operations in the
immediate future, the effect of such restrictions in the rapidly changing
telecommunications industry cannot be predicted.
Discontinuance of Use of "Time Warner" Name
Pursuant to a License Agreement with TW, the Company is required to
discontinue use of the "Time Warner" name upon:
. expiration of the initial four year term or any renewal term of such
agreement,
. TW's owning Interests having an aggregate participation percentage of
less than 30%,
. TW having the right to appoint less than three Representatives to the
Management Committee of the Company,
. the Company's non-compliance with the restrictions in the LLC Agreement
regarding Residential Services and Content Services or
. the transfer by a Member of its Class B Interests together with its
rights to appoint Representatives to the Management Committee under the
LLC Agreement.
Under such circumstances, the Company may change its name to TW Telecom and
the Company will no longer have the right to use the "Time Warner" name. Such
name change, and the inability to use the "Time Warner" name could have an
adverse effect on the Company's ability to conduct its business and on its
financial condition and results of operations.
Need to Adapt to Technological Changes
The telecommunications industry has experienced, and is expected to
continue to experience, rapid and significant changes in technology. While the
Company believes that, for the foreseeable future, these changes will neither
materially affect the continued use of fiber optic cable or digital switches and
transmission equipment nor materially hinder the Company's ability to acquire
necessary technologies, the effect of technological changes on the Company's
business and operations cannot be predicted. The Company believes that its
future success will depend, in part, on its ability to anticipate or adapt to
such changes and to offer, on a timely basis, services that meet customer
demands on a competitive basis. There can be no assurance that the Company will
obtain access to new technologies on a timely basis or on satisfactory terms.
Any failure by the Company to obtain new technologies could have a material
adverse effect on the Company's business, financial condition and results of
operations. Also, alternative technologies may develop for the provision of
services to customers. The Company may be required to select in advance one
technology over another, but it will be impossible to predict with any
certainty, at the time the Company is required to make its investment, which
technology will prove to be the most economic, efficient or capable of
attracting customer usage.
Dependence on Key Personnel
The Company's business is managed by a small group of key executive
officers. The loss of the services of any of these key individuals could have an
adverse impact on the Company. Although the senior executives of the Company
have considerable experience in the telecommunications industry, they have not
previously operated a public company. The Company has employment agreements with
each of Ms. Herda, Messrs. Jones, Powers, Rayner, Blount, and Whinery and Ms.
Rich. See "Management -- Employment Agreements." The Company does not carry key
man life insurance on any of such personnel. The Company believes that its
future success will depend in large part on its continued ability to attract and
retain highly skilled and qualified personnel. The competition for qualified
personnel in the telecommunications industry is intense and, accordingly, there
can be no assurance that the Company will be able to hire or retain necessary
personnel. See "Management."
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<PAGE>
Item 2. Properties
The Company leases network hub sites and other facility locations and sales
and administrative offices, substantially all of which are leased from TW Cable,
in each of the cities in which it operates networks. During 1996, 1997 and 1998,
rental expense for the Company's facilities and offices totaled approximately
$3.9 million, $4.7 million and $4.8 million, respectively. The Company owns no
material real estate. Management believes that its properties, taken as a whole,
are in good operating condition and are suitable and adequate for the Company's
business operations. The Company currently leases approximately 130,000 square
feet of space in Greenwood Village, Colorado, where its corporate headquarters
are located.
Item 3. Legal Proceedings
The Company is a party to various claims and legal and regulatory
proceedings arising in the ordinary course of business. The Company does not
believe that such claims or proceedings, individually or in the aggregate, will
have a material adverse effect on the Company's business, financial condition or
results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter
ended December 31, 1998.
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<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
During the past three years, except as set forth below, the Company has not
sold any securities without registration under the Securities Act. On July 14,
1998, pursuant to a reorganization of the assets and liabilities it business
that were previously owned by subsidiaries and divisions of Time Warner
Entertainment Company, L.P., Time Warner Entertainment-Advance/Newhouse
Partnership and Time Warner Inc., (the "Reorganization"), the Company issued
Class B Limited Liability Company Interests having an aggregate participation
percentage of 100% to Time Warner Inc. and certain of its subsidiaries, MediaOne
Group, Inc. and certain of its subsidiaries and Advance/Newhouse Partnership, in
a private placement under Section 4(2) of the Securities Act. There is no
established public trading market for the Class B Limited Liability Company
Interests. The Company plans to retain all earnings for investment in its
business and does not plan to pay dividends at any time in the foreseeable
future.
The Company sold $400.0 million principal amount of Notes on July 21, 1998.
Net proceeds from the offering were $387.5 million, of which the Company has
used $32.5 million as of December 31, 1998 for shortfalls in cash flow and
capital expenditures. The balance was invested in high quality marketable
securities.
In 1998, the Company issued options to purchase 6,115,250 Class A Units to
employees of the Company under the Company's 1998 Option Plan, in a private
placement under Section 4(2) of the Securities Act of 1933.
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<PAGE>
Item 6. Selected Financial Data
Selected Combined Financial and Other Operating Data
The following table is derived in part from the audited combined financial
statements of the Company. The financial statements of the Company for all
periods prior to the Reorganization that occurred on July 14, 1998 reflect the
"carved out" historical financial position, results of operations, cash flows
and changes in members' equity of the commercial telecommunications operations
of predecessors of the Company, as if they had been operating as a separate
company. The 1998 financial information reflects the offering of $400 million in
debt issued in July 1998. This information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the audited combined financial statements and the notes thereto.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------------------------------------
1994 1995 1996 1997 1998
---------- ---------- ---------- ----------- -----------
(in thousands, except per share and operating data amounts)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Dedicated transport services $ 2,169 $ 6,505 $ 20,362 $ 44,529 $ 84,024
Switched services -- 350 3,555 10,872 37,848
--------- --------- --------- ---------- ----------
Total revenues 2,169 6,855 23,917 55,401 121,872
--------- --------- --------- ---------- ----------
Costs and expenses:
Operating (1) 10,454 15,106 25,715 40,349 67,153
Selling, general and administrative (1) 26,066 34,222 60,366 54,640 77,401
Depreciation and
amortization (1) 1,213 7,216 22,353 38,466 50,717
--------- --------- --------- ---------- ----------
Total costs and expenses 37,733 56,544 108,434 133,455 195,271
--------- --------- --------- ---------- ----------
Operating loss (35,564) (49,689) (84,517) (78,054) (73,399)
Gain on disposition of investments (2) -- -- -- 11,018 --
Equity in income (losses) of
unconsolidated affiliates (1,611) (1,391) (1,547) (2,082) 127
Interest income -- -- -- -- 9,731
Interest and other, net (1) (3) (25) (52) (1,538) (29,198)
--------- --------- --------- ---------- ----------
Net loss $ (37,178) $ (51,105) $ (86,116) $ (70,656) ($ 92,739)
========= ========= ========= ========== ==========
Other Operating Data:
EBITDA (3) $ (34,351) $ (42,473) $ (62,164) $ (39,588) $ (22,682)
EBITDA Margin (4) (1,583.7)% (619.6)% (259.9)% (71.5)% (18.6)%
Capital expenditures 50,293 141,479 144,815 127,315 126,023
Cash provided (used) by operations (14,873) (35,605) (52,274) (29,419) (343)
Cash used in investing activities (52,632) (145,293) (149,190) (120,621) (378,083)
Cash provided by financing activities 67,505 180,898 201,464 150,040 483,566
Operating Data (5):
Operating Networks 8 15 18 19 19
Route miles 880 3,207 5,010 5,913 6,968
Fiber miles 24,995 116,286 198,490 233,488 272,390
Voice grade equivalent circuits 39,002 158,572 687,001 1,702,431 2,953,454
Digital telephone switches -- 1 2 14 16
Employees 239 508 673 714 919
Access lines -- 493 2,793 16,078 78,036
Balance Sheet Data:
Cash and cash equivalents $ -- $ -- $ -- $ -- $ 105,140
Marketable securities -- -- -- -- 250,857
Property, plant and
equipment, net 53,139 199,005 323,161 415,158 494,158
Total assets 60,604 214,963 341,480 438,077 904,344
Long-term debt (6) -- -- -- 75,475 574,940
Total members' equity 33,749 179,589 294,937 300,390 207,651
</TABLE>
(footnotes on next page)
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<PAGE>
(1) Includes expenses resulting from transactions with affiliates of $1.9
million in 1994, $6.5 million in 1995, $12.4 million in 1996, $17.1 million
in 1997 and $27.7 million in 1998, respectively. See note 7 to the
Company's financial statements appearing elsewhere in this report for an
explanation of these expenses.
(2) In September 1997, the Company completed a series of transactions related
to its interests in the Hyperion Partnerships, a group of unconsolidated
telecommunication partnerships serving the New York area, whereby it sold
its interests in the partnerships serving the Buffalo and Syracuse markets
in exchange for $7.0 million of cash and all of the minority interests in
the partnerships serving the Albany and Binghamton markets that were not
already owned by the Company. In connection with these transactions, the
Company recognized a gain of approximately $11.0 million.
(3) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income, cash flow and other measures of financial
performance and liquidity reported in accordance with generally accepted
accounting principles. Rather, EBITDA is a measure of operating performance
and liquidity that may be considered in addition to those measures. The
Company believes that EBITDA is a standard measure of operating performance
and liquidity that is commonly reported and widely used by analysts,
investors and other interested parties in the telecommunications industry
because it eliminates many differences in financial, capitalization, and
tax structures, as well as non-operating and one-time charges to earnings.
EBITDA is used internally by the company's management to assess on-going
operations and is a component of a covenant of the Notes that limits the
Company's ability to incur certain additional future indebtedness. However,
EBITDA as used herein may not be comparable to similarly titles measures
reported by other companies due to differences in accounting policies.
(4) EBITDA Margin represents EBITDA as a percentage of revenues.
(5) Includes all managed properties including unconsolidated affiliates
(MetroComm AxS, L.P. in Columbus, Ohio and the Albany and Binghamton, New
York networks). Albany and Binghamton were wholly owned at December 31,
1997.
(6) As of December 31, 1998, long-term debt consisted of (a) $400.0 million
principal amount of the Notes and (b) $174.9 million principal amount of
subordinated loans payable to the Parent Companies.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis should be read in conjunction with
the Company's financial statements, including the notes thereto, appearing
elsewhere in this report. Certain information contained in the discussion and
analysis set forth below and elsewhere in this report, including information
with respect to the Company's plans and strategy for its business and related
financing, includes forward-looking statements that involve risk and
uncertainties. See "Factors That Could Affect Future Performance" for a
discussion of important factors that could cause actual results to differ
materially from the results described in or implied by the forward-looking
statements contained herein.
Overview
The Company is a leading fiber facilities-based CLEC in selected
metropolitan markets across the United States, offering a wide range of business
telephony services, primarily to medium- and large-sized business customers. The
business of the Company was commenced in 1993 by TW Cable and reflects the
combined commercial telecommunications operations under the ownership or
management control of TW Cable. These operations consist of the commercial
telecommunication operations of TW and TWE-A/N that were each acquired or formed
in 1995, as well as the pre-existing commercial telecommunication operations of
TWE. All intercompany accounts and transactions between the combined entities
have been eliminated.
The Company was recently formed in connection with a reorganization (the
"Reorganization") of the assets and liabilities of its business, which were
previously owned by subsidiaries and divisions of TWE, TWE-A/N and Time Warner
(together, the "Parent Companies"). The Reorganization was consummated on July
14, 1998. In connection with the Reorganization, the assets and liabilities of
the Company's business were
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<PAGE>
contributed to the Company by the Parent Companies and in connection therewith,
Time Warner, MediaOne and Newhouse received 61.9%, 18.9,% and 19.2%,
respectively, of the limited liability company interests in the Company (all in
the form of Class B Limited Liability Company Interests). The Company accounted
for the Reorganization at each of the Members' historical cost basis of
accounting and accordingly, the Reorganization had no effect on the Company's
total members' equity which has been presented on a consistent basis.
The majority of the Company's revenues have been derived from the provision
of "private line" and "direct access" telecommunications services. Because the
Company has deployed switches in 16 of its 19 service areas as of December 31,
1998, management expects that a growing portion of its revenues will be derived
from providing switched services. The Company's customers are principally
telecommunications-intensive business end-users, IXCs, ISPs, wireless
communications companies and governmental entities. Such customers are offered a
wide range of integrated telecommunications products and services, including
dedicated transmission, local switched, data and video transmission services and
internet services. In addition, the Company benefits from its strategic
relationship with TW Cable both through network facilities access and cost-
sharing. As a result, the Company's networks have been constructed primarily
through the use of fiber capacity licensed from TW Cable. As of December 31,
1998, the Company operated networks in 19 metropolitan areas that spanned 6,968
route miles, contained 272,390 fiber glass miles and offered service to 4,321
buildings. The Company's 19 service areas include 18 networks that are wholly
owned and one that is owned through a 50% joint venture and is not combined with
the Company's financial results. The Company's combined revenues were $55.4
million and $121.9 million for the years ended December 31, 1997 and 1998,
respectively. As of December 31, 1998, the Parent Companies had invested $555.8
million in equity and $174.9 million in debt in the Company.
The Company's revenues have been derived primarily from business telephony
services, including dedicated transmission, local switched, long distance, data
and video transmission services and certain high-speed dedicated internet access
services. Since its inception in 1993, the Company has experienced significant
growth in revenues and in the geographic scope of its operations. Management
believes an increasing portion of the Company's future growth will come from the
provision of local switched services as a result of the 16 switches deployed as
of December 31, 1998. The Company believes that switched services provide the
opportunity for higher profit margins and better utilization of capital
investment than those expected from transport services. The shift of the revenue
growth to switched services may cause the Company's revenues to become less
predictable since a portion of such services are billed to customers on a usage
basis. Dedicated transport customers are typically billed a flat monthly rate
which produces a less variable stream of revenues for the Company. Furthermore,
it is expected that the growth in the switched service offerings will expand the
Company's customer base by making more services available to customers that are
generally smaller than those who purchase dedicated transport services. These
smaller customers are also expected to be the principal users of the Company's
long distance services (which were launched in the third quarter of 1998) and
high-speed dedicated internet access services. The Company expects to experience
a higher churn rate for these customers than it has traditionally experienced
with transport services. The Company intends to minimize this churn for long
distance and internet services to smaller customers by offering such service
under minimum one-year contracts.
The Company plans to expand its revenue base by fully utilizing available
network capacity in its existing markets and by continuing to develop and
selectively tailor new services in competitively-priced packages to meet the
needs of its medium- and large-sized business customers. The Company plans on
selectively entering new markets and intends to have networks under construction
or operational in 3 additional cities by the end of 1999. The Company has signed
a combination of long-term conduit and dark fiber leases in Dallas, Texas and
Jersey City, New Jersey and plans to commence offering fiber based telephone
services in those markets during the third quarter of 1999. The third city has
not yet been selected.
Operating expenses consist of costs directly related to the operation and
maintenance of the networks and the provision of the Company's services. This
includes the salaries and related expenses of operations and engineering
personnel as well as costs from the ILECs and other competitors for facility
leases and interconnection. These costs have increased over time as the Company
has increased its operations and revenues. It is expected that these costs will
continue to increase, but at a slower rate than revenue growth.
36
<PAGE>
Selling, general and administrative expenses consist of salaries and
related costs for employees other than those involved in operations and
engineering. Such expenses also include costs related to non-technical
facilities, sales and marketing, regulatory and legal costs. These costs have
increased over time as the Company has increased its operations and revenues.
The Company expects these costs to continue to increase as the Company's revenue
growth continues, but at a slower rate than revenue growth.
In the normal course of conducting its businesses, the Company engages in
various transactions with the, generally on terms resulting from negotiation
between the affected units that, in management's view, result in reasonable
allocations. In connection with the Reorganization, the Company entered into
several contracts with the Parent Companies in respect of certain of these
transactions. See "Certain Relationships and Related Transactions -- Certain
Operating Agreements." The Company's selling, general and administrative
expenses include charges allocated from the Parent Companies for certain general
and administrative expenses, primarily including office rent and overhead
charges for various administrative functions performed by TW Cable. These
charges are required to reflect all costs of doing business and are based on
various methods, which management believes result in reasonable allocations of
such costs that are necessary to present the Company's operations as if they are
operated on a stand alone basis. In addition, the Company licenses the right to
use the majority of its fiber optic cable capacity from TW Cable and reimburses
it for facility maintenance and pole rental costs. These costs are included in
the Company's operating expense. Finally, effective July 1, 1997 through July
14, 1998, all of the Company's financing requirements were funded with loans
from the Parent Companies. These loans are subordinated in right of payment to
the Notes, bear interest (payable in kind) at an annual rate equal to The Chase
Manhattan Bank's prime lending rate as in effect from time-to-time and mature on
August 15, 2008. The Company believes that this rate is comparable to rates that
could have been obtained from unrelated third parties. The Parent Companies and
the Members are not obligated to make additional equity investments in or loans
to the Company.
The Company expects that the net proceeds received from the sale on July
21, 1998, of $400.0 million principal amount of Notes and internally generated
funds, will provide sufficient funds for the Company to expand its business as
currently planned, pay interest on the Notes and to fund its currently expected
working capital needs through the middle of 2000. Thereafter, the Company
expects to require additional financing. However, in the event that the
Company's plans or assumptions change or prove to be inaccurate, or if the
Company consummates acquisitions or joint ventures, the Company may be required
to seek additional capital sooner than currently anticipated.
The Company has not historically, and does not currently, generate positive
operating cash flow. However, for the year ended December 31, 1998, 16 of the
Company's 19 service areas generated positive operating cash flow before
corporate allocations and the Company, as a whole, expects to begin generating
positive EBITDA during the second quarter of 1999. The following comparative
discussion of the results of financial condition and results of operations of
the Company includes an analysis of changes in revenues and EBITDA. EBITDA does
not include charges for interest expense or provisions for income taxes.
Accordingly, EBITDA is not intended to replace operating income, net income,
cash flow and other measures of financial performance and liquidity reported in
accordance with generally accepted accounting principles. Rather, EBITDA is a
measure of operating performance and liquidity that should be considered in
addition to those measures. The Company believes that EBITDA is a standard
measure of operating performance and liquidity that is commonly reported and
widely used by analysts, investors and other interested parties in the
telecommunications industry. However, EBITDA as used herein may not be
comparable to similarly titled measures reported by other companies.
The Company has had and will continue to have significant capital
expenditures. These expenditures pertain to the historical construction and
expansion of the networks and to the future expansion of the existing networks
as well as the construction of new networks.
37
<PAGE>
Results of Operations
The following table sets forth certain combined statement of operations
data of the Company, in thousands of dollars and expressed as a percentage of
revenues, for each of the periods presented. This table should be read in
conjunction with the Company's financial statements, including the notes
thereto, appearing elsewhere in this report:
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------------------------
1996 1997 1998
---- ---- ----
(in thousands, except per share amounts)
Statement of Operations Data:
Revenues:
<S> <C> <C> <C> <C> <C> <C>
Dedicated transport services...... $ 20,362 85.1% $ 44,529 80.4% $ 84,024 68.9%
Switched services................. 3,555 14.9 10,872 19.6 37,848 31.1
--------- ------ --------- ------ --------- ----
Total revenues.................... 23,917 100.0 55,401 100.0 121,872 100.0
Costs and expenses:
Operating (1)..................... 25,715 107.5 40,349 72.8 67,153 55.1
Selling, general and
administrative (1)................ 60,366 252.4 54,640 98.6 77,401 63.5
Depreciation and
amortization (1).................. 22,353 93.5 38,466 69.4 50,717 41.6
--------- ------ --------- ------ --------- ----
Total costs and expenses.......... 108,434 453.4 133,455 240.8 195,271 160.2
Operating loss (84,517) (353.4) (78,054) (140.8) (73,399) (60.2)
Gain on disposition of
investments (2)...................... -- -- 11,018 19.9 -- --
Equity in gains (losses)
of unconsolidated affiliates......... (1,547) (6.5) (2,082) (3.8) 127 --
Interest income........................ -- -- -- -- 9,731 8.0
Interest and other, net (1)............ (52) (.2) (1,538) (2.8) (29,198) (23.9)
--------- ------ --------- ------ --------- ----
Net loss............................... $ (86,116) (360.1)% $ (70,656) (127.5)% $ (92,739) (76.1)%
========= ====== ========= ====== ========= ====
Basic and diluted loss
per common share
Average common shares outstanding
EBITDA (3)............................. $ (62,164) (259.9)% $ (39,588) (71.5)% $ (22,682) (18.6)%
Cash provided (used) by operations (52,274) (29,419) (343)
Cash used in investing activities (149,190) (120,621) (378,083)
Cash provided by financing activities 201,464 150,040 483,566
</TABLE>
(1) Includes expenses resulting from transactions with affiliates of $12.4
million in 1996, $17.1 million in 1997 and $27.7 million in 1998.
(2) In September 1997, the Company completed a series of transactions related
to its interests in the Hyperion Partnerships, a group of unconsolidated
telecommunication partnerships serving the New York area (the "Hyperion
Partnerships"), whereby it sold its interests in the partnerships serving
the Buffalo and Syracuse markets in exchange for $7.0 million of cash and
all of the minority interests in the partnerships serving the Albany and
Binghamton markets that were not already owned by the Company
(collectively, the "Hyperion Transactions"). In connection with these
transactions, the Company recognized a gain of approximately $11.0 million.
(3) "EBITDA" is defined as operating income (loss) before depreciation and
amortization expense. It does not include charges for interest expense or
provision for income taxes. Accordingly, EBITDA is not intended to replace
operating income, net income, cash flow and other measures of financial
performance and liquidity reported in accordance with generally accepted
accounting principles. Rather, EBITDA is a measure of operating performance
and liquidity that may be considered in addition to those measures. The
Company believes that EBITDA is a standard measure of operating performance
and liquidity that is commonly reported and widely used by analysts,
investors and other interested parties in the telecommunications industry
because it eliminates many differences in financial, capitalization, and
tax structures, as well as non-operating and one-time charges to earnings.
EBITDA is used internally by the company's management to assess on-going
operations and is a component of a covenant of the Notes that limits the
Company's ability to incur certain additional future indebtedness. However,
EBITDA as used herein may not be comparable to similarly titles measures
reported by other companies due to differences in accounting policies.
38
<PAGE>
Year Ended December 31, 1998 Compared To Year Ended December 31, 1997
Revenues. Revenues increased $66.5 million, or 120.0%, to $121.9 million
for the year ended December 31, 1998, from $55.4 million for the same period in
1997. Revenues from the provision of dedicated transport services increased
$39.5 million, or 88.7%, to $84.0 million for the year ended December 31, 1998,
from $44.5 million for the same period in 1997. Switched service revenue
increased $27.0 million, or 248.1%, to $37.8 million for the year ended December
31, 1998, from $10.9 million for the same period in 1997. The increase in
revenues from dedicated transport services primarily reflects growth of services
and new products offered in existing markets. The increase in switched services
resulted from the offering of services in new markets and the growth of services
in existing markets including reciprocal compensation. Reciprocal compensation
represented 8.3% and 8.6% of total revenues for the years ended December 31,
1998 and 1997 respectively. At December 31, 1998, the Company offered dedicated
transport services in 19 metropolitan areas, 16 of which also offered switched
services, as compared to offering dedicated transport services in 19
metropolitan areas, 14 of which also offered switched services at December 31,
1997. The consolidated metropolitan areas do not include MetroComm AxS, L.P., a
50% owned entity of the Company.
Operating Expenses. Operating expenses increased $26.8 million, or 66.4%,
to $67.2 million for the year ended December 31, 1998, from $40.3 million for
the same period in 1997. The increase in operating expenses was primarily
attributable to the Company's expansion of its business, principally switched
services, and the ongoing development of existing markets resulting in higher
LEC charges for circuit leases and interconnection, higher technical personnel
costs, and higher data processing costs. As a percentage of revenues, operating
expenses decreased to 55.1% in 1998 from 72.8% for the same period in 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $22.8 million, or 41.7%, to $77.4 million for
the year ended December 31, 1998, from $54.6 million for the same period in
1997. The increase in selling, general and administrative expenses was primarily
attributable to higher direct sales costs associated with the increase in
revenues, higher property taxes, an increase in consulting expenses relating to
local regulatory matters, the implementation of new billing and system
software, and an increase in the provision for doubtful accounts related to the
increase in revenue. As a percentage of revenues, selling, general and
administrative expenses decreased to 63.5% in 1998 from 98.6% for the same
period in 1997.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $12.2 million, or 31.8%, to $50.7 million for the year ended
December 31, 1998, from $38.5 million for the same period in 1997. The increase
in depreciation and amortization expense was primarily attributable to higher
capital expenditures related to the ongoing construction and expansion of the
Company's telecommunications networks in both 1997 and 1998. As a percentage of
revenues, depreciation and amortization expenses decreased to 41.6% in 1998,
from 69.4% for the same period in 1997.
EBITDA. The EBITDA loss for the year ended December 31, 1998 decreased
$16.9 million, or 42.7%, to a loss of $22.7 million in 1998, from a loss of
$39.6 million for the same period in 1997. This improvement was primarily the
result of increased revenues due to the Company's expansion of local
telecommunications networks in new and existing markets and growth of the
Company's customer base, partially offset by higher operating expenses in
support of the larger customer base, and higher selling, general and
administrative expenses required to support the expansion.
Interest Expense. Effective July 1, 1997 through July 14, 1998, all of the
Company's financing requirements were funded with loans from the Parent
Companies. On July 21, 1998, the Company issued $400.0 million in Notes.
Interest expense relating to these loans and Notes totaled $29.2 million for the
year ended December 31, 1998, an increase of $27.7 million compared to the same
period in 1997.
Net Loss. Net loss increased $22.1 million, or 31.3%, to $92.7 million for
the year ended December 31, 1998, from a net loss of $70.7 million for the same
period in 1997. This increase resulted from higher depreciation and amortization
expenses relating to the Company's expansion of telecommunications networks in
new and existing markets, as well as interest expense relating to the
subordinated loans payable to the Parent Companies and the Notes.
39
<PAGE>
Year Ended December 31, 1997 Compared To Year Ended December 31, 1996
Revenues. Revenues increased $31.5 million, or 131.6%, to $55.4 million in
1997, from $23.9 million in 1996. Revenues from the provision of dedicated
transport services increased $24.1 million, or 118.7%, to $44.5 million in 1997,
from $20.4 million in 1996. Revenues from dedicated transport service increased
115.9% in those markets in which dedicated transport services were offered as of
December 31, 1996. Switched service revenues increased $7.3 million, or 205.8%,
to $10.9 million in 1997, from $3.6 million in 1996. Switched services revenues
increased 183.9% in those markets in which switched services were offered as of
December 31, 1996. The increase in revenues from dedicated transport services
primarily reflected growth of services offered in existing markets. The increase
in switched services resulted from the offering of services in new markets and
the growth of services in existing markets including reciprocal compensation.
Reciprocal compensation represented 8.6% and 7.4% of total revenues for the
years ended 1997 and 1996 respectively At December 31, 1997, the Company offered
dedicated transport services in 18 consolidated metropolitan areas, 14 of which
also offered switched services, as compared to offering dedicated transport
services in 15 consolidated metropolitan areas, 2 of which also offered switched
services at December 31, 1996.
Operating Expenses. Operating expenses increased $14.6 million, or 56.9%,
to $40.3 million in 1997, from $25.7 million in 1996. The increase in operating
expenses was primarily attributable to the Company's expansion of its business,
principally switched services, and the ongoing development of existing markets
resulting in higher technical personnel costs, higher LEC charges for circuit
leases and interconnection and higher data processing costs. As a percentage of
revenues, operating expenses decreased to 72.8% in 1997 from 107.5% in 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $5.8 million, or 9.5%, to $54.6 million in
1997, from $60.4 million in 1996. The decrease in selling, general and
administrative expenses was primarily attributable to the absence of a $5.5
million charge recorded in 1996 to terminate certain employees as a result of
the Company's reorganization at the end of 1996 as well as the on-going cost
reduction due to lower employee headcount, partially offset by higher direct
sales costs associated with the increase in revenues. As a percentage of
revenues, selling, general and administrative expenses decreased to 98.6% in
1997 from 252.4% in 1996.
Depreciation and Amortization Expense. Depreciation and amortization
expense increased $16.1 million, or 72.1%, to $38.5 million in 1997, from $22.4
million in 1996. The increase in depreciation and amortization expense was
primarily attributable to higher capital expenditures related to the ongoing
construction and expansion of the Company's telecommunications networks in both
1997 and 1996. As a percentage of revenues, depreciation and amortization
expenses decreased to 69.4% for 1997 from 93.5% for the same period in 1996.
Gain on Disposition of Investments. In September 1997, the Company
completed the Hyperion Transactions. In connection with these transactions, the
Company recognized a gain of approximately $11.0 million.
EBITDA. The EBITDA loss in 1997 decreased $22.6 million, or 36.3%, to $39.6
million, from a loss of $62.2 million in 1996. This improvement was primarily
the result of increased revenues due to the Company's expansion of local
telecommunications networks in new and existing markets and growth of the
Company's customer base, partially offset by higher operating expenses in
support of the larger customer base.
Interest and Other, Net. Effective July 1, 1997 all of the Company's
financing requirements were funded with loans from the Parent Companies.
Interest expense relating to these loans totaled approximately $1.5 million in
1997.
Net loss. Net loss decreased $15.4 million, or 18.0%, to $70.7 million in
1997, from a net loss of $86.1 million in 1996. This improvement principally
resulted from the one-time $11.0 million gain resulting from the Hyperion
Transactions and from increased revenues generated by the Company's expanded
networks, partially offset by increased operating and depreciation and
amortization expenses relating to the Company's expansion of telecommunications
networks in new and existing markets.
40
<PAGE>
Liquidity And Capital Resources
Cash Flows. For the year ended December 31, 1998, the Company's cash used
by operations was $343,000 as compared to cash used in operations of $29.4
million for the year ended December 31, 1997. This increase in cash provided by
operations of $29.1 million principally resulted from lower EBITDA losses and
working capital requirements in 1998. The Company expects to continue to have
operating cash flow deficiencies for the near future as it develops and expands
its business.
For the year ended December 31, 1997, the Company's cash used in operations
decreased to $29.4 million from $52.3 million for the year ended December 31,
1996. This decrease in cash used in operations of $22.9 million principally
resulted from lower EBITDA losses during 1997.
Cash used in investing activities increased $257.5 million to $378.1
million in 1998, as compared to $120.6 million in 1997. The increase was
primarily due to higher purchases of marketable securities of $286.4 million and
lower investment proceeds of $7.0 million. The Company did not receive any
proceeds from the sale of investments in 1998.
Cash used in investing activities decreased $28.6 million to $120.6 million
in 1997, as compared to $149.2 million in 1996. This decrease resulted
principally from lower capital expenditures due to a slower rate of expansion
and $7.0 million of cash proceeds received in 1997 relating to the Hyperion
Transactions. As discussed more fully above, the Company has made substantial
capital expenditures in order to develop and expand its business.
Cash provided by financing activities in 1998 reflected the receipt of
interest bearing subordinated loans from the Parent Companies amounting to $96.1
million and net proceeds from the sale of the Notes of $387.5 million. Prior to
July 1, 1997, the Company's cash flow deficiencies were entirely funded by non-
interest bearing capital contributions from the Parent Companies. In 1997, cash
provided by financing activities reflected the receipt of interest bearing loans
from the Parent Companies of $73.9 million, and net capital contributions from
the Parent Companies of $76.1 million. The total increase in cash provided by
financing activities of $333.5 million was primarily due to the proceeds from
the sale of the Notes.
Cash provided by financing activities reflected the receipt of non-interest
bearing capital contributions from the Parent Companies to fund the Company's
cash flow deficiencies through June 30, 1997. Effective July 1, 1997 through
July 14, 1998, all of the Company's financing requirements were funded with
interest-bearing loans from the Parent Companies. The loans from the Parent
Companies are subordinated in right of payment to the Notes, bear interest
(payable in kind) at an annual rate equal to The Chase Manhattan Bank's prime
lending rate as in effect from time-to-time and mature on August 15, 2008, one
month after the maturity of the Notes. The aggregate of net capital
contributions and loans from the Parent Companies decreased $51.5 million to
$150.0 million in 1997 as compared to $201.5 million in 1996. This decrease was
primarily due to lower cash funding requirements principally due to operating
cash flow associated with the Company's expansion of its customer base and
services in new and existing markets and lower capital expenditure requirements.
Financing. Historically, the Company did not maintain cash balances since
all the Company's funding requirements were provided by the Parent Companies.
The proceeds from the Offering after repayment of subordinated indebtedness to
the Parent Companies, together with the net proceeds from the sale of the Notes
and cash flow from operations, are expected to fund the Company's future cash
requirements through the middle of 2000. The Parent Companies and the Members
are not under any obligation to make any additional equity investments in or
loans to the Company. At a future date, the Company may negotiate a bank credit
facility to provide it with working capital and enhance its financial
flexibility. There can be no assurance that such financing will be available on
terms acceptable to the Company or at all.
The development of the Company's business and the installation and
expansion of the Company's communications networks, combined with the
development and operation of the Company's network operations center ("NOC"),
have resulted in substantial capital expenditures. These capital expenditures,
as well as the Company's historical operating losses, have resulted in
substantial negative cash flow for the Company since
41
<PAGE>
inception in 1993. Funding of this historical cash flow deficiency has been
primarily accomplished through the receipt of capital contributions from the
Parent Companies through June 30, 1997. From July 1, 1997 through July 14, 1998,
the deficiency has been funded through interest bearing loans from the Parent
Companies. Thereafter, the Company expects cash flow deficiencies to be funded
with the proceeds of the Notes and future financings as described above. This
indebtedness to the Parent Companies is subordinated in right of payment to the
Notes, bears interest (payable in kind) at an annual rate equal to The Chase
Manhattan Bank's prime lending rate as in effect from time-to-time and matures
on August 15, 2008, one month after the maturity of the Notes. In addition, the
Notes provide that the proceeds of an equity offering may be used to repay
subordinated indebtedness to the Parent Companies. The amounts due to the Parent
Companies, including interest accrued thereon, under this funding arrangement
was $174.9 million and $75.5 million as of December 31, 1998 and 1997,
respectively. Combined capital balances, which include all capital contributions
from the Parent Companies, have remained at $555.8 million since June 30, 1997.
On July 21, 1998, the Company issued $400.0 million principal amount in
Notes. Interest on the Notes is payable semiannually on January 15 and July 15,
beginning on January 15, 1999. The net proceeds from the sale of the Notes were
immediately invested in short term investments.
The Company expects that its future cash requirements will principally be
for working capital, capital expenditures and to fund its operating losses. The
Company expects that the net proceeds of the sale of the Notes and internally
generated funds will provide sufficient funds for the Company to meet the
Company's expected capital and liquidity needs to expand its business as
currently planned, pay interest on the Notes and to fund its currently expected
losses through the middle of 2000. Thereafter, the Company expects to require
additional financing. However, in the event that the Company's plans or
assumptions change or prove to be inaccurate, or the foregoing sources of funds
prove to be insufficient to fund the Company's growth and operations, or if the
Company consummates acquisitions or joint ventures, the Company may be required
to seek additional capital sooner than currently anticipated. The Company's
revenues and costs are dependent upon factors that are not within the Company's
control, such as regulatory changes, changes in technology and increased
competition. Due to the uncertainty of these and other factors, actual revenues
and costs may vary from expected amounts, possibly to a material degree, and
such variations are likely to affect the level of the Company's future capital
expenditures and expansion plans. Sources of financing may include public or
private debt or equity financing by the Company or its subsidiaries or other
financing arrangements.
Capital Expenditures. The facilities-based telecommunications service
business is a capital intensive business. The Company's operations have required
and will continue to require substantial capital investment for: (i) the
purchase and installation of switches, electronics, fiber and other technologies
in existing networks and in additional networks to be constructed in new service
areas; and (ii) the acquisition and expansion of networks currently owned and
operated by other companies. The Company's expected capital expenditures for
general corporate and working capital purposes include (i) expenditures with
respect to the Company's management information system and corporate service
support infrastructure and (ii) operating and administrative expenses with
respect to new networks and debt service. The Company plans to make substantial
capital investments in connection with the deployment of switches in all of its
existing networks, and plans to construct and develop new networks. Expansion of
the Company's networks will include the geographic expansion of the Company's
existing operations and will consider the development of new markets. In
addition, the Company may acquire existing networks in the future.
During the year ended 1998, capital expenditures were $126.0 million, a
decrease of $1.3 million from the year ended 1997. The largest commitment of
capital was related to the installation of transport and switch related
electronics to support the increase in sales activity and the addition of 1,055
route miles of fiber. During the year ended December 31, 1997, capital
expenditures were $127.3 million, a decrease of $17.5 million from $144.8
million in 1996. The decrease was principally due to a slower rate of expansion
into new markets in 1997. Based on historic capital requirements for network
construction in relation to sales volumes and network expansion plans, the
Company anticipates it will commit approximately $350.0 million over the next
two years to fund its capital expenditures. See "Certain Relationships and
Related Transactions -- Certain Operating Agreements."
42
<PAGE>
Year 2000
The Company is currently working to resolve the potential impact of the
Year 2000 on the processing of time-sensitive information by its computerized
information systems. Year 2000 issues may arise if computer programs have been
written using two digits (rather than four) to define the applicable year. In
such case, programs that have time-sensitive logic may recognize a date using
"00" as the year 1900 rather than the year 2000, which could result in
miscalculations or system failures. The Company utilizes a number of computer
programs across its entire operation. Year 2000 issues could impact the
Company's information systems as well as computer hardware and equipment that is
part of its telephony network such as switches, termination devices and SONET
rings that may contain embedded software or "firmware."
The Company's exposure to potential Year 2000 problems exists in two
general areas: technological operations in the sole control of the Company, and
technological operations dependent in some way on one or more third parties. The
majority of the Company's exposure to potential Year 2000 problems is in the
latter area where the situation is much less within the Company's ability to
predict or control. The Company's business is heavily dependent on third
parties, many of whom are themselves heavily dependent on technology. For
example, like all other telecommunications providers, the Company must
interconnect its networks with other carriers and service providers in order to
provide end-to-end service to customers. The Company cannot control the Year
2000 readiness of those parties but, to the extent practicable, the Company
plans to assess its interfaces with them and to work with those parties to
resolve any difficulties. In some cases, the Company's third party dependence is
on vendors of technology who are themselves working towards solutions to Year
2000 problems, such as suppliers of software systems for billing, ordering and
other key business operations. See "Factors That Could Affect Future
Performance--Dependence on Information and Billing Systems."
The Company has developed a Year 2000 action plan to address identification
and assessment of potential Year 2000 issues, remediation, testing and
implementation of any corrected software or firmware. The Company has completed
the first phase of such action plan which involved making the Company's internal
organizations aware of Year 2000 issues and assigning responsibility internally
for the Year 2000 readiness program. The Company has also completed the
assessment phase of its plan which involves an inventory and review of software
and equipment used in the Company's operations in order to determine the Year
2000 readiness of that software and equipment and the identification of
remediation measures that could be taken on a timely basis to alter, validate or
replace time-sensitive and date-sensitive software and equipment.
In the course of the assessment process the Company determined that all of
the equipment comprising its telephony networks depends on software or firmware
that is already represented by its vendor to be Year 2000 ready. The Company has
completed its own validation testing of approximately 90% of that equipment,
including its switches, to verify the vendors' representations. On the basis of
the test results, the Company believes that such equipment will continue to
accurately recognize and process date information on and after January 1, 2000.
The Company is developing test and verification plans for the remainder of its
equipment, applications and systems. The Company intends to complete the
verification process for transport network equipment by the end of April 1999.
The Company has already begun implementing certain remedial measures and
intends to complete its remediation efforts with respect to technological
operations within its sole control prior to any anticipated material impact on
its computerized information systems. The Company's early Year 2000 planning
took into account the Company's plans to replace, in the normal course of
business in 1999, many of the computer programs used by key business operations
and its financial systems. The specifications for these new systems are all Year
2000 compliant, but would require validation testing by the Company to verify
the Year 2000 readiness of those systems. The Company anticipates that some back
office systems for ordering, workflow management, service design and trouble
management may be delayed in implementation so that it may not be possible to
test these systems before the fourth quarter of 1999. The Company's Year 2000
action plan currently includes a moratorium on the installation of new hardware
or software systems during the last 60 to 90 days of 1999 in order to avoid the
possible creation of new Year 2000 issues during that period and to allow the
Company's information technologies personnel to focus on
43
<PAGE>
contingency planning. Therefore, the implementation of these new systems may not
occur until the first quarter of 2000. As a result, the Company is in the
process of testing and remediating the back office systems that would have been
replaced by the new systems and plans to complete validation testing of the
remediated systems during the third quarter of 1999.
Costs of addressing potential Year 2000 problems have not been material to
date and, based on preliminary information gathered to date from the Company,
its customers and vendors, are not currently expected to have a material adverse
impact on the Company's financial position, results of operations or cash flows
in future periods.
Total 1998 costs incurred with respect to Year 2000 issues were
approximately $115,000. Based on the Company's current Year 2000 action plan,
the Company expects that 1999 costs will be approximately $2.0 million. The
majority of the estimated 1999 costs represent the costs of personnel who will
conduct verification testing of equipment and software, costs of out-sourcing
the testing of some existing software systems, test equipment and costs for
replacement of certain personal computers. These costs do not include the cost
of replacing systems, the replacement of which is not being accelerated due to
Year 2000 issues, or the costs of software maintenance contracts that the
Company would have entered into in the normal course of business. In some cases
Year 2000 compliant upgrades to third party software systems licensed to the
Company are being supplied under these maintenance agreements. However, the
Company's Year 2000 costs could exceed these estimates if third party equipment
or software do not perform as represented, additional unanticipated Year 2000
issues arise or planned remediation efforts are unsuccessful.
The Company is in the process of developing specific contingency plans in
the event that unanticipated problems arise from Year 2000 issues, including
plans for extra staffing and surveillance of operations at year end,
prioritization of systems for restoral and manual work-arounds for automated
processes. As part of this process, the Company is examining its existing
emergency procedures to determine how those procedures could meet the demand of
failures resulting from Year 2000-related problems. The Company also plans to
conduct tests of its contingency plans by simulating interruptions in a test
laboratory which reproduces the Company's switch and transport environments.
Management believes that it has established a sound program to resolve
significant Year 2000 issues within its sole control in a timely manner and that
the Company has made satisfactory progress in addressing issues dependent on
third parties. However, the Company's Year 2000 program is not yet complete. The
Company's failure to correctly identify and remediate all Year 2000 issues
within its control or the failure of suppliers or other third parties with which
the Company interconnects to address their Year 2000 issues could pose various
risks to the Company. Those risks may include the possibility of interruptions
to the Company's basic services and difficulties in passing traffic to or
receiving traffic from other carriers, detecting and resolving trouble in the
networks, provisioning new service to customers, billing customers and other
carriers and collecting revenues. These impacts as well as disruptions
experienced by other parties could result in material adverse consequences to
the Company, including loss of revenue and substantial unanticipated costs, the
amounts of which cannot reasonably be estimated at this time.
Effects Of Inflation
Historically, inflation has not had a material effect on the Company.
Caution Concerning Forward-Looking Statements
The Securities and Exchange Commission encourages companies to disclose
forward-looking information so that investors can better understand a company's
future prospects and make informed investment decisions. This document,
together with management's public commentary related thereto, contains such
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, particularly statements anticipating future
growth in revenues, EBITDA and cash flow. Words such as "anticipate,"
"estimate," "expects," "projects," "intends," "plans," "believes" and words and
terms of similar substance used in connection with any discussion of future
operating or financial performance identify such forward-looking statements.
Those forward-looking statements are management's present expectation of future
events. As with any projection or forecast, they
44
<PAGE>
are inherently susceptible to changes in circumstances, and the Company is under
no obligation to (and expressly disclaims any such obligation to) update or
alter its forward-looking statements despite such changes.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company's interest income and expense are sensitive to changes in the
general level of interest rates. In this regard, changes in interest rates can
affect the interest earned on the Company's cash equivalents and marketable
securities as well as interest paid on its borrowings. To mitigate the impact of
fluctuations in interest rates, the Company generally enters into fixed rate
investing and borrowing arrangements.
The following table provides information at December 31, 1998 about the
Company's financial instruments that are sensitive to changes in interest rates.
For investment securities and debt obligations, the table presents principal
cash flows and related weighted-average interest rates expected by the maturity
dates. The Company also has financial instruments included in the liabilities
portion of its balance sheet. These liabilities are compromised of the
Company's Notes which are fixed rate debt at 9 3/4% and mature in 2008, and the
subordinated loans payable to affiliates of the Member which are variable rate
debt based on the Chase Manhattan prime rate (7 3/4% at December 31, 1998). The
loans to the Parent Companies are scheduled to mature in 2008 and are
subordinated in right of payment to the Senior Notes. The weighted-average
variable rate on the Company's long term debt is based on the Chase Manhattan
Bank's prime rate. The carrying amounts for the following financial instruments
approximate fair market value at December 31, 1998, except for the Company's 9
3/4% Senior Notes due 2008 for which the fair market value is estimated to be
$422 million based on market prices.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
1999 2000 Total
-------- ---------- --------
(thousands)
Assets
Marketable securities:
Shares of money market mutual funds $ 3,338 ----- $ 3,338
Average interest rate 4.62% -----
Certificates of deposit with banks $ 62,014 ----- $ 62,014
Average interest rate 5.65% -----
Corporate debt securities $262,479 $19,750 $282,229
Average interest rate 5.59% 5.69%
Foreign government debt securities $ 5,008 ----- $ 5,008
Average interest rate 5.99% -----
</TABLE>
Item 8. Financial Statements and Supplementary Data
See "Index to Consolidated Financial Statements" at Page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
45
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information (as of December 31, 1998)
with respect to the persons who are members of the Management Committee,
executive officers or key employees of the Company:
<TABLE>
<CAPTION>
Name Age Position
- ----------------------- --- -------------------------------------
<S> <C> <C>
Larissa L. Herda....... 40 President and Chief Executive Officer and Representative
Paul B. Jones.......... 52 Senior Vice President, General Counsel and Regulatory Policy
A. Graham Powers....... 52 Senior Vice President, Engineering and Technology
David J. Rayner........ 41 Senior Vice President and Chief Financial Officer
John T. Blount......... 40 Senior Vice President, Sales
Raymond H. Whinery..... 44 Senior Vice President, Technical Operations
Mark A. Peters......... 38 Vice President, Treasurer
Julie A. Rich.......... 45 Vice President, Human Resources and Business Administration
Jill Stuart............ 44 Vice President, Accounting and Finance and Chief Accounting Officer
Richard J. Bressler.... 41 Representative
Glenn A. Britt......... 50 Representative
Richard J. Davies...... 49 Representative
Stephen A. McPhie...... 45 Representative
Robert J. Miron........ 61 Representative
Audley M. Webster, Jr.. 45 Representative
Pearre A. Williams..... 44 Representative
- ---------
</TABLE>
Ms. Herda has served as President and Chief Executive Officer of the
Company since June 22, 1998. From March 1997 to June 21, 1998, Ms. Herda served
as Senior Vice President, Sales of the Company. From 1989 to 1997, Ms. Herda was
employed by MFS Telecom Inc., a CLEC, most recently as Southeast Regional Vice
President and General Manager. Ms. Herda has served as a Representative of the
Company since June 22, 1998.
Mr. Jones has served as Senior Vice President, General Counsel and
Regulatory Policy of the Company since August 1998. Prior to August 1998, Mr.
Jones served as Senior Vice President, Legal and Regulatory Policy of the
Company from October 1993. From 1992 to 1993, Mr. Jones served as Senior Vice
President, Corporate Development of Time Warner Cable Ventures. Mr. Jones was
Senior Vice President and General Counsel of Warner Cable from 1987 to 1992 and
Vice President, Strategy and Development of CBS Publishing Group from 1985 to
1986. From 1977 to 1979, Mr. Jones was the Assistant General Counsel for the
FCC.
Mr. Powers has served as Senior Vice President, Engineering and Technology
of the Company since June 1996. From August 1993 to May 1996, Mr. Powers served
as Senior Vice President, Operations Development and Business Implementation.
Prior to joining the Company, Mr. Powers was the President of Telecommunications
Strategy Inc., a technology consulting service, from May 1992 to July 1993 and
previously held various management positions at American Television and
Communications Corporation, a subsidiary of Time Warner Inc.
Mr. Rayner has served as Senior Vice President and Chief Financial Officer
of the Company since June, 1998. From February 1997 to May 1998, Mr. Rayner
served as Vice President, Finance. From May 1994 to February 1997, Mr. Rayner
served as Controller. From 1982 to 1994, Mr. Rayner held various financial and
operational management positions in TW Cable.
Mr. Blount has served as Senior Vice President, Sales of the Company since
June 24, 1998. Prior to that, Mr. Blount served as the Company's Regional Vice
President for the Midwest and Southwest regions from January 1997 and
Milwaukee's Vice President and General Manager from January 1996 to January
1997, having served as its
46
<PAGE>
General Manager from February 1995. Prior to joining the Company, Mr. Blount
held various sales positions at US WEST Inc., the predecessor of MediaOne,
starting in 1988, including Director of Sales for US WEST interprise in
Minneapolis from May 1994 to February 1995 and Sales and Service Manager for
South Dakota from January 1992 to May 1994.
Mr. Whinery has served as Senior Vice President, Technical Operations of
the Company since January 1997. From May 1994 to January 1997, Mr. Whinery
served as the Senior Director of Engineering and Planning. Prior to May 1994,
Mr. Whinery was employed by U S WEST, Inc. (the predecessor of MediaOne) from
1978 and served as General Manager for Idaho, Montana, North Dakota and South
Dakota from 1992 to 1994.
Mr. Peters has served as Vice President, Treasurer of the Company since
July 15, 1998. From March 1996 to July 1998, Mr. Peters participated in
entrepreneurial start-up ventures. From January 1990 to February 1996, Mr.
Peters was an executive officer with Nextel Communications, Inc. and predecessor
OneComm where he most recently held the position of Vice President of Finance
and Treasurer.
Ms. Rich has served as Vice President, Human Resources and Business
Administration of the Company since March 1998. From June 1996 to February 1998,
she owned an independent human resources consulting practice. From 1984 to 1996
she was a founder of XEL Communications, Inc., a telecommunications
manufacturer, and held positions of Director and Vice President of Human
Resources.
Ms. Stuart has served as Vice President, Accounting and Finance and Chief
Accounting Officer since July 1998. Prior to that, she served as Director,
Finance and Business Planning from September 1994 to July 1998. From August
1993 to September 1994 she operated a financial services consulting practice.
Mr. Bressler has served as a Representative of the Company since February
1998, as a director of TWT Inc. since July 1998 and as Executive Vice President
and Chief Financial Officer of Time Warner Inc. since January 1998. Prior to
that, he served as Time Warner Inc.'s Senior Vice President and Chief Financial
Officer from March 1995; as Senior Vice President, Finance from January 1995;
and as a Vice President prior to that. Mr. Bressler is also a member of the
Board of Representatives of TWE.
Mr. Britt has served as a Representative of the Company since July 1998, as
Vice President of the Company since July 1998 and as Chief Executive Officer and
President of Time Warner Cable Ventures, a division of TW Cable, for more than
the past five years and as President of TW Cable since January 1999.
Mr. Davies has served as a Representative of the Company since October
1998, and as Senior Vice President, Corporate Development, of Time Warner Cable
since September 1998. Prior to that, he served as Senior Vice President of TW
Ventures from 1996 to 1998 and as Chief Financial Officer of the Company from
March 1993 to June 1996.
Mr. McPhie has served as a Representative of the Company since July 1998,
and as Executive Vice President of MediaOne International, a division of
MediaOne, since August 1998. From January 1997 to June 1998, Mr. McPhie served
as President and Chief Executive Officer of the Company. Prior to that, Mr.
McPhie was Vice President of Business Development at U S WEST, Inc. (the
predecessor of MediaOne) from November 1995. From 1993 to 1995, Mr. McPhie
served as Senior Vice President of MFS Network Technologies, a CLEC, and from
1989 to 1993, he was the President of Mission Group, a telecommunications
consultancy.
Mr. Miron has served as a Representative of the Company since July 1998,
and as President of Advance/Newhouse Communications since April 1995, having
served as President of Newhouse Broadcasting Corporation from October 1986.
Mr. Webster has served as a Representative of the Company since July 1998,
and as Vice President -- Shared Corporate Resources of MediaOne since December
1997. Prior to December 1997, he was Vice President -- Corporate Strategy of
MediaOne from December 1996. Prior to that, Mr. Webster served as Executive
Director of US WEST, Inc. since February 1993.
47
<PAGE>
Mr. Williams has served as a Representative of the Company since July 1998,
as Vice President of MediaOne and as President of Multimedia Ventures of
MediaOne since July 1997. Prior to July 1997, Mr. Williams served as Vice
President, Business Development of MediaOne from June 1995 and as Vice
President, Corporate Development of U S WEST, Inc. the predecessor of MediaOne.
Mr. Williams is also a member of the Board of Representatives of TWE.
Item 11. Executive Compensation
Compensation of Executive Officers
The following table sets forth information concerning total compensation
paid to the Company's CEO and each of its four remaining most highly compensated
current executive officers (the "named executive officers") for services
rendered to the Company during 1998 in their capacities as executive officers.
<TABLE>
<CAPTION>
Summary Compensation Table
Annual Compensation Long-Term Compensation
---------------------- --------------------------------------------
Awards
---------------
Time Warner Class A
Common Stock Units Payouts
Underlying Underlying ------------
Options Options LTIP All Other
Name & Principal Position Salary(1) Bonus Awarded(2) Awarded(3) Payouts(4) Compensation(4,5)
------------------------- ------------ -------- --------------- ------------- ------------ -----------------
<S> <C> <C> <C> <C> <C> <C>
Larissa L. Herda(5) $300,000 169,381 7,600 375,000 $ -- $ 3,116
President and Chief Executive Officer
Paul B. Jones $259,242 171,748 16,700 166,000 $134,400 $ --
Senior Vice President,
General Counsel & Regulatory Policy
A. Graham Powers $175,479 118,448 7,600 100,000 $ 60,480 $ 4,800
Senior Vice President,
Engineering & Technology
David J. Rayner $171,000 94,792 7,600 125,000 $ -- $ 4,610
Senior Vice President and Chief
Financial Officer
John T. Blount $170,500 65,963 -- 100,000 $ -- $49,581
Senior Vice President, Sales
Stephen A. McPhie(6) $234,000 85,054 -- -- $ -- --
Former President and Chief Executive
Officer
</TABLE>
(1) The information provided under the heading "Salary" is the annual salary of
the named executive officers as of December 31, 1998 pursuant to their
employment agreements with the Company (except for Mr. McPhie for whom the
information provided represents his annual salary received prior to June
22, 1998. See note 6). Actual salaries received by Ms. Herda, and Messrs.
Jones, Powers, Rayner, Blount and McPhie were $242,129, $259,242, $175,479,
$153,564, $145,125, and $140,400 respectively. In accordance with rules of
the Securities and Exchange Commission ("SEC"), amounts of personal
benefits totaling less than 10% of the total annual salary and bonus
reported in the Table have been omitted.
(2) All of these options are exercisable for the common stock of Time Warner
Inc. ("TW common stock") and have been adjusted to reflect a two-for-one
stock split (the "TW Stock Split") of TW common stock effected on December
15, 1998. None of these options was awarded with tandem stock appreciation
rights ("SARs"). Mr. McPhie holds 12,450 restricted shares of common stock
of MediaOne awarded in February 1997 by U S WEST, Inc., all of which are
vested. No dividends were paid on these restricted shares of
(footnotes continued on next page)
48
<PAGE>
MediaOne common stock. The value of these restricted shares based on the
closing price of MediaOne common stock on the New York Stock Exchange
Composite Listing on December 31, 1998 was $585,150. None of the other
named executive officers was awarded restricted stock of MediaOne, Time
Warner Inc. or the Company during 1998 or holds any such shares.
(3) Options awarded under the Company's 1998 Option Plan.
(4) These payouts were made in 1999 to participants in the TW Cable Long-Term
Cash-Flow Incentive Plan for the 1995 to 1998 four-year cycle.
(5) The amounts shown in this column include the following:
(a) Pursuant to the TWC Savings Plan (the "Savings Plan"), a defined
contribution plan available generally to employees of the Company, each
executive named above, if eligible, may defer a portion of his or her
annual compensation and the Company contributes an additional two-
thirds of that contribution so deferred by the executive up to $4,800.
These Company contributions were invested under the Savings Plan. The
amount contributed for 1998 on behalf of Mr. Blount was $4,800 and for
each other named executive officer is disclosed under the heading "All
Other Compensation." (b) The Company maintains a program of life and
disability insurance generally available to all salaried employees on
the same basis. For 1998, prior to the July 1998 Reorganization, group
term life insurance was reduced to $50,000 for Mr. Jones, who was given
an annual cash payment equal to the cost of replacing coverage
amounting to three times base salary and annual bonus less $50,000.
(c) Mr. Blount received $44,781 in commissions during 1998 in his capacity
as Regional Vice President.
(6) Ms. Herda became President and Chief Executive Officer of the Company on
June 22, 1998 upon the resignation of Mr. McPhie who, effective August 1,
1998, became an Executive Vice President of MediaOne International, a
division of MediaOne. Prior to June 22, 1998, Ms. Herda served as the
Senior Vice President, Sales. Information with respect to Mr. McPhie
relates only to the period during which he was employed by the Company.
The compensation of the Company's executive officers was determined by the
Members and approved by the Management Committee, as reflected in the employment
agreements. See"--Employment Agreements."
Compensation of Representatives
Representatives who are employees of the Company or of any Member or their
affiliates receive no compensation for their services as Representatives. It is
currently anticipated that each Representative who is not affiliated with the
Company or of any of Members will be entitled to receive an annual retainer of
$25,000 (to be paid 50% in cash and 50% in Class A Units) and an additional
$1,000 plus reasonable expenses for attending each meeting of the Management
Committee. Currently, all of the Representatives are affiliated with the Company
or one of the Members.
Employment Agreements
The Company is a party to employment agreements with the each of the
current named executive officers of the Company. Among other things, the
agreements with the Company's named executive officers provide for: a three-year
term of employment in a specified executive post, commencing on July 14, 1998;
an annual salary; an annual bonus in the discretion of the Company, generally
targeted at 50% of the named executive officer's salary; and participation in
any pension, profit-sharing, employee equity ownership, vacation, insurance,
hospitalization, medical, health, disability and other employee benefit or
welfare plan, program or policy whether now existing or established hereafter,
to the extent that employees at such executive's level are generally deemed
eligible under the general provisions thereof. The minimum annual salaries under
these agreements are $300,000 for Ms. Herda; $259,000 for Mr. Jones; $175,497
for Mr. Powers; $171,000 for Mr. Rayner and $170,500 for Mr. Blount.
Generally, such agreements include a narrow definition of the "cause" for
which an executive's employment may be terminated and in that event, the
executive will only receive earned and unpaid base salary accrued through such
date of termination.
49
<PAGE>
These agreements typically provide that in the event of the Company's
material breach or termination of the executive's employment during the term of
employment without cause, the executive will be entitled to elect either (a) to
receive a lump-sum payment equal to the present value of the base salary and
annual bonus otherwise payable during the remaining portion of the executive's
term of employment, provided that such amount shall not be less than the sum of
such salary and bonus prorated for an 18-month period or (b) to remain an
employee of the Company for up to 18 months and, without performing any
services, receive the base salary and annual bonus otherwise payable, with a
lump-sum payment, if necessary for any remaining payment, at the end of such 18
months. Executives are not generally required to mitigate damages after such a
termination, other than as necessary to prevent the Company from losing any tax
deductions to which it otherwise would have been entitled for any payments
deemed to be "contingent on a change" under the Code.
If an executive becomes disabled during the term of his or her employment
agreement, the executive typically will receive 75% of the executive's then
current salary and his or her applicable target annual bonus amount prorated for
an 18-month period. Any such payments will be reduced by amounts received from
Worker's Compensation, Social Security and disability insurance policies
maintained by the Company.
If an executive dies during the term of an employment agreement, generally
the executive's beneficiaries will receive the executive's earned and unpaid
salary to the date thirty days after the date of death and a pro rata portion of
the executive's bonus for the year of his death.
Options Awarded by the Company During 1998
The following table sets forth certain information with respect to employee
options to purchase Class A limited liability company Interests ("Units")
awarded during 1998 with respect to the named executive officers. All such
options were nonqualified options and no SARs, alone or in tandem with options,
were awarded during 1998. These are the only options with respect to Class A
Units held by such persons.
<TABLE>
<CAPTION>
Option Grants During 1998 by the Company(1)
Individual Grants
-------------------------------------------------------------------------------------------
Percent of Potential Realizable Value
Number of Total at Assumed Annual Rate of
Securities Options Exercise or Unit Price Appreciation
Underlying Granted to or Base Option Term
Options Employees Price Expiration -----------
Name Granted in 1998 ($ /unit) Date 5% ($) 10% ($)
---------- ---------- ----------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Larissa L. Herda... 375,000 6.1% $12.00 8/5/08 $2,835,000 $7,155,000
Paul B. Jones...... 166,000 2.7% $12.00 8/5/08 $1,254,960 $3,167,280
A. Graham Powers.. 100,000 1.6% $12.00 8/5/08 $ 756,000 $1,908,000
David J. Rayner.... 125,000 2.0% $12.00 8/5/08 $ 945,000 $2,385,000
John T. Blount..... 100,000 1.6% $12.00 8/5/08 756,000 1,908,000
Stephen A. McPhie.. -- -- -- -- -- --
</TABLE>
(1) The options shown in the above table were awarded under the Company's 1998
Option Plan and the terms are governed by that plan and the recipient's
option agreement. The exercise price is the fair market value of the Class
A Units on the date of grant. The options become exercisable over a four-
year vesting period and expire ten years from the date of grant but become
immediately exercisable in full if the optionee's employment terminates by
reason of death or disability. If the Company has not conducted an initial
public offering of its equity securities, the Company will determine the
fair market value of the Units as of June 30 and December 31 of each year,
beginning in 1999. In such case vested Options may be exercised during the
30-day period after such valuation has been communicated to Option holders.
As a condition to the exercise of an Option, the holder will be required to
become a party to the Amended and Restated Limited Liability Company
Agreement of the Company dated July 14, 1998 (the "LLC Agreement"), and the
Stockholders
50
<PAGE>
Agreement, as defined in the LLC Agreement. If the Members elect to effect
the Reconstitution, the reconstituted company will assume the 1998 Option
Plan and any outstanding options would automatically be converted into
options to purchase shares of Class A Common Stock.
As required by SEC rules, the dollar amounts in the last two columns
represent the hypothetical gain or "option spread" that would exist for the
options based on assumed 5% and 10% annual compounded rates of Class A Units
appreciation over the full ten-year option term (resulting in 63% and 159%
appreciation, respectively). These assumed rates of appreciation applied to the
exercise price would result in a Class A Unit value on August 5, 2008 of $19.56
and $31.08, respectively. These prescribed rates are not intended to forecast
possible future appreciation, if any, of the Class A Units.
Stock Options Awarded by the Members During 1998
The following table sets forth certain information with respect to employee
options to purchase shares of TW common stock ("TW Options") awarded by TW
during 1998 to the named executive officers. All such TW Options were
nonqualified options and no SARs, alone or in tandem with stock options, were
awarded during 1998. No options to purchase MediaOne common stock were awarded
to the named executive officers during 1998.
Stock Option Grants During 1998 by the Members
<TABLE>
<CAPTION>
Individual Grants
-------------------------------------------------------------------------------------------
Percent of Potential Realizable Value
Number of Total at Assumed Annual Rate of
Securities Options Exercise or Unit Price Appreciation
Underlying Granted to or Base Option Term
Options Employees Price Expiration -----------
Name Granted in 1998 ($ /unit) Date 5% ($) 10% ($)
---------- ---------- ----------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Larissa L. Herda... 7,600 .04% $36.03 3/17/08 $172,512 $435,387
Paul B. Jones...... 16,700 .09% $36.03 3/17/08 $379,072 $956,705
A. Graham Powers... 7,600 .04% $36.03 3/17/08 $172,512 $435,387
David J. Rayner.... 7,600 .04% $36.03 3/17/08 $172,512 $435,387
John T. Blount..... -- -- -- -- -- --
Stephen A. McPhie.. -- -- -- -- -- --
</TABLE>
(1) These TW Options were awarded pursuant to stock option plans of Time Warner
Inc. and the terms are governed by such plans and the recipient's option
agreement, and, pursuant to these terms, have been adjusted to reflect the
TW Stock Split. The option exercise price is the fair market value of the
TW common stock on the date of grant. The TW Options shown in the table
become exercisable in installments of one-third on the first three
anniversaries of the date of grant. Payment of the exercise price of a TW
Option may be made in cash or, in whole or in part, in full shares of TW
common stock already owned by the holder of the TW Option. The payment of
withholding taxes due upon exercise of a TW Option may generally be made
with shares of TW common stock.
(2) Represents a percentage of all options granted to employees of TW during
1998.
As required by SEC rules, the dollar amounts in the last two columns
represent the hypothetical gain or "option spread" that would exist for the
options based on assumed 5% and 10% annual compounded rates of TW common stock
price appreciation over the full ten-year option term (resulting in 63% and 159%
appreciation, respectively). These assumed rates of appreciation applied to the
price on the date of the awards would result in a TW common stock price on March
17, 2008 of $58.69 and $93.45, respectively. These prescribed rates are not
intended to forecast possible future appreciation, if any, of the TW common
stock.
51
<PAGE>
Option Exercises and Values in 1998
None of the options exercisable for Class A Units held by the named
executive officers and listed under the heading "Option Grants during 1998 by
the Company" have been exercised, are exercisable or are "in-the-money." The
options were issued at an exercise price of $12 per Unit based on the Management
Committee's determination of the fair market value of the Units in July, 1998.
The Company has not yet conducted a valuation of the Units as none is required
until June 30, 1999.
The following table sets forth as to each of the named executive officers
information with respect to option exercises during 1998 and the status of their
options on December 31, 1998: (i) the number of shares of TW common stock, or
MediaOne common stock in the case of Messrs. Blount and McPhie, underlying
options exercised during 1998; (ii) the aggregate dollar value realized upon
exercise of such options; (iii) the total number of shares of TW common stock,
or MediaOne common stock in the case of Messrs. Blount and McPhie, underlying
exercisable and nonexercisable stock options held on December 31, 1998; and (iv)
the aggregate dollar value of in-the-money exercisable and nonexercisable stock
options on December 31, 1998. None of the named executive officers has been
awarded SARs alone or in tandem with options. This information has been adjusted
to reflect the TW Stock Split.
Aggregate Option Exercises During 1998 And
Option Values On December 31, 1998
<TABLE>
<CAPTION>
Number Of
Shares
Underlying Dollar Value Of
Number Of Unexercised Unexercised
Shares Dollar Options In-the Money Options
Underlying Value On December 31, 1998 On December 31, 1998*
Options Realized On --------------------------- ---------------------------
Name Exercised Exercise Exercisable Nonexercisable Exercisable Nonexercisable
- ---------------------- ---------- ----------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Larissa L. Herda...... -- -- 3,334 14,266 $ 134,302 $ 466,370
Paul B. Jones......... 4,000 $110,280 85,078 33,398 $3,656,870 $1,109,996
A. Graham Powers...... -- -- 29,402 15,198 $1,222,919 $ 505,103
David J. Rayner....... 1,600 $ 44,054 668 8,932 $ 26,909 $ 251,503
John T. Blount........ -- -- 521 -- $ 17,245 $ 0
Stephen A. McPhie(1).. -- -- 30,916 7,838 $ 886,526 $ 219,289
</TABLE>
* Based on a closing price of $62.0625 per share of TW common stock, and
$47.00 per share of MediaOne common stock with respect to stock options
held by Messrs. Blount and McPhie, on December 31, 1998 as reported on the
New York Stock Exchange Composite Listing.
(1) These options to purchase MediaOne common stock become exercisable in
installments of one-third on the first three anniversaries of the date of
grant and include a reload feature that gives the holder the right to
receive a further option, at the then current market price, for a number of
shares equal to the number of shares of stock surrendered in payment of the
exercise price of the original option.
The option exercise price of all options held by the named executive
officers is the fair market value of the stock on the date of grant. All of the
options held by the named executive officers become immediately exercisable in
full upon the occurrence of certain events, including the death or total
disability of the option holder, certain change-of-control transactions and, in
most cases, the Company's breach of the holder's employment agreement. The TW
Options held by the named executive officers generally remain exercisable for
three years after their employment is terminated without cause, for one year
after death or total disability, for five years after retirement and for three
months after termination for any other reason, except that such stock options
awarded before 1996 are exercisable for three months after a termination without
cause and after retirement and those awarded after July 1997 are exercisable for
three years after death or disability. All TW Options terminate immediately if
the holder's employment is terminated for cause. The terms of the options shown
in the chart are ten years.
52
<PAGE>
Pension Coverage
Although the Company does not currently expect to have its own pension
plan, Messrs. Jones, Powers and Rayner will, upon retirement, be entitled to
receive benefits under the Time Warner Cable Pension Plan (the "TW Cable Pension
Plan") based on service to the Company and/or TW Cable on or prior to December
31, 1998. Set forth below is a brief description of the TW Cable Pension Plan.
A participant accrues benefits under the TW Cable Pension Plan on the basis
of 1 1/4% of the average annual compensation (defined as the highest average
annual compensation for five consecutive full years of employment in the last
ten years, which includes regular salary, overtime and shift differential
payments, and non-deferred bonuses paid according to a regular program) up to
the average Social Security Wage Base plus 1 2/3% in excess of the average
Social Security Wage Base for each year of service up to 35 years and 1/2% for
each year of service over 35 years. In addition, there is a supplemental benefit
of $60 per year times years of service up to thirty years. Compensation for
purposes of calculating average annual compensation under the TW Cable Pension
Plan is limited to $200,000 per year for 1989 through 1993 and $150,000 per year
for 1994 and thereafter (each subject to adjustments provided in the Code).
Eligible employees become vested in all benefits under the TW Cable Pension Plan
on the earlier of five years of service or certain other events.
Federal law limits both the amount of compensation that is eligible for the
calculation of benefits and the amount of benefits derived from employer
contributions that may be paid to participants under the TW Cable Pension Plan.
However, as permitted by the Employee Retirement Income Security Act of 1974, as
amended ("ERISA"), TW Cable has adopted the Time Warner Cable Excess Benefit
Pension Plan (the "Excess Plan"), which provides for payments by TW Cable of
certain amounts which employees of TW Cable would have received under the TW
Cable Pension Plan if eligible compensation were limited to $250,000 in 1994
(increased 5% per year thereafter, to a maximum of $350,000) and there were no
payment restrictions.
The following table shows the estimated annual pension payable upon
retirement to employees in specified remuneration and years-of-service
classifications. The amount of the estimated annual pension is based upon a
pension formula which applies to all participants in both the TW Cable Pension
Plan and the Excess Plan. The estimated amounts are based on the assumption that
payments under the TW Cable Pension Plan will commence upon normal retirement
(generally age 65), that the TW Cable Pension Plan will continue in force in its
present form and that no joint and survivor annuity will be payable (which would
on an actuarial basis reduce benefits to the employee but provide benefits to a
surviving beneficiary). Amounts calculated under the pension formula which
exceed ERISA limits will be paid under the Excess Plan from TW Cable's assets
and are included in the amounts shown in the following table.
<TABLE>
<CAPTION>
Estimated Annual Pension for Years of Credited Service
------------------------------------------------------
Highest Consecutive
Five Year Average Compensation 10 15 20 25 30 35
- -------------------------------- ------- ------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
$ 50,000........................ $ 7,036 $10,555 $ 14,073 $ 17,591 $ 21,109 $ 24,627
$100,000........................ 15,370 23,055 30,740 38,425 46,110 53,795
$150,000........................ 23,703 35,555 47,407 59,268 71,110 82,962
$200,000........................ 32,037 48,055 64,074 80,092 96,111 112,129
$250,000........................ 40,370 60,556 80,741 100,926 121,111 141,296
$300,000........................ 48,704 73,056 97,408 121,760 146,112 170,464
$350,000........................ 57,037 85,556 114,075 142,593 171,112 199,631
</TABLE>
The estimated annual benefits payable under the TW Cable Pension Plan and
the Excess Plan, as of December 31, 1998, would be based on average compensation
of $261,321 for Mr. Jones, $189,395 for Mr. Powers and $123,226 for Mr. Rayner
with 11.0, 12.0 and 15.5 years of credited service, respectively.
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Item 12. Security Ownership of Certain Beneficial Owners and Management
Prior to the Reorganization, the Parent Companies beneficially owned all of
the assets and liabilities of the Company's business. In connection with the
Reorganization, the Parent Companies contributed such assets to the Company and
in return received all the Class B Limited Liability Company Interests having an
aggregate participation percentage of 100%, and the Parent Companies distributed
the Interests to the Members. TWT is a wholly owned subsidiary of the Company.
The following table sets forth certain information regarding the beneficial
ownership of the Interests of the Company as of December 31, 1998 by: (i) each
of the Representatives and the named executive officers; (ii) all
Representatives and executive officers as a group; and (iii) each owner of more
than 5% of any class of Interests of the Company ("5% Owners"). Unless otherwise
noted, the address for each executive officer of the Company is c/o the Company,
5700 S. Quebec Street, Greenwood Village, CO 80111.
<TABLE>
<CAPTION>
Class A Class B
Interests (1)(2) Interests (1)
----------------- --------------
Participation Participation
Percentage Percentage
<S> <C> <C>
TW (3)........................................................... 0% 61.9%
MediaOne (4)..................................................... 0% 18.9%
Newhouse (5)..................................................... 0% 19.2%
All Representatives and executive officers as a group
(12 persons) (6)(7)................................ 0% 0%
- ---------
</TABLE>
* Represents less than one percent.
(1) The Company has two classes of Interests, the Class A Interests and the
Class B Interests. Beneficial ownership of the Interests has been
determined in accordance with the rules of the SEC.
(2) Excludes an equal amount of Class A Interests into which Class B Interests
are convertible. The Class B Interests held by TW, MediaOne and Newhouse
represented participation percentages on a converted basis of 61.9%, 18.9%
and 19.2%, respectively, of the Class A Interests.
(3) Owned by Time Warner Companies, Inc., American Television and
Communications Corporation, Warner Communications Inc., TW/TAE, Inc.,
FibrCOM Holdings, L.P. and Paragon Communications, each a direct or
indirect wholly owned subsidiary of Time Warner Inc. The business address
of TW is 75 Rockefeller Plaza, New York, NY 10019.
(4) Owned by MediaOne Group, Inc., a Colorado corporation and wholly owned
subsidiary of MediaOne Group, Inc., a Delaware corporation. The business
address of MediaOne is 188 Inverness Drive West, Englewood, CO 80112.
(5) Owned by Newhouse. The business address of Newhouse is 5015 Campuswood
Drive, East Syracuse, NY 13057.
(6) None of the Representatives or executive officers of the Company
beneficially owns any Class A Interests or Class B Interests.
(7) As of December 31, 1998, all Representatives and executive officers held an
aggregate of 59,754 shares of TW common stock, including 23,744 shares held
by trusts under TW-sponsored benefit plans. In addition, such persons held
options which, on December 31, 1998, were exercisable within 60 days to
purchase 1,357,960 shares of TW common stock.
Item 13. Certain Relationships and Related Transactions.
LLC Agreement
In connection with the Reorganization, the Company was formed under the
laws of the State of Delaware on June 18, 1998. The following summary
description of the LLC Agreement does not purport to be complete and is
qualified in its entirety by reference to the text of such agreement, which is
filed as an exhibit to this report.
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<PAGE>
Additionally, there is no assurance that the Members will not cause the LLC
Agreement to be amended, modified or terminated or waive any provision of such
agreement.
The LLC Agreement provides that the Company may not, directly or indirectly
(through a subsidiary or affiliate of the Company), (i) engage in the business
of providing, offering, packaging, marketing, promoting or branding (alone or
jointly with or as an agent for other parties) any Residential Services or (ii)
engage in the business of producing, packaging, distributing, marketing,
hosting, offering, promoting, branding or otherwise providing Content Services,
in each case, without the affirmative vote of all the Members.
The LLC Agreement provides that the Members will appoint the
Representatives as follows: (i) up to seven Representatives appointed by the
Members, (ii) the CEO and (iii) two Representatives who are neither employed by
nor affiliated with the Company or any Member and who are appointed by a
subcommittee comprised of the Representatives other than the CEO and the
independent Representatives.
Under the LLC Agreement, the Representatives will be selected as follows:
initially three Representatives will be appointed by TW, three by MediaOne and
one by Newhouse. Under the LLC Agreement, the ability of the Members to appoint
any Representatives depends on the identity of the particular Member and the
participation percentage of Interests owned by it. Generally, each Member must
own Interests having an aggregate participation percentage of at least 9.44% to
appoint one Representative. In the case of TW, so long as it owns Interests
having an aggregate participation percentage of at least 18.88% it will be
entitled to appoint three Representatives. In the event that TW owns Interests
having an aggregate participation percentage of less than 18.88% (such event, an
"LLC TW Step Event") the number of Representatives which TW may appoint will
decrease proportionally with its ownership of participation percentages of the
Interests until it owns Interests having an aggregate participation percentage
of less than 9.44%, at which point it will not be entitled to appoint any
Representatives. In the case of MediaOne, so long as an LLC TW Step Event has
not occurred and it owns Interests having an aggregate participation percentage
of at least 9.44%, MediaOne will be entitled to appoint three Representatives.
If an LLC TW Step Event has occurred, the number of Representatives that
MediaOne is entitled to appoint will decrease proportionally with its ownership
of Interests (in accordance with the same percentage thresholds as apply to TW)
until it owns Interests having an aggregate participation percentage of less
than 9.44%, at which point it will not be entitled to appoint any
Representatives. If an LLC TW Step Event has not occurred but MediaOne owns
Interests having an aggregate participation percentage of less than 9.44%, it
will not be entitled to appoint any Representatives. In the case of Newhouse,
so long as it owns Interests having an aggregate participation percentage of at
least 9.44%, Newhouse will be entitled to appoint one Representative. The
foregoing percentages shall be decreased in the aggregate, from time to time, in
the event that the Company issues additional Interests, by an amount equal to
the participation percentage so issued, in proportion to their relative
participation percentages immediately before such issuance. The foregoing
percentages shall be increased in the aggregate, from time to time, in the event
that the Company repurchases Interests, by an amount equal to the participation
percentage of such repurchased Interest, in proportion to their relative
participation percentages immediately before such repurchase.
The LLC Agreement prohibits any transfer of Class B Interests held by the
Members, unless expressly permitted under the terms thereof. In addition,
voting agreements relating to the Class B Interests with any third party are
prohibited.
After the expiration of five years from the date of the Reorganization (the
"Restricted Period"), in the event that a holder of Class B Interests proposes
to sell all of its Class B Interests (a "Selling Class B Member") pursuant to a
bona fide offer from an unaffiliated third party, such Selling Class B Member
shall give notice (the "Refusal Notice") to all other holders of Class B
Interests, which notice shall contain the identity of the offeror and an offer
to sell such Interests to such holders of Class B Interests upon the terms and
subject to the conditions set forth in the offer from the third party. The non-
selling holders of Class B Interests will have the right (the "LLC Right of
First Refusal") to purchase pro rata all, but not less than all, of such Class B
Interests. If the non-selling holders fail to exercise their LLC Right of First
Refusal with respect to all of such interests, the LLC Selling Class B Member
shall be free, for a period of 90 days thereafter, to sell such Class B
Interests (as Class B Interests) to a third party on terms and conditions that
are no less favorable to the LLC Selling Class B Member
55
<PAGE>
than those contained in the LLC Refusal Notice. In connection with the sale by a
holder of all, but not less than all, of its Class B Interests, such holder
shall have the right to transfer all of its right, if any, to appoint
Representatives to the Management Committee. In addition, after the expiration
of the Restricted Period, if TW proposes to sell all, but not less than all, of
its Class B Interests and/or all or a portion of its Class A Interests that
represent an aggregate of more than one-third of the participation percentage of
the Company's Interests, then other holders of Class B Interests will have
certain "tag-along" rights that provide them with the right to sell their Class
A Interests and/or Class B Interests on a pro rata basis along with, and on the
same terms and conditions as TW, provided that such "tag-along" rights shall be
applied to all Class B Interests prior to being applied to any Class A
Interests. In connection with such sale, TW (and any other member transferring
all of its Class B Interests) shall have the right to transfer all of its right,
if any, to appoint Representatives to the Management Committee. In addition, TW
and the other selling members will not be required to convert their Class B
Interests to Class A Interests prior to such sale.
Except for transfers to affiliates and any other transfers described above,
immediately prior to any direct transfer of Class B Interests or certain
indirect transfers of Class B Interests all such Class B Interests will be
required to be converted to Class A Interests. In addition, except for
transfers described above, a Member will not have the right to transfer its
right to appoint Representatives to the Management Committee. A holder of Class
B Interests will not be required to convert into Class A Interests, and such
holder's right to appoint Representatives to the Management Committee will not
terminate, if such holder is acquired by a third party or such holder
distributes to its equity holders a company holding its Class B Interests (as
well as other assets).
If the Reconstitution occurs, the Members (who will then be stockholders)
will enter into a stockholders' agreement in a form prescribed in the LLC
Agreement.
Certain Operating Agreements
Capacity License Agreements. Each of the Company's local operations is
party to a certain Capacity License Agreement (collectively, the "Capacity
License") with the local cable television operation of TW Cable, providing the
Company with a 30 year exclusive right to utilize all of the capacity of
specified fiber-optic cable owned and maintained by the respective TW Cable
operation. For the Company's existing networks, such Capacity License has been
fully paid and does not require additional license fees (although certain
maintenance fees and fees for splicing and similar services are payable
periodically). The Company may request that the TW Cable construct and provide
additional fiber-optic cable capacity to meet the Company's future needs. TW
Cable is not obligated to provide such fiber capacity to the Company; however,
the Capacity License provides for the sharing of construction costs between the
Company and TW Cable to the extent that such costs are incurred to build
additional fiber-optic capacity which is licensed to the Company. See "Factors
That Could Affect Future Performance -- Relationship with TW Cable." If TW Cable
provides such additional capacity, the Company will pay an allocable share of
the cost of construction of the fiber upon which capacity is to be provided,
plus a permitting fee. Such payments are due one-half upon commencement of
construction and the remainder upon initial acceptance of the capacity by the
Company. The Company is responsible for all taxes and franchise or similar fees
arising out of its utilization of the capacity, and a portion of other out-of-
pocket expenses incurred by TW Cable with regard to the cable upon which such
capacity is made available. The Company is permitted to use the capacity for
telecommunications services and any other lawful purpose, except for the
provision of Residential Services and Content Services. Violations of the
limitations on business activities of the Company contained in the Restated
Certificate of Incorporation or the Capacity License may, subject to the cure
period provided in the Capacity License, result in a termination of the Capacity
License. The Capacity License does not restrict the Company from licensing
fiber-optic capacity from parties other than TW Cable. The Capacity License
expires in 2028. Although TW Cable has agreed to negotiate renewal or
alternative provisions in good faith at that time, there can be no assurance
that the parties will agree on the terms of any renewal or alternative
provisions or that the terms of any renewal or alternative provisions which may
be agreed upon by the parties will be favorable to the Company. If the Capacity
License is not renewed in 2028, the Company will have no residual interest in
the capacity under the Capacity License and may need to build, lease or
otherwise obtain transmission capacity in order to service its customers in the
service areas covered by the Capacity License; the terms of such arrangements
could have a material adverse effect on the Company's business, financial
condition and results of operations. The Company has the right to terminate a
Capacity License in whole or in part at any time upon 180
56
<PAGE>
days' notice and payment of any outstanding fees regarding the terminated
capacity. TW Cable has the right to terminate a Capacity License upon 180 days'
notice in the event of, among other things, certain governmental proceedings or
third party challenges to TW Cable's franchises or the Capacity License. The
Capacity License includes substantial limitations on liability in the event of
service interruptions. See "Factors That Could Affect Future Performance --
Relationship with TW Cable."
Facility Lease Agreements. The Company leases or subleases physical space
located at TW Cable's facilities for various purposes under Facility Lease
Agreements. In the event that at least a majority of the ownership of any TW
Cable system is not owned by one or more Parent Companies or of (i) TW's owning
less than 30% of the Common Stock, (ii) TW having the right to nominate less
than 3 nominees to the Board of Directors of the Company, (iii) the Company's
non-compliance with the restrictions in the Restated Certificate of
Incorporation regarding Residential Services and Content Services or (iv) the
transfer by an Existing Stockholder of its Class B Common Stock together with
its rights to designate nominees to the Board of Directors under the
Stockholders Agreement, the Company will be required, at its own expense, to
segregate and partition in a reasonable, secure manner its leased or subleased
space. The lease rates for properties owned by TW Cable and leased to the
Company are based upon comparable rents in the local market, taking into account
other factors such as the term of the lease, type of space, square footage,
location and leasehold improvements funded to date by TW Cable. Generally, the
term of such leases are for 15 years, with two five year options to renew. With
respect to properties leased by TW Cable, the Company is charged a pro rata
portion of the rent and fees payable under the primary lease. The duration of
the Company's subleases are coextensive with TW Cable's primary lease.
Services Agreement. TW Cable provides certain administrative and operating
services, tax, management information systems, and legal support services, to
the Company pursuant to Administrative Services Agreement (the "Services
Agreement"). The costs for such services are determined by TW Cable based upon
the Company's historical and projected usage, depending on the amount and type
of administrative services to be provided.
Residential Support Agreements. Pursuant to certain residential support
agreements ("Residential Agreements"), the Company will provide certain support
and interconnection services or service elements, on an unbundled basis, to TW
Cable for its residential telephony business. Generally, all rates for such
residential support services offered to TW Cable may be adjusted annually by the
Company, but may not be less favorable than the wholesale rates charged to the
Company's other customers.
TW License Agreement. The use of the "Time Warner" name by the Company is
subject to a license agreement with TW. The Company may change its name to "TW
Telecom Inc." and the Company will no longer have the right to use of the "Time
Warner" name upon expiration of the initial four year term or any renewal term
of such agreement or (i) TW's owning less than 30% of the Common Stock, (ii) TW
having the right to nominate less than 3 nominees to the Board of Directors of
the Company, (iii) the Company's non-compliance with the restrictions in the
Restated Certificate of Incorporation regarding Residential Services and Content
Services or (iv) the transfer by an Existing Stockholder of its Class B Common
Stock together with its rights to designate nominees to the Board of Directors
under the Stockholders Agreement. See " -- Stockholders Agreement."
The Company believes that the terms and conditions, taken as a whole, of
the transactions described under the headings "Capacity License Agreements,"
"Facility Lease Agreements," "Services Agreement," "Residential Support
Agreements," "Road Runner Agreement" and the "TW License Agreement" were no less
favorable to the Company than could have been obtained from unaffiliated
parties.
57
<PAGE>
GLOSSARY
Access Charges. The fees paid by long distance carriers for the local
connections between the long distance carriers' networks and the long distance
carriers' customers.
ATM (asynchronous transfer mode). A recently commercialized switching and
transmission technology that is one of a general class of packet technologies
that relay traffic by way of an address contained within the first five bits of
a standard fifty-three bit-long packet or cell. ATM-based packet transport was
specifically developed to allow switching and transmission of mixed voice, date
and video at varying rates. The ATM format can be used by many different
information systems, including LANs.
BOC (Bell Operating Company). A telephone operating subsidiary of an RBOC;
an incumbent local exchange carrier.
Broadcast Video TV-1. This Company service provides dedicated transport of
broadcast quality video signals.
CAP (Competitive Access Provider). A company that provides dedicated
telecommunications services (private line, local transport and special access)
as an alternative to the ILEC.
CDMA (Code Division Multiple Access). A form of wireless communications
technology.
Central Offices. A telecommunications center where switches and other
telecommunications facilities are housed. CAPs may connect with ILEC networks
either at this location or through a remote location.
Collocation. The ability of a telecommunications carrier to interconnect
its network to the ILEC's network by extending its facilities to the ILEC's
central office. Physical collocation occurs when the interconnecting carrier
places its network equipment within the ILEC's central offices. Virtual
collocation is an alternative to physical collocation under which the ILEC
permits a carrier to interconnect its network to the ILEC's network in a manner
which is technically, operationally and economically comparable to physical
collocation, even though the interconnecting carrier's network connection
equipment is not physically located within the central offices.
CLEC (Competitive Local Exchange Carrier). A company that provides local
exchange services, including Dedicated service, in competition with the ILEC.
Dedicated. Telecommunications lines dedicated to, or reserved for use by, a
particular customer along predetermined routes (in contrast to links which are
temporarily established).
Dedicated Transmission. The sending of electronic signals carrying
information over a Direct Transport facility.
DID. The ability of an outside caller to call an internal extension without
having to pass through an operator. In large PBX systems, the dialed numbers are
passed through from the Central Office.
Digital. A means of storing, processing and transmitting information by
using distinct electronic or optical pulses that represent the binary digits 0
and 1. Digital transmission and switching technologies use a sequence of these
pulses to represent information as opposed to the continuously variable analog
signal. The precise digital numbers preclude distortion (such as graininess or
snow in the case of video transmission, or static or other background distortion
in the case of audio transmission).
Direct Transport (aka Dedicated Transport). A non-switched point-to-point
telecommunications facility leased from a telecommunications provider by an end
user and used exclusively by that end user.
Diverse Routing. A telecommunications network configuration in which
signals are transmitted simultaneously along two different paths so that if one
path is cut or impaired, traffic can continue in the other direction without
interrupting service. The Company's networks generally provide diverse routing.
DOD. The ability to dial directly out from an internal extension without
having to go through an operator.
DS0, DS1, DS3. Standard North American telecommunications industry digital
signal formats, which are distinguishable by bit rate (the number of binary
digits (0 and 1) transmitted per second). DS0 service has a bit rate of 64
kilobits per second. DS1 service has a bit rate of 1.544 megabits per second and
DS3 service as a bit rate of 44.736 megabits per second. A DS0 can transmit a
single uncompressed voice conversation.
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<PAGE>
FCC. Federal Communications Commission.
FDMA (Frequency Division Multiple Access). A form of wireless
communications technology.
Fiber Miles. The number of route miles of fiber optic cable installed
(excluding pending installations) along a telecommunications path multiplied by
the number of fibers in the cable. See the definition of "route mile" below.
Fiber Optics. Fiber optic technology involves sending laser light pulses
across glass strands in order to transmit digital information. Fiber optic cable
is the medium of choice for the telecommunications and cable industries. Fiber
is immune to electrical interference and environmental factors that effect
copper wiring and satellite transmission.
Hub. Collocation centers located centrally in an area where
telecommunications traffic can be aggregated for transport and distribution.
Hybrid Fiber Coaxial (HFC). A new technology consisting of fiber optic
distribution facilities and coaxial cable deployed to the home or business. This
technology enables the operator to offer a wide variety of two-way broadband
services, including telecommunications and entertainment.
Interconnection Decisions. Rulings by the FCC announced in September 1992
and August 1993, which require the BOCs and other large ILECs to provide
interconnection in ILEC central offices to any CAP, long distance carrier or end
user requesting such interconnection to provide interstate special access or
switched transport services.
ILECs (Incumbent Local Exchange Carriers). The local phone companies,
either a BOC or an independent (such as GTE) which provides local exchange
services.
Internet. The name used to describe the global open network of computers
that permits a person with access to the internet to exchange information with
any other computer connected to the network.
ISDN (Integrated Services Digital Network). ISDN is an internationally
agreed standard which, through special equipment, allows two-way, simultaneous
voice and data transmission in digital formats over the same transmission line.
ISDN permits video conferencing over a single line, for example, and also
supports a multitude of value-added switched service applications such as
Incoming Calling Line Identification. ISDN's combined voice and data networking
capabilities reduce costs for end users and result in more efficient use of
available facilities. ISDN combines standards for highly flexible customer to
network signaling with both voice and data within a common facility.
IXC (Interexchange Carrier). A long distance carrier.
Kbps (Kilobits). One thousand bits of information. The information-carrying
capacity (i.e., bandwidth) of a circuit may be measured in "thousands of bits
per second."
LANs (Local Area Networks). The interconnection of computers for the
purpose of sharing files, programs and peripheral devices such as printers and
high-speed modems. LANs may include dedicated computers or file servers that
provide a centralized source of shared files and programs. LANs are generally
confined to a single customer's premises and may be extended or interconnected
to other locations through the use of bridges and routers.
LATAS (Local Access and Transport Area). The geographical areas within
which a local telephone company may offer telecommunications services, as
defined in the divestiture order known as the Modified Final Judgment ("MFP")
unless and until refined by the FCC pursuant to the Telecommunications Act of
1996.
Local Exchange. A geographic area defined by the appropriate state
regulatory authority in which telephone calls generally are transmitted without
toll charges to the calling or called party.
Local Exchange Service/Local Exchange Telephone Service. Basic local
telephone service, including the provision of telephone numbers, dial tone and
calling within the local exchange area.
Long Distance Carriers (Interexchange Carriers or IXC). Long distance
carriers providing services between LATAs, on an interstate or intrastate basis.
A long distance carrier may be facilities-based or offer service by reselling
the services of a facilities-based carrier.
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<PAGE>
Local Transport Services. Dedicated lines between the ILEC's central
offices and long distance carrier POPs used to carry switched traffic
Mbps (Megabit). One million bits of information. The information carrying
capacity (i.e., bandwidth) of a circuit may be measured in "millions of bits per
second."
Multiplexing. An electronic or optical process that combines a number of
lower speed transmission signals into one higher speed signal. There are various
techniques for multiplexing, including frequency division (splitting the total
available frequency bandwidth into smaller frequency slices), time division
(slicing a channel into timeslots and placing each signal into its assigned
timeslot), and statistical (wherein multiplexed signals share the same channel
and each transmits only when it has data to send).
Node. A point of connection into a fiber optic network.
PBX (Private Branch Exchange). A customer owned and operated switch on
customer premises, typically used by large businesses with multiple telephone
lines.
PBX Trunk. A transmission facility which connects a PBX to the Company's or
ILEC's central office switching center.
POPs (Points of Presence). Locations where a long distance carrier has
installed transmission equipment in a service area that serves as, or relays
telephone calls to, a network switching center of the same long distance
carrier.
Private Line. A private, dedicated telecommunications link between
different customer locations (excluding long distance carrier POPs).
Private Network Transport Service. This service is a private, dedicated
high capacity premium quality service over fully redundant, diverse routed,
SONET rings with band width that is dedicated and always available.
Public Switched Network. The switched network available to all users
generally on a shared basis (i.e., not dedicated to a particular user). The
local exchange telephone service networks operated by ILECs are the largest and
often the only public switched networks in a given locality.
PUC (Public Utility Commission). A state regulatory body, established in
most states, which regulates utilities, including telecommunications companies
providing intrastate services. In some states this regulatory body may have a
different name, such as public service commission ("PSC").
RBOC (Regional Bell Operating Company). The holding company which owns a
BOC.
Reciprocal Compensation. An arrangement in which two local exchange
carriers agree to terminate traffic originating on each other's networks in
exchange for a negotiated level of compensation.
Redundant Electronics. A telecommunications facility that uses two separate
electronic devices to transmit a telecommunications signal so that if one device
malfunctions, the signal may continue without interruption.
Route Mile. The number of miles along which fiber optic cables are
installed.
SONET (Synchronous Optical Network). A set of standards for optical
communications transmission systems that define the optical rates and formats,
signal characteristics, performance, management and maintenance information to
be embedded within the signals and the multiplexing techniques to be employed in
optical communications transmission systems. SONET facilitates the
interoperability of dissimilar vendors equipment. SONET benefits business
customers by minimizing the equipment necessary for various telecommunications
applications and supports networking diagnostic and maintenance features.
Special Access Services. The lease of private, dedicated telecommunications
lines or circuits on an ILEC's or a CAP's network which run to or from the long
distance carrier's POPs. Special access services do not require the use of
switches. Examples of special access services are telecommunications circuits
running between POPs of a single long distance carrier, from one long distance
carrier's POP to another long distance carrier's POP or from an end user to its
long distance carrier's POP.
STS-1. This dedicated transmission service is carried over high capacity
channels for full duplex, synchronous optical transmission of digital data on
SONET standards. This service eliminates the need to maintain and pay for
multiple dedicated lines.
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Switch. A mechanical or electronic device that opens or closes circuits or
selects the paths or circuits to be used for the transmission of information.
Switching is a process of linking different circuits to create a temporary
transmission path between users. Within this document, switches generally refer
to voice grade telecommunications switches unless specifically stated otherwise.
Switched Access Services. The connection between a long distance carrier's
POP and an end user's premises through the switching facilities of a local
exchange carrier.
Switched Services. Telecommunications services that support the connection
of one calling party with another calling party via use of a telephone switch
(i.e., an electronic device that opens or closes circuits, completes or breaks
an electrical path, or selects paths or circuits).
TDMA (Time Division Multiple Access). A form of wireless communications
technology.
Toll Services. Otherwise known as EAS or intra LATA toll services are those
calls that are beyond the free local calling area but originate and terminate
within the same LATA; such calls are usually priced on a measured basis.
Voice Grade Equivalent ("VGE") Circuit. One DS0. One voice grade equivalent
circuit is equal to 64 kilobits of bandwidth.
61
<PAGE>
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1), (2) The Financial Statements and Schedule II - Valuation and Qualifying
Accounts listed on the index on Page F-1 following are included herein by
reference. All other schedules are omitted, either because they are not
applicable or because the required information is shown in the financial
statements or the notes thereto.
<TABLE>
<CAPTION>
(3) Exhibits:
Exhibit
Number Description of Exhibit
--------------------------------------------------------------------------------------
<C> <S>
2.1 -- Reorganization Agreement among Time Warner Companies, Inc., MediaOne Group, Inc.,
Advance/Newhouse Partnership, Time Warner Entertainment Company, L.P., and Time
Warner Entertainment-Advance/Newhouse Partnership (filed as Exhibit 2.1 to Company's
Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998)*
3.1 -- Amended and Restated LLC Agreement of the Company (filed as Exhibit 3.1 to Company's
Registration Statement on Form S-1 (Registration No. 333-53553))*
3.2 -- Certificate of Formation of the Company (filed as Exhibit 3.4 to Company's
Registration Statement on Form S-1 (Registration No. 333-53553))*
3.3 -- Certificate of Amendment to Certificate of Formation of the Company (filed as Exhibit
3.5 to Company's Registration Statement on Form S-1 (Registration No. 333-53553))
4.2 -- Indenture, between TWT LLC, TWT Inc. and The Chase Manhattan Bank, as Trustee (filed
as Exhibit 4.1 to TWT LLC's Quarterly Report on Form 10-Q for the quarter ended June
30, 1998)*
10.1 -- Lease, between Quebec Court Joint Venture No. 2, Landlord, and Intelligent Advanced
Systems, Inc., Tenant, dated June 3, 1994 (filed as Exhibit 10.1 to TWT LLC's
Registration Statement on Form S-1 (Registration No. 333-53553))*
10.2 -- Agreement for Assignment of Lease, dated September 12, 1997, between Ingram Micro
Inc. and Time Warner Communications Holdings Inc. (filed as Exhibit 10.2 to TWT LLC's
Registration Statement on Form S-1 (Registration No. 333-53553))*
10.3 -- First Amendment to Lease, dated October 15, 1997, by CarrAmerica Realty, L.P. and
Time Warner Communications Holdings Inc. (filed as Exhibit 10.3 to TWT LLC's
Registration Statement on Form S-1 (Registration No. 333-53553))*
10.4 -- Time Warner Telecom LLC 1998 Option Plan as amended August 5, 1998 and December 16,
1998
10.5 -- Employment Agreement between the Company and Larissa L. Herda (filed as Exhibit 10.6
to Company's Registration Statement on Form S-1 (Registration No. 333-53553))*
10.6 -- Employment Agreement between the Company and Paul B. Jones (filed as Exhibit 10.5 to
Company's Registration Statement on Form S-1 (Registration No. 333-53553))*
10.7 -- Employment Agreement between the Company and A. Graham Powers (filed as Exhibit 10.7
to Company's Registration Statement on Form S-1 (Registration No. 333-53553))*
10.8 -- Employment Agreement between the Company and David J. Rayner (filed as Exhibit 10.8
to Company's Registration Statement on Form S-1 (Registration No. 333-53553))*
10.9 -- Employment Agreement between the Company and John T. Blount (filed as Exhibit 10.10
to TWT LLC's Registration Statement on Form S-1 (Registration No. 333-53553))*
10.10 -- Capacity License Agreement (filed as Exhibit 10.3 to Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998)*
10.11 -- Trade Name License Agreement (filed as Exhibit 10.4 to Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1998)*
21 -- Subsidiaries of the Company (filed as Exhibit 21 to Company's Registration Statement
on Form S-1 (Registration No. 333-53553))*
27 -- Financial Data Schedule
</TABLE>
* Incorporated by reference.
(b) Reports on Form 8-K.
None.
62
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, on March
31, 1999.
TIME WARNER TELECOM LLC
By: /s/ David J. Rayner
___________________________________
David J. Rayner
Senior Vice President and Chief
Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the Registrant in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
(i) Principal Executive Officer
/s/ Larissa L. Herda
________________________________ President and Chief Executive March 31, 1999
Larissa L. Herda Officer and Representative
(ii) Principal Financial Officer
/s/ David J. Rayner
________________________________ Senior Vice President and March 31, 1999
David J. Rayner Chief Financial Officer
(iii) Principal Accounting Officer
/s/ Jill Stuart
________________________________ Vice President, Accounting and March 31, 1999
Jill Stuart Finance and Chief Accounting Officer
(iv) Representatives
/s/ Richard J. Bressler
________________________________ Representative March 31, 1999
Richard J. Bressler
/s/ Glenn A. Britt
________________________________ Representative March 31, 1999
Glenn A. Britt
/s/ Richard J. Davies
________________________________ Representative March 31, 1999
Richard J. Davies
/s/ Larissa L. Herda
________________________________ Representative March 31, 1999
Larissa L. Herda
/s/ Stephen A. McPhie
________________________________ Representative March 31, 1999
Stephen A. McPhie
/s/ Robert J. Miron
________________________________ Representative March 31, 1999
Robert J. Miron
/s/ Audley M. Webster, Jr.
________________________________ Representative March 31, 1999
Audley M. Webster, Jr.
/s/ Pearre A. Williams
________________________________ Representative March 31, 1999
Pearre A. Williams
</TABLE>
63
<PAGE>
TIME WARNER TELECOM LLC
INDEX TO COMBINED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Audited Financial Statements:
Report of Independent Auditors F-2
Combined Balance Sheets at December 31, 1998 and 1997 F-3
Combined Statement of Operations for the years ended December 31, 1998, 1997 and 1996 F-4
Combined Statement of Cash Flows for the years ended December 31, 1998, 1997 and 1996 F-5
Combined Statement of Changes in Members' Equity for the years ended
December 31, 1998, 1997 and 1996 F-6
Notes to Combined Financial Statements F-7
Schedule II Valuation of Qualifying Accounts F-16
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors of TIME WARNER TELECOM LLC:
We have audited the accompanying combined balance sheets of Time Warner
Telecom LLC (the "Company") as of December 31, 1998 and 1997, and the related
combined statements of operations, cash flows and members' equity for each of
the three years in the period ended December 31, 1998. Our audits also included
the financial statement schedule listed in the index at page F-1. These
financial statement and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule 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 combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the Company
at December 31, 1998 and 1997, and the combined results of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects the information set forth therein.
/s/ Ernst & Young LLP
----------------------
ERNST & YOUNG LLP
Denver, Colorado
February 5, 1999
F-2
<PAGE>
TIME WARNER TELECOM LLC
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
-----------------------
1998 1997
---------- -----------
(thousands)
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents............................................... $ 105,140 $ --
Marketable securities................................................... 231,107 --
Receivables, less allowances of $2,692 and $776......................... 26,690 8,882
Prepaid expenses........................................................ 2,176 1,192
--------- ---------
Total current assets................................................ 365,113 10,074
Investments in unconsolidated affiliates.................................. 5,707 4,376
Property, plant and equipment............................................. 612,119 484,206
Less: accumulated depreciation............................................ (117,961) (69,048)
--------- ---------
494,158 415,158
Long-term marketable securities........................................... 19,750 --
Intangible assets, net.................................................... 19,616 8,469
--------- ---------
Total assets........................................................ $ 904,344 $ 438,077
========= =========
LIABILTIES AND MEMBERS' EQUITY
Current liabilities
Accounts payable........................................................ $ 38,888 $ 32,908
Accrued interest........................................................ 17,333 --
Payable to TW Cable..................................................... 16,801 --
Deferred revenue........................................................ 10,524 938
Accrued payroll and benefits............................................ 8,821 6,333
Accrued taxes and fees.................................................. 7,481 5,871
Other current liabilities............................................... 21,905 16,162
--------- ---------
Total current liabilities........................................... 121,753 62,212
Long term debt............................................................ 400,000 --
Subordinated loans payable to the Parent Companies (including
$3,399 and $1,544 of accrued interest, respectively).................... 174,940 75,475
Members' equity
Class A interests having an aggregate participation percentage of 0%.... -- --
Class B interests having an aggregate participation percentage of 100%..
Contributed Capital................................................. 555,807 555,807
Accumulated deficit prior to Reorganization......................... (299,340) ______--
--------- ---------
Total Class B interests.......................................... 256,467 555,807
Accumulated deficit..................................................... (48,816) (255,417)
--------- ---------
Total members' equity................................................... 207,651 300,390
--------- ---------
Total liabilities and members' equity.............................. $ 904,344 $ 438,077
========= =========
</TABLE>
See accompanying notes.
F-3
<PAGE>
TIME WARNER TELECOM LLC
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------
1998 1997 1996
----------- --------- ---------
(thousands)
<S> <C> <C> <C>
Revenues:
Dedicated transport services....................... $ 84,024 $ 44,529 $ 20,362
Switched services.................................. 37,848 10,872 3,555
-------- -------- --------
Total revenues................................. 121,872 55,401 23,917
-------- -------- --------
Costs and expenses:
Operating(a)....................................... 67,153 40,349 25,715
Selling, general and administrative(a)............. 77,401 54,640 60,366
Depreciation and amortization(a)................... 50,717 38,466 22,353
-------- -------- --------
Total costs and expenses....................... 195,271 133,455 108,434
-------- -------- --------
Operating loss.......................................... (73,399) (78,054) (84,517)
Gain on disposition of investments...................... -- 11,018 --
Equity in income (losses) of unconsolidated affiliates.. 127 (2,082) (1,547)
Interest income......................................... 9,731 -- --
Interest expense (a).................................... (29,198) (1,538) (52)
-------- -------- --------
Net loss................................................ $(92,739) $(70,656) $(86,116)
======== ======== ========
(a) Includes expenses resulting from transactions with
affiliates (Note 7):
Operating......................................... $ 2,041 $ 1,731 $ 1,303
======== ======== ========
Selling, general and administrative............... $ 5,063 $ 6,810 $ 6,106
======== ======== ========
Depreciation and amortization..................... $ 9,010 $ 7,064 $ 4,961
======== ======== ========
Interest expense, net................ $ 11,582 $ 1,544 $ --
======== ======== ========
</TABLE>
See accompanying notes.
F-4
<PAGE>
TIME WARNER TELECOM LLC
COMBINED STATEMENTS OF CASH FLOW
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1998 1997 1996
---------- ---------- ----------
(thousands)
<S> <C> <C> <C>
OPERATIONS
Net loss............................................ $ (92,739) $ (70,656) $ (86,116)
Adjustments for noncash and nonoperating items:
Gain on disposition of investments............. -- (11,018) --
Depreciation and amortization.................. 50,717 38,466 22,353
Equity in losses of unconsolidated affiliates.. (127) 2,082 1,547
Changes in operating assets and liabilities:
Receivables.................................... (17,808) (4,019) (2,553)
Accounts payable............................... 5,980 7,264 1,333
Accrued interest............................... 20,732 1,544 --
Payable to TW Cable............................ 16,801 -- --
Accrued payroll and benefits................... 2,488 4,093 919
Other current liabilities...................... 16,939 5,473 8,172
Other balance sheet changes.................... (3,326) (2,648) 2,071
--------- --------- ---------
Cash used in operation.............................. (343) (29,419) (52,274)
--------- --------- ---------
INVESTING ACTIVITIES
Capital expenditures................................ (126,023) (127,315) (144,815)
Investments and acquisitions........................ (1,204) (334) (4,375)
Proceeds from sale of investments................... -- 7,028 --
Purchases of marketable securities.................. (286,356) -- --
Proceeds from maturities of marketable securities... 35,500 -- --
--------- --------- ---------
Cash used in investing activities................... (378,083) (120,621) (149,190)
--------- --------- ---------
FINANCING ACTIVITIES
Proceeds from loans from the Parent Companies....... 96,066 73,931 --
Capital contributions from the Parent Companies..... -- 127,550 222,584
Distributions to the Parent Companies............... -- (51,441) (21,120)
Net proceeds from debt offering..................... 387,500 -- --
--------- --------- ---------
Cash provided by financing activities............... 483,566 150,040 201,464
--------- --------- ---------
INCREASE IN CASH AND EQUIVALENTS.................... 105,140 -- --
CASH AND EQUIVALENTS AT BEGINNING OF YEAR........... -- -- --
--------- --------- ---------
CASH AND EQUIVALENTS AT END OF YEAR................. $ 105,140 $ -- $ --
========= ========= =========
</TABLE>
See accompanying notes.
F-5
<PAGE>
TIME WARNER TELECOM LLC
COMBINED STATEMENT OF CHANGES IN MEMBERS' EQUITY
<TABLE>
<CAPTION>
Total
Class B Accumulated Members'
Interests Deficit Equity
---------- ------------ ---------
(thousands)
<S> <C> <C> <C>
BALANCE AT DECEMBER 31, 1995......................... $ 278,234 $ (98,645) $179,589
Net loss for 1996.................................... --- (86,116) (86,116)
Net capital contributions from the Parent Companies.. 201,464 --- 201,464
--------- --------- --------
BALANCE AT DECEMBER 31, 1996......................... 479,698 (184,761) 294,937
Net loss for 1997.................................... --- (70,656) (70,656)
Net capital contributions from the Parent Companies.. 76,109 --- 76,109
--------- --------- --------
BALANCE AT DECEMBER 31, 1997......................... 555,807 (255,417) 300,390
Net loss prior to Reorganization..................... --- (43,923) (43,923)
--------- --------- --------
555,807 (299,340) 256,467
Effect of Reorganization............................. (299,340) 299,340 ---
Net loss after Reorganization........................ --- (48,816) (48,816)
--------- --------- --------
BALANCE AT DECEMBER 31, 1998......................... $ 256,467 $ (48,816) $207,651
========= ========= ========
</TABLE>
See accompanying notes.
F-6
<PAGE>
1. Organization and Summary of Significant Accounting Policies
Description of Business
Time Warner Telecom LLC (the "Company") is a facilities-based competitive
local telecommunications services provider ("CLEC") in selected metropolitan
markets across the United States, offering a wide range of business telephony
services, primarily to medium- and large-sized business customers. The business
of the Company was commenced in 1993 by Time Warner Cable ("TW Cable"), a
division of Time Warner Entertainment Company, L.P. ("TWE"), and reflects the
combined commercial telecommunication operations under the ownership or
management control of TW Cable. These operations consist of the commercial
telecommunication operations of Time Warner Inc. and certain of its subsidiaries
(collectively, "Time Warner") and the Time Warner Entertainment-Advance/Newhouse
Partnership ("TWE-A/N") that were acquired or formed in 1995, as well as the
pre-existing commercial telecommunication operations of TWE (collectively, TWE,
TWE-A/N and Time Warner are referred to herein as the "Parent Companies").
In July 1998, the Company completed a reorganization (the "Reorganization")
under which the Parent Companies contributed all of the assets and liabilities
of the Company into Time Warner Telecom LLC ("TWT LLC") and in connection
therewith, Time Warner, MediaOne of Colorado, Inc. ("MediaOne") and
Advance/Newhouse Partnership ("A/N") and together with Time Warner and MediaOne,
received all of the limited liability company interests in TWT LLC. The
Reorganization has been reflected as of July 1, 1998 for accounting purposes.
To date, the majority of the Company's revenues have been derived from the
provision of "private line" or "direct access" telecommunications services.
Because the Company has deployed switches in 16 of its 19 markets, management
expects that a growing portion of the Company's revenues will be derived from
providing switched services. The Company's customers are principally
telecommunications-intensive business end-users, long distance carriers ("IXCs")
and internet service providers ("ISPs"), wireless communications companies and
governmental entities. Such customers are offered a wide range of integrated
telecommunications products and services, including dedicated transmission,
local switched, data and video transmission services and Internet services. In
addition, the Company benefits from its strategic relationship with TW Cable
both through access rights and cost-sharing. As a result, the Company's networks
have been constructed primarily through the use of fiber capacity licensed from
TW Cable.
Basis of Presentation
The combined financial statements of the Company reflect the "carved out"
historical financial position, results of operations, cash flows and changes in
members' equity of the commercial telecommunications operations of the Parent
Companies as if they had been operating as a separate company. The combined
statement of operations has been adjusted to retroactively reflect an allocation
of certain expenses pursuant to the final terms of the related agreements,
primarily relating to office rent, overhead charges for various administrative
functions performed by TW Cable and certain facility maintenance and pole rental
costs. These allocations were required to reflect all costs of doing business
and have been based on various methods (Note 7), which management believes
results in reasonable allocations of such costs.
Recent Pronouncements
Effective December 31, 1998, the company adopted FASB Statement No. 131,
"Disclosures About Segments of an Enterprise and Related Information" ("FAS
131"). FAS 131 requires disclosure of financial and descriptive information
about an entity's reportable operating segments under the "Management Approach"
as defined in the statement.
The Company operates in 19 locations and the Company's management makes
decisions on resource allocation and assesses performance based on total
revenues, EBITDA, and capital spending of these operating locations. Each of
the locations offer the same products and services, have similar customers and
networks, are
F-7
<PAGE>
regulated by the same type of authorities, and are managed directly by the
Company's executives, allowing the 19 sites to be aggregated under the
guidelines of FAS 131 resulting in one reportable line of business.
Basis of Combination and Consolidation and Accounting for Investments
The combined financial statements include 100% of the assets, liabilities,
revenues, expenses, income, loss and cash flows of the Company and all entities
in which the Company has a controlling voting interest ("subsidiaries"), as if
the Company and its subsidiaries were a single entity. Significant intercompany
accounts and transactions between the combined entities have been eliminated.
Significant accounts and transactions with the Parent Companies are disclosed as
related party transactions.
Investments in entities in which the Company has significant influence, but
less than a controlling voting interest, are accounted for using the equity
method. At December 31, 1998 and 1997, the Company's investments in
unconsolidated affiliates consisted solely of a 50% investment in MetroComm AXS,
L.P., a joint venture providing commercial telecommunications services in the
central Ohio area. Under the equity method, only the Company's investment in and
amounts due to and from the equity investee are included in the combined balance
sheet, and only the Company's share of the investee's earnings is included in
the combined operating results. In addition, only the Company's share of the
cash distributions and cash paid to the investee are included in the combined
cash flows.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
footnotes thereto. Actual results could differ from those estimates.
Revenues
Revenues for dedicated transport services are generally billed in advance
on a fixed rate basis and recognized over the period the services are provided.
Revenues for switched services and long distance are generally billed on a
transactional basis determined by customer usage with some fixed rate elements.
The transactional elements of switched services are billed in arrears and
estimates are used to recognize revenue in the period earned. The fixed rate
elements are billed in advance and recognized over the period provided.
Reciprocal compensation revenue is an element of switched service revenue, which
represents compensation from Local Exchange Carriers ("LECs") for local exchange
traffic terminated on the Company's facilities originated by other LECs.
Reciprocal compensation is based on contracts between the Company and the LECs.
The Company has chosen to defer revenue recognition on a portion of cash
payments associated with reciprocal compensation agreements that are under
dispute. The Company pays reciprocal compensation expense to the other LECs for
local exchange traffic it terminates on the LECs facilities. These costs are
recognized as operating expenses.
Significant Customers
The Company has substantial business relationships with a few large
customers, including the major long distance carriers. For the year ended
December 31, 1998, the Company's top 10 customers accounted for 37.8% of the
Company's consolidated revenues. Two of these customers were interexchange
carriers ("IXC"), which each accounted for more than 10% of the Company's
revenues in 1998, 1997 and 1996. Revenues included sales to these two IXC's of
approximately $28.9 million, $14.7 million and $5.2 million in 1998, 1997 and
1996, respectively.
Cash, Cash Equivalents, and Marketable Securities
The Company did not historically maintain any cash or marketable securities
since all funding of the Company's operating, investing and financing activities
were provided by the Parent Companies or by subordinated loans payable to the
Parent companies (Note 5). This funding consisted of non-interest bearing
capital contributions through June 30, 1997 and subordinated loans during the
period from July 1, 1997 through July 14, 1998. The
F-8
<PAGE>
non-interest bearing capital contributions have been included in paid-in
capital. The subordinated loans, including accrued interest, have been reflected
as long-term liabilities in the accompanying balance sheets.
The Company considers all highly liquid debt instruments with an original
maturity of three months or less, when purchased, to be cash equivalents.
The Company records its marketable securities in conformity with the
provisions of Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." This statement entails
categorizing all debt and equity securities as held-to-maturity securities,
trading securities, or available-for-sale securities, and then measuring the
securities at either fair value or amortized cost.
Management determines the appropriate classification of debt securities at
the time of purchase and reevaluates such designation as of each balance sheet
date. Debt securities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity. Held-to-
maturity securities are stated at amortized cost, adjusted for amortization of
premiums and accretion of discounts to maturity. Such amortization is included
in interest income. Interest on securities classified as held-to-maturity is
included in interest income.
Receivables
The Company does not require collateral for telecommunication services
provided to customers. However, the Company performs ongoing credit evaluations
of its customers' financial conditions and has provided an allowance for
doubtful accounts based on the expected collectability of all accounts
receivable. The provision for doubtful accounts was $2.0 million, $931,000 and
$207,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. Additions to property,
plant and equipment generally include material, labor, and overhead. The Company
licenses the right to use the majority of its fiber optic cable from TW Cable
divisions, in which they are co-located. The cost of these rights is capitalized
and reflects an allocable share of TW Cable's costs, which generally reflects
the incremental costs incurred by TW Cable to construct the fiber for the
Company. Such amounts do not always reflect TW Cable's total cost of
constructing the distribution plant in cases where TW Cable is also constructing
cable plants at the same time. In these instances, TW Cable's total cost of
construction is allocated between cable plant and the Company. The Company is
then charged for its incremental share of the construction costs related to its
share of the fiber. Depreciation is provided on the straight-line method over
estimated useful lives as follows:
<TABLE>
<CAPTION>
Buildings and improvements..................................... 5-20 years
Communications networks........................................ 5-15 years
Vehicles and other equipment................................... 3-10 years
Fiber optic use rights......................................... 15 years
Property, plant and equipment consist of:
December 31,
-------------------
1998 1997
------ -------
<S> <C> <C>
(thousands)
Buildings and improvements.................................................. $ 14,453 $ 12,846
Communications networks..................................................... 380,150 290,618
Vehicles and other equipment................................................ 58,224 46,086
Fiber optic use rights...................................................... 159,292 134,656
--------- --------
612,119 484,206
Less accumulated depreciation............................................... (117,961) (69,048)
--------- --------
Total................................................................. $ 494,158 $415,158
========= ========
</TABLE>
F-9
<PAGE>
Intangible Assets
Intangible assets primarily consist of goodwill, deferred right of way
costs and covenants not to compete, which are amortized over periods up to 20
years using the straight-line method. Amortization expense amounted to $2.3
million, $2.0 million and $271,000 for the years ended December 31, 1998, 1997
and 1996, respectively. Accumulated amortization of intangible assets at
December 31, 1998 and 1997, amounted to $2.2 million and $1.5 million,
respectively.
Income Taxes
In connection with the Reorganization (Notes 1 and 2), the Company was
formed as a limited liability company. As a limited liability company, the
Company is treated as a partnership for income tax purposes. As such, the
Company is not subject to Federal and state income taxation. The financial
statement basis of the Company's assets exceeds the corresponding tax basis by
approximately $ 97.9 million at December 31, 1998, principally as a result of
differences in accounting for depreciable assets for financial statement and
income tax purposes.
Fair Value of Financial Instrument
The carrying amounts reported in the balance sheet for the Company's
financial instruments approximate fair market value, except for the Company's 9
3/4% Senior Notes due 2008 ("Senior Notes"). The fair market value for these
instruments was determined based on market prices. At December 31, 1998, the
fair market value for the $400 million of Senior Notes was determined to be $422
million, based on the market price.
Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform with the 1998 presentation.
2. Members' Equity
In July 1998, the Company completed a reorganization (the
"Reorganization"), under which the Company's capitalization was authorized to
include two classes of interests, Class A Interests and Class B Interests. In
connection with the Reorganization, the Parent Companies contributed their
respective assets and liabilities of the Company's business to the Company and
in connection therewith, Time Warner, MediaOne Group, Inc. and certain of its
subsidiaries ("MediaOne"), and Advance/Newhouse Partnership ("Newhouse")
received Class B Interests having an aggregate participation percentage of 100%.
Following the Reorganization, Time Warner, MediaOne and Newhouse held Class B
Interests having participation percentages equaling 61.9%, 18.9% and 19.2%,
respectively. Time Warner, MediaOne and Newhouse are collectively referred to
herein as the "Members". Accordingly, the accompanying combined financial
statements have been adjusted to retroactively reflect the authorization of
Class A Interests and the authorization and issuance of Class B Interests having
an aggregate participation percentage of 100% for all periods. The
Reorganization has been reflected as of July 1, 1998 for accounting purposes.
The Class A Interests and Class B Interests are substantially identical in
all respects, except that the Class A Interests have no voting rights, provided,
however, that the approval of the holders of a majority (in participation
percentage) of the Class A Interests, voting as a separate class, is required
for any amendment to the Company's Limited Liability Company Agreement that
would have an adverse effect on the rights of the holders of such class. The
business and affairs of the company are managed by a management committee (the
"Management Committee"), except for certain matters which require the unanimous
vote of the holders of Class B Interests. Representatives of the Management
Committee are appointed by the Members.
F-10
<PAGE>
3. Option Plans
Time Warner Telecom LLC 1998 Option Plan
In connection with the Reorganization, the Management Committee approved an
option plan that provides for granting options to purchase Class A Interests
representing a 10% interest in the Company or 9,027,000 units. Such options
have been granted to employees of the Company at estimated fair value at the
date of the grant, and accordingly, no compensation cost has been recognized by
the Company relating to such option plan. Generally, the options become
exercisable over a four-year vesting period and expire ten days from the date of
the grant.
For purposes of applying FASB Statement No. 123, "Accounting for Stock
Based Compensation" ("FAS 123"), the fair value of each option grant by Time
Warner Telecom LLC is estimated on the date of the grant using the minimum value
option-pricing model. With regard to grants of Time Warner Telecom LLC options
to the company's employees in 1998, weighted average assumptions consisted of:
dividend yield of 0%; risk-free interest rate of 6.5%; and an expected life of 5
years. The weighted average fair value of a Time Warner Telecom LLC option
granted to the Company's employees was $3.33 per unit for the year ended
December 31, 1998.
A summary of option activity with respect to the Time Warner Telecom LLC
1998 Option Plan is as follows:
Number of
Units
-------------
Balance at December 31, 1997
Granted...................................................... 6,115,250
Exercised.................................................... --
Cancelled (a)................................................ (304,500)
---------
Balance at December 31, 1998.................................... 5,810,750
=========
(a) Includes all options cancelled and forfeited during the year.
There were no exercisable options held by employees at December 31, 1998.
Outstanding options held by employees at December 31, 1998 were all granted with
an exercise price of $12 per unit and have a weighted average remaining
contractual life of 9.6 years.
Time Warner and Media One Stock Option Plans
Time Warner and MediaOne also have stock option plans under which certain
employees of the Company have been granted options to purchase Time Warner or
MediaOne common stock. Such options have been granted to employees of the
Company at fair market value at the date of the grant, and accordingly, no
compensation cost has been recognized by Time Warner and MediaOne, nor charged
to the Company, related to such stock option plans. Generally, the options
become exercisable over a three-year vesting period and expire ten years from
the date of the grant. All options have been retroactively restated for stock
splits.
For purposes of applying FAS 123, the fair value of each option grant by
Time Warner and MediaOne is estimated on the date of the grant using the Black-
Scholes option-pricing model. With regard to grants of Time Warner stock options
to the Company's employees in 1998, 1997 and 1996, weighted average assumptions
consisted of: dividend yields of .5% in 1998 and 1.0% in each of 1997 and 1996;
expected volatility of 21.5%, 21.9% and 21.7%, respectively; risk-free interest
rates of 5.5%, 6.6% and 6.1%, respectively; and expected lives of 5 years in all
three periods. The weighted average fair value of Time Warner stock granted to
the Company's employees was $10.50, $6.48 and $6.09 for the years ended December
31, 1998, 1997 and 1996, respectively. In 1997, MediaOne granted options to a
director and former executive of the Company. The weighted averaged fair value
of a MediaOne stock option was $7.43, based on the following weighted average
assumptions: no dividend yield; expected volatility of 30%; risk-free interest
rate of 6.8%; and an expected life of 5 years.
F-11
<PAGE>
A summary of stock option activity in the Time Warner and MediaOne stock
option plans, with respect to employees of the Company, is as follows:
<TABLE>
<CAPTION>
Time Warner MediaOne
-----------------------------------------------------------
Number of Weighted-Average Number of Weighted-Average
Shares Exercise Price Shares Exercise Price
---------- ---------------- --------- ----------------
<S> <C> <C> <C> <C>
Balance at December 31, 1995..................... 264,350 $18.56 ---- $ ----
Granted........................................ 113,500 21.32 ---- ----
Exercised...................................... (1,268) 17.69 ---- ----
Cancelled (a).................................. (13,932) 20.32 ---- ----
------- ---------
Balance at December 31, 1996..................... 362,650 $19.35 ---- ----
Granted........................................ 27,700 21.78 5,566 $18.26
Exercised...................................... (3,500) 18.88 ---- ----
Transferred (b)................................ (98,100) 22.36 ---- ----
Cancelled (a).................................. (19,500) 20.49 ---- ----
------- ---------
Balance at December 31, 1997..................... 269,250 $18.43 5,566 $18.26
Granted........................................ 54,900 34.87 ---- ----
Exercised...................................... (59,164) 19.72 ---- ----
Cancelled (a).................................. (500) 18.78 ---- ----
------- ---------
Balance at December 31, 1998..................... 264,486 $21.55 5,566 $18.26
======= =========
</TABLE>
(a) Includes all options cancelled and forfeited during the year.
(b) Transfers represent individuals who were employed by the Company; but
transferred to another Time Warner affiliate.
The number of exercisable Time Warner and MediaOne options held by employees
of the Company is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- ------
<S> <C> <C> <C>
Time Warner stock options 166,730 121,433 70,408
MediaOne stock options 1,855 ---- ----
</TABLE>
Pro Forma Net Loss
In accordance with Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations, no compensation cost
has been recognized by the Company for any of the three option plans detailed
above. Had compensation cost for Time Warner Telecom LLC's, Time Warner's and
MediaOne's option plans been determined based on the fair value at the grant
dates for all awards made subsequent to 1994 consistent with the method set
forth under FASB Statement No. 123, "Accounting for Stock-Based Compensations"
("FAS 123"), the Company's allocable share of compensation cost would have
increased its net loss to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1998 1997 1996
---- ---- ----
(Thousands)
<S> <C> <C> <C>
Net loss:
As reported...................................... $(92,739) $(70,656) $(86,116)
======== ======== ========
Pro forma........................................ $(95,382) $(71,012) $(86,500)
======== ======== ========
</TABLE>
The Black-Scholes and minimum value method option valuation models were
developed for use in estimating the fair value of options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
F-12
<PAGE>
require the input of highly subjective assumptions such as expected stock price
volatility. Because the Company's employee options and those issued by Time
Warner and MediaOne have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
4. Long Term Debt
On July 21, 1998, the Company issued $400 million in Senior Notes. The
Senior Notes are unsecured, unsubordinated obligations of the Company and Time
Warner Telecom Inc., a wholly owned subsidiary of the Company, which are jointly
and severally liable, fully and unconditionally, with respect to the Senior
Notes. Interest on the Senior Notes is payable semiannually on January 15 and
July 15, beginning January 15, 1999. The net proceeds of approximately $387.5
million are expected to be used to expand and develop existing and new networks
and for general corporate and working capital purposes through the middle of
2000. The proceeds of the Notes were immediately invested in cash equivalents
and marketable securities. Interest expense relating to the Notes totaled
approximately $17.9 million for the twelve months ended December 31, 1998.
5. Subordinated Loans Payable to the Parent Companies
Effective July 1, 1997 through July 14, 1998, all of the Company's
financing requirements were funded with subordinated loans from the Parent
Companies. These loans from the Parent Companies are subordinated in right of
payment to the Senior Notes, except for a provision allowing repayment prior to
maturity with the net proceeds of any offering of common stock or equivalent
interest of the Company. These loans bear interest (payable in kind) at The
Chase Manhattan Bank's prime rate which was 7.75% at December 31, 1998.
Effective with the Reorganization, the maturity of these loans was extended
until 2008. Interest expense relating to these loans totaled approximately $11.6
million in 1998 and $1.5 million in 1997.
6. Marketable Securities
At December 31, 1998, the Company's marketable securities portfolio
consisted of shares of money market mutual funds, corporate debt securities,
certificates of deposit with banks, and foreign government debt securities. At
December 31, 1998, all of the Company's marketable securities were categorized
as "held-to-maturity" and carried at amortized cost.
Marketable securities at December 31, 1998, were as follows:
<TABLE>
<CAPTION>
Amortized
Cost
-----------
(thousands)
<S> <C>
Cash Equivalents:
Shares of money market mutual funds.................................. $ 3,338
Certificates of deposit with banks................................... 5,000
Corporate debt securities............................................ 93,394
--------
101,732
Current Marketable Securities:
Certificates of deposit with banks................................... 57,014
Corporate debt securities............................................ 169,085
Foreign government debt securities................................... 5,008
--------
231,107
Long-Term Marketable Securities:
Corporate debt securities............................................ 19,750
--------
Total Marketable Securities........................................ $352,589
========
</TABLE>
The estimated fair value of the marketable securities is not materially
different from the amortized cost. The company does not have any marketable
securities with a maturity of greater than two years.
F-13
<PAGE>
7. Related Party Transactions
In the normal course of conducting its businesses, the Company has various
transactions with the Parent Companies, generally on terms resulting from
negotiation between the affected units that, in management's view, results in
reasonable allocations.
The Company's operations, which in certain cases are co-located with TW
Cable divisions, are allocated a charge for various overhead expenses for
services provided by TW Cable. These allocations are based on direct labor,
total expenses, or headcount relative to each division. The Company is also
allocated rent based on the square footage of space occupied by the Company at
TW Cable facilities. The aggregate of these charges totaled approximately $2.1
million, $4.4 million and $4.3 million for the years ended December 31, 1998,
1997 and 1996, respectively.
The Company participates in the Time Warner Cable Pension Plan (the
"Pension Plan"), a noncontributory defined benefit pension plan which covers
approximately 75% of all employees. The remaining 25% of employees are
participating in a pension plan under the administration of MediaOne, their
previous employer. The Company also participates in the Time Warner Cable
Employees Savings Plan (the "Savings Plan"), a defined contribution plan. Both
the Pension Plan and Savings Plan are administered by a committee appointed by
the Board of Representatives of TWE and cover substantially all employees.
Benefits under the Pension Plan are determined based on formulas which
reflect employees' years of service and compensation levels during their
employment period. Total pension cost was $1.9 million, $1.7 million and $1.2
million for the years ended December 31, 1998, 1997 and 1996, respectively.
The Company's contributions to the Savings Plan can represent up to 6.67%
of the employees' compensation during the plan year. TWE's Board of
Representatives has the right in any year to set the maximum amount of the
Company's annual contribution. Defined contribution plan expense was $1.0
million, $710,000 and $606,000 for the years ended December 31, 1998, 1997 and
1996, respectively.
As of January 1, 1999, the Company does not participate in the Time Warner
Cable Pension Plan, the MediaOne Pension Plan or the Time Warner Cable Employee
Savings Plan, because the company has adopted its own benefit plans, including a
401(k) program.
The Company licenses the right to use the majority of its fiber optic cable
from TW Cable. The Company paid TW Cable $23.8 million, $32.5 million, and $41.3
million in the years ended December 31, 1998, 1997 and 1996, respectively, under
this arrangement. Such costs have been capitalized by the Company. The
amortization of these costs and fiber previously capitalized in the amount of
$9.0 million, $7.1 million and $5.0 million for the years ended December 31,
1998, 1997 and 1996, respectively, has been classified as a component of
depreciation and amortization in the accompanying combined statement of
operations. In addition, under this licensing arrangement, the Company
reimburses TW Cable for facility maintenance and pole rental costs, which costs
amounted to $2.0 million, $1.7 million and $1.3 million for the years ended
December 31, 1998, 1997 and 1996, respectively.
Effective July 1, 1997 through July 14, 1998, all of the Company's
financing requirements were funded with loans from the Parent Companies.
Interest expense relating to these loans totaled approximately $11.6 million in
1998 and $1.5 million in 1997 (see Note 5).
8. Commitments and Contingencies
The Company has non-cancelable operating leases for office space and
switching facilities expiring over various terms. Certain of these leases
contain renewal clauses. Rental expense for all operating leases totaled $7.0
million, $5.4 million and $4.2 million for the years ended December 31, 1998,
1997 and 1996, respectively.
The minimum rental commitments under non-cancelable operating leases are:
1999 -- $6.3 million; 2000 -- $6.1 million; 2001 -- $5.8 million; 2002 -- $5.9
million; 2003 -- $5.7 million and after 2003 -- $30.6 million.
F-14
<PAGE>
Pending legal proceedings are substantially limited to litigation
incidental to the business of the Company. In the opinion of management, the
ultimate resolution of these matters will not have a material adverse effect on
the Company's financial statements.
F-15
<PAGE>
SCHEDULE II - VALUATION OF QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Additions/
Balance at Charges to Balance at
Beginning Costs and End of
Of Period Expenses Deductions Period
---------- ----------- ----------- ----------
(thousands)
<S> <C> <C> <C> <C>
For the Year ended December 31, 1998:
Allowance for doubtful accounts receivable.. $776 $2,020 $(104) $2,692
For the Year ended December 31, 1997:
Allowance for doubtful accounts receivable.. $193 $1,213 $(630) $ 776
For the Year ended December 31, 1996:
Allowance for doubtful accounts receivable.. $ 21 $ 271 $ (99) $ 193
</TABLE>
F-16
<PAGE>
Exhibit 10.4
As amended as of:
December 16, 1998
TIME WARNER TELECOM LLC
1998 OPTION PLAN
ARTICLE I
Purpose of the Plan
The purpose of the Time Warner Telecom LLC (the "Company") 1998 Option Plan
(hereinafter the "Plan") is to provide for the granting of options to
representatives and employees of the Company and its Subsidiaries in recognition
of the valuable services provided, and contemplated to be provided, by such
representatives and employees. The general purpose of the Plan is to promote
the interests of the Company and its members and to reward dedicated
representatives and employees of the Company and its Subsidiaries by providing
them additional incentives to continue and increase their efforts with respect
to, and to remain in the employ of, the Company or its Subsidiaries.
ARTICLE II
Certain Definitions
The following terms (whether used in the singular or plural) have the meanings
indicated when used in the Plan:
(a) "Agreement" means the option agreement specified in Article XI.
(b) "Approved Transaction" means any transaction in which the Board (or, if
approval of the Board is not required as a matter of law, the members of
the Company) shall approve (i) any consolidation or merger of the
Company in which the Company is not the continuing or surviving company
or pursuant to which Interests would be converted into cash, securities
or other property, other than a merger of the Company in which the
equity holders of the Company immediately prior to the merger have the
same proportionate ownership of the equity value of the surviving
company immediately after the merger or (ii) any sale, lease, exchange,
or other transfer (in one transaction or a series of related
transactions) of all, or substantially all, of the assets of the
Company, or (iii) the adoption of any plan or proposal for the
liquidation or dissolution of the Company; provided that the
reconstitution of the Company as a corporation or other entity or a
public offering of the equity of the Company (or its successor) shall
not constitute an Approved Transaction.
(c) "Award" means grants of Options under this Plan.
(d) "Board" means the Management Committee of the Company.
<PAGE>
(e) "Board Change" means such time as the Initial Members and their
respective affiliates as a group cease to have the ability to elect a
majority of the members of the Board (other than the chief executive
officer of the Company and independent representatives; provided that
independent representatives shall be included in calculating whether the
foregoing majority requirement is satisfied if the representatives
nominated by the Initial Members and their respective affiliates do not
constitute a majority of the committee that selects the Board's nominees
for independent representatives) and a "person" or "group" (within the
meaning of Sections 13(d) and 14(d)(2) of the Exchange Act) (other than
the Initial Members and their respective affiliates) has become the
ultimate "beneficial owner" (as defined in Rule 13d-3 under the Exchange
Act) of more than 35% of the total voting power of the voting interests
of the Company on a fully diluted basis and such ownership represents a
greater percentage of the total voting power of the voting interests of
the Company, on a fully diluted basis, than is held by the Initial
Members and their respective affiliates as a group on such date.
(f) "Code" means the Internal Revenue Code of 1986, as amended from time to
time, or any successor statute or statutes thereto. Reference to any
specific Code section shall include any successor section.
(g) "Committee" means the Committee comprised of members of the Board
appointed pursuant to Article IV.
(h) "Company" means Time Warner Telecom LLC, a limited liability company,
and any successor thereto.
(i) "Effective Date" means the date the Plan becomes effective pursuant to
Article XV.
(j) "Exchange Act" means the Securities Exchange Act of 1934, as amended
from time to time, or any successor statute or statutes thereto.
Reference to any specific Exchange Act section shall include any
successor section.
(k) "Fair Market Value" of Units shall mean the fair market value of such
Units as determined in good faith by the Board after consultation with
an independent appraiser or other third party deemed appropriate by the
Board. In the event of an Approved Transaction involving the sale of
Interests of the Company, the Fair Market Value of a Unit shall be based
upon the price per Unit paid by the acquiror in connection with such
Approved Transaction, subject to appropriate adjustment to reflect
relative differences among the Units as determined in good faith by the
Board.
(l) "Holder" means a representative or an employee of the Company or any of
its Subsidiaries who has received an Award under this Plan. An
individual shall continue to be considered a Holder for purposes of this
Plan during the period such individual holds Units acquired pursuant to
an exercise of an Option.
(m) "Initial Members" means Time Warner Inc., MediaOne Group, Inc.,
Advance/Newhouse Partnership and the affiliates of each of the
foregoing.
2
<PAGE>
(n) "Interest" shall mean a Class A Interest in the Company as defined in
the Operating Agreement.
(o) "Operating Agreement" shall mean the Amended and Restated Limited
Liability Company Agreement of Time Warner Telecom LLC dated July 14,
1998, as in effect from time to time.
(p) "Option" means any option granted pursuant to this Plan.
(q) "Plan" has the meaning ascribed thereto in Article I.
(r) "Subsidiary" of a person means any present or future subsidiary of such
person as such term is defined in Section 425 of the Code and any
present or future trade or business, whether or not incorporated,
controlled by or under common control with such person. An entity shall
be deemed a Subsidiary of a person only for such periods as the
requisite ownership or control relationship is maintained.
(s) "Total Disability" means a permanent and total disability as defined in
Section 22(e)(3) of the Code.
(t) "Unit" shall mean an Interest in the Company expressed as a unit. As of
the date of the initial grant of Options under the Plan, the Board shall
determine the notional amount of Units considered to be outstanding and
the percentage interest of the equity value of the Company represented
by each Unit, which amounts shall be subject to adjustment as provided
in Section 3.02 and Section 6.06. Any references herein to Units include
any securities exchanged in the conversion of Units.
ARTICLE III
Units Subject to the Plan
SECTION 3.01 Number of Units. Subject to the provisions of Section 3.02 and
Section 6.06, the maximum number of Units in respect of which Awards may be
granted under the Plan shall be determined by the Board as of the date of the
initial grant of Awards under the Plan, but shall in no event represent more
than 10% of the equity value of the Company as of that date. The maximum number
of Units in respect of which Awards may be granted during any calendar year to
any one individual under the Plan shall not exceed one-half the number of Units
that may be subject to Awards granted under the Plan under the preceding
sentence. If and to the extent that an Option shall expire, terminate or be
canceled for any reason without having been exercised, the Units subject to such
expired, terminated or canceled portion of the Option shall again become
available for purposes of the Plan.
SECTION 3.02 Adjustments. In addition to the adjustment in the Interests as
described in Section 6.06, in the event that the Board determines that any
dividend or other distribution (whether in the form of cash, Interests,
securities or other property), recapitalization, reorganization, merger,
consolidation, issuance or exchange of Interests, other ownership interests or
other securities of the Company, issuance of warrants or other rights to
purchase Interests, other ownership
3
<PAGE>
interests or other securities of the Company or other similar corporate
transaction or event affects the Interests such that an adjustment is determined
by the Board in its discretion to be appropriate in order to prevent
inappropriate dilution or enlargement of the benefits or potential benefits
intended to be made available under the Plan, then the Board may, in such manner
as it may deem equitable, adjust any or all of (a) the number of Units, other
ownership interests or other securities of the Company (or number and kind of
other securities or property) with respect to which Awards may be granted, (b)
the number of Units, other ownership interests or other securities of the
Company (or number and kind of other securities or property) subject to
outstanding Awards or the percentage of Interests, other ownership interests or
other securities of the Company subject to Units and (c) the exercise price with
respect to any Option or, if deemed appropriate, make provision for a cash
payment to the Holder of an outstanding Option in consideration for the
cancellation of such Option. No adjustment shall be made on account of the
issuance of Interests with respect to Options.
ARTICLE IV
Administration
SECTION 4.01 Powers. The Plan shall be administered by the Board. Subject to
the express provisions of the Plan, the Board shall have plenary authority, in
its discretion, to grant Awards under the Plan and to determine the terms and
conditions (which need not be identical) of all Awards so granted, including
without limitation, (a) the individuals to whom, and the time or times at which,
Awards shall be granted or awarded, (b) the number of Units to be subject to
each Award, (c) when an Option can be exercised and whether in whole or in
installments, and (d) the form, terms and provisions of any Agreement (which
terms may be amended, subject to Article XIV).
SECTION 4.02 Factors to Consider. In making determinations hereunder, the
Board may take into account the nature of the services rendered by the
respective representatives and employees, their dedication and past
contributions to the Company and its Subsidiaries, their present and potential
contributions to the success of the Company and its Subsidiaries and such other
factors as the Board in its discretion shall deem relevant.
SECTION 4.03 Interpretation. Subject to the express provisions of the Plan,
the Board shall have plenary authority to interpret the Plan, to prescribe,
amend and rescind the rules and regulations relating to it and to make all other
determinations deemed necessary or advisable for the administration of the Plan.
The determinations of the Board on the matters referred to in this Article IV
shall be conclusive.
SECTION 4.04 Delegation to Committee. Notwithstanding anything to the contrary
contained herein, the Board may at any time, or from time to time, appoint a
Committee and delegate to such Committee the authority of the Board to
administer the Plan, including to the extent provided by the Board, the power to
further delegate such authority. Upon such appointment and delegation, any such
Committee shall have all the powers, privileges and duties
4
<PAGE>
of the Board in the administration of the Plan to the extent provided in such
delegation, except for the power to appoint members of the Committee and to
terminate, modify or amend the Plan. The Board may from time to time appoint
members of any such Committee in substitution for or in addition to members
previously appointed, may fill vacancies in such Committee and may discharge
such Committee.
Any such Committee shall hold its meetings at such times and places as it shall
deem advisable. A majority of members shall constitute a quorum and all
determinations shall be made by a majority of such quorum. Any determination
reduced to writing and signed by all of the members shall be fully as effective
as if it had been made by a majority vote at a meeting duly called and held.
ARTICLE V
Eligibility
Awards may be made only to (a) representatives, employees, including officers
and representatives who are also employees, of, and consultants to, the Company
or any of its Subsidiaries, (b) prospective employees of the Company or any of
its Subsidiaries and (c) any other individuals providing services to the Company
or any of its Subsidiaries. The exercise of Options granted to a prospective
employee shall be conditioned upon such person becoming an employee of the
Company or any of its Subsidiaries. For purposes of the Plan, the term
"prospective employee" shall mean any person who holds an outstanding offer of
employment on specific terms from the Company or any of its Subsidiaries.
Awards may be made to employees who hold or have held Awards under this Plan or
any similar or other awards under any other plan of the Company or its
Subsidiaries.
ARTICLE VI
Options
SECTION 6.01 Option Price. The purchase price of the Units under each Option
shall be determined by the Board and set forth in the applicable Agreement, but
shall not be less than 100% of the Fair Market Value of the Unit on the date of
grant.
SECTION 6.02 Term of Options. The term of each Option shall be for such period
as the Board shall determine, as set forth in the applicable Agreement, but not
more than 10 years from the date of grant (except as provided in Section
6.08(b)).
SECTION 6.03 Exercise of Options. An Option granted under the Plan shall
become (and remain) exercisable during the term of the Option to the extent
provided in the applicable Agreement and this Plan and, unless the Agreement
otherwise provides, may be exercised to the extent exercisable, in whole or in
part, at any time and from time to time during such term; provided, however,
that subsequent to the grant of an Option, the Board, at any time before
complete termination of such Option, may
5
<PAGE>
accelerate the time or times at which such Option may be exercised in whole or
in part (without reducing the term of such Option). The Agreement may contain
conditions precedent to the exercisability of Options, including without
limitation, the achievement of minimum performance criteria.
SECTION 6.04 Manner of Exercise. Payment of the Option purchase price shall be
made in cash or in whole Units already owned by the person exercising an Option
or, partly in cash and partly in such Units; provided, however, that such
payment may be made in whole or in part in Units held for six months and only if
and to the extent permitted by the applicable Agreement. In addition, before
the occurrence of an IPO (as defined below), the Company may, in its sole
discretion, lend, on a full recourse basis, funds sufficient to pay any
applicable exercise price; provided that any such loan shall (i) be made only in
the event of the Holder's death or the Holder's termination of employment by the
Company without cause (as determined by the Board), (ii) be made at commercial
rates and (iii) be payable in full by the borrower on the earliest to occur of
(a) the six month anniversary of the date of exercise, (b) 30 days after an IPO
or (c) the sale of the Unit(s) acquired upon exercise of the Option. Such an
Option shall be exercised by written notice to the Company upon such terms and
conditions as provided in the Agreement. The Company shall effect the transfer
of the Units purchased under the Option as soon as practicable. No Holder or
other person exercising an Option shall have any of the rights of a Unit holder
of the Company with respect to Units subject to an Option granted under the Plan
until due exercise and full payment has been made.
SECTION 6.05 Limited Transferability of Options. Except as set forth in this
Section 6.05 and Article XXI, Options shall not be transferable other than by
will or the laws of descent and distribution, and Options may be exercised
during the lifetime of the Holder thereof only by such Holder (or his or her
court appointed legal representative). The Agreement may provide that Options
are transferable by gift to such persons or entities and upon such terms and
conditions specified in the Agreement.
SECTION 6.06 Adjustment of Percentage of Interests Subject to Units. Upon the
issuance or redemption of Interests in the Company, the number of Units
available under the Plan and the number of Units subject to outstanding Options
shall be equitably adjusted as determined by the Board in its sole discretion to
prevent inappropriate dilution or enlargement of the economic interest
represented by such Units.
SECTION 6.07 Restrictions. As a condition to the exercise of an Option, the
Holder will be required to become a party to the Operating Agreement and the
Stockholders Agreement (as defined in the Operating Agreement) and the Interests
acquired upon exercise of the Option will be held subject in all respects to the
terms and conditions of the Operating Agreement and Stockholders Agreement. In
addition, certificates representing Interests issued upon exercise of Options
shall bear a restrictive legend to the effect that transferability of such
Interests is subject to the restrictions contained in the Plan and the
applicable Agreement.
SECTION 6.08 Special Exercise Delay/Extension of Options. The provisions of
this Section 6.08 shall apply to an Option unless the applicable Option
Agreement otherwise provides.
6
<PAGE>
(a) An otherwise vested Option shall not be exercisable until the "Liquidity
Date" which shall be the earlier of (i) an initial public offering of equity
securities (an "IPO") of the Company or a successor thereto and (ii) the first
anniversary of the initial grant of Options under the Plan; provided that the
Liquidity Date may be postponed at the discretion of the Board, to comply with
applicable securities laws or, prior to an IPO, to avoid the need for the
Company to register the Interests under the securities laws.
(b) If the vested portion of an Option would expire when the Liquidity Date
has not yet occurred, the expiration date of such vested portion shall be
extended until the later of (i) 30 days after the Liquidity Date or (ii) the
regularly scheduled expiration date.
(c) Prior to an IPO, vested Options may be exercised only during the 30-day
period starting on each Communication Date.
SECTION 6.09 Section 83(b) Election. Unless the Board determines otherwise, an
individual exercising an Option will be required to make a timely, valid
election under Section 83(b) of the Code.
SECTION 6.10 Tax Treatment of Exercise. Solely for purposes of determining the
appropriate tax treatment of the Members and the Holder, upon exercise of an
Option, a Holder will be treated as if the Company paid him or her an amount
equal to the aggregate difference between the exercise price and the Fair Market
Value of the Units subject to the Option and the Holder then purchased from the
Company for cash the applicable number of Units at the then-current Fair Market
Value of such Units.
SECTION 6.11 Value Determinations. Commencing in 1999, the Company shall
determine the Fair Market Value of the Units as of December 31 and June 30 of
each year (each, a "Valuation Date"). Such Fair Market Value shall be
communicated to Holders as soon as practicable following each Valuation Date
(each such date, a "Communication Date"). In the event that any Option become
exercisable prior to the initial Valuation Date as a result of an acceleration
under the Plan, the Company will determine the Fair Market Value of the Units as
of a date selected by the Chief Financial Officer no more than six months
earlier than the date of the event triggering the acceleration.
ARTICLE VII
Acceleration of Options
Notwithstanding any contrary waiting period or installment period in any
Agreement or in the Plan, or unless the applicable Agreement provides otherwise,
if a Holder's employment shall terminate by reason of death or Total Disability,
or in the event of any Approved Transaction or Board Change each outstanding
Option granted under the Plan shall immediately become exercisable in full in
respect of the aggregate number of Units covered thereby.
7
<PAGE>
ARTICLE VIII
Termination of Employment
SECTION 8.01 General. If a Holder's employment shall terminate prior to the
complete exercise of an Option, then such Option shall thereafter be exercisable
in accordance with the provisions of the applicable Agreement (including the
provisions of any other agreement referred to in the Agreement); provided,
however, that (a) no Option may be exercised after the scheduled expiration date
of such Option; (b) if the Holder's employment terminates by reason of death or
Total Disability, Options shall remain exercisable for a period of at least one
year following such termination (but not later than the scheduled expiration of
such Option); and (c) any termination by the employing company for cause will be
treated in accordance with the provisions of Section 8.02.
SECTION 8.02 Termination for Cause. If a Holder's employment with the Company
or any of its Subsidiaries shall be terminated for cause, by the Company or such
Subsidiary prior to the exercise of any Option, then all Options held by such
Holder and any permitted transferee pursuant to Section 6.05 shall immediately
terminate. For the purposes of this Section 8.02, cause shall have the meaning
ascribed thereto in any employment agreement to which such Holder is a party. In
the absence of an employment agreement, cause shall include but not be limited
to, insubordination, dishonesty, incompetence, moral turpitude, other misconduct
of any kind and the refusal to perform his duties and responsibilities for any
reason other than illness or incapacity; provided, however, that if such
termination occurs within 12 months after an Approved Transaction or Board
Change, termination for cause in the absence of an employment agreement shall
mean only a felony conviction for fraud, misappropriation or embezzlement.
SECTION 8.03 Miscellaneous. The Board may determine whether any given leave of
absence constitutes a termination of employment. Awards made under the Plan
shall not be affected by any change of employment so long as the Holder
continues to be an employee of the Company or one of its Subsidiaries.
ARTICLE IX
Right of Company to Terminate Employment
Nothing contained in the Plan or in any Award shall confer on any Holder any
right to continue in the employ of the Company or any of its Subsidiaries or
interfere in any way with the right of the Company or a Subsidiary to terminate
the employment of the Holder at any time, with or without cause; subject,
however, to the provisions of any employment agreement between the Holder and
the Company or any of its Subsidiaries.
8
<PAGE>
ARTICLE X
Nonalienation of Benefits
Except as specifically provided in Section 6.05 and Article XXI, no right or
benefit under the Plan shall be subject to anticipation, alienation, sale,
assignment, hypothecation, pledge, exchange, transfer, encumbrance or charge,
and any attempt to anticipate, alienate, sell, assign, hypothecate, pledge,
exchange, transfer, encumber or charge the same shall be void. No right or
benefit hereunder shall in any manner be liable for or subject to the debts,
contracts, liabilities or torts of the person entitled to such benefits.
ARTICLE XI
Written Agreement
Each grant of an Option shall be evidenced by an Option Agreement in such form
and containing such terms and provisions not inconsistent with the provisions of
the Plan as the Board from time to time shall approve; provided, however, that
such Awards shall be evidenced by a single agreement. The effective date of the
granting of an Award shall be the date on which the Board approves such grant.
Each grantee of an Option shall be notified promptly of such grant and a written
Agreement shall be promptly executed and delivered by the Company and the
grantee; provided that such grant of Options shall terminate if such written
Agreement is not signed by such grantee (or his attorney) and delivered to the
Company within 90 days after the date the Agreement is sent to such grantee for
signature. Any such written Agreement may contain (but shall not be required to
contain) such provisions as the Board deems appropriate to ensure that the
penalty provisions of Section 4999 of the Code will not apply to any stock or
cash received from the Company or any of its Subsidiaries by the Holder or a
transferee of such Holder if the Award, or any part thereof, has been
transferred pursuant to Section 6.05 or Article XXI.
ARTICLE XII
Right of First Refusal
The Agreement may contain such provisions as the Board shall determine to the
effect that if a Holder, or such other person exercising an Option, elects to
sell all or any Units that such Holder or other person acquired upon the
exercise of an Option awarded under the Plan, then such Holder or other person
shall not sell such Units unless such Holder or other person shall have first
offered in writing to sell such Units to the Company at Fair Market Value on a
date specified in such offer (which date shall be at least three business days
and not more than 10 business days following the date of such offer). If the
Company does not accept such offer within 10 days, the Units may be sold on
terms no more favorable than those offered to the Company. If the Units (i) are
not sold within 10 days of the date the Company declined to purchase the Units
or (ii) would be sold on terms more favorable than those offered to the Company,
the holder of the Units must again offer the Units for sale to the Company in
accordance with this Article XII before any subsequent sale of such Units. Any
transfer of Units that occurs after any violation of this Article XII shall be
null and void.
9
<PAGE>
ARTICLE XIII
Put Rights and Call Rights
SECTION 13.01 Recurring Put Rights.
(a) Prior to any IPO, if a Holder has exercised an Option and held the Units
acquired upon exercise for a period of more than six months, such Holder shall
have the right to sell to the Company all or any portion of such Units.
(b) The put right may be exercised only during the 30-day period starting on
each Communication Date, at fair market value determined as of the preceding
Valuation Date; provided that, unless otherwise determined by the Board, with
-------- ----
respect to any calendar year the Company shall not be required to purchase Units
issued pursuant to the Plan with an aggregate value in excess of $20,000,000
(the "Put Limit"). To the extent Units with a value in excess of the Put Limit
have been put to the Company, the Company shall purchase a pro rata share of the
Units put to the Company by each individual.
(c) The put right will not be available to any Holder who is terminated for
cause.
(d) Prompt payment in respect of the put right will be due, without interest.
(e) The determination of fair market value shall be made by the Board in good
faith. Such determination shall be made on a going concern basis and a minority
interest discount shall not be applied in assigning a value to the Units that
are being put back to the Company.
(f) Notwithstanding the foregoing, the Company shall not be obligated to take
any action or make any payment in satisfaction of a Holder's exercise of a put
right (the Company being hereinafter referred to as the "Put Obligor") (i) if an
event of default should then exist and be continuing under the terms of any
agreement for indebtedness for borrowed money to which the Put Obligor or any of
its subsidiaries is a party at such time or (ii) if such action or payment would
constitute a default or an event of default or result in a mandatory prepayment
requirement under the terms of any agreement for indebtedness for borrowed money
to which the Put Obligor or any of its subsidiaries is a party at such time
(each a "Financing Limitation")
(g) If the Put Obligor is unable to make payments in respect of the exercise
of a put right due to a Financing Limitation, the Put Obligor will make payment
of the Put Date Value at the earliest practicable date following the date when
such payment would no longer contravene a Financing Limitation, together with
interest at the prime rate from the Scheduled Payment Date to the date of
payment by the Put Obligor.
SECTION 13.02 Recurring Call Rights.
(a) Prior to an IPO, if a Holder whose employment has terminated for any
reason holds Units of the Company acquired upon the exercise of an Option, the
Company may, in its
10
<PAGE>
discretion, purchase all or any number of such Units that have been held by the
Holder for a period of more than six months.
(b) The call right may be exercised only during the 30-day period starting
on each Communication Date.
(c) The purchase price for called Units shall be the fair market value as
determined by the Board as of the preceding Valuation Date, as applicable, and
shall be determined under the principles governing the determination of fair
market value for purposes of the put right in Section 13.01 of this Plan.
ARTICLE XIV
Termination and Amendment
SECTION 14.01 General. Unless the Plan shall theretofore have been terminated
as hereinafter provided, no Awards may be made under the Plan on or after the
tenth anniversary of the Effective Date. The Board may at any time prior to the
tenth anniversary of the Effective Date terminate the Plan, and the Board may at
any time modify or amend the Plan in such respects as it shall deem advisable.
SECTION 14.02 Modification. No termination, modification or amendment of the
Plan may, without the consent of the person to whom any Award shall theretofore
have been granted (or a transferee of such person if the Award, or any part
thereof, has been transferred pursuant to Section 6.05 or Article XXI),
adversely affect the rights of such person with respect to such Award. No
modification, extension, renewal or other change in any Award granted under the
Plan shall be made after the grant of such Award, unless the same is consistent
with the provisions of the Plan. With the consent of the Holder (or a
transferee of such Holder if the Award, or any part thereof, has been
transferred pursuant to Section 6.05 or Article XXI) and subject to the terms
and conditions of the Plan (including Section 14.01), the Board may amend
outstanding Agreements with any Holder (or any such transferee), including,
without limitation, any amendment which would (a) accelerate the time or times
at which the Award may be exercised and/or (b) extend the scheduled expiration
date of the Award. Without limiting the generality of the foregoing, the Board
may but solely with the Holder's consent, agree to cancel any Award under the
Plan held by such Holder and issue a new Award in substitution therefor;
provided that the Award so substituted shall satisfy all of the requirements of
the Plan as of the date such new Award is made.
SECTION 14.03 Initial Public Offering.
(a) Upon the occurrence of an Initial Public Offering ("IPO") of stock by
the Company or a successor, the public corporation shall assume this Plan and
any outstanding Options in such manner as the Board shall determine to be
equitable and consistent with the purposes of the Plan. The Board shall, in its
discretion, determine the period during which the fair market value of the
equity interests subject to the Options are determined for purposes of this
Section 14.03.
11
<PAGE>
(b) The Board shall have the right to require all Holders to participate in
a sale or merger transaction and to sell their Units to a third party purchaser
in connection with such sale or merger. Such right shall be exercisable by
written notice (the "Buyout Notice") given to each Holder which shall state (i)
that there has been a proposal to effect the sale of the Interests of every
Member of the Company to such third party purchaser, (ii) the proposed purchase
price per Unit to be paid by the third party purchaser for the Interests of all
of the Members, and (iii) the name of the third party purchaser, and to which
shall be attached a copy of all writings between such selling Member and the
other parties to such transaction necessary to establish the terms of such
transaction. Each such Holder agrees that, upon receipt of a Buyout Notice,
each such Holder shall be obligated to sell his Option Interests upon the terms
and conditions of such transaction (and otherwise take all reasonably necessary
action to cause consummation of the proposed transaction, including voting any
such Option Interest in favor of such transaction). The third party purchaser
shall furnish evidence reasonably satisfactory to the Board to the effect that
it has the financial ability to consummate the proposed purchase of the
Interests of all of the Members. For purposes of this paragraph, "Holder" means
a person who holds an unexercised Option or who holds an Interest acquired upon
exercise of an Option. The term "Option Interest" means either an Option or an
Interest acquired pursuant to exercise of an Option.
SECTION 14.04 Corporate Reconstitution. If the Company's business is
reconstituted in corporate form, outstanding Options shall be assumed by the
successor corporation in accordance with the principles set forth in Section
14.03.
ARTICLE XV
Effectiveness of the Plan
The Plan shall become effective upon approval by the affirmative vote of a
majority of the Members of the Company entitled to vote thereon.
ARTICLE XVI
Government and Other Regulations
The obligation of the Company with respect to Awards shall be subject to all
applicable laws, rules and regulations and such approvals by any governmental
agencies as may be required, including, without limitation, the effectiveness of
any registration statement required under the Securities Act of 1933, and the
rules and regulations of any applicable securities exchange.
12
<PAGE>
ARTICLE XVII
Withholding
The Company's obligation to deliver Units in respect of any Award under the Plan
shall be subject to applicable federal, state and local tax withholding
requirements. Federal, state and local withholding taxes paid upon the exercise
of any Option may be paid in Units upon such terms and conditions as the Board
shall determine; provided, however, that the Board in its sole discretion may
disapprove such payment and require that such taxes be paid in cash.
ARTICLE XVIII
Separability
If any of the terms or provisions of this Plan conflict with the requirements of
applicable law or applicable rules and regulations thereunder, including the
applicable requirements, if any, of Section 162(m) of the Code or Rule 16b-3
under the Exchange Act, then such terms or provisions shall be deemed
inoperative to the extent necessary to avoid the conflict with applicable law,
or applicable rules and regulations, without invalidating the remaining
provisions hereof.
ARTICLE XIX
Non-Exclusivity of the Plan
Neither the adoption of the Plan by the Board nor the submission of the Plan to
the Members of the Company for approval shall be construed as creating any
limitations on the power of the Board to adopt such other incentive arrangements
as it may deem desirable, including, without limitation, the granting of stock
options and the awarding of stock and cash otherwise than under the Plan, and
such arrangements may be either generally applicable or applicable only in
specific cases.
ARTICLE XX
Exclusion from Pension and Profit-Sharing Computation
By acceptance of an Award, each Holder shall be deemed to have agreed that such
Award is special incentive compensation that will not be taken into account, in
any manner, as salary, compensation or bonus in determining the amount of any
payment under any pension, retirement or other employee benefit plan of the
Company or any of its Subsidiaries. In addition, each beneficiary of a deceased
Holder shall be deemed to have agreed that such Award will not affect the amount
of any life insurance coverage, if any, provided by the Company or any of its
Subsidiaries on the life of the Holder which is payable to such beneficiary
under any life insurance plan covering employees of the Company or any of its
Subsidiaries.
13
<PAGE>
ARTICLE XXI
Beneficiaries
Each Holder may designate any person(s) or legal entity(ies), including his or
her estate, as his or her beneficiary under the Plan. Such designation shall be
made in writing on a form filed with the Secretary of the Company or his or her
designee and may be revoked or changed by such Holder at any time by filing
written notice of such revocation or change with the Secretary of the Company or
his or her designee. If no person shall be designated by a Holder as his or her
beneficiary or if no person designated as a beneficiary survives such Holder,
the Holder's beneficiary shall be his or her estate.
ARTICLE XXII
Governing Law
The Plan shall be governed by, and construed in accordance with, the laws of the
State of New York.
14
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